Safety Stock Guide: Using the Safety Stock Formula to Avoid Stockouts
Avoiding an out-of-stock situation is critical for direct-to-consumer brands. Not only do you lose sales when you run out of a SKU, but you may also lose customers for good.
So, how can you plan ahead and have systems in place to accommodate unexpected changes in supply and demand? Fortunately, there’s a simple safety stock formula to help you order enough product to avoid out-of-stock issues, secure inventory replenishment, and normal distribution.
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What is safety stock?
Safety stock is the excess product you keep on hand in case of an emergency or supply chain failure that causes less than average inventory to be available.
Typically, businesses do their best to predict future sales and then manage inventoryand inventory costs according to that prediction. If sales were always constant and the lead time on orders never an issue, this would be a very simple process. But not everything in business is predictable, and there can be delays in the retail supply chain.
Safety stock is a way to keep a cushion in your inventory levels to make sure you don’t run out of items if your inventory forecast isn’t perfect. The amount of safety stock you need is based on a simple formula.
It’s worth noting that safety stock should be for an interim increase outside of the demand you’ve forecasted — not an additional full year’s worth of inventory.
How to calculate safety stock (+ safety stock formula)
If crunching numbers isn’t in your strong suit, don’t worry! The formula for how to calculate the amount of safety stock you need is actually quite simple whether you use software or an inventory sheet template.
Here’s how to calculate safety stock equation for your ecommerce store:
1. Find the following for each SKU:
- Maximum daily usage
- Maximum lead time
- Average daily usage
- Average lead time
Keep in mind that if you order new products once a week, you can calculate safety stock using maximum and average weekly usage instead of daily (or whatever your timeframe is for ordering), as your guideline.
Average daily usage and average lead time are just that — an average. Look at your sales and lead time for the recent periods and use the average number to estimate what to expect.
For instance, if you sell 100 units on an average day (based on historical sales) and it takes you 5 days to replace that stock from your supplier, 100 and 5 are the respective averages or numbers that you need to plug into the formula.
Maximum daily usage and maximum lead time are reflected by the highest sales your historical records show and the longest lead time you can expect or have experienced. Be sure to account for delays for holidays like Chinese New Year if your supplier is in Asia.
If your average is 100 units daily, but you’ve sold up to 150 units in a day, you would use 150 as your maximum daily usage in the calculation.
Similarly, if it has taken as long as 10 days to restock inventory (even though the average is 5 days), 10 would be the maximum lead time for your calculation.
2. Calculate your max (maximum daily usage x maximum lead time)
Next you’ll multiply the maximum daily usage by the maximum lead time.
Again, this is your worst case scenario. What would happen if you sell as many units as your historical maximum and you experience the longest possible lead time from your supplier? This number will help you create a big enough cushion of extra stock.
3. Calculate your average (average daily usage x average lead time)
Now multiply the average daily usage by the average lead time. This is the number you would likely order on a typical purchase order since it’s what you need to replenish stock with average customer demand.
4. Subtract the two
Finally, subtract the average number from the maximum number for a complete safety stock calculation like this:
(Maximum daily usage x maximum lead time) – (average daily usage x average lead time)
The difference will show you the safety stock level you need in order to be prepared for an extreme scenario. Note: It’s possible that it won’t be enough buffer stock to cover an extreme surge in sales, but it will be enough to prevent stockouts most of the time.
Safety stock example within the supply chain
Let’s say a business sells just one SKU — a coffee mug.
To calculate how much safety stock it should hold, the business first gathers the following information from its records:
- Maximum daily usage = 125
- Maximum lead time = 35
- Average daily usage = 50
- Average lead time = 14
Using this information, the business calculates safety stock as follows:
Safety stock = (Maximum daily usage x maximum lead time) – (average daily usage x average lead time)
Safety stock = (125 x 35) – (50 x 14)
Safety stock = 4,375 – 700
Safety stock = 3,675 units
The business follows this formula, and keeps 3,675 units in reserve at all times.
A few months later, the business is featured on a very famous influencer’s Instagram account. As a result, demand for the mug skyrockets and the business receives hundreds of orders over the next several days.
With so many orders flooding in, the business quickly begins fulfiling orders using its regular inventory. When the stock hits its reorder point, the business places an order for another 5,000 units of the product.
However, while the business waits for the next shipment of inventory to come in, customers continue to place orders. Before long, the business has sold through its entire regular inventory — but the replenishment shipment has not yet arrived.
In this instance, the business dips into its safety stock. Using the 3,675 units it kept in reserve, the business is able to keep fulfiling orders and meeting demand. After 12 days, the business receives the 5,000 extra units. The business then puts any safety stock that’s left back into long-term storage, and continues to fulfil orders using the new inventory.
In this way, safety stock allows the business to keep making sales and bringing in revenue while waiting on more inventory from their manufacturer, all without ever stocking out.
How much does a stockout cost your business?
Stockouts lead to a host of costs for your business. Some of these costs are tangible, and force a business to spend money to mitigate damage or fix the stockout. For example, a business may split the shipment (e.g., when one product is in stock and the other is not) in an effort to minimise the stockout’s impact on customers, but in doing so will have to pay additional shipping costs (two labels and two sets of packaging, instead of one).
Other costs are intangible, and result in an opportunity cost to your business. Customers who are ready to buy but find their desired product is out of stock may not purchase anything, which is a lost sale. That customer may also go to a competitor, which can result in lost sales in the future.
Stockouts and backorders can also cause customers to cancel orders (which costs your business revenue), or even leave negative reviews to discourage others from purchasing in the future.
Why safety stock is so important for ecommerce
Safety stock is critical for all businesses, but especially ecommerce. Remember those customers who will go elsewhere if you’re out of stock? Online shoppers are used to getting products quickly and easily. They can also jump to a competitor’s website faster than if they were window shopping at brick and mortar shops.
1. Minimise stockouts
Preventing stockouts is the biggest benefit of calculating safety stock. Every time you hit a cap on how much stock you have available, that represents the additional sales you weren’t able to make. Safety stock helps you maximise your revenue.
2. Leverage your warehouse
The right amount of safety stock makes the best use of your inventory storage system and capital. You could always avoid stockouts by ordering huge amounts of product, but that would clog up your storage space, increase your inventory carrying costs, and tie up money you could be spending more strategically, elsewhere. If you use multiple warehousing locations to store inventory, optimise levels of stock based on the expected demand per location.
3. Forecast demand
The same method used to calculate safety stock can also help you predict other aspects of your business. For example, demand forecasting (or predicting demand for your products) can help you plan for shipping and customer service level needs, so you have enough help on hand to ensure your service levels don’t suffer. You can also anticipate surges in sales during different times of the year and plan accordingly.
4. Keep up with the seasons
Maximum daily usage represents the highest sales volume of product you have sold during a period of time. It could be the most you’ve sold during a specific season, or even on a specific day (like a holiday). Recognizing these trends will help you be prepared with extra stock when you need it.
For example, if you know that every Cyber Monday you double your online sales, you can effectively calculate how much safety stock you should have on hand for upcoming holiday inventory prep. That way, you won’t risk losing out on sales on one of the hottest buying days of the year.
[Related: A Tale of 4 Direct-to-Consumer Brands: Comparing Seasonal, High-Growth, Unplanned, and Gradual Sales]
5. Higher customer satisfaction
Customers expect to be able to purchase your products at any time, so stockouts are rarely a welcome surprise. Adding safety stock into the equation to reduce the chance of stockouts is an internal measure that customers never know about, but it helps ensure that the customer’s purchasing and delivery experiences are seamless, which improves customer satisfaction.
6. Improved efficiency rates
Safety stock enables a business to fulfil orders even while waiting on a replenishment shipment to arrive. This way, operations can continue and a business can keep selling without supply chain delays slowing down productivity.
Common stockout risks
Stockouts can happen to all sorts of ecommerce companies, but some challenges make a business even more vulnerable to them. Here are some common stockouts risks and how to avoid them.
Inaccurate demand planning
If your initial demand forecasts are off, you risk not having enough inventory to meet customer demand. Implementing measures to gather more accurate data and use better tools to analyse it can improve demand forecasting, positioning your business to be able to fulfil every order.
Unexpected surges in demand
While surprise spikes in demand can be a good thing for businesses, they can also result in stockouts. Even though your business cannot always anticipate when a spike is coming, keeping tabs on consumer trends and macroeconomic shifts can give you a heads-up and more of a chance to prepare.
Poor inventory management
Mistakes happen — but if inventory is consistently lost, damaged, stolen, or miscounted, these errors can have serious consequences. For example, if a business signs off on the wrong inventory during receiving, it may stock out of the SKUs they were supposed to receive. Similarly, if a business relying on safety stock to fulfil orders discovers that units of that SKU are damaged or missing, then they will have to reactively announce backorders to affected and future customers.
To improve inventory management, conduct regular inventory audits of both inventory levels and standard procedures for handling inventory. You should also invest in a good inventory tracking system that provides visibility into stock levels and SKU movement throughout the supply chain.
Replenishment timing is off
Ecommerce businesses need to be proactive about reordering inventory. If you wait to reorder a SKU until regular inventory has sold out, or until your safety stock is almost used up, you could stock out before you receive the replenishment shipment, and miss out on sales.
Some inventory management softwares include automatic reorder notifications that alert you when a SKU has hit its reorder point of your choosing. If the reorder point was calculated correctly, these automatic reminders enable you to time replenishment perfectly.
Natural disasters or accidents in transit can wipe out part or all of a business’s inventory, which can cause quick, unexpected stockouts.
To mitigate this risk, ecommerce businesses should consider distributing their inventory across multiple fulfilment centres or warehouses in various locations. This way, if a natural disaster impacts one facility’s stock, the business can still use inventory from other locations to fulfil customer orders.
Overselling through multiple channels
It can be easy for multichannel businesses to accidentally sell inventory without realizing the inventory is already out of stock. For example, a business might sell a unit of a product on its ecommerce website, but not realise that the last unit of that product had just been sold on Amazon two minutes before.
Establishing omnichannel visibility across order and inventory channels is crucial to prevent overselling. With the right software, you should be able to view inventory levels across channels and locations in one place, making it much simpler to manage sales and avoid stockouts.
How 3PLs implement the safety stock formula to maintain optimal stock
This safety stock calculation is a very simple formula, and you must also track and calculate for changing conditions. Your business won’t always run like clockwork, and it can be difficult to stay on top of your numbers.
“Off the bat, I liked that I would be able to control multiple warehouses through one page with ShipBob. With my old 3PL, I could never just open a page and get the info I wanted. I had to click several times, then export it, and try to make sense of it. ShipBob lets you manage your inventory while providing important data in a very digestible way.”
Wes Brown, Head of Operations at Black Claw LLC
Luckily, there’s a way to calculate and manage your safety stock automatically. A third-party logistics (3PL) provider, like ShipBob, can provide you with real-time tracking of stock levels and formulas to set reorder points and safety stock. Using historical sales data, we can help you calculate your ideal reorder quantity and how much safety stock you need to avoid stockouts, while storing your inventory and fulfiling your orders.
The success of your ecommerce business depends on getting your products into your customers’ hands quickly and easily. You want to maximise sales, deliver orders on time, and provide an experience that drives customers to leave you glowing reviews. By having the proper amount of safety stock on hand, you can avoid catastrophic out-of-stock issues, ensuring that your customers get what they need when they need it.
“So many 3PLs have either bad or no front-facing software, making it impossible to keep track of what’s leaving or entering the warehouse.
On the supply chain side, I just throw in what we placed at the factory into a WRO in the ShipBob dashboard, and I can see how many units we have on-hand, what’s incoming, what’s at docks, and so on. I can see all of those numbers in a few seconds, and it makes life so much easier.”
Harley Abrams, Operations Manager of SuperSpeed Golf, LLC
Ready to take the guessing and manual calculations out of your ordering? Get a free quote from ShipBob for real-time inventory management, the tools to forecast demand and automatically calculate reorder points for each SKU, and the best ecommerce fulfilment services.
Safety stock FAQs
Here are answers to some of the most common questions about safety stock.
What is good safety stock?
What qualifies as good safety stock (or a good amount of safety stock) will depend on a business’s maximum and average sales and lead times, as well as the nature of the SKUs in stock.
The higher your business’s daily usages and reorder lead times, the more safety stock you’ll need. If your products are perishable, you’ll need to make sure that your safety stock is still in sellable condition before you fulfil it.
What is the difference between safety stock and minimum stock?
Minimum stock is the minimum number of units of a SKU that a business should have on hand in its regular stock to meet customer demand. At this point, the business should be submitting a purchase order to the manufacturer so more inventory arrives in time without the chance of a stockout.
Safety stock, on the other hand, is the amount of stock a business should hold in reserve at all times (as a buffer) to be able to continue fulfiling orders if a business runs out of regular stock.
What percentage of inventory should be safety stock?
The percentage of inventory that should be safety stock will vary from business to business. For most businesses, about 50% of the average amount of inventory you use during your reorder lead time is a sufficient amount of safety stock.
How does inventory management software maintain safety stock?
An inventory management software that includes capabilities like automatic reorder point notifications, inventory visibility, and SKU tracking that can help you maintain your business’s safety stock.