In ecommerce, you can do all the planning in the world, but situations will still come up that affect your inventory. Whether it’s a surge in sales of a particular item, your supplier’s machinery breaking down, or a natural disaster that delays your incoming stock, supply chain problems happen.
How can you, as an ecommerce retailer, handle these types of situations? You don’t want to have to stop selling your product or alert your customers that their purchases are on backorder, because that could risk potential sales and customer loyalty. This is where safety stock comes in.
What is Safety Stock?
Safety stock, also called buffer stock, is defined as the level of extra stock that is kept to mitigate the risk of overselling due to unpredictable variations in supply or demand. Safety stock ensures that when you run out of cycle stock (the inventory that you forecasted selling), you still have inventory to fill orders if there is an unexpected demand for products or a problem in the supply chain.
Why is it Important?
Having safety stock benefits ecommerce businesses in the following ways:
- It prevents stock-outs, which is especially important for your best-selling products.
- It mitigates unexpected disruptions in your supply chain.
- It lessens the blow if your business makes a forecasting error and underestimates the demand for a product.
- It keeps customers happy and prevents lost sales.
Ultimately, the most significant benefit of having safety stock is customer satisfaction. If a shopper has to leave your site because the product they want is out-of-stock, they may never return to your store. Additionally, if you have to delay fulfillment because purchases are on back order, it can destroy your customers’ experiences with your brand. They might choose to go to your competitors’ sites in the future.
Not only do you risk losing customers and sales if you oversell stock, but it can also damage your standing with platforms like Amazon. Too many oversold products can result in getting kicked off of the platform and make it very difficult to get reinstated.
Keeping safety stock on-hand is a way to perfect your supply chain and prevent these issues from happening. However, carrying too much inventory ties up capital and could eat into your profits. Striking the right balance with your safety stock can be challenging if you don’t know how to do it. Fortunately, there’s a way to calculate it.
How Do You Calculate Safety Stock?
There are two ways that you can calculate safety stock. One is a simplified version while the other uses standard deviation. For the purposes of this article, we’re going to use the simplified formula. If you want to tackle the more complicated version, you can check out method #2 here.
Here’s the simplified formula:
(max. daily sales X max. lead time) – (avg. daily sales X avg. lead time) = Safety stock
Lead time refers to the amount of time it takes, in days, from when you place a purchase order for stock to reach your warehouse. Daily sales refers to the number of units that’s sold in a day. Maximum is the highest number of units and the longest lead time for that time period.
Now that you understand all the terms, here’s an example of how the formula works:
Let’s say that you sell clothing online, but it’s jeans that your brand is known for. On average, you sell 100 pairs of jeans in a day. On your best sales day, you sold 250 pairs.
When you order a new shipment of jeans, it takes an average of 10 days for you to get it. There have been times when you’ve gotten it in 5 days, but also during busy times (like before major sales holidays), it’s taken as long as 20 days.
So, to get your safety stock amount, you plug in the numbers like this:
(250 X 20) – (100 X 10) = 2,500 – 1,000 = 1,500
Your ideal level of safety stock is 1,500 pairs of jeans. Now that you have that number, it’s important to determine when you should place a new order for products. This is called the reorder point – and there’s a formula for that too.
How Do You Calculate the Reorder Point?
The calculation for determining the ideal reorder point uses the safety stock amount while factoring in the lead time for a new order. Here’s the formula:
(avg. daily sales X avg. lead time) + Safety Stock = Reorder Point
Here’s what that looks like for our jeans example:
(100 X 10) + 1,500 = 2,500
That means that the reorder point for your store’s jeans would be 2,500 units. So, when your jeans inventory reaches about 2,500 units in your warehouse, it’s time to place another order for more stock. Using the reorder point will ensure that you have enough stock on-hand to handle your normal sales volume without dipping into your safety stock. However, should something happen that affects demand or supply of jeans, your safety stock will cover your sales.
The Right Amount Means Fewer Stock-Outs and More Happy Customers
It’s important to remember to review your inventory data, lead times, and demand averages regularly so you always have the most accurate safety stock and reorder point numbers. Understanding and calculating safety stock and reorder points will save your business money and help keep your customers satisfied.
Need inventory management software to help you keep track of all these variables? Give ecomdash a try. We’ll keep track of your safety stock, quantity on hand, and reorder points, allowing you to focus on growing your business.