What is safety stock?
Safety stock is essentially the extra inventory that is held by a retailer or a manufacturer in case of a situation in which demand increases or spikes unexpectedly. Basically, you could say that your safety stock is the additional stock above the desired inventory level that you would generally hold for day-to-day operations.
Retailers and manufacturers generally adopt a safety stock strategy is to avoid having to face stockouts. Stockouts are generally caused by changes in consumer preferences and demand, incorrect stock forecasts, variance in the lead times for raw materials.
You could say that safety stock is an inventory cushion of sorts. Holding safety stock can aid the supply chain manager in improving the availability of the products in the presence of uncertainty.
You want to have enough safety stock so that you can meet the spikes in demand when they come around, but not so much that the carrying costs and inventory holding costs become too high to bear and defeat the purpose of carrying this safety stock in the first place.
You might feel like it would be a good idea to hold enough safety stock to last you until a fresh consignment comes in, but you need to keep in mind the fact that the more stock you carry, the higher your holding costs are. The stock that you sell does not need to cover just its own carrying costs, you also need it to cover the carrying costs of your safety stock as well.
Why is safety stock needed in supply chains?
Safety stock is needed in supply chains to satisfy spikes in demand that are caused by unpredictable demand fluctuations and to reduce product shortages and stockouts. This extra merchandise is stored so that the retailers and manufacturers have some items to fall back on in a situation where they run out of stock on their shelves.
A lot of companies can’t make use of the just-in-time inventory system in which they would be ordering small amounts of inventory on a regular basis. If they could use that model, they could get rid of all storage facilities and only order enough inventory to last them for the day or week. Some of them could even have their inventory delivered as often as a few times a day. But unfortunately for them, they can’t use the just-in-time inventory system due to the fact that their suppliers are not close enough or the inventory is just too difficult to ship.
Such companies find themselves having to use the safety inventory system. When they make use of this inventory system, they buy a higher level of inventory than they anticipate selling. They hold the excess inventory as their safety stock.
Holding this excess inventory helps them make sure that the company won’t run out of their inventory during a busy season or if they face an unexpected spike in demand.
These companies are essentially overstocking their inventory to make sure that they don’t run out of popular products. This might be somewhat risky for the business’s cash flow, but it is really good for customer satisfaction and loyalty. If your customers know that they can always find what they want at your store, they are going to feel better about you and they won’t feel like making the effort to find another store that stocks the products that they are looking for. Whenever they need that product they’re going to immediately think about your business.
In a way, maintaining a level of safety stock helps businesses protect their brand reputation, earn customer loyalty, and increase their customer lifetime value.
How do you calculate safety stock?
Figuring out the right amount of safety stock to hold is one of the most challenging tasks in inventory management. If you want to figure out how much of the stock you need to replenish and when you need to do it, you got to keep in mind the fact that you’re dealing with uncertainties and several variables.
When you’re dealing with such a large amount of uncertainties and variables, your best bet is to use standard deviation to determine variations in supply and demand.
Essentially, you first find the average for a set of data. You then need to calculate the total by adding the average and the data set. You then need to take the total and divide it by the sample proportion to get the variance. Then you add the variance to the average and the sum of that will be your standard deviation.
The formula that you can use to calculate safety stock is given by the equation:
Z × σLT × D avg
Z is the number of orders that you expect to fulfill in the given period.
σLT is the standard deviation of the lead time. It can take some effort (and complex math) to calculate this, but you can use a standard deviation calculator for that. The variables that you’ll need to enter are the lead times for each inventory order within the given period.
D avg is the average amount of demand within a particular time period. For safety stock, it is most common to find the average daily demand. For that, you’ll have to add the number of sales that you made in that specific period and then divide that figure by the number of days in that period.
What is the difference between safety stock and buffer stock?
Though the terms ‘safety stock’ and ‘buffer stock’ are very commonly used interchangeably, there is a difference between them. Safety stock protects you from incapability in your upstream processes and your suppliers while buffer stock protects your customers from you in the event of a sudden demand change.
What is the difference between cycle stock and safety stock?
The difference between cycle stock and safety stock is that cycle stock is the stock allocated to meet regular customer demand over a specific period of time while safety stock acts as a backup inventory to be used if you run out of your cycle stock and there is an unexpected increase in customer demand.