To avoid a possible stockout, a product should be ordered as soon as its replenishment position or net available quantity (i.e., On-Hand – Committed on Current Customer Orders + Current Replenishment Orders) falls down to its reorder point or minimum stock quantity. That is, a quantity sufficient to meet customer demand during the lead time (plus some safety stock or reserve inventory). Unfortunately, vendors often do not accept purchase orders that just contain one product. Even if they do, the terms they offer for a small order probably prevent you from competitively selling the item. In order to meet the supplier’s terms and buy “at the right price,” you must order a certain amount of the vendor’s products.
We refer to this size order as the “target buy”. A target buy is a vendor’s purchase requirement that provides you with the discounts or terms that allow you to competitively sell the vendor’s products. The order cycle (also known as the review cycle) is the average amount of time, usually expressed in days, necessary to sell, transfer, or otherwise use enough of the products in a vendor line to achieve the target buy requirement.
Unfortunately, the buyers in many organizations issue purchase orders based on tradition. For example, I have often heard someone say, “We always buy vendor line Acme Widget products every other week”. Or worse, they will set a single order or review cycle for all vendors, regardless of how often customer demand could achieve a particular supplier’s target order requirement. I visited a distributor several weeks ago that had set a 30 day order cycle for all of their vendors. Their buyers explained that they had always issued monthly purchase orders because “it was convenient”. Unfortunately, this practice resulted in both a negative effect on customer service as well as an unnecessary increase in their inventory investment.
Why?
• Most computer systems won’t suggest you order less than anticipated demand during the upcoming order cycle for the primary vendor. After all, ordering a seven day supply of a product every two weeks will result in stockouts and miserable customer service. If a vendor’s target order requirement can be met every seven days, an organization can order a seven day supply of expensive or bulky products. If an order cycle is set higher than the amount of time necessary to meet a particular vendor’s target order requirement, their system will buy unneeded inventory of some items. In the case of my customer, an artificially set 30 day order cycle caused their ERP system to purchase a minimum of a 30 day supply of every item; even when they could buy from some key vendors two or three times a month!
• A shorter order cycle gives buyers more flexibility in placing orders with a vendor. Because orders can be placed more often, less safety stock (i.e., reserve inventory) will be needed to maintain the desired level of customer service. Buyers can also purchase non-stock or special order items sooner if they don’t have to wait for the end of a long order cycle. Be careful not to confuse order cycles with anticipated lead times. Order cycles reflect how frequently you can buy material from a vendor and achieve their target order requirement. Anticipated lead times equal the time it will take the vendor to fill a purchase order, ship the material to your facility, and have it prepared for sale or use. One of my customers imports most of their material. Anticipated lead times average120 days. However, they can meet one vendor’s target order requirement every week. They maximize the performance of their inventory by placing an order with the vendor each week. At any one time they have many orders with the vendor “in the pipeline”. The order they place this week will arrive in 120 days. The order that arrived this week was placed 120 days ago. Continually receiving one week supplies of expensive and bulky items has contributed to the maximization of this firm’s inventory performance.
Key elements of “best practice” purchasing are:
1. calculate order cycles for primary suppliers at least twice a year
2. be sure to consider purchases of non-stock or special order items in determining how often you can meet the target order requirement
Accurate order cycles help you ensure that you are buying the right quantity at the right time, a key element in achieving the goal of effective inventory management.