Figuring safety stock into your sales forecast is not doing you any favors.
Wait, what?
Safety stock is a foundational concept in the world of inventory management. Yes, that’s true.
Let’s take a step back. What is the purpose of setting safety stock?
Suppliers screw up. They sent the wrong products, or worse yet don’t send them at all. Been there and done that. The need for a buffer to allow for the real world of eCommerce stock management is real.
Setting safety stock is not the best way to build in a buffer for your inventory needs. There is a smarter way to build in some padding to your stock on hand, to allow for these real life complications that come up.
First let’s look at what doesn’t work about safety stock.
Safety stock is static. That means it does not grow as your store grows.
For example, 5 units might be a meaningful number now. Over time as your store grows, 5 units could become a meaningless amount to use as a buffer. You need to manage a stock buffer that grows with your store.
If safety stock doesn’t meet your needs, how can you build in a buffer?
Days of stock.
What are ‘days of stock’?
Days of stock are the number of days that your current inventory will cover considering customer demand for those products.
Let’s look at an example. If your sales velocity is 2 units per day and you have 50 units on hand, the days of stock is 25 days.
When calculating your sales forecast, one important consideration is how many days of stock is ideal for you to keep on hand? Remember that the sales forecast is an estimate.
If you keep enough product to cover 7 days of stock, then you don’t have much additional inventory on hand in case an enthusiastic customer wants to make a large purchase.
How much inventory will allow you to meet customer demand without being overstocked and having too much cash tied up in inventory sitting on your warehouse shelves? A typical place to start is 30 days of stock. For a product that is selling well, this should be more than enough time for you to recuperate your investment and spend your profit on more of that product or another area of growing your business.
How can ‘days of stock’ build in a buffer for supply chain problems?
A smart sales forecast is calculated using the sales velocity and the sales trends in recent months. (We’ll exclude seasonal products from the discussion for now.) Sales velocity is the rate of sales excluding out of stock days.
Once you have your forecasted sales and determined your desired days of stock to have on hand, then you can think about how to build in a buffer to account for supply chain problems. A dynamic way to handle this buffer is to add to your days of stock.
If you start with 30 days of stock, you could increase that to 35 days so that you have additional stock on hand in case of supplier mis-shipments. The additional five days of stock will be based on your sales velocity and will meet the level of customer demand for your products.
How is using days of stock better than safety stock to forecast inventory demand?
If you’re using safety stock as a buffer, then you’re creating extra work for yourself maintaining a solution that doesn’t match customer demand. Ask yourself how you’re determining your safety stock level. Is it based on customer demand? If so, when was that demand? Are you changing and updating your safety stock level every time you see a change in customer demand? How often does customer demand change…weekly or monthly? Are you updating safety stock to meet that changing demand on a weekly or monthly basis? If so, you’re working too hard.
Using days of stock, your inventory buffer is updated dynamically to match changes in customer demand. If you’re selling 2 units per day in January then later selling 5 units per day in September, the number of units to cover 30 days of stock goes from 60 units to 150 units. When you add 5 days of stock as a buffer, then you’ll stock another 25 units. If you had set the safety stock in January at 10 units, then by September that is only a 2 day buffer. It won’t grow as customer demand grows. Using additional days of stock will steadily increase the units needed to cover another 5 days.
You’re doing a lot to grow your business: driving traffic, optimizing conversion on site, merchandising to meet your customers’ needs. Done right, these activities are increasing sales for your store. Make sure you’re building in operations that are growing with your business. Use a smart sales forecast based on sales velocity and use days of stock to have the right amount of stock on hand. Building in a buffer for your inventory needs is smart risk management. Don’t blow it by creating more work for yourself or miscalculating how much buffer to build into your stock levels.