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Buffer stock refers to an amount of physical stock that a company keeps on hand to protect against unexpected supply and demand variations. Choosing the right amount of buffer stock can be a difficult balance between waste and shortfall. In a wider context, buffer stock involves governments buying and selling commodities to attempt to stabilize prices.
While a company can estimate the amount of stock it will need on hand at any time, this can prove incorrect for both supply and demand reasons. On the supply side, a company may face delays in getting raw materials, may suffer machinery breakdowns or labor disputes, and may find the levels of mistakes and breakages in production is bigger than expected. On the demand side, a company may find a product becomes more popular overall, or that changes among rival sellers mean more customers come to the company.
There are several reasons to keep buffer stock at as low a level as possible. Having too much can increase storage costs or strain the limits of existing storage capacity. With perishable goods, excess stock can lead to wastage.
Maintaining buffer stock can provide a useful side effect in that it allows a company to check how accurate its forecasts have been. A company can measure its buffer stock either at the end of the year or as an average over time. The higher the level of this stock, the more accurate the company's original forecasts for stock requirements has proven to be. In turn, the company may then feel it can reduce the amount of buffer stock needed in the future.
A variation on this process, known as a buffer stock scheme, can be used in a market as a whole. In this context, the organization operating the scheme is acting to influence prices rather than as a manufacturer aiming to make a profit. The scheme involves buying up goods when there is a surplus in the market, then selling them when there is a shortage. In theory, this process helps maintain prices by avoiding major price falls when there is excessive supply, or price hikes when supply is insufficient. Because of the aims of the process and the large scale on which it must be carried out to be effective, such schemes are usually only carried out by governments that take an interventionist approach to economics.
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