Lead time in inventory management: what it is and how to reduce it
For many companies, strategic inventory management is an essential part of doing business.
Ultimately, inventory management is about making sure you’re able to get products or projects into your customers’ hands with minimal friction.
Unless you already have the required stock on hand, then your calculations will start with an understanding of when you’ll be able to get what you need from your suppliers.
In short: you need to understand lead time.
What is lead time?
Lead time can be used to refer to the amount of time that elapses between the beginning and completion of any business process.
For inventory management purposes, lead time refers to the amount of time it takes for a purchase order to be completed in full.
For example, if it takes 5 days from the date of ordering a shipment to then reach the designated spot in your warehouse, the lead time for shipment is 5 days.
Lead time vs. cycle time
Though the terms “lead time” and “cycle time” are related in inventory management, they aren’t exactly the same, and confusing the two could be problematic for your business.
The main differences to know:
Cycle time is the amount of time it takes a manufacturer to produce a product
Lead time is the amount of time it takes, from the date of purchase, for the order to be fulfilled.
Your supplier’s cycle time might be a part of your lead time for a specific order – but lead time also includes the time it spends in transit to reach you.
While you can’t necessarily influence your supplier’s or manufacturer’s cycle time, it’s important that you know how long it takes them to produce the products you order.
(We’ll come back to this in a bit.)
How do you calculate lead time?
Calculating lead time at its simplest means counting the days between the purchase and receipt of your order. But you can also calculate the average lead time for potential orders using the following formula:
Lead Time (LT) = Supply Delay (SD) + Reordering Delay (RD)
Reordering delay is the time it takes the supplier to process the order.
Supply delay is the amount of time it takes the supplier to fulfil an order once it’s been processed.
Often, reordering delays are built into the supplier’s policy. For example, a supplier may process reorders only once a week, which could result in longer lead times for those who place orders before the 7 day reorder period has elapsed.
Example of a lead time calculation
Let’s take a look at a quick example of how to calculate lead time using the above variables:
You’re looking to place an order for 30 widgets. Your supplier, ACME, can create 10 widgets a day and can deliver shipments within two days of finishing production. You’ve recently placed an order and must wait a day before your next order will be processed.
supplier cycle time: 3 days (for 30 widgets at 10/day)
supplier shipment time: 2 days (post-production)
reordering delay: 1 day (for this purchase).
(Also, remember: supply delay is calculated by adding supplier cycle time and supplier shipment time.)
So, your lead time calculation would be:
(5 days for supply delay) + (1 day for reordering delay) = 6 days total lead time
What are the components of lead time?
Let’s now take a closer look at the 6 steps involved in the purchasing process, and the impact they have on your overall lead times.
1. Preprocessing time
This is the initial, preparatory stage of the purchasing process. Steps at this stage include:
recognising the need for a business purchase
requesting a purchase order
receiving approval to submit a purchase order.
This all happens on your end, and as such is completely under your control.
2. Processing time
Processing time again relates to your supplier’s policies and procedures regarding incoming purchase orders. At this point, your lead time is in your supplier’s hands.
3. Waiting time
Waiting time on your end is determined by how long it takes the manufacturer or supplier to begin the production process.
4. Storage time
On your supplier’s end, storage time is how long your order will spend in holding before being shipped out.
5. Transport time
This is the time it takes the supplier to deliver your shipment.
6. Inspection time
This final step is when you make sure that the product you ordered meets your specifications.
How does lead time impact inventory management?
Strategic planning is the key to effective inventory management.
Being strategic in any regard requires identifying, with near certainty, as many variables as you can.
When it comes to inventory management, lead time is one of the most important variables to consider.
If you don’t know how long it'll take to receive your next shipment, you won’t know when to replenish your current stock. Wait too long, and you may be out of stock for days; order too soon and you may find yourself with more product than warehouse space.
The fact is, without a firm grasp of your lead times, your inventory management efforts will always be difficult to manage.
What variables can impact production lead times?
A lot can happen throughout the fulfilment process that can impact your lead times.
Order processing delays
Order processing delays can occur on either the customer or supplier side, for a number of reasons.
On your end, if your purchase order workflows aren’t streamlined, your lead time may increase. Similar problems on your supplier’s end will, unfortunately, have the same impact on your side.
(And again, any reordering policies your supplier has in place will add even more time to these delays.)
Supplier stock outages
If your suppliers literally can’t fulfil your orders, for the time being, your lead times will be delayed.
Though problems are bound to occur from time to time, if your supplier is consistently unable to fulfil your orders in a timely fashion, you may want to consider switching to a competitor.
Slow transport methods
The delivery methods your supplier offers will impact your ability to receive orders on time. And on your end, lead time is impacted by the quality of your warehouse transportation workflows and equipment. The longer it takes to bring the shipment to storage, the longer your lead time will be.
Poor inventory management processes can have a more subtle – but just as damaging – impact on your lead times.
Without a clear understanding of your inventory levels (current and/or future), you may not know when it’s time to reorder until it’s too late. This initial delay can easily snowball – and might cause other problems throughout the purchase order process.
At this point, your lead time may unfortunately be just one of your many worries.
How do long lead times impact business?
You can probably guess that long lead times aren’t exactly good for business. Unnecessarily long lead times can have far-reaching effects on your overall operations – both directly and indirectly — as follows.
Greater risk of stock shortages
We’ve touched on this, but let’s quickly reiterate: The longer it takes your orders to come in, the greater your risk of stockouts.
If demand increases substantially in a short period of time, you simply won’t be able to fulfil the additional orders on time. In the meantime, your customers will essentially be on hold until your shelves are replenished.
Higher inventory costs
In the interest of curbing stockouts when long lead times are unavoidable, you might decide to increase your volume per order. This, in turn, will lead to higher inventory costs and other related issues.
Not only will you need more space, but you may also need to revamp your inventory management processes altogether. In worst-case scenarios, your excess stock may be subject to spoilage – making your efforts to reduce lead times irrelevant.
Inability to generate revenue
Going back to stockouts: If you don’t have stock on hand to sell, you won’t be making any sales.
Unfortunately, these missed sales opportunities potentially mean even more missed sales opportunities. If a customer can’t purchase the main product they wanted to buy, they probably aren’t going to buy any accessories.
Violations of contracts and agreements
If you’re under contract with your customers, your supplier’s long lead times could land your business in legal trouble.
At the least, operating with long lead times puts you at risk of having contracts nullified by dissatisfied customers.
Negative customer experiences
Whether they can’t place an order, can’t receive service as planned or have to wait longer than expected, your customers aren’t going to be happy.
While even one mistake can be enough to cause customers to leave you for the competition, consistent lateness will make sure of it.
How can businesses reduce lead times?
As impactful as lead times can be to your operations, your customer relationships, and your business as a whole, you’ll want to do whatever you can to minimise them.
Below are some tactics to help get you started.
Increase order frequency and decrease order volumes
As we said before, increasing order volume isn't a practical or economical solution to your lead time issues. In fact, you might actually benefit from doing the opposite.
Since it takes longer for your supplier to produce and package larger shipments, it'll take longer for said shipments to get to you. But, with less to produce and pack, your suppliers can get your shipments out the door in minimal time.
This will require taking full advantage of your supplier’s reordering policies. As long as they’re willing to ship more often (and at a negligible additional cost), making smaller purchases is a quick and easy way to decrease your lead time.
Improve demand forecasting
Improving your demand forecasting doesn’t directly reduce your lead times. But when you have a more accurate understanding of future demand, you can adjust your order volumes and frequency accordingly.
Share sales forecasts with suppliers
Help your suppliers by sharing your sales forecasts. If you can show them when demand is likely to increase, they can be better prepared to fulfil your orders.
Work with local suppliers
The closer your suppliers are to your warehouse, the shorter your lead times will be. Aside from the obvious geographical convenience, there’s also less chance of problems occurring during shipment that could extend your lead time indefinitely.
Shipments from faraway suppliers may also be subject to higher shipping rates, taxes and other additional costs. While not necessarily related to lead time, these are all factors worth considering.
Incentivise your main suppliers
Since your lead time is highly dependent on your suppliers’ efforts, you may need to incentivise them to keep them on track.
First, you need to be a model customer for them. Reliability is key here: paying on time, receiving shipments without friction, and maintaining contact are all part of forging a healthy business relationship with your suppliers.
Secondly, consider building incentives for consistent or early deliveries, or for any efforts your suppliers take to help minimise your lead times. If you’ve found a supplier that always delivers as promised, you want to keep them around no matter what it takes.
Switch to faster shipping methods
Paying for faster shipping is a standard way to reduce your lead times. In some cases, you might need to pay your suppliers a higher shipping fee per transaction.
If the options your suppliers provide aren’t enough, though, you may need to work with them to find a shipping method that works better for both parties. Again, if you’ve found an otherwise reliable and affordable supplier, working together to this end will be well worth the effort.
Vertically integrate fulfilment processes
If you really want to take control of your lead times, you might want to consider vertically integrating your supply chain. To put it more simply, vertical integration may mean bringing some of your processes in-house — creating your own production line, or managing your own shipping, for example.
Automate inventory management and tracking
With inventory management being so integral to reducing lead times, optimising and automating your related processes is crucial.
With the right inventory management tools in place, you’ll:
improve your demand forecasting efforts
enhance communications within your team and with suppliers
make more informed decisions and more effective plans for managing inventory.
If you can make all this happen, keeping lead times to a minimum will be easier than ever.
Control stock and lead times with inventory management software
If you’re looking to reduce lead times, and gain more control over your inventory-related processes in general, there’s no getting around it:
You need MYOB’s inventory management software.
With our software, you’ll always know:
what’s selling (and what’s not)
how much product you have on hand
when your next shipment will be coming in.
Ready to get started? Try MYOB’s inventory management software FREE for 30 days now.
Disclaimer: Information provided in this article is of a general nature and does not consider your personal situation. It does not constitute legal, financial, or other professional advice and should not be relied upon as a statement of law, policy or advice. You should consider whether this information is appropriate to your needs and, if necessary, seek independent advice. This information is only accurate at the time of publication. Although every effort has been made to verify the accuracy of the information contained on this webpage, MYOB disclaims, to the extent permitted by law, all liability for the information contained on this webpage or any loss or damage suffered by any person directly or indirectly through relying on this information.