Safety stock is a term used by logisticians to describe a level of extra stock that is maintained to mitigate risk of stockouts (shortfall in raw material or packaging) caused by uncertainties in supply and demand.
Adequate safety stock levels permit business operations to proceed according to their plans.
[1] Safety stock is held when uncertainty exists in demand, supply, or manufacturing yield, and serves as an insurance against stockouts.
It acts as a buffer stock in case sales are greater than planned and/or the supplier is unable to deliver the additional units at the expected time.
With a new product, safety stock can be used as a strategic tool until the company can judge how accurate its forecast is after the first few years, especially when it is used with a material requirements planning (MRP) worksheet.
The less accurate the forecast, the more safety stock is required to ensure a given level of service.
With an MRP worksheet, a company can judge how much it must produce to meet its forecasted sales demand without relying on safety stock.
However, a common strategy is to try to reduce the level of safety stock to help keep inventory costs low once the product demand becomes more predictable.
That can be extremely important for companies with a smaller financial cushion or those trying to run on lean manufacturing, which is aimed towards eliminating waste throughout the production process.
The amount of safety stock that an organization chooses to keep on hand can dramatically affect its business.
In addition, products that are stored for too long a time can spoil, expire, or break during the warehousing process.
Too little safety stock can result in lost sales and, in the thus a higher rate of customer turnover.
The main goal of safety stocks is to absorb the variability of customer demand.
Creating a safety stock will also delay stockouts from other variations, like an upward trend in customer demand, allowing time to adjust capacity.
Safety stock is used as a buffer to protect organizations from stockouts caused by inaccurate planning or poor schedule adherence by suppliers.
As such, its cost (in both material and management) is often seen as a drain on financial resources that results in reduction initiatives.
In addition, time-sensitive goods such as food, drink, and other perishable items could spoil and go to waste if held as safety stock for too long.
[1] Various methods exist to reduce safety stock; these include better use of technology, increased collaboration with suppliers, and more accurate forecasting.
[1] In addition, ERP systems use established formulas to help calculate appropriate levels of safety stock based on the previously developed production plans.
An inventory node is supplied from a "source" which fulfills orders for the considered product after a certain replenishment lead time.
In this case, the safety stock is calculated considering the demand and supply variability risks during this period plus the replenishment lead time.
In this case, safety stock is calculated considering the risk of only the replenishment lead time.
If applied correctly, continuous inventory policies can lead to smaller safety stock whilst ensuring higher service levels, in line with lean processes and more efficient overall business management.
[12] [13] It makes several implicit assumptions: Another popular approach described by Nahmias[14] uses the standardized unit loss integral L(z), given by: