Achieving the magical balance of minimal inventory while meeting variable customer demand in the face of unreliable supply is only possible with optimal safety stock levels.
Without optimal safety stocks, product availability and the value of inventory oscillates between stock-outs and having too much inventory based on who shouts the loudest:
- Customers or sales saying “I can’t believe we’re out of stock!”
- Finance saying “We have too much money invested in inventory!”
Why do we need safety stock?
Safety stock is our insurance against running out of stock due to uncertainty in demand and supply – it protects our fill rate and sales revenue.
For example: if we knew exactly what we were going to sell and when, and our suppliers always delivered the quantity we asked for on time and in full, there would be no need for safety stock.
- Sales are hard to forecast as some items may sell smoothly, others seasonally; items could have regular demand or might sell sporadically; items could be big sellers or sell a few units per year; and we continue to add new items to our range
- Suppliers may deliver on time, late or, in some cases, early
- Suppliers may deliver the quantity we ordered, too little or too much
Setting safety stock for the right reasons
By monitoring how well we have forecast an item and how reliable the supply has been, we are able to dynamically adjust the safety stock based on the risk to the business.
For products where we are more likely to end up with excess, we reduce the safety stock:
- We keep forecasting more than we end up selling, and buy too much
- Suppliers mostly deliver early or more than we ordered
For products where we are more likely to run out of stock, we increase safety stock:
- We continually sell much more than we forecast, and buy too little
- Suppliers mostly deliver late or short quantities
Other factors that influence safety stock
- The length of the lead time
- Supplier minimum order quantity and order multiple constraints
- The frequency of ordering
Target fill rate + inventory risk = predictable outcome
Establishing your inventory investment by setting a target fill rate that reflects your market offer and factoring in the “inventory risk” in your business results in an optimal safety stock level. For every single product. In every location. Everyday.
While we protect the fill rate, we also target the fill rate we want to achieve and compute safety stocks to deliver that fill rate. With optimally set safety stocks we take investment away from products that do not need it and invest more in products that do.