How do you evaluate the trade-offs between inventory models and service levels?

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Inventory planning is a crucial skill for any business that deals with physical goods. It involves balancing the costs and benefits of holding different amounts of inventory to meet customer demand and avoid stockouts. However, there is no one-size-fits-all inventory model that works for every situation. Different inventory models have different assumptions, parameters, and trade-offs that affect the service level, or the probability of satisfying customer orders without delay. In this article, you will learn how to evaluate the trade-offs between inventory models and service levels, and how to choose the best inventory model for your business.

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Prathamesh Mehendale (He/Him)

Global Inventory Analytics Lead at Mondelez International
Mohamed Sadek, CPIM

Demand Planning Manager MENA @ adidas | CPIM
hemant SHARMA ヅ ????

Amazon | 16x Linkedin Top Voice | Trust of 1M+ professionals & 45M+views | Actively helping Jobseekers & Recruiters…

1 Inventory models overview

Inventory models are mathematical formulas that enable you to calculate the amount of inventory needed and when to order it. These models consider factors such as demand pattern, lead time, ordering cost, holding cost, and stockout cost. The Economic Order Quantity (EOQ) model minimizes the total cost of ordering and holding inventory by finding the optimal order quantity that balances these two costs. The Reorder Point (ROP) model determines the inventory level at which a new order should be placed to avoid running out of stock; it depends on the average demand and lead time. Safety stock adds a buffer of extra inventory to the reorder point to protect against demand variability and lead time uncertainty; however, it increases holding cost. Lastly, the Periodic review model orders inventory at fixed intervals, such as weekly or monthly, rather than when the inventory level reaches a certain point; while this simplifies the ordering process, it requires more safety stock.

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Vijaydeep Pawar
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Evaluating trade-offs between inventory models and service levels involves analyzing factors like demand variability, lead times, and cost constraints. For instance, while a higher service level ensures customer satisfaction, it may result in increased holding costs. Conversely, a lower service level may reduce holding costs but risk stockouts and customer dissatisfaction. Balancing these trade-offs requires considering the impact on customer experience, operational efficiency, and financial objectives. Continuous monitoring and adjustment of inventory models based on changing market conditions help optimize service levels while managing costs effectively.

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Asif Jamil Janjua CSCP

Logistics & Warehouse Operations Manager | Supply Chain Professional | Strategic Inventory Management | Warehouse Management | Material Management Transforming Logistics Operations | Inventory Auditing & Cycle Counting.
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Inventory management is a crucial aspect of any business, as it directly impacts the service levels provided to customers. However, there are trade-offs that must be evaluated when choosing between different inventory models and service levels. Factors such as inventory costs, customer demand, and lead times must be carefully considered to strike the right balance between maintaining adequate inventory levels and meeting customer expectations. It is essential to analyze these trade-offs and make informed decisions to ensure optimal inventory management and service levels for the success of the business.

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2 Service level definition

Service level is a measure of how well you meet customer demand with your inventory. It is usually expressed as a percentage or a probability of not having a stockout, or a shortage of inventory, during a given period. For example, a service level of 95% means that you can fulfill 95% of customer orders without delay, and only 5% of orders will experience a stockout. Service level is influenced by the demand variability, the lead time variability, and the inventory model you use.

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hemant SHARMA ヅ ????

Amazon | 16x Linkedin Top Voice | Trust of 1M+ professionals & 45M+views | Actively helping Jobseekers & Recruiters #hshelpinghand | the world is full of nice people, if u cant find one. BE ONE
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Maintaining a high service level is key to customer satisfaction and loyalty. Striving for a 95% service level ensures most customer orders are met promptly, reducing the risk of stockouts. Balancing inventory with demand and lead time variability helps in achieving this goal effectively.

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3 Trade-offs between inventory models and service levels

Inventory models and service levels have a trade-off relationship: increasing the service level usually requires increasing the inventory level, which in turn increases the inventory cost. Conversely, decreasing the inventory level usually reduces the inventory cost, but also lowers the service level. Therefore, you need to evaluate the trade-offs between inventory models and service levels to find the optimal balance for your business.

To evaluate the trade-offs, you need to calculate the inventory costs and benefits of different inventory models and service levels. The inventory costs include the ordering cost, the holding cost, and the stockout cost. The ordering cost is the fixed cost of placing an order, such as administrative and transportation fees. The holding cost is the variable cost of storing and maintaining inventory, such as rent, insurance, and depreciation. The stockout cost is the opportunity cost of losing sales or customer satisfaction due to inventory shortages. The inventory benefits include the revenue and profit generated by fulfilling customer demand and increasing customer loyalty.

To compare different inventory models and service levels, you can use a spreadsheet or a software tool to simulate various scenarios and compare the total inventory costs and benefits. You can also use graphical methods, such as cost curves or service level curves, to visualize the trade-offs and find the optimal point. The optimal point is where the marginal benefit of increasing the service level equals the marginal cost of increasing the inventory level.

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Mohamed Sadek, CPIM

Demand Planning Manager MENA @ adidas | CPIM
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Increasing the service level usually requires increasing the inventory level, which in turn increases the inventory cost. Decreasing the inventory level usually reduces the inventory cost, but also lowers the service level. But with high demand forecast accuracy, high service level would be achieved with high inventory turnover with lower inventory carrying cost.

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4 How to choose the best inventory model for your business

Choosing the best inventory model for your business depends on several factors, such as your business objectives, customer expectations, demand characteristics, lead time characteristics, and cost structure. Generally speaking, if your demand is stable and predictable, and your lead time is short and consistent, you should use a simple model like EOQ or ROP to minimize inventory cost and achieve a high service level. On the other hand, if your demand is variable and uncertain, and your lead time is long and variable, you need to use a more complex model such as safety stock or periodic review to increase service level and reduce stockout risk. Additionally, forecasting techniques like moving averages or exponential smoothing can be used to estimate future demand and lead time. If customer expectations are high and the market is competitive, you may need to aim for a higher service level than competitors at an increased inventory cost. Furthermore, product differentiation, quality, and delivery speed can be used to enhance customer value proposition. Finally, if business objectives are aligned with customer expectations, a customer-oriented inventory model like fill rate or cycle service level can be used to maximize customer satisfaction and retention.

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Prathamesh Mehendale (He/Him)

Global Inventory Analytics Lead at Mondelez International
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The best inventory model helps model realistic supply chain constraints w.r.t. to how we are moving inventory within company's network especially space & transport capacity & shelf life constraints. Best model should also help you model various safety stock policy parameters as well as various service level types (OTIF or Fill rate). Best model should be hosted on IT platform which enables flexible front end views and backend reporting capabilities because business landscape keep evolving & so tools need to catch up. Also best inventory model do not recommend safety stock to cover prebuild planning this is wide spread misconception and must be calibrated that prebuild is supply problem to be solved after deciding inventory targets

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Martín Chávez Gallardo

Ayudo a propietarios de empresas y gerentes a mejorar sus procesos y optimizar sus inventarios, a través de las mejores prácticas en Supply Chain.
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Considero que un modelo de inventario debería tener: Capacidad almacenamiento y análisis datos históricos (comparativo desempe?o entre varios periodos de tiempo: -1m, -3m, -6m, -1 a?o) que permita visualizar tendencias y estacionalidades. Flexibilidad para colaborar la información (lotes, tiempo, costos, precios, variaciones, etc.), adaptable a cambios en la demanda y las condiciones del mercado. Además, debe incorporar herramientas de optimización para gestionar eficientemente los niveles de inventario, minimizando costos y maximizando la disponibilidad de productos. Es vital que el modelo sea escalable, facilitando la integración con otras áreas de la empresa y permitiendo ajustes rápidos para responder a nuevas oportunidades y desafíos.

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5 How to improve your inventory planning skills

To become a more proficient inventory planner, you should immerse yourself in the field by reading books, articles, and blogs, as well as listening to podcasts. Additionally, you can take online courses or certifications, join online communities and forums, seek feedback from experts, peers, or managers, and practice your inventory planning methods and tools on real or simulated data. Doing so will help you stay up-to-date with the latest trends and techniques in inventory planning.

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6 Here’s what else to consider

This is a space to share examples, stories, or insights that don’t fit into any of the previous sections. What else would you like to add?

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How do you evaluate the trade-offs between inventory models and service levels?

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1 Inventory models overview

2 Service level definition

3 Trade-offs between inventory models and service levels

4 How to choose the best inventory model for your business

5 How to improve your inventory planning skills

6 Here’s what else to consider

Inventory Planning

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