Excess stock can be the safety net that catches extra orders during surprising climbs in demand or quicksand that eats up your available cash flow and storage space. So, how do you find the perfect balance between stockouts and obsolete inventory? Use the right mix of safety stock calculation methods for your products.
Discover the importance of safety stock, different methods for calculating the right amounts for every SKU, and what you risk without achieving accuracy.
The Importance of Safety Stock Inventory for Businesses
“Nothing stays the same,” and “the only constant is change.” Whichever axiom you prefer, safety stock is all about “expecting the unexpected.”
As supply chain management leaders, we deal with daily volatility, uncertainty, complexity, and ambiguity (VUCA). Supply chain delays, rapidly changing consumer preferences, financial fluctuations, and more can make maintaining right-sized inventory challenging.
The right amount of safety stock provides a boost to help you navigate these challenges deftly. Without that boost, you may fall behind competitors, facing stockouts, lower service levels, and unsatisfied customers.
Preventing Stockouts
Changes in demand, inaccurate forecasts, and supply problems can all cause stockouts. When you don’t have the stock to meet demand, you lose out on easy sales opportunities.
Safety stock helps prevent stockouts, giving you time and grace to deal with delays and mislaid plans before you run out entirely. In other words, safety stock lets you keep your service levels high without breaking the bank on expedited shipping from suppliers when the unexpected happens.
Managing Demand Fluctuations
Consumer demand no longer follows linear, seasonal trends from year to year. Everything from social media trends to upcoming events to major weather events can complicate demand forecasting.
When you suddenly have an influx of new customers interested in the same product, a safety stock strategy that considers variability can help you take advantage of new sales opportunities. Conversely, when customers fall out of love with one of your products in favor of something else, changing your safety stock calculations can help you reduce the amount of that product you’re holding as it nears obsolescence.
Safety Stock Formulas and Calculation Methods With Examples
At its most basic level, the ideal buffer stock amount is formulated by multiplying the number of a specific product sold each day by the number of days of safety stock you want for that product. For example, if you want a week’s worth of stock in a product you typically sell 100 times a day, you need 700 units of that product as safety stock at any given time.
Another basic starting point, the 50% rule of safety stock, calls for maintaining additional inventory levels around half a product’s average lead demand time. Following this rule, you multiply your average daily sales in a product by its average lead time and halve the result to find ideal safety stock levels.
To keep it simple, let’s use the same example numbers as above — 100 units sold per day, now with one week of lead time. Using the 50% rule, multiply the two to get 700, then divide that by two to get 450 units in safety stock.
If only inventory management for businesses was as easy as following a single rule of thumb. As demonstrated, VUCA variables in demand, lead time, and more can cause the ideal safety stock amount for different products and locations to shift suddenly at any time. As a result, better inventory optimization techniques involve complex models that consider several possible future scenarios.
Variable Demand Method and Formula
When lead times are stable, but demand fluctuates, the variable demand formula can help you determine how much extra stock to hold at any given time. The formula is usually expressed as:
- Safety stock = Z x σD x √LT
The equation translates your desired service level percentage into a “Z-score” using a normal distribution chart. The Z-score represents the standard deviations from the mean within which your desired service level falls. For example, if your desired service level is 90%, the corresponding Z-score is usually around 1.28.
The standard deviation of demand, accounting for order fluctuation, is represented by σD. In our example, suppose demand for this specific product typically fluctuates by 10 units in either direction of average demand.
Lastly, LT stands for “lead time.” To continue building this example, we’ll choose a number with a clean square root — nine days.
Putting all the elements together, let’s multiply our 1.28 Z-score by our 10-unit standard deviation of demand to get 12.8. Next, we’ll multiply that 12.8 by the square root of our nine-day lead time (three), making your ideal safety stock amount about 38 units.
When lead times and demand switch roles, meaning demand remains stable while lead times fluctuate, you can adjust the formula to suit your needs. Plug in your variables and calculate using this formula:
- Safety Stock = Z x Average Sales x σLT
Dependent Demand and Lead Times Methods and Formulas
When demand for a product depends on demand for other products, a formula must account for that extra step in the supply chain. For example, car parts manufacturers only know how many car parts they need to make right now by knowing the near-future demand for finished vehicles.
The same goes for products with lead times dependent on the completion of something else beforehand. In the same example, consider the car salesmen at the end of the supply chain who interfaces with customers. How long it takes them to receive ready-to-sell cars depends on how long it takes manufacturers to make, assemble, and ship individual car parts further back in the supply chain.
The formula for products with dependent demand is:
- Safety Stock = (Z x Standard Deviation of Demand During Lead Time) + Average Demand During Lead Time
Using our 1.28 Z-score, five as our standard deviation of demand during lead time, and 50 as the average demand during lead time, we get an optimal safety stock level of about 56 units.
The formula for products with dependent lead time is:
- Safety Stock = (Maximum Daily Demand x Maximum Lead Time) – (Average Daily Demand x Average Lead Time)
With a maximum daily demand of 65, an average of 50, a 15-day maximum lead time, and a 10-day average, safety stock should be set at 475.
Risks of Inadequate Safety Stock Strategies
Without the safety net of right-sized additional stock to mitigate risks, you may experience problems like:
- Safety stock declining or dropping to zero: You may run out of your safety stock, increasing your risk of stockouts and causing service levels to plummet below targets.
- Static safety stock during business expansion: Your planning efforts will become outdated as the business grows, leading to a higher risk of stockouts or overstocks.
- Over-reliance on standard formulas: You won’t be able to accurately predict needed safety stock in a rapidly evolving business environment using only basic formulas and rules of thumb.
- Imbalance between stockout risks and costs: You’ll hemorrhage money if you keep too much safety stock for too long, but you might lose out on sales if you don’t have enough.
Find the Best Solution for Dynamic Safety Stock Management
Continuously adapting your safety stock to current conditions positions you to stay on top of changes and avoid missteps in stockouts and overstocks. GAINS’ inventory optimization software gives you a bird’s-eye view of your entire inventory and restocking program across SKUs and locations, helping you shift safety stock strategies and agilely meet demand or lead time changes.