In inventory control, there is a financial trade-off between purchasing more inventory and the cost of a potential stock-out. The more stock you have, the more working capital is needed and with too little stock on hand there are potential sales that can be missed, and even entire production processes that could be interrupted.
This balance essentially depends on two factors. Firstly - and fairly obviously - is demand and the need to understand the amount of items that will be consumed or bought. Secondly, is the lead time - i.e. the delay between a reorder decision and the stock actually being available to customers. This may seem somewhat simple, until you consider that these two factors are both subject to various uncertainties. Demand can vary massively due to human behaviour, causing it to evolve in unpredictable ways. Lead times can always be impacted when suppliers or transporters are faced with unplanned difficulties.
However, simply waiting until a stock-out occurs is not a viable method, as it usually means that it’s too late to place an order. As such, businesses need a way of controlling this level of uncertainty and being prepared for every possible scenario - this is where safety stock comes in. Stock can be organised into two categories: the working stock that’s actually required and this “cushion” of safety stock.
What are the levels of safety stock that should be maintained? Unfortunately, there is no universal formula to calculate safety stock. But there are many methods that can help to calculate for random events such as Gaussian distribution, which allows supply chain practitioners to make educated guesses at the most likely scenarios. However, these methods assume that demand is a succesion of independent, normal, random variables, where in reality demand is very often influenced by completely external random factors. For a company’s supply chain to be at its most efficient a more sophisticated approach is required.
Find out more about Safety Stock.