What are the best practices for reducing safety stock costs?

1 Safety stock formula

The basic formula for safety stock is:

Safety stock = (Maximum daily demand x Maximum lead time) - (Average daily demand x Average lead time)        

This formula assumes that you know the maximum and average values for your daily demand and lead time, which are the time it takes to receive new inventory from your suppliers. The formula calculates the difference between the worst-case scenario and the normal scenario, and tells you how much extra inventory you need to cover that gap.

2 Safety stock examples

Let's look at some examples of how to use the safety stock formula. Suppose you run a bakery and you need to order flour from your supplier. You know that your average daily demand for flour is 10 kg, and your average lead time is 5 days. You also know that your maximum daily demand for flour is 15 kg, and your maximum lead time is 10 days. Using the formula, you can calculate your safety stock as:

Safety stock = (15 x 10) - (10 x 5) = 100 kg        

This means that you should always have at least 100 kg of flour in your inventory, in case you face a spike in demand or a delay in delivery. If you have less than 100 kg, you risk running out of flour and losing sales.

Now suppose you run a clothing store and you need to order jeans from your supplier. You know that your average daily demand for jeans is 20 pairs, and your average lead time is 7 days. You also know that your maximum daily demand for jeans is 30 pairs, and your maximum lead time is 14 days. Using the formula, you can calculate your safety stock as:

Safety stock = (30 x 14) - (20 x 7) = 280 pairs        

This means that you should always have at least 280 pairs of jeans in your inventory, in case you face a surge in demand or a longer lead time. If you have less than 280 pairs, you risk losing customers and revenue.

3 Safety stock costs

Safety stock can be a useful tool to prevent stockouts, but it also comes with a price. Holding costs, such as storage, maintenance, and insurance, increase with the amount of inventory you have. Additionally, opportunity costs, or the money you could have invested elsewhere, are also affected by the amount of inventory you have. Finally, obsolescence costs, or the costs of inventory becoming outdated, damaged, or expired, are also higher with more inventory. Consequently, it is important to find the right balance between safety stock and service level, so that customer satisfaction is not compromised while minimizing costs.

4 Safety stock optimization

Optimizing safety stock and reducing inventory costs is a key part of inventory management. To achieve the best balance between service level and costs, it is important to consider the following best practices. Improving demand forecasting is essential, as the more accurate the forecast, the less safety stock is needed. Additionally, reducing lead time variability is beneficial, as it can be done by negotiating with suppliers, streamlining the ordering process, and monitoring delivery performance. Furthermore, implementing inventory replenishment systems, such as a reorder point system, can help to avoid overstocking or understocking. Finally, using inventory management software can help to track, manage, and optimize inventory across the supply chain, as well as generate reports, alerts, and recommendations to improve inventory performance.