This week we wanted to discuss the topic of safety stock. While we have touched on safety stock in multiple previous blogs, we have never dug into the topic itself. This blog is aimed to define what safety stock is, why it is needed, and how it is calculated.
Safety stock is defined as inventory that acts as a buffer to uncertainties in both supply and demand of products. A company’s total inventory consists of two types of inventory: cycle stock and safety stock. The cycle stock is the amount of inventory a company expects to sell within a given period while safety stock is layered in to protect against fluctuations in the supply chain whether customer driven or supply driven. For example, a company may carry four weeks of cycle stock equally 30 units, but due to the lead time and the service level carries an additional 15 units of safety stock giving the company a total of 45 units of inventory.
So what are the cause of needing safety stock? It turns out there are realistically dozens of reasons you may need safety stock, but here are some of the main reasons:
Safety Stock = σdemand* √LT* Z, where σdemand is the standard deviation of demand, √LT is the square root of the lead time, and Z is the Z-score of the desired service level.
The z-score can be found in a z-table, but some of the main z-scores are for 98%, 95%, and 93%, which are 2.05, 1.64, and 1.48, respectively. It is similar to finding the z-score for calculating a confidence interval in statistics. An example for an item with a monthly standard deviation on demand of 54.606 and a 1.5 month lead time with 95% service looks like this:
Safety stock = 54.60603*√1.5*1.64 = 109.6807 units or 110 units of safety stock
Stay tuned for the next blog to discuss how to work in tandem with reorder point and how to apply reorder point into your supply chain!