Replenishing Inventory: A Manufacturing Strategy Applied to Retailers
Within an end-to-end business system, manufacturers can reduce supply chain costs and maximize profits, while avoiding costly excess inventory or stock outs. An end-to-end solution provides much needed visibility throughout the supply chain and helps get reorder quantities and reorder points right.
For years, manufacturers have mastered the ability to use the most efficient replenishment strategy based on their business model. So why can’t retailers do the same? An optimized business solution can streamline the inventory replenishment process, but only once an appropriate strategy has been chosen, and this is not an easy decision.
With the manufacturing approach to inventory replenishment as the backbone, this blog provides four strategies to choose from, and in what scenarios they work best. However, choosing a replenishment strategy can be complex, so before diving into the options, here is an overview of a few important concepts:
- Safety stock level – The minimum amount of inventory needed in stock before an order is placed
- Economic order quantity – The most efficient quantity to order, balancing inventory carrying costs and ordering costs, while factoring in average demand. It is the quantity ordered each time when using a fixed reorder quantity
- Fixed reorder point – Reordering at a specified time interval (e.g., each week)
- Fixed reorder quantity – Reordering the same amount at each time (this is usually the economic order quantity or EOQ)
- Variable reorder point – Reordering whenever inventory goes below safety stock level
- Variable reorder quantity – Reordering various amounts of inventory each time, up to a specified inventory level.
Inventory replenishment strategies
Order Point, Periodic Review (fixed reorder point, fixed reorder quantity)
This strategy uses a fixed reorder point and a fixed reorder quantity. With this method, inventory levels are analyzed once each period, and the same quantity is ordered each time inventory is needed. The order is placed once the inventory level is below the safety stock level.
Usage case: Most useful for retailers who have steady demand across all seasons. Often, the EOQ is used to calculate the quantity to be ordered each period, and it doesn’t fluctuate.
Benefit: Provides a stable and predictable ordering cycle.
Risk: Does not guarantee inventory levels very well because you are ordering the same amount of inventory at the same periodic intervals. If demand fluctuates you risk shortages or excess inventory. Also, an order is not placed until the inventory falls below the safety stock level, which increases risk.
Order Point, Continuous Review (variable reorder point, fixed reorder quantity)
This strategy uses a variable reorder point and a fixed reorder quantity. An order for a fixed quantity is placed whenever the stock position reaches a reorder point. This strategy assumes an instantaneous replenishment and orders are placed as soon as the inventory falls below the pre-determined order level.
Usage case: Useful for organizations that can keep low inventory carrying costs as the inventory levels fluctuate.
Benefits: Triggers an order as soon as the inventory falls below the reorder level, therefore rarely eating into the underlying safety stock layer. Orders are created when required, and need to be managed as such.
Risk: Potentially increased inventory carrying costs.
Lot-for-Lot Replenishment (fixed reorder point, variable reorder quantity)
This strategy uses a fixed reorder point and a variable reorder quantity. Inventory levels remain low, as only the amount needed to meet demand is ordered each period. The order is placed, and the inventory is replenished up to a designated inventory level. For example, if a car dealership has a demand of 100 vehicles in period 1, they will order 100 vehicles. If the demand for cars in period 2 is 50, then the dealership will only order 50 vehicles for that period. However, if items are not discrete and come in packages of multiples such as windshield wipers, then the items will be ordered in the EOQ quantity.
Usage case: Most useful for retailers that sell discrete items. This means that the items can be counted individually and are normally of greater value. Lot-for-lot replenishment is also useful for retailers that take orders and then sell their items. For example, a custom suit company won’t have several suits in their inventory that they adjust and fit to the consumer’s size. They probably have little to nothing in inventory, and will order materials based on the number of consumer orders incurred during the period. Note: No order is placed if the inventory level at the time of review is higher than the pre-determined reorder level. This means, at the beginning of period 1, if the demand for bikes is 10 and there are 10 in inventory, none are ordered.
Benefit: Significantly reduces inventory carrying costs because you only order as much as demand requires.
Risk: Higher risk for stock outs because if the demand fluctuates, you will likely not have the product on hand and will need to backorder the item to the next period.
Order Up-To Method (variable reorder point, variable reorder quantity)
This strategy uses a variable reorder point and a variable reorder quantity. With this method, the fixed quantity (often EOQ) is ordered whenever the stock position reaches a reorder point. The stock “position” is the on-hand balance adjusted by orders placed but not delivered and inventory already allocated for a specific use.
Usage case: Useful for companies with low ordering costs, and unpredictable demand. This strategy enables the company to essentially order as much inventory as they need, whenever they need it.
Benefits: Low risk of stock outs.
Risk: Can increase ordering costs.
For retailers, these replenishment strategies can be very easy to implement. It is just a matter of managing two factors: how much to order, and when to order. These two decisions can be made after analyzing your business model, and understanding which replenishment strategy is best suited for your organization.
For assistance implementing a replenishment strategy, contact the retail solution experts at ArcherPoint. (http://dynamicsretailsoftware.com/contact)