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What is safety stock and how much of it should I hold?
Safety stock is extra inventory held to cover uncertainty in demand and supplier lead time. How much you need depends on how variable demand and lead times are and how often you are willing to run out. More variability or a stricter service target means more safety stock, which ties up more cash.
A common approach multiplies the standard deviation of demand during lead time by a service factor from the normal distribution. That is a reasonable starting point, but it assumes demand is roughly bell-shaped, which is often false for slow-moving or lumpy items.
Practical advice:
- Set different service levels for fast sellers, slow sellers and critical items.
- Reduce variability where possible, such as shorter lead times or better forecasts.
- Review holding cost against the cost of a lost sale.
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