Inventory Policy: Details Grid & Reorder Frequency

Inventory Policy: Details Grid & Reorder Frequency

This article is part of the Inventory Policy series, split from the original Inventory Policy article.

Grid: Details

Reorder Frequency calculation

With the Reorder Frequency calculation you can
  1. Reorder the frequency calculation per individual location instead of the combined demand across all locations.
  2. Run the reorder frequency calculation with the Calculate Reorder Frequency By Location checkbox under Settings. Click Apply, then Publish to update official values.
  3. Read the per-location Reorder Frequency results in the policy grid (each item-location gets its own value). Check Calculate Frequency By Location. Select a Reorder Frequency from the dropdown under Settings, click Apply, and Publish to update official values. 

The reorder interval (or frequency) is usually defined as the average time between consecutive reorders. The average reorder quantity is expected to fulfil demand until the next replenishment.
One method of determining the Reorder Frequency uses the Economic Order Quantity (EOQ) model. This model balances the cost of holding the inventory and the cost of reordering the material. goal is to find a balance between:
  1. Ordering cost: Cost incurred each time an order is placed. This cost decreases as fewer, larger orders are placed.
  2. Holding cost: Cost to store and maintain inventory. This cost increases with higher inventory levels.
The EOQ model finds the "sweet spot" where the combined cost of ordering and holding inventory is minimized.



















EOQ Formula

To calculate EOQ:

EOQ = sqrt((2 * D * S) / H)

Where:
  1. D = Average Annual demand
  2. S = Ordering cost per order
  3. H = Holding cost per unit per year
Once EOQ is known, the reorder Frequency (how often to place an order) can be calculated as:

Reorder Frequency (in days) = EOQ / Daily Demand

Discretizing Reorder Frequency
The EOQ calculation results in a different order frequency for each SKU. In practice, fractional reorder intervals (like 1.7 or 3.5 days) are impossible to implement. To simplify implementation of the EOQ approach, we normally select just a few fixed reorder frequencies and assign each SKU to one of these.

Research has shown that selecting order intervals are “geometric” is efficient. In fact

(Actual Cost using predefined geometric intervals)/(Optimal Cost using unrestriced intervals)≤ 1.06

In other words, when we use this simple implementation strategy, we sacrifice at most 6% of the optimal cost.

Implementation

Step1
Select the shortest reorder frequency that is practical given the business. In the case where we have a number of retailers served by a regional warehouse, the shortest reorder time may be one day if a truck is dispatched to each regional retailer daily. 
In the case of an off-shore vendor, the shortest practical reorder frequency may be one month.
If the shortest reorder interval is one month, then the other candidate reorder intervals would be two months, four months, eight months, and so on.

Step 2
The SKU with the highest daily demand rate is assigned to the shortest reorder interval. From the EOQ formula, the ratio of the EOQ1 to EOQ2 is:

EOQ1/EOQ2 = sqrt((2*D1*S) / H)/sqrt((2*D2*S)/H)

Which upon simplifying is

EOQ1/EOQ2 =sqrt(D1/D2)
If item 1 is the highest demand SKU and has the Demand D1, we would assign item 2 to the same reorder interval as item 1 as long as sqrt(D1/D2)<1.414. 

Below is the cut-off table for reference: 


  1. Calculate EOQ for each item using demand, ordering cost, and holding cost.
  2. Convert EOQ to a reorder interval by dividing by daily demand.
  3. Round the interval to the nearest allowed frequency (e.g. 1, 2, 4, 8, 16).
  4. Check that rounding does not increase total cost by more than the allowed tolerance.
  5. Adjust reorder frequency between locations based on relative demand.


Inventory Policy series