5 Steps to Optimize Inventory and Sales Service (Delivery) Levels

Posted on: April 13, 2012 | By: SuperUser Account | Microsoft Dynamics AX/365

This is the third of a 3 part series on 1) Increasing Inventory Turns, 2) Reducing Inventory and 3) Improving Service Levels.

In today’s competitive environment, companies want to place the customer #1. Part of placing the customer #1 means providing sales service excellence – fulfilling a customer order within the customer’s desired lead time. The degree to how quickly you plan to fill a customer order can have a major impact on inventory investment, working capital, and carrying costs. Therefore, it is critical that a company balance the level to which the customer is served against the investment required to meet that commitment. Fortunately, there are statistical models available that provide a quantitative basis for this decision. The inputs to these models are discussed below, but it is important to note that these methods should not replace open dialogue with your customers to determine their actual lead time needs and projected demands.

We recommend the following 5 steps to determine the appropriate service level targets for your company:

1) Collect and understand historical demand for your products.
2) Determine inventory cost for several service levels
3) Determine indirect inventory holding costs
4) Determine costs related to missed orders (stock outs, back orders)
5) Select the sales service level that balances the inventory and related cost with the cost of not filling an order.

1) Collect and understand historical demand for your products.
The first step in performing this analysis is to collect data on your products. Though there are many possible ways to organize this data, we have found collecting product unit sales by week for the past year is a good place to start. You’ll also want unit sale price and cost as these will allow you to project inventory investment, turns, and carrying costs.

2) Determine inventory cost for several service levels.
Using this “raw” data, you can calculate the average demand, annual demand and standard deviation. You can then use a standard service level table to determine the service level factor needed to achieve a certain service level percentage.

The service level factor multiplied by the standard deviation gets you to a safety stock. You can then calculate your order cycle, lead time, lead time demand and order point.

Using this information, you can calculate the cost of inventory and then the carrying cost of the inventory using your cost of capital.

3) Determine indirect inventory holding costs
You should also identify and quantify your indirect inventory costs. You will want to factor these in once your equation generates a given service level to see how it might be modified.

4) Determine costs related to missed orders (stock outs, back orders)
So let’s say you have determined that at a 98% service level, your cost is X. Now, what does that 2% cost you? Is it merely a delay in the order or did your customer go try out the competition? Did you violate a service level agreement? Did you lose an entire order because of this item?

5) Select the sales service level that balances the inventory and related cost with the cost of not filling an order.
Often times, you can work with your customers to agree upon a service level and then show them how you are ensuring the level. You can agree to specific penalties for back orders/stock outs and review the parameters and results periodically. These types of agreements can often reduce your overall inventory investment and maintain high customer satisfaction.

Most ERP systems allow you to enter the above parameters by product in the item master. They also perform most if not all of the above calculations.

For additional information please feel free to reach out to us at info@loganconsulting.com or (312) 345-8817.

All the best!

Logan Consulting
www.loganconsulting.com

© Copyright 2012 L.G. Consulting Inc.



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