The rise of online retail has totally transformed the face of business. In particular, it’s drastically raised customer expectations: customers expect that their orders will reach them with the minimum of delay. This has brought new challenges for retail businesses, which are also operating in a much more competitive market.
Efficient inventory management and a smooth supply chain are vitally important. Retailers must ensure that they have the right products, in the right amounts, at the right time. Poor inventory management can result in a string of disasters, with customer orders going unfulfilled or getting lost, and delivery dates not being met.
This is why it’s so important for retailers to use the appropriate metrics to ensure that customer orders don’t take an inordinate amount of time to arrive. One such metric is lead time, which plays an important role in planning reorders and thus in inventory management as a whole.
In this guide, we’ll define lead time at greater length and explain how to calculate it. We’ll then go on to explain why it matters, the impacts it can have and the factors that can potentially affect it. We’ll conclude by outlining how to shorten lead time and the benefits this can have for your business.
What is lead time?
The term ‘lead time’ can take on a number of different meanings depending on the context. In general, it denotes the period between the initiation of a certain process and its completion. So, manufacturing lead time covers the sourcing and preparation of raw materials, their manufacture into finished products, and their dispatch.
In project management, the term may also be used to denote the period involved in completing a particular task or a series of interrelated tasks.
Let’s take a closer look at some of the relevant terminology:
- Customer lead time: the amount of time it takes to fulfil a customer’s order.
- Material lead time: the amount of time it takes to receive materials from a supplier after the initial order has been placed.
- Production/factory lead time: the amount of time it takes for a manufacturer to complete an order after a merchant makes it.
- Cumulative lead time: the amount of time it takes to manufacture a product from start to finish, from procurement of raw materials to subassembly of related units.
There are also a couple of other, related terms to remember:
- Cycle time: the number of days it takes to complete a particular task, or cycle, from start to finish.
- Takt time: the rate at which products need to be completed in order to keep up with customer demand.
How to calculate lead time
When you’re forecasting inventory, you need to factor in lead time. How you calculate this will depend on the specific context. Different processes have different components, which obviously affects their overall length.
In general, lead time in inventory management is the amount of time between when a purchase order is placed to replenish products and when the order is received in the warehouse. Order lead times can vary between suppliers; the more suppliers involved in the chain, the longer the lead time is likely to be.
Let’s look at some of the ways by which you might go about working out lead time.
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The formula for lead time calculation
The formula you use to calculate lead time will vary according to the circumstances. Manufacturing lead time, for instance, needs to factor pre-processing (planning), processing (procurement and manufacturing) and post-processing (dispatch) lead times into account. So, we can summarise this in the following way:
Manufacturing lead time = pre-processing time + processing time + post-processing time.
When calculating lead time in inventory management, these are two key factors to consider: supply delay (the period between ordering and receiving inventory) and reordering delay (the period you have to wait before ordering supplies). These two factors, between them, cover the amount of time it takes for suppliers to process and fulfil orders.
Therefore, the formula for calculating inventory lead time is as follows:
Lead time = reordering delay + supply delay
If you have any further difficulty with working out your lead time, you can simply use a lead time calculator to determine it. These lead times can be used with inventory management software to set delivery dates, automating aspects of the process.
Examples of lead time calculation
Let’s look at an example of cumulative lead time in action to get a better idea. Say, for instance, that a jewelry brand like Brightpearl’s customer, Alex Munroe, sells pre-made and made-to-order necklaces. To work out lead time, it’ll need to include pre-processing, processing and post-processing in its calculations.
Imagine that orders are picked up the day after they’re placed (pre-processing), and it takes two weeks to make an item to order (processing). Once packaged and sent out (post-processing), it can take three days to be delivered to the customer.
Following our earlier formula for manufacturing lead time, we’d calculate it by adding pre-processing, processing and post-processing together, as follows:
1 day + 14 days + 3 days = 18 days
Placing an order for a pre-made item might have a shorter lead time, instead only requiring two days in the processing stage:
1 day + 2 day + 3 days = 6 days
Having accurate lead times for both types of product can improve customer satisfaction, and help set clear expectations.
Why lead time is central to inventory management
Lead time is a central pillar of inventory management. Businesses must ensure that they have a solid understanding of lead time and that they can keep it under control. Otherwise, there could be serious knock-on effects, with ensuing delays for customers.
Indeed, if lead times start to get out of control, this can come to form a vicious circle, with lead times growing steadily worse as the supply chain seizes up thanks to the increased number of units required. This can then lead to longer delays for consumers, causing lead times to deteriorate further.
Poorly-managed lead time can mean that stocks run out and customers can’t get their orders fulfilled. Inadequate order management can do a great deal of damage to businesses’ reputations, causing them to lose custom to competitors. It is essential, therefore, that you do everything you can to control lead times as effectively as you can.
Impacts of longer lead time
When suppliers struggle to deliver a purchase order on schedule and in the right quantities, it can cause serious problems to a business’s workflow. It leaves businesses with only their existing, on-hand stock with which to fulfil orders; if this stock proves to be insufficient to meet customer demand until new stock arrives, customers will face delays or unfulfilled orders.
Lead time can have a significant impact on the customer experience. Consumers have a lot of choice at their disposal now, and it’s easy for them to take their custom somewhere else if they have a bad experience with a retailer. If their orders are delayed or they can’t find what they want, they’re likely to seek alternative outlets.
Furthermore, if lead times are persistently too long, storage costs will likely be higher as businesses will need to store higher levels of inventory so that they’re prepared for demand. This will increase product pricing and render businesses less responsive; introducing new products is made more difficult as existing stocks are harder to shift.
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Factors that affect lead time
Sometimes, unforeseeable factors may have an adverse effect on lead time. The Covid-19 pandemic proved that: according to one survey, 68 per cent of global retailers reported that they had experienced either heavy or moderate supply chain disruption due to the impact of the virus.
Of course, it’s not just pandemics that can seriously disrupt supply chains. Freight and shipping may be subject to delays, holding up supplies and thus increasing lead time. Border and customs agencies may step up checks at ports, thereby delaying the arrival of imports and again leading to increased lead time.
Businesses may also find that suppliers simply can’t uphold their end of the bargain, and that promises which are made are subsequently not kept. This is why it’s absolutely essential to ensure that, when you choose suppliers, you’re confident you can rely on them to deliver what’s needed of them.
It’s all but inevitable that there’ll be some teething problems as business supply chains grow bigger and more complex. This will likely have some short-term effects on lead time. However, as businesses and suppliers get to know one another’s requirements more intimately, lead time should start to improve accordingly.
How to shorten lead time
There are various steps businesses can take to reduce lead time. For example, financial bonuses for meeting lead time targets (or penalties for failing to meet them) could be stipulated as contractual requirements. This can prove highly effective at keeping suppliers focused on meeting the requisite lead time.
Another option is to source supplies as locally as possible. Sourcing them from overseas may be cheaper as manufacturing costs are often much lower than in the United States, but the downside of this is the added logistical complexity involved; this can result in increased or simply unpredictable lead times.
Alternatively, you can use inventory management software to take the strain out of supply chain management. Brightpearl’s automated inventory management tool allows you to manage multi-location inventories with ease, providing smart demand planning and real-time insight into your sales performance, profitability and costs.