How much stock does your e-commerce business need to satisfy current and future customer orders? How much inventory do you need on hand to create and package your products for sale?
For e-commerce sellers, it takes inventory to sell inventory. If you handle fulfillment in house, this means having enough merchandise on hand to fulfill your current and future orders before needing to re-up from your suppliers. For sellers utilizing third-party logistics (3PL) services, it means making sure you have distributed enough inventory to all of your partners so that orders can continue to be fulfilled reliably on your behalf. For dropshippers, it means making sure your suppliers are able to meet the demand of your customer base.
Whatever your omnichannel business looks like, the moment you aren’t proactive in establishing and maintaining access to proper inventory levels, your catalog fills with out-of-stock notices, and you run the risk of overselling. Customers who intend to purchase your products can’t get them. Customers who have already placed orders wind up getting notices that their orders have been canceled.
Establishing the ideal amounts of buffer stock and buffer inventory for your online retail business is critical to avoiding these types of profit-killing scenarios. Having the right tools and workflows in place to manage these logistics can make it both simple and pain-free to do so.
The Difference Between Buffer Stock and Buffer Inventory
For most e-commerce businesses, there are two types of physical goods that move in and out of their warehouses: stock and inventory. While oftentimes these terms are used interchangeably, there is a significant difference:
- Stock is any finished, retail product ready to be marketed and sold to a customer. They are typically assigned SKUs and listed for sale in your e-commerce catalogs.
- Inventory refers to the totality of the physical goods in your business’s possession. This includes stock (finished products), raw materials, and work in progress (WIP) products not yet fully in a state ready for sale. From an accounting perspective, inventory even includes the tools and equipment used in maintenance, repair, and operations (MRO).
For your omnichannel e-commerce business to run smoothly, you need to always have enough inventory – of all types – to keep production and fulfillment moving forward. This is where buffer stock and buffer inventory come in.
- Buffer stock – sometimes referred to as safety stock – is a quantity of ready-to-ship products that you maintain to protect against overselling.
- Buffer inventory is an excess amount of raw materials and MRO that allow you to continue to produce stock for future orders. Buffer inventory also includes the amount of WIP products that you maintain to keep production moving forward and the aforementioned buffer stock quantities.
The optimal versions of these two amounts can look vastly different across brands and businesses. The nature of your products, production processes, supply chain, carrying costs, and storage arrangements will all play a part in determining the ideal buffer stock and buffer inventory levels for your company.
Furthermore, your ideal buffer levels may fluctuate over time depending on both internal and external factors. Events like supply chain delays, holidays, and promotions may necessitate increases in buffer inventory levels. Slow seasons or declining sales trends may lead to lower need. Ultimately, however you choose to calculate buffer quantities, it should be flexible and agile enough to adapt to your ever-evolving circumstances as an e-commerce retailer.
Ways to Calculate Optimal Buffer Stock and Inventory Levels
Ideally, all amounts of buffer inventory you keep in your warehouse should be enough to give your business peace of mind without incurring unnecessary carrying costs. Orders can be fulfilled without delay. Production can continue without interruption.
How you settle on what these numbers should be is up to you, but there are several popular methods widely used across the retail industry:
- Setting a fixed buffer inventory – Rather than opting for any of the more complicated algorithms below, the simplest option for some businesses is to just select and set a comfortable inventory quantity threshold as their buffer. This can be a particularly effective plan for e-commerce businesses that can afford to carry large amounts of excess stock due to either the nature of their products or their warehousing arrangements. It is a quick – albeit imprecise – approach.
Despite being called “fixed,” the buffer levels are certainly not set in stone. These levels can be manually increased or decreased based on sales forecasts or other business considerations.
- The “Traditional” safety stock formula – If you have access to some basic sales, production, and supply figures, you can use this method of calculating the proper amount of buffer inventory to keep on hand for a given product or material.
(Maximum daily sales x Maximum lead time) – (Average daily sales x Average lead time)
One disadvantage of this method is that it may lead to carrying more inventory than necessary. It also may be insufficient to satisfy sharp spikes in customer demand.
- More complex buffer stock formulas – For those looking for a more nuanced approach, there are several more complicated ways to generate more accurate figures. This is particularly useful for e-commerce businesses with high warehousing overhead, large products, particularly dynamic sales rates, inconsistent supply chains, and/or other types of logistical hurdles.
One popular buffer inventory formula is the Heizer and Render formula:
Z x 𝜎dLT
In this formula, Z is a variable known as Z-score that is set according to your desired service factor. It represents how many standard deviations above the mean level of demand you want to be certain that you will not oversell a given product or run out of a given piece of inventory. The higher the number, the lower the odds you will run out, but the more buffer inventory you will inevitably carry. 𝜎dLT represents the standard deviation in lead time – or the variation between your average supplier lead times and their actual fulfillment times.
This particular formula is useful in protecting you against out-of-stocks caused by suppliers that provide you with inconsistent fulfillment speeds and lead time requirements.
Another useful formula for calculating optimal buffer inventory levels is known as Greasley’s method.
Z x 𝜎dLT x Davg
Just like Heizer and Render, Greasley’s formula includes the Z-score confidence variable and the standard deviation in lead time variable. However, the addition of the average demand variable (Davg) offers an extra layer that considers patterns of customer behavior as a predictor of your buffer inventory needs. E-commerce sellers that regularly face sales variances due to seasonality, promotions, or otherwise volatile markets would be better served to opt for buffer calculations that account for fluctuations in customer demand.
No matter which method you choose, implementing and maintaining a buffer inventory is made simple with a proper, reliable inventory management system.
An Effective Inventory Management Platform is Critical to Managing Buffer Stock and Buffer Inventory Levels
Keeping track of order inventory and production stock is already challenging. Managing incoming and outgoing orders, juggling multiple warehouse locations, and tracking complex logistics operations all can be complicated workflows in their own rights. Modern omnichannel e-commerce all but requires a unified inventory management platform to manage it all.
Ideally, the platform you choose should also provide you with the tools you need to establish and maintain the buffer inventory and stock levels required to keep your business running smoothly and efficiently. Sellercloud’s family of products are ideally suited to this challenge. Not only does our omnichannel growth platform give you all the tracking and organizational tools you need to process orders, track inventory, maintain an omnichannel catalog, and manage all of your warehouse operations, but our predictive purchasing tools can also help automate the maintenance of your stock and inventory levels.
Using one of the methods outlined above, establish the buffer inventory levels you require. This may be for every product you sell, or possibly just for your highest-performing inventory.
From there, Sellercloud allows you to set a per-product “safety quantity” that will establish a stock buffer against overselling. This “safety quantity” is subtracted from the actual quantity of a product you have on hand before it is pushed out to your omnichannel listings. For instance, if you have 100 units on hand and a safety quantity buffer set to 10 units, Sellercloud will report to channels that you only have 90 units available for sale. This buffer can be used in tandem with predictive purchasing to ensure that you always have enough stock to meet customer demand.
For more on how Sellercloud can help you keep your omnichannel e-commerce business growing while protecting you against pitfalls like overselling, contact us directly for a free demo.