Reorder quantity: Meaning, Criticisms & Real-World Uses

What Is Reorder Quantity?

Reorder quantity refers to the specific number of units of inventory that a business orders when its stock level reaches a predetermined reorder point. This crucial metric falls under the broader financial category of inventory management, which aims to optimize the balance between holding too much stock and running out of essential goods. The reorder quantity dictates the size of each replenishment order, playing a significant role in managing inventory levels, minimizing costs, and ensuring continuous supply. An effectively calculated reorder quantity helps businesses maintain efficient operations and meet customer demand without unnecessary holding costs or the risk of a stockout.

History and Origin

The concept of managing inventory has existed for centuries, with early merchants tracking purchases and sales to ensure they had sufficient goods. Before the Industrial Revolution, inventory tracking was largely manual and based on experience or simple handwritten notes.¹⁸,¹⁷ The need for more sophisticated systems grew with increased efficiency and mass production during the Industrial Revolution.¹⁶

One of the earliest attempts at an automated inventory control design emerged in the 1930s, when a Harvard University Business Administration team, led by Wallace Flint, conceived a system using punch cards for checkout and inventory management.¹⁵,¹⁴ While this initial system, designed to read cards, relay information to storerooms, and mechanically retrieve items, was too expensive for widespread adoption at the time, it laid conceptual groundwork for future advancements.¹³ The subsequent development of barcodes in the late 1940s and 1960s, along with the advent of computers, significantly enhanced mechanized inventory control, making systematic reordering more feasible.¹²,¹¹

Key Takeaways

Reorder quantity is the fixed amount of inventory ordered each time stock needs replenishment.
It is a core component of inventory management strategies, particularly fixed-order quantity models.
Calculating the optimal reorder quantity aims to minimize total inventory costs, including ordering costs and holding costs.
Factors such as demand forecasting, lead time, and desired safety stock influence the reorder quantity.
An efficient reorder quantity helps prevent stockouts while optimizing working capital.

Formula and Calculation

The most common method for calculating the optimal reorder quantity is the Economic Order Quantity (EOQ) model. The EOQ formula helps determine the order quantity that minimizes the total of annual holding costs and annual ordering costs.

The formula is:

EOQ = \sqrt{\frac{2DS}{H}}

Where:

(D) = Annual demand for the product (units)
(S) = Cost per order (ordering cost)
(H) = Annual holding cost per unit

This formula provides a theoretical ideal for the reorder quantity, assuming constant demand and costs.

Interpreting the Reorder Quantity

Interpreting the reorder quantity involves understanding its relationship to a company's operational efficiency and financial health. A properly determined reorder quantity indicates the most cost-effective amount of a particular item to purchase at one time. If the reorder quantity is too high, it can lead to excessive holding costs, increased obsolescence risk, and tied-up working capital. Conversely, a reorder quantity that is too low can result in more frequent orders, leading to higher ordering costs and an increased risk of stockout, which can disrupt operations and harm customer satisfaction.

The reorder quantity is typically used in conjunction with a reorder point. When inventory levels drop to this point, an order for the reorder quantity is automatically triggered. This interplay ensures that inventory is replenished just as it is needed, balancing the costs of carrying inventory against the costs of ordering it and the risks of not having it. Businesses often adjust their reorder quantity based on changes in demand forecasting, supplier lead time, and strategic objectives.

Hypothetical Example

Consider "TechGear Inc.," a company that sells high-demand specialized circuit boards.

Annual demand ((D)) for the circuit board: 12,000 units
Cost to place one order ((S)): $100
Annual holding cost per circuit board ((H)): $5 per unit

Using the Economic Order Quantity (EOQ) formula to determine the optimal reorder quantity:

EOQ = \sqrt{\frac{2 \times 12000 \times 100}{5}}

EOQ = \sqrt{\frac{2,400,000}{5}}

EOQ = \sqrt{480,000}

EOQ \approx 692.82

Based on this calculation, TechGear Inc. would set its reorder quantity at approximately 693 circuit boards. This means every time their inventory level for circuit boards drops to its reorder point, they would place an order for 693 units to replenish their stock. This quantity aims to minimize the combined costs of ordering and holding inventory for this specific item.

Practical Applications

Reorder quantity is fundamental in various aspects of financial and operational management. In manufacturing, it is critical for managing raw materials and finished goods inventories to ensure smooth production schedules. For retailers, establishing appropriate reorder quantities helps maintain adequate stock on shelves to meet customer demand without overstocking.

For example, large manufacturers track their manufacturing inventories closely, with data often analyzed by institutions like the Federal Reserve to gauge economic activity.¹⁰ Companies like Airbus, for instance, might face challenges with their supply chain if component reorder quantities are not met, leading to inventory buildup of unfinished products.⁹ Similarly, the overall level of inventories across industries can be impacted by global events, as seen with tariffs on copper products leading to significant inventory overhangs at U.S. ports.⁸

Reorder quantity also plays a role in working capital management, as excessive reorder quantities can tie up significant cash in inventory, while too low quantities risk lost sales due to stockout. Effective reorder quantity planning is essential for optimizing cash flow and maintaining financial liquidity.

Limitations and Criticisms

While the concept of reorder quantity, especially when derived from models like the Economic Order Quantity (EOQ), provides a structured approach to inventory management, it comes with several limitations. A primary criticism is that the EOQ model assumes constant demand, ordering costs, and holding costs over time, which rarely holds true in dynamic market conditions.⁷,⁶ Real-world demand can fluctuate due to seasonality, promotions, or unforeseen events, rendering a fixed reorder quantity less effective.⁵

Another drawback is that these models often don't account for supplier lead time variability or minimum order quantity (MOQ) requirements from suppliers, which can force businesses to order more than the calculated reorder quantity.⁴,³ Additionally, the EOQ model treats all inventory items equally, regardless of their value or importance to the business, which can lead to inefficient allocation of resources.² Continuous monitoring of inventory, often required by fixed-order quantity models, can also be costly, especially for businesses with a vast number of products.¹ For these reasons, many businesses complement or replace basic reorder quantity calculations with more advanced inventory management techniques that incorporate real-time data, like Just-in-Time (JIT) systems, or more sophisticated demand forecasting methods.

Reorder Quantity vs. Reorder Point

Reorder quantity and reorder point are two distinct but interconnected components of inventory management. The reorder quantity is the amount of inventory to order when a replenishment is needed. It answers the question: "How much should we order?"

In contrast, the reorder point is the level of inventory at which a new order should be placed. It answers the question: "When should we order?" When a product's stock level drops to or below its reorder point, it triggers the ordering of the pre-determined reorder quantity. Both are critical for preventing stockout and optimizing inventory levels, but they address different aspects of the replenishment process.

FAQs

Q: What is the primary goal of determining a reorder quantity?
A: The primary goal of determining a reorder quantity is to strike an optimal balance between minimizing holding costs (costs associated with storing inventory) and ordering costs (costs associated with placing and receiving an order), while ensuring sufficient stock to meet demand and avoid a stockout.

Q: Does the reorder quantity change over time?
A: Yes, while the reorder quantity might be fixed for a period, it should be periodically reviewed and adjusted. Changes in product demand forecasting, supplier lead time, or the costs associated with ordering and holding inventory necessitate recalculations to maintain efficiency.

Q: Is reorder quantity only applicable to physical goods?
A: While most commonly associated with physical goods in inventory management, the underlying principle of managing replenishment quantities can apply to other resources that are consumed and need periodic replenishment, such as digital licenses or specific project components.

Q: What is the difference between a continuous review system and a periodic review system in relation to reorder quantity?
A: In a continuous review system, inventory levels are constantly monitored, and a fixed reorder quantity is ordered whenever the reorder point is hit. In a periodic review system, inventory levels are checked at fixed intervals (e.g., weekly or monthly), and the order quantity varies to bring the stock up to a target level. The reorder quantity is typically fixed in the former, while it can vary in the latter.