How to Set your Inventory Service Level Targets

In this article, I outline six drivers that influence how much service level you need to provide to your clients to maximize your profits (while minimizing your costs and risks). I conclude it by introducing a service level targets classification matrix.

Inventory is the connection between your supply chain and your clients. Stocking products allows you to decouple demand from supply and grants your clients instant access to your goods. Higher service levels will only bring more satisfaction to your clients — but it will come at a financial cost and the risk of overstocking. Ultimately, you might even be left with piles of dead stocks.

Horsehead Nebula (credit: my father, picture taken from his garden in Brussels, Belgium)

If you work as an inventory planner, you are familiar with setting service level targets for your products and clients. At the center of your inventory cockpit lies the question of how much service level you want to offer: 80%, 90%, 95%, 99%? How much is enough? How much is too much?

In a previous article, I outlined my framework for inventory optimization. I highlighted how inventory targets have to cope with both supply & demand, and balance five main costs (purchasing, transaction, holding, expiration, and shortage). Obviously, in a perfect world — where we would have access to all cost data — you would want to target the exact service level that would result in the highest profit and lowest cost. (A mathematical model might not be up to this challenge. Instead, you could use simulations.)

Five main costs influencing inventory targets.

But, we are not in a perfect world.

Yet, we need to set service level targets.

Service Level Definitions

As we lack data to run perfectly accurate mathematical models, we might prefer to look at the main business drivers behind…