The safety stock method requires the following information to be effective:
- Lead Time: The time it takes to receive an order after it has been placed. This includes the time it takes to prepare and ship the order, as well as any transit time.
- Demand Variability: The variation in demand for a product over a given period of time. This can be measured by calculating the standard deviation of demand.
- Service Level: The level of customer service that a company aims to provide, expressed as a percentage. This is the probability that demand will be met from available inventory.
- Mean Demand: The average demand for a product over a given period of time.
With these pieces of information, the safety stock formula can be used to calculate the minimum amount of inventory that must be kept on hand to ensure that demand is met even during times of uncertainty. The formula takes into account lead time, demand variability, service level, and mean demand to determine the safety stock level.
It’s important to note that the safety stock calculation should be reviewed and updated regularly, as changes in demand, lead time, or other factors may require adjustments to the safety stock level.
The formula for calculating safety stock is as follows:
Safety Stock = (z-score x standard deviation of demand) x lead time + mean demand
Where:
- z-score represents the number of standard deviations from the mean that correspond to the desired service level (e.g., for a 95% service level, the z-score is typically 1.96)
- standard deviation of demand is a measure of the variation in demand for a product over a given period of time
- lead time is the time it takes to receive an order after it has been placed, including preparation and shipping time
- mean demand is the average demand for a product over a given period of time
The safety stock calculation is based on statistical theory, and the z-score is used to determine the likelihood that demand will exceed available inventory. By adding the safety stock to the mean demand, a company can ensure that it will have enough inventory to meet customer demand even during periods of increased variability.