Safety stock is extra inventory retailers hold to prevent stockouts in case of an issue in the supply chain or an increase in demand.
Without safety stock, your customers may end up disappointed because the item they want isn’t available. With too much safety stock, however, you’ll have a risk of spoilage, dead stock, and high storage costs.
The goal is to hold just enough safety stock to avoid either of these two extremes. You can achieve this with accurate data and the right safety stock formula.
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What is safety stock?
Safety stock, also known as buffer stock, is like an emergency fund. If you sell more of a given product than you expected, your supply chain is disrupted, or your merchandise gets damaged, safety stock allows you to keep selling that product regardless.
The biggest risk of not having a safety stock is having a stockout.
Let’s say one of your popular products goes out of stock and customers keep asking for it. If the lead time with your supplier is short, meaning you can get new inventory in mere days, this is a small issue.
But if the lead time is already long, that product might be out of stock for months. The same goes in case of a supply chain issue, like a material shortage. For example, microchip shortages in 2021 significantly increased the time customers had to wait for a new car, made some features unavailable, and drove prices up.
Safety stock is your protection from unforeseen circumstances.
Safety stock vs. reorder point
There’s an important distinction between safety stock and a reorder point.
Safety stock is additional inventory you keep on hand in case of fluctuations in demand and supply.
Reorder point is a predefined inventory level at which you replenish your stock.
For example, suppose there’s a product in your inventory that you order 100 units at a time. Once the inventory for that product comes down to 15 units, it triggers a new order of 100 units. Based on past customer demand for that product and the time it typically takes to receive that inventory, the 15 units will suffice.
In this example, 15 units represents the reorder point.
Then there’s safety stock. Let’s say that, during one period, customer demand exceeds 15 units. On another one, your supplier can’t get the merchandise to you in the usual timeframe. This is where you can tap into an additional 30 units you hold in case of unpredictable situations like this one.
Those 30 units are your safety stock.
Ideally, you’ll have both safety stock to ensure inventory for unforeseen circumstances, and a reorder point to automate replenishing.
Why do you need safety stock?
Account for demand uncertainty
Customer demand for the products you sell can increase for many reasons.
Some of them are predictable due to their seasonality. For example, the demand for surfboards and garden furniture spikes in hot months and is non-existent during the snow season. Patterns like these are relatively easy to adjust your inventory to.
However, demand can spike for reasons that are less predictable or obvious. Factors like local events, competitor changes, or trends can drive more customers than usual to your store, or to a particular item.
Without safety stock, this change in demand becomes a missed opportunity.
Protection against supply issues
If the supply chain you rely on runs into problems, you may struggle to keep serving your customers.
Shortage of materials, manufacturing issues, and problems in transport (like port congestion) are just a few reasons you may not be able to get your products as quickly and reliably as usual.
When you hold enough safety stock, you extend your ability to keep selling your products. You’ll eventually need your supply chain to go back to business as usual, but safety stock can postpone (and often avoid) a stockout.
Build customer loyalty
Customer loyalty increases revenue, improves your brand reputation, sparks word-of-mouth marketing, and helps you gather valuable feedback.
When your customers rely on you for specific products, and run into an empty shelf (either virtual or physical), you risk losing them.
Online shoppers might see your product out of stock and look for an instant alternative on a competitor’s website. Customers that used to visit your brick-and-mortar store regularly may stop coming in after they’ve walked out empty-handed a few times.
In other words, customers that once trusted you won’t do so anymore, which could add up to a significant revenue loss.
On the flipside, if customers know they’ll always find what they need, whether online or in-store, they’ll confidently keep coming back to you.
Try Shopify POS
Use Shopify POS to forecast demand and calculate safety stock to protect against costly stockouts.
How to calculate safety stock
There are six common ways to determine the amount of safety stock you need. We’ll cover:
- Safety stock formula
- Fixed safety stock
- Heizer and Render’s formula
- Time-based calculation
- Greasley’s method
- Safety stock with EOQ
1. Safety stock formula
The simplest option is adopting this widely used safety stock formula:
Safety stock = (maximum daily usage x maximum lead time) – (average daily usage x average lead time)
Here are the variables that go into this formula:
- Maximum daily usage: the maximum number of units sold in one day
- Maximum lead time: the longest it has taken your supplier to deliver the inventory
- Average daily usage: the average number of units sold in one day
- Average lead time: the average time it takes your supplier to deliver the inventory
This formula is a great starting point. Keep in mind, however, that it works for average scenarios but not for seasonal changes in demand.
2. Fixed safety stock
Fixed safety stock is a predetermined number of units you keep as safety stock for each item. Retailers use their sales numbers from recent months to determine a fixed amount of safety stock to hold.
Although there’s no special formula for fixed safety stock, you can calculate it this way:
Fixed safety stock = number of days x average daily usage OR maximum daily usage
For example, you can decide to keep two weeks’ worth of safety stock for an item. Its average daily usage is 10 and its maximum daily usage is 17. Your fixed safety stock for this product would be between 140 and 238.
Fixed safety stock is based on your best assumptions, and doesn’t take your supplier’s lead time or demand fluctuations into account. It works best in stores with consistent demand and only occasional mild interruptions to the supply chain.
3. Heizer and Render’s formula
If there are significant variations in your supplier’s schedule, Heizer and Render’s formula is the way to go.
The formula goes as follows:
Safety stock = Z score x standard deviation in lead time (σLT)
In inventory management, Z score is the desired service factor—the number of standard deviations above mean demand needed to protect you from having stockouts.
The lower the Z score, the higher the chances of a stockout. Products of greatest value to your store need a higher Z score. A Z score of 1.65, which equals a 95% chance you won’t have a stockout, is considered acceptable even for important stock.
The standard deviation in lead time (σLT) is the frequency and degree by which your supplier’s average lead time differs from the actual lead time.
Heizer and Render’s formula is ideal when your supplier’s lead time varies, but doesn’t take into account changes in customer demand.
4. Time-based calculation
Time-based calculation allows you to calculate safety stock levels over a specific time period based on future demand forecasts.
You need two parameters for a time-based calculation:
- Previous data for product demand and sales, including units sold and products that were low on stock or out of stock. Your POS system is a great place to pull this data from.
- Demand forecast for the upcoming season. You can use different demand forecasting methods, like trend projection, barometric technique, and market research, to predict future demand.
This approach is useful for stores with a steady customer demand and a consistent product offering. Of course, it doesn’t account for unpredictable events that interrupt your business (think back to March 2020 lockdowns), so there’s a risk of holding more stock that you can sell.
5. Greasley’s method
Greasley’s safety stock formula is based on both your supplier’s lead time and the fluctuations in product demand:
Safety stock = Z score x standard deviation in lead time (σLT) x average demand (Davg)
Greasley’s method adds the average demand factor to the earlier mentioned Heizer and Render’s formula.
The demand for a product can change seasonally (for example, school supplies based on the start and end of the school year) or long-term (for example, at-home fitness gear based on the growing popularity of an active lifestyle). Greasley’s formula emphasizes the impact of such change in demand.
6. Safety stock with EOQ (economic order quantity)
Economic order quantity (EOQ) is the ideal product inventory you should purchase to minimize inventory costs, including holding, shortage, and order costs. You can use it as a reference for your safety stock.
The EOQ formula is calculated as:
EOQ = square root of (2 x setup costs per order x demand rate) / holding costs
For example, if you sell 1,000 units of a certain product per year, the fixed cost to place an order is $5, and it costs you $4 to store this inventory, your EOQ is 50.
Common safety stock pitfalls
There are also potential pitfalls associated with calculating safety stock that you’ll want to avoid, which can lead to negative outcomes for your business.
Setting safety stock to zero
Some supply chain professionals might advise you to set your safety stock to zero. They do so because they believe this is the way to reduce overall inventory and the costs of holding it.
But by now you know that stockouts also come with a price—the cost of lost revenue and customer trust and loyalty. Safety stock helps you hold the right amount of buffer stock in case of unforeseen circumstances, so make sure you don’t default it to zero.
Not accounting for all variables
The safety stock calculations we outlined include a range of variables, including:
- Average daily sales of a product
- Maximum daily sales of a product
- Supplier’s average lead time
- Supplier’s maximum lead time
- The desired service factor (Z score)
- Possible changes to supplier’s lead time
- Yearly demand
- Costs of ordering and holding inventory
Choose the formula that best serves your store’s circumstances and includes all relevant variables.
If you have consistent sales numbers and your supplier’s lead time rarely deviates from the average, the standard safety stock formula is ideal for you.
If your average and maximum daily sales haven’t changed in years, but the supplier’s lead time tends to fluctuate, Heizer and Render’s formula might suit you best.
And if all these variables have a significant impact, you need a formula like Greasley’s method to account for them all.
Carrying too much safety stock
If you want to avoid out-of-stock scenarios no matter what, you may end up on the opposite end of that spectrum and overstock your products.
Overstocking increases storage costs and the risk of product expiration, and it negatively impacts cash flow. Just like stockouts, this can hurt your store’s success and be hard to recover from.
That’s why it’s important to approach safety stock calculations through numbers instead of emotions and fear. Rely on data from your POS, market research, conversations with suppliers, and demand forecast to make the most informed safety stock call.
Choosing the right safety stock formula for your store
Use the formula that fits your store’s circumstances so you can always offer the products your customers need without overstocking your inventory.
Leverage Shopify POS to calculate safety stock
With Shopify POS, you can track fluctuations in product demand over time and any past stockouts. Use this data to inform your safety stock formula and order the right buffer stock to keep your store running smoothly.