The reality for any ecommerce business is that supply chain problems are bound to happen, and you need to be prepared when they do. So how do you protect your business against unexpected problems without frustrating customers and compromising your reputation? This is where calculating safety stock (also known as buffer stock) factors in.
Safety stock is an inventory management formula retailers use to determine the emergency stock – the extra stock of products they need to have in case of unforeseen circumstances that can put them on the verge of selling out. You want to have enough products to help you deal with supply chain problems that arise.
Some examples are breakdowns of production machinery, any weather-related troubles affecting your stock or deliveries, or unpredicted surges in your product’s popularity leaving your supplier unable to match demands. At the same time, you don’t want too much excess inventory that you end up with the carrying costs that are too high for your sales level.
While this sounds fairly straightforward, it is important to know how to calculate inventory in order to determine the optimal stocking level. The purpose of safety stock is to avoid stockouts, where a product that is ordered can’t be delivered because you have run out of inventory. Stockouts can negatively affect a business in several ways.
How do you Calculate Safety Stock?
Calculating the appropriate level of safety stock is a critical part of inventory management. There are several methods that businesses can use to calculate safety stock, but one of the most common is the statistical safety stock method. This method involves calculating safety stock based on the standard deviation of demand over a specific period, typically the lead time for the product.
To calculate safety stock using this method, businesses need to know the following information:
- Average demand: The average amount of a product or component that a business sells over a given period.
- Lead time: The amount of time it takes for a business to receive an order from a supplier after placing an order.
- Standard deviation of demand: A measure of the variability of demand over the lead time.
Once a business has this information, it can calculate safety stock using the following formula:
Safety stock = (Standard deviation of demand) x (Service factor)
The service factor is a number that represents the desired level of service that a business wants to provide to its customers. For instance, a business may decide that it wants to provide a 99% service level, which means that it wants to ensure that it has enough stock to fulfill 99% of customer orders.
The value of the service factor depends on several factors, such as the level of competition in the market, the importance of the product or component to the business, and the level of customer demand. Businesses may need to adjust the service factor based on these factors to ensure that they can maintain the appropriate level of safety stock.
5 Benefits of Utilizing Safety Stock
Improved Customer Service
One of the most significant benefits of safety stock is that it can help businesses maintain high levels of customer service. By having enough stock on hand to meet customer demand, businesses can ensure that they can fulfill orders promptly and efficiently, which can lead to increased customer satisfaction and loyalty.
Reduced Stockouts
Safety stock can also help businesses to avoid stockouts. By maintaining a buffer stock of inventory, businesses can ensure that they have enough stock to meet unexpected increases in demand or supply chain disruptions. This can reduce the risk of stockouts, which can have significant consequences for businesses, including lost sales, reduced customer satisfaction, and damaged reputations.
More Efficient Operations
Safety stock can also help businesses to operate more efficiently. By having enough inventory on hand, businesses can reduce the need for rush orders or expedited shipping, which can be costly and time-consuming. This can help to streamline operations and reduce costs, which can be beneficial for businesses of all sizes.
Improved Planning and Forecasting
Maintaining safety stock can also help businesses to plan and forecast more effectively. By having a clear understanding of the minimum level of inventory needed to maintain operations, businesses can develop more accurate forecasts and plan for future growth. This can help businesses to make more informed decisions about inventory management, production planning, and overall business strategy.
Better Supplier Relationships
Safety stock can also help businesses to develop stronger relationships with suppliers. By having enough inventory on hand to meet demand, businesses can reduce the need for rush orders or expedited shipping, which can put strain on supplier relationships. By maintaining safety stock, businesses can demonstrate their commitment to their suppliers and build stronger, more collaborative relationships.
The Importance of Reorder Point in Safety Stock
Reorder point and safety stock are closely related concepts in inventory management, and both are essential for businesses to maintain adequate inventory levels. The importance of the reorder point lies in its ability to ensure that businesses order enough inventory to avoid stockouts while minimizing the holding cost of inventory.
The reorder point is the inventory level at which a business should place an order for more inventory to avoid running out of stock. This level is calculated based on factors such as lead time, demand variability, and safety stock level. By calculating the reorder point, businesses can ensure that they order enough inventory to meet customer demand while avoiding overstocking, which can lead to increased holding costs.
The importance of the reorder point in safety stock lies in its ability to ensure that businesses maintain adequate inventory levels while minimizing holding costs. By calculating an appropriate reorder point, businesses can ensure that they order enough inventory to avoid stockouts without overstocking. This, in turn, can help businesses to reduce holding costs associated with excess inventory while ensuring that they can meet customer demand.
What is a Good Safety Stock Level?
A good safety stock level is the difference between a product’s maximum daily sales and its average daily sales, times the product’s average lead time. This provides enough spare units of a product to sell in the event of rapid demand fluctuation. Even the fastest lead times are usually two weeks, and you can’t rely on that when you need products to sell right now.
The Downside of Safety Stock
While avoiding stockouts is important, it should be pointed out that there are some downsides to holding safety stock as well.
- Holding inventory costs money – both because the stock itself must be purchased, tying up capital – and because higher volumes of inventory require more warehouse space, as well as staff and other costs such as insurance.
- Holding excess inventory can also lead to significant losses through wastage, as many types of inventory can spoil or devalue over time: foods, beverages and medicines all fall into this category. Others can break, go out of fashion, or become redundant. A company making consumer electronics, for example, would need to carefully balance the risk of a potential stockout against the risk of holding excess inventory that never sells.
Bottom Line
You want to make sure you can ship customer orders on time and maximize sales while ensuring your supply chain processes are streamlined. Calculating the safety stock levels of all of your SKUs is a great way to get started. As a result, you will be able to minimize stockout scenarios, better utilize your warehouse space, improve demand forecasting, and keep up with seasonal trends. And when you’re ready to grow your business, consider partnering up with a 3PL (third-party logistics provider) that takes care of safety stock for you.
Help with inventory management is one of the many benefits to working with a 3PL. If you are seeking logistics support we’d love to hear from you. You can read DCL’s list of services to learn more, or check out the many companies we work with to ensure great logistics support. Send us a note to connect about how we can help your company grow.
