Lead Time, Reorder Level, Safety Stock1st February 2021
A lead time is the latency between the initiation and completion of a process. For example, the lead time between the placement of an order and delivery of new cars by a given manufacturer might be between 2 weeks and 6 months, depending on various particularities.
Lead time is the amount of time that passes from the start of a process until its conclusion. Companies review lead time in manufacturing, supply chain management, and project management during pre-processing, processing, and post-processing stages.
One business dictionary defines “manufacturing lead time” as the total time required to manufacture an item, including order preparation time, queue time, setup time, run time, move time, inspection time, and put-away time. For make-to-order products, it is the time between release of an order and the production and shipment that fulfill that order. For make-to-stock products, it is the time taken from the release of an order to production and receipt into finished goods inventory.
Components of lead time
- Pre-processing time: This is also referred to as the planning time, and it includes the time taken to receive a request for replenishment, understand it and create a purchase order (when buying an item), or create a job in the case of a manufacturing firm.
- Processing time: The processing time is the time taken after receiving a purchase order to procure or produce the item.
- Waiting time: The time that’s taken between procuring necessary items to the time when the production process commences.
- Storage time: Storage time is the amount of time that items stay in the warehouse or factory awaiting delivery.
- Transportation time: The time that the produced item takes to move from the warehouse/factory to the customer.
- Inspection time: The time spent by the customer checking the product to see if it meets the specifications. Also refers to the time required to deal with any non-conformity with the order request.
The following are some of the ways that a company can reduce lead time:
- Reduce non-value-added activities
The company should perform value stream mapping to identify non-value-added activities that prolong the lead times. Prepare a list of these activities and eliminate those that the company can do without, and maintain those that provide a positive impact on product quality.
- Change shipping methods
The company can also organize for alternative shipping methods that are quicker than the current shipping methods, or that offer more frequent shipments. The suppliers may prefer shipping methods that are slow but result in more cost savings, which can affect lead times. Transitioning to a more flexible shipping method can gradually reduce the lead time, even though it may come at an additional cost.
- Source locally
If the raw materials imported by the company are available locally, the company can change to the local suppliers, as long that does not compromise the quality of products. Buying products locally, as opposed to sourcing from international suppliers, reduces the lead time because the goods are transported over shorter distances.
- Vertical integration
Vertical integration may involve combining the processes of two suppliers or production processes of the company. For example, where a company manufactures and assembles components in locations that are far apart, it may consolidate the two processes internally. This reduces the transportation time of the components from one location to another.
- Automate the process
Sometimes, lead time delays are caused by human errors, when the person responsible for ordering new stock delays contacting suppliers. The company can use a Vendor-Managed Inventory (VMI) or a Vendor-Owned Inventory (VOI) system to replenish the stock automatically when it nears completion. Such a system reduces lead time since the supplier gets a request early enough before the company experiences a stock out.
Reorder level of stock (also known as reorder point or ordering point) in a business is a present level of stock or inventory at which the business places a new order with its suppliers to obtain the delivery of raw materials or finished goods inventory.
The reorder point (ROP) is the level of inventory which triggers an action to replenish that particular inventory stock. It is a minimum amount of an item which a firm holds in stock, such that, when stock falls to this amount, the item must be reordered. It is normally calculated as the forecast usage during the replenishment lead time plus safety stock. In the EOQ (Economic Order Quantity) model, it was assumed that there is no time lag between ordering and procuring of materials.
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 point is always 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 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 due to fluctuations in demand.
Reorder Point = Normal consumption during lead-time + Safety Stock
Safety stock: [Maximum demand or usage (in days, weeks or months) × Maximum lead time (in days, weeks or months)] + Safety stock
Safety stock is a term used by logisticians to describe a level of extra stock that is maintained to mitigate risk of stockouts (shortfall in raw material or packaging) caused by uncertainties in supply and demand. Adequate safety stock levels permit business operations to proceed according to their plans. Safety stock is held when uncertainty exists in demand, supply, or manufacturing yield, and serves as an insurance against stockouts.
Safety stock is an additional quantity of an item held in the inventory to reduce the risk that the item will be out of stock. It acts as a buffer stock in case sales are greater than planned and/or the supplier is unable to deliver the additional units at the expected time.
Safety stock is an additional quantity of an item held by a company in inventory in order to reduce the risk that the item will be out of stock. Safety stock acts as a buffer in case the sales of an item are greater than planned and/or the company’s supplier is unable to deliver additional units at the expected time. If the company is a manufacturer, a safety stock of materials could minimize the risk of production being disrupted.
Of course, there are additional holding or carry costs associated with safety stock. However, the holding costs could be less than the cost of not filing a customer’s order on time or having to stop its production line.
How to calculate safety stock
To get the benefits of keeping safety stock, you need to know how much safety stock to keep. This is because too much safety stock can lead to higher holding costs, and too little safety stock results in loss of sales. Using a formula will help you calculate the optimal amount of safety stock for your business.
Each method of calculating safety stock uses slightly different details, but they all require you to know your lead time, which is the time between the initiation of an order and the completion of the delivery process.
There are several different methods to calculate safety stock:
- Fixed safety stock
- Time-based calculation
- The general formula
- Heizer Render’s formula
- Greasley’s method
Fixed safety stock
Fixed safety stock is a method used by production planners. They determine the amount of safety stock to keep from the maximum daily usage for over a period of time, but without using a particular formula. The value for fixed safety stock generally remains unchanged unless the production planner decides to change it. Fixed safety stock levels can even be set to zero for items that you want to phase out. However, if there is a sudden demand surge for an item with very little safety stock, you might not be able to fulfill the orders.
In this method, safety stock levels are calculated over a particular time period, based on the future forecast for the product. This method includes a combination of actual demand from sales orders, and forecasted demand based on statistical methods. This method cannot predict business uncertainties, so using it involves a risk that you might end up carrying too much unwanted stock if your products are moving slower than forecasted.
The general formula
This is the simplest and commonly used method to calculate safety stock. It calculates the average safety stock the company needs to hold during a stockout scenario, but it doesn’t consider the seasonal fluctuations of demand.
Safety Stock = (Max. Daily Usage*Max lead time in Days) – (Avg. Daily Usage* Avg. lead time in Days)