A strategic supply management system is crucial for any business’s success. It ensures reduced operational costs, increased customer satisfaction, and steady cash flow. However, it’s not easy to main a successful execution of supply chain management. There is a need to roll the technology, processes, and people together in the right quantity, to get the right product, at the right time, to the right customer. That’s why the safety stock be used to mitigate the supply chain risks. It helps businesses stay ahead and prevent any potential stock-out situation.
What is safety stock?
Safety stock is the extra quantity of items held by a company to reduce the risk of being out of stock. It works as a buffer when a supplier is unable to deliver expected additional units of an item.
This strategy is often used in case of stocking out caused by:
- Changes in consumer demand
- Raw materials variability in lead times
- Forecasting incorrect stocks
Why should you use safety stock?
Being out of stock during high seasons results in a negative brand image. There are two main reasons why you should ensure your safety stock: lead time uncertainty and demand uncertainty.
Lead time uncertainty
For companies whose products contain several components, lead time refers to the time needed to assemble pieces into a complete item. It is crucial to determine safety stock requirements and minimum inventory.
For example, automobile manufacturers often experience engines and other components arrive at the factory just a few hours before the production. This delay, if not addressed well, might cause the whole system to shut down.
Every manufacturer and retailer has products selling throughout the year. If the demand and supply are consistent, it does not require a large amount of safety stock. Nevertheless, there’re always seasons when the demand is higher than others. For instance, products like desk fans often experience high demands during the summer. It’s not easy to calculate the expected demands, hence, you need safety stock.
Safety stock formula
You can calculate the amount of stock needed by looking at the sales volume in the previous year. The formula is:
Safety stock = (Maximum daily usage x maximum lead time in days) – (average daily usage x average lead time in days)
For example, it takes 40 days for a retailer in New York to receive the tea sets made in Russia. The company sells nearly 15 sets a day, which can be considered the average daily usage. Meanwhile, a sale of 25 on good days can be taken as the maximum daily usage. In Russia, unfortunately, snowstorms and traffic jam result in delays up to 55 days and it may be taken as the maximum lead time in days.
Taking the calculation:
(25 x 55) – (15 x 40) = 775
It means 775 tea sets must be carried at all times as safety stock, particularly when the winter season is coming in Russia.
All in all, knowing the stock holding formula helps businesses in navigating safely through demand and fluctuations. Without safety stocks, businesses risk failing customers’ expectations, hence negatively impacting the sales revenue.
However, note that this is only one solution for inventory management. You should also look at your KPI, assistant tools, identify trends and issues.