A reorder point is an indication that the stock or inventory needs to be updated, restocked, or replenished. It is a calculation of the level at which businesses need to place an order for more stock so that the inventory is managed properly.
How to Calculate Reorder Point?
There are two ways to calculate reorder points: either with or without safety stock.
Reorder Point With Safety Stock
Reorder Point = Daily Unit Sales x Lead Time + Safety Stock
This formula is handy for those businesses that have a little extra stock available in their inventory in case of unforeseen circumstances. This extra stock is known as safety stock and plays a key role in determining the reorder point.
Let’s understand this concept with the following example.
Consider you are a plastic bottle retailer. Your average daily sale is 500 bottles. It takes your vendor 2 weeks to deliver the plastic bottles batch. You are habitual in maintaining a safety stock for 10 days.
Let us calculate the order point:
Lead time = 10 days
Safety stock = 500 bottles x 10 days = 5000 bottles
Reorder point = 500 x 2 + 5000 = 6000 bottles.
This means that when you have 6000 bottles left in your inventory, you should restock them by placing the order.
Reorder Point Without Safety Stock
Reorder Point = Daily Unit Sales x Lead Time
Sometimes businesses do not follow the strategy to keep or maintain a safety stock. That is when the above-mentioned reorder point formula comes into play.
Here is how these businesses calculate their reorder points:
Consider the same above example but do not consider the safety stock this time.
Lead time = 10 days
Reorder point = 500 x 2 = 1000 bottles.
Without safety stock, according to the reorder point formula, you need to replenish your stock when there are 1000 bottles left in the inventory.
What Factors Influence the Reorder Point?
Safety Stock
Safety stock is also known as buffer stock. It is a practice in which retailers or suppliers often maintain an inventory by ensuring surplus purchases so that the business does not have to suffer from a stockout situation.
Daily Sales
A key determinant that provides insights about how much of a specific product your business is selling daily. Here is how you can calculate your daily sales:
Average daily sales = Total sales / the number of days
Calculating daily sales is an important metric for businesses. This is mainly because it gives an estimation of how well your business is doing and is a critical factor for reorder point calculations.
Lead Time
Lead time is the time your shipper takes to supply you with the items or products that you have ordered. The lead time is calculated in days.
What Is Reorder Point Usage?
As we have discussed before, a reorder point is a threshold limit that signifies that the business might run out of the specific product if they do not place an order for it. A reorder point plays a key role in streamlining the decisions regarding the inventory process.
Moreover, it is easy to use reorder points and incorporate their analysis into the inventory management process.
What are the Benefits of Reorder Point?
Given below are some of the benefits of reorder points and their role in the business maintenance process.
Saves Your Money
With the help of ROP, businesses can effectively manage their inventory. From reducing the possibility of stockout to optimizing inventory, ROP also plays a key role in minimizing the chances of overstocking.
Reduces the Onset of Stockouts
A stockout is a situation where the business runs out of items or products. This situation can happen for the following reasons:
Incorrect demand forecast Inefficient inventory management process Shortage of working capital
Stockouts can be deadly for businesses. It can cost them their customers. It can lead to businesses losing their customers. That is why the reorder point is important because it estimates when businesses need to replenish their stock inventory.
Increases the Opportunities for Business
Reorder points provide insight regarding the products that need to be replenished in the inventory. This calculation promises precision and gives businesses a chance to expand their horizons. The more regularly retailers and suppliers maintain tabs on the inventory, the less the chances of losing customers because of a stock shortage.
What Are the Limitations of Reorder Point?
While there are many perks of using a properly established ROP system, there are some limitations to its usage as well.
Cannot be Projected for Complex Manufacturing Operations
As the reorder point only caters to the lead supply, daily sales, and safety stock (on an optional basis) it does not comply with the relationship between various items and their production flow.
Reorder point mostly caters to just simple metrics like the ones that we have discussed above.
This calculation is limited because it does not include other factors such as various production/supply lines, multiple items, and complex operations of the inventory.
Doesn’t Consider the Production Capacity
The reorder point does not entertain the production facilities’ capacities.
That is why retailers and suppliers often try to incorporate this factor manually while calculating the reorder point.
The consideration of production capacity is highly important for the inventory management system. If businesses do not take into account the limitations of the production capacity they might end up losing their customers.
Ineffective for Fluctuating Demand
ROPs are highly effective when the products in question have a stable customer base and a stable lead from the supplier.
But when these two inputs are changed the reorder point fails to provide the right values.
The best example of this limitation is that the reorder point works in those products that are made-to-stock. Made-to-stock products are produced by the manufacturers in bulk because of their high demand in the market. Such products and their planning are often done on a prior basis.
On the other hand, there are engineer-to-order products. These products are only produced when there is a demand for them or when the customer specifically asks about them. The reorder point falls flat in terms of the engineer-to-order products category.
What Are the Strategies for Reorder Points?
Take Reorder Point Calculations Seriously
One of the most important things to consider while inventory management is to take the calculations of reorder points seriously. There is no point in calculating it in the first place if you are going to ignore it.
As reorder points are the indication that you need to place a reorder, it is highly important to consider its metrics at the right time to avoid any sort of discomfort in the later stages.
Avoid Rigid Methodology
It is often tempting for people to use the same ROP calculations for similar products in the inventory, businesses should avoid this practice. Remember that e-commerce is a dynamic world where supply and demand are constantly changing. This type of dynamic change can be predicted by the supplier market conditions as well.
Therefore it is important to avoid the same rigid or fixed ROPs. Remember to update them regularly to cater to any possible market change.
Keep an Eye on the Reorder Quantities
There are two ways to do this. If you are over-relying on reorder quantities and only stacking up the stock when it’s an absolute necessity, it is an indication of the fact that you are not ordering the justified quantities. Moreover, if you are always managing your stocks because of more products in the stock than necessary or needed, you might end up paying more money than is necessary for inventory management.
A key thing to remember here is that the reorder point is important because it gives you a time bracket to restore the goods in your inventory. But it does not give you insights regarding the order quantities. That is when you should rely on EOQ ( Economic Order Quantity).
Try Sales Forecasting
The above-provided formula of ROP works well in those scenarios when the lead times and the daily sales are constant for a longer period.
But if your lead time is four days and you run a business where the weekend sales are higher than the weekday sales, a better approach is to use your expected sales over the next four days in the formula. This approach will save you from any potential and unprecedented stockouts during the weekends.
Conclusion
Reorder points and their calculation are highly important because they help businesses to find a common ground between spending too much on inventory management and having too few stocks on hand.
Although a rather simple formula that often falls flat in terms of complicated inventory management inputs, reorder points can still provide valuable information regarding inventory management.
