Safety stock definition

What is Safety Stock?

Safety stock is excess inventory that acts as a buffer between forecasted and actual demand levels. This inventory is maintained so that a company has sufficient units on hand to meet unexpected customer and production demand. Safety stock does not just involve finished goods; it can also be applied to raw materials, to guard against delays in the delivery of materials from suppliers. Higher safety stocks may be warranted during periods of supply restrictions, to guard against missing or short supplier deliveries.

It is possible to fine-tune the level of safety stock needed, based on a statistical analysis of historical demand records and future demand estimates. However, this can be an expensive and time-consuming approach, so it is more common to set a fixed safety stock level, and review the adequacy of this level from time to time. Pareto analysis can be employed to revise safety stock levels on a more frequent basis for only the most heavily-used inventory items.

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10 Reasons to Maintain Safety Stock

There are many reasons to maintain some level of safety stock, including the following:

  • To protect against demand fluctuations. Customer demand can be unpredictable, even with good forecasting tools. Safety stock acts as a buffer to ensure products are available when sudden spikes occur. This helps avoid stockouts and lost sales opportunities.

  • To compensate for supplier delays. Even reliable suppliers can face delays due to transport issues, labor shortages, or raw material problems. Maintaining safety stock allows operations to continue smoothly while waiting for delayed shipments. It reduces the risk of production stoppages or unhappy customers.

  • To account for inaccurate forecasts. Forecasting is never 100% accurate, and errors can lead to underestimating demand. Safety stock helps cushion against these mistakes, giving a company time to react and replenish inventory. It reduces the financial impact of poor planning or market surprises.

  • To manage lead time variability. Lead times can vary based on supplier performance, shipping conditions, or customs delays. Safety stock absorbs the impact of longer-than-expected lead times. This ensures consistent availability of goods, especially in just-in-time environments.

  • To mitigate disruptions in the supply chain. Global supply chains are vulnerable to disruptions such as natural disasters, strikes, or political instability. Safety stock acts as insurance, keeping operations running during such events. It provides resilience and flexibility in uncertain conditions.

  • To meet customer service level goals. Companies often have target service levels, like 95% order fulfillment on time. Safety stock helps meet these targets by providing extra inventory to cover unexpected demand. This strengthens customer satisfaction and trust.

  • To avoid lost sales. When inventory runs out, customers may turn to competitors, causing lost revenue and damaged reputation. Safety stock helps prevent this by ensuring the product is on hand when needed. It also reduces the administrative burden of handling backorders or rush shipping.

  • To smooth production schedules. In manufacturing, safety stock of raw materials ensures production lines don’t halt due to missing inputs. This allows for more stable and predictable production planning. It also helps avoid costly downtimes or overtime labor costs to catch up.

  • To manage seasonal demand peaks. Many businesses experience seasonal spikes in demand that are difficult to meet with regular inventory levels. Safety stock prepared in advance can help cover these periods. It supports marketing campaigns and high sales volumes without delays.

  • To buffer against quality issues. Sometimes received inventory is defective or doesn’t meet specifications, requiring rework or returns. Safety stock ensures there’s still usable inventory to fulfill orders or maintain production while problems are resolved. This helps avoid customer dissatisfaction and interruptions.

Formula for Safety Stock

To calculate the proper amount of safety stock, subtract the average daily usage rate from the maximum daily usage, and multiply the result by the lead time. The safety stock formula is as follows:

(Maximum daily usage - Average daily usage) x Lead time = Safety stock

Constraint analysis holds that the only safety stock that matters in a manufacturing environment is the inventory buffer located directly in front of the bottleneck operation; this buffer should be sufficiently large to ensure that no variations in the production process upstream from the bottleneck operation interfere with the bottleneck. This can require a substantial safety stock if there are ongoing problems with the upstream production process.

Fixed Safety Stock

Rather than using the preceding safety stock formula, an alternative approach is to simply set a fixed safety stock amount. This amount is not changed unless an event occurs that convinces the materials management staff to alter it. In some cases, this fixed amount could even be set at zero, in cases where demand variability is minimal. The usual outcome of this approach is that inventory levels tend to be too high. The reason is that a high safety stock level will not result in any stockout conditions, so there is no management pressure to set the level lower. Conversely, if the fixed level results in a stockout condition, then there will be pressure to set it higher. Both situations tend to result in an excessive investment in safety stock.

Safety Stock Best Practices

A good way to deal with safety stock is to segment the reasons for its use among different customers. It is possible that the ordering histories of only a small number of customers are highly variable. If so, the company is essentially maintaining extra safety stock just for these customers. In this case, there are several possible courses of action:

  • Calculate the cost of holding the extra safety stock for these customers, and include the cost in an analysis of customer profitability. If the extra cost makes a customer unprofitable, drop the customer.

  • Approach the customer about paying the company a fee in exchange for maintaining a reserve of inventory for their specific use.

  • If the company earns a large profit percentage on the sale of a product, it makes more sense to maintain a large safety stock than if the profit is inconsequential.

  • There may be a contractual obligation to provide a certain speed of fulfillment to a customer. If the company cannot deliver goods on a timely basis, it may be under default, and is contractually penalized. If so, there is no way to avoid retaining a large amount of safety stock.

  • If there is strong competition for a customer, the company may be forced to maintain a large safety stock for that customer; otherwise, someone else with a better fulfillment speed may obtain the

When to Reduce Safety Stock

A company may elect to reduce or eliminate safety stock levels in cases where there is little customer demand, customers are indifferent if deliveries are delayed, or where it is too expensive to maintain an adequate safety stock level. For example, if an adequate safety stock level is considered to be $100,000 in order to maintain a 99% fulfillment rate, versus just $10,000 to maintain a 95% fulfillment rate, management may choose the lower inventory investment. Safety stock can also be reduced when there are similar items in stock, toward which the customer service staff can direct customers.

Terms Similar to Safety Stock

Safety stock is also known as reserve inventory or buffer stock.

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