Are you a growing D2C or eCommerce brand looking to manage your supply chain? Or do you simply want to be prepared for disruptions in the market? Safety stock is a critical part of managing your supply chain and is one of the most important initiatives that a growing business can undertake. Innovative businesses are building “up” their safety stocks through various formulas (discussed in detail below) to ensure that they have sufficient inventory on hand at the start of each season or product cycle.
In this blog, we will explain what safety stock is and why it is important for your business. We will also share how much safety stock would you need as per your demand and supply cycle.
Safety stock explained
Safety stock, also known as buffer stock, is the extra inventory that businesses keep in the warehouse to prevent stockouts in case of supply chain disruptions or excess demand. It is an important aspect of your business growth and is used mainly in cases of:
- Excess demand
- Delays in supplies
- Inefficient inventory management (placing an inadequate amount of supply)
- Financial constraints
Pro tip: Buffer stock is best suited for products that have a high sell-through rate or long supplier lead time.
Importance of buffer stock for your business
Here are the top five reasons why you should be building safety stock of your product’s:
Properly managing safety stock can minimize risk and keep operations running smoothly during stockouts. As it takes days to weeks to refurbish your inventory, you must plan your inventory management efficiently.
Meet sudden demand
The buffer stock is also used when a company experiences sudden spikes in demand for its products. For instance, if a company produces widgets and experiences a sudden surge in demand for them on the day of an impending holiday, safety stock can be used to meet this unexpected demand. The unexpected rise in demand could be due to any reason – competitor increases prices, trends, etc. Without safety stock, this change in demand can lead to a missed opportunity.
Reduce the impact of price changes
Stock shortages or changes in market dynamics can lead to an increase in prices, as suppliers scramble to get their products into marketplaces where demand is high. Buffer stock can help you avoid paying inflated prices for raw materials or upcoming deliveries. Also, having safety stock available can reduce the number of unexpected expenses that a business has to deal with while re-ordering the product.
Ensure customer satisfaction
Your customers rely on you for specific products. When they visit your store (online or offline)and find that products are out of stock, they may become frustrated and angry and look for an instant alternative. This can damage your brand image and lead to lost sales. Therefore, it is important to keep track of inventory levels and keep buffer stock so that you can avoid this situation in the first place. Secondly, responding quickly to customer complaints can help restore faith in your brand and increase sales. Being proactive about safety stock management is key to ensuring customer satisfaction.
Minimize the impact of supply chain disruptions
Inventory shortages can lead to sales declines and financial losses for businesses. They can be caused by a variety of factors, such as natural disasters, transportation failures, or the unavailability of raw material. By keeping tabs on inventory levels and having ample safety stock, businesses can avoid any sales declines or financial losses due to disruptions in the supply chain.
How much safety stock does your business need?
You need to decide on how much safety stock to reap its benefits. Here are some formulas that you can use to calculate the amount of safety stock needed for a product:
Average safety stock formula
This formula is great when you have just started and works for average scenarios. It is the difference between the maximum daily usage and average daily usage for a product.
I.e. Safety stock = (Maximum amount of sales x Maximum lead time) – (Average amount of sales x Average lead time)
Let’s understand this with an example. Let’s say the maximum number of units sold in one day at your store is 100 and the longest it has taken the supplier to deliver the product is 15 days. On the other hand, the average number of units sold in a day is 60 and the average time it takes the supplier to deliver the inventory is 10 days.
Then, the safety stock that your business would need would be:
Safety stock = (100*15)-(60*10) = 900 units.
Fixed buffer stock
You determine the fixed number of units you would want for each product depending on the sales chart from recent months. There is no fixed formula for having a fixed safety stock but you can calculate it this way:
Fixed buffer stock: Average/maximum daily usage * number of days
For example, if the average daily usage of a product is 10 and you want a safety stock of 15 days. Then, the fixed safety stock = 10*15 – 140 units of the product.
This method of calculating safety stock does not take into account the demand or supplier lead time fluctuations.
Heizer and Render’s formula
This formula is best if there are significant variations in your supplier’s schedule. It does not take into account the changes in demand.
The formula is: Buffer stock = Z score * standard deviation in lead time
Here, the z score is the number of standard deviations above the means demand needed to prevent any stockouts. The standard deviation in lead time is the frequency by which your supplier’s average lead time differs from the actual lead time.
This method takes into account both the fluctuations in demand of the product as well as suppliers’ lead time. Its formula is:
Safety stock: Z score * standard deviation in lead time * average demand
5. EOQ (economic order quantity) formula
Economic order quantity (EOQ) is the optimal inventory you should have to minimize other inventory costs such as ordering, holding, and ordering costs. Its formula is:
EOQ = square root of (2 x setup costs per order x demand rate)/holding costs
Let’s understand this with an example. For instance, if you sell 500 units of a specific product annually, the fixed cost to place an order is $2.5, and it costs you $2 to hold this inventory, then,
EOQ = square root of (2*500*2.5)/2 = 35 units
We have shared some formulas for calculating the buffer stock. Choose the one that best fits your business needs so that you can meet the demands of your customers without overstocking. Overstocking will increase your holding (storage) costs as well as the risk of product expiration, impacting cash flows negatively.
To summarize, safety stock helps you manage customer demand and supply chain disruptions. If you have enough stock in buffer, you don’t have to rely on your suppliers for quick delivery or lose your customers by not giving them the product they require. It covers you until your next batch of inventory arrives. Make sure that you don’t estimate your buffer stock with just ideas but a definite formula.
Do you also keep safety stock of all your products? Which formula or software do you use for calculating safety stock for your product? Do let us know in the comments section below.
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