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?
The appropriate amount of safety stock to keep on hand can be calculated with this formula:
- Step 1: Average daily sales of product x average lead time = average safety stock
- Step 2: Maximum daily sales of product x maximum lead time = maximum safety stock
- Step 3: Step 2 result – Step 1 result = optimal safety stock
Having an optimal amount of safety stock ensures you can address demand surges without inventory holding costs being too high. Make sure to periodically update your safety stock based on fluctuations in demand and supplier timelines.
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.
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.