How much safety stock do you really need?
To a lot of business owners, holding huge swathes of safety stock seems like a good idea. Having the safety net of deeper availability will keep your customers happy and profits soaring.
Miscalculate it however, and it’ll be one of the costliest mistakes you can make – and your entire business could suffer.
The amount of disruption in the world today eclipses what we’ve been used to. There’s strike activity throughout key supply chain hubs, war raging, upheaval from the pandemic and growing concerns over the environment.
Consequently, the art of running a successful supply chain has never been trickier.
It seems we’re only ever one day away from another disaster dropping on our doorstep, be that from unstoppable inflation, a recession or a left-field political shift. The stakes for your supply chain are higher than ever before.
Allowing wasted revenue, space or throwing away out-of-date or unsaleable products into landfill will increase this risk on your business tenfold.
So how do you strike the perfect balance for safety stock? Let’s run through it.
What is safety stock?
Let’s start with the basics.
The purpose of safety stock is to buffer against uncertainty. It’s the amount of inventory you hold on to, on top of what you expect to sell.
Obviously, demand fluctuates as does supply. The right level of safety stock will ensure you are able to supply the products your customers want. And with the optimal level of safety stock, you’ll have enough inventory to fulfil your orders, keep your customers happy, eliminate financial loss from lost sales and uphold your brand reputation.
Safety stock is essentially your buffer against the worst-case scenario. It helps you in the times your suppliers let you down and works as an inventory overdraft for times of turmoil.
Therefore, the level of this buffer stock should be backed up with robust analysis to calculate future demand.
How to calculate safety stock
If you were to sell out of a product you’d just introduced, would you consider that to be a roaring success?
It’s highly likely most companies would. And yet, what’s also highly likely is the fact that, by not ordering sufficient stock, you’d be disappointing a huge number of potential customers who had wanted to spend their money with you. That’s lost revenue and lost profit.
The truth is, when this happens, it shows that you’ve been overly cautious with your stocking decisions. You should have invested in more to begin with.
That’s a tricky thing to do with a product introduction because the amount of demand is unknown. It’s understandable to not want to over commit to stock you might not sell. But now you’ve sold out, you’ll pay the price for not buying more.
Should you have bought more and taken a bigger risk? Possibly. But just as you can’t predict a product’s success, you also can’t predict its failure.
Products whose success rides on the coattails of a fad can be even harder to foresee. Take the rise and fall of fidget spinners. In a matter of days, these toys swept through playgrounds across the country.
Many businesses invested in these products. And for a short period, they accounted for 17% of total toy sales.
Investing in safety stock seemed like a fairly obvious decision then. Only, as quickly as they had arrived on the market, they departed from consciousness in much the same way.
Sales of fidget spinners, ironically a product designed to lower stress and anxiety, have now flopped completely. Any company that had the misfortune of over investing in them probably still has a few thousand left in their warehouse … unless, of course, they have already been sent to landfill.
The lesson here is simple. When it comes to safety stock, striking this fine balance is a tightrope walk you don’t want to falter on. You must find the right trade-off between service levels and investment of working capital in stock and risk.
What factors should safety stock account for?
You can spend as much time and money on data and analytics as you like, the reality is it’s almost impossible to perfectly predict actual demand.
Similarly, as good as your relationship with your suppliers is, their delivering on time, and at the right quantity, is always hard to predict.
This is where safety stock comes in. It can protect you against the disruption from both of these factors.
However, you must account for 4 key areas in your safety stock calculations:
- Volatility in demand
- Lead-times and supplier reliability
- Service level targets
- The “real” risk of going out of stock