Reorder point system to keep inventory instock

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REORDER POINT SUBSYSTEM

In the EOQ model discussed we have made the assumption that the lead-time for procuring material is zero. Consequently, the reorder point for replenishment of stock occurs when the level of inventory drops down to zero. In view of instantaneous replenishment of stock the level of inventory jumps to the original level from zero level. In real life situations one never encounters a zero lead-time. There is always a time lag from the date of placing an order for material and the date on which materials are received. As a result the reorder level is always at a level higher than zero, and if the firm places the order when the inventory reaches the reorder point, the new goods will arrive before the firm runs out of goods to sell. The decision on how much stock to hold is generally referred to as the order point problem, that is, how low should the inventory be depleted before it is reordered.

The two factors that determine the appropriate order point are the procurement or delivery time stock which is the Inventory needed during the lead time (i.e., the difference between the order date and the receipt of the inventory ordered) and the safety stock which is the minimum level of inventory that is held as a protection against shortages.

Therefore Reorder Point = Normal consumption during lead-time + Safety Stock.

Several factors determine how much delivery time stock and safety stock should be held. In summary, the efficiency of a replenishment system affects how much delivery time is needed. Since the delivery time stock is the expected inventory usage between ordering and receiving inventory, efficient replenishment of inventory would reduce the need for delivery time stock. And the determination of level of safety stock involves a basic trade-off between the risk of stock-out, resulting in possible customer dissatisfaction and lost sales, and the increased costs associated with carrying additional inventory.

Another method of calculating reorder level involves the calculation of usage rate per day, lead time which is the amount of time between placing an order and receiving the goods and the safety stock level expressed in terms of several days' sales.

Reorder level = Average daily usage rate x lead-time in days.

From the above formula it can be easily deduced that an order for replenishment of materials be made when the level of inventory is just adequate to meet the needs of production during lead-time.

If the average daily usage rate of a material is 50 units and the lead-time is seven days, then Reorder level =Average daily usage rate x Lead time in days = 50 units x 7 days = 350 units

When the inventory level reaches 350 units an order should be placed for material. By the time the inventory level reaches zero towards the end of the seventh day from placing the order materials will reach and there is no cause for concern.

Learn about safety stock - Once again in real life situations one rarely comes across lead times and usage rates that are known with certainty. When usage rate and/or lead time vary, then the reorder level should naturally be at a level high enough to cater to the production needs during the procurement period and also to provide some measure of safety for at least partially neutralizing the degree of uncertainty.

The Reorder Point Formula - Even in a relatively simple situation considered in the example above, the amount of calculations involved for arriving at the reorder level is large. In real life situations the assumption of independence in the probability distributions made in the example above may not be valid and the number of time periods may also be large. In such cases the approach adopted earlier can become much more complex.

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The Reorder Point System To Keep Inventory In Stock