Last month we discussed calculating the order cycle (also commonly known as the review cycle). That is, how often you should place replenishment orders with a vendor. Another way of defining it is how often you sell or use enough of a particular vendor’s products to achieve that vendor’s target order requirement. Above all, it is imperative that you calculated or manually maintained order cycles that are not too long or too short. Either of these extremes will prevent you from achieving the goal of effective inventory management.
Suppose a vendor has no minimum order requirement. They will accept any size order that you place. You could actually place individual replenishment orders for single products all day long. But is this practical? Think of the volume of small receipts with which your receiving and accounts payable departments would have to deal. In most cases, it makes far more sense to accumulate your needs and place orders with the vendor once or twice a week. Of course, there will be exceptions for products that must be immediately ordered. But, the practice of planning to issue orders no more often that every four to seven days will facilitate far more efficient warehouse and back office operations.
But what happens if the opposite is true? You only generate enough demand of a supplier’s products to place an order with the vendor every two or three months. This is detrimental to your operations for two reasons:
- It will harm customer service. If you can only place an order with a vendor every 60 or 90 days there may be a significant delay in ordering a special order or non-stock product for a customer.
- It will increase your costs and inventory investment. You may have to go to an alternative source (and pay a higher price per piece) to obtain a quantity of a popular item whose stock was unexpectedly depleted by an unusually large order. And if you can only place an order every two or three months you must order at least a 60 to 90 day supply of any product you order.
This is why we recommend that you try to maintain order cycles between 4 and 30 days for your primary vendors. If you find that you must order less often to “get the right cost” considers the following risks:
- You are gambling that demand for the vendor’s products will follow your forecasts. Like the weather, the further out into the future you forecast the less reliable your predictions will be.
- You are betting that the cost of the item will not decrease before you can sell the large quantity you purchased. In the past several years we have experienced large swings in the cost of many products (especially commodities).
- And, as we mentioned before, you might have to place an “emergency” order to cover an unexpected need.
But what if a vendor offers a much lower cost for ordering a larger quantity of their products? When is the additional savings associated with a large purchase worth taking the risks we outlined? Next month we will outline a process for making an intelligent objective decision in these situations.