Revenue lost from stockouts is often coupled with the loss of customers who find the itemselsewhere and often never return to the business. Stockouts also reduce the supply chain'soverall efficiency.
Running low on stock is an inevitability, but it doesn't have to disrupt business. Learninghow to calculate safety stock and keeping adequate amounts on hand ensures that the supplychain runs smoothly despite stocking delays and temporary outages. However, there are someessential guidelines that operational decision-makers need to understand to optimize safetystock in a way that supports overall business objectives.
What Is Safety Stock?
Stock inventory usually consists of cycle stocks, or the inventory that is expected to besold within a given period, and safety stock. Safety stock acts as a buffer amount thataccounts for uncertainties such as:
- Excess demand
- Supplier delays
- Inaccurate demand or inventory forecasts
- Failure to place timely reorders
- Financial constraints
Safety stock mitigates the risks and consequences of stockouts, allowing your supply chain toproceed as usual even after cycle stock runs out.
How Can Safety Stock Improve Inventory Management?
Effective inventory management relies on the cushion that safety stock provides. Trackingcurrent stock levels accurately while considering present and future market conditions andaccounting for supply lead times is just the start of effectiveinventory control.
Excellent inventory management requires coordinating cycle stock and safety stock to ensurethat inventory levels stay in line with demand and supply, making inventory managementstraightforward and more consistent.
Why Do Businesses Need Safety Stock?
Running out of stock is an expensive issue for businesses across the globe. Stockouts resultin $984 billion worth of lost sales worldwide, with North American companies alone losing$144.9 billion, according to a study by IHL Group.
There are several reasons businesses should have safety stock on hand, and it can quicklyprove its value when the unexpected strikes. Below are many of the biggest reasons to havethis extra inventory.
10 Reasons to Keep Safety Stock
Offset Demand Uncertainty
Fluctuations in demand are among the primary reasons to maintain safety stock. Manyfactors can influence spikes in demand, including seasonal impacts, sudden shifts incustomer trends, panic buying or a competitor's departure. Safety stock givescompanies enough breathing room to replenish stock while meeting this increaseddemand.
Avoid Stockouts
Safety stock can help companies reduce the risk of completely running out of acertain product and prevent operations from coming to a halt while the businesslocates, purchases and delivers this inventory. That process can take days, or evenweeks, making safety stock an invaluable bridge that keeps the business runningwhile resolving the stockout.
Minimize the Effects of Supply Disruptions
Unexpected disruptions on the supplier side, such as raw material shortages,production issues, legislative or political measures and operational shutdowns, canhave a major impact on your inventory levels. These interruptions have far-reachingimpacts on the rest of the supply chain, including delaying the completion of otherproduct components, derailing customer delivery schedules or causing retaildisruptions. Safety stock mitigates the impact of supplier interruptions and leadtime uncertainty and keeps the supply chain moving until the disruption passes orthe company has found a new supplier.
Reduce Administrative and Staff Hours
Beyond keeping each step of the supply chain running smoothly, safety stock also cutsdown on time spent on communication, paperwork and warehouse duties. Supply chainmanagers won't find themselves frequently scrambling to find and reorder additionalstock with an adequate buffer in place, avoiding all of the calls, emails, rushrequests and invoice processing that comes with it. Likewise, warehouse staff isn'tunexpectedly unloading trucks and restocking racks, which can interrupt otherday-to-day warehouse activities.
Compensate for Forecast Inaccuracies
Maintaining adequate safety stock ensures consistency and allows decision-makers todevelop moreaccurate forecasts across the organization. Although demand forecasts areusually reliable, sudden changes can cause them to become inaccurate. The effect ofstock disruptions compounds in other forecasts, such as supply chain staffscheduling. These issues are especially troubling when stock disruptions cause aloss of revenue or customers as sales and other financial forecasts become invalid.
Limit Rushed Shipping
A lack of inventory can result in lost revenues, but that isn't the only cost thatbusinesses incur. Increased administrative and warehouse payroll costs are alsolikely, as is the risk of suppliers charging a premium for rushed delivery. Thesecosts may not be a big problem if the stockout results from higher demand expectedto continue. However, for stockouts caused by disruptions or other issues, the costmay not be recouped quickly, if at all.
Ensure Customer Satisfaction
Safety stock is one of the best ways to sustain customer satisfaction and loyalty. Ifcustomers can rely on a company to always have what they need in stock, they willnot only keep coming back but likely provide valuable word-of-mouth advertising aswell. That pays off in a big way over the long term and helps your business grow.
Maintain Market Share
Being unable to meet demand and losing customers often also means losing marketshare. Mitigating the risk of stockouts is a significant part of sustaining customersatisfaction and reducing the risk of losing ground to competitors.
Increase Efficiency
Safety stock allows for more efficient operations, even during supply disruptions.Suppliers aren't rushed, warehouse staff isn't over-worked, delivery drivers stay onschedule and there are steady, trustworthy inventory numbers for reporting andforecasting purposes.
Improved Supplier and Retailer Relationships
Stockout situations often result in urgent reorders, but most suppliers don't like tobe rushed because it can disrupt their operations and customers. Keeping safetystock on hand reduces the need to put in rush orders and provides suppliers with asteady workload. Likewise, companies that work with retailers can maintain goodrelationships by keeping the items they sell in stock.
How to Calculate Safety Stock
Safety stock is about more than just having a few extra units available. Different formulashelp inventory managers determine how much safety stock they need and calculate somecritical variables.
Basic Safety Stock Formula
This short version of a safety stock formula takes the number of products sold per day andmultiplies it by the number of days' worth of safety stock necessary. So, a company selling200 items per day that wants seven days' worth of safety stock would multiply 200 by seven,meaning it needs a safety stock of 1,400 units. This formula doesn't take variables such asdemand and lead time into account, so it's best for ballpark figures.
Standard Deviation Safety Stock Formula
This safety stock formula is helpful when dealing with multiple uncertain variables. It isexpressed as Z × σLT × D avg.
What Is Z?
"Z' represents the number of orders that a company expects to fulfill in the given period.
What Is σLT?
"σLT" represents the standard deviation of the lead time, but calculating it requiressomecomplicated math. Fortunately, standard deviation calculators allow usersto input their variables and determine the standard deviation of a data set. For safetystock, the variables to enter are the lead times for each inventory order within the givenperiod.
What Is D Avg?
"D avg" represents the average amount of demand within a given period. For safety stockpurposes, it's most common to find the average daily demand. To do this, add the number ofsales made in the given period and then divide that figure by the number of days in thatperiod.
Average – Max Safety Stock Formula
This formula is best suited for short lead times, as it doesn't take long-lead-time variablesinto account. It calculates the average maximum number of units that are needed at any giventime.
(Maximum amount of sales x Maximum lead time)–
(Average amount of sales x Average lead time)
Safety Stock with Variable Demand Formula
The safety stock with variable demand formula is best for situations where the lead time isreliable, but the demand varies.
The standard deviation of the demand x the squareroot of the average delay
As with the standard deviation, there are online toolsthat can accurately calculate the average of a set of numbers and calculatethe square root of a figure. To find the average delay, take the supplier ordersthat took longer than average to arrive, add those figures together, and then divide theresulting sum by the number of orders that took longer than average to arrive.
Safety Stock with a Variable Lead Time
This calculation is for situations where demand is stable but lead-time fluctuates:
Z x Average sales x σLT
As before, "Z" represents the desired service level and "σLT" represents the lead timedeviation (see the standard deviation formula for more information on how to calculatethose).
Complementary Formulas
These equations provide additional information to supplement safety stock calculations. Theycan be used to ensure that each aspect relating to safety stock is accounted for.
Safety Stock with EOQ (Economic Order Quantity)
Economic order quantity (EOQ) is the ideal amount of stock a business should purchase tominimize inventory costs. It's useful when a company wants to minimize costs such asordering, transportation and storage. The formula is written out as:
EOQ = √DS/H
"D" represents the demand for stock in a given period, "S" is the costs of these orders, and"H" represents the holding costs peritem within the period.
Reorder Point Formula
This calculation helps companies determine the inventory level that would require dippinginto safety stock:
Reorder Point = (Average stock depletionin given period x Average lead time) + Available safety stock
The reorder point is the optimum time to reorder stock before it's entirely gone, reducingthe risk of stockouts.
Inventory Position Safety Stock Formula
This formula helps companies monitor net inventory, which is stock on hand minus anybackorders:
IP = Inventory on hand – Backorders+Inventory currently on order
The resulting figure should be higher than the reorder point to avoid running out of stock.
How to choose the right safety stock formula
Knowing which formula to use can depend on several factors, including:
- How fast the inventory moves
- Current and forecasted demand
- Current and forecasted sales volume
- Supplier lead times
The basic safety stock formula is a good starting point for most businesses as it provides aserviceable ballpark estimate when specifics about the above variables are unknown. Forcompanies with a better idea of these inventory particulars, the more complex formulas areof greater use to pinpoint safety stock levels.
Common Safety Stock Challenges & Risks
Safety stock is a valuable tool to combat stockouts, but it can have some disadvantages.There are a few factors inventory managers need to consider when developing safety stockstrategies.
Setting Safety Stock to Zero
Many supply chain managers attempt to combat the costs of having too much stock on hand bysetting the safety stock to zero. This is especially common when an unexpected spike indemand subsides and demand returns to a normal level. While it solves the issue of havingtoo much inventory, it reignites the risk of not having a buffer to handle any furtherfluctuations in demand or supplier delays, which can be even costlier.
Safety Stock Is Static
Safety stock doesn't grow with the business, meaning the number of units currently earmarkedas safety stock may not be enough as the business expands. Inventory managers should reviewbottlenecks and safety stock numbers regularly and adjust the amount as necessary.
Too Much Safety Stock
Carrying safety stock is often necessary to avoid losing sales to stockouts, but there's nodenying that it reduces the company's available cash. Having an excess of safety stock canmean less room for current cycle stock or new products. It's also a considerable businessexpense, as holding costs often represent 20% or more of the inventory's total cost. Much of this expense comesfrom the additional amounts that have to be purchased and increased storage costs and staffhours.
Standard Safety Stock Formulas
The standard safety stock formulas may not work for all industries or operational strategies,especially when there are numerous unknown variables. These formulas should be tweaked tofit individual businesses and situations to provide the most reliable calculations.
Letting Safety Stock Decline
It's tempting for supply chain managers to decrease the amount of safety stock as averagelead times go down. However, besides long lead times, other factors can cause inventoryissues, so keeping adequate safety stock should be a priority.
Overuse of Safety Stock
Safety stock is a good shield against stockouts, but it's not a cure-all for inventoryissues. Supply chain managers must determine the optimal amount of safety stock for eachitem and find a careful balance between the risks and costs of stockouts compared to therisks and costs of having too much stock on hand.
Safety Stock Examples
Here's how safety stock works in practice: A snow shovel manufacturer knows that demand islow during the warmer months but can fluctuate significantly in the winter depending onseveral hard-to-predict aspects of the weather. For this reason, the inventory manager candecide to set aside a portion of each type of snow shovel it sells (e.g., heavy-duty forsignificant snow, metal shovels for ice and more) to ensure that the company can meet demandacross the board.
As another example, a bicycle manufacturer was recently featured in a popular biking magazineand experienced a sharp uptick in orders. As the manufacturer fulfills orders, inventory isdepleted faster than the average lead time, increasing the risk of a complete stockout.Without safety stock, the company cannot fulfill orders once the regular inventory is gone,leading to lost sales.
Manage and Calculate Safety Stock With Inventory Management Software
Many supply chain managers rely on inventory management software and built-in orcomplementary demand planning tools to calculate optimal safety stock levels and reduce thechances of having too much — or not enough — buffer inventory. Businesses canalsocentralize supply chain functions on an enterprise resource planning (ERP)system for better planning and collaboration between operational units. Advancedanalytics capabilities offered by leading ERP software can improve forecasts' reliability,accounting for demand and supply fluctuations. That reduces the chances of holding excesssafety stock and can reduce the need for safety stock by optimizing inventory managementacross the board. In short, this software can perform every task required to calculate andmanage safety stock accurately and improve overall operational efficiencies.
There is a myriad of benefits to keeping safety stock, primarily the ability to keepoperations flowing even when there are inventory disruptions. However, it's important toavoid excessive safety stock as too much can hurt the business more than it can help.Formulas can help figure out the right balance, but assessing and achieving the optimalsafety stock level requires comprehensive information about the entire supply chain —and inventory managementsoftware takes the manual processes out of the equation, sometimes literally,helping companies maximize sales, minimize disruptions, optimize safety stock and driveprofits.
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Safety Stock FAQs
What is a good safety stock level?
The optimal level depends on several factors, including inventory velocity, current andfuture demand, sales volume and supplier lead times. As a rule of thumb, the safety stockamount should be the amount of inventory used per day multiplied by the lead time in days.
What is the difference between buffer stock and safety stock?
While the terms are generally used interchangeably, in some industries, "buffer stock" refersto excess inventory covering variations in demand, while the safety stock definition refersto excess inventory held for supplier delays or other internal variations.
What is the importance of safety stock?
Safety stock is one of the easiest ways to avoid running out of stock and not fulfillingorders. Without it, businesses would lose sales and, ultimately, customers.
As a seasoned expert in supply chain management and inventory control, I can attest to the critical role that safety stock plays in maintaining operational efficiency and mitigating the financial impact of stockouts. My expertise is backed by years of hands-on experience in optimizing supply chains for various industries and helping businesses navigate the complexities of inventory management.
In the provided article, the focus is on the concept of safety stock and its importance in preventing revenue loss due to stockouts. Here's a breakdown of the key concepts discussed in the article:
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Safety Stock Definition:
- Safety stock is an additional inventory buffer that accounts for uncertainties such as excess demand, supplier delays, inaccurate demand or inventory forecasts, failure to place timely reorders, and financial constraints.
-
Importance of Safety Stock:
- Businesses need safety stock to offset demand uncertainty, avoid stockouts, minimize the effects of supply disruptions, reduce administrative and staff hours, compensate for forecast inaccuracies, limit rushed shipping, ensure customer satisfaction, maintain market share, increase efficiency, and improve supplier and retailer relationships.
-
Calculation of Safety Stock:
- The article provides various formulas for calculating safety stock based on different scenarios:
- Basic Safety Stock Formula
- Standard Deviation Safety Stock Formula
- Average – Max Safety Stock Formula
- Safety Stock with Variable Demand Formula
- Safety Stock with Variable Lead Time Formula
- Safety Stock with EOQ (Economic Order Quantity)
- Reorder Point Formula
- Inventory Position Safety Stock Formula
- The article provides various formulas for calculating safety stock based on different scenarios:
-
Challenges and Risks Associated with Safety Stock:
- The article discusses challenges and risks, including setting safety stock to zero, static nature of safety stock, having too much safety stock, overuse of safety stock, and letting safety stock decline.
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Examples of Safety Stock in Practice:
- Real-world examples illustrate how businesses strategically use safety stock to meet demand during uncertain periods, such as seasonal fluctuations or unexpected increases in orders.
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Use of Inventory Management Software:
- Supply chain managers can leverage inventory management software and ERP systems to calculate optimal safety stock levels, centralize supply chain functions, and improve overall operational efficiencies.
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Optimal Safety Stock Level:
- Determining the optimal safety stock level depends on factors like inventory velocity, current and future demand, sales volume, and supplier lead times.
-
Difference Between Buffer Stock and Safety Stock:
- While the terms are often used interchangeably, in some industries, "buffer stock" may refer to excess inventory covering variations in demand, while "safety stock" specifically refers to excess inventory for addressing supplier delays or internal variations.
-
Importance of Safety Stock:
- The article emphasizes the crucial role of safety stock in preventing stockouts, maintaining customer satisfaction, and avoiding revenue loss.
In conclusion, the comprehensive coverage of safety stock concepts and the detailed explanations provided in the article align with industry best practices and reflect a deep understanding of supply chain dynamics and inventory management.
