Safety Stock
Safety stock is an inventory management concept. It refers to the extra stock of an item kept on hand to prevent stockouts (out-of-stock situations) caused by uncertainties in supply (like delays from suppliers) or demand (unexpected spikes in customer orders). The main goal of safety stock is to ensure that operations continue smoothly when there are disruptions in the usual supply and demand patterns.
Factors Influencing Safety Stock Levels:
- Lead Time Variability: The time between placing an order and receiving it can vary. If your supplier usually takes two weeks to deliver but occasionally takes three weeks, you’ll want to have an extra week’s worth of stock as a buffer.
- Demand Variability: If your sales forecasts are not always accurate or if demand is unpredictable, you’ll need more safety stock.
- Desired Service Level: The higher the desired service level (i.e., the probability of not having a stockout), the more safety stock you’ll need.
- Supplier Reliability: If a supplier is known to occasionally miss delivery dates or send incomplete orders, higher safety stock might be necessary.
- Ordering Costs: If it’s expensive to place orders (because of shipping fees, administrative costs, etc.), a company might want to order less frequently and keep more safety stock on hand.
- Cost of Stockouts : If running out of stock is very costly in terms of lost sales, customer dissatisfaction, or production delays, a company will want more safety stock.
Calculating Safety Stock:
While there are multiple methods to calculate safety stock, a basic formula is:
Safety Stock = (Maximum Lead Time in Days − Average Lead Time in Days) × Average Daily Usage
This formula works under the assumption that usage remains relatively constant and lead time is the primary variable. However, in more complex scenarios where demand also varies, more advanced statistical methods may be used.
Example of Safety Stock
Lucia owns a small bakery that specializes in artisanal sourdough bread. She has a steady flow of customers and usually sells around 50 loaves per day. She receives flour deliveries from her supplier every week. While her supplier typically delivers within 3 days of an order, there have been occasions when it took up to 5 days.
Lucia knows that running out of flour would mean she can’t bake her bread, leading to lost sales and disappointed customers. To prevent this, she decides to keep safety stock of flour.
Variables:
- Average Daily Usage: Lucia uses enough flour to bake 50 loaves per day.
- Average Lead Time: It typically takes 3 days for flour to be delivered.
- Maximum Lead Time: Sometimes it takes 5 days for delivery.
Calculating Safety Stock:
Using the formula:
Safety Stock = (Maximum Lead Time − Average Lead Time) × Average Daily Usage
Safety Stock = (5 days − 3 days) × 50 loaves/day = 100 loaves
Lucia would need enough flour to produce an extra 100 loaves of bread as her safety stock. This ensures that even if her supplier is late by 2 days (the difference between maximum and average lead time), she will have enough flour on hand to continue baking her daily average of 50 loaves.
After implementing this safety stock level, Lucia feels more secure in her operations. Even if there’s a delay in her flour delivery, she can still meet her customer demand. Over time, she periodically reviews and adjusts her safety stock levels based on any changes in customer demand or supplier reliability.
