Author Zilvinas Lapacinskas 
– The average reading time for this post is 4 minutes –
In my previous article, I stated that “only an increased replenishment frequency allows the inventory level to be moved down with safety. Increasing replenishment frequency is a good idea, not only because of cutting inventories; it also enables a faster reaction when market conditions are changing, providing a higher service level in hardly predictable conditions”.
On the other hand, some say the additional costs for processing orders and receipts is the downside of an increase in replenishment frequency. The question is reasonable, but supply-chain managers should always calculate how much the increase in cost compares with the benefits received. To increase the replenishment frequency or not to increase? A question worthy of Shakespeare himself, and in this blog I will try to describe possible calculation scenarios that could help you evaluate your next steps in managing your inventory efficiently.
Let’s start from the cost structure.
In this case, among all possible costs we are interested only in those that vary depending on the replenishment frequency:
Costs that increase when the replenishment frequency is increased. Usually these are shipping costs, order-processing costs and receipt costs (see total receipt costs in the chart below). The annual relationship between these costs and the replenishment frequency is expressed in the chart below.
Costs that decrease when the replenishment frequency is increased. From our previous article, it is clear that a higher replenishment frequency means there is less inventory in stock. Because of lower stock, the warehouse cost and capital costs are also lower (holding costs on chart No. 2). The situation in this case is totally opposite to that in chart No. 1:It is clear that when the replenishment frequency is greatly increased, the inventory costs can go sky high, and this is exactly what some supply-chain managers are afraid of when thinking about more frequent replenishment.
So far, this is still not an optimal decision, especially in cases when future demand cannot be predicted with 100% accuracy. When demand is not predictable with high accuracy, we are usually dealing with a risk of overstock or stock-out. Both produce additional losses, and because of this, the total costs are higher than predicted at the planning stage. The dependence of overstock and stock-out costs is expressed in the chart below, and the combined Total Costs curve gets another shape with the minimum point at a higher replenishment frequency (EOQ+ mark on chart).Combining the two dependences (receipt costs and holding costs), we obtain the so-called Economical Order Quantity model, where optimal replenishment frequency is at the minimum point of the combined Total Costs curve (EOQ mark on the chart).
If you have your own warehouse, warehousing costs do not change with a 1% increase or decrease in stock, as would be the case in a warehouse outsourcing scenario. For example, if you consider increasing your replenishment frequency by 5%, probably your costs will not increase unless you are forced to hire 1 additional warehouse employee, or to buy 1 additional loader. In that case, your costs will probably increase by more than 1%, but so will your capacities, allowing you to have a higher-than-planned replenishment frequency.Overstock and stock-out losses are related almost proportionally with replenishment frequency . Faster replenishment means a shorter planning horizon (the amount of time that we look into the future when preparing an inventory plan), so there is less possibility for mistakes in forecasting. Faster replenishment allows for a faster reaction when market conditions change; at the same time, having less inventory in stock decreases the risk of having over-stock if sales goes down unpredictably.
Let’s assume that 10% is the minimal level at which it is possible to change the variable of your own warehouse costs. In the chart below, you can see that in our example, with a 10% cost increase, it is possible to increase the replenishment frequency by more than 70%, thus reducing the risk of overstock and stock-out (EOQ + 10% mark on the chart).
In our example, we decided to increase the replenishment frequency by almost 4 times compared to the EOQ model. Of course, in real life the result of the calculations will be different for each company and sometimes even for every item; still, most companies can at least double the replenishment frequency for more than half of their SKUs, and enjoy positive changes to the bottom line.
SOFT4, as a provider of software solution for efficient inventory management, is constantly releasing blog articles about how to meet and cope with the trends, tendencies, and challenges, and give suggestions as to how to react to the changing environment in order to stay competitive.
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