Reorder point
Encyclopedia
The reorder point is the level of inventory
when an order should be made with suppliers to bring the inventory up by the Economic order quantity
("EOQ").
drops down to zero. In view of instantaneous replenishment of stock the level of inventory jumps to the original level from zero level.
In real life situations one never encounters a zero lead time
. There is always a time lag from the date of placing an order for material and the date on which materials are received. As a result the reorder point is always higher than zero, and if the firm places the order when the inventory reaches the reorder point, the new goods will arrive before the firm runs out of goods to sell. The decision on how much stock to hold is generally referred to as the order point problem, that is, how low should the inventory be depleted before it is reordered.
The two factors that determine the appropriate order point are the delivery time stock which is the Inventory needed during the lead time (i.e., the difference between the order date and the receipt of the inventory ordered) and the safety stock
which is the minimum level of inventory that is held as a protection against shortages due to fluctuations in demand.
Therefore:
Several factors determine how much delivery time stock and safety stock should be held. In summary, the efficiency of a replenishment system affects how much delivery time is needed. Since the delivery time stock is the expected inventory usage between ordering and receiving inventory, efficient replenishment of inventory would reduce the need for delivery time stock. And the determination of level of safety stock involves a basic trade-off between the risk of stockout
, resulting in possible customer dissatisfaction and lost sales, and the increased costs associated with carrying additional inventory.
Another method of calculating reorder level involves the calculation of usage rate per day, lead time which is the amount of time between placing an order and receiving the goods and the safety stock level expressed in terms of several days' sales.
From the above formula it can be easily deduced that an order for replenishment of materials be made when the level of inventory is just adequate to meet the needs of production during lead-time.
When the inventory level reaches 350 units an order should be placed for material. By the time the inventory level reaches zero towards the end of the seventh day from placing the order materials will reach and there is no cause for concern.
Re-order point = Average Lead Time*Average Demand + Z*SQRT(Avg. Lead Time*Standard Deviation of Demand^2 + Avg. Demand^2*Standard Deviation of Lead Time^2)
Reorder point = S x L + J ( S x R x L)
Where
Inventory
Inventory means a list compiled for some formal purpose, such as the details of an estate going to probate, or the contents of a house let furnished. This remains the prime meaning in British English...
when an order should be made with suppliers to bring the inventory up by the Economic order quantity
Economic order quantity
Economic order quantity is the level of inventory that minimizes total inventory holding costs and ordering costs. It is one of the oldest classical production scheduling models. The framework used to determine this order quantity is also known as Wilson EOQ Model or Wilson Formula. The model was...
("EOQ").
Continuous Review System
The reorder point for replenishment of stock occurs when the level of inventoryInventory
Inventory means a list compiled for some formal purpose, such as the details of an estate going to probate, or the contents of a house let furnished. This remains the prime meaning in British English...
drops down to zero. In view of instantaneous replenishment of stock the level of inventory jumps to the original level from zero level.
In real life situations one never encounters a zero lead time
Lead time
A lead time is the latency between the initiation and execution of a process. For example, the lead time between the placement of an order and delivery of a new car from a manufacturer may be anywhere from 2 weeks to 6 months...
. There is always a time lag from the date of placing an order for material and the date on which materials are received. As a result the reorder point is always higher than zero, and if the firm places the order when the inventory reaches the reorder point, the new goods will arrive before the firm runs out of goods to sell. The decision on how much stock to hold is generally referred to as the order point problem, that is, how low should the inventory be depleted before it is reordered.
The two factors that determine the appropriate order point are the delivery time stock which is the Inventory needed during the lead time (i.e., the difference between the order date and the receipt of the inventory ordered) and the safety stock
Safety stock
Safety stock is a term used by logisticians to describe a level of extra stock that is maintained to mitigate risk of stockouts due to uncertainties in supply and demand. Adequate safety stock levels permit business operations to proceed according to their plans...
which is the minimum level of inventory that is held as a protection against shortages due to fluctuations in demand.
Therefore:
Reorder Point = Normal consumption during lead-time + Safety Stock .
Several factors determine how much delivery time stock and safety stock should be held. In summary, the efficiency of a replenishment system affects how much delivery time is needed. Since the delivery time stock is the expected inventory usage between ordering and receiving inventory, efficient replenishment of inventory would reduce the need for delivery time stock. And the determination of level of safety stock involves a basic trade-off between the risk of stockout
Stockout
A stockout, or out-of-stock event is an event that causes inventory to be exhausted. Reorder points are often specified in such a way as to reduce the likelihood of stockouts during replenishment, due to the vendor's lead time, which cause interruptions to sales or deliveries.Stockouts are...
, resulting in possible customer dissatisfaction and lost sales, and the increased costs associated with carrying additional inventory.
Another method of calculating reorder level involves the calculation of usage rate per day, lead time which is the amount of time between placing an order and receiving the goods and the safety stock level expressed in terms of several days' sales.
Reorder level = Average daily usage rate x lead-time in days .
From the above formula it can be easily deduced that an order for replenishment of materials be made when the level of inventory is just adequate to meet the needs of production during lead-time.
Example
If the average daily usage rate of a material is 50 units and the lead-time is seven days, then:Reorder level = Average daily usage rate x Lead time in days = 50 units x 7 days = 350 units
When the inventory level reaches 350 units an order should be placed for material. By the time the inventory level reaches zero towards the end of the seventh day from placing the order materials will reach and there is no cause for concern.
Re-order point = Average Lead Time*Average Demand + Z*SQRT(Avg. Lead Time*Standard Deviation of Demand^2 + Avg. Demand^2*Standard Deviation of Lead Time^2)
Reorder point = S x L + J ( S x R x L)
Where
- S = Usage in units per day
- L = Lead time in days
- R = Average number of units per order
- J = Stock out acceptance factor
- The stock-out acceptance factor, `F', depends on the stock-out percentage rate specified and the probability distribution of usage (which is assumed to follow a Poisson distribution).