‘Availability’ is the golden word for any business. Every business wants to ensure the availability of products when their customers are looking for them. Every ‘out-of-stock’ sign means lost sales and often lost customers. But to stay available and still profitable, you cannot overstock your inventory. Besides the hefty warehousing costs, overstock means paying for inventory waste or deadstock.
The key to availability is consistent inventory replenishment, so you never fall short. But sometimes, your supply chain management can go askew, causing an unaccounted delay. Anything from delayed raw material delivery to transit weather delay can cause you to run out of inventory before your replenishment order arrives.
That’s why every business maintains a safety stock. Safety stock in the supply chain is what keeps you floating between your replenishment orders. Companies often rely on demand planning software to calculate and maintain optimal safety stock for their business. This article will discuss the risk and importance of safety stock for your business and how you can best calculate it.
What is safety stock?
Also known as buffer inventory, safety stock is excess inventory maintained to ensure product availability during demand fluctuations, supplier delays, inaccurate forecasts, delays in placing orders, and financial constraints. It helps you avoid stockouts and ensure a smooth-running supply chain.
Why do you need safety stock?
In a nutshell, your safety stock ensures you never go out of stock. A stockout scenario can cost you a lot of money. Besides the lost sales, you can lose your customers’ trust permanently. Your safety stock ensures this doesn’t happen by reimbursing your inventory while your replenishment arrives.
Here are a few reasons why you need a well-optimized safety stock.
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Maintain availability during demand spikes
No matter how accurate your forecast is, your demand can experience sudden spikes due to seasonality, changing customer trends, panic buying, or a competitor’s departure from the market. Your safety stock saves your inventory from a stockout. It ensures availability while your replenishment stock reaches the warehouses.
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Save money during market fluctuations
If you don’t use demand planning software, unprecedented fluctuations in the market can make production expensive. Increased prices or scarcity of raw materials, unexpected demand rise, new competitors, or changing policies can increase the cost of goods. Safety stock can help you avoid buying raw materials at high prices without losing any sales.
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Compensate for inaccurate forecasting
There is always a scope for demand forecasting inaccuracies due to sudden or unaccounted changes. Safety stocks help you compensate for this inaccuracy and save revenue while helping you make your forecasts more accurate with time.
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Ensure buffer during long lead times
Your supplier lead times can be affected if there is a shortage of raw material, production delays, operational shutdowns, extreme weather, etc. Safety stock can help soften the blow of such a situation by ensuring availability while your orders get delivered.
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Better customer satisfaction
When your customers get what they need, when they need it, they prefer you over others. Ensuring availability helps increase customer satisfaction and loyalty to your business. Moreover, if your customers rely on your business, they are more likely to advertise your product via word of mouth.
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Increase your staff’s efficiency
By ensuring availability during market disruptions, safety stock enables you to avoid urgent orders, costly rushed shipping, overworking employees, and overstaffed warehouses. This keeps your supply chain running steadily, maximizing efficiency.
How is safety stock calculated?
When maintaining a safety stock, you cannot guesstimate the amount to be secured. Industry leaders often use demand planning software to accurately calculate their safety stock. It’s necessary to take a calculated approach when deciding the right safety stock for your business. There are various methods to calculate safety stock including –
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Basic safety stock formula
This formula calculates basic safety stock for a given period without accounting for any demand or time variable, giving you a rough estimate of the safety stock.
The formula can be represented as –
Safety stock = (Avg. no. of sales) × (No. of days)
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Heizer & Render’s safety stock formula
This is also known as the standard deviation safety stock formula. It’s useful during supply variations due to the vendors and helps you determine how frequent late shipments occur. The formula considers a lead time deviation and is represented as –
Safety stock = Z*σLT*d
Where Z is the number of expected orders to be fulfilled in a certain period, σLT is the lead time deviation, and d is the average demand during that period.
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Average- max safety stock formula
This formula helps you calculate an average maximum number of units required in a specified period. Since it only considers short lead times, it’s not as useful for longer lead times. It is represented as –
Safety stock = (Maximum sales × Maximum lead time) – (Average sales × Average lead time)
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Variable demand safety stock formula
You can use this formula when the demand varies but the lead time remains constant. But to calculate safety stock with this formula, you must calculate a standard deviation of your demand and average delay separately. It is represented as –
Safety stock = Standard demand deviation x square root of the average delay
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Greasley’s safety stock formula
This formula accounts for changes in both the lead time and demand over time. But it doesn’t consider the products currently under production. This might skew the safety stock amount. The formula is represented as –
Safety Stock = Z x Average sales x σLT
Challenges and risks in safety stock optimization
As necessary as safety stock is for your business, it comes with some risks if not done right. Here are a few challenges to look out for during safety stock optimization.
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Safety stock at zero
To save on cost, demand planners might consider setting their safety stock at zero to save inventory space, especially during a regular demand phase. But this runs the risk of losing sales if the market changes and the demand rises.
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Static safety stock
Your demand changes with time and so should your safety stock. As you grow, the demand for your product rises. If you maintain a static safety stock, you might run out of stock during rising demand or delayed delivery. You need to ensure your safety stock increases as you grow.
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Excessive safety stock
Just like low safety stock, excessive safety stock is equally harmful. It can take up too much space in the inventory and lead to deadstock. Also, in the case of perishable items, it might create loss as the products expire.
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Using a textbook safety stock formula
Though there are multiple safety stock formulas available, none are foolproof for all businesses. You can tweak the formula you require as per your requirement. Also, every formula considers a few variables, but not all. It is advised not to rely on just one formula for accurate safety stock calculation.
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Excessive reliance on safety stock
Your safety stock helps you avoid stockouts but shouldn’t be relied on excessively. If your safety stock is being overused, you must work towards enhancing your demand planning system’s accuracy and plan your inventory better.
Optimize your safety stock the right way!
Safety stock in the supply chain is your cushion to fall back on during a disrupted supply chain. But the process from calculating to maintaining the right safety stock for your business can seem hectic.
TransImpact’s demand planning software uses 250+ advanced forecasting algorithms to forecast your demand and calculate the right safety stock. With safety stock optimization, you can easily and efficiently manage a safety stock while saving on inventory costs and avoiding stockouts.
Book a demo of our demand planning software with our experts. All you have to do is get in touch!