THREE COMMON SENSE APPROACHES TO INVENTORY PLANNING
How should a planner set the reorder point and reorder quantity (or order-up-to level) for thousands of items, perhaps at multiple locations? Due to the absence of an "intelligent‟ planning system, three commonly used approaches have been Brute Force Review, Economic Order Quantity, and Periods of Supply, usually done in spreadsheets.
In Brute Force Review, planners examine each item at each stocking location and manually set the min and max controls. This is such a time-intensive process that the results get out of date as soon as they’re updated, yet nobody has time to update them. Moreover, without good tools there is no guarantee that the controls will be set well even at the start.
Economic Order Quantity (EOQ), a simple calculation of the reorder quantity as a tradeoff between the cost of carrying inventory and the cost of placing an order, is another commonly used approach. Frequent re-orders minimize inventory holding, but incur high ordering costs. Likewise, buying in quantity reduces the ordering cost, but results in low inventory turns and high carrying costs. Although EOQ calculations are frequently available in Enterprise Resource Planning (ERP) systems, planners have difficulty determining the two driving parameters: order cost and inventory holding cost.
A third approach is to apply “periods of supply” for the max quantity. For example, average demand may be 120 units per week over the last four months. Taking two weeks of stock for the min and 8 weeks for the max, this approach would calculate min of 240 units and max of 960. Such an approach has the advantage of being easy to calculate. Although it is safe for high volume items, it works poorly for low and medium volume items.
The biggest problems with both EOQ and “periods of supply” are that neither:
1. Fully considers the real potential or level of a spike in demand
2. Takes into account the impact of short life cycles
3. Factors in the timing of trend or seasonal changes
These inefficiencies combined with situations where the planner may not have a system that handles “every” item requiring to be planned, accounts for the over or under buying that occurs daily.
The next installment of our 5 part series - The State of Inventory Planning - will cover "Ways to Improve Replenishment Planning."