Is it appropriate to add safety stock to forecasted finished goods demand? In different words, should safety or buffer stock be included in the forecasted demand for products, or be driven separately in the planning system? Seems like a simple question, but I am not sure of the answer, and possibly the answer depends on many factors.
Typically, a forecast is developed first by applying statistical model(s) to sales history with the result referred to as the ‘statistical’ forecast. The technical statistical forecast is then adjusted by various other fundamental factors such as product life cycle phase, seasonality, or marketing or sales promotions, usually as part of the Sales and Operations Planning (S&OP) process. The resulting forecast is typically known as the ‘consensus’ version of the forecast. However, related to planning, and to account for potential upsides in sales and to maximize customer service, some buffer or uplift may be added to the forecast. Moreover, this uplift can be driven in the planning system by being added to the forecast or as safety stock.
From my perspective, the basic difference between adding a buffer quantity to the forecast versus driving safety stock in the planning system is that a buffer quantity in the forecast could be consumed by actual customer orders if the buffer is realized by actual customer orders. On the other hand, safety stock (depending on the approach utilized) will plan to keep a certain level of inventory regardless of customer order levels. Conceptually, I am wondering what the best approach is for this. To summarize it seems that there are three options:
1. Forecast should inherently account for potential upsides in customer demand based on the statistics used and the fundamental factors or adjustments applied.
2. Additional ‘buffer’ should be added to the forecast – advantage is that the forecast can be consumed by actual sales orders and the disadvantage is that this buffer needs to be separately maintained.
3. Safety stock should be planned in addition to the forecast – advantage is that the buffer does not need to maintained and can be calculated by the planning system, whereas the primary disadvantage is that additional or excess inventory may result.
Intuitively, to me it seems that the option 1 above should be used – let the forecast drive demand in the planning system and not attempt to plan any buffer or safety stock. However, as we know, the first rule regarding forecast is that they will be wrong. Therefore, to complement, a way to get early signals that there will be customer demand greater than the forecast and have a system to rapidly respond to potential shortages in supply needs to be present.
Do you have any experience or insights into this? Please let me know your thoughts.