Reorder Point


Definition

Reorder Point (ROP), also known as reorder level, is the level of inventory which triggers the order for replenishment of inventory.

Formula

Reorder Point=(Average Lead time x Average usage) + Safety Stock

where:

  • Average Lead Time is the average number of days it takes between the moment an order is placed and when the inventory is actually received from the supplier and made available for consumption.
  • Average Usage is the average rate of consumption of inventory per day
  • Safety Stock is the additional inventory necessary to reduce the risk of a stockout in case of a delay in the order delivery (i.e. due to higher than average lead time) or a higher than average inventory usage.


Explanation

Unlike EOQ which is concerned with how much of inventory is to be ordered, the reorder point determines when the order for inventory is to be placed.

ROP is essentially the normal consumption of inventory during average lead time plus some safety stock if the lead time or inventory usage are variable.

If lead time and inventory usage are constant there will be no stock-outs and hence no need for maintaining a safety stock to guard against the risk. In such cases, ROP is simply calculated as:

Reorder Point=Average Lead time x Average usage

If however either lead time or inventory usage are variable, which is usually the case, ROP is calculated as follows:

Reorder Point=(Average Lead time x Average usage) + Safety Stock

The degree of variability of lead time and inventory usage will affect the level of safety stock that will be required to minimize the risk of running out of inventory.

Example

Cars PLC, a car distributor, needs to find when it should place orders for a specific model of car from its manufacturer. Relevant information is as follows:

Average Sales20 cars per day
Average Lead Time50 days
Safety Stock100 cars
EOQ2000 cars

Calculate the Reorder Point and comment on your answer.


Reorder Point=(Average Lead TimexAverage usage)+Safety Stock
=(50x20)+100
=1,100 cars

Cars PLC should order 2000 cars from the manufacturer each time its inventory level falls to 1100 cars.


Importance

Placing orders at the reorder point ensures that the replacement stock arrives just in time to ensure that no stock outs take place. ROP also helps to avoid unnecessary inventory holding costs that may result from placing orders too early thereby causing inventory to pile up.