The Right Way to Determine a Targeted Service Level

Understand Expected Service Levels

The first step in determining the “right” inventory level is to understand the expected service level associated with that inventory. As someone responsible for inventory management it is imperative to connect the two and understand that they are correlated. Management must understand that a blanket focus on inventory reduction must go hand in hand with how that goal will effect service levels.

The Right Way to Think About Service Levels

With that being said, as we will explore below, there is a right and a wrong way to think about service levels and that by leveraging certain inventory optimization techniques companies can simultaneously raise fill rates, service levels, or on-time deliveries while lower inventories. While this goal may seem obvious, some will say that is impossible due to the fact that service levels and inventories at first glance appear to be almost perfectly negatively correlated. While it is certainly true that there is a negative correlation between the two we will demonstrate below that selecting the proper targeted service level is not intuitively obvious and that when done correctly companies can simultaneously improve service levels and reduce inventories.

The example below describes a straightforward product made up of three components. The company has developed a new device that will be connected to the Internet of Things (IoT), but the device needs to be shipped with country specific power cords and packaging. The Bill of Materials is:

The company decides an on-time delivery performance of 95% is acceptable to their down-stream supply chain. The planner assigns the following targeted service levels (TSL) to each component:

After a few months of monitoring fill rates, the company realizes they are falling short of their customer satisfaction goals. The reason is simple; while each individual component is available to ship 95% of the time, different components are not available to ship at different times. The company fill rate for the end products is:

0.95 X 0.95 X 0.95 = .8573 or 85.73%

A little math is done and the following formula is used where:

• TSL Comp = Targeted Service Level of the Components
• #BOM = Number of components in the Bill-of-Material
• TSL Product = Targeted Service Level of the Shippable Product

The company realizes to achieve to stated goal of 95.0% on-time delivery, each component needs a targeted service level of 98.304%. The planner assigns new service levels to each component as follows:

Optimize Service Levels by Part

As time goes on and the company continues to monitor fill rates they realize the customer satisfaction goals are being met, however, inventory levels are higher than hoped. Assigning the same service levels to all components assumes all component are the same. They are not. The company could have achieved their goals by setting the TSL of the inexpensive parts to essentially 100% and the expensive items to 95%. Inventory is slightly increased for the cheaper components and significantly decreased for the expensive components. The correct service levels are now assign as followed:

Lowering Inventory While Raising Service Levels

With the correct services levels in place the company can realize the dual goals of high customer on-time delivery rates and lower inventory.  These conclusions may seem obvious to some but in reality they are counter intuitive to most. Too many supply chain managers assign a high service level to the “important”, “expensive” or large volumes products and lower service levels to the cheaper, “unimportant” items. The reality is that a product is equally “unshipable” whether it is missing the component that makes up 99% of the cost or a two-cent screw.   The goal is to minimize the dollar value of a company’s inventory so it makes sense to minimize the amount of expensive components carried and make up for the lower service level by having higher service levels on less expensive components. The above illustrates the proper approach whereby targets are met and inventory is minimized.

FlowVision helped to pioneer these ideas; we offer training courses to educate companies and teams around best practices and will help organizations implement this into their operations.   Along with that we offer a software solution, ION, that automates this process, helps teams gain a much deeper understanding of areas to optimize their inventory, and gives them a platform to execute on inventory optimization strategies.