Should safety stock be added to forecasted FG demand?

MaxJeffrey

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.

Note: I posted an excerpt of this piece on the Supply Chain Expert Community – Join the discussion!

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Discussions

  1. In general I would say that safety stock can be used on FG level when we expect a rather stable independent demand. If the demand is not sufficiently stable (almost always the case), then forecasting might fit better. Forecasts will always have an uncertainty. This uncertainty could be tackled with….. a buffer or safety stock. So if safety stocks and forecasts are used at the same time, then the safety stock could handle the uncertainties in the forecast volumes to achieve better delivery performance.

  2. Hi Max

    I see what you are getting at, but I fear that your cure is worse than the symptom. One of the biggest problems in forecasting is bias, and you solution will only encourage bias.

    I also believe that postponement needs to be considered in this discussion, in other words FG is a red herring. The real question is where should buffer or safety stock be kept. If the order-to-delivery (OTD) lead time is 1 day and the supply lead time (from start of production to FG) is, say, 3 weeks, then the safety stock has to be kept as FG. If the OTD is 2 weeks, then safety stock should be kept in WIP, and if OTD is 5 weeks, then SS should be kept in raw materials.

    Having said that, many years ago HP introduced a very innovative prpogram to segment demand for individual products into:
    – Low Scenario: 100% confidence
    – Base Scenario: Very confident of reaching this level
    – Upside Scenario: Less confident, but some indication that this could be achieved.

    They used very different supply chain strategies for each of these demand segments. For the Low scenario they focussed on the cheapest total supply chain cost and were willing to use inventory to buffer between demand and supply, especially FG. For the Base scenario WIP was used as the buffer, while for the Upside scenario, raw material was used as the buffer. Of course there were cost/margin and lead time consequences to the different strategies.

    Perhaps in this manner HP showed us a way to combine different inventory policies based upon risk.

  3. Hello,

    Hopefully my opinion will help a little bit. I used to work inside one EMS as Business Process Coordinator for 4 years, working also in Kinaxis all this period.

    In terms of what a system like Kinaxis should be able to offer, my answer is both FG safety stock and component safety stock.

    Getting back to your question I will answer from 2 perspectives:
    – Contract Manufacturer: if we are talking about a manufacturer, best option is to have component safety stock ( in Kinaxis language this should be Virtual Safety Stock – VSS ). This will decrease the risk of potential excess and it is quite easy to manage. Both SAP and Baan have good capabilities to manage automatically VSS, applied both to stocks and purchase orders.
    In the case of a demand cut, with components safety stock, the signals to all supply chain suppliers will be more accurate than FG demand cut. I experienced quite some chaos when it comes to FG demand cut, while safety stock demand cut was better 🙂
    One other thing we have to keep in mind is ERRORS. A mistake in forecast safety calculation will kill everybody, in components safety stock it can be hidden 🙂 Been there, done both 🙂
    Also all the time we have to think about the cash implications. For a CM, dollar wise, they will preffer to have component safety stock rather than forecast safety stock because of the total value.
    Example: one CM builds 100000 units of a TV tuner and all demand is cut. Forecast cost will be 1 USD, component cost will be $0.7. The CM will show a demand cut higher with 30% only because of this. Big financial implications only because of the Value Add 🙂

    – Customer:
    From a customer perspective the best option is Forecast safety stock. This way all the responsability is transfered to manufacturer/supplier. This way there will be a better control over the supplier, excess mitigation will be a lot easier, demand increase can be controlled, supplier pushed etc.

    Surely there is a lot to talk about on this subject but in the end my conclusion is Component Safety Stock.
    Do contact me on messenger for a complete discussion: sorin.teleptean@live.com

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