In the current business landscape, with constant market changes and unpredictable situations, accurately predicting inventory needs has become more difficult. There is a persistent risk of running out of stock, which can result in lost revenue, decreased customer satisfaction, and ultimately, a negative effect on profits. This is where utilizing AI-based calculations for safety stock can be beneficial.
What is Safety Stock?
Safety stock is the additional inventory held to safeguard against unexpected demand or supply fluctuations. It acts as a buffer stock that companies keep in reserve to meet unexpected demand or supply chain disruptions. Safety stock is an essential component of inventory planning, and calculating the right amount of safety stock is crucial to avoid stockouts and optimize inventory levels.
Why is Safety Stock Essential?
Having a safety stock is crucial to prevent stockouts due to unforeseen events such as supplier delays or sudden spikes in demand. It ensures that you have a sufficient amount of inventory available to fulfil customer orders, even in such circumstances.
- Safety stock protects against demand variations and aids in meeting unforeseen demand spikes.
- Additionally serving as a buffer stock, safety stock protects you from any supplier supply delays. Stocks might be delayed for a variety of reasons, including weather, equipment failure, and other factors.
- The supply chain may be affected by factors such as a lack of raw materials, transportation problems, natural disasters, etc. This lengthens the delivery window for the goods and raises the possibility of stockouts. But this can be avoided with safety stocks and good inventory management.
- Safety stocks make sure that products are always stocked in the inventory and that there are no sales losses. Customers would get dissatisfied and their commitment to the company would be hampered by out-of-stock situations.
- The cost of the products rises as a result of changes in market value. With safety stocks, you can withstand difficult and unusual circumstances.
- If there is a supply shortage, you might have to buy from new sources, which would increase your expenditures. This can be prevented using safety stockpiles.
Why is AI Essential for Safety Stock Calculations?
Traditionally, safety stock calculations were based on historical demand patterns and supplier lead times. However, this approach is no longer sufficient, as it fails to account for the dynamic nature of today’s markets. AI-powered inventory planning solutions, on the other hand, can analyze a vast amount of data, including real-time sales data, production schedules, supplier lead times, and market trends, to provide more accurate safety stock recommendations.
How AI Calculates Safety Stock?
AI-led inventory planning systems use machine learning algorithms to analyze a wide range of data points and provide a more accurate safety stock recommendation. Here are some of the key factors that AI takes into account:
- Historical demand patterns
- Sales forecast
- Supplier lead times
- Production schedules
- Market trends
- Seasonality
- Customer behaviour
- Economic indicators
The machine learning algorithms analyze these factors to calculate the safety stock level required to meet unexpected demand or supply chain disruptions. By considering all these factors, AI-led inventory planning tools can provide a more accurate recommendation, which can help businesses avoid stockouts.
Factors to Consider for Calculating Safety Stock
Determining the appropriate level of safety stock is essential for businesses, as maintaining excessive safety stock results in increased carrying costs, while insufficient safety stock can lead to missed sales opportunities. Employing an effective inventory planning approach that incorporates a suitable formula allows companies to calculate the ideal safety stock level for their specific needs. Various formulas are available for calculating safety stock, including:
1. Fixed Safety Stock
Production planners favour this approach because it does not rely on a specific formula, and the quantity remains unchanged unless the production manager decides to adjust it. If the lead time is brief and the sales rate is slow, the fixed number can be minimal.
2. Time-Based Calculation
The calculation of safety stock for a particular timeframe is based on the forecasted product demand. While combining predicted and actual demand provides a more accurate estimate, uncertainties make it challenging to anticipate exact figures. As a result, there is always a risk of overstocking if sales fall short of expectations.
3. General Formula
This method of stock calculation is both straightforward and widely used, as it helps determine the average safety stock needed to prevent stockouts. However, it does not account for seasonal demand variations. To calculate safety stock using this method, multiply the maximum quantity of a product sold by the longest lead time and then subtract the average daily usage of the product.
4. Demand Variability
To calculate demand variability, the average squared difference between actual daily sales and forecasted sales is determined.
5. Service Level Factor
Inventory planning systems apply different service level multipliers based on the categorization of the SKU value, typically determined by an ABC scale. High-value SKUs are assigned a 95% service level multiplier, allowing them to account for up to 95% of the differences between actual sales and forecasts observed historically.
6. Plan Coverage Days
This plan specifies the duration, the number of days covered, and the lead times for suppliers.
7. Supplier Fill Rate
The supplier’s fill level refers to the percentage of orders that a supplier typically fulfills. To adjust safety buffers, the fill rate considers the SKU-vendor level data from previous purchases and goods received notes (GRN). Inventory planning software can incorporate the 95th percentile of supplier lead time to account for variability in lead times when generating order proposals.
It is essential to understand all these methods, evaluate which one would be most suitable for your business, and make a wise choice.
About the Company
Fountain9 offers retail companies the ability to effectively calculate safety stock using their inventory planning software, Kronoscope. Kronoscope’s dynamic demand sensing and inventory planning capabilities provide companies with the flexibility to manage cash flows and working capital. With dynamic safety stock levels, businesses can create a buffer only for products with high demand variability or unpredictable lead times. For high-selling products with high demand variability, maintaining high dynamic safety levels is recommended. This approach optimizes working capital by spending only on high-risk products, giving businesses greater control over their supply chain and ensuring optimal inventory levels.
