Any company that sells physical products will always be open to interruptions in their supply chain. Eventually, someone is going to miscalculate the demand for a product or something will go wrong in a shipment — causing everything to arrive late.
Being out of stock on an in-demand product is the fastest way to lose customers to your competitors. And during the holidays or when specific trends are rising, being the only seller of a hot item can make gaining long-term conversions much easier.
But it's hard to measure how well items are going to sell, and nearly impossible to predict when things won't get shipped on time. You need a solution that keeps a supply available at your warehouse (so you can keep your customers happy).
Safety stock does exactly that, by compensating for unexpected variability from your customers or from your suppliers. When you need a few extra units to cover incorrect calculations or supplier mistakes, safety stock buys time while you order additional inventory.
But you can't just blindly estimate how much safety stock you need. Luckily, safety stock formulas help you determine the right amount of inventory to keep orders flowing without incurring extra holding costs.
If you struggle to find a balance between running out of stock and having too much of it, it might be time to adopt a safety stock formula. We'll tell you everything you need to know about these formulas, as well as how you can automate these calculations for even greater accuracy.
What is Safety Stock?
Safety stock is surplus inventory that is kept in storage in case of a sudden surge in demand or supply chain issues to reduce the risk of stockouts.
Safety stock is an inventory management best practice relevant to any business who deals with inventory — from raw materials, to manufacturing, to consumer goods. With that said, there’s a fine line between having the optimal safety stock and overstocking.
What is Buffer Stock?
Buffer stock is the surplus inventory retailers store at their warehouse. Typically, buffer stock serves as a safety net in case of emergency, supply chain delays, or a sudden surge in demand.
The amount of buffer inventory you have will largely depend on the type of products you sell, your average production or order lead times, as well as your historical inventory data.
Buffer Stock Example
At times, fluctuations in demand are predictable — like when you run a flash sale or another type of promotional campaign. But at other times, businesses experience an influx in sales due to a market shortage or a sudden change in the economic landscape. In this case, buffer inventory can be a big help as you’re navigating these unforeseen circumstances.
With buffer stock, companies can continue making sales in the midst of supply chain disruptions or shifting consumer behaviors. In that way, buffer stock helps your brand reduce stockouts and bypass dreaded shipping delays that tend to frustrate customers.
A terrific example of buffer stock was seen in the first half of 2020. As you likely remember, toilet paper was a hot commodity during this time period (i.e. the early days of the pandemic). Tons of shoppers were panic buying toilet paper from both in-person and ecommerce retailers. And yet, this bulk buying only exacerbated the toilet paper shortage.
While some consumers used this shortage as an opportunity to transform their bathroom, others were doing anything they could to get their hands on a roll or two. This second group became less picky about their brand preferences, and instead bought up any toilet tissue they could find.
But almost as quickly as warehouse shelves were emptied, they were filled back up with increased levels of buffer stock. According to Forbes, buffer stock of toilet paper increased by 4% (by June 2020) to deal with the “volatility caused by the pandemic.”
Although a steady flow of supply and demand is always ideal, it’s clear that buffer stock is a valuable resource and not to be overlooked within your greater inventory management strategy.
Buffer Stock vs Safety Stock
The terms ‘safety stock’ and ‘buffer stock’ are often used interchangeably. Both describe the extra stock retailers use as a cushion for unexpected demand or uncertainties within the supply chain. Still, in some cases, there is a slight difference between the two.
For instance, buffer stock can refer to inventory that’s specifically held for an abrupt increase in demand (like when your marketing brings in even more business than you’d anticipated). Safety stock, on the other hand, can refer to inventory that’s held in case of supplier delays (like when there’s a manufacturing shutdown or a shortage of raw materials).
Despite these nuanced definitions, safety stock and buffer stock share the same end goal: to ensure you have enough available inventory to meet demand and ship on-time orders.
Safety Stock vs Reorder Point
Safety stock is the extra inventory businesses can draw from when actual demand spikes beyond their projections. Reorder point, however, is the predetermined inventory level for a product that triggers a replenishment order.
Why is Safety Stock Important in Inventory Management?
Despite inventory management myths that state the contrary, safety stock is essential for your business. That’s because even the best data analysts in the world can’t accurately predict customer desires or unexpected mishaps along the supply chain.
When these events inevitably occur, safety stock gives you some emergency padding. Without it, you’ll fall behind your competitors the moment something unexpected comes up.
Running a business that sells physical goods is all about inventory optimization. It can take months — or even years — to get your supply chain ecosystem running smoothly and on time. Safety stock prevents your sales from coming to a complete standstill when manufacturing is slower than you’d planned (and while you wait for replenishment to arrive).
In summary, the main benefits of safety stock are:
- Prevents you from running out of stock, especially on your most popular items.
- Protects you from unexpected circumstances, like sudden spikes in demand.
- Gives you the flexibility to order more products when you make a forecasting error.
- Keeps customers happy and prevents lost conversions.
Overall, safety stock’s biggest impact is on customer satisfaction. A customer who leaves your website because you're out of their preferred item will likely never come back for it. Similarly, if you’re forced to cancel or delay fulfillment because you’re out of stock, it ruins the customer’s experience with your brand — and they'll probably spend their money somewhere else.
There's also a chance they'll never return to your store, period. That single purchase might be all your competitor needs to convert them into a loyal, long-term customer. And if that customer tells other people about the mishap, it could have long-lasting effects on your reputation.
Safety stock will prevent or stop these issues entirely. If you want to avoid the damaging effects of stockouts, you should begin factoring safety stock into your inventory carrying costs. Scrambling to reorder more stock prevents you from compiling purchases to maximize your discounts — meaning it’s not a cost-effective approach to managing your inventory.
How to Calculate Safety Stock Using the Formula
While there are multiple safety stock formulas, each one uses similar methods to determine how much merchandise you should order. Here’s what you need to know before choosing one.
First, you’ll need access to your sales history and inventory statistics to make an accurate demand forecast. You can estimate if necessary, but remember a bad estimation can lead to inaccuracies and excess inventory. If you’re using inventory management software, that information should be readily available — though it’ll be harder to find if you’re relying on spreadsheets.
These are the terms you’ll need to know to calculate safety stock:
- Lead time: Time it takes from when you place an order until it reaches your warehouse.
- Daily Usage: How many products you sell per day.
- Service Level: The desired level of service represented as a percentage. (Here, it refers to the probability of avoiding a stockout.)
- Demand: How many products you sell within a certain time period.
- Average: Central value in a set of data. An average helps you understand how your products typically sell, or how often you tend to receive shipments.
- Standard Deviation: In a safety stock formula, it measures the variance of lead times.
Also, keep in mind the difference between cycle stock and safety stock. Cycle stock is the inventory expected to be purchased by consumers, while safety stock is like the margin of error you can dip into when things go wrong. These calculations should always be kept separate.
Knowing all of that, let’s get into the safety stock formulas.
3 Safety Stock Calculation Methods
Each method for estimating safety stock has its own pros and cons. If you want a quick and easy answer, you can start by using our safety stock calculator. Otherwise, you can dig into the sections on manual calculation and how to use the "King" formula.
Safety Stock Calculator
Fill in the below inputs to easily calculate your safety stock.
The simplest method for manually calculating safety stock levels is with this formula:
(Maximum Daily Usage x Maximum Lead Time) - (Average Daily Usage x Average Lead Time)
Let's say your company sells an average of 10 products per day, and your lead time is about 14 days. However, during peak periods, you sell up to 15 products per day, and delays in inventory shipment mean it takes up to 18 days for products to arrive at your warehouse.
Here's the formula in action: (15 × 18) - (10 × 14)
This makes your safety stock level 130 units. In other words, you’ll need to keep 130 extra products on hand to compensate for delays in shipping or periods of high demand.
That formula is pretty straightforward, which makes it great for small businesses. The downside is, average lead time can be hard to figure because it's so variable — and outliers can seriously skew your calculations.
Large companies may need a better formula to compensate for a greater product volume and a wider variety of supply and demand.
The "King" Formula
What if you’re trying to target a certain level of service? The “King” formula can help you calculate this using the following equation:
Z × σLT × D-avg
Here, Z is your target service level, σLT is the standard deviation of your lead time, and D-avg is the average demand for a product. This formula requires a bit more algebra, but rest assured it's just a matter of filling in the variables.
Service level (Z) is the target probability of avoiding a stockout. The majority of products have a service level of 85 to 90%, with crucial goods coming in at 95% (and higher). The higher the service level, the more money you’ll need to spend.
To use service level in this formula, you’ll need to convert it to a service factor. Use this calculator or the NORMSINV feature in Excel and round your answer to the nearest hundredth decimal. If you want a service level of 95%, your service factor should be 1.64.
Next is σLT, the standard deviation of lead time. Because suppliers rarely deliver products at the same intervals, you'll need an accurate representation of the delivery variance.
To calculate the standard deviation, you’ll need your expected lead time and the actual time the shipments took. Then, write down the variance of each shipment — i.e. how many days over (or under) the expected time it took. Positive numbers are late, and negative numbers are early.
Add the total variances together and divide this answer by how many shipments you measured. Then, add this to your expected time, and you have your standard deviation.
Let’s say you expected a shipment in 14 days, but it actually took 15, 12, 17, 14, and 19 days to arrive (a variance of 1, -2, 3, 0, and 5). This leaves you with a standard deviation of 15.4.
Lastly, you’ll have to calculate average demand. Pick a time interval — like a week or a month — or use your typical lead time. Then, list how much you sold during each interval. Add up the total sales volume and divide it by how many days you measured.
If you sold 1,500 units of stock in one month, your demand average is 50; on average, you sell 50 units per day.
Now, let’s plug all our examples into the “King” formula: 1.64 × 15.4 × 50
That leaves you with a safety stock of 1,262.8 (or 1263). If your desired service level is 95%, you’ll need to get shipments about every 14 days, and sell 1,500 products (on average) each month.
The “King” formula is somewhat complicated, but it's also very useful. The main issue is that only established businesses will have the statistics needed to get accurate results. This formula also assumes that lead time varies, but demand doesn't — which isn't always true.
Making a forecasting error by overestimating the target service level can do serious damage. It's better to buy too little than to waste hundreds of products, so be moderate with your estimates until you've gotten the hang of purchasing extra stock.
There are plenty of more complicated safety stock formulas, but these two calculations are a great place to start.
But even spreadsheet formulas and calculations can become limiting, especially if you want to scale your business quickly. Fortunately, inventory management software can consolidate your inventory data in a snap. Using metrics like lead time, projected forecasts, and buffer days, inventory software provides actionable recommendations to inform your safety stock process.
For example, Extensiv (formerly Skubana) has automated features that use this data to estimate the number of units to reorder, and automatically creates purchase orders you can adjust. Extensiv can also calculate your daily usage for each product, giving you accurate data to use for adjustments.
How To Manage Safety Stock
Some big questions remain: How do you know you're using the safety stock calculation correctly? And is safety stock even right for your business?
The truth is, no formula is perfect, and the real world is much more variable than what standard deviation can capture. That’s why you should never rely on the exact number output by the safety stock formula. Instead, you should always keep track of your stock levels and use your best judgment on what makes strategic sense.
Start small & scale up
It might sound cliché, but start small with your safety stock. If your current surplus level is zero, don’t jump up to 5,000 extra units. Make gradual adjustments as you gather more data, and use the number you get as a guideline (not a rule). Eventually, you’ll reach optimum stock levels.
Almost any company that sells physical goods should make use of safety stock. If applied correctly, it can have huge benefits for customer satisfaction and keep your sales flowing.
3 cases where safety stock isn’t the best strategy
Although safety stock is a good practice to optimize inventory, there are a few cases where it might not be the best investment. This is typically true for:
- Startups and businesses who are still in the early growth stages. At this point, you haven't been in operation long enough to accurately calculate supply and demand. Overestimating how much you'll need could cripple your finances.
- Struggling businesses should be wary unless stockouts are contributing to a lack of funds. When money is tight, focus on doing what you can to revive your business (like implementing proficient software) instead of purchasing inventory that might go to waste.
- Sellers of perishable items must be extra careful. There's certainly a place for safety stock in these types of businesses, but buying too much can be especially devastating.
Consider the stage of your business
What if your supply chain has run smoothly for years? Shipments are never late, you rarely run out of stock, and you’re making a decent profit. Adding safety stock could be disruptive.
It would be a valid choice to only purchase safety stock when you notice potential issues with stockouts. But remember that events like sudden demand, weather disasters, or supplier failure can occur without warning (and at the worst possible time).
Before you begin implementing safety stock, consider how well established your business is. Think about your current profits, the shelf life of your products, and how smoothly your supply chain runs, and then decide whether safety stock is necessary.
What is Anticipation Inventory?
Anticipation inventory is the extra finished goods or raw materials businesses purchase to meet an anticipated spike in demand. In other words, companies maintain anticipation inventory when they expect a change in demand in the near future. This kind of stock benefits retailers by ensuring they can meet customer demand (even as that demand is surging).
Anticipation Inventory Example
Anticipation inventory is frequently used within retail environments. Essentially, companies purchase and store this inventory in preparation for an anticipated future event — like a seasonal jump in sales or a forecasted increase in the costs of goods.
Examples of seasonal anticipation inventory include buying extra chocolate ahead of Valentine’s Day, or stocking more notebooks in late summer to prepare for back-to-school sales.
The second use for anticipation inventory is to protect against a price increase from your suppliers (or a potential shortage of raw materials). If you’re a clothing retailer and you know the price of cotton is about to go up, you might purchase additional fiber before those prices surge. This way, you’ll have all the cotton you need, but you can keep inventory costs relatively low.
Making anticipatory purchases can certainly save you money, but it’ll require you to gather all materials before the price hike and while supplies are still readily available. Luckily, determining anticipatory inventory levels is a lot easier with the help of an inventory management system.
This type of software supports greater inventory control, meaning you can weigh the cost of purchasing — and holding — anticipation inventory against the risk of lost sales and frustrated customers (if you wind up running out of stock).
Anticipation Inventory vs Safety Stock
Anticipation inventory is similar to safety stock in that both strategies help retailers tackle changes in supply and demand. With that said, there are notable differences between the two.
Typically, businesses keep anticipation inventory to meet a predicted increase in demand or price. That is to say, they foresee a surge in seasonal demand or supplier pricing, and they stock anticipation inventory to better prepare for these circumstances.
Safety stock, by contrast, helps to hedge against uncertainty — such as unforeseen supplier delays or an unusual shortage of materials. So while anticipation inventory is geared towards predictable events, safety stock is there in case of a totally unexpected occurrence.
Why is Anticipation Inventory Necessary?
Anticipation inventory is a necessary piece of the inventory management puzzle, because it reduces the risk of stockouts, lost sales, and disappointed customers. Anticipation inventory ensures you have all the inventory/supplies you need, well in advance of your expected sales.
But on top of that, anticipation inventory can also protect you against rising materials costs (or a shortage of materials altogether). This makes anticipation inventory a good way to save money, since your preparedness helps you avoid price gouging and keeps your bottom line intact.
Advantages and Disadvantages of Anticipation Inventory
Anticipation inventory is full of benefits for ecommerce retailers — but that’s not to say it doesn’t have a few drawbacks, as well. Below are the most common advantages and disadvantages of using anticipation inventory.
Advantages of Anticipation Inventory
- Minimizes stockouts, lost sales, and dissatisfied customers.
- Protects against expected increases in the cost of supplies.
- Supports consistent output (and a stable workforce) throughout the year.
- ERP systems can be used to forecast anticipation inventory.
Disadvantages of Anticipation Inventory
- Increases the risk of product obsolescence.
- Increases total inventory carrying costs.
- Difficulty predicting how much demand might change.
- Overstocking can occur, leading to selling inventory at a loss.
Ultimately, it’s up to you to weigh the good with the bad and decide whether anticipation inventory is the right move for your ecommerce brand.
Optimize Your Safety Stock and Anticipation Inventory with Extensiv Order Manager (formerly Skubana)
As a business, you need to turn a profit — so buying extra supply may seem counterintuitive. But upsetting customers by constantly running out of stock will ultimately do more harm to your finances and your reputation. Here’s where Extensiv comes in.
Get Instant Inventory Oversight
To know what your optimal safety stock is, your business needs a bird’s eye view of all your inventory. The more channels you have, the more challenging this task. Extensiv Order Manager solves this by offering a multichannel overview of all inventory items and their sales performance. Once you have this data, you can make inventory decisions that positively impact your bottom line.
Leverage Smart Inventory Automation
Proper inventory management is the key to determining whether safety stock is a worthwhile investment. Extensiv takes things a step further by using your replenishment and inventory data to offer smart recommendations on managing your safety stock levels. Extensiv does the heavy lifting by performing safety stock calculations for you — meaning you can boost revenue and keep customers happy with minimal effort on your end.
Request a personalized demo from Extensiv today, and start experiencing the difference for yourself.