Safety stock inventory Q&A

Sam Phipps

Last updated: June 13, 2023
Sam Phipps Slimstock Round 230x230 Webp

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Allowing wasted revenue, space or throwing away out-of-date or unsaleable products into landfill will increase this risk on your business tenfold.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.


Safety Stock Full Warehouse


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.


Safety Stock Fidget Spinner


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

Man Working On Slim4 software


Book a demo today

How do I calculate perfect safety stock levels?

To work out the perfect safety stock levels for your business, you need to analyse the cost of holding excess stock and weigh this up against the risk (and impact) of running out of stock.

Here are some simple pointers to assess your safety stock requirement:

1.  Determine the lead time:

How long will it take for your supplier to get your goods to you once you’ve placed an order?

The longer this period, the greater the risk of disruption and uncertainty. If your lead times are extremely short, the need for safety stock is less urgent.

However, if your lead times are measured in months, chances are, your safety stock level will need to be higher.

2. Determine the demand variability:

Is it likely that this product will go the same way as fidget spinners and drop off a cliff? Or does the item in question have longevity? You can calculate demand variability by analysing historical sales data or using statistical forecasting methods.

3. Calculate the service level:

How important is the product to your customers? To answer this question, businesses set the service level targets. The higher the target service level, the greater the requirement for safety stock.

However, some products are more important than others. Therefore, it makes sense to prioritise your investment in safety stock in the products that matter most.

4. Apply the right safety stock formula:

How do you currently assess your safety stock levels? Do you stick a finger in the air? Or do you use the data to make a rational decision? There are several safety stock formulas that you can use.

Here is a quick summary of some of the main formulas:

Formula Calculation Suitable for
Fixed Safety Stock Fixed Quantity Appropriate for items with consistent demand and lead time
Periodic Review (Max Demand x Max Lead Time) – (Average Demand x Average Lead Time) Appropriate for items with seasonal or intermittent demand
Service-Level-Driven Safety Stock Z-score x Standard Deviation of Lead Time Demand x Average Lead Time Demand Appropriate for items with unpredictable demand or lead time
Erlang C (Average Lead Time Demand x Lead Time in Days) + Safety Factor Appropriate for items with long lead times and short selling seasons

How do the mechanics of safety stock work?

One of the most common is the service-level-driven approach. Taking a deeper look at the equation can explore some of the permutations of the model and the intimate relationship between service levels and safety stock.

As highlighted in the table below, the formula in question is:

Safety stock = Z-score x Standard Deviation of Lead Time Demand x Average Lead Time Demand

In the next section, we will get a little bit technical. But stick with us …

What is Z-score?

A Z-score (or standard score) is a term which represents the number of standard deviations a data point is from the average. To achieve a higher service level target, you must be able to cover a greater level of deviation to reduce the risk of stockouts.

Hence the Z-score increases as the target service level is increased.

You can look up the appropriate Z-score based on your desired service level in a standard normal distribution table:

Service Level Z-Score
90% 1.28
92% 1.75
95% 1.96
97% 2.17
99% 2.58

What is Standard Deviation of Lead Time Demand?

The next step is to consider the standard deviation of demand during the lead time. This represents the statistical measure of the variability in the demand for a product during the lead time from suppliers.

It quantifies the degree to which the demand for a product can fluctuate or deviate from its average value during the lead time. To calculate this, look at historical sales data or use statistical forecasting methods.

A higher standard deviation suggests a greater level of uncertainty or variability in the demand, while a lower standard deviation indicates more stability in the demand patterns.

What is Average Lead Time Demand?

The final piece in this puzzle is the so-called average lead time demand.

Average lead time demand refers to the average level of demand you anticipate during the lead time. This, of course, is the duration between placing an order for a product and receiving it from the supplier or manufacturer.

To calculate the average lead time demand, you typically consider the historical or expected demand for the product over a specific period to estimate the amount of demand you can expect during this period.

Something important to mention here is that this isn’t a one off. You need to be performing this analysis on an almost constant basis. It’s not just for when you introduce a new product or go to market. You should be perpetually monitoring and adjusting as demand patterns and lead times change over time.

How does uncertainty in demand impact the requirements for safety stock inventory?

It should be common sense, but let’s detail it anyway.

If you have lower volatility in your demand levels, it’s less likely you’ll need safety stock. Those businesses who can set their watch by their demand will rarely run out. But they’ll also rarely have demand which falls short either.

Businesses with demand patterns like this are few and far between, if they exist at all. It’s far more likely that your business, and others competing with it, will see constant volatility in demand.

Most businesses have exposure to stockouts and excess. This uncertainty makes the requirement for safety stock a must and getting the calculation over its size incredibly important.

How can lead time influence the need for safety stock?

Safety stock is an incredibly useful tool in covering the uncertainty that arises from variable lead times.

You’ll know how infuriating it is to wait longer for a product than expected after placing an order … even if that’s your usual Friday evening takeaway. When that product is the difference between a profit and a loss however, it’s even more important.

For products with very short lead times this isn’t so much of a worry. This is especially true because, with a shorter lead time, typically comes a shorter variance in volatility. If, for example, you have an order with a 1-day lead time, it’s highly unlikely that a disturbance will push it beyond manageable levels. It does happen, but it’s much less likely.

In this case, you’d expect your customer to be fairly understanding of receiving their product a day late, and therefore, safety stock is probably not needed to cover a shortfall.

Compare this with products being shipped from the Far East to the UK however, and both the lead time and the risk is likely to be far higher. Let’s say it takes up to 12 weeks for an order to be received. In this case, there’s far more opportunity for things to go wrong. There are more variables, and the potential increase in lead time is far greater.

Is a customer of yours happy to wait a further 12 weeks on top of the 12 they’re already waiting? It’s probably unlikely.

And even if they do wait, they’re not likely to be happy doing so. Therefore, to continue with the same product availability, you’ll need a greater reserve of safety stock.

Should safety stock inventory cover supplier reliability issues?

It’s easy to blame delivery delays and issues on your supplier. They are, after all, the ones in charge of getting their stock to you, so that it becomes your stock.
But playing the blame game will only get you so far. And it’ll do nothing to instil faith in your customers that you’ll be able to eventually supply the goods they want.

So, should you increase safety stock on the off chance that your suppliers will be unreliable? Probably. There’s no point in telling your customers you’ve been let down by suppliers again. They’ll simply shop elsewhere and perhaps gently ask why you didn’t have a contingency in place.

However, if a supplier is consistently late or regularly fails to deliver your complete order as promised, questions should be asked. Perhaps there are gaps in your data. Or maybe it’s time to address the situation head-on, be that through collaboration or by finding an alternative source of supply.

Why do service levels have such a big impact on safety stock?

Maintaining a 100% service level seems like a fair target. Sadly however, it’s grossly unrealistic, if not virtually impossible.

Of course, it’s only natural to want to offer your customer 100% satisfaction, based on their demand. But aiming for 100% would likely require such a deep reserve of safety stock, you’d be leaving your business open to high levels of risk.

The reason service levels are such a high driver of safety stock is this direct correlation between the two. And it needn’t be a number as high as 100% to increase your risk.

The greater your desire as a business to satiate the demand of your customer, the larger your safety stock needs to be. Yet, the more the risk increases. Ok, leaving your business open to the possibility of a stockout is regrettable – you’re leaving profit on the table and not maximising opportunity – but having hoards of excess waste is just as big a problem.

When you invest in safety stock, you commit valuable working capital. And if this stock never shifts, your cash could be lost for good.

But also, let’s not ignore the stress that high levels of inventory place on your warehouse and logistics operation.

Therefore, it’s important that you challenge your presumptions around safety stock:

What you need to analyse is the strategic importance of those products.

  • Do they have a shelf life?
  • Are the products likely to sell eventually?
  • Are they generally quick moving?
  • Is the product a fad or seasonal?
  • Could you use the money to invest in other pockets of the business which have lower risk?

What if the risk of a stockout is low?

There are some occasions when the risk of running out of stock is extremely low, like a product with a minimum order quantity that covers the likely customer demand for an entire year.

If your business is only making one order per year, and that demand is steady and unlikely to impact customer satisfaction until many months down the line, it’s less of a problem.

Even if the product shot up in demand and experienced higher levels of volatility, you’d have plenty of time to replenish your stock should levels become low.

You’d also expect to have good damage limitation from lead times, given how far down the line you’d know about the potential of a stockout.

How appropriate are your safety stock levels?

Safety stock, on the face of it, seems like an easy conundrum to resolve: order some, but not so much as to make it a risk. Except that, making a decision of this magnitude with only a guess or estimate based on nothing more than a stab in the dark is a very bad move.

Use the formula above to make a continuous assessment, and you’ll ensure your business is safeguarded against volatility in the market.

There’s not much you can do to stop a war or another pandemic raging through the world. But you can take care of your own business by being well prepared.

By limiting the impact of stockouts and managing your revenue closely, you’ll have a tight control on safety stock and a better outlook for the future.

Essentially, it boils down to these two questions:

  1. Do you have enough stock to meet demand?
  2. Do you have too much?

There’s a fine line between too much and too little. But luckily, we can help you toe that line.

Speak to one of our experts for free, and we’ll have you on the path to safety stock success in no time at all.

FAQs about safety stock

What is safety stock?

Safety stock refers to the inventory that a company holds beyond its average expected demand to act as a buffer against uncertainties in demand and supply. It serves as a safety net to mitigate risks associated with fluctuations in customer demand, supplier delays, production issues, or other unforeseen disruptions in the supply chain.

Why is safety stock important for inventory management?

Safety stock is essential for protecting your business against volatility in demand and supply. Essentially, safety stock protects availability against lead time delays, supplier performance issues, and unexpected demand.

How do you calculate safety stock?

There are several approaches for calculating safety stock. The specific method you should apply depends on the nature of the business and your inventory management goals. Here are two commonly used methods for calculating safety stock:

  • Standard deviation method
  • Service-level-driven-approach
  • Reorder point method
  • Min/max approach

How can safety stock be optimised to balance cost and service levels?

Safety stocks are not something which can be set once and forgotten about. You should continuously review and challenge your safety stock.

To optimize safety stock and find the right balance between cost and service levels, there are a few things you can do including

  • Improve the accuracy of your demand forecasts
  • Optimise service levels
  • Collaborate with suppliers to avoid delays and bottle necks
  • Enhance internal communication to ensure aligned planning

Please select your location to see content specific to your country