According to Harvard research, when a product is out of stock, more than 40% of customers move to another store instead of settling for a substitute. Most modern consumers do not have the patience to wait for inventory to be restocked. Instead, they go shopping somewhere else. Stockouts are a major problem for any business and can be quite expensive! It is estimated that stockouts result in losses of almost one trillion dollars for retailers around the world.
Predicting supply and demand is tough. There is no guaranteed method for businesses to forecast inventory requirements. Today’s manufacturers, suppliers, and retailers rely on software to smooth the edges of uncertainty. Maintaining buffer inventory is one method e-commerce businesses use to prevent shortages and delays in the retail fulfillment process.
In this post, we’ll look deeper into what buffer inventory is, how to calculate it and why having buffer inventory is a good idea.
What is Buffer Inventory?
Buffer inventory (also known as safety stock, supply chain safety net, or contingency stock) is excess inventory held in a warehouse in the event of an emergency, supply chain breakdown, or transportation delays. It can also be referred to as the amount required to protect against customer-induced fluctuations or spikes in demand. The amount of buffer stock you store depends on the type of product you sell, production lead times, and historical trends.
Buffer Stock vs Safety Stock
Both ‘buffer inventory’ and ‘safety stock’ are often used interchangeably to refer to the excess stock that an e-commerce company keeps on hand to act as a cushion for supply and demand fluctuations.
However, in certain scenarios, ‘buffer inventory’ refers to inventory maintained specifically for unexpected increases in product demand (for example, a promotion that generates more sales than planned), whereas ‘safety stock’ refers to inventory retained in case of work-in-process inventory or supplier delays.
For example, consider a manufacturer of candies. They keep extra levels of raw materials like sugar and fruit flavors to account for disruptions from their supplier. This is their safety stock. It ensures smooth production even in an event of an unexpected raw material shortage. They also keep extra packets of candy, labelled and ready for sale in their warehouse. This is their buffer stock. This buffer stock helps them keep convert sales in the event of an unexpected demand spike that might otherwise stretch their inventory.
Overall, they serve the same purpose: to ensure there is enough inventory to meet demand and fulfil orders on time.
How do you calculate Buffer Inventory?
Several variables influence how much inventory you keep on hand as a buffer. You will have to do some math to calculate the right quantity of buffer inventory. You can use the following three formulas to figure out the correct quantity for your business:
Safety Stock Formula
The safety stock formula is a great technique to quickly find an ideal quantity of inventory buffer in the event of an unforeseen circumstance. When calculating the proper amount of buffer inventory, you’ll need the following information:
- Maximum daily usage
- Maximum lead time
- Average daily usage
- Average lead time
Once you’ve gathered this information, you can use the formula below:
(Maximum daily sales x Maximum lead time) – (Average daily usage x Average lead time)
Hezier and Render’s method
The Hezier and Render’s buffer inventory method is based on the standard deviation of the lead time distribution and the desired service factor (i.e., probability that a stockout will not occur). This method provides you with a more realistic view of how much buffer you should keep on hand.
The Hezier and Render method is determined by multiplying your desired service factor (Z) by the standard deviation in lead time (𝜎LT), which is the difference between the average and actual lead time. The Hezier and Render’s method forumula is:
Z x 𝜎LT
Greasley’s inventory calculation technique is different from Hezier and Render’s method as it considers not just the standard deviation of lead time and desired service factor, but also average demand.
In this method, the standard deviation in lead times refers to the unpredictability in lead times over time, whereas average demand denotes the number of items required to fulfill consumer demand in a given period. The formula is:
𝜎LT x average demand x Z
Advantages of Buffer Inventory
Protects against stockouts
A stockout is an event that causes inventory to be exhausted. Running out of e-commerce inventory is never good for business, but maintaining buffer inventory gives you a cushion against stockouts. Buffer inventory can be advantageous since it can help in ensuring that consumers have consistent access to your goods and gives you time to replenish your inventory.
Buffer inventory provides businesses stability as it helps them effectively handle unexpected surges in demand. It protects against fluctuations in the demand and supply of your goods. Buffer inventory also promotes consistent sales levels and revenue generation by helping convert sales even during unexpected demand spikes.
Maintaining buffer inventory can help you avoid a lot of unnecessary costs. It is an excellent way to reduce stockout expenses. Stockout expenses refer to the lost income and added expenses due to a shortage of inventory. Buffer inventory helps avoid costs due to delays in order fulfillment and shipping, and it additionally protects your business from opportunity losses.
However, buffer inventory should be used with caution. A company may maintain high levels of buffer stock, but the demand for all of the goods may never materialize. Having excess, unsold inventory will also cause you to incur more storage expenses. Thus, careful consideration and forecasting must be done before deciding what level of buffer inventory you should maintain. It is not intended to be a replacement for regular inventory; rather, it serves as a backup. It provides you with a piece of mind and operational flexibility when production is halted, accidents occur, or clients unexpectedly purchase more.