Inventory management is all about supply and demand; if you don’t have enough products in your inventory, you could lose sales and jeopardize your business. Safety stock is also crucial if there are changes in consumer demand, stock problems, or bottlenecks in your supply chain. But how much is too much, and how do you calculate what you need?
About safety stock
American retailers have, on average, around $1.43 in inventory for every dollar of sales they generate. Sometimes, though, this just isn’t enough. This is because there are many variables that influence the number of products you sell, such as surges in consumer demand and general market conditions.
Maintaining safety stock levels reduce stock-outs and ensure customers receive their products on time. Safety stock is useful in the following circumstances:
- Consumer demand changes
- A problem with your supply partners and you are unable to order more stock
- A problem in your warehouse and you are unable to produce more stock
Pros and cons of safety stock
Safety stock provides you with a safeguard if there is a sudden change in demand for your products. Supply and demand can fluctuate without notice, so many retailers store additional items for peace of mind. That said, safety stock is expensive. If you keep too many products in your inventory, you might be holding them for an extended period of time.
Determining safety stock value
This is the difficult part. If you don’t order enough safety stock, you’ll increase the likelihood of stock-outs. If you order too much, you’ll end up wasting cash.
Use demand planning software to gauge demand
It can be difficult to anticipate demand because you can’t predict the future. A low-selling product might suddenly be in demand if an influencer features it on social media, for example. Although not an exact science, using the latest demand planning software helps you determine supply and demand in your organization. These programs analyze historical sales data and make predictions about which products are likely to sell in the future, and which products won’t.
Use a safety stock formula
Using a safety stock formula helps you determine the right amount of stock to keep in your inventory. There are many different formulas that different software companies leverage, for example leveraging the standard deviation to determine variations in supply and demand. The definition of standard deviation is a quantity calculated to indicate the extent of deviation for a group as a whole. Effectively this means you:
- Find the average of a set of data
- Calculate the sum of the average and the data set
- Take the sum and divide it by the sample proportion to get the variance
- Add the variance to the average
The sum is your standard deviation.
With this in mind, the formula for calculating safety stock is as follows:
Z × σLT × D avg
where Z is the desired service level, σLT is the standard deviation of lead time, and D avg is demand average.
Don’t be intimidated. The simplest method for calculating safety stock only requires a four-step process to calculate these variables. For more advanced, automated calculations, reach out to Vanguard Software.
Reduce variability in demand
Find out which variables impact supply and demand in your business. For example, do you tend to sell more products during promotional periods? Do longer lead times result in less demand for products? Reducing variability in demand helps you manage safety stock more effectively.
Tips for keeping safety stock
Buying in bulk provides you with enough products to meet regular demand, as well as additional stock in the event of an emergency. Purchasing excess stock from suppliers is less expensive than re-ordering items over time.
Make sure that you have enough warehouse space for additional stock, and factor in the cost of additional storage costs when you’re creating your safety stock strategy.
Maintaining safety stock is a critical component of your inventory management strategy. Calculating safety stock ensures that you reduce inventory costs.