I received a call from a customer this week saying that the minimum quantities in his computer system were far too high. Joe explained, “We normally sell four pieces of product #A100 per month. The computer system has a minimum quantity set at eight pieces. If we kept a minimum of eight pieces in inventory, we would be overstocked. Why is the system telling us to keep so much material on the shelf?”
Joe was making a common mistake. Minimum stock quantities in computer systems (commonly used in minimum/maximum replenishment) do not represent the lowest quantity you should have on-hand. They signify the stock level that should prompt your buyer to issue a purchase, transfer, or work order to replenish your stock of the product. The lead time for product #A100 (from the above example) is 60 days. If Joe reorders the product when he has eight pieces in stock, his company will probably sell all eight pieces (i.e., 2 months x 4 pieces/month) before the replenishment shipment arrives. If Joe wants to maintain some safety stock for the product (just in case his company sells more than four pieces per month or there’s a delay in receiving the replenishment shipment) he might want to raise the minimum quantity above the current eight-piece quantity.
Minimum quantities should be set to equal anticipated demand during the lead time plus any desired safety stock. The anticipated lead time should not include only the length of time it takes to get the product once it is ordered, but also the normal length of time between receiving replenishment shipments (also known as the “order cycle” or the “review cycle”).
The average lowest inventory quantity you will have in your warehouse should be equal to the safety stock – that is, you will sell or use that portion of the minimum equal to anticipated lead-time demand before the replenishment shipment arrives. For this reason, some computer systems have replaced the term “minimum quantity” with “order point” or “reorder point.” After all, it is the “point” when your buyers should reorder the product.
Like minimum quantities, maximum quantities in a computer system don’t represent the maximum quantity you will have on hand at one time. Most systems will suggest that a buyer order up to the maximum quantity when they issue a replenishment order for a product. Because you will continue to sell or use the product after placing the order, the greatest amount of stock you should have on hand at one time is not the maximum, but a quantity equal to the maximum less anticipated demand during the lead time. It makes sense that some computer systems have renamed the maximum quantity the “order up to” amount.
If buyers are to do a good job deciding when to reorder products and how much to order, it is critical that they understand the definition of all of the replenishment parameters in your system. This should be an integral part of your plan to achieve effective inventory management.