In today’s volatile and uncertain world, stock management has become strategic for companies. It represents a key lever to mitigate risks, optimise inventory costs and ensure customer satisfaction. To cope with changes and uncertainties, many companies maintain consistent safety stock in their warehouses. The challenge lies in knowing how to effectively calculate safety stock, using precise formulas, and implementing the right optimisation strategies for procurement.
Safety stock: Definition
Safety stock, also known as buffer stock, refers to an additional inventory level held by a company to deal with unforeseen circumstances. This safety stock is set aside for emergency situations.
A delivery delay or a spike in demand can quickly prevent the smooth flow of the supply chain. Optimal safety stock allows precisely for preventing potential stockouts related to such uncertainties, without tying up too much capital. This helps avoid potential damages to the company such as customer dissatisfaction, decreased turnover, or additional costs.
There are two main types of uncertainties that can impact stock levels:
- Supply-related uncertainties such as delivery delays, nonconforming goods, production issues…
- Demand-related uncertainties such as unexpected or seasonal spikes in demand, orders from a major customer…
Mehdi Kharab, co-founder and Chief Revenue Officer of Colibri, a Sales & Operations Planning solution, reminds us that effective stock management relies on two key elements: "To have the right stock, in the right place, at the right time, a factual and rigorous methodology combined with an efficient stock management tool are the best allies."
Which products are concerned?
Within a company, not all products necessarily need safety stock, or the same level of safety stock. Before even calculating safety stock, it’s crucial to determine which products will be concerned. Otherwise, this safety stock can cause extra stock in the warehouse and generate unnecessary holding costs.
Pareto’s law
Pareto’s law, or the 80/20 rule, considers that 80% of the overall value is produced by 20% of the most important units. In our case, this means that safety stock should be maintained for 20% of the products that represent 80% of the total value.
The spend method
Inspired by Pareto’s law, the spend method allows for a more refined classification of products based on their value:
- Head spend: 20% of products representing 80% of the value;
- Mid-tail spend: 30% of products for 15% of the value;
- Long tail spend: 50% of products for 5% of the value.
For each category, different stock management strategies should be applied, with adapted levels of vigilance regarding safety stock.
Variables for calculating safety stock
All safety stock is influenced by different variables: Fluctuations in demand, supplier lead times… Regardless of the method and mathematical formula chosen to calculate safety stock, these variables must be determined.
Lead time
Lead time indicates the time in days required to receive a new order after placing it. This includes processing, production, and delivery time. This time can vary depending on several factors, notably geographical distance and supplier reliability.
Service levels
Each company sets objectives in terms of customer service levels. However, this variable depends on the commercial policy, the type of products sold, and the business sector. Service quality is characterised by a company’s ability to meet customer demand, i.e. customer expectations.
Demand variability
Consumption is sometimes unpredictable and difficult to control, despite accurate demand forecasts. Demand volatility is amplified by competition, market effervescence, etc. And that’s without counting product seasonality. This is why it can be wise to calculate demand variability based on the standard deviation or coefficient of historical sales data variation.
Methods for safety stock calculation
There are several possible methods for calculating safety stock, of which we will detail the workings and mathematical safety stock formulas. Today, many companies calculate their safety stock automatically, using specialised software.
The simple safety stock formula
The company knows its average sales and decides to rely on its experience to determine a reasonable period that should be covered by its safety stock.
Safety stock = average sale x period to be covered by safety stock
The average and maximum safety stock formula
The company refers to sales variations observed in the past and decides to apply a method that will allow it to respond to the same trends.
Safety stock = (maximum sale x maximum delivery time) - (average sale x average delivery time)
The normal distribution
The normal distribution, or Gaussian distribution, applies when sales volumes are larger. This method allows for quite precise estimates in relation to a normal distribution of demand, to which uncertainties regarding demand and/or lead times are integrated, whether they are independent or not.
-
Your safety coefficient based on the desired service rate;
-
The standard deviations of your sales and supplies.
When demand is uncertain
Safety stock = safety coefficient x standard deviation of sales x square root of average delivery time
When lead times are uncertain
Safety stock = safety coefficient x average sales x standard deviation of delivery times
When demand and lead times are uncertain and independent
Safety stock = safety coefficient x square root ((average delivery time x (standard deviation of sales)²) + (average sales x standard deviation of delivery times)²)
When demand and lead times are uncertain and dependent
Safety stock = (safety coefficient x standard deviation of sales x square root of average delivery time) + (safety coefficient x average sales x standard deviation of delivery times)
Best practices to go even further
To further optimise stock management, there are several strategies well known to logistics professionals.
Defining your reorder point
After calculating your safety stock, it is crucial to determine your reorder point, or replenishment point. This serves to define at what minimum stock level (alert stock) the company should trigger replenishment procedures. This action occurs before dipping into the safety stock.
To calculate the reorder point, use the formula below:
Reorder point = (average sale x average delivery time) + safety stock
Equipping yourself with a warehouse management system
Stockouts can sometimes be linked to poor management of stock data within the company itself. To facilitate stock management, a WMS (Warehouse Management System) solution can really make a difference. These tools allow you to accurately obtain recorded stock data as well as the location of products in the warehouse.
Better collaboration with your suppliers
Companies also have every interest in establishing solid relationships with their suppliers to reduce replenishment times and their variability. Partnership agreements and constant communication allow for better forecasting of potential problems and proactive stock adjustment.
From mastering key variables, choosing the right calculation method, and adopting appropriate optimisation strategies, logistics managers can prepare for any stockout. As you’ve understood, effectively managing a good safety stock will help you gain agility, minimise risks within the supply chain, and ensure the sustainability of your business.
