Picking Safety Stock Levels
Planning safety stock levels of your inventory is a critical part to supply chain management. Safety stock can be thought of as the amount of inventory for each item that we never want to drop below. You can think of it as the “zero” for each item. In unpredictable times, deciding and maintaining proper safety stock levels will keep orders going out the door and keep your business running. There are plenty of formulas out there to determine safety stock, but at the end of the day determining safety stock levels is an art and a science. With so many unpredictable variables in the business world, I have found that successfully picking safety stock levels is best done by using your gut after analyzing the demand and supply of your business.
Understanding Demand
I start by looking at historical sales of each item on a rolling 12 month basis. I calculate what roughly 1 month of supply is by averaging the trailing 3 month sales for each item.
Then I see how volatile my sales are to understand if that average is a good representation of what to expect for monthly sales. PRO TIP: Put the sales in a chart. Look at one item at a time. If you have a lot of items, start with your high movers. The visual representation makes a big difference in helping to understand the peaks and valleys of sales.
Pause here and ask yourself some questions:
Are sales close to the average? Within ~10-20%
Are some months way higher or lower than others? Do you know why?
What is the overall trend of sales? Going up? Down? Flat?
Next I’ll get a more granular view of my sales. I look at historical sales for each item over the past 13 weeks. Are sales consistent week to week, or do certain weeks of the month lead to much higher sales? It can be helpful to put these numbers on a graph as well.
Understanding Supply
Next we have to understand our supply chain. Here are the considerations I make:
Lead Times – I’ll start by understanding what the lead time is to receive a replenishment order.
Production Capacity – Next I want to understand what my production capacity is. Is my supplier running 24 hours a day, every day of the week to meet my orders, or do they only run for a short time to complete the order. Do they have extra time on their line to run more product if needed? And most importantly, can they deliver more product than you are selling within their lead times? Meaning if a supplier’s lead time is 1 month, can they deliver more than your average monthly sales?
Service Levels – I’ll consider my supplier’s historical service levels. Do they reliably meet the requested delivery dates for your orders? Are there any weak links in your supply chain that cause delays to orders?
Shelf life – Does your product have a shelf life? If you have a shelf life you don’t want to buy more than what you’ll sell before the product expires or you can no longer sell it.
Cash – I’m grouping this with supply, but it’s really a business question. Are your products expensive? Buying too much product will put most of your company’s cash into inventory, which can handcuff the business. Make sure you have a conversation with whoever is in charge of your finances to ensure they agree with your plans and are comfortable with the dollar value that will be tied up in inventory.
Picking Your Safety Stock Levels:
Once you’ve analyzed your business’s demand and supply, you’re ready to feel out what your stocking levels should be. Remember even though we can get super calculated with picking safety stock levels, there is no perfect science to it. The goal is to not run out of inventory, but also not have too much.
Here’s the flow in my mind for how I think about safety stock target levels:
If sales are consistently around the average monthly sales I’m usually more comfortable holding relatively less safety stock. And vice versa, if sales are volatile, I will usually want to hold more safety stock. With consistent sales, I like to start with a 1 month safety stock level when sales are around the average. If sales are more volatile, I’ll usually pick a 2 month safety stock level.
Then I’ll make sure to understand if I have any shelf life considerations. Will the product be at risk to expire? If so you need to change your thinking to be based around holding as much product as you can without it risking expiring. If no shelf life considerations 1-2 months of supply is still a good target.
I’ll next look at lead times. Are my lead times less than 1 month? If yes I’m still feeling good about that 1-2 month safety stock target. If my lead times are longer than 1 month, I’m most likely going to increase the safety stock a bit. In today’s world supply chains are way too unpredictable. Longer lead time orders are more likely to get pushed back. Consider the historical service levels of your supplier to add in any extra inventory buffer. Use historical delays to get a sense of how much extra to add. Example is if orders are usually delivering ~2 weeks after the requested date, add ~2 weeks worth of inventory to your safety stock levels.
Then I’ll look forward using a forecast and make sure I’m stocked accordingly for any unusual upcoming spikes to demand. This could be for a large promo or upcoming peak season. Usually you want to hold more inventory going into those times so you can capitalize on sales. If you don’t have a forecast, make one. Refer to post #11 for more help.
And lastly, I’ll consider cash. I do this last because my job as the person in charge of inventory planning is to make sure we have the right amount of inventory. If cash is tight and we need to hold less inventory, that will be a risk the company will need to weigh.
In the end, I’m usually setting my safety stocks to be ~1-3 months of supply for my items. This might seem like a long way to get to a pretty simple answer, but that’s the point. The key is to really understand the supply and demand variables of your business. If you do that and monitor your inventory levels closely, over time you will create a strong gut feel for if you have the right safety stock levels. Use that gut feel to help your business maintain healthy inventory levels and keep orders going out the door.
Looking for more resources on safety stock and supply chain I came across this blog recently, which I really love.
