Service level in logistics: what mistakes in assessment can be avoided?

More than ever, there is fierce competition. Companies keep a careful eye on the behavior of their customers and competitors. New items are quickly reproduced and copied. Companies must maintain an attractive and thoughtfully priced product line, but without superior service levels, they will struggle to stand out in the market.

In reality, research indicates that 66% of consumers expect businesses to understand their needs and that 80% of customers value the interaction they have with a supplier as highly as the products they provide.

High service levels improve client loyalty and boost sales. Contrarily, poor customer satisfaction and competitive loss are the risks that could be caused by low service levels.

In developing supply chain and inventory management methods, service levels are equally crucial. You must take service level into account to evaluate your inventory’s quantity and structure properly. If not, this estimation will be biased and narrow. As a result, the majority of inventory management automation projects set the purpose to raise service levels and assist businesses in fulfilling their commitments to customers.

But how do you calculate and track service levels? There might be a difference in approaches between sectors. For instance, in the retail industry, the out-of-stock level (lost sales resulting from a shortage of inventory) is calculated along with its inverse indicator, the level of availability on the shelf. When it comes to production and distribution, we assess how well customer orders were fulfilled. However, if we don’t calculate these indicators accurately, we won’t be able to evaluate business activities in a trustworthy or objective manner.

Top 4 Mistakes When Measuring Service Levels

Here are four common mistakes that companies make when measuring their service levels:

1. You don’t fix the initial client’s order (i.e., true demand)

Some ERPs automatically modify an order’s quantity to consider the warehouse’s current on-hand balance. The quantity is set to 80 in the ERP, for instance, if an order for 100 units is received but there are only 80 units on hand.

When the business compares the number of units that were ordered (80) with the number of units that were shipped (80) it determines that the service level was 100%. However, the unfixed amount (20) should be included in this assessment because it was still a part of the initial demand.

Client satisfaction in these circumstances is quite far from 100%, creating a significant difference between the indicator and the actual reality.

2. You measure the shipped quantity of goods on an aggregate basis, not by position

Let’s say a business receives a 100-unit order, 50 of which will be for product A and 50 for product B. 100 units will be shipped as a whole to fulfill this request. But imagine for some reason we could ship only 40 units of product B and 30 units of product A and decided to make up the difference with product C which is similar to A and B but not the complete analog of them. 

Formally, the order’s service quality is acceptable. But is the customer happy with the way his order was fulfilled? Most likely not. Eventually, the supplier will be considered unreliable and unwelcome for partnership.

3. You measure order fulfillment by quantity, not time

Consider a scenario in which your client receives 100 units – exactly as requested. But what if the order was completed a month afterward the deadline because the needed quantity wasn’t on hand and had to be ordered or specially produced? Customer loyalty suffers significantly when lead times are not met, so this factor must also be taken into account when estimating service levels.

4. You set different service levels for different types of goods

If a company decides that for category C even 75% of the service level is quite satisfactory it will artificially overrate the service indicator. The truth is it’s just an effort to conceal faulty planning. As a result, a high service level is kept up primarily for group A goods, which comprises things with significant sales but poor margins. At the same time, category C (large margin, high demand variability) products receive insufficient attention. This strategy is related to the widely held belief that the higher service is required the more inventory should be kept. This is a remnant of the classical approach, if you change the concept and methodology, the results can be completely different.

Insights lie in the analysis of deviations but not in monitoring what goes according to plan.

According to our expertise, there is an indicator that can be used to estimate service level and order fulfillment quality while avoiding the distortions mentioned above. We advise using the OTIF (on-time and in-full indicator), which is the result of the division number of rows (parts) so that were delivered on time and in full by the total number of ordered SKUs.

According to McKinsey research, 96% of the surveyed companies use the OTIF, in particular:

  • 79% of companies track OTIF integrally (both on-time and in-full)
  • 17% of companies calculate OTIF separately (on-time and in-full individually)

Сalculating this indicator enables companies through all supply chains to assess if all customer requirements are met (number of products in order, ordered quantity, delivery time) OTIF stands out from other indicators as it evaluates the supply from the perspective of the customer. It provides the answer to the question: How frequently do customers receive what they want exactly when they want it? Retailers regularly release reports with OTIF data on a monthly or quarterly basis to stimulate suppliers’ on-time deliveries. Usually, OTIF is calculated as a percentage. For its correct measurement, the following requirements should be met: 

  • Consider the desired customer delivery date (in some cases even time) specified in the demand order
  • Fix the date and time of the actual delivery
  • Keep a record of the reasons why an order fulfillment doesn’t meet the OTIF conditions

If the customer has several orders at the same time, analyze and assess each delivery separately. 

There are four possible scenarios:

  1. In full and on time
  2. In full, but not on time
  3. On time, but not in full
  4. Not in full and not on time

The OTIF meets two conditions at the same time — on time and in full delivery. Companies need this indicator to evaluate the performance of the logistics department. And don’t forget to consider the impact of such factors as seasonality, marketing campaigns, and promos while collecting data for OTIF.

It would be useful to monitor OTIF along with another supply chain metrics. Leading businesses regularly compare their customer lead times to the average LT for their sector or to the LT of their main rivals. 

Calculating, analyzing, and improving OTIF is an effective tool for businesses to boost sales (due to the fact that products are in stock more often) and reduce operational costs (due to making the supply chain more reliable and predictable, reducing the customer delivery time, and keeping optimal inventory level).

It’s important to understand that by using OTIF we can assess the results of the company’s activity only retrospectively by reporting facts that we can’t change in past. Correct OTIF measurement and analysis should be supported by proactive measures that will raise the level of product availability in the warehouse:

  • Timely replenishment and order execution control
  • Operative reaction to changes
  • Fixation in ERP system and preparation work for events that may affect the availability of goods (promotions, tender orders, seasonality).
  • Comprehensive Overall inventory management automation

Maintaining high product availability for clients while optimizing inventories and improving logistics continues to be a difficult task in the post-pandemic world. Inventory management will become much more effective when all phases of procurement and delivery are tracked and analyzed, including using the OTIF.

You Can’t Manage What You Don’t Measure

Service level increase takes time, finances, and organizational resources. But according to surveys, 84% of businesses who have prioritized service level improvement report higher annual income. The high rate of client retention and loyalty, the increase in re-buys, and the rise in the number of active customers – all explain these figures. As a result, the emphasis on service complies with market trends and is vitally important for the growth of contemporary manufacturers and distributors.

Alina Dorosh 

Has 6+ years of experience in business consulting and project management. She has been involved and in charge of about 25 projects focused on inventory management optimization and automation in retail, distribution and manufacturing companies from different industries and business areas (FMCG, DIY, health and beauty, toy distribution, household appliances production, metalworking, building materials production).

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Author: Чорна Карина

Co-founder of Representative office of Demand Driven Institute in CIS region, business trainer

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