Safety stock provides protection against stock outs due to unexpected demand for a product or delays in receiving a replenishment shipment from a supplier. It is insurance – and like other types of insurance, it is an expense of doing business. Like many other types of insurance. there is no “right” or optimum amount. When you are determining safety stock quantities you have to ask yourself: “How much do we want to spend to prevent stock outs of this product?”
The answer will probably be different for various products you stock. In determining the safety stock amount for a particular product, you have to ask:
- What is the likelihood that this product will experience a stock out?
- How disappointed will customers be if this product is not stock?
Products are more likely to be out of stock if they experience:
- Inconsistent supplier lead times – If vendor shipments are often several weeks late, you may want to keep some extra stock to “cover” customer demand during these unexpected delays in receiving a replenishment shipment.
- Large fluctuations in sales or usage – You might sell 10 pieces or 1,000 pieces of a product in a month without much advance notice of when usage will significantly increase.
Though it is evident that some items need more safety stock than others, many companies maintain safety stock quantities with some general rules that apply to all stocked products. Typical safety stock policies include:
- We will maintain safety stock for all products equal to a certain percentage of lead time usage
- We will keep a certain number of days on hand as safety stock for all items
The result is that some products have too much safety stock (unnecessarily tying up funds, suppressing turnover, and taking up too much warehouse space), while other items have too little safety stock (resulting in additional stock outs and disappointed customers). Rather than applying safety stock across your entire inventory with a paint roller, we would like you to take a fine-tipped artists’ brush and “dab” specific amounts of safety stock exactly where it is needed.
To determine what products need more safety stock, analyze the safety stock quantity and actual sales or usage for each product over the previous three months to calculate the “residual inventory value”:
Forecast + Safety Stock – Usage = Residual Inventory Value
If (1) the residual inventory value is less than or equal to zero actual sales, or (2) usage was equal to or exceeded the sum of the forecast (what you predicted you would sell) + safety stock (your reserve inventory), you might have experienced a stock out on the item in that month. You probably can’t afford enough inventory to avoid stock outs on all stocked items. However, you might consider increasing the safety stock on “critical” products that have a negative residual inventory value in one or more of the previous three months.
Your decisions regarding safety stock are somewhat subjective. There is no “right” answer. But with some simple tools and analysis you can make an informed decision that will ensure that the funds you make available for safety stock are invested as wisely as possible.