In a quest to minimize your investment in inventory, the consistency of vendor lead times can have a major impact and deserves your examination. Consider the following situation.
I was working with a customer a couple of months ago who had major problems with inconsistent vendor deliveries. Buyers complained that they might receive shipments one week or six weeks after ordering material, but rarely when the vendor said the inventory would be shipped.
We refer to the time it takes to order and receive a replenishment shipment as the anticipated lead time. The anticipated lead time is a critical factor in determining when to reorder a product. For example, if we sold or used two pieces per day, and we had an anticipated lead time equal to seven days, we would have projected usage during the lead time equal to 14 pieces:
7 days x 2 pieces/day = 14 pieces
We need to reorder the product when we have at least 14 pieces on the shelf in order to avoid a potential stock-out of the product. In order to protect customer service and avoid stock-outs, the buyers have no choice but to set the anticipated lead time for these products to the “longest normally anticipated lead time.” In our example where lead times ranged from one to six weeks, I advised the buyers to set the lead time equal to the longest normally anticipated lead time of six weeks, or 42 days.
But I also told the buyers to inform the vendor what their inconsistency in delivering material was costing. If the vendor delivered material in seven days (the shortest anticipated lead time), we would have a 35-day supply of the item on the shelf gathering dust when the replenishment shipment arrived. This particular product had customer demand of 15 pieces per day, and the items cost $9.50 each. As a result, our additional stock was worth $4,987.50:
35 days supply x 15 pieces/day x $9.50 = $4,987.50
The customer’s annual cost of carrying inventory is 20%, so they are incurring an annual extra expense for maintaining the inventory of this item of $997.50:
$4,987.50 x 20% = $997.50
The vendor line is comprised of 254 products. Applying this logic to each item, we found the vendor’s inconsistency was costing our customer an annual extraordinary expense of over $200,000!
We met with the vendor and showed them what their inconsistency of supply was costing in dollars and cents. It was surprising, but they were shocked and have taken steps to smooth out their supply methods. The vendor has now agreed to a consistent lead time of four weeks with a substantial penalty if they exceed this parameter. We now can plan to reorder the vendor’s products when we have a four week supply inventory (plus a little safety stock to cover unanticipated demand during the lead time).
This analysis and subsequent vendor negotiation allowed us to stock fewer items and still meet our product availability goals. Consistent lead times are an essential element in the process of achieving effective inventory management.