Category Archives: Inventory

EOQ Part I: The Quantity You Can’t Depend On The Computer to Calculate!

I was reminded of this while reading Mr. Koray Köse’s great piece on how our supply chains are literally drowning in wannabes who mistake theory for expertise where he accurately and astutely noted that most of today’s so called “experts” could not pass his Economic Order Quantity (EOQ) exam question. And I totally agree. Because

1) Math (where competency in many Western nations decreases every year and where the US is literally becoming math stupid, as reflected in the latest OECD ranking which puts it 25 out of 31 “developed” countries that were globally measured with countries like Croatia coming in ahead of it).

2) No real understanding of supply chain or total supply chain cost!

3) Even less understanding that your EOQ (Economic Order Quantity) is not your suppliers EPQ (Economic Production Quantity) and for high cost/complex products, this can sometimes (but not always) be much more important (and impactful) than the classic EOQ formula would dictate.

Mr. Köse illustrates this deftly when he shared one of the questions he uses to gauge whether or not his MBA students truly understand EOQ. The core variant of the problem he shared with us was this:

  1. The purchasing manager for Spacely Sprockets orders mechanical gears from an industrial supplies distributor, Cogswell Cogs.
  2. Spacely Sprockets uses 5,000 gears per year.
  3. Annual inventory carrying costs are 20% and order costs are 3,400 per order.
  4. The following order discount price schedule is provided by Cogswell.
    • 0,200-0,999 $1300 / unit
    • 1,000-2,999 $1250 / unit
    • 3,000-4,999 $1200 / unit
    • 5,000+      $1175 / unit
    

    5. 

  5. Determine the optimal order quantity, total cost, and actual per unit cost (once order costs and inventory carrying costs are taken into account).
    6. 



Now, if you were a prepared student, you might have memorized the classic EOQ formula:


    

  • EOQ = √ ( (2 x ACPO x AUU) / (UC x CCP) )
    • 



where


    

  • ACPO = Acquisition Cost Per Order = 3,400
    • 

  • AUU = Annual Usage in Units = 5,000
    • 

  • UC = Unit Cost
    • 

  • CCP = Carrying Cost Percentage = 0.20
    • 



and this leaves you with


    

  • EOQ = √ ( 34,000,000 / (0.2 * UC) )
    • 



and you can work this out at each price break:


    

  • 1,300: √ ( 34,000,000 / 260 ) = √ (130,769) = 362
    • 

  • 1,250: √ ( 34,000,000 / 250 ) = √ (136,000) = 369
    • 

  • 1,200: √ ( 34,000,000 / 240 ) = √ (141,666) = 376
    • 

  • 1,175: √ ( 34,000,000 / 235 ) = √ (144,680) = 380
    • 



which indicates the first price bracket is the correct one for you, and you should be making 13.8, rounded to 14, orders every 26 days (and net a total volume of 5,068 units over the year) and, on average, you will carry each unit of inventory for 13 days.


    

  • unit cost: 5,068 * 1,300 = 6,588,400
    • 

  • inventory carrying cost: 13/365 * 0.2 * 6,588,400 = 46,931
    • 

  • order cost: 3,400 * 14 = 47,600
    • 

  • total cost: 6,682,931
    • 

  • unit cost: 1,319
    • 



But this is NOT an EPQ for the supplier, which means that you might be paying more than you need to. To figure that out, you have to analyze the costs at each breakpoint that is reasonable for you.


These are:


    

  • 362, your computed EOQ, with 14 orders per year
    • 

  • 1014, the first discount tier, at 5 orders per year every 73 days, with 36.5 days of inventory on average
    • 

  • 5,068, at the third discount tier, at 1 order per year every 365 days, with 183 days of inventory on average
    • 

  • … because you can’t hit the 2nd tier more than once
    • 



First run the calculation at 5,068, because your greedy executives only understand unit discounts:


    

  • unit cost: 5,068 * 1,175 = 5,954,900
    • 

  • inventory carrying cost: 183/365 * 0.2 * 5,954,900 = 595,490
    • 

  • order cost: 3,400 * 1 = 3,400
    • 

  • total cost: 6,553,790
    • 

  • unit cost: 1,293
    • 



You quickly see that you clearly want the discounts even if your inventory costs shoot up because 633.5K in savings is greater than 595.5K in expected inventory carrying costs.


But you’re not done yet. Now you have to run the calculation at 1,014 units an order over 5 orders, because it’s also a valid option and captures the suppliers first EPQ point:


    

  • unit cost: 5,068 * 1,250 = 6,335,000
    • 

  • inventory carrying cost: 36.5/365 * 0.2 * 6,335,000 = 126,700
    • 

  • order cost: 3,400 * 5 = 17,000
    • 

  • total cost: 6,478,700
    • 

  • unit cost: 1,278
    • 



which is your actual EOQ because it not only takes advantage of the supplier’s EPQ level but does so at the breakpoint that is closest to that given by your traditional EOQ calculation!


Now we’ve now clearly demonstrated why most of today’s so called experts couldn’t calculate EOQ with a computer because it’s not always the classic EOQ formula (or whatever pseudo-random formula happens to be in the forecasting system they try to use), or the supplier’s optimal EPQ level (if that leads to a significantly high storage cost for you — JIT is a core tenet of lean for a reason, inventory is costly, and while you need a safety stock, too much not only presents too much obsolescence risk but shoots your carrying costs way up), but usually somewhere in between (where the optimal curves intersect closest to their respective minima). Good luck doing that if you can’t do math, don’t know supply chain, and think Chat-GPT holds the answer to everything.


What we didn’t demonstrate is why, in reality, you often need a computer to calculate it (and that comes down to the inventory carrying costs which are often much more involved than Finance believes) and your associated supply chain costs. The reality is that you might have to re-write your formulas, which really will require a computer to constantly calculate and recalculate your true inventory carrying costs, but the reality is that you will only be able do this AFTER you understand what the proper order volumes should be (because you need to check that you worked out the formulas and calculations right for your supply chain)! We might tackle this in another article, because the only way to get costs way down is to help Finance and Operations understand the true costs and how to tackle them (because if you’re still running on an average ICC of 20%, or even worse, 25% to 30%, someone, somewhere, is performing pretty poorly in their profession).

					

		
		
	


	

				

			
						

				Materials Requirement Planning DOES NOT Optimize Materials Replenishment.  GenLots!
			

								


				

			
If you engage in direct manufacturing, chances are you have a semi-modern Enterprise Resource Planning solution (or at least a precursor Material Requirements Planning Solution) augmented by a semi-modern Supply Chain Planning solution designed to optimize your forecasts, inventory levels, and production. Chances are also good that based on forecasts (which are at least calculated down to weekly, if not daily, intervals), inventory levels (which are updated based on weekly or daily utilization by production), desired safety stock levels, and safety buffers on lead times, you have auto-replenishment set-up and the ERP will automatically generate re-orders based on lead times, safety stock alerts, or manual forecast alterations.


Chances are even greater that your demand planners will believe these are good and automatically approve them without further thought because the material requirements plan was optimized against the forecast and all available data.


NOTHING COULD BE FURTHER FROM THE TRUTH!


An optimal plan for production is NOT an optimal plan for purchase. Production requires having the right inventory on hand when you need it for the levels you need to support, balancing inventory against stock-out and obsolescence/expiration risk. Purchasing requires buying at the right volumes to take advantage of economies of scale (and tier discounts) and using the right distribution options to optimal capacity, balancing an economic order quantity (that minimizes total landed cost at a minimum) against inventory holding costs and risks of obsolescence/expiration. Your SCP enhanced ERP/MRP does the first. NOT the second. (There may be dozens of SCP systems out there, but since NONE of them support sourcing or procurement, NONE of them have the other half of the data that they would need to do this.)


And for mid-size manufacturers, this is costing them MILLIONS of dollars a year. And for large enterprise manufacturers, tens of millions of dollars a year. (In fact, the average loss from failing to optimize replenishment is 10% of inventory! This means that for every 100 Million of inventory maintained in a large enterprise, 10M is being lost. TEN MILLION.)


This is why GenLots exists — to optimize replenishment and minimize overall material lifecycle costs while maintaining (and, if possible, increasing) service levels and reducing overall working capital needs. In fact, this is so important, that this is all GenLots does (because no one else does it — which is partially the case because none of these SCP solutions do Direct Sourcing or even Direct Procurement properly, as per an ongoing Sourcing Innovation series being co-developed with Supply Chain Matters).


There are three main parts to the GenLots solution:


    

  • Order AI: the core optimization engine that can be directly integrated with your ERP (and is currently directly connected to SAP as a SAP Partner on the SAP store) that automatically pulls (and deletes) all the auto-generated replenishment orders from the ERP and replaces them with MR-optimized orders
    • 

  • Order UI: the UI that allows the purchasing manager to see all of the orders generated, what the original order was, and what savings and service level increases resulted from the modified order
    • 

  • Policy Advisor: the optimization-enhanced simulation engine that advises the organization on how to set their safety stocks, lead time buffers, MOQs, preferred discount tiers (for suppliers to bid against), default re-order windows, etc.
    • 



Order AI


Built on solid decision optimization and machine learning algorithms, the Order AI automatically retrieves every generated purchase order for a raw material in the ERP and calculates the right order quantity (and order date) based upon the raw material cost model (including the logistics costs using the proper mode of transport and default mode capacity), lot constraints (due to supplier or carrier capacity), scheduling requirements (based on delivery windows and processing time), safety settings (stock levels and lead time buffers), expiry windows (for perishable or decomposable stock), and, if desired, CO2 emissions (based on the available distribution options).


Order UI


This allows you to examine the orders created by GenLots and not only see the differences in order quantity and order/ship date, but the overall impacts on cost, overhead, working capital, and service level. For each material, it will break down the difference between the original supply chain cost with the system generated orders and the current supply chain cost with the GenLots orders by computing the order savings (processing and logistics costs), inventory (overhead) savings, and waste/scrap/obsolescence savings. And while the average is 10%, they have seen savings of 50% or more due to high shipment costs from too many shipments (with trucks going half full) on low value inventory, and from high waste costs (from manufacturers that pushed the safety stock and safety buffers too high and ended up wasting a lot of materials in F&B and Pharma manufacturing where shelf life of some products is very limited). It will also indicate the (estimated) service level achieved with its plan.


Policy Advisor


Optimal buys require not just optimal plans (because if that were enough, then maybe the SCP solutions wouldn’t be doing such a dismal job and costing you 10 Million on every 100 Million that flows through your warehouses), but also optimal parameters. The Policy advisor can be used to run multiple simulations to determine, for each material (based upon the production forecasts it is tied to), the appropriate safety settings (to optimize inventory levels against required service levels, warehouse capacities and carrying costs, and risk of waste), stock levels, lot sizes (and price tiers to request from suppliers), and service levels for the organization, which can lead to even greater cost savings in material replenishment when appropriately defined. (Remember, the optimization works within parameters you restrict it to, so if you restrict it to bad bounds, it won’t be able to save you nearly as much as you could save.)


Expert Support


Even though it’s available on the SAP Store, this is one solution where you should go direct (to GenLots). GenLots preferred methodology, even if the integration is literally plug-and-play for you as a SAP client (who has invested the effort to clean up their forecasting and ERP-based re-order and approval processes and ensure that clean, valid data is always available down to at least weekly intervals) is to work with its clients for the first six to twelve weeks (depending on organizational size), make sure everything runs smooth, and help its clients define the optimal (starting) policy to maximize the value and success of the GenLots solution. This is because they not only want you to see results, but see the full extent of results possible. When it comes to material replenishment, the reality is that just because you identify a few million in savings, that doesn’t mean the solution is working well. If your inventory value over a year exceeds 100 Million, it’s likely that you have a ten million dollar savings opportunity and they want to do everything in their power to maximize your chances of seeing that.


(And if, at the end of the day, with their expert guidance you only see a few million in savings, you can pat yourself on the back for being best in class in forecasting, re-order windows, and optimizing inventory policies, because you’d have to be to not see a massive savings in your first year. [Odds of this happening are less than 1/5 though if you are going through over 100M in inventory a year.] It’s no different than applying strategic sourcing decision optimization across your major categories — no matter how good you thought you were doing, studies showed time and time again an average savings of over 10% because you just couldn’t model all of the variables and compute all of the trade-offs [while adhering to all the constraints] through simple spreadsheet calculations.)


Proven Solution


GenLots may not be a name that you know in North America, but it’s one you should. Founded in 2017, the solution has been under consistent development for eight years, in daily production for six years, and is currently being used by 100 Billion-Plus companies to optimize their replenishment schedules, reduce inventory up to 20%, deliveries up to 50%, and save up to 10 Million for every 100 Million of inventory processed. It’s the best kept secret that needs to be exposed because you’re losing millions, your SCP and ERP providers will never admit otherwise, and you can stem the bleeding with a software license that starts at only 5 figures a year!

					

		
		
	


	

				

			
						

				MeRLIN Sourcing, A Platform With a Twist …
			

								


				

			
INTRODUCTION


When their founders were young men

they paced the fact’ry floors

from Vellore down to Chennai

they must have walked ’em all

cause they learned all of the problems

that plagued the Procurement side.

Those listen, look, and learn guys

sure made a lean platform.




The founders of MeRLIN, who started Rheinbrucke Consulting in 2013, started developing a stand-alone application for direct source-to-contract (and, for those who need it, source-to-pay) in 2018 using their decades of experience supporting direct manufacturing clients. MeRLIN was then frst released it to the market in 2022, after ensuring it actually solved the problems they were seeing and met the needs of the companies they were working with.


(While some companies might take it as a badge of honour to get a “minimally viable product” to market in a year, the reality is that when it comes to manufacturing enterprises, nothing you can develop in a year will actually solve more than a fraction of their problems, and unless what you deliver can integrate tightly into their existing enterprise software landscape, it won’t be adopted, or even bought. That’s why there are so many offerings in indirect [many of whom will succumb to the marketplace madness] and so few that offer true direct sourcing solutions, and fewer still that offer fully integrated source-to-contract / source-to-pay suites.)


PLATFORM SUMMARY


MeRLIN, which bills itself as a Source-to-Contract platform for Direct Material (primarily Discrete Manufacturing) Sourcing, is actually a Source-to-Pay platform where the Procure-to-Pay platform capabilities are baseline (and wouldn’t go head-to-head with best-in-class) and designed for the mid-market (and large enterprise) clients that don’t have a Procurement solution in place already (either through the ERP, AP, or a third party system). Since most larger enterprises have some form of decent P2P, MeRLIN decided to focus primarily on the critically underserved strategic sourcing marketplace in discrete manufacturing and direct sourcing and the capabilities all of the companies the founders worked with in manufacturing were universally missing.


MeRLIN was designed as a modular solution where


    

  • a client could license just the modules they wanted/needed,
    • 

  • common modules, and capabilities, were broken out into their own modules so their was no duplication of functionality, and
    • 

  • key modules could be augmented with additional value-added functionality not typically found in average products.
    • 



MeRLIN has all the standard modules you’d expect in a Source-to-Contract:


    

  • (Program &) BoM Management (Requirement for any Direct Solution)
    • 

  • Requisition Management (Intake)
    • 

  • Sourcing (Event) Management (Sourcing)
    • 

  • Supplier Management (SXM)
    • 

  • Contract Management & Contract Authoring (CLM)
    • 

  • Reports & Dashboard (Reporting & Analytics)
    • 



As well as basics for Procure-to-Pay:


    

  • Purchase Order Management
    • 

  • Invoice & Payment Management
    • 



But also has modules for:


    

  • Demand Management (Consolidation of Requirements from Requisitions, Manufacturing Programs, and MRPs)
    • 

  • Category Management (Part/BoM grouping & management)
    • 

  • Supply Chain Compliance (GSCA / LkSG)
    • 

  • Supply Management (Document & Shipment Management)
    • 



and the standard suite foundational modules of:


    

  • Master Data Management
    • 

  • Business Administration
    • 

  • Security Management
    • 

  • System Management
    • 



And even modules for:


    

  • Strategic Project Management (Project Management/Orchestration)
    • 

  • Finance Management (Budgets, Prices)
    • 



We’re not going to discuss all the modules and instead focus in on just the core Source-to-Contract modules, as they are the modules that are critical to direct sourcing and the modules that will allow you to understand the value, and potential, MeRLIN has for you.


Supplier Management


Supplier Management is designed to onboard, evaluate, approve, and manage suppliers, including their contacts, surveys, ratings, and documents. Qualification starts with a simple request based on supplier name, country, email, and unique (DUNS) identifier. Based on the supplier category, the next step will be to send the suppliers the qualification surveys and pull in the external risk information, send it to technical and risk reviewers, and if that passes, it will go off to compliance to ensure the supplier can comply with all necessary regulations the company is subject to and then, if that passes, the supplier will get a registration invite to provide all of the additional information necessary to do business with the company as well as details on additional products and services.


Supplier Management captures all of the core company information, locations, accounts, questionnaires, risk information and scores, compliance reviews, scorecards, and approvals. For each of these there are standard fields, and as many additional fields can be added by the customer organization as needed.


Compliance Management


Collects and manages the organizational policies, supplier policy statements, compliance surveys, audits, risks, scorecards, and complaints. It can accept all documents, support custom surveys, import third party data from financial and environmental (and other) risk providers, provide you with compliance scorecards, and automatically extract and centralize all “risks” from the surveys based on scores and/or responses in a risk management view.


Moreover, in full compliance with the German Supply Chain Act (GSCA, known as the LkSG within Germany), MeRLIN provides the buying organization, each of their suppliers, and their entire employee base, a unique portal where they can register complaints. They have upgraded their platform to fully support the GSCA and can also support other supply chain acts as well (and future releases will encode more out-of-the-box support, even though it can already be custom figured on a client-by-client basis to support the majority of acts out there).


Requisition


Requisitions can be used as traditional requisitions for purchase orders against existing contracts for goods and services normally used by the company or as intake requests for sourcing. When they are used as intake requests, they go to a central management screen where the buyer can group them by material, bill of material, and/or category to identify sourcing event requirements and then create a sourcing event off of a bundle of them.


Sourcing


Sourcing is primarily RFX based, but auctions are supported as well off of base RFQs. A sourcing event can be kicked off from one or more requisitions, a category, a BoM, or an event template, which can consist of one or more RFIs, questionnaires, and line-items with custom price breakdowns in the RFQ. Associated with the RFQ can be the suppliers, addendums, budgets, stakeholders, terms and conditions, contract template, event schedule, and ongoing Q&A.


In addition to being able to review bids by total cost per unit and evaluation score (by the relevant stakeholders), the application also supports automatic award recommendation by criteria which can include target award by supplier, range of suppliers to split the award between, minimum and maximum shares, and preferred supplier status.


Contract “Authoring” & Management


The platform is primarily “signature” and “execution” management, as authoring is simply the packing up of contract templates, terms and conditions, specifications, and associated addendums for agreement by electronic signature. The electronic signature capability is compliant with USA regulations and most European regulations for private enterprise contracts. Once the contract is signed, the platform can manage the project timeline, stakeholders, documents, events, milestones, and obligations. In addition, the user can define alerts against any event, milestone, document, obligation or other entity on status change or due date.


Reporting & Dashboards


Reporting and Analysis in MeRLIN is through widget-based dashboards that summarize any data of interest in the system. Right now there are hundreds to select from in the reporting library, with more being added as needed. For each of the built in reports and dashboards (on suppliers, spend, process, etc.), the user can apply multiple filter options and save the configuration to their liking. There is no Do-It-Yourself (DiY) widget report builder yet, but more DiY analytics enhancement is on the roadmap.


Strategic Project Management


This is MeRLIN‘s built in project management capability where a user can define and instantiate RFX templates, supplier onboarding workflows, contracting processes from award specifications, procurement processes, and even entire Source-to-Procure projects which collect all of the necessary templates and workflows together. In addition, leadership is provided with a high level overview of sourcing projects.


Master Data Management


All of the system master data templates can be altered by the user including, but not limited to, currencies and conversions, items, locations, plants, prices, suppliers, contract metadata and milestones, and other key items. The customer can control it’s master data and master data identifiers.


Business Administration


All of the templates in the system can be managed and customized in the business administration section including, but not limited to supplier onboarding, qualification, evaluation, and audit questionnaires, product and item templates, requisitions, RFQs, purchase orders, contract terms, contracts, statements of work, email, and workflow templates.


Bill of Materials Manager


A key aspect of Direct Sourcing is managing the Bill of Materials. In the Merlin platform, that can be done through the BOM Manager, which unlike basic direct sourcing platforms, can maintain as many versions of a Bill Of Materials as the organization wants to maintain (for correlation with historical sourcing and procurement and cost estimates during new product design and/or product modification).


These versions can be uploaded from the ERP (or your PLM of choice with custom integration) or created in the BOM Manager, and this creation can be from scratch or from a previous BoM version which can be copied and modified as needed.


The best part of MeRLIN‘s BOM manager is its built-in ability to allow for easy should-cost analysis during NPD and BOM (re)design. Once a BOM has been uploaded or created, the user can click a button to “cost” and it will automatically find prices for every component in the BOM for which it has a price from a contract (first), catalog/commitment (second), or quote (third). Then, the user can push the remaining items to the Demand Management module for quick quote (or import into the internal catalog from a connected source) or simply create a place holder item (with an estimated cost). They can then return to the BOM Manager and re”cost” the BOM to get a complete cost estimate, which can be compared against the cost of all prior BoM versions (that were costed). This allows the organization to understand the costs associated with BOM changes over time (independent of supplier or distributor pricing changes). Gone are the days where you have to use a completely separate application to do BOM cost estimation.


Finally, the next update to the BOM Manager will allow for the user to enter a cost estimate directly in the BOM manager for materials/parts not yet quoted for even quicker price estimates, and those estimates will be clearly marked as internal estimates only.


Other Capabilities


We’re not going to discuss the procurement modules as they are not MeRLIN‘s focus (but we will assure you that they cover the foundations if you don’t have P2P and need it), demand management as you know what forecasting should do, category management (and category strategy management) as that is rather self explanatory, or finance management, as budget and price management is also straight forward.


The Full Picture


The platform is quite deep in all core areas and one could write pages about each module and its deep capabilities, but hopefully this is enough to convey the facts that


    

  • the MeRLIN platform was designed from the ground up to support direct and discrete sourcing,
    • 

  • has the capability to support these projects from inception to contract signing through the very last order against the award, and
    • 

  • goes beyond just raw sourcing capability to related capabilities of supplier risk, compliance, and execution (tracking the order to the delivery and qualification)
    • 



CONCLUSION


Given the relative lack of true direct and discrete sourcing platforms in the mid-market, MeRLIN is a platform you should definitely be aware of. If you’re in direct manufacturing, automotive, aerospace, and related industries, you might want to check them out today.




It’s for discrete wizards,

it’s a platform with a twist.

A discrete wizard

needs a tech assist …



					

		
		
	


	

				

			
						

				When Managing Supply, Don’t Forget …
			

								


				

			
… sometimes supply comes from within the four (virtual) walls of your business. This is one fact that is overlooked by many S2P suites which are setup to acquire external goods and services (and, specifically, finished goods and services that typically fall into indirect categories.


When we are talking about MRO, the goods and services you need might be in a storage room in another building. If we are talking about consumables, like what you might need for a new hire, everything you need might be one floor down, left behind by another hire who, after the probation period, didn’t work out.


Inventory and Asset Management are key to successful Supply Management, and to successful Procurement. One should NOT buy what one does not need. This is the other form of demand management — which is two parts. The curbing of need for consumables (less paper for the printer, less usb drives when there are secure network share folders, etc.), and the re-use of what you have. Laptops or cell phones less than 6 months old should never go unused or reassigned. Expensive MRO replacement parts can often be couriered from site to site for $40 — why spend $5000 ordering another 4-pack to fix the production line and have your minimum “3” on hand when another facility still has 8 in storage.


When you are upgrading your e-Pro / P2P / S2P system, keep this in mind. Either find one that includes inventory management or integrates with an inventory management system, and you’ll save a lot.


But to truly win, make sure it supports end-to-end asset management. It’s not just expensive hardware that often collects dust in storage closets, is also expensive assets. Like expensive snowblowers that are bought, put in the basement, forgot about when the business gets a new, better, facilities contractor and the internal maintenance team doesn’t have to do it anymore instead of being sold or sent to another facility. Expensive 3-D software licenses that are not transferred to another engineer, and then bought again 6 months later when a new hire needs them. Patent or other IP library that could be licensed by sales to a partner for extra revenue. Etc. This last part is key. Not only are unused assets costing the company money (because thy were bought to fulfill a need, which is not being met by them, but costing the company money if they can be licensed, rented, or, in the case their value becomes limited, sold.


So when you are upgrading your e-Pro / P2P / S2P system, keep this in mind too. Make sure it’s inventory and asset management or integrates with an inventory and asset management, and you will not only save a lot, but help the organization generate value.

					

		
		
	


	

				

			
						

				What’s the right level of safety stock?
			

								


				

			
Severe weather events and transportation disrupting natural disasters are on the rise, and the only thing that we can be sure of is they are going to keep coming fast and furious in the near future. We don’t know when, where, or what extent the impact will have, but we know it’s coming.


The resulting disruptions to your supply chain will last days, weeks, or months. And if the part of your supply chain that is disrupted is one supplying a critical component that is sole-sourced or in a supply shortage, any and all products it is used in will be in jeopardy once the inventory runs out. As a result, JiT inventory is becoming a thing of the past. However, too much inventory on hand is NOT a good thing. You want a balance between JiT and everything you need for the planned production run. And that balance could be anywhere from a few extra days (for inventory that can be obtained from another source on short notice) to a a few months (for something otherwise hard to get).


But how do you figure out the right stock levels? It’s not just rarity. After all, stock costs money and ties up working capital … capital that likely has better uses. After all, early supplier payments can bring cost reductions. Investments can bring recurring cast. R&D can develop new, more profitable, products for sale. And so on.


So how do you determine the right level of safety stock? Expand the working capital optimization model to allow for a variable disruption cost based upon variable stock levels, each of which has an associated investment cost (in the form of tied up working capital), and determine the stock levels from the investment that optimizes working capital.


Again, the right level of safety stock falls out of working capital optimization.