Within production, purchasing or selling operations there is always an element of uncertainty. These can include:
- An increase in an order;
- Unforeseen circumstances such as strikes and industrial action;
- Machinery breakdowns; and/or
- Suppliers may not be able to deliver when promised.
To try and offset the possibility of stock outs resulting from these uncertainties, organisations may keep a safety stock. This type of inventory is deemed to be dead inventory. It provides a safeguard but adds to the costs of keeping inventory. The level of safety stock can be determined in three different ways:
- Percentage of lead time demand;
- A given period’s worth (e.g. one day’s supply); and
- Average deviation method.
Safety stock is expressed as a set period of time which is multiplied by the average demand during that period. For most items, 50 per cent of lead time demand generally provides an adequate safety stock quantity.
For example:
Demand per day = (450/30) 15 items
Projected lead time = 10 days
Demand during lead time = (10 x 15) = 150 items
Safety Stock = (150 x 50%) = 75 items
The 15 items per day is multiplied by the projected lead time of 10 days resulting in a lead time demand of 150 items. Safety stock is half this amount, or 75 items. This quantity represents a five-day reserve (5 days x 15 items per day).