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The inventory advisor

Feb 5, 2020

What is safety stock, and factors to consider when calculating it?

Supply and demand are what drives the supply chain. In a perfect world, if our suppliers always delivered on time and in full, and we knew for sure how much customers would spend each month, we could match the supply with the demand, and all would be well. However, in reality, suppliers’ lead times often vary, and they may not always deliver the full shipment in one delivery. Additionally, due to seasonal and fashionable trends, customer demand fluctuates. To protect yourself from supply risks, you need to have a certain amount of safety or buffer stock available. Having safety stock ensures that your customer service levels are maintained.

In our personal lives, we have car insurance to lessen our risk, and we are happy to pay for this policy even though we may never use it. Car insurance helps us sleep better at night, knowing we are financially protected. Specific risk profiles are associated with car insurance policies, and your monthly premium amount will depend on these risk factors. Factors that insurance companies look at when determining your risk level are things like age, sex, demographics, and previous history. The same considerations apply when looking at your safety stock. Insurance companies look at the history and behavior of the driver; inventory planners look at the history and behavior of a stock item to determine what its ‘safety premium’ should be.

Safety stock is there to protect you from late or part deliveries and from underestimating your sales. There are a few factors and considerations to take into account when calculating what your safety stock should be.

 Suppliers history

Look at your supplier’s order delivery history and analyze this in detail:

  • Analyze your order information against your goods received information and specifically look for: 
    • How often were items delivered in full or in part? 
    • Supplier anomalies – remove these from your equation so as not to skew the results. 
    • Irregularities such as goods airfreighted in on special orders or orders where there was an unexpected delay. 
  • By taking out these anomalies, you get an accurate representation of how that supplier generally performs. When determining overall supplier performance, look at how well they deliver stock to you in terms of both quantity and time.

Previous sales & forecast history

From an outbound supply chain perspective, analyze your sales history against your previous forecast. Look at the level of accuracy and predictability – what is the variation between your sales and your forecast?

  • Don’t only look at the last forecast for the month compared to the sales – the purchase decision is often taken months in advance of that.
  • Start the measure when there was stock of the item to sell, rather than the date the product was added to the master list.
  • Factor in both computer and staff overrides into the forecast measure – it is the combination that results in what you end up buying.

By taking the real risk associated with the forecast into the calculation of your safety stock, you will have the buffer you need to help your buying and sales teams do what they do best. 

Target fill rate (customer service levels)

We should all aim to provide 100% customer service levels by having stock available 100% of the time, but unfortunately, this is not always possible. As a start, ensure that the safety stock on your fast movers is higher than on your slow movers – you wouldn’t want to get caught with no stock on your popular items!. The higher the target fill rate of the item, the more safety stock is held to buffer the risk. Remember to model that impact. Setting high target service levels when you have poor service right now, will cost a lot of extra stock – can you afford to do that all in one go? Should you rather slowly increase the levels to get to where you want to be?

Calculate your safety stock in days, not units. 

Some inventory management systems and tools allow you to set the safety stock or minimum stock in units. If you are using units, for example, 100 units in high season may not be enough, but in the low season may be way too much. Rather use a time metric. Using days, for example – 25 days’ worth of inventory, may be 200 units, but in low season 25 days may only be ten units. In this way, you can bring your inventory down, but at the same time, improve your service level to your customers. 

To keep your fill rates up without burying your working capital in excess stock, keep analyzing the risks and adjust your safety stock accordingly. Long lead times and bad forecasts are the roots of all evil when it comes to inventory. Work on the business processes and look at the tools you are using to perform your inventory planning. If you are still using spreadsheets, you may want to look for a solution that has been built and developed to address all inventory planning challenges.