skip to Main Content

Safety Stock How Much is Too Much (or too Little)?

Supply Chain Management Supply Chain Planning Supply Planning
10/06/2020

Do we really know how to get levels of safety stock balanced? Here’s a good analogy that might explain things. In the children’s story of ‘The Three Bears’, Goldilocks spends much of her time in the bears’ home looking for balance. She sat in a chair that was too hard, one that was too soft and then one that was pretty darn comfortable before repeating the rigmarole with a prolonged porridge tasting session. We left Goldilocks to her uncertain fate when she was discovered by her ursine pals, fast asleep in a bed, not too lumpy or saggy, but ‘just right’ .

Much like Goldilocks searching for the perfect balance of things on her adventure, so too do companies seek a perfect balance in the amount of safety stock they hold. Too much, and cash flow is inhibited with valuable money tied up in the warehouse. Too little, and stockouts occur, risking the loss of customers to a competitor. But just the right amount of safety stock can maintain cash flow while keeping service levels high.

What is Safety Stock?

Safety stock is the amount of extra material and components maintained to prevent stockouts based on demand. It ensures that if a company runs through its cycle stock, then additional demand can be met until regular replenishment can occur. Essentially, safety stock is the buffer used to absorb and smooth out demand volatility. And when used correctly, it can have several benefits including:

  • Avoids or reduces incidents of stockouts
  • Compensates for forecast inaccuracies brought on by unexpected shifts in demand
  • Mitigates variations in supply to prevent manufacturing disruptions.

Finding the Goldilocks Zone

So how does a company decide how much safety stock to hold? The first step is to determine where the uncertainty lies within the supply chain. One type of uncertainty is in demand. If demand spikes suddenly (think toilet paper at the onset of the COVID 19 crisis), then the safety stock formula chosen must address the demand uncertainty.

If the uncertainty is driven by lead time, the formula must address that as well. This is common in companies that rely on a supply chain that consists of local goods with little lead time alongside longer lead time materials that come from overseas and often only in bulk. Here, a delay caused by a missed ship or a hold up at a customs facility can mean that critical components do not arrive while other low lead time items are waiting in stock tying up cash.

Once the cause of uncertainty is established, there are several methods of calculation that can be used to determine safety stock.

  1. Fixed: Here, a standard calculator or judgement call by a planner is used to set a specific level of stock in units or by product family if the same materials can be used in multiple finished goods.
  2. Time-Based: Time-based safety stock calculations are useful in accounting for lead time uncertainty. In this calculation, the cycle stock is established and then increased by a percentage to allow for a specific number of days, weeks or months supply “on hand” to address demand or lead time shifts.
  3. Statistical: Statistical safety stock formulas use advanced formulas to take many variables into account to derive an optimal safety stock level. These variables include lead time, demand volatility and service level goals.

Finding the right Goldilocks zone for a company’s safety stock requires more than just a human judgement call. And that’s the problem with fixed and lead time calculations. They require that planners use the same logic as the Goldilocks analogy in sampling methods that are too much, others that are too little, until they settle on one that is just right.

As a result, the journey can be expensive in terms of excess inventory or lost sales. And because it’s backward looking and static rather than dynamic, it must assume that today’s “just right” will be next month or next year’s “just right” level as well.

Reducing Variability Through Automation

Very few companies can set their safety stock to zero and fewer still can rely on textbook formulas to ensure optimal levels of cycle and safety stock. The best way to set a reliable safety stock is through automation with demand and supply software. This software unlocks advanced analytical capabilities, statistical solutions for calculating safety stock and other advanced planning tools that eliminate human judgement as the determining factor for setting stock levels.

Software also uses both historical and near real-time data to unlock advanced analytical capabilities that help calculate economic order quantities, lead times and stock levels. This software also allows forecasting of time-phased inventory needs so timing and quantity for replenishment can be automated. And because today’s demand challenges are especially variable, it also offers ABC analysis based on revenue, margin, cost or units so that safety stock levels can be set for the most profitable items.

If you’re looking to optimize inventory and set reliable safety stock to the “just right” level and skip the costly too much/too little phase, try DemandCaster’s inventory planning and optimization software. With this, you’ll quickly find your Goldilocks zone and maintain optimal service levels through a safety stock level that removes both demand and lead time uncertainty.

 

 

 

Related Articles

Three Keys to Agility

Agility is defined as ‘the ability to move quickly and easily’. And over the last few years, agile methodology has been applied to everything from project management to software development. But agility can also apply to supply chains as well. [...]

Capacity Planning in Today’s Uncertain Environment

Simply put, ‘capacity planning’ is the process businesses use to make decisions on how much capacity is needed to meet demand. Along the way, companies aggregate historical data, produce forecasts, and interpret market and sales data to make determinations that [...]

A Bridge too Far – Why ERP Systems Alone Short Change Supply Chain Planning

In business, the search for a “convergence” of devices and software allowing a single solution to address all problems has been an ongoing goal. However, the reality is that such equipment and software doesn’t exist. This is true of Enterprise [...]

Supply Chain Planning to the Rescue – Cash Flow Management During COVID-19

During the best of times, managing cash flow can be challenging. But during long-term disruptions such as COVID-19, cash flow management can become an existential exercise. As companies look to assess the damage from the pandemic, in order to define [...]

Demand Forecast Accuracy – A Better Way to Fight the Bullwhip Effect

Supply chain disruptions are nothing new. As 2020 continues to demonstrate, some disruptions can have a greater, catastrophic impact. But even small fluctuations can cause what is known as the “Bullwhip Effect”. This phenomenon occurs when demand signals are amplified [...]

Beating Disruption with Digital Supply Chains

In the past, companies relied on the shared knowledge of a handful of people within an organization - and sometimes just one person - to plan and manage supply chain requirements. Supply Chain Management (SCM) consisted of phone calls, desk [...]

A Comprehensive Guide to Predictive Inventory Planning and Management

Inventory management remains an important operational feature that determines the successes and failures of enterprises especially in the manufacturing and retail industries. For inventory management, the challenges for most enterprises are similar at a basic level. The mom and pop [...]

5 Steps to Digitize Your Inventory Planning Process

Many companies cite “inventory optimization” as a goal.  And with the digital tools available today, companies can manage their inventories better than ever with cutting edge inventory planning software such as that provided by DemandCaster.  These platforms empower companies to [...]

Advanced Planning Challenges in Brownfield Facilities

The manufacturing industry relies on its legacy systems and equipment to get work done. This has been the way for decades. A report on the state of the manufacturing industry states that only 26% of manufacturing plants believe implementing new [...]

6 Tips to Improve Inventory Management through Automation

For companies with outdated or manual inventory management systems, lack of certainty about the accuracy of inventory levels can make managers and decision-makers apprehensive during busy times.  If calculations and inventory management practices are off, companies may find themselves with [...]
Subscribe to our Blog
Back To Top