In an environment where shortages are becoming commonplace, many logistics managers have made it a reflex to build up a safety stock. This is of vital importance to the overall performance of the supply chain. By optimizing reserve levels, it is possible to anticipate demand and increase productivity and competitiveness. But how do you set up an effective safety stock management procedure? What calculation methodology should be adopted? Is there a standard formula to follow? Let's take a closer look.
In a nutshell:
- 🛡️ Importance of safety stock: Safety stock is crucial to guard against unforeseen events in the supply chain, and to avoid stock-outs which can affect customer satisfaction and overall company performance.
- 📈 Methods for calculating safety stock: Several methods exist for calculating safety stock, each adapted to different levels of uncertainty about demand and supply lead times. These methods range from basic to complex, using coefficients to adjust stock levels according to risk and desired service.
- ⚠️ Risk and cost management: Although safety stock is a protective measure, it is essential to manage it effectively to avoid excessive storage costs and other logistical problems, based on accurate data and reliable forecasts.
| 🔢 Method | 📏 Formula | 🎯 Use |
|---|---|---|
| Basic method | Average sale x Number of safety days | Simple, for low variability |
| Average - max method | (Maximum sales x Maximum lead time) - (Average sales x Average lead time) | When reliable data are available |
| Normal law method | Various formulas depending on uncertainty of request and/or deadline | For high variability and significant uncertainties |
Definition of safety stock
Safety stock, also known as " security stock", represents a surplus of stock held by a company above the minimum required level, in order to counter the vagaries of demand and fluctuations in supply lead times. It acts as a shield against stock-outs that could harm customer satisfaction and the company's overall performance.
The primary objective of safety stock is toavoid costly interruptions in product availability due to inaccurate demand forecasts or delays in the supply chain. Maintaining an adequate level of safety stock helps tomitigate these unforeseen events and ensure business continuity.
The importance of safety stock
The need for safety stock arises mainly from two sources of uncertainty: demand variability and the vagaries of supply lead times.
- Variability of demand: Customer demand can fluctuate according to many factors, from seasons to market trends. Some products are predictable, while others are more volatile. By adjusting safety stock to take account of this uncertainty, potential shortages can be avoided and optimum service levels maintained.
- Lead time uncertainties: Procurement lead times are subject to a multitude of variables, from order placement to final delivery. Delays can occur at every stage of the process, from production to transport and customs formalities. By anticipating these risks and allocating adequate safety stock, it is possible to reduce the negative impact of delays and maintain optimal stock levels.
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What are the factors to be considered for safety stock?
No matter how much time and resources you invest in data collection and analysis, the reality remains: it's virtually impossible to predict actual demand with absolute certainty. Similarly, no matter how good your relationship with your suppliers, it's always difficult to predict whether they'll deliver on time and in sufficient quantity. That's where safety stock comes in. It can protect you from the disruption caused by these two factors.
However, there are four key parameters to consider when calculating safety stock:
- Demand volatility;
- Your suppliers' delivery times and reliability;
- Your service level targets ;
- The "real" risk of breaking down.
Different methods for calculating safety stock
1- "Basic" method :
A traditional method of calculating safety stock is to multiply average sales by the number of safety days.
Formula: Average sale x Number of safety days
Limitations: This approach, although simple, remains fixed in time and does not take into account the different variables. It must therefore be combined with other safety stock calculation methods.
2- "Average - max" method :
This method involves calculating the difference between maximum sales and maximum lead time, and average sales and average lead time.
Formula: (Maximum sales x Maximum lead time) - (Average sales x Average lead time)
Simple and commonplace, this method is effective when highly reliable data are available, particularly in the case of low volumes.
Limitations: This method calculates the delta between the ratios "sales and maximum lead time" and "sales and average lead time" per month. If the lead time was very long at one point in the year, this will have a significant impact on the calculation, which may not correspond to the reality of your business.
3- Methods using the Normal Law :
Normal Law is a mathematical law that predicts the probability of selling a certain quantity, thanks to a safety coefficient calculated according to the desired service rate. These mathematical formulas are not suitable for all demands and lead times, as they do not take into account very low sales or extreme cases, and do not apply to sectors subject to seasonality.
A- "Normal distribution with uncertainty on demand" method:
This method is recommended for high-volume sales, especially when the uncertainty relates solely to demand, and the lead time is stable and predictable.
Formula: Coefficient Z x Standard deviation of demand x Root of average lead time
B- "Normal distribution with uncertainty on the delay" method :
Use this method when your forecasts are highly reliable but your lead times are uncertain.
Formula: Safety factor Z x Average sale x Lead time variance in months
C- "Normal distribution with uncertainty on independent demand and delay" method:
This method is recommended when lead times are uncertain, especially when demand is also uncertain, and the two are completely independent.
Formula: Safety factor Z x Root ((Average lead time x (Demand standard deviation)2 + (Average sale x Lead time deviation)2)
Please note : The safety stock obtained with this formula is larger, as it takes into account both lead-time and sales uncertainty.
D- "Normal distribution with uncertainty on dependent demand and delay" method:
Use this method when lead time causes uncertainty in demand and vice versa. It is suitable when both are completely independent but uncertain.
Formula: Coefficient Z x Demand standard deviation x Root (average lead time) + Coefficient Z x Average sale x Lead time standard deviation
Please note: This method, which combines methods 3 and 4, is quite extreme and results in a high safety stock.
Risks associated with safety stock
Before examining the calculation formulas, it's worth highlighting the risks inherent in safety stock. While it can offer a certain peace of mind, safety stock often reflects underlying issues such as imprecise data and unclear forecasts, and maintaining excessive levels can lead to disproportionate storage costs. To calculate your safety stock effectively, it's crucial to have accurate data, reliable demand forecasts and transparent communication with your suppliers. This will enable you to maintain optimum safety stock levels, minimizing costs while ensuring maximum customer satisfaction.
