What Are Reorder Points and How to Calculate Them
Congrats! You’ve done the hard work of building your startup into a successful ecommerce business. The last thing you want is to run out of your bestsellers, but how do you know when to order more? Many small companies leave this up to their manufacturers or wholesalers, but that can be risky. Supply chain delays, like those we’ve all experienced recently, can mean lost sales. Others take an educated guess and hope for the best, which isn’t a strong strategy either.
If you order too late, you may run into supply chain issues or have an unexpected surge in demand that you can’t fulfill. On the other hand, if you order too soon, you may not have enough room to store the new products, or you may have to pay more than expected for storage and holding costs.
The good news is that there’s an easy formula ecommerce businesses can use to calculate the optimum reorder point for each SKU in your product line. This article will explain what reorder points are and show you how to calculate them.
What is a Reorder Point?
A reorder point (ROP) is a predetermined minimum number of units for each SKU that, when reached, triggers an order for more. It’s like getting a text notification when your checking account balance falls below a certain number. Ideally, calculating the reorder point for each SKU will ensure that you always have enough inventory on hand to meet demand, while minimizing inventory costs. So, how do you determine what the unit count for the reorder point should be? There’s a formula for that!
How to Calculate a Reorder Point
To calculate the optimum reorder point for a particular SKU you’ll first need to know the lead time required to replenish the inventory, the expected demand during this lead-time period, and how much safety stock you have on hand. First, let’s calculate the Demand During Lead Time.
How to Calculate Demand During Lead Time
You probably already know the average number of units sold per day, and how that fluctuates during the year. For the ROP formula you’ll need to calculate how many units you require to satisfy demand during the time it takes your new inventory to arrive (lead time) — that is, from the day you order it until the day it’s ready for sale. Simply multiply the average number of units sold per day during this time of year by the number of days in lead time.
Demand During Lead Time = Lead Time x Average Daily Sales
Let’s say that last year, during this same time of year, you sold an average of 30 blue tea kettles per day. Your manufacturer is currently running about 2 weeks behind on orders, and requires 2 additional weeks to complete the order. You prefer economy shipping which takes 5-6 days. Your Demand During Lead Time is calculated as follows:
34 Days (14 + 14 + 6) x 30 Avg. Units/Day = 1,020 Units Demand During Lead Time
What is Safety Stock?
Safety stock is like an emergency fund; it’s extra inventory you keep on hand to fill orders during an unexpected surge in demand or a supply chain delay. For the reorder point formula, you should use the actual number of units you have in safety stock, but there is also a formula for calculating the ideal number of units to keep on hand as safety stock.
To figure out how much safety stock you’ll need, simply calculate the difference between your worst-case supply/demand scenario and your average scenario. What is the maximum daily sales per unit you might ever experience? And what is the maximum number of days a restocking order might be delayed? Multiply these two numbers and you’ll have the maximum number of units you would need in case of a perfect storm. From that number, subtract the average number of units you sell during an average lead time to get the quantity you should keep as safety stock.
Safety Stock =
(Maximum Daily Orders x Maximum Lead Time) – (Average Daily Orders x Average Lead Time)
Using the tea kettle example above, let’s say the maximum number of blue tea kettles you’ve ever sold in one day is 45. Your manufacturer has been 30 days behind on occasion, but never more than that. Manufacturing time is still 14 days and shipping time (6 days) are the same, so maximum lead time is 50 days. Average lead time is 30 days, including manufacturing and shipping, and over the course of a year you sell an average of 29 units per day. You can calculate the optimum number of units to have in safety stock like this:
(45 max. units x 50 max.days) – (29 avg. daily units x 30 avg. days)
2,250 max. – 870 avg. = 1380 Units Safety Stock
Now let’s put all this together to calculate the Reorder Point!
Reorder Point Formula
Reorder Point = Demand During Lead Time + Safety Stock
Using the tea kettle example again, add your demand during lead time to the number of units in safely stock to get your reorder point:
1,020 Units (Demand During Lead Time) + 1,380 (Safety Stock) = 2,400 Units
When the number of blue tea kettles you have in stock drops to 2,400, it’s time to reorder!
Advantages of Using Reorder Points
The most obvious advantage to using reorder points is to avoid running out of stock and angering your customers. While supplier problems are out of your control, maintaining safety stock can mitigate the damage to your ecommerce business.
Minimizing Warehouse Storage Costs
In addition to preventing stockouts, reorder points ensure that you’re not ordering too frequently and having to store excess quantities of inventory. Not only will reorder points help you save on warehousing costs, but you’ll have less capital tied up in inventory. Another formula, the Economic Order Quantity (EOQ), can be used to determine the optimum number of units you should be ordering each time to minimize shipping and setup costs. When used in conjunction with the reorder point formula, the EOQ formula helps minimize inventory warehousing costs even further.
Demand forecasting and inventory management rely on accurate data. The sooner you start using the reorder point formula to quantify demand and lead times, the more reliable data you’ll collect for the future, and the more accurate your forecasting will become.
Technology Makes it Easy
The more products you have, the harder it is to manage inventory levels without some form of automation. A tech-forward fulfillment center or third party logistics partner (3PL) with a powerful order and inventory management system can track inventory levels in real time, and set automatic reorder points for you.
Of course, not all systems are created equal. ShipMonk’s industry transforming fulfillment software provides order, inventory, and warehouse management that is both powerfully robust and completely user-friendly. Orders coming from multiple sales channels are prioritized and routed, while inventory distributed across multiple fulfillment centers can be tracked and managed in real time.
Ecommerce businesses of all sizes can use reorder points to optimize inventory levels. But at some point in your growth, it makes sense to outsource these tasks to an ecommerce fulfillment center or 3PL. Contact ShipMonk today for a quote or software demo, and take advantage of our powerful technology and fulfillment expertise to better manage your inventory and ecommerce order fulfillment.