KPI of the Day – Retail: # Reorder point (ROP)
Measures the level of inventory at the point where a new order should be placed with suppliers, so as to bring the inventory up.
To indicate the moment when a new order should be placed, so as to replenish the stock.
There should be a balance between the risk of stock-out, resulting in possible customer dissatisfaction and lost sales, and the increased costs associated with carrying additional inventory.
This is why the decision on how much stock to hold is generally referred to as the order point problem. Lead time demand is the forecast demand during the lead-time period. For example, if the forecast demand is 5 units per day and the lead time is 10 days, the lead time demand would be 50 units.
This KPI is essential for establishing the point in time best suited for reordering a certain inventory item. If the reorder is placed too early, the excess items will require extra storage costs while, on the other hand, if the reorder is conducted too late, customers will have to wait for a prolonged period of time which is bound to cause drops in their satisfaction levels.
In order to effectively calculate and employ # Reorder point (ROP), further insight should first be generated in reference to its two sub-metrics: # Lead time demand, respectively # Safety stock. The latter has already been defined as the extra inventory required to ensure that customer demand will be honored at all times.
As far as the former sub-metric is concerned, it consists of two basic concepts: demand, which can be defined as the number of units sold within a certain time-frame (per day, for instance) and lead time, which refers to the number of days required for an order to arrive after it has been placed.
Thus, # Lead time demand is calculated by multiplying the approximated number of days for an order to arrive by the number of items which would be in demand during those days of waiting. The result will be a certain number of product units: when the inventory decreases and reaches that certain number of units, it is time for the retailer to place a new order to the supplier.
Recommendations for this KPI also include the following:
- Tracking purchases and sales orders in order to identify patterns and trends, in the case of smaller businesses,
- Implementing an Inventory Management Software System which will track inventory movement in all locations, in the case of multiple store retailers;
- Building on historical data to accurately forecast demand and plan out on inventory stock.
In a theoretical model, the reorder point for replenishment should occur when the level of inventory drops to zero. However, in actual business situations, there is a lag between the moment of placing an order and the moment when the products are received, thus the reordering point will always be higher than zero.
Optimized inventory management systems operate with a lower reorder point, as a higher level locks in more capital.