What is Safety Stock?
Safety stock or buffer stock is the additional quantity of an item above the desired quantity that is held in the on-hand inventory. Such extra inventory is held with the sole purpose of avoiding the risk of running out of stock. Safety stock serves as an insurance or a cushion for manufacturers and retailers against possible out of stock situations for an item. Such stock outs are caused usually by:
- Changes in the demand for the item
- Inaccuracies in the forecasts of the item
- Unforeseen disruption to the supply line of the item
Maintaining safety stock for an item comes with its own challenges. The first is the identification of the appropriate method of calculation in arriving at the right quantities that need to be maintained for each item. The second is the increase in the working capital to store additional on-hand quantities. So, the right safety stock for an item should strike a balance between the conflicting goals of maximizing customer experience (satisfaction) and the cost of managing additional inventories.
Why to maintain Safety stock?
The important reasons to maintain the safety stock is to prevent the business from stock out situations which arise due to various internal and external factors. Some of the major factors are:
- Fluctuation in demand: A spike in consumer demand often results in stock outs. Spikes in consumer demand can be attributed to many reasons including festivals, seasonal and any act of nature (epidemic).
- Variation in supply line: Any disruption to the supply line by the vendor leads to stock outs. It might be due unforeseen reasons including weather-related shipping delays, and vendor’s production bottlenecks.
- Inaccurate Forecasts: Any inaccuracies in the forecasts lead to stock outs. Such inaccuracies might be due to the nature of the product itself, or lack of accurate data and lack of proper tools and techniques.
- Production delays: Any unexpected delays in the production and transportation in the internal value chain lead to stock outs. It might be due to unexpected breakdowns in the production line and industrial unrest.
Variation in consumer demand is the single major reason for the maintenance of safety stocks.
Stock outs are undesirable as they adversely affect the business. Some of the major impacts to business are:
- Loss of Sale: In the highly competitive marketplace, it is quite tough to regain a lost sale, and often declared as the ‘lost opportunity’.
- Erosion of Market Share: Poor service delivery due to stock out starts with the erosion of customer base and ends with the erosion of market share.
- Strained Supply chain: Stock out puts additional burden on the supply chain, and it strains the relationship between partners of supply chain.
The advantages of maintaining safety stock levels
Holding sufficient levels of safety stock reduces the risk to stock out and there by provides the business the following insurance cover:
- Prevents stock out due to sudden spikes in consumer demands
- Prevents stock out due to uncertain lead times of vendors and internal production line
- Prevents stock out due to disruption to the supply line from vendors
- Prevents stock out due to inaccurate forecast
- Ensures customer service and satisfaction levels
- Ensures continued sales and market share
- Helps to maintain healthy relationship with supply chain partners
- Helps to automate the reorder points
How to employ Safety stock in the supply chain?
Though the purpose of maintaining safety stock is to avoid stock outs, it is not intended for all stock outs but for majority of them. While calculating the safety stock levels a right balance should be arrived between the opposing objectives of satisfying customer requirements at a specific service level and the cost of holding additional inventory. Since not all items are same, any general application of safety stock policy has adverse effects.
Some organizations often employ the policy of using their rule of thumb to arrive at the safety stock levels in the absence of any modern automation tool or software under their disposal. Such policies often end up with more disturbances to business than the expected improvement.
A robust inventory management system supported by a dynamic planning engine is required for business to handle the safety stock level and to process automate item replenishments. A statistical calculation technique is required for business to manage the conflicting goals of maximizing customer experience and the cost of managing the additional inventories. Microsoft Dynamics 365 offers a robust and scalable supply chain solution to manufacturers and retailers with end-to-end supply chain and inventory management processes, including the safety stock management, and seamlessly integrated with the modules of Finance, Purchase and Master Planning for accounting, replenishment and reporting.
Solution offered by D365 Finance & Supply Chain (or Operations)
Safety stock level fulfills the following purposes:
1. Act as the buffer stock against to prevent stock out scenarios
2. Act as a demand (reorder point) thereby triggering the automatic fulfillment orders
While safety stock levels prevent stock outs, it also serves as the reorder point or act as a system generated demand, where automatic replenishment policies can plan for item coverage for a given period. Thus, safety stock offers the process automation and reduces human efforts in managing the desired stock levels. As part of item replenishment policy, safety stocks are configured for items according to their consumption and importance to business. With a clear marking of safety stocks for items, master planning engine takes care of replenishment based on the (Coverage plan) policies attached to the item.
Management of safety stocks in D365 F&O requires knowledge about 3 different aspects of safety stock.
- Configuration required for using safety stock
- Automatic replenishment policies
- Recalculation of safety stock levels
Configuration and automatic replenishment policies
The configuration and automatic replenishment policies for safety stock cover the following:
- What to plan?
- Where to plan?
- When to plan?
- How to plan?
What to plan:
The fundamental and one of the important set up for safety stock is the setup of the coverage plan (replenishment policy) for the item. Items that have variants*, might follow different policies at the variant level. As part of item master definition, the coverage plans are set accordingly for an item.
*variants often include different versions of the item that can be differentiated by its configuration, size, color or style.
Where to plan:
After the item is configured, the next in sequence is the configuration of storage location (Storage dimension). Based on logistics and supply chain requirements, companies design the replenishment policies either at the warehouse level or at the site level. An item can have different policies at different location based on the business needs.
When to plan:
While planning for the replenishment, purchase lead time plays a vital role. With the advent of modern supply chain techniques like Just In Time(JIT), it’s always wise consider the purchase lead time while planning for the replacement orders. The replacement order generation and the required delivery dates are automatically calculated based on the purchase lead times.
How to plan:
Various stock replenishment policies including 1) based on per requirement, 2) based on cumulative requirements for a period and 3) based on the min-max quantities, are commonly used across industries. The quantities and the date of expected delivery in the replenishment orders are arrived based on the policy attached to the item as each policy has its own way of arriving them.
Apart from the above four aspects of safety stock configuration, the process of ‘master planning and scheduling in D365 F&O offers whole lot of planning techniques including the time fence of planning, and forecasted demands, which affects the quantities of the replenishment orders. These are extensive topics requiring individual write ups in the future.
Recalculation of Safety stock level
As the sales trend and consumption pattern are an ever changing phenomena in business, the safety stock levels too should change according to such changes. Inventory and operation heads often employ their valuable time and resources to check if the safety stock levels maintained are still beneficial to business. Companies often struggle to recalculate the safety levels based on the current trend and this is where D365 F&O offers a tool to arrive at the redefinitions of stock levels.
Safety stock journal is the feature that offers robust calculation procedure to arrive at the new safety levels of items. While calculating the new safety stock (new minimum) proposal, two major methods are available, which could be used according to the business requirements. They can be employed in parallel to different items.
The first being the average issue (consumption / sales) of items during the reference period, the period can be dynamically selected, with a facility to add any manual variations / fluctuations in the issue. This is one of the basic methods, where average sales for the given period is considered as the base and the forecasted demand can be considered as the multiplication factor to arrive at the new minimum safety stock level.
In the second method, the service level to customer orders is considered as the parameter of the calculation. A pre-defined dropdown offers various service levels ranging between 50% to 99.99%. While higher service level will result in fewer stock outs, such service levels obviously need higher level of safety stocks, in turn the working capital. Thus, practically companies thrive to achieve the service levels between 90% to 98%, the safety levels are maintained accordingly. This method uses the statistical tools including the average issue and standard deviation to arrive at the new minimum.
In both methods, the proposal arrives at the new safety stock levels (minimum) and throws an insight into the effect of the proposed changes on business in quantity and in value. As the proposed changes have direct effect on the working capital, considering the proposal as the new minimum is purely a business decision. Thus, the onus lies with business to weigh between the opposing objectives of customer service and the cost of inventory.
As these proposals are simulations, they can be used as a tool for the ‘what if analysis’ through various test cases. While the proposals are simple simulations offering multiple iterations, they can be considered as new minimums. The proposal can be used to update the items for the new minimums, reducing a whole lot of manual efforts.