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What is Order Cycle Optimization?
Most wholesale distributors place replenishment orders on a fixed schedule. Say, on a weekly basis. It has always been done that way, and no one ever questioned it. BUT… What they don’t know is how much money that assumption leaves on the table!
Today we’re looking the economics behind fixed-schedule buying and the way-smarter alternative, order cycle optimization.
Order cycle optimization saves companies millions of dollars simply by using technology to evaluate when and how much inventory your purchasing team buys.
It’s Like This…
Let’s say you always buy 1 box of cereal for your family every week. Think about what it costs to take time off of work, drive to the store, drive home, stock that 1 box into your pantry once a week – and then do it all over again every week.
Now, what if you had an inventory optimization system that could run a quick analysis on those acquisition costs and tell you exactly what you’d save by buying on a different frequency? For example, the system tells you that if you switched to buying 2 boxes of cereal every 2 weeks, you’d save 60% in acquisition costs – or thousands of dollars annually.
Now, Super-Size it
Now think about doing that on a macro-scale, with hundreds of thousands of SKUs across multiple locations. Over the course of a year, those savings add up big time!
Have we piqued your curiosity? Let’s dive in deeper to ‘What is Order Cycle Optimization?”
Optimizing supplier order cycles is a replenishment process that is often overlooked by buying teams. Order cycle optimization is the process of evaluating acquisition costs and carrying costs to determine the most profitable, or least costly order cycle to a supplier. This is defined as an economic order cycle.
Simply put, it is the determination of how frequently you should purchase inventory from a supplier. Financially, does it make the most sense to order inventory from a supplier once every 7 days, once every 30 days, or somewhere in between?
The result will come down to how much it costs to order that inventory, versus how much it costs to carry that inventory.
Economic Order Cycle Process
To accurately calculate your economic order cycle, you first need to understand and isolate the components that make up an order cycle calculation. We’ll go into further depth regarding the makeup of those components, but to reiterate their role in the calculation, the process should evaluate the carrying cost of inventory and the ordering cost of inventory from a supplier.
As you order less frequently or increase your supplier order cycle (in terms of days), the carrying cost of inventory goes up. As you order more frequently or decrease your supplier order cycle (in terms of days), the acquisition cost of that inventory goes up. The goal of determining an economic order cycle is to find an order frequency which balances these costs.
Two Key Components
- Carrying Cost:
The carrying cost of inventory, otherwise referred to as holding cost, includes all costs associated with storing unsold stock. The total value should include costs related to holding inventory, such as warehouse costs, insurance and taxes.
Carrying costs should also include factors such as opportunity costs, shrinkage, depreciation and obsolescence. These various costs can often be grouped into a company’s physical carrying rate and their capital rate — both of which make up the carrying cost of that inventory.
Carrying cost is often expressed as a percentage of total inventory during a timeframe.
For example, a company with an average annual value of inventory of $2 million and an inventory carrying cost of 25% has an annual inventory carrying cost of $500,000.
The ordering cost of inventory, otherwise referred to as the acquisition cost, describes all expenses incurred to purchase inventory. These costs should include all expenses related to reviewing an order, submitting that order to a supplier, the cost for Accounts Payable to reconcile a purchase order to an invoice and process necessary payment to a supplier.
Ordering cost should also include all costs incurred to receive inventory from a supplier.
Companies can generally break out ordering cost into:
- An order header cost,
- The cost to place a purchase order to a supplier,
- An order line cost, and
- The cost to receive the inventory on that order
Advanced Needs: Supplier Constraints
Order cycle optimization is not only about calculating an economic order cycle. To truly optimize your ordering, other factors should be considered as well.
Many suppliers require a minimum order quantity (MOQ), while others also require quantities to be rounded to multiples, such as a box, carton or pallet.
Although an ordering frequency may be the most economic choice, that exact number of days is not always possible, as we must consider supplier ordering constraints.
Knowing each supplier’s economic order cycle is the most import step for optimizating your order cycles and driving business profit. It is also a key piece of information for a business to have when negotiating supplier contracts.
Inventory Optimization, Simplified
“Most buyers have no idea that the acquisition/receiving costs are far deadlier than the carrying cost. They focus on quick turns. But the real value is in knowing your numbers.”
The good news is you don’t have to do this analysis on your own. Advanced inventory optimization solutions do the heavy legwork for you, faster and with far greater accuracy. These technologies run intelligent replenishment algorithms across your entire assortment and deliver recommendations in seconds.
Learn more about intelligent Replenishment Optimization solutions and let us know if you have any questions.