23.08.2023
E-commerce: finding the right balance for your safety stock
Carefully calculating your safety stock can help to avoid stock-out incidents.
Unfulfilled orders due to temporary stock shortages can have a negative impact on any e-Commerce company's reputation. Not having sufficient products available for dispatch can lead to dissatisfaction among customers, who will choose a competitor for their future purchases... and perhaps create a poor impression of your company.
To avoid such product shortages, you need to have sufficient stock available... but not too much. If you overestimate the amount of stock you need, you risk paying additional storage costs, or even losing money in the long run by accumulating unsold stock.
It’s therefore necessary to find the right balance. There’s a solution for this: safety stock. In this article, we explain how to calculate it, and how to optimize your stock levels according to the results obtained.
Why calculate your e-commerce safety stock?
In the world of e-Commerce, the difficulty lies in keeping just the right level of stock. It’s important that you determine the safety stock, i.e. the amount of stock that will enable you to avoid a stock shortage, an unfulfilled order... and an unsatisfied customer.
The required level of safety stock will be different for each merchant. It will be dependent on three main variables: the delivery lead time you can guarantee, the stability of demand (does the number of orders vary greatly according to the time of year?) and finally, the lead times your suppliers can guarantee. Are they able to quickly provide you with back-up stock during your peak periods or in the event of a surge in orders?
Safety stock: how should it be calculated?
The Max-Average method: for businesses with low volumes and stable forecasts
The simplest method for calculating the level of safety stock for each unit of product that you offer on your e-Commerce website is the "Maximum minus Average" method. This method takes into account the maximum variations in your suppliers' delivery lead times and your maximum sales levels versus the averages for these metrics. The safety stock is calculated as follows:
(Maximum sales x Maximum delivery time) - (Average sales x Average delivery time)
For example: Let's say you’re selling shoes. You sell a maximum of 35 pairs a day, and an average of 25. The longest delivery lead time guaranteed by your supplier is 30 days, but it’s usually 20 days.
The calculation would be as follows:
(35 sales maximum x 30 days maximum) - (25 sales on average x 20 days on average)
This gives us:
1050 – 500 = 550
Your company's safety stock should therefore be 550 pairs of shoes.
In this calculation, care must be taken to use the same unit of time for all variables. You also need to exclude exceptional values that could lead to an excessively high safety stock.
Given that this method will always cover your worst-case scenario, it’s best suited to products where the variables are relatively stable, and to businesses with low volumes or small products involving a lower inventory cost.
The probability-based method: for businesses with high volumes and different contingencies
For larger businesses with more variations, the probability distributions allow for a more detailed calculation of the safety stock.
For fast-moving consumer goods with high sales and fast rotations, it’s possible to estimate sales behaviour based on normal distribution. For example: if your average monthly sales are 1,000 units, the probability of making fewer sales will be the same as the probability of making more sales in any given month. If this is the case, you can calculate your safety stock using the Normal Distribution.
Formulas of varying complexity can help you deal with various contingencies. Let's say we want to calculate our safety stock in a context of stable lead times but unpredictable demand. In this case the formula used will be :
Safety stock = safety coefficient x lead time x standard deviation of the sales
- The safety coefficient is provided by the Normal Distribution according to the desired service level. If we are aiming for a service level of 90%, we calculate the coefficient on a spreadsheet, using the formula NORMINV(0.90) = 1.28.
- The lead time is stable in this method: either your lead time is almost always the same, or you can take an average based on experience if you are missing data. For our example, let's say there is a 2-month lead time.
- The standard deviation in demand is calculated based on a series of sales data. Take your historical sales figures per month over as wide a period as possible: use the STDEV formula on the data set. Make sure you retain the same frequency for the lead time and sales (in this case monthly).
Let's say for example that our standard deviation for sales is 100 units, our safety stock for this activity is: 1.28 x 2 x 100 = 256 units.
The same method can be used in the case of major variations in supply lead times and relatively stable sales. We calculate the lead time variation rather than the variation in sales, and we multiply by the average sales rather than by the average lead time.
Whatever the formula used, the reliability of the data is paramount. Monitoring your business activity (sales, lead times, etc.) is essential for calculating this safety stock; it will enable you to make realistic forecasts of variations, based on the data you have collected in advance. No more uncertainty!
How your safety stock helps to avoid stock-out incidents
Carefully calculating your safety stock provides a way for e-Commerce businesses to avoid out-of-stock incidents. They can fulfil customer orders following a sale, deliver quickly and maintain a good reputation.
But calculating your safety stock level for each item is not always enough to avoid stock shortages. In addition to this, there are a number of methods and best practices you can use to ensure optimum stock levels and to optimise your inventory:
Tip no.1: Keep a watchful eye on developments in the marketplace and the legislative environment at a global level
The latest news can affect supply chains and cause disruption. During the Covid pandemic for example, cargo ships were blocked out at sea, delaying shipments... and causing multiple inventory shortages! Hence the importance of keeping a close eye on market trends, from the prices of raw materials to transport and logistics costs. You should also keep track of changes in the law, and as far as possible, anticipate any problems that could slow down the delivery and reception of your products.
Tip no.2: Diversify your suppliers
Having several suppliers in your contact book can help avoid inventory shortages. Let's say one of your suppliers suffers delays in production or delivery: it's better to be able to rely on an alternative supplier when this happens, in order to ensure you are re-supplied!
Take the time to build good business relationships with all your suppliers: find out how they operate in order to achieve a better understanding of what you require of them in the event of unforeseen circumstances.
You should also find out how important you are to your supplier: how much turnover do you represent and where will you stand in your supplier's priorities in the event of business trouble?
Tip no.3: Analyse your previous stock reports
Are you regularly out of stock? While the occasional inventory shortage is normal, if it occurs frequently this should serve as a warning. It might be worth examining them, in order to limit them and maintain a decent inventory level.
To do this, you can study your stock reports. They will tell you what stock is available, and the number of items sold. Is your stock dangerously low? You may need to order new products from your suppliers.
We can also learn a lot from the data on orders previously placed. How many products have been ordered but not yet dispatched? Taking account of this quantity, is a stock shortage incident likely?
Finally, take a close look at your sales reports to identify both your bestsellers and less selling products. Safety stock calculations will not apply to all your product references in the same way. For example, you’ll have a higher required service level for your bestsellers than for your lower-rotation products.
Tip no.4: Use the services of a 3PL provider
Why not consider outsourcing your logistics to a logistical service provider like GEODIS eLogistics?
A service provider can help you manage your e-Commerce logistics more effectively and support your growth through improved distribution. You will benefit from digital solutions enabling you to monitor your business in real time, optimise your stock, monitor order preparation and dispatch, and manage returns.
Thanks to these useful resources, you’ll be able to monitor your stock with the utmost precision, with details of the overall stock as well as the reserved stock (orders yet to be dispatched). You’ll be able to adapt your purchasing policy, item by item.
The eLogistics solution from GEODIS, an expert in all Supply Chain activities, supports the growth of your e-Commerce business thanks to a team of experts. Including cyclical calculations, estimates and optimization... they’ll work with you to ensure that your stock levels are always optimal. During operational meetings, they’ll provide you with their analyses of your customers’ order behaviour and stock levels for each reference, optimizing your logistics in as far as possible.
