When using formulas or equations, you must take care not to use them indiscriminately. Most equations apply to specific circumstances and the square root law is no exception to this. (Read more about the square root law here and here.) There are circumstances where the square root law is not applicable and, if used, will yield incorrect results.
The square root law of inventory states that if you are starting out with inventory at one location and you decide to disperse that inventory over four warehouses in different locations, then you will have to increase your safety stock by a factor of two, or the square root of the new number of inventory locations.
Three situations in which this law should not be used are described below:
When Your Customer Regions Consume Different Products
Suppose you sold high school class rings and banners to fifteen different high schools located in fifteen different cities. The demand variability of each school requires that you have safety stock for each one.
However, since each school requires a product unique to them, your total safety inventory covering all fifteen schools will remain the same whether stored in a central inventory location or in fifteen different local warehouses. Even though all fifteen schools won’t likely experience peak demand at the same time, the inventory for schools with low demand can’t be used for schools with peak demand because the products can’t be cross sold.
If you were selling items that could be sold to all fifteen schools, such as pens, then you wouldn’t need a safety stock for each separate school if you used a single warehouse location. Since they won’t all require use of safety stock at the same time, you could satisfy the needs of the few schools that experience peak demand by using a reduced safety stock of pens stored in a centralized warehouse.
When There is Little Variability In Demand
If the demand of all of your customers were always the same, there would be no need for safety stock. Whether you have 10 separate warehouses or one, the amount of safety stock required is still zero. Since the square root law tells you the effect that multiple warehouse locations have on inventory levels due to safety stock requirements, it wouldn’t be applicable. Likewise, if the demand variability were very small but not quite zero, the safety stock requirements aren’t much affected by the number of warehouse locations.
When Demand Variability Isn’t Random
This situation is similar to the previous situation of having no demand variability. When your customers are always predictable – meaning they have low demand variability, as stated above, and rarely if ever experience large demand spikes – stocking your inventory to match is simple: no safety stock required.
Again, the square root law of inventory says that if you are starting out with inventory at one location and want to disperse that inventory to other locations, you’ll have to increase your safety stock by the square root of the number of new warehouses. Since, in the aforementioned scenarios, you aren’t in need of safety stock, you shouldn’t use the square root law of inventory, regardless of the number of warehouse you stock. The square root law assumes variability in your demand, so a lack of variability equals a lack of need for the square root law.
As a final point, suppose the demand of all of your customers were synchronized so that all experienced peak demand at the same time. Since the square root law assumes random variability, this means it expects some customers to be in peak demand while others are not. This is another situation in which the square root law would not apply.
Still not sure about the square root law of inventory? Have other inventory management questions? For more information on parts inventory management or on the use of inventory control software, please contact Acumen Information Systems today.