Accurate Order Cycles are Critical to Effective Inventory Management
By Jon and Matt Schreibfeder
In order to avoid stockouts, you must reorder products when you still have enough stock remaining in inventory to satisfy customer demand during the anticipated lead time. You also might want to keep some safety stock just in case you sell more than you forecast or there is a delay in receiving a replenishment shipment. The result is the “order point” formula:
Order Point = (Anticipated Lead Time * Demand/Day) + Safety Stock
But often you can’t order just one item by itself. You must place a certain size order to get the discounts or terms that allow you to competitively sell the vendor’s products. This is known as a target order requirement. An order cycle (also known as a review cycle) is the amount of time it takes for you to sell or use enough of a supplier’s products to meet the target order requirement.
We have often observed that many companies have used the same order cycles for many years. One of our clients used a 30-day order/review cycle with a major supplier because “that is the way we’ve always ordered products from that vendor.” But after a quick analysis we discovered that they could place an order every 14 days that met the vendor’s target order requirement. Using a 30-day order cycle was causing them to not only to overstock products but also had a detrimental effect on customer service. That is, it resulted in more out of stock situations and delays in delivering products to customers.
Overstock – Because they were only placing an order with the vendor every 30 days, they had to order a minimum of a 30-day supply of each item included on a purchase order. Reducing the order cycle to 14 days will allow them to replenish stock with a two-week supply. This will help avoid overstocking (i.e., by ordering half as much material on each target order) and significantly increase inventory turnover.
Detrimental Effect on Customer Service – What if a customer orders a non-stock or special order in this vendor line or you experience an unusually large sale of one of the vendor’s products during a 30-day order cycle? It might be several weeks before you can include these items in the next replenishment order you place with the vendor. The customer must wait longer for delivery. A shorter order cycle allows you to be more reactive to your customers’ needs.
It is critical that you calculate and maintain accurate order cycles for each supplier. Divide your purchases from the vendor over the past 12 months (including non-stock products) by the vendor’s target order requirement. The result is the projected annual number of purchase orders you can place with the vendor. For example, if you ordered $250,000 worth of material from the vendor over the past year and the vendor has a $5,000 target order requirement you will probably be able to place 50 orders with the vendor each year or about one every seven days:
$250,000 ÷ $5,000 = 50 Purchase Orders
365 Days ÷ 50 Orders = 7.3 ≈ 7 Day Order Cycle
While shorter order cycles lead to increased inventory turnover and better customer service, there are some situations where they can be unreasonably short. If a vendor does not have a target order requirement, purchase orders can be issued whenever any product drops down to its order point. The result could be issuing multiple purchases with that vendor every day. Imagine your receiving department processing 6 or 12 stock receipts from a single vendor every business day. Will they be happy? Your accounts payable department may also be overwhelmed with the number of invoices they receive as the result of the numerous small replenishment orders. For most organizations “best practice” is to set a minimum order cycle somewhere between three and seven days.
Accurate order cycles are critical to effective inventory replenishment. Next month, we will utilize vendor order cycles in calculating our second minimum stock level or items with recurring usage: the “line point” (also known as the “reorder point” in some systems). In the meantime, please let us know if you have any questions concerning how you can lead your company to the goal of effective inventory management.