You always knew you didn’t care for items with long lead times, but you could never fully express why.
Let this Lead Time – Service Goal % Heat Graph illustrate your pain:
How to read this heat graph
Heat graphs are great storytellers and this one is speaking loud and clear. We pulled many thousands of items together from various categories and types. The data includes a typical mix of forecast levels, demand deviations and more.
The graph compares Service Level Goal % across the bottom with Lead Time Ranges on the side. The resulting blocks show the Average Safety Stock Days required. The color changes as we move from very low safety stock needs in green, to safety stocks approaching two months’ supply in red.
This picture quickly tells us that long lead times are expensive!
Long lead times inflate safety stock needs
Although your demand forecast is your foundational component, for many of you, true safety stocks were the missing link before you implemented an advanced system.
Let’s remind ourselves of the key components of Safety Stock Days:
- Service Goal %
- Demand Deviation
- Lead Time Forecast
- Lead Time Deviation
- Order Cycle
For most, your eyes naturally go to the Service Goal % and Demand Deviation as the key safety-stock drivers. However, as the lead time moves up to a few weeks or more, it can quickly become the most influential safety stock component. The heat graph above tells that story clearly.
Why is the heat so high?
Replenishing for next week is relatively easy. You already have great knowledge and stability in your inventory planning world. Replenishing for 90 days from now adds dramatic uncertainty. Not only are you forecasting for demand 90 days out, but you have to determine if demand will go as expected between now and then.
Yes, you are reading the heat graph correctly. Lead times of 1-2 weeks, combined with service goals in the low ’90s, require safety stocks of just a few days.
However, long lead times of 20, 30, 60 days or higher drive safety stock needs from days to weeks. Request a high service goal on long lead-time items, and your safety stock needs go north of 1 month and beyond! Unfortunately, that’s where many wholesalers and distributors are right now, according to a recent study:
“63% of wholesalers reported having more than 1 month of inventory on hand. Those figures are even higher among those who cited volatile demand as a challenge, with 7 in 10 reporting at least 1 month of inventory to spare. At the same time, however, 27% missed sales of more than 4%, which was an 8% increase over 2018.” Related webinar: State of Wholesale Distribution Supply Chain Report
The moral of this story is: inflating safety stock is not an effective supply chain strategy!
Who needs to know?
If you don’t know your inventory numbers, you don’t know your business. Every leader and stakeholder should understand the influence of lead time.
Merchandising, Finance and Category and Product Managers are just a few of the teams who need this information. Decisions need to be made based on Net Profit, rather than Gross Revenue. Lead times have a dramatic influence on Net Profit.
How should we react?
Long lead times drive safety stock, inventory and inventory carrying costs high. These extra costs drive profit down.
You need to consider this heat graph during the following processes:
- Item Mix: Can we afford the item in our merchandising mix? Perhaps these costs have never been considered before, but this information needs to be part of your product decisions. Some of your items might fall within that perfect storm of slow-moving, high-demand deviation, and high lead time. All of those combined might drive the safety stock and the inventory expense to a negative profit.
- Domestic vs. Import: Are your costs higher because of rising transportation costs or tariffs overseas? How much is the increased overhead stealing from your additional margin? Do the additional expenses make the domestic supply a more profitable option? Perhaps you are seeing the clear picture, but are you sharing this insight with your peers so that the answer is the same from every angle in the company?
- Service Goal: Would you like to be in the high ’90s on the item, but can’t afford it? Are you still making the margin you need? Despite losing some sales, is a 95% goal a moneymaker where a 98% goal is only break-even?
The heat graph above reminds you to do the analysis and make smart inventory decisions. Moving from 95% to 99% on the short lead time items is a difference of days. But that same jump on long lead time items is measured in weeks of supply.
The sleeper component
We often call Lead Time “the sleeper component” and the reasons why are growing. We are always reminded that a correct lead time value helps us buy early enough, but that correct lead time value also helps drive the proper safety stock. And seeing the true safety stock needed might be more of a nightmare than a deep sleep.
Now that you know, educate your suppliers
The realities of this heat graph deliver an important lesson to all: lead time must be watched and communicated among everyone in the supply chain. A multi-echelon inventory optimization solution can be highly valuable in cases where you have multiple DCs with dependent locations or many suppliers with different requirements and varying lead times.
Study it, embrace the reality, and use it in your inventory decisions. But don’t stop there. Watch for real-life changes. When your suppliers run into issues and their delivery times are extended, your safety stock needs go up.
Not only do you need to buy earlier because of their troubles; your inventory goes up due to the new safety stock needs. This is really their safety stock that you are holding. The inventory is measurable and so is the expense. Can you collaborate in a way to be reimbursed?
Your data reveals many profit stories
- Data tells us new stories every day.
- Turn your data into stories, and your stories into action. This inventory intelligence will inspire action and deliver results.
- Use the information to educate your peers and raise the inventory IQ of your organization.