In this article, we explore exactly what inventory safety stock is and why it’s important. We will also walk you through our step-by-step process on how to optimize your safety stock effectively. Read on to learn more.
Safety stock is a term used in inventory management to describe the additional quantity of an item kept in stock to mitigate the risk of stockouts. It acts as a buffer against unpredictable supply and demand fluctuations.
Example: FarmFresh Produce Co. always maintains an additional 2,000 pounds of potatoes in their inventory. This buffer ensures that even if there's a sudden spike in demand from restaurants or a disruption in their supply from farmers, they can continue delivering to their clients seamlessly.
Safety stock plays a critical role in efficient inventory management. Here are some key reasons why:
Avoid Production Halts: In industries where production runs continuously, safety stock ensures there are no unexpected stoppages due to lack of raw materials.
Customer Satisfaction: Keeping an extra supply means businesses can meet sudden spikes in demand, ensuring customers always get their products on time.
Compensate for Forecast Errors: No forecasting method is perfect. Safety stock acts as a safeguard against underestimations in demand predictions.
Mitigate Supply Chain Disruptions: In case of unforeseen events like natural disasters or strikes, having safety stock can keep the production or sales going.
Maintain Sales Momentum: For retail businesses, a stockout can mean a lost sale. Safety stock ensures that popular items are always available on shelves.
Competitive Advantage: Companies that consistently have products available can develop a reputation for reliability, setting them apart from competitors who frequently run out of stock.
Calculating the right amount of safety stock helps you avoid overstocking or understocking. The following are some common methods to calculate inventory safety stock for your business:
Safety Stock = (Maximum Daily Usage - Average Daily Usage) x Maximum Lead Time
This formula calculates the buffer stock by examining the difference between maximum and average usage, then factoring in the longest expected time to resupply. It's a straightforward method ideal for businesses with predictable fluctuations.
Consider this example:
Maximum Daily Usage: On their busiest days, Book Haven sells 150 books of a particular title.
Average Daily Usage: On an average day, they sell 80 books of that title.
Maximum Lead Time: The longest it has taken their supplier to deliver is 5 days.
Using the Basic Safety Stock Formula:
Safety Stock = (150 books - 80 books) x 5 days
= 70 books x 5 days
= 350 books
So, Book Haven should ideally keep a safety stock of 350 books of that title to ensure they don't run out during periods of high demand or unexpected supply delays.
Safety Stock = Z x σ√L
Here, Z is the desired service level, and σ√L is the standard deviation of lead time demand.
This method takes into account the statistical variability in both demand and supply, aiming to provide a probability-based safety net.
For example:
Z (Desired Service Level): Glam Fits aims for a 95% service level, which corresponds to a Z-value of 1.65 (from the Z-table or normal distribution table).
σ (Standard Deviation of Daily Demand): Let's say, on average, Glam Fits sells 50 units of a specific dress daily, but this can vary with a standard deviation of 10 units.
L (Lead Time in Days): The time it takes for their supplier to deliver the dress is 7 days on average.
First, we need to calculate the standard deviation of lead time demand, which is the product of the daily demand standard deviation and the square root of the lead time:
σ√L = 10 units x √7 ≈ 10 units x 2.65 ≈ 26.5 units
Now, using the Safety Stock formula:
Safety Stock = Z x σ√L
= 1.65 x 26.5 units
≈ 43.7 units
Rounded up, Glam Fits should maintain a safety stock of about 44 units of that specific dress to ensure a 95% service level given the variability in demand and lead time.
Some businesses opt for a fixed quantity of safety stock based on their storage capacity and capital. It's a simpler but less flexible approach.
Optimizing your safety stock system is crucial to ensure smooth operations while minimizing inventory costs. Here's our simple step-by-step framework:
Consistently review and update your safety stock levels based on historical sales data, seasonal trends, and market dynamics.
Example: Techtronics Ltd. reviews its safety stock levels every quarter. In Q2, they noticed a consistent 15% increase in sales for a specific gadget. As a result, they increased their safety stock by 1,000 units for the following quarter to meet the growing demand.
Use sophisticated forecasting tools or software that consider various factors like seasonality, market trends, and historical data.
Example: Style Fits Clothing uses AI-driven forecasting software that predicted a 20% rise in sweater sales for the upcoming winter. They adjusted their safety stock from 2,000 to 2,500 units in anticipation.
Foster good relationships with suppliers to ensure timely deliveries and better communication about potential disruptions.
Example: Auto Makers Corp. maintained a close relationship with its tire supplier. When the supplier faced a potential strike, they gave Auto Makers an early heads-up, allowing the company to temporarily increase safety stock from 500 to 700 tires.
If you have multiple storage locations, optimize safety stock levels for each based on their specific demands and lead times.
Example: Book World Stores has both urban and rural outlets. While the urban store requires a safety stock of 1,000 books due to high demand, the rural store only needs 300 books, reflecting the different market dynamics.
Reduce safety stock by setting up a system where products arrive just when they're needed, minimizing storage costs.
Example: Kitchen Gourmet, a kitchenware manufacturer, sets up a JIT system with its ceramic supplier. Instead of keeping a safety stock of 2,000 plates, they reduced it to 500, as fresh supplies arrive just before assembly.
Brew Cafe Enterprises is a rapidly growing chain of coffee shops experiencing inventory challenges due to fluctuating demand.
Here's how they optimized their safety stock inventory system following our 5-step framework:
Upon analyzing the past year's sales data, BrewCafe noticed that their demand for coffee beans surged by 20% during winter months. Consequently, they decided to review their safety stock levels every season. This led them to adjust their safety stock from 1000 pounds to 1200 pounds of coffee beans for winter months.
BrewCafe implemented an AI-based forecasting tool which predicted a spike in demand during local festivals. For such special occasions, they raised their safety stock by an additional 200 pounds.
Having cultivated a good rapport with their primary coffee bean supplier, BrewCafe received an early warning about potential delays due to a transport strike. This heads-up allowed them to temporarily increase their safety stock by another 150 pounds.
With both urban and suburban outlets, BrewCafe recognized the varied demand patterns. Their urban outlets maintained a safety stock of 1300 pounds, while the quieter suburban ones kept 900 pounds.
To further optimize, BrewCafe collaborated with a local bean supplier for quicker replenishments, reducing the safety stock requirement in their central storage by 10%, thus saving storage costs without risking stockouts.
With this plan, BrewCafe not only streamlined their inventory management but also ensured that every outlet consistently met the demands of its customers.
We hope this article has given you a better understanding of what safety stock is and how to optimize your safety stock inventory system best.
If you enjoyed this article, you might also like our article on inventory restocking or our article on out of stock inventory.
