Service level
You decide you are willing to be caught short in one replenishment cycle out of twenty, and to hold enough stock to cover the other nineteen. That decision — the chance you accept of being able to supply an item from stock while you wait for the next delivery — is called the service level.
How the service level works
The service level is not a measurement. It is a dial, and what it is wired to is your safety stock.
The reasoning behind it, in words: you know roughly how much of an item sells in the time it takes your supplier to deliver, and you know roughly how much that varies. Safety stock is the cover you hold for the variation. Choose a higher service level and you are choosing to cover rarer demand peaks, which means more cover. The relationship is not a straight line: the buffer grows gently up to around 90 per cent and then steeply, because the peaks you are now insuring against get further apart faster than they get bigger.
What you achieve afterwards is the fill rate, which is a measurement. Setting a 98 per cent service level does not produce a 98 per cent fill rate: a late supplier, a bad forecast or stock that is not where the system says it is will all take their cut. There is a safety stock calculator on this site for seeing what a given choice asks of you.
There is no good number
A spare part for a machine that stops a production line and a novelty mug do not belong at the same service level, and the real mistake is not picking the wrong figure but picking one figure for everything. A flat number across the range quietly buys too little cover on the items customers care about and far too much on the long tail, where it becomes dead stock.
So the useful question is not "what should our service level be" but "which items deserve which". Differentiate by what the item earns, how badly a customer needs it today, and how easily they can take something else instead.
In practice
An item sells about 100 units a week and the supplier takes four weeks, so around 400 units cover the lead time before any buffer. Demand varies week to week.
At a 95 per cent service level the buffer works out at 40 units. Raising that item alone to 99 per cent takes the buffer to 70. Those 30 extra units are the price of covering the rarer peaks, and on one item it is nothing.
Now apply the same step to 200 items. That is 6,000 units of extra stock sitting in the building, carried all year, to protect peaks on items that between them may account for a small share of orders. The top twenty sellers deserve the 99; the other 180 very likely do not. The figures here are an illustration, not a recommendation for your range.
What moves the figure
Because it is a decision, the things that should move it are commercial rather than operational:
- What the item earns. Margin and volume together, not either one alone.
- How substitutable it is. If a customer will happily take the next size up, a stockout costs you very little. If they will call a competitor, it costs you the account.
- How unreliable the lead time is. Variation in delivery dates drives safety stock harder than the length of the lead time does. A reliable six weeks is easier than an erratic three.
- Contractual commitments. An OTIF target in a retail agreement is a service level someone else has already chosen for you.
- Shelf life and obsolescence. Cover you will throw away is not service.
- What the cover costs to hold. See inventory carrying cost; the last few points of service are where the two curves cross.
Frequently asked questions
Is the service level something we measure?
No, and this is the most common confusion in the whole subject. The service level is a number you choose, and it decides how much safety stock you hold. What you then achieve is the fill rate. One is the dial; the other is the reading.
Should every item have the same service level?
Almost never. A single figure across the range means either your fast movers run short or your slow movers turn into dead stock, and usually both. Differentiating by value, margin and how easily a customer can substitute is where most of the money is.
Why does 99 per cent cost so much more than 95?
Because the safety stock has to cover rarer and rarer demand peaks, and those peaks get further apart faster than they get bigger. The buffer needed grows gently up to about 90 and then steeply.
What about short shelf life?
A high service level on a product with weeks of shelf life is a write-off plan rather than a service plan. On those items the honest conversation is about lead time and order frequency, not about the buffer.
Further reading
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