Reorder Point Technique and Safety Stock

MRP in the your ERP computer systems accommodates all order trigger methods and review techniques. Reorder Point is one the order methods used.

The risk of not using Reorder Point n your inventory control is that your available stock balance will dip into safety stock level or a stock-out will occur before an order is even released during your next review period. Planners have a choice of two types of Reorder Point trigger techniques which are logic controlled within most of today’s computerized systems – quantity-based or demand-based reorder triggers.

Quantity-based reorder

Quantity-based reviews are triggered by events which cause the projected net inventory balance to dip into safety stock or reach zero bin. You normally set the re-order review flag in your computer systems in events such as when parts are frequently having high rate of quality inspection rejects, parts having consistent high volume transaction, new parts are added into BOM, or other action that causes the stock balance to reach re-order level where an order must be released. These parts are reviewed online normally through the programmed nightly run via MRP in your ERP systems, and one or more purchase requisitions are suggested for planner review or are released to purchase orders automatically.

Demand-based reorder

Demand-based reviews are triggered normally by new requirements. Planners set the review flag when there is new product released and MRP will explode bill-of-material to generate new requirements. Other cases when planners will also set the review flag are when the supply vs demand are often in shortfall, ie. [(stock on-hand balance + pipeline stock + released orders) - (customer firmed orders + safety stock target level)]. Such cases includes when you frequently have to schedule out promise dates, expediting or de-expediting an order, inventory adjustments, returned materials, and new replacement  parts.

If the reorder review occurs too early, average inventory levels may exceed the target as stock are replenished far earlier than the actual date of the projected stock-out or before safety is dipped into. If the reorder review occurs too late, a shortage may occur and additional costs may be incurred to expedite the needed parts.

Parts using a lot-for-lot dependent demand order are never reviewed using reorder point but are only ordered as each individual demand occurred. Lot-for-lot order quantity is generated automatically as part of the MRP explosion process. Parts without target safety stock and MRO inventory items do not need reorder point. Planners must give special attention to the overall “Time-to-receive” for parts using reorder levels – this includes order review and order release time, supplier lead time, transportation time, custom clearance, receiving, inspection and storage time. Base on the knowledge the planners have on the parts, supplier performance and business conditions, they will adjust reorder levels necessarily, change review cycle or order methods.

Types of control with reorder trigger 

The planners use different planning methods for order review triggers, base upon the types of parts stocked for manufacturing, after-sale service and operating support; types of parts procured externally or manufactured on-demand, and the company’s computer system logic used. Most companies today use MRP triggers but some use a combination of MRP and inventory reorder triggers. Three different part categories determine the type of control that planner should apply: master-schedule planned parts, MRP-planned parts, and inventory-planned parts (figure 3.1).

 Figure 3.1 Master Production Schedule explosion and demand types

Master-schedule planned parts

Master Schedule system reviews only those parts within the bills of material being processed. MS system may not even need flags since MS system review parts for ordering at each step in the BOM explosion process. Every part that is MS-planned will be reviewed only in each Master Schedule run. For any firmed customer order, the master production schedule explosion will typically consists of Lot-For-Lot parts at the highest levels, and some combination of MRP-planned and inventory- planned parts at the lower levels as shown in figure 3.1.

MRP-planned parts

This includes dependent and dependent demand parts planned within the MRP system. Today’s MRP systems like SAP are powerful enough to review every part for order action everyday, with dynamic updates based on operational changes (canceled orders, production or customer returned parts, short-shipment).

Planners sometimes decrease the assembly order quantity in a work order booked for certain customers, change its due date that will affect the quantity and timing of the lower and upper level demands. MRP systems are capable of online recalculation and planner can immediately see the effect of the change. However, the planner should analyze the effect before committing the change especially when changing the promise date is affecting a customer who is already very unhappy with the company’s poor service level performance or is a strategic customer.

Inventory-planned parts

Inventory-planned parts include independent-demand parts planned using the planner’s specified logic. These consist of regular replenishment parts purchased externally, service parts, and MRO parts. The inventory system plans these parts in companies where the MRP system does not have the embedded logic to handle parts whose demand is not triggered by master production schedule.

Reorder Point Technique

ROP technique is used for inexpensive independent-demand, and sometimes high volume usage parts where sufficient safety stock can be maintained to minimize risk of a stock-out. The concept of ROP is that order must be placed with the supplier at the point where there will be enough time to receive the material by the time the stock on-hand balance reaches the safety stock level. ROP assumes that the safety stock will never be dipped into but practically it often is not true. Below is the ROP formula. It is better to use forecasted daily usage rate than forecasted monthly usage rate because the number of workdays is not consistent every month.

   ROP = [(Forecasted daily usage x Lead time in days) + Safety stock]

Figure 3.2  Three review conditions of a Reorder Point technique

Figure 3.2 shows three reorder review conditions that are faced by the planners – actual usage rate equal to, less than, or greater than forecasted usage rate. In the first case, actual usage rate may match the forecast, and generally this means that you are right on target with your inventory level as you planned.

In the second case, actual demand may exceed the forecasted usage rate. If such higher usage rate continues, safety stock will be consumed and the part will stock-out before the released order is received into warehouse. You will have a lower average inventory level than targeted. The planner must have good knowledge of the part type, part family and its demand profile to determine whether the actual high usage rate will continue to be higher than forecast or whether it will average out to the forecast over time. If the planner judged that the actual demand will continue to be higher and safety stock won’t be enough to prevent the part from stock-out, the planner will expedite open orders and flag the part for next reorder level review. Of course the 3rd case, if the actual demand is lower than the forecasted usage rate, you have a higher than average inventory level and lower turns.

Let’s see this example.

This means that this part will be expected to have stock-out if the current usage rate of 4 per day continues. This is because safety stock will only cover against a quantity 2 of forecasted daily usage rate. At current daily usage rate of 4, the ROP is revised to 65 instead of forecasted 37.

Time-Phased Order Point Technique

This type of order review technique is used extensively by purchasers/material planners in MRP system and in Central Distribution Center (CDC) system. CDC receives orders from regional warehouses (dependent-demand using Inter-Company Order or sometimes called Transfer Order) and also directly from customers (independent-demand). The logic is embedded in your company’s MRP system but I want to give you a refresher here with an example below.

In the above table, the weekly dependent demand comes from requirements determined as a result of higher level bill of material exploded by MRP system. The constant independent demand comes from forecast calculated from historical usage. You can download this worksheet with the formula.

There are 60 pc available in the current period (beginning inventory 80 - safety stock 20). 140 pc based on fixed-order qty are scheduled to be received in week 11, the week after next. If 140 pc scheduled receipt in week 11 did not happen, there will not enough projected on-hand to meet the gross requirement 40 pc in week 12. Hence the negative net requirement of 8 pc. Now look at week 14, the gross requirement of 52 pc can not be satisfied by its beginning stock balance of 41 pc. This gives the net requirement of 11 pc (52-41) but fortunately you still have the safety stock 20 pc to meet the shortfall of 11 pc. Since there is no open order scheduled for receipt in week 14 and none in the weeks after that you can possibly expedite, the system will know that an order need to be released. Embedded logic in your system will calculate backward 21 days from week 14 to determine the exact date when the order must be released - it will be a date week 11. Assuming this released order is received as scheduled, 129 pc will be the projected inventory for week 15. The planner will extend the weekly demand and ordering profile to the end of the planning horizon.

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