Safety stock is a retail term used to refer to an additional quantity of items help by a company in inventory to reduce the risk of being out of stock. In a perfect world, we would never run out of stock. Unfortunately, it’s not a perfect world and at some point, it can happen to you. To reduce the risk of stock out, companies maintain safety stock.
Safety stock acts like a buffer just in case demand rises for a product or if a supplier is unable to deliver additional products for a longer duration than normal. Retailers would keep additional products on hand while manufacturers would keep a safety stock of materials to minimize the risk of production interruptions.
Now, if it’s that easy to avoid out of stocks, why doesn’t every company use safety stock? Ultimately, it’s due to cost as safety stock can be very expensive. On top of that, you have holding cost or carry cost you have to deal with. While holding and carry cost can be expensive, lost sales may be more expensive, so it’s a delicate balance that companies must control on a regular basis.
Things Can Change Quickly, Even Instantly
An unpredictable surge in your product’s popularity can leave your supplier unable to match the level of demand, at the least it may take a long time to replenishing your inventory. Things can breakdown in production, you may need machinery repaired that can put you down for days. Severe weather, from snowstorms or hurricanes (or other weather related troubles affecting your stock) can strike with very little warning, the unexpected can happen. Having safety stock in place is one way we can be prepared for the unexpected.
As it pertains to your supply chain, problems are going to happen, but what’s the best way to handle these types of incidents when they happen? It’s not like you can just stop selling until everything is back to normal. There’s no way you can do that, so what’s the right answer?
I’m sure many of you reading this would likely ask, “what about backordering?” Now, backordering could work but there’s risk associated to it, like missing sales and bad customer loyalty. There has to be a better way, right?
There is… it’s called safety stock. Safety stock is like a small emergency warchest you can break out when the going gets tough and it looks like you’re on the verge of selling out. You’d want to have enough in it to help you weather the storms when they roll around, but not so much that the carrying costs end up straining your finances. While this sounds like common sense, the trick is to decide on how much safety stock to carry.
There’s the temptation to stock enough to last you until a fresh shipment (or two) comes through, but always remember that the more you stock, the higher your carrying costs become. Just think about it; whatever you sell doesn’t just have to cover its own carrying costs – it has to cover the carrying costs of the safety stock as well.
How To Calculate Safety Stock?
1. Multiply your maximum daily usage by your maximum lead time in days.
2. Multiply your averare daily usage by your average lead time in days.
3. Calculate the difference between the two to determine your Safety Stock.
Safety Stock = (Maximum Daily Usage x Maximum Lead Time In Days) – (Average Daily Usage x Average Lead Time In Days)
It may take a second to do the calculations but it’s simple. All you need to start is your purchase and sales orders history.
As usual, we’ll give you an example.
There is a business based in the United States (Doug’s Gold Coins) and they’re selling graded gold coins in Canada. On an average, it takes about 48 (average lead time in days) days to get the graded coins from Canada to the United States. Doug’s Gold Coins sell about 15 coins a day (average daily usage), and on weekends and bank holidays, they can sell as many as 18 (maximum daily usage). Unfortunately, in Canada they have bad snow storms, this results in longer lead times, up to 60 days (maximum lead time in days).
So for Doug’s Gold Coins, their safety stock levels would be:
(18 x 60) – (15 x 48) = 360
This means Doug’s Gold Coins would need to have about 360 units of safety stock on hand at any time (especially during the fall and winter when snow storms are common). With 360 units in their safety stock stockpile, selling about 90 gold coins a week (15 per day on weekdays and 18 per day on weekends), Doug’s Gold Coins will have enough stock to last just over three and half weeks.
Your safety stock is there to protect you against all the fluctuations in demand and lead time, buffering you against all unexpected occurrences. From a surprise spike in demand to a boom in popularity or delays caused by the weather, your safety stock is there to get you through any trials and tribulations you should face.
While it varies on exactly what you’re selling or manufacturing, you always need to pay attention to the different seasons. If you’re like Doug’s Gold Coins, you may see a spike in demand around the holiday season. Doug’s gold coins tend to fly off the shelves come December as they make great Christmas presents, tripling demand. So for December, Doug’s Gold Coins would need to make sure there’s enough safety stock just in case demand doubles or higher.
Now, once the peak of the season has passed, you’ll need to start reducing your safety stock levels. Remember: more safety stock = higher carrying costs. After the holiday season has passed, there’s going to be a lot less people shopping, which equals less opportunities to sell your products.
Stock Levels And Reorder Point
Now, you just learned how to calculate your safety stock and what levels will your reorder points.
When it’s time to decide your reordering quantity, you shouldn’t keep your safety stock locked up. Instead, it should be a quantity that exists in your order management software, especially since it’s a vital part of reorder point calculations.
*Accelerated Analytics publishes resources like this to provide insights to different analytical metrics, data points and formulas. Please be aware, we’re not claiming that our POS reporting services will offer this example or any other metric, data point or formula. To learn exactly what our reporting covers, please feel free to schedule a demo or give us a call. Thanks for understanding.