Safety Stock and Inventory Management

Computer systems maintain the stock of inventory items with parameters such as minimum and maximum quantities. Some of these parameters are objective – that is, there is one right or optimum answer. For example, an economic order quantity balances the actual cost of a product, inventory carrying costs, and costs of purchasing to determine the specific replenishment amount that results in the lowest total cost of each piece of the product.

Other inventory parameters are subjective in nature. There is no one best answer. Safety stock (also known as safety allowance) is one of these. Safety stock provides protection against stock-outs due to unexpected demand for a product or delays in receiving a replenishment shipment from a supplier. It is insurance. Like many other types of insurance there is no "right" or optimum amount. If you talk to three different life insurance agents, they will probably suggest you buy three different amounts of insurance. When you are determining safety stock quantities you have to ask yourself, "how much do I want to invest in preventing stock-outs?"
The answer will probably be different for various products you stock. In determining the safety stock amount, you have to ask:

* What is the likelihood that this product will experience a stock-out?
* How disappointed will customers be if this product is not stock?

Products are more likely to be out of stock if they experience:
* Inconsistent supplier lead times. If vendor shipments are often several weeks late, you may want to keep some extra stock to "cover" customer demand during these unexpected delays in receiving a replenishment shipment.
* Large fluctuations in sales or usage. You might sell 10 pieces or 1,000 pieces of a product in a month without much advance notice of when usage will significantly increase.
In deciding how much safety stock you want to maintain, perform this analysis for all of the items in your inventory to see how many total potential stock-outs you will experience with the various levels of safety stock. Also note when all of the resulting ending balances for a product represent a very high level of inventory. These products probably have fairly predictable usage and consistent lead times.
With this information the customer began to fine-tune their investment in inventory. They examined the stock-outs of painful backorder items and selectively increased the safety stock until there were no out-of-stock situations.
Your investment in safety stock is subjective. There is no "right" answer. But with some simple tools and analysis you can make an informed decision that will ensure that the funds you make available for safety stock are invested as wisely as possible