Reorder point

The reorder point is the inventory level at which a new replenishment order should be placed. It answers the timing question in inventory replenishment — when to order — that the economic order quantity leaves unanswered. Together they form a complete continuous-review replenishment policy.

The basic formula

Reorder point = (Average daily demand × Lead time in days) + Safety stock

The first term — lead time demand — is the inventory the firm expects to consume during the time it takes a new order to arrive. The second term — safety stock — is a buffer against the variability of demand and lead time during that window.

Lead time demand

If a product sells 40 units per day on average and the supplier lead time is 10 days, the firm will consume roughly 400 units between placing an order and receiving it. If inventory dropped to zero at the moment of ordering, the firm would stock out throughout the lead time. The reorder point must therefore be at least 400 units.

Safety stock

Demand and lead time are rarely constant. A 10-day lead time may be 8 days some weeks and 14 days others; daily demand may range from 25 units to 60. Safety stock is the cushion that absorbs this variability without triggering stockouts.

The size of the safety stock depends on:

• Demand variability — measured as the standard deviation of daily demand
• Lead time variability — measured as the standard deviation of lead time
• Service level target — the probability of not stocking out during the lead time, often expressed as a percentile (95%, 98%, 99%)

A common formula is:

Safety stock = Z × √(Lead time × Demand variance + Demand² × Lead time variance)

Where Z is the service level multiplier (1.65 for 95%, 2.05 for 98%, 2.33 for 99%).

A worked example

A product with average daily demand of 40 units, lead time of 10 days, daily demand standard deviation of 10 units, and a 98% service level target:

• Lead time demand = 40 × 10 = 400 units
• Safety stock ≈ 2.05 × √(10 × 100) ≈ 65 units
• Reorder point ≈ 400 + 65 = 465 units

When inventory drops to 465, a replenishment order is placed. The 65-unit safety stock absorbs typical demand variability during the 10-day lead time at the 98% service level.

Why it matters

A reorder point set too low produces stockouts and lost sales. A reorder point set too high produces excess average inventory and wasted carrying cost. The right level is a deliberate trade-off between service level and inventory cost.

The most common organisational pattern is reorder points set by intuition or supplier suggestion, often disconnected from actual demand and lead time data. Moving to a calculated reorder point typically reduces both stockout frequency and average inventory simultaneously — a rare win-win in inventory management.

EOQ and reorder point as a complete policy

EOQ sets the order quantity; reorder point sets the trigger level. Together they define a continuous-review replenishment policy: monitor inventory continuously, and when it crosses the reorder point, place an order for the EOQ quantity. This is the dominant policy for most stable-demand products and is the foundation of automated inventory replenishment systems.