Reorder point

What Is Reorder Point?

The reorder point is a crucial metric in inventory management that signals when a business should place a new order to replenish its stock of a particular item. It is a specific threshold level of inventory that, when reached, triggers the procurement process. The primary objective of setting a reorder point is to prevent a stockout while minimizing the amount of excess inventory held. By calculating and adhering to the reorder point, businesses aim to ensure that new stock arrives just as existing stock is about to be depleted, maintaining continuous operations and meeting customer demand efficiently. This concept is fundamental to effective operations management.

History and Origin

The concept of managing inventory to avoid shortages has roots in ancient trade practices, where merchants manually tracked goods using methods like tally sticks and clay tokens.³²,³¹ However, formalized inventory management systems began to emerge with the Industrial Revolution, driven by the increased scale and complexity of production.³⁰ In the early 20th century, advancements in industrial engineering and scientific management laid foundational principles for modern inventory control.²⁹ Figures like Frederick Winslow Taylor emphasized efficiency and standardized processes, indirectly contributing to the need for systematic inventory planning.²⁸,²⁷

The development of mechanical systems using punch cards in the early 1900s, and later electronic systems with the advent of computers in the 1950s, allowed businesses to track inventory levels more efficiently and in real time.²⁶,²⁵ The widespread adoption of barcodes in the 1970s further revolutionized inventory tracking, enabling more precise data collection and facilitating the implementation of concepts like the reorder point on a broader scale.²⁴,²³ The reorder point, as a specific trigger for replenishment, evolved as a practical tool to optimize stock levels and ensure timely procurement in increasingly complex supply chain networks.²²

Key Takeaways

• The reorder point is the inventory level that triggers the placement of a new order to replenish stock.
• It helps businesses avoid stockouts and maintain continuous operations.
• The calculation typically factors in average daily usage, lead time, and a safety stock buffer.
• Effective reorder point management can optimize working capital and reduce holding costs.
• Regular review and adjustment of reorder points are essential due to fluctuating demand and supply chain dynamics.

Formula and Calculation

The basic formula for calculating the reorder point incorporates key variables to ensure stock is replenished before depletion. The most common formula for the reorder point is:

Where:

• Average Daily Usage Rate: The average number of units of a product sold or consumed per day. This can be determined through historical demand forecasting.
• Lead Time: The number of days it takes for an order to be placed with a supplier and for the goods to be received and made available in inventory.
• Safety Stock: An extra quantity of inventory held to prevent stockouts due to unexpected increases in demand or delays in lead time.²¹,²⁰

For example, if a business sells 25 units of a product per day, the supplier's lead time is 4 days, and the company decides to hold a safety stock of 50 units, the reorder point would be:

This means that when the stock level of that product falls to 150 units, a new order should be placed.

Interpreting the Reorder Point

The reorder point is not merely a number; it is an action trigger within inventory management. When the quantity of a particular item in stock drops to or below its calculated reorder point, it signifies that an order for replenishment must be initiated. Interpreting this value involves understanding the balance between avoiding stockouts and managing holding costs.

A properly calculated reorder point aims to ensure that new stock arrives precisely when the existing inventory, including any allocated safety stock, is about to be consumed. This synchronization minimizes the need for excessive storage space and reduces capital tied up in unsold goods, thereby optimizing working capital. Businesses must regularly monitor their inventory levels against their reorder points. Deviations from expected lead time or demand fluctuations necessitate adjustments to the reorder point to maintain optimal profit margins.

Hypothetical Example

Imagine "Eco-Gadgets Inc.," a small online retailer specializing in sustainable electronics. One of their popular products is a solar-powered phone charger.

• Average Daily Usage: Eco-Gadgets Inc. sells an average of 15 solar chargers per day.
• Lead Time: Their supplier takes 10 days to deliver an order after it's placed.
• Safety Stock: To account for unexpected surges in demand or potential supply chain delays, Eco-Gadgets Inc. maintains a safety stock of 30 chargers.

Using the reorder point formula:

So, the reorder point for solar chargers is 180 units. This means that when the stock of solar chargers at Eco-Gadgets Inc. drops to 180 units, they should immediately place a new order with their supplier. If they do, the new shipment is expected to arrive just as their current stock, including the safety stock, is nearly depleted, preventing any interruption in sales, even if there are minor shifts in business cycles.

Practical Applications

The reorder point is a cornerstone of effective inventory management across various industries. In retail, it ensures that shelves remain stocked with popular items, preventing lost sales due to unavailability. Manufacturing firms utilize reorder points for raw materials and components, ensuring uninterrupted production lines. For operations management professionals, it is a key metric for maintaining efficiency and responsiveness.

Globally, the importance of precise inventory control, including the reorder point, has been underscored by recent supply chain disruptions. For instance, the COVID-19 pandemic highlighted how vulnerabilities in global supply networks could lead to significant impacts on inflation and overall economic stability, making robust inventory strategies critical.¹⁹ Organizations like the World Economic Forum emphasize supply chain resilience by advocating for strategies that include optimizing inventory levels to mitigate the effects of unforeseen events.¹⁸ Implementing reorder points helps businesses manage risk management associated with fluctuating demand and unreliable deliveries, supporting continuous operations and stable product availability.

Limitations and Criticisms

While the reorder point is a valuable tool for inventory management, it has certain limitations, particularly in dynamic environments. One significant criticism is its reliance on historical data for average daily usage and lead time.¹⁷,¹⁶ If demand patterns are highly volatile or supply chain lead times are unpredictable, a static reorder point can lead to either excessive inventory or frequent stockouts. For instance, products with seasonal demand or those heavily influenced by rapid market trends may render a fixed reorder point ineffective.¹⁵,¹⁴

The reorder point also does not inherently account for production capacity or the economic efficiency of the order quantity itself.¹³ This means that while it tells a business when to order, it does not advise on how much to order to minimize overall costs. For determining optimal order quantities, businesses often turn to other models, such as the Economic Order Quantity (EOQ).¹² Furthermore, businesses adopting lean inventory practices, such as Just-in-time (JIT) systems, may find that traditional reorder point calculations, especially those incorporating large safety stock, contradict their philosophy of minimizing inventory.¹¹

Reorder Point vs. Safety Stock

The terms reorder point and safety stock are often discussed together in inventory management, but they represent distinct concepts with complementary roles. The reorder point is the specific quantity level at which a new order for replenishment should be placed. It serves as the trigger for action. Its purpose is to ensure that incoming inventory arrives before existing stock is exhausted, maintaining continuity of supply.¹⁰,⁹

In contrast, safety stock is a buffer amount of extra inventory held to guard against unforeseen fluctuations in demand or unexpected delays in lead time. It acts as a cushion to prevent stockouts during periods of higher-than-expected usage or longer-than-anticipated supplier deliveries.⁸,⁷ While the reorder point dictates when to order, safety stock contributes to how much buffer is needed to achieve a desired service level, directly impacting the reorder point calculation itself. Without safety stock, the reorder point would only cover the expected usage during lead time, leaving no protection against variability.

FAQs

How does the reorder point help prevent stockouts?

The reorder point is set at a level that accounts for the amount of product expected to be sold during the lead time (the time it takes for a new order to arrive) plus any desired safety stock. By placing an order when stock reaches this point, a business aims to have the new items arrive just as the current stock is about to run out, thereby avoiding a stockout and ensuring continuous availability for customers.⁶

Is reorder point the same for all products?

No, the reorder point is typically different for each product. It depends on factors specific to that item, such as its average daily sales volume, the lead time from its supplier, and the amount of safety stock deemed necessary for it.⁵,⁴ High-demand products with short lead times will have different reorder points than low-demand items with long lead times.

How often should the reorder point be reviewed?

The reorder point should be reviewed regularly, especially if there are significant changes in sales patterns, supplier lead times, or supply chain reliability.³ Economic shifts, seasonality, or new marketing campaigns can all impact product demand, necessitating adjustments. Frequent reviews help ensure that the reorder point remains accurate and effective in optimizing inventory levels and managing cost of goods sold (COGS).

What happens if the reorder point is set too high or too low?

If the reorder point is set too high, a business will order new inventory too frequently or in larger quantities than necessary. This can lead to excessive holding costs, increased risk of obsolescence, and reduced cash flow due to capital being tied up in stock. If it's set too low, the business risks frequent stockouts, which can result in lost sales, dissatisfied customers, and damage to its reputation.²,¹