Lead time is the time between a company placing an order to receive goods as inventory and finally receiving the same goods. It is a crucial concept of effective inventory management.
Effective control over lead time helps a business maintain optimal inventory levels, reduce stockout situations, and increase customer satisfaction by providing them with products they want to buy when they want to buy them. However, factors such as delays in transportation, production, the time it takes to manufacture the goods, and the availability of suppliers can negatively impact the lead time for a business and lead to lost revenue as goods wanted by customers may not be available at the time they are needed.
In this article, we will delve deeper into the concept of lead time, its significance in inventory management, and how you can manage it effectively and enhance the overall efficiency of the supply chain.
Lead time and cycle time are related terms in inventory management. We’ll help you understand these terms through a highly relatable example.
For example, when you visit your favourite fast food restaurant, you place an order at the counter and are then assigned a table number along with your bill. Finally, one of the staff brings the food to your table. Let’s assume you placed your order at 9:00 PM as per the time mentioned on your invoice. Your complete order arrives at your table at 9:10 PM. The lead time, in this case, is 10 minutes.
Now, from the time you place your order, the order will be processed, and one or more of the staff will start manufacturing or assembling the products that are part of your order, e.g. filling up the glass of soft drink, making your burger, and deep frying your french fries. The time taken to do all these activities is the cycle time.
It is clear from the above example that cycle time will always be shorter than the lead time, as the production of the goods happens before fulfilling orders.
Knowing the cycle time of your manufacturer is crucial to calculating your own lead time, as it will determine how much time you need to give your manufacturer to fulfil your order.
Calculating the lead time means counting the number of days that elapsed between placing an order for goods and receiving the same goods as per the order.
The formula for lead time is:
Lead Time (LT) = Supply Delay (SD) + Reordering Delay (RD)
The supply delay is the number of days between the manufacturer processing your order and finally delivering your complete order.
The reordering delay is the additional number of days you need to make your inventory last, owing to the delay in the manufacturer processing your order.
For example, on 10th January, you order 1000 pairs of shoes from your supplier, who is also the manufacturer. The manufacturer, however, only processes new orders on the 1st and the 15th of every month. So, even though you placed your order on the 10th, it will be processed only on the 15th. This delay of 5 days is the reordering delay. Let’s assume that once the order is processed, the manufacturer takes 15 days to manufacture the shoes, package them and deliver them to the location where you keep your inventory. Thus, the supply delay is 15 days. The lead time, in this case, is 20 days (supply delay of 15 days + reordering delay of 5 days).
A longer lead time for businesses means they must keep a larger stock of goods to fulfil the demand for their products for extended periods before replenishing their inventory. If they don’t do that, it could result in lost revenue as customers ready to buy are turned away. Such situations may also cause customers to be dissatisfied.
Since companies need to hold greater quantities in their inventory, they will need to pay higher costs to stock that inventory, thus reducing their profit margins. It may also hamper the company’s ability to come up with new innovative products, as they must divert their resources towards maintaining a larger stock in their inventory.
As lead time reduces, there is a positive impact on customer satisfaction and profit margins as well.
Following are some ways for companies to reduce their lead time.
Lead time is a critical factor in inventory management as it directly impacts the efficiency of the supply chain. Understanding lead time can help businesses optimise their inventory levels and improve customer satisfaction by ensuring products are available when needed. By accurately forecasting lead time and implementing strategies to reduce it, organisations can reduce costs, minimise stockouts, and maintain a competitive edge in the marketplace.
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