Policy Fundamentals
Inventory policies are rules that automate your ordering decisions. Instead of checking inventory manually, policies tell you when and how much to order.
What is an Inventory Policy?
An inventory policy is a set of automated rules that answer:
1. WHEN should I order? → Reorder Point
2. HOW MUCH should I order? → Reorder Quantity
3. HOW MUCH is MINIMUM? → Minimum Level (Safety Stock)
4. HOW MUCH is MAXIMUM? → Maximum Level
The Four Core Questions
1. When Should I Order? (Reorder Point)
Reorder Point = The inventory level that triggers an order
Formula:
Reorder Point = (Average Daily Sales × Lead Time) + Safety Stock
Example:
Blue T-Shirt:
├─ Average daily sales: 10 units
├─ Supplier lead time: 30 days
├─ Safety stock (buffer): 50 units
└─ REORDER POINT: (10 × 30) + 50 = 350 units
Action: When inventory drops to 350 units, order more
Why it works:
Average Daily Sales × Lead Time= How much you'll sell while waiting for delivery+ Safety Stock= Extra buffer for demand spikes or supplier delays- When you hit this point, you order so new stock arrives before you run out
2. How Much Should I Order? (Reorder Quantity)
Reorder Quantity = How many units to order each time
Three common methods:
Method A: Fixed Quantity
Order the same amount every time (simple, predictable)
Always order: 500 units per order
Method B: Cover X Weeks
Order enough to cover a specific time period
Average weekly sales: 70 units
Order to cover: 6 weeks
Reorder quantity: 70 × 6 = 420 units
Method C: Economic Order Quantity (EOQ)
Balance holding costs vs. ordering costs (most sophisticated)
Formula: √(2 × Annual Demand × Order Cost / Holding Cost)
Result: Optimal quantity that minimizes total costs
Most common: Method B (cover X weeks) — simple and practical
3. How Much is MINIMUM? (Safety Stock)
Minimum Level = The absolute lowest inventory before risk of stockout
Formula:
Safety Stock = Average Daily Sales × Safety Days
Example:
Blue T-Shirt:
├─ Average daily sales: 10 units
├─ Safety days: 5 days (for Grade C), 10 days (for Grade B), 15 days (for Grade A)
├─ Grade B safety stock: 10 × 10 = 100 units
└─ MINIMUM LEVEL: 100 units
Action: Never let inventory drop below 100 units (except during lead time)
Safety stock days by grade:
- Grade A (high priority): 12-15 days
- Grade B (medium): 8-10 days
- Grade C (low): 3-5 days
4. How Much is MAXIMUM? (Maximum Level)
Maximum Level = Highest inventory before you're overstocked
Formula:
Maximum Level = Reorder Point + Reorder Quantity
Example:
Blue T-Shirt:
├─ Reorder point: 350 units
├─ Reorder quantity: 420 units
└─ MAXIMUM LEVEL: 350 + 420 = 770 units
Action: Try not to exceed 770 units (it's excess inventory)
Why a maximum?
- Avoids tying up excess cash
- Reduces obsolescence risk
- Saves storage space
- Prevents waste
The Healthy Inventory Zone
770 ─────────────────────────────────────── MAXIMUM
│ (Too much)
│ You have orders, selling normally
│ Inventory decreases naturally
│
350 ─────────────────────────────────────── REORDER POINT
│ ⚠️ ALERT: TIME TO ORDER!
│ You still have inventory, but running low
│ Submit new order now (it'll arrive in 30 days)
│
100 ─────────────────────────────────────── MINIMUM (Safety Stock)
│ 🚨 DANGER ZONE
│ Below safety stock = Risk of stockout
│ Should only happen during lead time
│
0 ─────────────────────────────────────── STOCKOUT
(Bad - Lost sales)
How Policies Work Over Time
Month 1: Normal Cycle
Day 1: Inventory = 650 units (healthy, in range)
Status: Normal ✓
Day 10: Inventory = 500 units (still good)
Status: Normal ✓
Day 20: Inventory = 350 units (hits reorder point!)
Action: TRIGGER REORDER
Order: 420 units
Expected arrival: Day 50 (30-day lead time)
Status: Order placed ✓
Day 25: Inventory = 320 units (below reorder point during lead time)
Status: Expected during delivery ⚠️
Day 50: Inventory = 50 units
Action: ORDER ARRIVES (+420 units)
New inventory: 470 units
Status: Back to healthy ✓
Day 60: Inventory = 350 units (back at reorder point)
Action: Time to order again
Cycle repeats
When Problems Occur
Scenario 1: Demand spikes (higher than average)
Normal: 10 units/day
Spike: 20 units/day (demand doubled!)
Day 20: Inventory = 350 units (hits reorder point, order placed)
Day 25: Inventory = 250 units (dropping faster!)
Day 30: Inventory = 150 units (moving into danger zone!)
Day 35: Inventory = 50 units (CRITICAL!)
Day 40: Inventory = -50 units (STOCKOUT! Lost sales!)
Why? Because safety stock was too low for this demand level
Solution: Increase safety stock for high-demand products
Scenario 2: Supplier delay (longer than 30 days)
Normal lead time: 30 days
Actual: 45 days (unexpected delay)
Day 20: Order placed, expect arrival Day 50
Day 25: Inventory = 250 units (in range)
Day 35: Inventory = 100 units (in range)
Day 40: Inventory = 50 units (low)
Day 45: Inventory = 0 units (STOCKOUT! Waiting for delivery!)
Day 50: Order finally arrives
Why? Lead time calculation was wrong
Solution: Add lead time buffer or check supplier reliability
Policy Components
Every inventory policy has these parts:
| Component | Purpose | Example |
|---|---|---|
| Reorder Point | When to order | 350 units |
| Reorder Quantity | How much to order | 420 units |
| Safety Stock | Minimum buffer | 100 units |
| Maximum Level | Don't exceed | 770 units |
| Lead Time | Days to delivery | 30 days |
| Review Cycle | How often to check | Weekly |
| Grade | Priority level | B (medium) |
| Service Level | Target fill rate | 95% |
Three Policy Approaches
Approach 1: Simple Reorder Point
Complexity: Low
Automation: High
Set: Reorder point = 350 units
When inventory ≤ 350, system alerts "Time to order"
You decide quantity (usually fixed)
✓ Easy to understand
✓ Works for stable products
✗ Not optimal for volatile products
Approach 2: Min-Max System
Complexity: Medium
Automation: High
Set: Minimum = 350, Maximum = 770
System checks: Is inventory between min-max?
If below min: Order to bring to max
If above max: Wait, don't order
✓ Prevents both stockouts and overstock
✓ Automatic reorder logic
✗ Requires data for optimal levels
Approach 3: ABC with Policies
Complexity: High
Automation: Very High
Grade A products: Tight min-max, frequent checks
Grade B products: Normal min-max, standard checks
Grade C products: Loose min-max, infrequent checks
✓ Prioritizes high-value products
✓ Different rules for different importance levels
✓ Optimizes total cost
✗ Requires good product grading
Real Example: Three Products
Store: Small apparel shop
Decision: Apply same lead time (30 days) to three products
Product 1: Winter Jacket (Grade A - High Revenue)
Average daily sales: 5 units
Lead time: 30 days
Safety days: 12 days (high priority)
Reorder point: (5 × 30) + (5 × 12) = 150 + 60 = 210 units
Reorder quantity: 5 × 7 × 4 weeks = 140 units
Maximum: 210 + 140 = 350 units
Policy: Keep between 210-350 units
Check: Weekly (monitor closely)
Service level: 95% (rarely stockout)
Product 2: Blue T-Shirt (Grade B - Core Product)
Average daily sales: 10 units
Lead time: 30 days
Safety days: 8 days (standard)
Reorder point: (10 × 30) + (10 × 8) = 300 + 80 = 380 units
Reorder quantity: 10 × 7 × 6 weeks = 420 units
Maximum: 380 + 420 = 800 units
Policy: Keep between 380-800 units
Check: Bi-weekly (every 2 weeks)
Service level: 90% (occasional stockout OK)
Product 3: Niche Item (Grade C - Low Revenue)
Average daily sales: 1 unit
Lead time: 30 days
Safety days: 4 days (low priority)
Reorder point: (1 × 30) + (1 × 4) = 30 + 4 = 34 units
Reorder quantity: 1 × 7 × 4 weeks = 28 units
Maximum: 34 + 28 = 62 units
Policy: Keep between 34-62 units
Check: Monthly (once per month)
Service level: 80% (stockouts acceptable)
FAQ
Q: Can I change policies mid-year?
A: Yes, but carefully. Change only when data improves (better lead time info, sales pattern changes). Don't change too frequently or you'll never optimize.
Q: What if I don't know average daily sales?
A: Use last 3 months of data to calculate. Formula: Total sales ÷ 90 days = average daily sales.
Q: Should safety stock be the same for all products?
A: No. Grade A gets more, Grade C gets less. Seasonal products need more. Volatile products need more.
Q: What's a good reorder frequency?
A: Grade A: Weekly. Grade B: Bi-weekly. Grade C: Monthly. Adjust based on urgency.
Q: Can policies work without forecasting?
A: Yes, reorder point policies work based on historical data. They're reactive. But if you forecast demand changes, you should adjust policies ahead of time.
Next Steps
- Calculate for one product — Use your actual sales data
- Set reorder point — (Daily sales × Lead time) + Safety stock
- Set reorder quantity — Cover 4-6 weeks of sales
- Define maximum — Reorder point + Quantity
- Monitor for 30 days — See if it works
Related Articles
- ABC Rules & Prioritization — Grade your products
- Reorder Points & Safety Stock — Detailed calculations
- Min-Max Inventory Levels — Min and max explained
Questions?
Contact support@synplex.io for help with your specific products.