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Safety Stock: Everybody Wants To Use, Nobody Wants To Own James Workman; Natalie Scheidler 2606 words 1 October

2009 Journal of Business Forecasting JBT 4 Volume 28; Issue 3; ISSN: 1930126X English 2009 Journal of Business Forecasting. Provided by ProQuest Information and Learning. All Rights Reserved. Describes three key factors-demand variability, supply variability, and strategic considerations which should be used in the calculation of safety stocks... less inventory will be needed if we consolidate labels of Spanish-speaking countries into one label product instead of having a separate label for each country...if your suppliers are sometimes late, then your model should account not only for how often they are late, but also by how much. Companies use safety stock to reduce the risk of stock out and to keep the customer service high. The question is how to determine the right amount of safety stock. In this article, we share our experience about the safety stock model that we use at Eli Lilly and Company, and show the factors we account for in the calculation, and why. Safety stock is a major cost to a company, which must be kept under control to run the business smoothly and efficiently. Companies can do this without making large investments in tools because it is not necessary to have expensive tools for the best results. We have found that readily available tools, such as Microsoft Excel, can easily be used to calculate the desired safety stock levels. However, we still need business processes to manage their implementation, which can be done by a supply chain manager. Here we will describe the methodology and the tool used at Eli Lilly to calculate safety stock targets, as well as the process to manage the targets across different business units. Lilly provides customers "Answers that Matter" through innovative medicines manufactured at plants across 13 countries. We will first describe factors we account for in determining safety stocks, and then the modeling tool used to compute them to ensure availability of material. Finally, we will show how to use the model for an efficient supply chain management. FACTORS INFLUENCING SAFETY STOCK LEVELS Several factors influence the level of safety stock. However, at Lilly we look at three factors, which are: (1) demand variability, (2) supply variability, and (3) strategic considerations. Although appropriate levels of safety stock can be determined by using just one or two of these factors, due to the nature of our products and manufacturing lead times, we consider all the three. In our model, we use the following equation: Safety Stock = SS^sub Demand^ + SS^sub Supply^ + SS^sub Strategic^

where SS^sub Demand^ = Safety stock required to account for demand variations SS^sub Supply^ = Safety stock required to account for supply variations SS^sub Strategic^ = Safety stock required to account for strategic considerations Let us now look at each of these factors in detail. The first is demand variability, which describes the quantity of safety stock carried to account for variations in demand. At a sales location (or distribution center) this is the variability in actual sales vs. forecast. This variability is quantified as forecast accuracy expressed in percentage. If we want to have safety stock expressed in number of days, we calculate the safety stock needed to cover demand variability as follows: SS^sub Demand^ = (1 -Forecast Accuracy) Lead Time = Days of Coverage Needed If, instead, we want to determine safety stock in units, we calculate it as follows: SS^sub Demand^ = Days of Coverage Needed Average Daily Usage Whichever unit of measure we choose to describe our safety stock (days or units), we must be consistent across all three factors: demand variability, supply variability, and strategic considerations. The next factor to be covered by safety stock is supply variability. Here sales locations must determine the variability between the actual delivery date and quantity and the promised delivery date and quantity received from their suppliers. This is identified in our model as Supplier on Time Delivery, expressed in percentage. That is, the percentage of deliveries from the supplier made on time and in full quantity (or within a quantity tolerance). If we are calculating safety stock in days, we determine the quantity needed to cover supply variability as follows: SS^sub Supply^ = (1-SupplieronTime Delivery) Lead Time = Days of Coverage Needed If we want it in units, then: SS^sub Supply^ = Days of Coverage Needed Average Daily Usage Next we have to account for strategic considerations such as life-saving or critical products, unexpected events, and multi-market labels. We hold extra safety stock for life-saving or critical products because of severe consequences that our customers will have if we run out. In other cases, we carry extra inventory to cover for catastrophic events such as weatherrelated damage

at plant sites, breakouts of disease, or changes in operations of foreign governments. In contrast, for multi-market labels, we choose to hold less safety stock than what is calculated by our model after accounting for demand and supply variability. A multi-market label is the one that can be sold in many countries. For example, a product with a "Spanish" country label can be sold in number of countries. Where a same product is sold with a specific label for each country, we try to consolidate them - country-specific labels into one multi-market label - to decrease our overall safety stock burden. The method used to quantify strategic considerations varies depending on the strategic element to be accounted for, but the unit of measure is kept consistent to account for demand and supply variations, so that these three values can be easily summed up. Here, based on our best judgment, we decide on the Days of Coverage Needed to cover for a specific strategic consideration. SAFETY STOCK METHODS There are two ways for determining safety stocks: Dynamic (Time Based) Safety Stock and Static Safety Stock. Dynamic Safety Stock is used when the actual quantity of safety stock may vary with the demand. Here the safety stock level is expressed as the days of coverage, and is calculated as follows: Safety Stock = SS^sub Demand^ + SS^sub Supply^ + SS^sub Strategic^ where SS^sub Demand^ = (1- Forecast Accuracy) Lead Time = Days of Coverage Needed SS^sub Supply^ = (1 -Supplier on Time Delivery) Lead Time = Days of Coverage Needed SS^sub Strategic^ = Days of Coverage Needed The Dynamic Safety Stock method works best for items or markets that experience variation in demand resulting from such things as seasonality, new product launches, or product deletions. However, for products with seasonal demand or new product launches, we must make sure that we have enough warehouse space to handle fluctuations in inventory. The Static Safety Stock method is used when a set quantity is to be carried. In this case, the safety stock level expressed in units is calculated as follows: Safety Stock = SS^sub Demand^ + SS^sub Supply^ + SS^sub Strategic^ where

SS^sub Demand^ = (1 - Forecast Accuracy) Lead Time Average Daily Usage SS^sub Supply^ = (1 - Supplier on Time Delivery) Lead Time Average Daily Usage SS^sub Strategic^ = Days of Coverage Needed Average Daily Usage Static Safety Stock is best for items or markets with a stable demand. Furthermore, this method is best for a company with limited warehouse space because it allows set inventory targets around which warehouse needs can be easily planned. Products with Static Safety Stock include milk and bread, which have a fairly stable demand. DESCRIPTION OF THE MODEL Theories behind safety stock are well known, but how are we going to put them into practice? At Lilly, we have adapted the theory described above to our business model. One aspect of this is to use safety stock to ensure customer service. Unlike some manufacturers, our customers often require that product is available when needed. If a patient needs insulin, he cannot wait for two weeks. He needs it right away. Although we have official customer service targets, we unofficially aim for 100%. We recognize that these targets are difficult to achieve, but we do our best to meet them. For our supply chain, our plants make active ingrethents, convert ingrethents into a dose, fill the product into a bottle, blister, or vial, and then put it in its final package configuration that satisfies the regulatory labeling and insert requirements. Within the organization, our plant sites sell to the next plant site downstream. The last manufacturing plant site in the supply chain sells to the distribution center (DC). The DCs are located in most of the markets we serve. While we have very high customer service rates, our customer service levels within our internal supply chains are not that high. In order to achieve our customer service goals, we have developed a process where we take into account various factors that drive the requirements for safety stock. Beyond the formulas described earlier, we have developed an integrated process among several business functions to determine our appropriate safety stock levels. Our safety stock model calculates the demand variability component by item using each market's three-month forecast accuracy and the supply variability component by product family using our plant site customer service metrics. We add the safety stock resulting from supply and demand components to the one resulting from the strategic component to arrive at the recommended safety stock target. SAFETY STOCK MODEL: DEMAND VARIABILITY The Lilly safety stock model utilizes our forecast performance metrics, which are calculated and reported monthly. For our forecasting metrics, we calculate 1 -month, 3 -month, and 12-month forecast accuracy. So in developing a model, make sure it utilizes a measure that is most appropriate for you. We uses the 3 -month forecast accuracy metric as it provides a good balance between 1 -month forecast accuracy metric and 12-month forecast accuracy metric. SAFETY STOCK MODEL: SUPPLY VARIABILITY

Our "Safety Stock Tool" utilizes the average Plant Site On-Time-InFuIl (OTIF) metric by product family, downloaded from metrics available in our internal manufacturing website. By utilizing this metric, we know how often we ship orders on-time (on the requested delivery date) and in full (within the allowed quantity tolerance). This enables us to know the percentage of orders that we missed in quantity and/or in delivery date. Those misses are what we need to cover with safety stock. To apply this safety stock model in your company, you need to determine if your company's model should incorporate a measure of lateness in delivery or the frequency of lateness. If your suppliers are sometimes very late, then your model must account for not only how often they are late, but also by how much. SAFETY STOCK MODEL: STRATEGIC SAFETY STOCK The model we use at Lilly utilizes the strategic components for most of our products, though they vary from one product to another. We want to make sure that our customers get the medicines they need and when they need. Thus, our strategic safety stock values are developed in collaboration with our Corporate Supply Chain and Global Marketing Product Teams. LILLY SPREADSHEET MODEL At Lilly, we have developed an Excel spreadsheet for our model. It has numerous tabs, which include an instruction tab, a theory tab, and a tab for each of the three components: demand variability, supply variability, and strategic. After each of these components is calculated for a product, another tab links all the three together, and then calculates a total safety stock value (in days of supply). When this calculation is complete, each of the Demand Management Coordinators (DMC) reviews the calculations and adjusts the values, if necessary, based on their knowledge of the product and the market. After these adjustments are made, each distribution center reviews and negotiates adjustments made by the DMC. Once everyone agrees on the safety stock numbers, they are entered into the SAP system by the DMC. All of the negotiations that take place are a very useful and necessary part of our process, because they allow us to balance the risk of running out of product with the cost of investment in inventory. At the end of the day, the "correct" safety stock is nothing more than a good guess. The more collaborative input that goes into setting a safety stock target the better should be the result. SAFETY STOCK EXCEPTION FLAGS After the safety stock levels have been agreed upon and implemented, it is important to maintain them. One way to do this is through a report that shows the following: * Some items have less than 60% of the inventory target, or coverage duration less than or equal to seven days. Items that show up here imply that their safety stocks are too low.

* Some items have even less than one week of inventory. This also implies that their safety stocks are too low. * The "Goal Post" report provides a view of the inventory position on all items. It shows whether inventory is between the min (safety stock) and max (safety stock + standard order quantity) values (i.e., between the goal posts). As such, it flags items that have either too much or too little safety stock. * Monthly inventory points out the variations from the plan, if any. It may flag items, families, or locations where safety stock needs to be adjusted. If you see variations from the plan, the best thing is to find out what causing them. CONCLUSIONS In summary, remember the following while determining safety stocks: * Consider all of the factors that influence the safety stock levels including demand variability, supply variability, and strategic components. * There is no right or wrong answer. The best process is to agree collectively on a safety stock that is likely to minimize inventory and ensure availability of products. * Develop a system that is suitable to your needs. Every company is different, so use a model that makes sense for you. (http://ww.ibf.org) Companies use safety stock to reduce the risk of stock out and to keep the customer service high. The question is how to determine the right amount of safety stock. In this article, the authors share their experience about the safety stock model that they use at Eli Lilly and Co, and show the factors they account for in the calculation, and why. Several factors influence the level of safety stock. However, at Lilly they look at three factors, which are demand variability, supply variability, and strategic considerations. In summary, remember the following while determining safety stocks: 1. Consider all of the factors that influence the safety stock levels including demand variability, supply variability, and strategic components. 2. Agree collectively on a safety stock that is likely to minimize inventory and ensure availability of products. 3. Develop a system that is suitable to your needs. Copyright Journal of Business Forecasting Fall 2009 | Mr. Workman is an Associate Supply Chain Consultant in the Demand Management Center at Eu Lilly. He has over 20 years of experience in materials management and has held positions as Master Scheduler, Planner/ Buyer, Materials Manager, Demand Manager, and Demand Management Consultant at various companies. He has implemented four MRP II / ERP systems, most recently SAP. He has a Bachelor of Science in Industrial Management from Purdue University and is APICS CPIM certified. | Mrs. Scheidler is a Senior Demand Management Coordinator for the Asia and Pacific Rim regions in Elanco Animal Health, Eli Lilly's animal health division. She has 12 years of

experience in supply chain as a Master Scheduler, as well as a consultant for SAP R/3 for Production Planning and APO. She has a Master of Business Administration with a focus on Operations Management from Ball State University and is APICS CPIM certified. She also teaches certification courses for an APICS Chapter.

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