How reorder levels are calculated
Understanding how reorder levels are calculated is fundamental to understanding order recommendations
Read the tutorial
In this tutorial we explain how the reorder levels are calculated and how they dynamically adjust for both seasonality and multiple streams of demand.
A quantity-versus-time sawtooth diagram
The simplest way to illustrate this is by using a quantity-versus-time saw-tooth diagram, which shows the units of stock on hand over time.
A: As we sell or use stock, the units on hand reduces
B: The quantity on hand is at its lowest point, or MIN, when the next delivery arrives
C: Once the delivery is receipted, the stock on hand increases to the MAX level
Safety stock and cycle stock
The safety or buffer stock is there to protect against unreliable supply and unreliable demand, it is our insurance against running out of stock.
The replenishment or order cycle defines how often the item is ordered and is the stock that actually sells and generates profit.
So, the MIN = safety stock, the MAX = safety stock + cycle stock, and we want our on hand stock levels to stay between the min and the max.
The model level
On average, our on hand stock level will be halfway between the MIN and the MAX – we call this level the MODEL level.
The model level can be computed as SS + ½RC
WHEN and WHAT to order
Ideally we would like to receipt an order when the stock on hand is predicted to be at the safety stock level. For an order to be received then, it must be placed a lead time prior.
Adding the demand over the lead time to the MIN gives us the reorder point – answering the question WHEN to order. So, an order is triggered by the reorder point for arrival a lead time from now.
Any item that is on or below its reorder point today, will be ordered – answering the question WHAT to order.
HOW MUCH to order
Adding the demand over the lead time to the MAX, gives us the order up to – answering the question HOW MUCH to order.
In a perfect world
In a perfect world, we would sell exactly what we expected over the lead time and our stock on hand after receipt of the order would equal safety stock + cycle stock.
For very seasonal products, the stock levels needed to support sales out of season are typically low. During peak season, the stock levels needed to support sales increase dramatically.
In the App, the lead time, safety stock and replenishment cycle are in days, and are converted to units by looking forward at the future demand.
This results in dynamic inventory levels that are appropriate for the anticipated sales.
Lower levels out of season
Increased levels leading up to the season
Higher levels during season
Multiple streams of demand
The same applies to businesses that have multiple streams of demand:
A forecast for direct sales, including existing customer orders
BOM demand from finished goods
Demand from subsidiary locations that the central warehouse supplies
The nett result of these demand streams – whether we sell, transfer to another location or use stock internally – is a projected closing stock into the future – the saw-tooth we covered earlier.
For stocked items, applying the basic calculation of days to units using future demand results in appropriate dynamic levels to cover all demand streams.
Non-stocked items will only ever order for firm demand.
And that’s it for my tutorial on re-order levels.
You should now know the principles behind the calculation of the levels.
And that converting days to units, results in appropriate dynamic levels that cater for seasonality and multiple demand streams.