Inventory Service Levels: What Does 75% Mean?

Net profits are a derivative of sales.  And sales, of course are a function of both consumer demand and the extent to which the retailer has on hand sufficient desirable inventory and in the appropriate amounts.

That sounds both reasonable and doable. Just keep the store filled with “A” merchandise or the 20% of items that generate 80% of your sales. And, in all likelihood, the retailer is trying hard to do just that.

The extent to which you actually accomplish this is known as “service level” or the percentage of time you are actually in stock on “A” merchandise. Unfortunately, most retailers have no idea what their service level is or how to measure it.

“Service level” is expressed as a percent of time the retailer is in stock on key items and is expressed as a percentage. If you have a service level of 67% that means that 2/3 of the time you will be able to fulfill the consumers request to purchase specific goods. It also means that 33% of the time you will not be in stock and will lose the sale.

Expressed alternatively, you will lose every third sale because of stock outs. And just to be clear, if you have inventory on a key item but it is in the stock room and not on the sales floor, technically you have lost the sale.

Let’s quantify all of this. Suppose your service level is 66%. Thus 2/3 of time you can fulfill a consumer’s request for key inventory. It also means that you fail to consummate the sale on every third customer. This begs the question, what would happen to your sales if you could increase the service level to 75% from 66%?

Suppose you had annual sales of $1,200,000 with a service level of 67%. If you could increase your service level to 75% through better stock fulfilment practices, then theoretically your sales would increase by 12% (75 – 67 = 8 / 67 = 12%) or $144,000 (.12 X 1,200,000) for a total of $1,344,000 (1,200,000 + 144,000 = 1,344,000). 

“Great” you say, but this generates two fundament questions: (1) how do I know which are my “A” items and (2) specifically how do I measure the number of stock outs?

The venerable 80/20 rule is applied here to define the “A” items. Statistically, for most retailers 80% of their business is generated by only 20% of their SKU’s, aka “the A items”. Many inventory management systems will calculate and provide this data. If not, it can be developed on an Excel spreadsheet wherein gross annual sales per SKU are ranked by dollars in descending order along with the concomitant accumulated sales number.

Thus, if you count down 20% of the total items and note the accumulated dolllar sales for the 20%, you will note that approximately 20% of your top items produce about 80% of your annual sales.

The second key question is, how do you determine your stock status on these “A” items. Granted you could check computer system, but if the inventory is in the warehouse or stock room versus the sales floor, you will have a false reading.

The remedy is rather simple. List approximately 100 key “A” items and physically check the stock status on the sales floor. If you are in stock on 70 of the 100 items then you have a service level of 70%.

To sum it up, if you don’t measure your service level or specifically know the 20% of the items that are generating 80% of your sales volume, then you are undoubtedly leaving both sales and profits “on the table.”