Example safety stock calculation for Kwikjet printers

GreaBuy sells an average of 50 Kwikjet printers a day, that is, an average of 700
Kwikjets every two weeks. It takes two weeks for Zags to ship an order of Kwikjets to
GreatBuy, so the “Demand during lead time” of Kwikjets is 700 units.

In an ideal world, the demand for Kwikjets would always be exactly 50 units per day
(700 units every two weeks), and the shipments of Kwikjets from Zags would always
arrive in exactly two weeks. In this case, GreatBuy would never need to order anything
more than exactly 700 Kwikjets every 2 weeks without ever running out of stock.

However, in actual practice, the demand for Kwikjets is never exactly 50 Kwikjets per
day. Sometimes it’s higher and at other times it’s lower. Also, Zags doesn’t always take
exactly 2 weeks to fill a Kwikjet order from GreatBuy. Sometimes, the Kwikjets arrive in
less than 2 weeks, but there have been cases where Zags took 4 weeks to deliver an
order. So GreatBuy needs to maintain a safety stock of Kwikjets to avoid running out of
stock when the demand is higher or when Zags takes longer to deliver an order.

The key question is, how much safety stock should GreatBuy hold? Historical data
shows that the maximum demand for Kwikjets that GreatBuy has ever had is 80 units/
day, and the maximum time Zags has ever taken to deliver an order is 28 days.

So if they order 700 Kwikjets based on the average demand of 50 units/day and the
average lead time of 14 days, they must hold a safety stock of

80*28 – 50*14 = 1540 Kwikjets.

Keeping a safety stock of 1540 Kwikjets will avoid a stock-out 100% of the time, giving
GreatBuy a 100% Service level.

However, holding such a large safety stock is very risky, since the Kwikjets can get
damaged or become obsolete. Also the historical data shows that this combination of
maximum demand and maximum lead time happens very rarely – usually only once a
year or less. Digging deeper into the historical data, we find that the maximum demand
is 55 units/ day or less 95% of the time, and the maximum lead time is 16 days or less
95% of the time. So to avoid running out of stock 95% of the time, that is, to have a
95%Servicelevel, GreatBuy would need to hold a safety stock of
55*16 – 50*14 = 180 Kwikjets

This sounds like a good deal, since by taking the relatively small risk of running out of
stock 5% of the time, GreatBuy is able to reduce its safety stock from 1540 to only 180
Kwikjets, greatly reducing the risk of being stuck with damaged or obsolete inventory.

In general, it has been observed across many industries that demand tends to be close
to the average most of the time, with large deviations from the average being very rare.
So it usually makes sense to risk running out of stock a small percentage of the time. It
greatly reduces the amount of safety stock needed.