In the complex world of inventory planning and management, maintaining a delicate balance between meeting customer demand and optimizing inventory costs is a perpetual challenge. One crucial tool that helps businesses navigate this balancing act is safety stock. Often mentioned hand in hand with the concept of reorder point, safety stock acts as a strategic buffer that safeguards against unexpected demand fluctuations, supply chain disruptions, and other uncertainties.
Calculating safety stock correctly helps you strike the right balance between having enough inventory to meet customer needs and preventing excess inventory with limited demand. Calculating safety stock enables you to find that sweet spot where you can confidently fulfill orders while maintaining optimized inventory levels.
So, let’s dive into the world of safety stock and uncover the key steps necessary to ensure your inventory is always balanced. We will also explore different ways to calculate safety stock, the pros and cons of certain kinds of safety stock, and the formulas that can help determine your optimal inventory levels for a given product.
What is Safety Stock?
Safety stock is a precisely calculated additional quantity of inventory meant to reduce the risk of stockouts or excess stock caused by fluctuations in supply and demand. It serves as a buffer inventory between forecasted and actual demand levels, and certain businesses maintain safety stock levels in order to have sufficient units to meet unexpected customer demands or accommodate production or supply chain issues.
The recent COVID-19 pandemic provided many retail, wholesale, and e-commerce businesses with a stark reminder of the critical importance of safety stock in supply chain management. The global crisis disrupted supply chains worldwide, causing widespread manufacturing, transportation, and logistics disruptions. Businesses operating their inventories on too small of a margin found themselves out of products to sell when demand increased.
But before we look at how to calculate safety stock levels, let’s explore how not having the right amount of safety stock can affect your business.
Impact of Safety Stock
Not Enough Safety Stock
Not having enough safety stock can lead to stockouts, which cause a whole host of problems. Firstly, there is an immediate loss of sales revenue, as customers can only purchase products if they are in stock. This loss of revenue not only affects the current sales but also has the potential to impact future customer loyalty and brand reputation. Stockouts can lead to dissatisfied customers who may switch to competitors when they can’t find what they’re looking for. There are also additional costs that can potentially be associated with stockouts, including the cost of backorders, back-in-stock sales processes, and expedited replenishment, which can further impact profitability.
Too Much Safety Stock
On the other hand, when you have too much safety stock, your cash flow can be compromised. More safety stock than you need ends up becoming unnecessary excess stock, which can result in additional inventory holding and storage costs, tying up cash flow that could be better utilized in other areas of your business. If the excess stock fails to move or becomes unpopular, you are at risk of being left with dead stock that must be sold at a discount for minimal revenue or even a loss. Because of these risk factors, it’s critical that merchants only order enough safety stock to accommodate fluctuations in supply or shifts in demand, but not so much that it can put cash flow and revenue at risk.
Calculating the Right Amount of Safety Stock
Safety stock levels are all about finding the right inventory balance between not enough and too much. Because of this, it’s important to consider the many factors that can influence how to calculate ideal safety stock levels. These include:
- Forecasting complexity. Many variables need to be taken into account to ensure precise forecasting accuracy, such as changing market conditions, influencer culture, viral campaigns, and customer behavior shifts.
- Large SKU volume. Managing safety stock becomes more challenging as the number of SKUs increases. Each SKU may have different demand patterns, lead times, and levels of variability, making it necessary to analyze and adjust safety stock levels for each individual item.
- Multi sales channels + multi inventory locations. Each sales channel may have its own demand patterns, resulting in different inventory needs. When inventory is spread across multiple locations, you must carefully calculate safety stock levels for each location, which requires comparing sales channel selling patterns with inventory location supply patterns.
- Seasonality. Seasonal customer demand fluctuations affect your inventory needs, requiring additional considerations to adjust safety stock levels.
- Supply chain variability. Unpredictable variations in lead times, supplier reliability, and production delays can impact safety stock levels. Disruptions in the supply chain, such as supplier issues or transportation delays, can affect replenishment timelines and necessitate adjustments to your safety stock calculations.
- Demand variability. Demand variability refers to the fluctuations and unpredictability in customer demand for a product or service over a given timeframe. When customer demand fluctuates unexpectedly, it directly affects your inventory levels and ability to meet customer needs.
All these challenges make maintaining the right safety stock nearly impossible when done manually. Unless you have very few SKUs or your supply and demand trends are very stable, safety stock calculations are too complex to execute accurately using manual methods. You need the right tool to ensure you have the right inventory levels. That’s where Inventory Planner comes in.
How to Calculate Safety Stock
Making an educated guess or using outdated spreadsheets to make decisions about your inventory will lead to suboptimal safety stock levels. You must make precise calculations to avoid too much safety stock and its higher holding costs and too little safety stock and its lost sales and revenue. There are multiple formulas for calculating safety stock that fit different use cases.
Fixed Safety Stock
Fixed safety stock is a method companies use to create a set inventory level for each SKU, which includes safety stock. This method is more straightforward than other methods of calculating safety stock, as it does not account for lead times or demand fluctuations. Fixed safety stock levels can be set based on the maximum daily sales of an item for a period of time. The amount of fixed safety stock generally remains unchanged, making it a good option for companies with stable product demand that don’t experience significant fluctuations in lead time variability. It may not be the best option for companies with high demand or lead time variability, as it can result in stockouts or excess inventory.
Fixed safety stock = number of days x average daily sales OR maximum daily sales
Time-Based Safety Stock
A time-based safety stock formula is used to compute safety stock levels based on future demand forecasts over a fixed time period. This formula is useful when demand is expected to change over time. To use this safety stock formula, you need to know the maximum daily sales, maximum lead time, average daily sales, and average lead time. The maximum daily sales is the highest number of units sold in a day, while the maximum lead time is the longest timeframe to receive goods once you place an order. The average daily sales is the average number of units sold daily, and the average lead time is the average time it takes to receive goods once you place an order. Once you have these values, you can plug them into the formula to calculate the appropriate safety stock level.
Safety stock = (maximum daily sales x maximum lead time) – (average daily sales x average lead time)
Heizer Render Safety Stock Formula
The Heizer Render formula calculates safety stock levels based on the desired service level and the standard deviation of lead time. The Heizer Render formula for calculating safety stock works by multiplying the Z score by the standard deviation in lead time (𝜎𝑑𝐿𝑇). The standard deviation in lead time is the degree and frequency by which the average lead time differs from the actual lead time. The desired service factor, or Z score, measures the probability of not running out of stock during the lead time. It is a factor used in the formula to determine the safety stock needed to meet a certain service level. The higher the desired service factor, the higher the safety stock level required to meet that service level.
Safety stock = Z score x standard deviation in lead time (σLT).
Greasley’s method is a formula used to calculate safety stock levels that considers both demand fluctuations and lead time variability. This method is regarded as one of the most accurate ways of calculating safety stock levels. Greasley’s method is useful for companies that experience high demand variability and lead time variability, and it can help ensure that you have enough inventory on-hand to meet customer demand without incurring unnecessary inventory holding costs.
Safety stock = Z score × standard deviation in lead time (σLT) × average demand (D avg)
How Inventory Planner Can Help
Inventory Planner is the market-leading inventory planning software for retail, e-commerce, and wholesale businesses. It’s designed to help merchants maintain optimal inventory levels without the need for calculating safety stock. Unlike traditional methods that rely on static safety stock levels, Inventory Planner employs a dynamic process that continually monitors and adjusts customer demand forecasts. By utilizing historical sales data and considering various factors such as new selling patterns, seasonality, customer demand shifts, marketing campaigns, and more, Inventory Planner helps businesses stay current on exactly how much inventory they should have at all times. Using up-to-date forecasting data, the system calculates the ideal amount of inventory needed and determines the right ordering point, so you’ll easily know what to order and when to order to meet demand without accumulating excess inventory.
The beauty of Inventory Planner lies in its automation. Using advanced algorithms, the platform automatically generates inventory buying recommendations at every level, from SKU and product category to warehouse and supplier levels, saving businesses valuable time and resources.
Whether you’re selling on multiple channels and/or using multiple inventory locations, or have a large catalog of SKUs, you can benefit from Inventory Planner’s automated, reliable, and intelligent inventory forecasting and planning recommendations.
Should supply chains fluctuate drastically, as they did for many businesses during the pandemic, Inventory Planner allows you to increase the ideal “stock cover days” for items that experience unpredictable or lengthier-than-usual lead times to make sure you always have the right stock to meet customer demand. Once the stock cover days are adjusted, Inventory Planner will automatically update your forecast and inventory purchasing recommendations accordingly.
With dedicated and tech-savvy inventory planning software like Inventory Planner, you can streamline your inventory planning processes by eliminating tedious, error-prone manual calculations, leading to increased efficiency, reduced costs, higher customer satisfaction, and a competitive edge in the marketplace.
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