Navigating Demand and Lead Time Variability: Can We Truly Eliminate Safety Stock?

A senior supply chain leader recently posed an intriguing question: “If demand variability and lead time variability are zero, can we manage a retail store with only replenishment orders and maintain zero safety stock?” This question, while seemingly straightforward, opens up a complex discussion about the intricacies of supply chain dynamics. Let’s delve deeper into this scenario with a technical lens.

Safety Stock Formula

To quantify the dependency of safety stock on demand and lead time variability, we use the following formula:

Safety Stock= z× SQRT ((average daily demand)^2×(standard deviation in lead time)^2+((total lead time / time increment used for calculating standard deviation of demand))×(standard deviation in demand) ^ 2)        

Where:

• ( z ) is the z-score corresponding to the desired service level.
• Average daily demand is the mean number of units sold per day.
• Standard deviation in lead time measures the variability in the time taken for replenishment orders to arrive.
• Standard deviation in demand measures the variability in daily demand.

This formula highlights how both demand and lead time variability contribute to the required safety stock. Even with zero variability in one factor, the other can still necessitate maintaining safety stock.

Understanding Demand Variability

Demand variability refers to the fluctuations in customer demand over a specific period. To address the question, we must first consider the time granularity at which demand variability is measured.

• Monthly Demand Variability: Assuming zero variability at a monthly level implies that the total demand for each month is consistent. However, this does not account for daily or weekly fluctuations. For instance, a retail chain store might experience higher demand on weekends compared to weekdays. If replenishment orders are placed monthly, the store must have sufficient storage capacity to handle peak daily demands, which is often impractical.
• Daily and Weekly Demand Variability: Even with zero monthly variability, daily or weekly demand can vary significantly. For example, a store might sell 100 units of a product on weekends but only 20 units on weekdays. Without accounting for these fluctuations, the store risks stockouts or overstocking, both of which are costly.

Lead Time Variability

Lead time variability refers to the fluctuations in the time taken for replenishment orders to arrive. While it is ideal to assume zero lead time variability, real-world scenarios often differ.

• Stable Distribution Networks: Even in highly stable networks, factors such as traffic congestion, supplier delays, and natural disasters can introduce variability. For example, a sudden snowstorm could delay deliveries, disrupting the store’s inventory levels.
• Buffer Against Disruptions: To mitigate these risks, safety stock acts as a buffer. Without it, any delay in replenishment can lead to stockouts, affecting customer satisfaction and sales.

Practical Considerations

Given these complexities, the answer to whether zero safety stock is feasible hinges on several practical considerations:

• Storage Capacity: Can the store accommodate the entire monthly demand in a single replenishment? If not, more frequent orders are necessary, increasing the need for safety stock to buffer against daily and weekly demand variability.
• Demand Sensing: Advanced forecasting techniques, such as machine learning algorithms, can help predict demand more accurately at finer granularities, reducing the need for high safety stock levels. However, perfect forecasting is rarely achievable.
• Supply Chain Resilience: Building a resilient supply chain that can quickly adapt to disruptions is crucial. This includes having multiple suppliers, flexible transportation options, and robust contingency plans.
• Infrastructure Investment: Managing lead time variability often requires significant investment in infrastructure capabilities, such as additional warehouses and transport fleets. These investments help ensure that the supply chain can handle variability and maintain service levels without excessive safety stock.
• Type of Goods: In some cases for example where goods are very expensive and holding cost for safety stock is too high then it might be worth to invest in costly and more reliable mode of trasportations like air freight to cover the peak demands. In such cases, cost of shipping should be insignificant as compared to the cost of holding the goods in warehouse.

Conclusion

While theoretically possible, managing with only replenishment orders and zero safety stock requires an ideal scenario with perfect demand and lead time predictability. In reality, the dynamic nature of supply chains necessitates maintaining some level of safety stock to buffer against uncertainties. By leveraging advanced forecasting techniques, investing in infrastructure, and building resilient supply chains, businesses can optimize their inventory levels, balancing cost and service levels effectively.

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