There are 2 primary external drivers to establishing how much inventory you carry:

1. Volatility of Demand
2. Volatility of Supply

In this posting, we will review the volatility of demand.

Volatility of demand is simply a numerical description of the level of unpredictability of your demand.  As shown below, a volatile demand pattern typically exhibits numerous spikes of demand that are exponentially above the norm.

What makes this pattern significant from an inventory optimization perspective is that high levels of volatility require more on hand stock to hedge against the likely occurrence that the company could realize an unusual spike in demand.  In the example above, the average monthly demand is 125 units however due to the volatility the statistical calculated safety stock requirement is 250 units or two months of demand.  The safety stock alone increases the inventory investment and reduces turns to 6 times a year not including the inventory you must carry above the safety stock to manage normal order requirements.  

The graphic below is for the same item as above, however in this case the profile has been scrubbed to eliminate many of the large spikes.  This scrubbing reduced the safety stock by more than half to 100 units. 

Now I am not suggesting that the data be scrubbed in this manner to reduce the safety stock investment, in fact I strongly caution against it unless the demand was a planned event.  A better approach is to use the demand data to work with customers to establish predictable ordering patterns and if necessary provide incentives to reinforce the desired behavior.  You may not be able to reduce your safety stock to 0 but you will be in a much better position to service your customers at a lower overall operating cost and do so in a manner that will keep them happy.