A lot of companies spend extensive time and effort improving the accuracy of demand forecasts. That is their predictions of what they will sell or use in the future. But this is only one aspect of achieving the goal of effective inventory management, which is to "meet or exceed your customers' expectations of product availability which the amount of each item that will maximize your profits".
The other important element in determining when to replenish inventory is the anticipated lead time. That is how long it takes you to replenish your stock of an item. Let's say that seven days are required to replenish your stock of an item. That means that you must issue a replenishment order when you have no less than a seven day supply (i.e., forecast demand per day multiplied by seven days) in your warehouse. If your anticipated lead time is too short (e.g., it really takes 14 days rather than seven days to order and receive a shipment) you stand a very good chance of running out of stock of the product.
Let's discuss how to ensure your anticipated lead times are as accurate as possible.
The first step in this process is to realize that the anticipated lead time is comprised of four elements:
1. The time it takes you to place the order
Once you realize that the stock of an item needs to be replenished, how long does it take to deliver a replenishment order to the primary source of supply?
2. The time it takes the supplier to fill your order for the item
Note that if a vendor quotes you delivery time for an item, they are probably only considering the element of anticipated lead time.
3. Transportation time from the supplier to your facility
If you import products from overseas, this may be the longest element of the anticipated lead time.
4. The time it takes you to prepare the material in the stock receipt for sale or use
This includes the time it takes to receive the shipment, inspect the material, perform any value-added operation such as assembly or repackaging, and place the item in its proper bin location.
Not considering all four elements usually results in too short anticipated lead times and increases the risk of a stock out.
Notice we say the anticipated lead time, not "average lead time". A lot of systems will calculate and use an average lead time based on the last several stock receipts from the primary supplier of a product. This works well if lead times for a product are consistent. However, if the lead time for an item radically changes, using an average lead time may create stock shortages.
Let's look at an example:
A supplier previously delivered products consistently in 14 days. But due to changes in production, the lead time for the latest (and future shipments) is 42 days. If you calculate an average lead time, the result would be 28 days [(14 + 42) ÷ 2 = 28]. But the anticipated lead time for future shipments is 42 days. If you use the average lead time, you will plan on replenishing stock when there is only a 28 day supply on the shelf. There is a very good chance you will run out of inventory before the replenishment shipment arrives.
How do you know when it is time to update an anticipated lead time? By notifying the appropriate buyer when the lead time associated with the latest stock receipt significantly differs from the existing anticipated lead time.
- The lead time arrived more than 50% later or earlier than the existing anticipated lead time (e.g., a shipment arrives in more than 21 days or less than 7 days while the anticipated lead time is 14 days).
- The shipment is more than a week early or late.
When one of these instances occurs, the buyer should contact the supplier to determine if the existing anticipated lead time should be modified. Accurate anticipated lead times result in buyers issuing purchase orders at the right time, which is a key element in your quest to achieve effective inventory management.
To learn more, read Tribridge's whitepaper, The Continuing Evolution of Wholesale Distribution.