Congratulations! You’ve done the hard work of growing 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 businesses leave this to their manufacturers or wholesalers, but that can be risky. Supply chain delays like we’ve all been experiencing lately can result in lost sales. Others take educated guesswork and hope for the best, which isn’t a strong strategy either.
Ordering late may cause problems in the supply chain or an unexpected surge in demand that you are unable to meet. On the other hand, if you order too early, you may not have enough space to store the new products, or you may have to pay more than expected for storage and warehousing costs.
The good news is that there’s a simple formula that ecommerce businesses can use to calculate the optimal reorder point for each SKU in your product line. This article explains what reorder points are and shows 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 a backorder. It’s like receiving a text alert when your checking account balance falls below a certain number. Ideally, calculating the reorder point for each SKU ensures you always have enough inventory to meet demand while minimizing inventory costs. So how do you determine what the quantity should be for the reorder point? There is a formula for that!
How to calculate a reorder point
To calculate the optimal reorder time for a specific SKU, you first need to know the lead time required to replenish inventory, the expected demand during that lead time, and how much safety stock you have on hand. First we calculate the needs during the lead time.
How to calculate the need during the lead time
You probably already know the average number of units sold per day and how it varies throughout the year. The ROP formula requires you to calculate how many units you need to meet demand during the time it takes for your new stock to arrive (lead time) – ie from the day you order it up to the day it is ready for sale. Simply multiply the average number of units sold per day during that time of year by the number of days in lead time.
Demand during lead time = lead time x average daily sales
Let’s say you sold an average of 30 blue tea kettles per day during the same time of year last year. Your manufacturer is currently about 2 weeks behind on orders and will need 2 more weeks to complete the order. They prefer economy shipping which takes 5-6 days. Your demand during the lead time is calculated as follows:
34 days (14 + 14 + 6) x 30 Avg. Units/day = 1,020 units required during lead time
What is safety stock?
Safety stock is like an emergency fund; It is extra inventory that you keep on hand to fulfill orders during an unexpected surge in demand or a delay in the supply chain. 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 you have in safety stock.
To find out how much safety stock you 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 could ever make? And how many days can a repeat order be delayed at most? Multiply these two numbers and you get the maximum number of units you would need in the event of a perfect storm. Subtract from this number the average number of units you sell during an average lead time to get the amount you should hold as safety stock.
safety stock =
(Max Daily Orders x Max Lead Time) – (Average Daily Orders x Average Lead Time)
Using the tea kettle example above, let’s say you sold a maximum of 45 blue tea kettles in one day. Their manufacturer has occasionally been 30 days behind, but never more than that. Manufacturing time is still 14 days and delivery time (6 days) is the same, so the maximum delivery time is 50 days. The average delivery time is 30 days, including manufacturing and shipping, and over the course of a year they sell an average of 29 units per day. You can calculate the optimal number of units to have in safety stock as follows:
(45 max units x 50 max days) – (29 avg daily units x 30 avg days)
2,250 max – 870 average = 1380 units of safety stock
Now let’s put all of this together to calculate the reorder point!
Formula for reorder points
Reorder point = need during delivery time + safety stock
Using the tea kettle example again, add your demand during lead time to the number of units sure to be in stock to get your reorder point:
1,020 units (requirements during delivery 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!
Benefits of using Reorder Points
The most obvious benefit of using reorder points is that you avoid running out of stock and upsetting your customers. While supplier issues are out of your control, maintaining safety stock can mitigate the damage to your ecommerce business.
Minimization of storage costs
Reorder points not only prevent stock outs, but also ensure that you do not have to order too frequently and store excess stock. Not only do reorder points help you save on storage costs, you also have less capital tied up in inventory. Another formula, Economic Order Quantity (EOQ), can be used to determine the optimal number of units you should order each time to minimize shipping and setup costs. In conjunction with the Reorder Point formula, the EOQ formula helps to further minimize storage costs.
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 going forward and the more accurate your forecasts will be.
Technology makes it easy
The more products you have, the harder it is to manage inventory without some form of automation. A tech-forward fulfillment center or third-party logistics partner (3PL) with a powerful ordering and inventory management system can track real-time inventory levels and set automatic reorder points for you.
Of course, not all systems are the same. ShipMonk’s industry-transforming fulfillment software offers order, inventory, and warehouse management that’s both powerful and utterly easy-to-use. Orders from multiple sales channels are prioritized and routed, while inventory spread 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 use our powerful technology and fulfillment expertise to better manage your inventory and e-commerce fulfillment.