How to Calculate and Reduce Lead Time in the Supply Chain

Lead Time In Supply Chain July 26, 2020

Jin Hyun

Writer

Supply chain management is the mindful control of all of the component steps that inventory takes from the supplier to the customer. For successful supply chain management, all of these steps need to be run with the utmost efficiency.

An essential component of supply chain management is lead time, a term used to describe the time it takes for goods to be delivered to the company's warehouse or store after it has been ordered from the supplier.

Knowing the lead time for certain goods is crucial to make decisions on how much, and when to re-order stock. The shorter the lead time, the faster the goods can be sold to consumers, and the more accessible it is for companies to have the working capital to increase their profits.

Understanding the factors that affect lead time and how to reduce this amount with simple supply chain management techniques is a way for businesses to reach greater success in meeting customer demand.

Understanding the Lead Time Formula

Lead time is a key performance indicator (KPI) for supply chain management to determine if any inefficiencies exist in the process of ordering, handling, and ultimately selling goods. The goal for companies is to reduce lead times to streamline processes, enhance productivity, and boost revenue by increasing the consistent output of goods. Longer lead times, on the other hand, can negatively affect the ordering, manufacturing, and sales processes.

The following circumstances can create longer lead times-

Inaccurate inventory management and documentation

Delay in the production process of raw materials to create the final goods

Transportation issues can halt production if deliveries are delayed

Ultimately, if supply chain management is ineffective, it can increase the chances of stockouts where orders cannot be fulfilled due to inadequate replenishment strategies. Excess inventory can also place a strain on company budgets, as a result of wasted purchasing expenses.

Having an accurate knowledge of supplier lead time informs businesses how much stock they should hold at a given time to prevent these situations. Longer lead times may indicate that a company should order greater quantities of stock while shorter lead times would allow businesses to be more flexible with their reordering strategies.

To calculate lead time, the formula is as follows-

Lead Time = Supply Delay + The Reordering Delay

Supply Delay - How long the shipment will take to reach a company's warehouse/inventory storage after ordering.

The Reordering Delay - The amount of time that a supplier takes to accept and process an order (taking into account whether the supplier accepts re-orders every 3 days, for example).

Example-

A company sells printed T-shirts. The supplier that makes the shirts has a standard 2-day delivery time when shirts are complete. However, the supplier takes 3 days for the production of the shirts, from printing to quality checking, before they send for delivery. In this case, the lead time is 5 days.

Lead Time = Supply Delay (2-day delivery) + Reordering Delay (3-day production) = 5 days

Why Businesses Should Reduce Lead Times

The key reason for reducing lead times involves enhancing the bottom line. There are additional factors that play into this, ranging from customer satisfaction to a more balanced operational process.

Below are the 3 main benefits that businesses will enjoy by reducing their lead times-

1. Higher Customer Rapport

When customers trust the company and are confident that their orders will arrive accurately and on time, they'll be far more likely to become returning customers. Consumer satisfaction relies on meeting the expectations of buyers, which is greatly affected by order accuracy and quick delivery.

Additionally, there will be a higher regard for your business when the process of returns or replacements is also fast and accurate. A reduced lead time, as well as effective inventory management, will ensure that customers get their replaced goods efficiently.

2. Reduced Operating Costs

There are three key operating costs that can be reduced with shortened lead times-

Inventory Cost - If suppliers can quickly deliver goods, a company can avoid high inventory costs. Inventory costs can include expenses associated with the handling, holding, and management of stored goods before they are sold. Less inventory being held means more working capital for businesses. This is dependent on a short and consistent lead time from suppliers.

Production Cost - When raw material components aren't delivered in a timely manner by suppliers to a production facility, that company can experience increased costs due to wasted labor wages and no output due to shortages.

Total Supply Chain Cost - Effective supply chain management is expressed in processes of managing inventory where customer service goals are met (order fulfillment) with the total cost being the lowest amount possible. When the total supply chain cost is low, the company can enjoy enhanced profits.

3. Financial Position Improvement

Companies should not underestimate the power of making seemingly small shifts when it comes to the supply chain management process, as it can greatly impact the bottom line. Companies may be able to decrease fixed assets like large warehouses and vehicles for transportation if the vendor network is efficient enough to require limited inventory storage. When the lead time is short, companies will no longer need to hold as much stock.

How Companies Can Achieve Efficient Lead Time

To reap the benefits of a well-oiled supply chain and minimized lead times, businesses can consider implementing the following best practices to optimize their operations.

1. Use Local or Domestic Suppliers

The closer the supplier is to a company, the faster the lead time (in almost all cases). When the supplier needs to ship between states or over borders, this can cause extra delays due to customs processing and transportation time.

2. Re-assess the Production Process

Companies can reduce costs by obtaining more standard component raw materials from suppliers, rather than obtaining the fully customized, completed product. This reduces the manufacturing lead time and makes the production more efficient with finishing touches being made on the receiving end, rather than relying on the entire production to be done prior to receiving the goods.

3. Consolidate All Suppliers

Many companies will have multiple suppliers to manage. Consider the amount of time spent coordinating these vendors and handling ordering, receiving, invoicing, and payments. This might lead to more labor and time, which translates to higher costs to manage multiple suppliers.

While it is recommended to have a back-up supplier so companies aren't completely dependent on one source, having two or more back-up vendors will likely add more complexity than needed. Additionally, companies should check whether the vendors produce similar goods and choose to drop one in favor of streamlining processes and obtaining a variety of products from fewer sources.

4. Value Communication

Rather than just having the least amount of dialogue as possible with suppliers, or only communicating via purchase orders and invoices, it is more beneficial for companies to have a stream of open communication throughout the supply chain process.

This ensures that there is a healthy relationship between companies, where they are able to discuss delays in a transparent manner immediately as they arise. However, if errors and delays continue to be regular issues, the company should consider switching suppliers altogether.

5. Offer Incentives

Companies can also offer suppliers bonuses if they are ahead of schedule in their order completion. Creating incentives for partnerships with suppliers can ensure a good relationship and reduce the instances of longer lead times. Additionally, incentives could position your company ahead of the other businesses that the supplier may deliver to, with your orders being prioritized due to the mutually beneficial agreements that have been made.

6. Conduct Sales Forecasting

Giving vendors access to projections of when reorders are expected to be made based on sales forecasting is a way to allow the supplier to anticipate reorders. When doing this, both parties can benefit, with less possibility of long lead times for companies receiving the goods, and the supplier already having this expected reorder even before purchase orders are produced.