Essential Knowledge: What You Need to Know About the Reorder Point
If you’re wasting expiring products or missing out on sales, you may need to educate yourself on a concept known as reorder point. In this guide, we’ll tell you everything you need to know.
Following Amazon’s launch of free same-day deliveries, the implications for other, smaller businesses were huge. What would be the effect on customer loyalty?
A Dotcom Distribution survey reported that customers are willing to pay extra for fast delivery.
Customers care more about delivery speed than quality. They want transparency and they have a low tolerance for error.
The challenge is to be able to meet customer expectations for fulfillment. This means being in-stock without having too much stock. If you’re missing out on sales, read on to learn everything you need to know about reorder point.
What is the Reorder Point?
Running a distribution system can sometimes seem like a no-win situation. Whether you are running an e-commerce fulfillment center, a retail business or supplying parts to a manufacturing operation you have a dilemma.
Do you very tight and reduce wastage, keep investment low and manage space efficiently? Alternatively, do you hold high stocks, always deliver speedily and never lose a sale? Both of these approaches have an upside and a downside.
Your ambition has to be to hold just the right amount of stock to meet expectations but not so much that it is inefficient and uneconomic. You need to hit the sweet spot of the right stock in the right place at the right time.
That’s why you need to understand reorder point.
“Reorder point” is a number that tells you when it’s the right time to order stock, goods or materials from suppliers to meet your customers’ needs. When stocks fall below the reorder point you need to place an order.
It considers the lead time for the product, demand, and the safety stock you need.
Lead Time
When you place an order with a supplier it does not instantly arrive on your warehouse shelves.
The lead time is the number of days between ordering a product from a supplier and when it is delivered to you and is sitting ready to be dispatched to your customers.
The lead time includes the time it takes to make the order out, communicate it to your supplier, and the time they take to deliver it. It also includes any delay between the delivery and having the product available for dispatch to your customers if ordered.
In the case of an imported product, the time between order and fulfillment can be long. The product may not be manufactured until an order is received. It may then need to be packed and shipped halfway around the world.
Once it arrives at a port it will then need to pass through customs, transported by road or rail and then delivered to your warehouse. The total number of days that this process takes is the lead time.
Demand
If it takes 30 days from order to receipt of goods you will need to be able to meet your customer demand for that product throughout the time you are waiting for delivery of your next shipment.
This means you have to forecast the demand for that product and hold that amount of stock. If you get this wrong you will run out of that product before stocks are replenished.
If the typical demand for a product is 10 a day, then you need to hold stocks of 300 items to meet demand until the next delivery arrives, 30 days later. If you placed an order every 30 days for 300 items and the order was delivered in 30 days every time, you would never lose a sale.
This is fine, so long as nothing goes wrong.
Safety Stock
Sometimes, things don’t go to plan. Your estimate of demand may be wrong. There may be a blip in demand and suddenly all your stock is dispatched leaving you wondering what sales you might have achieved if only you had some stock.
An order may be lost or damaged in transit. A breakdown of a vessel at sea could result in a long delay. The supplier may go out of business.
This is where contingency planning comes to the fore. Safety stock is the amount of stock you believe will protect you from surges in demand or supply problems. This is a matter of risk assessment.
A risk assessment involves deciding how likely a change in demand or problem with supply will be. Also, decide what the scale of the impact will be.
One way of quantifying this is to estimate the maximum daily sales multiplied by maximum lead time in days. Subtract the average daily sales multiplied by average lead time in days. The result is the safety stock
The Magic Formula
Once you understand your lead time, demand and safety stock you are ready to calculate your reorder point. Multiply your daily sales by the lead time and add the safety stock to it. Once the stock level hits this number you need to order stock.
Once you understand this simple magic formula you can then become a little more sophisticated. Ordering less quantity, but more frequently may mean that you can establish a flow of stocks and be more sensitive to changes in demand. Taking account of your supplier’s minimum order quantities and buying terms might also mean you have to adjust your reorder point.
It is essential to have accurate sales and stock information in order to calculate the reorder point. Unreliable or outdated information will reduce the accuracy of the reorder point. Keeping on top of the data is key.
If all this seems to be getting too complicated for your manual processes perhaps you feel you will be better to rely on gut feel. There is an answer.
Automation
Managing your inventory is key to your business. Tying too much money up in slow-moving stock can lead to business failure. Missing sales because of out of stock positions can be equally bad for business.
If it is so crucial it is worth investing in a solution to the problem.
You may be ready to invest in an inventory management software system. Automating this aspect of your business using a system such as inFlow can mean you meet customer expectations while operating a profitable business model.
Win-Win
If customers value effective fulfillment then resolving the reorder point problem is key to customer satisfaction. Don’t drive customers away because you are out of stock. Make every sale a profitable one because you maintain optimal inventory levels.
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