Average demand can give you a misleading sense of stability. A product may have an average demand of 30 units per day, but your daily demand could range from 20 to 45 units. If you set your reorder point based on average demand alone, then even a couple of high-demand days can deplete your stock faster than expected and lead to a stock-out before your replenishment arrives.
Safety stock is the extra stock you hold to account for variability. It is added to your expected demand during the replenishment lead time. For example, if your average demand is 30 units per day and your replenishment lead time is five days, then your expected demand during lead time is 150 units. If you add 40 units of safety stock to this calculation, your reorder point will become 190 units. That extra 40 units isn’t part of your expected demand; it’s there to cover unexpected variations.
Variations don’t always come from demand. Your supplier may confirm the order late. Production may run late. Your carrier may miss its pickup window. Receiving at the warehouse may take longer than expected. Safety stock can provide additional protection against potential stock-outs while one of these issues is being resolved. However, safety stock won’t resolve the underlying issue that caused the delay. You must identify and address any recurring delays. If you consistently rely on safety stock to meet demand, then investigate your suppliers’ reliability, your communication processes, and your lead times.
On the flip side, too much safety stock also presents problems. Inventory takes up space, uses capital, and can go unused in case of changing demand. A high safety stock can mask poor forecasting and slow replenishment rather than improve them. The objective isn’t to eliminate all stock-outs. It’s to find an appropriate level of protection for your business and recognize the trade-off between service levels and carrying costs.
Take a short exercise to see this in practice. Let’s say you have a ten-day period of demand. Use 30 units as your average, but make your daily demand figures vary above and below that figure. Calculate the amount of stock used over the five-day lead time across multiple cycles. One cycle might see a usage of 140 units, another 165 units, and another 180 units. Compare these numbers to the baseline of 150 units. Notice the variance. One number won’t tell the whole story.
Make sure you’re including units and assumptions when looking at your answer. Are you calculating daily demand vs. lead time in days? Does your lead time include weekends? Do you have pending orders that are still en route? You could be facing a stock-out scenario, but still have stock arriving before your reorder point kicks in.
An important indicator of whether your safety stock is effective isn’t how much it fluctuates. Rather, you should be able to explain what led to any increases or decreases in the stock by looking at demand variability, supplier performance, and desired service levels. You shouldn’t leave your safety stock at a fixed number if your inputs keep changing.