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How Do We Really Determine Stock Quantities?

It appears to be man’s natural proclivity to meet what he perceives as complexity with what he also perceives as the only rational response: a complex solution. If not genuine, complexity, then at least, the pretense of complexity, even when it is ultimately reduced to something much less complex.

Take the matter of deciding the stock quantities to carry.

Inventory Illustration

Our Complex Supply Chain “Solutions” to Determine Stock Quantities

In order to meet “complexity” with “complexity,” as it seems we are obligated to do, we first divide our stock artificially into two distinct portions.

We have our “safety stock,” which is intended to protect us—and our customers—from variability. On top of that safety stock, we have our working stock. This is the quantity we believe will cover “average usage” over the “average” replenishment cycle.

Our software—or our spreadsheets—then provides us with formulas or algorithms that break these down further. We have…

  • Formulas or algorithms to calculate average demand
  • Formulas or algorithms to calculate forecasts of demand
  • Formulas or algorithms to calculate average lead times
  • Formulas or algorithms to calculate forecasts of lead times
  • Formulas or algorithms to calculate the resulting safety stock quantities
  • Formulas or algorithms to calculate the resulting working stock quantities

Is That How it Really Works?

At this point, I’d like to take a little side-trip to tell you a true story.

One day I was on-site working with a client. The firm was a large distributor for a national equipment company—a name some of you would undoubtedly recognize if I were to mention it.

This firm was struggling with typical supply chain troubles—too much of some things, not enough of others—and I was there to help them get to the bottom of it. So, I was sitting with one of their buyers in order to learn how they were going about making their buying decisions.

The company was still using a system they had acquired some years earlier. They were running some inventory management software on (if I recall correctly) an old IBM System/36. I was watching over the shoulder of the buyer as he was describing what he was seeing and doing as screens flew by on the text-based green-screen where he did his work.

The buyer said, “So, when I bring up this screen, the computer looks at my stock levels and my history for the SKU that I enter here,” as he pointed to a spot on the screen and typed in an item number. Another keystroke or two, and a new screen full of data appears.

Now, this screen shows me some of the recent history and here,” he went on pointing to various aspects of the data on the screen, “it shows me the quantity that the computer thinks I should order.”

"So,” I asked, “do you generally agree with the computer and order according to what the system suggests?”

No!” he laughed. “No, the computer and I don’t agree right away,” he went on. “See this number right here?”

I nodded.

Well, the computer lets me change that number up or down. And, when I change it, it recalculates the screen and the quantity the computer recommends for the order changes with it,” the buyer explained. “So, I just keep changing that number until the computer agrees with the quantity that I think we should order each part.”

At this point, I had to bite my tongue to keep from breaking out it laughter.

The buyer had no idea what he was doing relative to changing “that number.” He had not the slightest inkling as to what was going on with the software. But, I did.

That System/36 the firm was paying big bucks every year to own and maintain was using exponential smoothing, sometimes called “alpha-smoothing,”  because the smoothing factor is frequently expressed using the Greek letter alpha. By changing the alpha-factor, the smoothing factor, one can get different results when the other inputs remain the same. The buyer was just manipulating the alpha-factor until he got the results that agreed with his thinking on each SKU.

Now, you might laugh right along with me reading that story. But, let me remind you that there are even more simplistic things that happen in a good many companies—maybe even yours!—that fly right in the face of all the “big bucks” spent by firms on costly software to help improve their supply chain performance.

Here we have, for certain, the pretense of complexity, while the real operation is reduced to “seat of the pants” management.

How many times—right in your own operations—are the real decisions about how much stock to carry of this SKU or that SKU driven, not by science and math, but by who screamed loudest or who screamed last? If it was sales and marketing raising the ruckus, chances are inventory quantities went up. And, if it was the finance department calling inventory managers on the carpet or raising havoc in some meeting, then there’s a big chance that inventories are on their way down—never mind what that expensive software might have to say about it!

Intuition is Often Right, but it Can’t be Driven by Fear or Anxiety

Interestingly, intuition is frequently a good place to start for deciding on what quantities your firm should carry in stock. However, we need to separate intuition from reactions driven by fear or anxiety. And, it makes little difference if that fear or anxiety is driven by the finance department’s fear of cash-flow problems or obsolescence, or the sales and marketing department’s fear of lost sales or lost customers.

In my next article, I will talk about how inherent simplicity can be leveraged for a simple approach to determining stock levels at each SKUL (SKU-Location). Inherent simplicity places high value on intuition and tribal knowledge, while dramatically reducing the damaging affects of countervailing impositions of fear and anxiety.


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