What Is Lead Time In Inventory Management?
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
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.
How To Calculate Lead Time?
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).
Business Impact of Lead Time
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.
Components Of Lead Time
- Preprocessing Time – This is also known as planning time. It is the time taken to receive a request for replenishment, comprehend the request, create a purchase order or, in the case of a manufacturing company, a job.
- Processing Time – Processing time is the time taken to procure or manufacture a product after receiving a purchase order for it.
- Waiting Time – It is the time between procuring the necessary items and when the production process commences.
- Storage Time – The time items stay in the warehouse or factory awaiting delivery.
- Transportation Time – The time taken to move the procured or manufactured item from the warehouse or factory to the customer’s desired location.
- Inspection Time – The customer’s time spent inspecting the product to ensure it complies with the requirements is known as the inspection time. It also refers to the amount of time needed to address any order request non-conformities.
How To Reduce Lead Time
Following are some ways for companies to reduce their lead time.
- Reduce Activities that don’t add value – The company should analyse its activities critically so as to identify activities that don’t add value but negatively impact the lead time. Doing away with the activities deemed to be unnecessary will have a positive impact on lead time. But this is a balancing act, as some activities that may increase the lead time also help maintain the quality of the product, so companies must be careful while doing such an analysis.
- Change Shipping Methods – The company can organise alternative shipping methods or offer frequent shipments. Supplies may prefer slow shipping methods that result in cost savings, which can affect the lead times. Even though it could cost more, gradually switching to a more flexible transportation option can lower the lead time.
- Source Locally – If there is a way to locally source the raw materials that a company currently imports, then the company may consider switching to local suppliers as long as the quality of the product does not get compromised. Buying products locally instead of sourcing them from abroad reduces the lead time because the goods need to be transported over shorter distances.
- Vertical Integrations – It may involve combining the process of two suppliers or the company’s production processes. For example, in situations where a company is manufacturing and assembling components in two different locations that are geographically far from each other, it should try to consolidate the two processes internally at a single location. This will result in less time taken to manufacture the finished goods, thus reducing the lead time.
- Automate The Process – Sometimes, lead delays are caused by human error when the person responsible for ordering new stock delays containing suppliers. The company should consider using a vendor-managed inventory (VMI) or Vendor Owned Inventory (VOI) system to replenish the stock of a product automatically just before the product is about to be out of stock.
Conclusion
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.
For seamless inventory management, try BUSY Inventory Management Software.
