Understanding the Cost of Service

Rod Daugherty

Vice President, Product Strategy

Julian works for a retail enterprise that has a distribution center, forward selling locations primarily serviced from the DC, and an e-commerce channel. Among other things, Julian is responsible for the inventory investment for the company. A key part of that investment is the safety stock that defends against variability in supply and demand. Julian understands that safety stock is based primarily on statistical probability, but he would like to have greater control and visibility to that part of the overall inventory investment. Julian’s boss, the president of the company, does not understand why they should ever be out-of-stock for any item.

Business Scenario

Item Volume Ranking: Before setting service goal policy, Julian must classify the item/location combinations so he has a stratification—setting the most important items as “A” items, the next most important items as “B” items and so on. Julian wants to be able to configure the cut-offs for item/location classification using different measurements. For example, in some locations it’s best to classify item/locations using units & currency. In other locations, he wants to rank by profit.

In some locations, Julian also wants to rank items in smaller groups, considering the items in the location by Item Group 1 versus ranking the items for the entire location top to bottom. The value in Item Group 1 is the same as “Department” in Julian’s business. The reason he wants to do this is because some departments have very fast moving, high volume items, while others have slow selling, expensive items. These slow selling items are still of high importance to their business, so Julian does not want the items to be summarily ranked lower relative to the entire item population.

Setting Service Goal Rules: Next, Julian wants the ability to set up multiple service goal policies. Let’s say the different service goal policy simulations look like this:

Julian wants to run those service goal policies (simulation 1 – 6 in our example above) against the preferred item/location classifications (velocity ranking). Then, he can view the cost of service for each policy in a simulation and compare the effects of higher or lower overall service versus how much it costs in terms of safety stock investment.

Understanding the Cost of Service: In doing his comparison analysis of the trades-offs between higher overall service and the cost associated with it, Julian needs to see metrics like:

  • Annual cost of service (safety stock investment) associated with each service goal stratification. This is really the “bottom line” number that makes it easy to compare the cost of each possible set of service goal rules.

The following metrics add context along with the cost of service to help Julian select the service goal rules that are best for his business:

  • The annual demand in both units and currency
  • The average demand filled in units and currency
  • Average shortages in units and currency
  • Overall service level percent in units and currency


The good news for both you and Julian is that all of these requirements will be included in the new Cost of Service Analysis tool in Blue Ridge Supply Chain Planning v2016. This powerful new feature allows you select from a variety of item classification techniques to use with up to six different sets of service goal rules that can be simulated simultaneously. The simulation returns annual safety stock investment metrics that empower the business user and provides intelligent decision support in selecting the optimal set of service goal rules. Finally, all of these service goal planning tools culminate in your ability to apply the best rule set to your item/locations. This enables you to execute proper velocity codes and service goals on the items to fine-tune your safety stock investment.