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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Formula for Safety Stock
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.
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.
Inventory Holding Costs
Having too much safety stock can result in many holding costs , such as the costs of obsolescence , inventory storage, interest expense , and spoilage . This can be a major concern when inventory has a short shelf life, perhaps due to fashion trends or because it spoils within a short period of time. When this is the case, a well-run business will constantly monitor its inventory levels and sell off excess stocks within a short period of time. However, doing so can annoy customers if the result is stockout conditions when customers want to make a purchase. In short, it can be quite difficult to optimize the precise level of safety stock at which a company's customers are least unhappy, while also minimizing the investment in inventory.
Terms Similar to Safety Stock
Safety stock is also known as reserve inventory or buffer stock .
