Safety Stock

Running low on the stock might be inevitable, but disruption of your business isn’t. Safety stock, sometimes called buffer stock, is necessary for keeping customer service levels high and ensuring business continuity.

Meaning of safety stock and importance

Safety stock inventory refers to the extra amount of goods stored in a warehouse to prevent out-of-stock situations. Safety stock serves as insurance against change in demand.

Reasons to maintain safety stock

Safety stock helps in eliminating the disturbance caused by the out-of-stock situation. If there’s sufficient safety stock, a business doesn’t need to turn away its customers or rely on its vendors to supply quickly due to the depletion of its inventory levels. Safety stock provides cover until the next batch of supplies arrive. Let’s find out how safety stock helps a business:

·   Safeguard against surges in demand – Safety stock safeguards a business against unexpected demand spikes and erroneous market forecasts which could happen during a festive season. Safety stock is a cushion when the business comes across an unexpected increase in demand for its products requiring higher inventory.

·   Protection against longer lead times – Unanticipated production or transportation-related delays could hamper the business. During these unexpected situations, it assists the business, acting as a defence against a stockout scenario and fulfilling the orders until the ordered stock arrives.

·   Protection against price fluctuations – Unexpected market fluctuations could cause the cost of goods to rise abruptly, reducing the margins for a business. If a business has enough safety stock during such unprecedented situations, it could help a business in avoiding the higher costs of buying a stock without sacrificing its sales.

Calculation and formulae of safety stock

General formula – Using the general formula, the safety stock can be calculated as below:

Safety Stock = (Max Daily Usage X Max Lead Time) – (Avg. Daily Usage X Avg. Lead Time), where

–   Maximum daily usage refers to the maximum number of units sold per day

–   Maximum lead time refers to the longest time taken to receive the supplies

–   Average daily usage refers to the average number of units sold per day, and

–   Average lead time refers to the average time taken to receive the supplies

Fixed safety stock method – This method is used by the production planners. A production planner determines the safety stock from the maximum daily usage over a period without the help of any particular formula. The fixed safety stock usually remains unchanged unless the planner wishes to change it. However, in case there’s an unexpected spike in demand for a product with limited safety stock, a business might not be able to fulfil its commitments.

Time-based method – In the time-based method, the safety stock is calculated over a while, depending on the demand forecast for the product offering. This method involves a combination of actual demand and forecasted demand. The time-based method can’t envisage business uncertainties. Therefore, there’s a risk of carrying excessive stock if the forecast is higher than the demand.

Choosing the right safety stock formula

Knowing which safety stock formula to use could depend on various factors, including:

·       Actual and forecasted demand of the product

·       How fast the inventory moves

·       Supplier’s lead time

The general safety stock formula can be a good starting point for businesses as it offers a usable ballpark figure when specifics about the inventory are unknown. Complex formulas are better at pinpointing safety stock levels for businesses with a better idea of the above variables.

Safety stock challenges and risks

Safety stock is a handy tool in combating stockouts; however, it could pose some challenges and risks to a business. There are some factors that an inventory manager should consider while developing his safety stock strategy.

Zero Safety Stock – Supply chain managers, try to combat the inventory costs by keeping the safety stock to zero or negligible levels. It’s common when an unanticipated surge in demand subsides, and the product demand reaches normal levels. While it helps resolve the issue of high inventory stocks, it involves the risk of not having a buffer for handling any future demand fluctuations or delays by the supplier, which could be even expensive to the business.

Static Safety Stock – At times, the safety stock doesn’t change with the growth of a business, implying that the number of products earmarked as safety stock isn’t enough as the business grows. Production planners must review safety stock levels and bottlenecks regularly and adjust as necessary.

High Safety Stock Levels – Having safety stock is necessary for avoiding loss of sales to stockouts. However, there is no denying that it blocks the available cash for a company. Having extra safety stock would mean less or no room for new products. High levels of safety stock are also a significant business expense, as most of this arises from the additional inventory purchased and higher storage expenses and staff hours.

There are a few risks associated with the safety stock formula. Below are two which a production manager should consider:

• Maintaining safety stock increases inventory storage costs and the increased risk of inventory spoiling or inventory becoming obsolete.
• As demand and supply aren’t constant, businesses need to employ significant time and energy for maintaining optimal safety stock levels.