Stockouts occur when businesses do not restock their inventories at the appropriate time. The lack of inventory planning can make it harder to keep the right inventory, particularly when there are variations in demand or delays in supplier deliveries.
This is where the concept of the reorder point becomes important. A reorder point, also known as a reorder level, is the inventory level at which a business should place a new order to avoid running out of stock. It considers the expected demand during the supplier's lead time and the safety stock needed to handle demand or supply changes.
To determine more effective reorder points, businesses can rely on accurate demand data, evaluate supplier lead times, and ensure they have the appropriate amount of safety stock. Another benefit of an inventory management system is that it can monitor stock levels and alert them when the inventory reaches the reorder level.
What Is Reorder Point/Level?
Reorder point is the level of inventory at which a new order should be placed so that incoming stock arrives in time to meet customer demand without interruptions. Reorder point plays a vital role in maintaining efficient inventory and supply chain operations.
When a business holds more stock than needed, it increases inventory holding costs. On the other hand, running out of stock can lead to missed sales and dissatisfied customers. The reorder point indicates when inventory has reached the level at which the business needs to replenish its stock.
Reorder Point = When to reorder
Order Quantity = How much to order
The reorder point tells a business when to place a new order. It does not determine how much inventory to order.
Reorder Point vs Safety Stock
Reorder point and safety stock are related, but they serve different purposes.
| Concept | What it tells you |
|---|---|
Reorder Point | When to place a new order |
Safety Stock | Extra inventory kept as a buffer |
Safety stock is one component of the reorder point. It helps protect the business from unexpected changes in demand or supplier delays.
The basic reorder point formula is:
Reorder Point = (Average Daily Demand × Lead Time) + Safety Stock
For example, if a business sells 50 units per day, the supplier takes 6 days to deliver, and the business keeps 100 units as safety stock:
Reorder Point = (50 × 6) + 100 = 400 units
This means the business should place a new order when inventory reaches 400 units.
The reorder point tells you when to reorder, while the order quantity determines how much to order.
How Reorder Point Works
Inventory keeps moving as customers place orders. At the same time, suppliers need time to deliver new stock. A business needs enough inventory to cover this lead time and avoid running out of stock.
The reorder point works through a simple process:
- Inventory is consumed: Customers purchase products, which reduces the available stock.
- Supplier lead time matters: Once the business places an order, the supplier takes a certain amount of time to deliver it.
- Demand during lead time is covered: The business needs enough inventory to meet expected demand while waiting for the new stock to arrive.
- Safety stock provides a buffer: Extra inventory helps cover unexpected demand increases or supplier delays.
The basic relationship is:
Reorder Point = Expected Demand During Lead Time + Safety Stock
This means a business should set its reorder point high enough to cover normal demand during the supplier's lead time while keeping some additional stock as a buffer.
What is the Importance Of Reorder Level?
Reorder level or point plays a vital role in business inventory management. Here is a list of them below.
1. Prevents Stockout Issues
It indicates that a business should order products from the supplier before the product goes out of stock.
2. Maintain Smooth Operations
The reorder level allows for a smooth relationship between manufacturers and retailers.
3. Improves Order Fulfilment Process
It allows a business to keep enough stock to meet customer demands. This improves the order fulfillment process and enhances customer satisfaction.
4. Improves Cash Flow
A well-calculated reorder point can help reduce unnecessary excess inventory while maintaining enough stock to meet expected demand.
5. Better supplier planning
When businesses know when inventory is likely to reach its reorder point, they can plan purchase orders and supplier coordination more effectively.
Reorder Level Formula and How To Calculate Reorder Point
The reorder point shows when a business should place a new order. It is calculated using expected demand during the supplier's lead time and the safety stock maintained as a buffer.
Reorder Point Formula
Reorder Point = (Average Daily Demand × Lead Time in Days) + Safety Stock
There are three essential components of the reorder point:
1. Average Daily Demand
Average daily demand is the average number of units a business sells or uses each day during a specific period.
For example, a company sells 8,00,000 computer parts in a year. Assuming 365 days:
Average Daily Demand = 8,00,000 ÷ 365 = 2,192 units per day
So, the company needs to plan for an average demand of about 2,192 computer parts per day.
2. Lead Time
Lead time is the time between placing a purchase order and receiving the inventory from the supplier.
A longer lead time means the business needs enough stock to cover more days of demand. A shorter lead time reduces the amount of inventory needed to cover the waiting period.
3. Safety Stock
Safety stock is the extra inventory a business keeps as a buffer against unexpected demand or supply delays. The required amount depends on factors such as demand changes, supplier reliability, and the desired service level.
Reorder Point Example
Let's calculate the reorder point for a retailer that sells phone chargers.
- Average daily demand: 50 chargers
- Supplier lead time: 8 days
- Safety stock: 90 chargers
Using the formula:
Reorder Point = (50 × 8) + 90
Reorder Point = 490 chargers
The retailer should place a new order when its inventory reaches 490 chargers. This gives the retailer enough stock to cover expected demand during the 8-day lead time while keeping 90 chargers as a safety buffer.
Factors That Impact the Reorder Point
Several factors can change the reorder point. Businesses should review these factors regularly to keep inventory levels aligned with actual demand and supply conditions.
- Average Demand: When daily demand increases, the business needs more inventory to cover sales during the supplier's lead time. This can increase the reorder point.
- Lead Time: A longer supplier lead time means the business needs enough stock to cover more days of demand. This can result in a higher reorder point.
- Safety Stock: Businesses may need more safety stock when demand is unpredictable or suppliers have inconsistent delivery times. A higher safety stock level increases the reorder point.
- Seasonality: Demand can increase during holidays, festivals, sales events, or specific seasons. Businesses may need to adjust their reorder point to avoid stockouts during these periods.
Reorder Point vs Safety Stock vs Economic Order Quantity (EOQ)
Reorder point, safety stock, and EOQ serve different purposes in inventory management. Understanding the difference helps businesses decide when to reorder, how much extra stock to keep, and how much to order.
| Concept | Purpose | Answers |
|---|---|---|
Reorder Point (ROP) | Determines when to replenish inventory | “When should I reorder?” |
Safety Stock | Provides a buffer against unexpected demand or supply delays | “How much extra stock should I keep?” |
Economic Order Quantity (EOQ) | Determines an economical order quantity | “How much should I order?” |
How They Work Together
A business can use ROP to determine when to order, EOQ to determine how much to order, and safety stock to protect against uncertainty.
For example, when inventory reaches the reorder point, the business can place an order for the EOQ amount. The safety stock helps protect the business from unexpected demand or supplier delays while waiting for the new inventory to arrive.
Common Mistakes Businesses Make With Reorder Level
A business may decide on a reorder point correctly on the first go, and yet find that it is either stockout or overstock if it does not regularly review the reorder point. Some of the typical errors are:
1. Not Updating ROP After Demand Changes
The reorder point is established, and then the same number is maintained in many businesses. If the sales volume and/or customer demand changes, the old ROP may become inaccurate, which can cause stockouts or excess inventory
2. Ignoring Supplier Delays
Production or transportation delays, or other causes, can cause supplier lead times to vary. Without taking action on these changes, it can result in stockouts before the next delivery.
3. Using One-Size-Fits-All Reorder Points
The demand pattern, lead time and sales volume vary from product to product. Having the same reorder point for all products can lead to products ending up out of stock when they are moving at a high velocity and accumulating when they are moving at a low velocity.
4. Not Aligning ROP With Business Growth
As a business grows, its sales and order volumes can change. Continuing to use an old reorder point may not provide enough inventory to meet the new demand.
5. Using Average Demand Without Considering Variability
Average demand alone may not reflect sudden changes in sales. Seasonal spikes, promotions, supplier variability, and demand fluctuations can make an average-based reorder point less reliable.
6. Depending Only on Manual Tracking
Manual methods of inventory tracking can cause data entry mistakes and late stock updates. Businesses can utilize inventory management systems to keep track of their stocks and recognize when inventory levels are nearing the reorder point.
Best Practices for Setting and Maintaining Reorder Points
By using inventory technology, reorder point management can be made a more consistent process. Businesses can use inventory systems to help them keep track of stock and automatically alert them to restock when the stock level falls to the desired level.
This is normally the way it goes:
Sales & Order Data → Inventory Visibility → Reorder Threshold → Alert → Purchase Order → Replenishment
1. Sales and Order Data
The system tracks sales and order activity when products are sold or used. This information can be used to determine the demand and changes in inventory needs of a business.
2. Real-Time Inventory Visibility
A WMS or inventory management system updates a stock record as products are received, picked, dispatched and returned. This provides teams with a better understanding of what inventory is available.
3. Reorder Threshold
Each product has a reorder point determined by the business based on the demand, supplier lead time, and safety stock. Once this point is reached, the system can determine that the inventory needs to be replenished.
4. Replenishment Alert
The system can generate an alert when stock reaches the defined reorder point. This reduces the need for teams to check every product manually.
5. Purchase Order
Based on the business process, the alert can prompt the purchasing team to review demand and place a purchase order. The reorder point tells the business when to order, while the required order quantity determines how much to order.
6. Replenishment
The warehouse receives and records new stock in the system once the supplier delivers the stock. The inventory level is replenished, completing the inventory replenishment process.
This workflow is used to link the reorder point formula to the day-to-day inventory operations. It can decrease manual tracking, make stock visible, and assist companies in reacting more quickly when stock drops.
When Should You Recalculate Reorder Point?
A reorder point should change when the conditions used to calculate it change. Businesses do not need to recalculate ROP on a fixed schedule if inventory conditions remain stable. Instead, review it when there is a significant change in demand, supply, or business operations.
Consider recalculating the reorder point when:
- Demand changes significantly: A sustained increase or decrease in sales can make the existing reorder point inaccurate.
- Supplier lead time changes: If a supplier starts taking longer or shorter to deliver, update the ROP to reflect the new lead time.
- A new supplier is onboarded: A new supplier may have different delivery times and reliability, which can affect the required safety stock.
- Seasonality changes: Seasonal demand, festive sales, or planned promotions can require a different reorder point for a specific period.
- A product enters or exits a growth phase: Fast-growing products may need higher reorder points, while declining products may require lower inventory levels.
- A new sales channel is added: Selling through a new marketplace, retail store, or ecommerce channel can change overall demand and inventory requirements.
- Service-level requirements change: If the business wants to reduce stockout risk and maintain higher product availability, it may need to increase safety stock and adjust the ROP.
- Supply disruptions become more frequent: Repeated supplier delays, transportation issues, or other disruptions may require changes to lead time assumptions and safety stock.
The goal is not to keep changing the reorder point unnecessarily. Recalculate it when the demand, lead time, safety stock, or business conditions behind the calculation have changed.
Final Words
Inventory management plays a vital role in effective supply chain management. A reorder point helps businesses decide when to replenish inventory and reduce the risk of stockouts without holding unnecessary stock.
However, ROP is not a fixed number. It should reflect average demand, supplier lead time, and safety stock. Businesses should also review and recalculate it when demand, supplier performance, seasonality, or other operating conditions change.
With accurate inventory data and the right inventory management system, businesses can maintain better stock visibility and make more informed replenishment decisions.
