Thursday, March 21, 2013

Reorder level planning for finished goods in the distribution network

There are many situations where reorder point planning is a very good choice of policy. Unfortunately, as to my experience and opinion, it is rarely used for finished products. And even more unfortunate, I have seen it being used in a way that really doesn't help with the communication, delivery service rating or inventory holding targets that are required in an effective supply chain.

A reorder level procedure is a stochastic replenishment method where stock is held before the actual orders come in. Therefore product is Made To Stock! The idea is to deliver to customer orders (or other requests... let's say from a warehouse or distribution center) from free available inventory; immediately! You should not - and I have seen this many times - wait until you have an order before you trigger any action to replenish and fulfill the order.

Look at the following graphic:

on the upper part you can see an example of a inventory level for a finished product on a timeline. Every time an order comes in, the inventory level drops. Only when an order causes the inventory level to drop below the reorder level, a replenishment is triggered... and only then! And if the reorder level is set (and designed) to have enough inventory within the replenishment lead time, you will not run out of stock. Any variability can be covered by having a safety stock lift up the reorder level.

If you follow this simple rule you will not run out of stock - within limits of course. And that limit is defined by the service level setting of... 95%? 98%? 99%? careful! the higher the service level, the more stock you'll carry in safety.

However, if the rules are not followed you might be faced with a situation like the following:
In case the planner waits until the orders come in before the replenishment is triggered, it will be very hard to get the inventory above the reorder level. In that case replenishment is triggered every time an order is placed and the production scheduling people are faced with an insolvable task. Your customer lead time will also be extended from only a few days for delivery, to many weeks including production, raw materials procurement, transport and delivery.

Reorder point processing is a great tool for automated service level and inventory holding optimization; but your planners need to use it the right way.