As a business sells inventory, an important decision is: When should we order more products from our suppliers? From small boutiques and large superstores to online shops and everything in between, this is a nearly universal problem for businesses selling physical goods, avoiding running out of inventory while keeping excesses to a minimum. Having a systematic way to deal with this recurring question can lower both costs and anxiety levels while ensuring there's enough inventory to meet customers' needs.
What Is a Reorder Point (ROP)?
A reorder point is the level of inventory at which a business should place a new order or run the risk that stock will drop below a comfortable level, or even down to zero — leaving customers unhappy and orders unfulfilled. Usually, ROP refers to buying inventory to replenish stock. But the concept is not limited to businesses that buy inventory for resale (e.g., buying at wholesale prices and selling at retail). Reorder point logic and math can also apply to storefront locations of large businesses where the "supplier" is a warehouse owned by the same company, as well as to buying items from suppliers to make the products your business then sells.
Why Is Reorder Point Important?
Reorder points are important for two main reasons. First, reorder points allow a business to make fast, low-stress, data-driven decisions about ordering inventory, without having to start from first principles every time. A simple, rules-based approach saves time and reduces the possibility of costly mistakes in inventory management.
Second, identifying and using a reorder point to trigger inventory resupply helps a business operate more efficiently by balancing two competing needs. If a business reorders too much, too soon, it will be spending money before it needs to, while also incurring costs to carry the extra inventory, some of which may never be sold (especially for products nearing the end of their life cycle). On the other hand, if a business waits too long to reorder or doesn't order until the inventory is already needed, lag times between order placement and receipt of the goods will create stockouts (i.e., out-of-stock events where a business has to turn customers away or orders aren't fulfilled).
Reorder Point Explained
Reorder point is necessary because we don't live in the hypothetical business world described in an Economics 101 textbook, a world with perfect information and no transaction costs or need for inventory controls, and no need to keep more inventory on hand than what your customers need immediately. In this theoretical world, you'd be running a business with no need for inventory, placing orders as the customers come to you and having your customers served instantly. But in reality, there aren't enough trucks to ship a single toothbrush at a time; and if there were, those trucks wouldn't get to your stores instantly; and even if you did have an infinitely large fleet of warp-drive-equipped delivery trucks, it would be quite costly.
In the real world, businesses aim to place bulk orders in advance of when those orders will be needed. Businesses plan for the customers they expect to serve while accounting for uncertainty and variation, usually with "safety stock" — inventory kept on hand in addition to what they think they'll need to serve their anticipated flow of customers. Safety stock helps serve unexpected surges in demand (e.g., an increase in customers or the same customers with unusually high needs for a given product).
ROP sets an inventory level for restocking that accounts for lead times and operational "friction." The simplest way to think about it is this: If your inventory is at a level where, if you placed an order right now, you'd expect to just be reaching zero inventory (or down to only your safety-stock cushion) when your order arrived, then it's time to reorder.
How Are Reorder Points Used?
Reorder points are used as thresholds or trigger points. When inventory reaches the level specified by the ROP, that means it's time to act. In some cases, this step can even be automated (though if actual money is changing hands, and you're not just getting a resupply from your own warehouse, it's usually best to have a human double-check the decision). Reorder points simplify and streamline the business decision of when to reorder inventory.
Using reorder points is very easy, if you have an inventory management system in place that gives you a real-time view of inventory. It's just a matter of placing new orders when your inventory drops to the reorder point level. The more complicated part is determining what those reorder points are, which is a function of the variables that go into a reorder point calculation.
Reorder Point Inputs
There are three key variables, or inputs, to consider in a basic reorder point calculation. For example, in a simple scenario where the business is ordering inventory to then sell to customers (that is, the business isn't ordering components for a production process to create inventory), those variables are:
- Daily sales velocity: How much of this item are you selling every day?
- Lead time: How long does it take from the time you place an order with your supplier until the items you ordered are ready to be sold to your customer? To make the math easy, make sure this is measured in the same time units as sales velocity (usually "days" is appropriate, but some businesses may find another unit of time works better).
- Safety stock: This is the amount of buffer or contingency inventory you always want to have on hand. It's a rainy-day stash of extra inventory that can cover a sudden surge in demand or an unexpected delay in deliveries. The exact amount of safety stock you want is usually the result of a separate determination; including this in your reorder point calculation helps relieve some of the uncertainty.
Some businesses include other inputs, such as the standard deviations of sales velocity and lead time. Adding such fancy math is useful when using more complex models and assumptions, which are often best for situations where sales and lead times vary quite a bit. But the three variables above form the core of almost every ROP calculation.
Note that the size of the order isn't one of the key variables or the result of the calculation. Reorder points are fundamentally about the timing, not the size, of your orders.
Reorder Point Formula
The reorder point formula must accomplish a complex mission: It must make sure you're reordering in sufficient time so you (1) don't run out of stock and (2) don't dip below your safety stock unless something unexpected happens, while (3) also making sure you're not ordering so early that business costs rise unnecessarily.
Using the three-variable model, the formula is:
Reorder point = (daily sales velocity) × (lead time in days) + safety stock
In English, that says to reorder when inventory equals the amount you expect to sell during the time it takes to get your order from the supplier, plus your safety stock (which serves as a cushion for unexpectedly high demand or slow deliveries). In other words, it calculates the point where if you don't reorder, your inventory will drop to unacceptably low levels — or to zero, if you don't have safety stock.
How to Calculate a Reorder Point
To illustrate: Let's say you run a popular neighborhood coffee shop that also sells jewelry made by a local artist. Jewelry isn't your main business, but you do wind up selling four pieces per day. You've determined that you always want to have a safety stock of 20 pieces (maybe the most you've ever sold in a day is 14, which is 10 more than your daily projection, plus you want another 10 on display at all times to showcase the offerings). And your supplier, the local artist, needs a fair amount of lead time to fill an order: five weeks. What should your reorder point be?
Looking at the formula — (sales velocity) x (lead time) + safety stock — you might plug in 4 x 5 + 20 and get 40. But remember, the sales velocity and lead time must be in the same units of time. If you're selling four per day and need five weeks (i.e., 35 days, or 7 days for 5 weeks) for your order to arrive, you can expect to sell 4 x 35 = 140 pieces of jewelry while you're waiting for your resupply. Putting everything in days, the calculation comes to:
Reorder Point = 4 × 35 + 20 = 160 pieces of jewelry
When your inventory is down to 160 pieces, that's when you need to order more from your supplier. It might seem like a lot for a product that only moves four units a day, but in this case it's the long lead time that drives the result.
ROP With Safety Stock
Reorder points usually incorporate safety stock, as shown in the standard formula just discussed. Even if they don't do so explicitly, it's good to build in some allowance to cover uncertainty and unexpected events. If your business doesn't have a concept of safety stock (or a similar concept that serves as a cushion in your inventory levels), you may still want a "safety stock" term in your equation. If you're not going to go with a more complicated, probabilistic model where lead times are drawn from a probability distribution, then you may want to think about how many days you might have to wait for a delivery that's late but not shockingly so. How much would you sell over that period? That number could serve in place of your safety stock number, or even be added to your safety stock if late deliveries are a legitimate concern.
ROP Without Safety Stock
It's rare that a company will calculate reorder points without any safety-stock factor or acknowledgment of any of the issues a safety stock addresses. But it's not unheard of, and it's not always unwise. If you're calculating your ROP to figure out when to resupply from a warehouse you own, using logistics mostly under your control, you may not need a safety stock to account for unexpected delays in the supply chain. You may also be selling products that are ordered very far in advance — maybe you sell to big conferences that plan years ahead of time, or to people planning weddings a year in advance. Last-minute rush orders might be so rare, and expensive to plan for, that they're not worth considering. Most businesses won't want to ignore the need for safety stock (or at least the logic behind it), but there are valid and useful cases of reorder points that omit safety stock.
6 Reorder Point Strategies
A reorder point is a fairly straightforward concept, but successful implementation requires paying attention to nuance and details about the business, suppliers and customers. Here are a few strategies that will help you turn theory into practice.
- Don't ignore your reorder point. The most important strategy for successfully implementing a reorder point is to consistently execute on it. The benefit of a reorder point is that it tells you when you need to reorder, but it only works if you actually reorder at that point.
- Err on the side of caution. You won't necessarily be able to reorder at exactly your reorder point every time, unless you're using automated software to place orders. That being the case, would you rather reorder when you're approaching your ROP, or after you've already passed it? The answer will depend on what's more costly to you: having too little inventory or too much. If your inventory is perishable, you may be more inclined to wait, while if your on-site storage costs are low and demand is highly variable, you're probably better off ordering before you hit the reorder point.
- Use sales forecast knowledge to improve your formula. Multiplying daily sales times lead time works well if lead times and daily sales are constant through the weeks and months and years. But suppose lead time is three days, and you know that sales are higher on weekends. You'd be better off using your expected sales over the next three days in the formula, rather than your average daily sales, because what looks like perfectly fine inventory on a Monday may be insufficient on a Friday morning going into a busy weekend. In some cases, you may even want to look a few days further than your lead time to see what's coming.
- Be practical about the calendar. In the previous example, sales go up on weekends. But what if, on top of that, the lead time isn't three days but three business days? You can't place an order on Thursday and have it come on Sunday, so the actual lead time would be longer. Anything you need for the weekend would have to be in by Friday or you can't sell it on Saturday or Sunday. This means you need to order your weekend supplies by Tuesday, which, in turn, means you need to be looking almost a week ahead and not just three days when deciding when and how much to order.
- Pay attention to order quantities. If you find yourself constantly hitting your reorder point, you may not be ordering a high enough quantity with each reorder. Conversely, if managing your on-site inventory is becoming difficult or costly due to how much you have, and you're not reordering very often at all, you may have set the quantity too high. Reorder points are about timing, not quantity, but that doesn't mean quantity isn't important. If you're struggling with order quantity, economic order quantity (EOQ) calculations, which are designed to find a given business's optimal order quantity, may be useful.
- Don't over-optimize at the expense of other parts of your business. When applying a new concept, it's easy and understandable to try to get as much value out of it as possible. But the goal of any implementation is improving your business, not optimizing an individual metric or process at any expense. Say you own a store selling art supplies. You have reorder points for paint brushes, paints, canvases and a hundred other items. If most of them come from the same few suppliers, it might be cheaper, and much better for your supplier relationships, to group orders together in fewer, larger orders. But if you have a separate reorder point alert set up for every item, you may wind up placing a new order every few hours. You'll be optimizing for not having too much or too little inventory, but at a much higher cost than storing a few extra paint brushes so you can place fewer large orders. In this specific example, you might just place orders for anything getting close to its reorder point — maybe anything under 150% or even 200% of the calculated reorder point gets a reorder in your larger, more infrequent purchases. Reorder points should be integrated into your business processes to ensure sufficient inventory levels, but they shouldn't supersede other priorities.
Keep Reorder Points Simple With NetSuite
A reorder point is a simple concept, but when you have dozens or hundreds of reorder points across different types of inventory, as well as nuances derived from forecasts, logistics and supply-chain issues, it can get complicated to track. NetSuite Inventory Management software can be a big help in monitoring inventory levels for many products (e.g., SKUs, for a lot of businesses) and applying more complex reorder point logic. One advantage of installing a platform like NetSuite's to monitor your ROP thresholds is that it also integrates with the rest of your inventory management activities and data. Having everything in one place reduces the need for humans to move data and run analyses, and, in doing so, it also reduces the potential for errors to creep into the data.
Reorder points are a valuable tool for making sure you have sufficient inventory on hand for your customers without having so much inventory that it becomes costly and unmanageable. Even simple calculations can yield valuable guidelines, and further customization can turn a challenging part of inventory management into an almost automatic process that rarely demands much worry or intervention. Investments in setting up smart reorder points today can yield dividends in efficiency for years to come.
Reorder Point FAQs
How do you calculate a reorder point?
The details may vary according to a business's specific circumstances, but a reorder point is calculated by adding your safety stock level to the amount of inventory you anticipate selling during the time it takes to receive an order after placing it.
What are EOQ and ROP?
ROP stands for reorder point, which tells a business when to place an order (where the "when" is given in terms of current inventory levels). EOQ stands for economic order quantity, which determines how much to buy when placing those orders.
What is the ideal reorder point?
The ideal reorder point is one where the ordered inventory will arrive before you dip below a comfortable level, but not so early that storing and tracking it becomes a problem. Inventory that arrives too early is especially problematic with perishable inventory, such as meats and produce.
How do you calculate reorder point with example?
A simple reorder point calculation is daily unit sales multiplied by lead time between inventory order and its arrival in days, plus safety stock. So, if a business sells 30 printers a day and its supplier takes 10 days to deliver an order, and it wants safety stock of at least 25 printers, then the reorder point is 30 x 10 + 25 = 325 printers. This means the business must reorder printers when it has 325 left in stock, or it will risk dipping below its safety-stock level before the new printers arrive.