Effective Inventory Management, Inc.
Dealing with a Chaotic Supply Chain – Part #4
Controlling Inventory Explosions Due to Extended Lead Times
By Jon and Matt Schreibfeder
Due to supply chain disruptions, a lot of organizations are experiencing drastically increasing lead times for obtaining replenishment shipments of material from their vendors. A vendor that used to be able to deliver material in seven days might now require 30 days (or more) to replenish your stock. These extended lead times are drastically increasing reorder points or minimum quantities. For example, if an anticipated lead time is seven days, you need to reorder a product when your net available quantity (i.e., On-Hand – Committed + On Replenishment Order is no less than a seven-day supply. If the lead time increases to 30 days, you must now reorder the product when the net available quantity is no less than a 30-day supply to avoid a stock out.
Updating your parameters with the extended lead times caused by supply chain disruptions may result in some large, one-time, suggested purchase orders. This is because most computer systems will ensure that a suggested replenishment order will include enough of an item so that the net available quantity, including the quantity on a new replenishment order, is at least equal to the reorder point or minimum quantity. The reorder point or minimum quantity is equal to:
Safety Stock + Anticipated Lead Time Usage + Anticipated Order Cycle Usage
The Order Cycle is the normal length of time between issuing replenishment orders with a vendor. For example, you might normally place a purchase order with a particular vendor once every two weeks or 14 days. Safety stock is the reserve or insurance inventory maintained to avoid stock outs due to unusual demand or delays in receiving replenishment shipments. Unfortunately, current supply chain disruptions have caused stock receipt delays far beyond what can be satisfied by most calculated safety stock quantities.
Let’s look at an example of a large, one-time purchase caused by a significantly increased anticipated lead time. If the item in the above example costs $10 per piece and demand was two pieces per day, the cost of material to cover a seven-day anticipated lead time would be $140 (2pc./day * 7 day lead time * $10). The cost to cover a 30-day lead time would jump to $600; a $460 increase! And this is only for one item in the vendor line. We have seen many organizations experience “sticker shock” when they see these recommended buys.
However, it is important to realize that these on-time large purchases are only necessary if you want to be able to fulfill all demand for a product that might accumulate during the extended lead time. That is, if you ran out of stock during the additional 53 days of the new lead time, are all of your customers willing to wait for delivery until your replenishment shipment arrives? But every customer might not be willing to wait. Perhaps some will go elsewhere to obtain the product. Or others might be willing to accept a substitute product.
If you anticipate losing all the sales you couldn’t fulfill due to the stockout, you could just order enough to cover anticipated demand during the next order/review cycle (plus safety stock). If the order cycle was 14 days, you could order a 14-day supply. That 14-day supply would arrive in 60 days. When using this approach, it is critical that you continue to reorder at least enough to cover demand during the next order cycle at the end of each order cycle. In our example that means ordering a 14-day supply every 14 days. This will prevent future stockouts following this initial one caused by the drastic lead time increase.
If you anticipate losing some but not all the orders you couldn’t immediately fulfill, you might include some of the new anticipated demand in your next purchase order and then proceed with ordering quantities to cover order cycle demand.
Most replenishment shipments were designed before we experienced supply chain disruptions. We have to adopt the recommendations coming out of these systems to deal with our new reality of a chaotic supply chain. This process includes carefully analyzing large one-time buys resulting from increasing anticipated lead times.
Do you have questions about your specific inventory-related situation? Send us an email and we’ll set up a time to talk.