Most of the times, when a question arise about why NAV suggest such a planning proposal, it arises the question on how planning parameters are determined by the given company. When we talk about planning parameters, we refer to: reorder point, reorder quantity and safety stock.
The safety stock is the quantity a company would like to hold on stock to address uncertainty. Lets come back later to this.
Reorder point is based on certainty. For a company, the certainty is based on the demand profile. So, if we have historical data which defines that the average demand is X during the vendor lead time, we should set this reorder point to a minimum of that average demand. In other words:
- we know that vendor lead time is 7 days
- the average demand during 7 days is about 125 pieces
- reorder point should be 125
Once we determine this reorder point, it will act as a trigger so when stock is on or below that stock level, it will generate an action for planners to create a replenishment. In other words, if our stock falls below 125 pieces, we need to replenish since it will take 7 days for the vendor to complete our order and we need to ensure we have enough in stock to cover the demand within those 7 days.
Of course, there are industries where uncertainty needs to be planned for. In this case, we use the safety stock and the reorder point will be increased to account for: average demand during lead time + safety stock.
The reorder quantity is calculated depending on the specific item type, ordering costs, or other consideration. In some cases, we reorder as much quantity as we can allocate in the warehouse space we have for this bin (maximum quantity). In other cases, this is based on the economic order quantity where we need to determine the optimal quantity to be ordered.
In any case, planning parameters have to be thought, agreed and continuosly verified. In other case, NAV planning will not be able to provide realistic results when planning parameters are not based on what your business is about.