The Definition of Reorder Point

Executive Summary

• Reorder points are one of the oldest methods of supply planning.
  We cover the definition of reorder point as well as their origin.

Video Introduction: The Definition of Reorder Point

Text Introduction (Skip if You Watched the Video)

The definition of a reorder point is necessary to understand a major method of supply planning. Reorder point was the first of the supply planning methods, and it became considered passe after forecast based planning methods like MRP appeared on the scene. However, reorder points are still valid today and in some cases will outperform forecast based planning methods. You will learn about the use of reorder points and where reorder points are setup in widely used supply planning applications.

Our References for This Article

If you want to see our references for this article and related Brightwork articles, see this link.

The History of Reorder Point

Reorder point planning was the primary way that supply chain planning was performed before computers existed. Reorder point planning was first performed manually. Just before the arrival of MRP systems, reorder point planning software was commercialized in mainframe computers in the 1950s and 1960s in the United States. This is why inventory systems were not perpetual or instantly updated when, for instance, the actual inventory changed because each reorder point had to be recalculated by hand. Therefore, each product location combination was set onto a different review periodicity.

After MRP was first developed in the 1960s and broadly implemented in the late 1970s, companies moved away from reorder point planning. Reorder point planning was relegated to a lower status vis-à-vis MRP/DRP. Again reorder point planning was soon considered passé. Of course, much of the reason for this was that MRP/DRP software vendors said that reorder points were passé. Most of the consulting companies that were obtaining an increasing percentage of their consulting revenues from MRP/DRP software implementations naturally agreed.

The Definition of Reorder Point: What Happened Since Reorder Points Were First Introduced

Since this time, the concept has generally been that all products should have a supply planning method applied to them rather than use reorder points. In a few paragraphs, I will discuss why this is incorrect and why proponents of “Lean” have caught on to something correct concerning reorder point planning, which many experts in supply planning are missing.

I consider this explanation necessary because individuals that recommend reorder point planning for some items tend to meet stiff resistance from those of an MRP bent; however, much of this resistance is due to not properly considering the conditions under which reorder point planning is adequate.

What Are Reorder Points in Their Essence

A reorder point is very simply a quantity of stock or an interval at which a “reorder,” or order is created. In reorder point planning, orders are not triggered by a specific requirement (such as a forecast or dependent requirement) but instead by depleting stock over time, eventually triggering the minimum stock level or reorder point. Production orders, purchase orders, and stock transfer orders are generated based on the relationship between the stocking and reorder points. This is stated by SAP in its application help:

“Available stock at plant level plus the firmed receipts that have already been planned (purchase orders, production orders, firmed (emphasis added) purchase requisitions and so on) are compared with the reorder point. If the sum of the stock plus receipts is less than the reorder point, a material shortage exists.”

Reorder points can be used with any of the supply planning methods, or they can be used to control the supply plan without any of the methods exclusively. However, when used solely to control the supply plan, the company is said to be performing reorder point planning, as opposed to forecast-based planning.

MRP/DRP and APS (heuristic, allocation, cost optimization, inventory optimization) methods are forecast-based planning. As the terminology would indicate, reorder point planning does not require a forecast. The following graphic shows how this works:

The reorder point is a calculated value, expressed as a stocking level, which is then implemented in a supply planning system and stored as a master data parameter. If a company had 100 products, all of which had a reorder point entered in the product location master, and 50 were excluded from the supply planning run. Let’s say the MRP run, then 50 of the product locations would be using the MRP supply planning method, and the other 50 would be on reorder point planning. Therefore, a reorder point can be used with or without a specific supply planning method.

This is the Lot Size tab to the product location master in SAP APO/SCM. As can be seen, there are not a lot of alternatives provided here, just the basics. The reason for this is these reorder points are not designed to control the planning (that is supposed to be performed by heuristics, the optimizer, or CTM.). But instead, these order points are used to moderate the order creation in APO.

In the application Demand Works Smoothie, the inventory parameters are very concentrated on a single tab. Important fields that relate to reorder point planning are the Fixed Minimum Inventory, Minimum Reorder Quantity (Min ROQ), the Minimum Reorder Quantity Basis (Min ROQ Basis), the Quantity Increment (Qty Increment), as well as the Minimum Cover Days (Min Cover Days).

When the inventory level drops below the Fixed Minimum Inventory, an order is triggered. Therefore the Fixed Minimum Inventory is the reorder point. The order will be created in the Min ROQ in the UOM of the Min ROQ Basis (either a quantity or in days), and any order created that exceeds the Min ROQ will need to be created by incrementing upward in the Qty Increment. More on the Fixed Minimum Inventory is explained in the Smoothie Help:

“This is interpreted by Smoothie as the quantity that the inventory must not go below. Smoothie will recommend receipts to keep ending inventory above this amount (outside the supply fence) and report over/under conditions within the supply fence. The Fixed Min Inventory value drives the Minimum Inventory when the Use Statistical Mins selector is set to No. If the selector is on Linear (or Linear No Outliers), then the greater value (Fixed or RMSE Safety Qty) will be selected as the minimum inventory. Fixed Min Inventory is ignored if the Use Statistical Mins selector is set to Cover (or Cover No Outliers).”

In Smoothie, consumption-based replenishment can also be triggered by falling below the Min Cover Days. This allows the replenishment trigger to be stated in days rather than in quantity. All of this brings up the economic order quantity, which goes hand in hand with the reorder point. Now is an excellent time to cover the economic order quantity (EOQ). The reorder point tells the system when to reorder, while the economic order quantity tells the system how much to order; as such, they are necessarily highly integrated values.

How Should EOQ and Other Supply Planning Parameters be Calculated?

One would be able to, for example:

Item #1: Simulation

Set the supply planning parameters in a way that one can simulate the impact on the overall supply plan. When using supply planning systems, inventory parameters are typically managed on a "one by one" basis. This leads to individual planners entering values without considering how inventory parameters are set across the supply network. 

Item #2: Interactivity of Changes

This is the ability to see the relationship between changes to service levels and the simulated output. 

Item #3: Seeing Financial Implications

This is the ability to see the impact on the dollarized inventory for different aggregate settings. 

Item #4: Mass Change for Efficient Maintenance

This allow the parameters to be changed en mass or as a mass change function. Both supply planning systems are designed to receive parameters; they are not designed to develop the parameters.

Getting to a Better Parameter Setting Capability

We developed an approach where EOQ and reorder points are calculated externally, which allows for a higher degree of control. And for the average inventory to be coestimated in a way that provides an observable total system inventory, holding cost, service level, and a picture of what is happening to the overall system. Calculating individual parameters like EOQ without an appreciation for the systemwide does not make any sense. Also, in many, perhaps even most cases, there is no reason to use EOQ for the purposes given above. Instead, an alternative custom order batching method can be created to replace EOQ. There is nothing magical about EOQ. It is not a "best practice." It will not provide you with "digital transformation." It is not "Six Sigma." You will not get a "black belt" for using it.

After observing ineffective and non-comparative supply planning parameter setting at so many companies, we developed, in part, a purpose-built supply planning parameter calculation application called the Brightwork Explorer to meet these requirements.

Few companies will ever use our Brightwork Explorer or have us use it for them. However, the lessons from the approach followed in requirements development for supply planning parameter maintenance are important for anyone who wants to improve order batching and supply parameters. 

Conclusion

This article attempted to define a reorder point.

Reorder points are triggers set in the supply planning system that initiate orders once the point is decremented below.

One of the best ways to understand how to set reorder points externally, we developed an approach where reorder points are calculated externally, which allows for a higher degree of control and for the average inventory to be coestimated in a way that provides an observable total system inventory, holding cost, service level and a picture of what is happening to the overall system. This is called the Brightwork Explorer. Calculating individual parameters like reorder points without an appreciation for the systemwide does not make any sense.