Balancing supply and demand is a challenge for any business in eCommerce it's nothing short of a fine science. Holding too much stock is wasteful but holding too little runs the risk of disappointing customers. Understanding and applying the reorder point formula helps you strike that balance keeping cash flowing your way.
What is the reorder point formula?
Every product in your inventory should have its own ROP. This represents the number of remaining units at which you should replenish your stock of that particular product. The ROP leaves you with enough stock to keep filling incoming orders while your new shipment comes in.
You calculate the ROP for each of your products using an ROP formula. This takes into account how fast each product is likely to sell vs how fast new stock typically reaches you. The formula lets you manage your eCommerce inventory so that you're never sitting on too much stock but also never selling out completely.
How to calculate the reorder point formula
To calculate a product's ROP you need to know the lead time demand for that product as well as its safety stock level. To work out those two metrics you'll need to know:
- Average daily sales for each product
- Highest ever daily sales for each product
- The average amount of time it takes each product to restock
- The longest it's ever taken for each product to restock
ROP = lead time demand + safety stock level
Working out lead time demand
A product's lead time is how many working days it takes to restock once you've placed an order. If you're ordering domestically that might be only a few days. If you ship in from overseas lead time could be considerably longer.
Over that period of time customers will still be placing the same average number of orders each day. That's your lead time demand.
Lead time demand = average lead time in days x average daily sales in units
Working out safety stock level
Of course both demand and supply are fluid. A supplier who usually ships to you in seven days on average might take five days to deliver one order then nine for the next then six then eight. Meanwhile demand for your product will be fluctuating too.
If demand increases at a time when suppliers slow down lead time demand isn't going to be enough to stop you selling out of a product. You need to know you've got enough stock to cover emergencies. That's your safety stock level.
Take the highest ever daily sales for each product and multiply that by the longest it's ever taken for that product to reach you. This is a worst-case scenario if you were to run out of stock.
Then take your lead time demand (average daily sales x average lead time) and subtract it from your worst-case scenario figure to find your safety stock level. This is the margin by which demand might outstrip supply if orders went up and suppliers' shipments got delayed.
Add that margin to your lead time demand to find a product's ROP.
Safety stock level = (highest daily sales x highest lead time) (average daily sales x average lead time)
Example: Sports shirts through the seasons
Let's see this in action. A company which sells sports t-shirts is trying to work out the ROP for a particular team's shirt let's call it Design Z. Looking at their sales data they see that:
- Design Z sells an average of 100 units each day
- On the day that Design Z's team won a major prize a record 200 were sold
- It usually takes 10 working days for suppliers to restock Design Z
- Supply chain disruption meant that once it took 14 days to restock
Using the formula given above we can calculate:
- Lead time demand for Design Z would be 10 days x 100 daily sales = 1000 shirts
- Design Z's safety stock level is (14 days x 200 daily sales) (1000 shirts) = 1800 shirts
- This puts the ROP for Design Z at 2800 shirts
Whenever stocks of Design Z get down to 2800 the company restocks. They do so with confidence knowing that even if demand skyrockets and supply is disrupted they're still unlikely to run out of shirts for sports fans.
Why is a reorder point formula important?
Knowing exactly when to restock each product in your inventory is going to net you three big benefits:
- Less sitting on deadstock
- Fewer instances of selling out
- Expanded insight into business performance
If you buy way more stock than you can sell in the near future you've got to pay to store it somewhere. In a worst-case scenario demand for that product might drop off and you end up having to discount it or throw it out entirely. Both options are going to hit your bottom line.
Too much of this deadstock can be a serious drain on eCommerce businesses. By knowing the ROP for each product you won't end up sitting on a load of stagnant products. You only buy more when you can reasonably assume it's going to sell.
Avoiding product sellouts
On the other end of the scale not keeping enough stock presents its own problems. If you run out of items frustrated customers will go elsewhere for what they need. They might not come back particularly if they get a better service experience from another brand.
Plus running out of stock means you simply have nothing to sell. You can't start bringing in any more money until you replenish which takes time. Restocking as soon as a product hits its ROP means you're always going to have enough stored to satisfy customers and keep them loyal.
As we're about to explore knowing an accurate ROP for each of your products requires deep insight into how your business is performing. You need to know how trends change over time and focus on potential disruptions to your supply chain.
All that knowledge can benefit your business beyond the point of improving stock management. You can use it to inform marketing expand your product range with relevant opportunities or develop bundle deals to help upsell.
Basically there are very few situations where having a better understanding of business performance can't help you. A good ROP formula gives you that understanding.
Extra tips for managing your eCommerce inventory
The lessons you learn from calculating a product's ROP can help other areas of your brand but it's not a one-and-done thing. Here are four ways to step things up.
Recalculate your reorder point every quarter
Demand isn't static it changes with the seasons and evolves with new emerging trends. Don't simply work out a product's ROP once and forget about it. Recalculate every quarter to make sure customers are still behaving the way you expect.
Simple human error can extend lead time if for example someone falls ill or forgets to restock a product. This process can be automated whenever an item hits its ROP to make sure nothing is neglected.
Keep a close eye on your supply chain
Calculating ROP gives you a solid idea of how your suppliers are performing. If someone is letting you down too often think about whether they're the best partner for you. Reward those suppliers who can be trusted to come up with the goods and buy from them instead.
Know how everything fits together
eCommerce lives on data and no data is useless. Be sure not to silo your ROP insights away put them to good use elsewhere. Marketing R&D customer research; there are plenty of areas where deeper knowledge of supply and demand is beneficial to you.
Keeping and maintaining accurate ROPs for all your products is invaluable to your end-to-end fulfilment process. Not only that it can give you data to refine every aspect of your business down to the tiniest details. Best of all it ensures happy customers who come to you first for the products they love most.