Learn how to calculate how much safety stock you should carry to protect against stockouts without inflating your inventory carry costs.
Learn how to calculate how much safety stock you should carry to protect against stockouts without inflating your inventory carry costs.
Inventory is typically categorized in one of two ways. It is either cycle stock, which is the inventory that a merchant plans to sell through within a certain period of time. Or it’s safety stock, which is backup stock that a merchant plans to hold on to as a buffer against stockouts and missed sales opportunities.
Safety stock protects against stockouts, and with the current state of the supply chain, stockouts have been top of mind for merchants and consumers alike. In fact, concerns around low inventory levels were front-page news during the holiday 2021 shopping season. According to a 2022 consumer survey, 48% of consumers encountered a stockout notification while shopping.
The real risk of a stockout, especially for emerging brands, is the risk of losing a long-term customer. Of those 48% of shoppers that experienced a stockout while holiday shopping, 33% shopped for a similar product from a different brand, and 36% opted for a completely different product altogether.
Safety stock protects merchants from stockouts in two distinct cases:
Another important purpose of safety stock is to protect margins in the following two instances:
While it is important to have a certain level of safety stock, there is risk involved in carrying too much. The primary risk is increased inventory carry costs, which is an especially important consideration now, when warehouse vacancy rates are at historic lows and storage costs are high.
Ideally, storage costs should not make up more than 12% of your monthly expenses. Otherwise, it may be time to think about liquidating inventory, running a promotion, or eliminating SKUs from your catalogue altogether to save on storage costs.
Ultimately, the amount of safety stock you carry will depend on your risk tolerance as a business. A higher tolerance for the risk of running out of inventory means you can carry inventory levels that require the least amount of capital expenditure. High-risk inventory planning leads to higher profits and frees up capital to invest in other areas of the business. On the other hand, a lower risk tolerance means your top priority will be insuring against stockouts. A low-risk approach requires greater capital expenditures but usually leads to greater customer satisfaction.
A good starting point to determining how much safety stock you need is by using a standard safety stock formula.
There are four key variables you’ll need in order to calculate safety stock.
With all of the variables in place, the formula for safety stock is to multiply Maximum Daily Usage by Maximum Lead Time and then subtract the Average Daily Usage multiplied by the Average Lead Time.
(Maximum Daily Usage x Maximum Lead Time) – (Average Daily Usage X Average Lead Time)
In light of ongoing supply chain disruptions, many merchants may be considering carrying more safety stock. Between China’s Zero COVID Policy, freight delays, and a truck driver shortage, it may feel riskier than ever to carry lean levels of inventory. On the other hand, warehouse space is limited, and storage rates are historically high, so carrying excess inventory is costlier than ever.
One tactic to increase safety stock without significantly increasing inventory carry costs is to carry fewer SKUs overall. When looking at your sales history, you will likely find that you have a few top performing SKUs that significantly drive the profitability of your business. It may be wise to increase the quantities of those SKUs while eliminating your slow-moving SKUs entirely.
By carrying fewer SKUs you will significantly reduce your warehouse footprint, allowing you to carry greater quantities and keep more safety stock on hand. When analyzing your SKU catalogue and determining which SKUs you may want to discontinue, it’s important to find the right balance between specialization and having the variety of choices that your customers expect.
For many small to mid-sized merchants, the time it takes to calculate safety stock can be prohibitive. Finding the variables alone is time consuming, and in order to get the most accurate measure, it’s important to re-evaluate those measurements regularly to monitor for changes in demand.
Partnering with a tech-enabled 4PL like Ware2Go gives merchants of all sizes access to automated inventory reporting tools and a dedicated support team to advise them on SKU count, reorder points, and inventory distribution to improve service levels without sacrificing margins.
If you’re looking for a fulfillment partner with an intelligent inventory management solution, talk to one of our fulfillment specialists today.