Safety Stock and EOQ Optimization
Stockout is a production murder; excessive stock is a silent financial suicide. Success comes from determining when and how much to order with pure mathematical formulas, not with emotions.
Variabilities in the supply chain —a supplier's delay or sudden explosions in customer demand— are inherent to the system. Safety Stock is the buffer mechanism that ensures the ship does not sink against these unpredictable storms. However, determining safety stock is not an intuitive guessing game; by calculating lead time fluctuations and demand standard deviations, a statistical amount is determined according to the service level target (e.g., 95% availability). This buffer is an untouchable insurance policy, the glass of which is broken and used only in moments of disaster, otherwise untouched by the system.
The answer to the question of how much we should order is hidden in the EOQ (Economic Order Quantity) formula. Every order has a cost (transportation, operation); on the other hand, keeping the ordered product in the warehouse also has a separate cost (opportunity cost, insurance, space occupation). The EOQ model calculates the ideal order quantity where the total cost is mathematically lowest by finding that golden point where the order cost curve and the holding cost curve intersect. This optimization is a perfect balance mechanism that ensures the cash in the company's safe works with maximum efficiency.
