A truly efficient warehouse is a delicate balancing act of product quantities. Running out of inventory and missing out on potential sales is just as disastrous and wasteful as not having enough warehouse space to stock sufficient inventory. In this article, we’ll explore how you can use the reorder point formula to ensure you never miss out on sales!
It’s a tricky balancing act:
- How can you keep enough inventory to meet demand without having too much?
- When do you tip the scales to reorder?
- How do I avoid ordering too early or too late?
- What amount of safety stock do I need to meet demand until restocking?
There’s a bit of art to balancing everything but there’s a lot more science than most people think. While it’s impossible to know every variable, you can project based on historical demand, adjusting for seasonal changes, and order cycles.
As your business grows, products get added, and the list of SKUs gets longer, the more science you need. Analyzing the right data points can help you keep things in balance. This is where the Reorder Point (ROP) formula comes in.
What is a Reorder Point?
The reorder point formula helps you walk the thin line between having enough inventory to meet demand and tying up funds in unnecessary stock. It establishes the bottom line for how much product you want to have on your shelves at any one time. When stock levels hit this bottom line, it’s time to reorder.
At its most basic, the reorder point formula will show you the right time to order more inventory or material from your vendors or suppliers. This helps eliminate avoidable interruptions to your supply chain.
Your reorder point should include every item in your inventory, including kits and product combinations that you sell. If you manufacture or assemble products, it needs to track the raw materials you need to create products. If you use multiple vendors for items or materials, it must also track lead times across suppliers to make sure you have the pieces you need when you need them.
It’s easy if you only have a couple of SKUs or vendors but even small retail operations can get overwhelmed quickly if they aren’t using the right inventory management system and letting automation help establish reorder points.
The reorder point formula is used in warehousing to forecast and to make sure you always have the right amount of product to meet demand. It is an essential formula for any warehouse because it ensures the product will be replenished in alignment with demand. The reorder point helps you determine the point in which you have enough inventory to survive the demand of sales while waiting for your next shipment to come in.
Automate reorder points with smart reports.
Let us help you order the right amount of inventory the first time. Schedule a demo with SkuVault to learn how.
Managing Safety Stock in Your Retail operation
Safety stock (AKA backup stock) is used to calculate reorder points because it is a warehouse’s safety net for inventory quantities to prevent stockouts. As your inventory diminishes and you reach your reorder point, your safety stock becomes essential for holding you over until the next shipment of products comes in. The lead time between when you order the product and when it arrives in your warehouse is when you need this safety stock to fulfill customer demand until you can restock. Estimating this incorrectly can create havoc.
Why is the Reorder Point Formula Important?
The reorder point formula helps you forecast demand and stock needs. This means more sales and fewer stock-outs, and better forecasting for efficient use of your warehouse space.
This decreases your overhead costs by not tying up your money in excess stock. That’s important because, at any one time, there is more than $1.3 trillion tied up in working capital globally. It’s estimated that U.S. retail operations already have $1.36 of inventory for every $1 in sales revenue. If you can shave even a few cents off your holding costs, your profit margin will increase significantly.
How to Use the Reorder Point Formula
Everything in your retail operation starts with making sure your inventory counts are accurate. If you have incorrect counts, your data won’t tell you the right story. Make sure you are using an inventory management system (IMS) that tracks your inventory and manages your fulfillment process. This gets especially tricky if you are selling across multiple sales channels or digital platforms. Each platform has its own proprietary way of accounting for inventory and it’s easy to get out of sync. The right IMS keep everything in sync. This is crucial to establishing the correct reorder points.
How Do You Calculate the Reorder Point?
To calculate the reorder point, you will need to know your lead time demand and your safety stock numbers to plug into the equation.
Lead Time Demand + Safety Stock = Reorder Point
To find lead time demand, multiply the lead time by your average daily sales. Lead time is the amount of time it takes from the point you request an order from your supplier to when it arrives in your warehouse. Many times, suppliers will provide lead times but you know they aren’t always as accurate as you would like. Use their lead times as an estimate while taking into consideration past practices and your data on order times versus delivery to increase the accuracy. This can project a more meaningful number that better reflects reality. You’ll want a realistic lead time average that you can rely on to calculate your other measures.
Your safety stock is pretty much what it says. It provides a safety net to hold you over until the next delivery arrives. If you calculate the wrong reorder point, you’ll dip into your safety stock more than you want to do. This means increasing the next order to replace it.
However, there’s an extra cost to that as well as additional inventory cost money. Your optimal reorder point is the latest you can reorder to make sure you don’t go below your safety stock levels.
Your safety stock calculations should take into account the current inventory in stock, including raw materials if necessary and compare it to historical demand.
Once you’ve determined realistic lead times and the appropriate amount of safety stock you need to have on hand, you can effectively calculate the reorder point using the reorder point formula.
An Example of the Reorder Point Formula & Reorder Level of Inventory
Here’s an example of how this works in practice: Let’s assume one of your bestsellers is an iPad. Because it sells consistently and has a strong margin, you want to make sure you always have adequate inventory in stock. If you run out, it hurts your sales. Customers get frustrated and they may go directly to your competition to buy. Too many iPads sitting on the shelves increases your carrying costs, may take up the room you need for other products, and runs the risk of becoming outdated before selling.
You know based on historical evidence and supplier data that it takes 30 days from time of order to delivery of iPads to your warehouse.
Average Daily Sales
Based on sales data, you know that you sell an average of 8 iPads daily.
Your Lead Time Demand
Your lead time demand would be 8 x 30 or 240 lead time demand for iPads in your operation.
You’ve determined that you need a safety stock of 10 iPads.
Lead Time Demand + Safety Stock = Reorder Point
So, your reorder point would be 240 + 10 = Reorder Point. Under this scenario, you should reorder more iPads when your stock levels dip to 250 iPads.
Real World Examples of the Importance of the Reorder Point Formula
A broken supply chain crushed candy-maker Hershey’s Halloween sales one year when they missed on the right reorder level of inventory They failed to deliver nearly $100 million worth of inventory to retailers because they didn’t have the right ingredients in house to manufacture and deliver Hershey’s Kisses and Jolly Ranchers to stores. They were unable to meet retailer’s lead times and it had a ripple effect that hurt store sales.
Failing to manage your reorder points and supply chain can be devastating to your business.
If you order too early, inventory can start to stack up. Inventory pileup ties up capital that could be used elsewhere to grow your business and negatively impacts your profitability and returns.
Also, the longer a product sits on a warehouse shelf, the greater the risk of shrink as products age, expire, or consumer trends shift. You can get stuck with dead stock and unsalable products while continuing to pay for the added cost of warehousing and managing the excess inventory. You may even have to take a loss when you mark it down to move it out.
If you order too late, you’ll run out of stock. It’s a retailer’s nightmare scenario to have customers that want to buy from you and you are unable to fulfill their orders. It can frustrate customers to the point where they stop doing business with you and send them running right to your competitor’s door.
Reorder points are vital for keeping a warehouse running optimally. You can use forecasting tools to predict needs and ensure you can meet demand and replenish stock efficiently. Optimizing the reorder point formula will create a more effective workflow.
Common Questions About Reorder Points
Here are some of the common questions we get asked about reorder points, the reorder point formula, and setting safety stock levels.
How Much Do Reorder Points Vary?
There will obviously be differences from product to product. Each SKU has its own sales cycle and suppliers will have different lead times for restocking. Seasonal sales patterns will also play a significant role in reorder points.
It can get complex quickly, especially if you have a lot of SKUs. The right software can automate the process.
How Do I Set Safety Stock Levels?
Reorder points will also vary depending on how much safety stock you are comfortable keeping on hand to hold you over until replenishment orders arrive. From a mathematical standpoint, the actual formula looks like this:
Z × σLT × D avg
Yes, it’s got the omega symbol ( σ ) in the middle.
Z = the desired service level.
σLT = the standard deviation of lead time
D avg = the demand average.
You can learn more about how this works here. The formula can seem complex, but your inventory software, coupled with your historical data, will make it easy for you to automate the process.
Here’s another way to look at it:
(Maximum Daily Usage x Maximum Lead Time) – (Average Daily Usage x Average Lead Time)
Let’s look at a scenario where you sell an average of 3 widgets daily. Some days, you may sell as many as 5. Your average time to replenish your supplies of widgets is 7 days, but there have been times it can take 10 days. In this example, it would break down this way:
Maximum Daily Usage = 5
Maximum Lead Time = 10
Average Daily Usage = 3
Average Lead Time =7
(5 x 10) – (3 x 7) = 50 – 35 = 15
In this example, you would want to make sure you had at least 15 safety stock items to avoid stock-outs.
How Often Should I Recalculate Reorder Points?
Reorder points will change as your business grows. You may change suppliers or vendors, add or subtract SKUs from inventory, or change warehousing procedures. Disruptions occur to the supply chain that are out of your control. If you have the right software, when there’s a change, reorder points can be adjusted automatically. You can change your safety stock levels at any time to fit your comfort level.
You should recalculate reorder points often. A good rule of thumb is to re-evaluate your reorder level of inventory quarterly. Once you have it set up and running in concert with your inventory management system, most of it will happen in the background and flag you when things get off track. When stock levels hit reorder points or go below the levels you set, SKUVault will let you know to take action.
Can I Automate My Reorder Point?
Yes. SkuVault’s inventory and warehouse management system can analyze historical sales data, make seasonal adjustments, and calculate supplier lead times to recommend an optimal reorder point for each product. It can create purchase orders based on what is already on order, in-house, and pending.
As lead times change across vendors and suppliers, and inventory changes in warehouses serving multiple online marketplaces, SkuVault will automatically recalculate reorder points.
How SkuVault Helps with Reorder Points
From there, you can easily evaluate which products need reordering, and make your purchase orders accordingly. There is no more worrying about stock-outs because an automated system is taking care of business for you. SkuVault can even automate the purchase and reorder process.
To be competitive in the eCommerce industry, you have to offer a consistent level of products and services. To do this, you need to be on top of your inventory to prevent stock-outs and overstocks. That means having the right amount of stock to fill orders and an automated system to manage your reorder level of inventory and purchase orders.