A Retailer’s Guide to Reorder Points and the ROP Formula

If you wait until you’ve run out of inventory to reorder, you’ll have a stockout until the shipment arrives and miss out on sales opportunities. Knowing how quickly your products sell and how long it takes for a new shipment to reach you can help you set reorder points and avoid stockouts.

In this retailer’s guide to reorder points, you’ll learn everything you need to know to set effective reorder points and much more. Let’s get started.

What is a reorder point (ROP)?

A reorder point (ROP) indicates when it’s time to reorder inventory so you can restock before you sell out completely.

ROP is expressed as a quantity, such as 20 t-shirts or 50 apples. When your inventory falls to that quantity, it’s time to order more.

“Reorder point is the point at which if the inventory level drops below that number, the retailer has to make a new order,” says Sentao Miao, Assistant Professor of Operations Management at McGill University’s Desautels Faculty of Management.

As soon as your inventory level drops to that point, you’re going to put in an order for a new batch of products to come to your warehouse. By the time they come to your warehouse, you will have used up the warehouse inventory you have

For example, if your ROP for a certain chair is 15, you should order more chairs from your supplier when you have only 15 left in stock. By the time you sell the remaining chairs, your stock will be replenished. An accurate ROP allows you to avoid both a stockout and overstocking.

“Reorder point is calculated based on different factors of cost and risk, such as backlog and lost-sale costs, holding costs, fixed and variable ordering costs, ordering lead time, and others. For instance, if the backlog or lost-sale cost is much higher than the holding cost, the retailer should set a higher reorder point to avoid stockout, and vice versa. It’s very important to use a model that fits the business scenario of the retailer,” Miao says.

A grocery store, for example, would likely have higher reorder points for quick-selling produce than a furniture store would for slow-selling mattresses.

Importance of setting reorder points

“Setting a reorder point is a simple but effective way to keep inventory at a safe level. With a carefully determined reorder point, retailers can not only lower the risk of stockout, but also reduce inventory holding costs,” Miao says.

In other words, if you want to run an efficient business, you can’t rely on intuition to determine when to reorder stock. 

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Lower inventory costs

“When you end up having a lot of inventory that you cannot sell to your customers, that’s costly because inventory is what you have paid for and your customers have not paid for yet. And if you have excessive inventory, you will have to do a couple of things.

Either you have to carry that inventory, let’s say from today to tomorrow, or let’s say from this week to next week, or this month to next month – and inventory holding is always costly. Or, in some cases, such as fresh food, you will have to literally throw away the food at the end of the day, because you cannot keep it tomorrow or next week or next month,” Nasiry says.

Obsolescence isn’t just a problem for grocers. No matter what your category, if you have products you can’t sell, you either have to keep paying to store them, or you need to dispose of them, which also comes with a cost.

But when you know your reorder point, you’re less likely to have too much cash wrapped up in inventory. You can order just enough as you need it, instead of stockpiling and spending on storage costs and inventory. In other words, setting a reorder point can help you reduce holding costs.

Avoid stockouts

It can also help you avoid lost sales.

When you don’t have enough inventory, you have a shortage problem. Customers come around, they’re checking the shelves, they’re looking for a certain product, but you don’t have it because you didn’t order enough or didn’t receive them on time. This is costly, and it can happen in any inventory system.

Knowing your ROP helps you place an order with enough time to receive, process, and restock it.

If you wait to order until you have run out of inventory, then there will be a lag between when you place the order and when you can sell your new inventory. Setting a reorder point can help you reorder in time to avoid this availability gap.

Reorder point formula

The formula for reorder point is:

Reorder Point (ROP) = (Daily Sales Velocity x Lead Time) + Safety Stock

The end result will produce an inventory quantity that will indicate when it’s time to order more.

If you want to run a lean business and don’t mind risking stockouts, you may not have safety stock. In that case, the formula is:

Reorder Point (ROP) = Daily Sales Velocity x Lead Time

How to calculate and set reorder points

Here’s a breakdown of each of the inputs for the ROP formula:

• Daily sales velocity
• Lead time
• Safety stock

Let’s look at each a bit closer.

Daily sales velocity

Daily sales velocity measures how many items you sell each day. If you sell 5 chairs each day, for example, your daily sales velocity is 5. Your POS reports can help you determine this rate.

Lead time 

Lead time is how long it takes for you to get the inventory from your suppliers when you order it. The longer it takes for you to receive new stock, the higher the reorder point would be and thus the longer your lead time would be.

Let’s say your chair manufacturer is in China and your store is in Canada. Because this manufacturer makes chairs to order, they need 3 weeks to make 100 chairs (your typical order quantity) and another 2 weeks to ship them. Your lead time, then, is 5 weeks, or 35 days.

Safety stock

Supply-chain and shipping interruptions are all too common nowadays. Safety stock is the amount of extra inventory you keep just in case you don’t receive a new shipment within the specified lead time.

“So the more uncertainty you have,” says Nasiry, “the higher the reorder point would be. To [maintain] a certain service level for your customers, you will have a higher reorder point, which means you want to be on the safer side and have some inventory in your warehouse.”

For example, you could keep 15 extra chairs, 3 days’ worth of products, in stock in case the shipment arrives late.

Reorder point sample calculation

Now we’ll plug the figures from our example into the reorder point formula.

Reorder Point (ROP) = (Daily Sales Velocity x Lead Time) + Safety Stock

According to our example, we have a daily sales velocity of 5 chairs per day, a lead time of 35 days, and 15 chairs of safety stock. 

Now we’ll enter those figures into the formula: 

• (5*35)+15=190

That means that when your inventory drops to 190 chairs, it’s time to reorder them.

Tips for setting reorder points

• Review reorder points regularly
• Leverage technology
• Don’t rely solely on the reorder point formula

Knowing [your] business, including target, risk, and cost, is the first and necessary step [to setting reorder points]. Then, having an accurate demand forecast helps you calculate the optimal reorder point. To achieve these goals, the retailer should have business and analytics teams work closely to find the solution for their own scenario.

Here are a few ways to implement his advice.

Review reorder points regularly

Things change constantly in the retail world. Sales pick up and supply chains can slow down at a moment’s notice.

Recalculate your ROP whenever you experience major changes to maintain optimal stock levels.

Leverage technology

With the right tools, there’s no need to manually calculate reorder points.

Shopify POS, for example, calculates ideal reorder points for products based on supplier lead times and the average number of sales per day. This ensures you know which products are running low on stock and have enough lead time to replenish inventory before quantities reach zero. 

Don’t rely solely on the reorder point formula

The reorder point formula shows what happens in an ideal scenario, but things may work out differently in practice than they do in theory.

For example, if there’s a supply chain interruption, you may need to rework your formula, give more lead time, and order more often. If sales are unusually slow or impacted by seasonality, you may need to hold off on reordering.

Use POS data and empirical evidence to determine when to reevaluate your ROP.

Set reorder points for your store

When your inventory reaches a reorder point, it’s time to replenish that stock. By reordering before you’ve run out of inventory, you ensure you don’t have a gap in the products and services you can offer customers.

As we explained, you determine reorder points by multiplying your daily sales velocity by shipment lead time, and adding in any safety stock. If you notice a change in sales velocity or lead time, it’s time to set new reorder points.

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