When Your Target Order Requirement Is Not Practical?
By Jon and Matt Schreibfeder
One of the things we look forward to is answering great questions from our readers. In the next several issues of our newsletter, we will discuss some of the more interesting subjects we’ve addressed in our efforts to help organizations throughout the world achieve effective inventory management.
Often a supplier requires a distributor to place a certain size order to receive the discounts or terms that allow them to competitively sell the vendor’s products. This is known as a target order requirement. It may be expressed as a monetary amount, a number of cases or pieces, or a specific weight or cubic volume.
An order cycle (also know as a review cycle) is the average amount of time it takes you to sell or use enough of the vendor’s products to achieve the target order requirement. You can calculate an order cycle by first taking your total annual purchases from the vendor and dividing that number by the target order requirement. For example, if you purchase $160,000 worth of material from a vendor in a year and the vendor has a $4,000 target order requirement, you can place 40 purchases a year that meet the requirement for a “good order” ($160,000 ÷ $4,000 = 40). Dividing 365 days by the 40 purchases results in an order cycle of about nine days. That means that a replenishment order should be placed with the vendor about every nine days.
A client in the food distribution industry emailed us that they calculated an order cycle for a vendor of nine days, but this supplier insists on receiving orders only on Wednesday afternoon, so that they can utilize a particular transportation company. In effect, the vendor is forcing the distributor to utilize a seven-day order cycle. They asked if they should ignore the calculated order cycle and place weekly orders with the vendor.
Unfortunately, placing a “target order” of $4,000 every week will result in overstock. Selling or using $4,000 worth of the vendor’s products every nine days equates to demand of $444.44 per day ($4,000 ÷ 9 = $444.44) or $3,111.08 per week. ($444.44 * 7 days = $3,111.08). In order to meet the target order requirement of $4,000 every seven days, they would have to order an average of $888.92 of unneeded stock every week. This would result in about $46,223.84 in surplus stock (52 weeks * $888.92 = $46,223.84) accumulating each year.
We suggested several possible remedies to this situation:
• Order from the vendor every other Wednesday utilizing an order cycle of 14 days. This will allow the distributor to easily meet the target order requirement without acquiring unneeded material.
• Encourage salespeople to sell more, or customers to buy more, of the vendor’s products each week to reduce the calculated order cycle to seven days.
• Negotiate with the vendor to allow for orders to be placed every nine days.
Calculating and using order cycles helps guide your buyers to purchase as often as practically possible, while avoiding the accumulation of unneeded stock. It is an essential element of achieving effective inventory management.
In the meantime, if you have any inventory-related questions, please email Jon ([email protected]) or Matt ([email protected]). Our goal is to help your organization achieve effective inventory management.