Why “Minimum Stock Quantity” is a Misleading Term
By Jon and Matt Schreibfeder
One of our clients sent an email last week questioning why the calculated minimum stock quantity for a product with the following characteristics was so high:
- Monthly Forecast – 10 pieces (or 0.33 pieces per day)
- Minimum Stock Quantity – 60 pieces
Management at his company questioned why they would have a minimum of a six-month supply of this product in inventory; especially when their goal was to “turn” their inventory at least six times a year.
The problem was a misunderstanding of the term “minimum stock quantity”. It is logical to think that this is the least amount of an item you should have in inventory to meet your customers’ needs. But most computer systems define the minimum stock quantity as the net available quantity (i.e. On-Hand Quantity – Quantity Committed on Outgoing Orders + Quantity on Incoming Replenishment Orders) that will prompt you to place a replenishment order with your supplier.
The item in question is imported and has an anticipated lead time of four months. That means that the company will sell about 40 pieces during the lead time. If a replenishment order is issued when the net available quantity is less than 40 pieces, there is a good chance that the company will experience a stock out of the item before a replenishment shipment arrives. Note that the company does not have possession of the replenishment shipment quantity as soon as it is ordered from the supplier. The actual on-hand quantity of the item will decrease during the lead time and will only increase when the replenishment shipment arrives. The material that is on a replenishment order but not yet received is commonly referred to as “in the pipeline”.
But there is a chance that the company will sell more than 0.33 pieces per day. Or there may be a delay in receiving the replenishment shipment. If either of these situations occurs, there will be demand for more than 40 pieces during the lead time. To protect customer service, the company has decided to keep a one month (i.e. 10 pieces) as “safety stock” or reserve inventory. If both the forecast and anticipated lead time are accurate, the safety stock quantity should be in the warehouse when the replenishment shipment arrives.
So, we have anticipated lead time usage of 40 pieces and 10 pieces of safety stock for a total of 50 pieces. Why is the minimum stock quantity 60 pieces? The other 10 pieces represents anticipated order cycle (also known as review cycle) demand. The company can only place a target order with the vendor once a month. That is the size order that meets the supplier’s requirement to receive the terms or discounts that allow them to competitively sell the vendor’s products. If the company’s buyer places a target order on April 1st, we predict they will place the next target order with the vendor on May 1st. If the product’s net available quantity falls below 50 pieces (i.e., anticipated lead time usage + safety stock) between April 2nd and April 30th, there probably won’t be enough accumulated need to place a target order with the vendor and the company will have to:
- Risk a stockout by waiting until the end of the order cycle to include this item on the
next target order. - Placing a small order with the vendor that does not meet the target order
requirement and pay a higher price than normal. - Placing a target order with the vendor before the end of the current order cycle by
including items that do not yet need to be reordered. This will result in surplus
stock.
As a result, best practice is to include anticipated order/review cycle usage in the calculation of the minimum stock quantity.
The total minimum stock quantity is Safety Stock + Anticipated Lead Time Usage + Anticipated Order Cycle Usage or 60 pieces. At the end of each order cycle a suggested purchase order will be created which includes any item whose net available quantity is below the minimum stock quantity. But remember that the lowest planned on-hand quantity will be the safety stock quantity. That is, the reserve inventory you maintain to protect you from experiencing stock outs due to unanticipated demand or delays in receiving replenishment shipments. To avoid the confusion resulting from misinterpreting minimum quantities, some ERP systems now refer to this trigger for replenishing inventory as the “reorder point”.
Regardless of the terminology used by your ERP system, it is critical that your buyers understand the components of the minimum stock quantity, and that each of these elements is accurate.
Next month we will continue our discussion by exploring how to determine the maximum and average amount of inventory you will have on hand for each stocked item. In the meantime, please let us know if you have any questions, or would like to schedule a time to discuss your organization’s specific inventory challenges.