Published: 20 August 2024
Contributors: Alexandra Jonker, Alice Gomstyn
Safety stock is extra inventory of an item held to reduce the risk of item stockouts and overpromising to customers. Businesses use safety stock as a safeguard against demand, supply and manufacturing variability.
Maintaining extra stock is a best practice of effective inventory management. Inventory management is a critical element of the supply chain and refers to the process of ordering, storing and selling a company's inventory. Its objective is to have the right products in the right place, at the right time.
Determining adequate safety stock levels can be a complex calculation based on one or many safety stock formulas—and both too little and too much safety stock can negatively impact business. Today, technologies such as artificial intelligence (AI), the Internet of Things (IoT) and inventory visibility software are helping businesses optimize their safety stock management, inventory costs and demand planning.
With the optimal safety stock, businesses can be confident they have enough items to maintain customer satisfaction and meet demand even amid fluctuations such as:
- Demand spikes
- Supply chain disruptions
- Inventory forecasting errors
Demand spikes
Sudden increases in customer demand result from predictable seasonality (such as holidays) and unpredictable challenges such as resource scarcity, weather events and increased competition.
Supply chain disruptions
Supply chains involve multiple stakeholders. Key players might be unable to complete their duties due to unforeseen circumstances such as natural disasters, labor strikes or other global events that cause bottlenecks and raw materials shortages.
Inventory forecasting errors
Slow, error-prone and disconnected planning cycles might lead to a demand and supply mismatch and a slow turnaround in replenishment and order fulfillment.
While they might sound similar, safety stock is different from cycle stock. Both are important to meeting demand and maintaining customer satisfaction.
Cycle stock is the amount of inventory of a certain item needed to meet regular demand over a particular time period. Safety stock is the buffer inventory kept in addition to cycle stock.
It can be complex to balance the right amount of safety stock across multiple locations. Too much safety stock increases carrying costs. In retail, for example, excess inventory leads to markdowns or worse, liquidated stock. In B2B, excess safety stock might mean thousands of specialized parts kept at high holding costs. Perishable, time-sensitive goods such as food are also at risk of spoiling when held too long.
Alternatively, when businesses do not have enough stock on hand, they risk lost sales, aggravated customers and harm to their brand reputation. For these reasons, accurately calculating safety stock is essential.
Determining the right level of safety stock for each item or SKU (stock keeping unit) requires careful calculation. However, there is not a universal formula for calculating optimal safety stock levels. A business's formula of choice depends on its use case and various supply chain variables.
Variables in safety stock calculations
Many of the most common safety stock formulas include these variables:
- Z-score
- Standard deviation of lead time (σLT)
- Average demand (D avg)
Z-score
The Z-score is the desired service level or desired service factor. It represents the probability of a business meeting actual demand. A higher Z-score means a lower chance of a stockout and more safety stock. A lower Z-score means a higher chance of a stockout and less safety stock.
Standard deviation of lead time (σLT)
This measures how much the average lead time for a product differs from the actual lead time. A higher standard deviation indicates a more dispersed data set.
Average demand (D avg)
This variable is the average demand for an item within a certain time period, usually per day when used in safety stock calculations.
Common safety stock formulas
There are several safety stock formulas and each has its own use case:
- The fixed formula
- The average-max formula
- Greasley’s formula
- The Heizer Render formula
- Complementary formulas
The fixed formula
This formula is one of the most basic as it does not account for demand or lead time variability. Businesses with consistent demand and supply chain operations are more likely to use this formula.
(Average daily sales) x (Number of stock days)
The average-max formula
This formula calculates the average maximum number of units needed during a certain period. While it does consider lead time variability, it does not consider demand variability. This formula helps businesses avoid the risk of stockouts but might not yield enough safety stock for extreme or seasonal demand surges.
(Maximum daily usage x Maximum lead time) – (Average daily usage x Average lead time)
Greasley’s formula
Some refer to this formula as the Standard Deviation Safety Stock Formula. It considers fluctuations in lead time and demand. It is one of the more accurate safety stock formulas.
(Z-score) x (σLT) × (Davg)
The Heizer Render formula
This formula accounts for substantial supply variations. It does not consider demand fluctuations. It is often the formula of choice for businesses that experience frequent supplier delays and long lead times.
(Z-score) x (σLT)
Complementary formulas
There are also formulas that complement safety stock calculations. For example, the economic order quantity (EOQ) formula determines the optimal amount of stock a business should keep to help minimize inventory costs. Another formula, the reorder point (ROP) formula, uses safety stock amounts and other variables to determine the specific time at which new products should be ordered to prevent running out.
In addition to formulas, different technologies and tools can help with safety stock management and optimization:
- Enterprise resource planning (ERP) systems
- Inventory management software
- Inventory visibility solutions
- Artificial intelligence (AI)
- The Internet of Things (IoT)
ERP systems
ERP systems are designed to manage all parts of a business, including supply chain management and manufacturing. They can more accurately forecast sales, which can help businesses reduce required safety stock levels. ERP systems are especially useful for e-commerce retailers, who can use such systems to assist with purchase orders and warehouse management.
Inventory management software
This software can track and manage a business’s amount of inventory, orders, sales and deliveries. It can help a business identify trends, forecast demand, establish pricing and optimize their amount of stock.
Artificial intelligence (AI)
With machine learning (ML) algorithms, artificial intelligence can significantly enhance demand forecasting functions and accuracy. By accessing real-time internal and external data, AI can enable a deeper understanding of what drives demand. This can result in more accurate forecasts, helping ensure that businesses have enough inventory.
Internet of Things (IoT)
In inventory management, IoT devices such as radio frequency identification (RFID) tags or smart shelves can track inventory levels in real-time. This feature can provide early warnings for potential stockouts.
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Inventory management is tracking inventory from manufacturers to warehouses and from these facilities to the point of sale.
Supply chain management (SCM) is the coordination of a business’ entire production flow, from sourcing raw materials to delivering a finished item.
Asset tracking is the practice of monitoring the location of an organization’s physical assets to maximize efficiency and minimize loss.
Demand planning is a SCM process that companies use to project future demand and customize company output according to those projections.