Safety stock is a term commonly used to describe a certain amount of inventory kept by a business in reserve, to protect against unforeseen events such as spikes in demand or supply shortages. Most businesses employ some kind of minimum level of stock in this way. The principal goal of safety stock is to ensure that there is sufficient product available to the customer.
Safety stock is necessary because in most industries it is impossible to predict with 100% certainty the amount of stock that will be needed, and the amount of stock available, to supply customers over a given period of time. Demand is variable to at least some degree, affected by seasonal effects, one-off ‘shock’ events, new customers being engaged, or old customers leaving. The best that a business can do is to make forecasts that are as accurate as possible, but ultimately these are just predictions. It is also impossible to fully guarantee an expected level of supply, as suppliers have their own problems in meeting demand requirements, and thus may not always deliver what is needed on time. Due to this uncertainty, having an amount of inventory in reserve can allow a business to weather any difficulties with demand or supply, and keep the customer satisfied.
Despite the clear need for some degree of safety, it must be emphasised that safety stock comes at a cost. There are many costs to holding inventory, and the more safety stock a business has, the larger these costs will be. Some examples of these costs are the cost of renting storage space, warehouse staff wages, security costs, and the costs of stock becoming dated or obsolete. When added up these costs are significant: the general consensus is that the total cost of holding inventory is between 20-40% of the cost of the stocked merchandise. This is not a one-off outlay, but something that a business must pay every year. Because of this high cost of holding inventory, a business faces a trade-off between safety against demand and supply changes, and minimising inventory costs.
Faced with this balancing of cost and safety, there are several points a business should consider in determining safety stock levels, regardless of the method used to do this. Firstly, customer satisfaction, while hard to quantify, has a large impact on the success of a business. In the modern world, one unhappy customer for a retail business can mean a large reduction in potential customers, especially if that customer spreads their dissatisfaction through social media.
In non-retail businesses that only supply a few key clients, relationships are everything, and one or two instances of failure to supply could cost a business a client that may make up a large fraction of their revenue. Second, different industries will face different levels of fluctuation in both demand and supply, and any method of determining safety stock should reflect these differences: the greater the potential fluctuation, the greater the level of safety stock should be.
Finally, businesses should be aware that specialised inventory software, which can track and calculate safety stock levels, is now available at a fraction of the cost that it used to be. This software can accommodate the various factors involved with supply and demand variability when calculating safety stock levels, and can provide constantly updated data without owners having to take the time to do this manually. Given the difficult trade-off that has to be made, this software is often a worthwhile investment.