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.
- 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.
- 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.
- 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.