Inventory Optimization - Safety Stock

Inventory exists to account for the facts that:

1) Item Usage - for each inventory item, we need to determine how much is used per day, week, or month. Because item usage is often highly variable, we have to consider both the average usage, e.g. average per day, as well as account for the degree of variability we have seen in usage for the item )

2) Demand Predictability/Unpredictability - One item item may be used predictably with every case, or every patient, and the number of cases or patients cannot be predicted with exactness, while another item may be used for only particular patient conditions, and we never know when such a patient may show up. We need to consider where each item falls on this continuum of predictability vs. unpredictability of demand. Obviously, the more unpredictable the demand, the more we need to keep on hand, "just in case" demand is initiated.

2) Lead Time - When the item is reordered, there is normally a lead time between the time an item is identified as needing to be ordered, and when it is actually received into stock. This lead time may also range from highly predictable (e.g. a stock item from a medical/surgical distributor) to fairly unpredictable (e.g. an item that is customized and manufactured in large batches for a particular health system).

3) Safety Stock - Given unpredictability of demand, and variability of actual usage, it is usually wise to reorder items before the inventory on hand is exhausted. Safety Stock is the quantity of an item that you want to have on hand to cover the potential of demand exceeding ordinary averages, or having something else in the reorder process take longer than normally expected.

From the field of Operations Research, the concept of a K-factor has evolved to promote mathematical determination of safety stock values. The basic formula is: 3 * Sqrt(Usage During Lead Time). Thus for an item that we use 10 per week of, and requires one week to reorder and replenish (2 weeks for total lead time), for a total of 20 for usage during lead time, the safety stock will be: 3 * SQRT(20), or 13.4.

The next topic, Reorder Points, links Safety Stocks, Usage and Lead Times allowing calculation of Reorder Points, i.e. the stock level at which it is time to trigger a reorder event.