What it means
Every item you hold has a natural rhythm: it runs down at some average daily rate, and it takes a supplier a certain number of days to replace it. The reorder point is simply the amount of stock you need in hand to cover that gap without disappointing a customer.
The business case is a direct trade-off between two costs. A stockout costs you the margin on the lost sale and sometimes the customer, while excess stock costs you storage, insurance, obsolescence and the interest on the cash tied up in it.
The buffer at the end of the calculation is called safety stock, and it exists to absorb variability. If demand can spike or a supplier can slip, safety stock is what stands between an ordinary bad week and an empty shelf.
Reorder points are set per item, not per warehouse, and they need revisiting whenever usage or lead times shift. A supplier moving from air freight to sea freight can add three weeks of lead time, which changes the reorder point far more than any change in demand.
The reorder point answers when to order; the economic order quantity answers how much to order. The two work as a pair in most inventory systems, and modern software simply recalculates both from live usage data rather than from a figure typed in once a year.
In practice
Real-world examples.
Example
A dental practice uses 40 boxes of gloves a week and its wholesaler delivers in four days. The reorder point of about 30 boxes is set in the ordering system, so a reminder appears automatically rather than depending on someone noticing an empty cupboard.
Example
A craft brewery imports a specialist hop with a 45 day lead time from harvest markets. Its reorder point runs into several tonnes, and the finance director models the working capital effect before agreeing to stock the variety at all.
Example
An e-commerce seller of phone accessories cuts safety stock on slow moving colours after finding that 40% of its warehouse space held items selling fewer than two units a week. Reorder points on those lines drop sharply, releasing $180,000 of cash for faster moving products.
Think of it
“Reorder point is your trigger level-when stock hits this number, it's time to order more.
Formula
Calculation
Reorder point = (average daily usage x lead time in days) + safety stock
A garden equipment retailer sells an average of 120 units of its best selling hose reel per day. Its supplier takes 10 days from order to delivery, so ordinary demand during the lead time is 120 x 10 = 1,200 units.
For safety stock, the retailer looks at its worst weeks and sees that daily sales can reach 160 units. The extra cover needed is (160 - 120) x 10 days = 400 units.
The reorder point is therefore 1,200 + 400 = 1,600 units. When stock on hand falls to 1,600 the buying system raises a purchase order, and at normal demand the retailer will still have roughly 400 units left on the day the delivery lands, with that buffer fully consumed only if demand runs at the 160 unit peak for the whole lead time.Case study
Seen in the real world.
The following is an illustrative and fictional example. Fenwick Tools, an invented supplier of professional hand tools, kept stock levels by feel, and its warehouse manager reordered whenever a shelf looked thin. Service levels averaged 91%, which meant nearly one order line in ten could not be filled on the day.
In this fictional case the finance and operations teams calculated a proper reorder point for the 300 lines that made up 80% of revenue, using twelve months of usage data and each supplier's actual delivered lead time rather than the quoted one. Several suppliers turned out to take 18 days rather than the promised 10, which alone explained most of the stockouts.
With reorder points reset and safety stock sized against real variability, Fenwick's imaginary service level rose to 98% while total inventory value fell by 14%, because the discipline also exposed a long tail of items that had been over-ordered for years.
Watch out
Common mistakes.
- Using the supplier's quoted lead time rather than the delivered lead time actually observed over the past year, which is often several days longer.
- Setting one blanket safety stock rule for every item, when a cheap fast moving part and an expensive slow moving one call for very different levels of cover.
- Forgetting to include stock already on order when comparing current stock against the reorder point, which leads to ordering the same item twice.
Questions
People also ask.
How is the reorder point different from the economic order quantity?
The reorder point tells you when to place an order and the economic order quantity tells you how many units to buy, so most systems use both together.
Should the reorder point change during a seasonal peak?
Yes, because average daily usage is the main driver, and a retailer heading into its busiest quarter should raise reorder points well before demand actually lifts.
What if the supplier is unreliable rather than slow?
Variability in lead time is handled through safety stock in exactly the same way as variability in demand, so an inconsistent supplier justifies a larger buffer or a second source.
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