You can lead a horse to water, but you can't make him fulfill orders in a timely manner.
For that, you need a well-controlled supply chain with an inventory control manager (see inventory control manager salary) who tracks and acts on their lead time. As such, lead time is a vital metric for any business.
Do you regularly track your lead times?
If not, don't worry, we'll help you. It's an important part of our inventory control guide and a vital metric for any successful order management specialist. Read on to learn what lead time is, how to calculate it, and some ways you can keep yours low and grow your sales.
What Is Lead Time?
Lead time definition is the amount of time that goes by from the start to finish of any given process. In business, this means the amount of time that passes between a customer placing an order and the products getting to them.
Lead time is one of the most important measures in inventory control. It affects all businesses within a supply chain and can cause major issues if it gets out of control. Calculating, understanding, and acting on changes in lead time allows a business to prevent losses and fulfill orders quickly and efficiently.
Manufacturing Lead Time
Manufacturing lead time, or production lead time, is the amount of time between a merchant placing an order and the manufacturer completing it. This includes the time taken to procure supplies, manufacture, and ship the goods.
Lead Time In Supply Chain
Total lead time is affected by every step within a supply chain. Production takes time, shipment takes time, and any other intermediary steps take time. As such, lead time in inventory management needs to be monitored and planned for.
Lead Time ARO
ARO, or after receipt of order, is the point that the supplier receives the order. Any actions taken between ARO and the delivery of goods are a part of the lead time for that order. This starts the clock on production and is the first substantial number when measuring lead time.
What Are the Types of Lead Time?
There are four main types of lead time:
- Customer lead time is the amount of time that passes between when a customer places an order and when they receive the product. This can be affected by several factors, including the manufacturing process, shipping method, and any delays on the part of the customer.
- Material lead time is the amount of time it takes to procure the materials needed to produce a product. This can be affected by supplier Lead times, transportation times, and any delays in receiving materials.
- Production lead time is the amount of time it takes to produce a product once all of the materials have been received. This can be affected by the manufacturing process, the number of workers available, and any machinery downtime.
- Cumulative lead time is the total amount of time that a product or order spends in the production process, from start to finish. It includes both the time spent in active production (work-in-progress) as well as any time spent waiting for materials or other resources. This metric is often used to assess the efficiency of a manufacturing process and to identify potential bottlenecks.
Lead times are an essential part of the manufacturing process and can significantly impact the speed at which products are brought to market. Companies should consider all types of lead time when planning production to ensure they can meet customer demand in a timely manner.
Why Long Lead Time Is Bad
Lead time issues are a headache no matter where a business is in the supply chain, whether it’s the food supply chain or high demand products in eCommerce. Extended lead time can cause several problems that interfere with a business’s ability to fulfill orders. With uncontrolled lead time, it is impossible to ensure you purchase the optimal economic order quantity, or EOQ.
For retailers, a long lead time means a loss of sales and angry customers. On the manufacturing front, a long lead time can cause production to halt entirely and cause a bullwhip effect throughout the supply chain. It also leads to increased lead time for the retailers, hurts your inventory turnover ratio, and strains relationships. Every additional day that goods are delayed, money is lost.
Working Toward Lead Time Reduction
Lead time reduction takes time, energy, and data but can help your business improve its sales and fill rate. The most important factor when trying to reduce lead time is looking at your historical data. These numbers can help you determine average lead times and help you discover where lead times are increasing so you can head them off.
There are a few ways you can use this information to reduce your lead times:
- Change suppliers. Your lead time may be increasing due to poor supplier relationship management. If they can’t get it under control and meet your needs, it’s to look elsewhere.
- Reorder more often. Another likely cause of lead time increasing is waiting on shipments to arrive. This is especially common if you order via bulk shipping. It may be worth ordering smaller batches more frequently. That requires adjusting your reorder point formula and possibly a different warehousing approach.
- Share inventory forecasting data with your supplier. If you are predicting a massive increase in sales in the future, let your supplier know. They can change their plans and begin working on production sooner to ensure you get the necessary goods. This will also help with inventory reduction.
- Try kitting. Kitting is a great way to consolidate orders (sometimes otherwise dead stock (see dead stock meaning) and limit the time it takes to pick and ship products. This, in turn, lowers your lead times. It can also be done on a product level and turn multiple SKUs into a single SKU number by way of SKU rationalization.
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Importance of Lead Time In Inventory Management
Understanding and controlling lead time is paramount in inventory management. Lead time affects each step in the supply chain and can cause all operations to fall behind. This can cause further delays with subsequent orders leading to ever-growing lead times and unhappy customers.
Improperly managed lead time in inventory management can cause a lack of stock (read more about backorder meaning), canceled orders, delays at the online marketplace level, and loss of revenue.
Lead Time Calculator
Calculating total lead time is not nearly as complicated as it may seem. All you need to know is the various steps involved in the supply chain and the time each step is expected to take. With these numbers, you don't need a lead time calculator software. It's as simple as using a formula.
Lead Time Formula
Discovering your lead time requires a simple formula. There are two options depending on if you're a manufacturer or a retailer.
For manufacturers, the lead time formula is:
Total Lead Time = Manufacturing Time + Procurement Time + Shipping Time
For retailers, the lead time formula is:
Total Lead Time = Procurement Time + Shipping Time
How to Calculate Lead Time
Now that we have the above lead time formulas let's look at an example of calculating lead time. For this, we'll be a food producer looking to calculate their lead time for an order of 1,000 cans of tuna.
First, we can look at the company's previous data on tuna cans to discover manufacturing time. Let's assume the average amount of time for manufacturing 1000 tuna cans is two weeks.
Next, we need to look at procurement time. For a manufacturer, this is the amount of time it takes for all components and raw materials inventory used in production to arrive onsite. In this case, we'll assume it takes five days to get the necessary materials.
Lastly, we need to find the time it takes to ship the tuna cans to their destination. Here we'll say it will take one week to ship. This can be estimated based on previous shipments, or an external shipping company will provide it.
Now, we can use the manufacturing formula above!
Total Lead Time = Manufacturing Time + Procurement Time + Shipping Time
Total Lead Time = Two weeks (14 days) + 5 days + One week (7 days)
Total Lead Time = 26 Days
In this example, the lead time calculator will show us that the total lead time for this order is 26 days. With this information, you can keep the customer informed and look at any areas where there is room for improvement.
Take Us to Your Leader
The most important thing for anyone trying to manage inventory is to track average lead times and act quickly when any variances are found. Uncontrolled lead times can have drastic effects on a business. Keeping lead times minimal can save businesses thousands of dollars from the loss of sales to halted production runs.
Using the inventory tracking tools and formulas above and a regular inventory audit, you can keep your business operating smoothly, avoid surprise inventory shrinkage, and focus on increasing eCommerce sales and revenue.
Frequently Asked Questions About Lead Time Definition and Formula
Lead time is one of the most challenging things to get right in a physical products business. It helps to have examples to know how to use it properly. Check out the commonly asked questions below for more information:
What Is a Lead Time Example?
Lead time is the amount of time between an order being placed and the buyer receiving it. Successful supply chain operations rely on the proper use of lead time.
Here is one example of lead time: if a particular supplier takes a month to get an order to a customer but they need it in two weeks, the purchaser hasn’t accounted for lead time.
Another example of lead time is that a buyer is informed of their company’s production deadline in six weeks. They research wholesale products after learning how to find vendors from a wholesale directory and find a supplier with a lead time of two to a half weeks. This gives them enough time to place the order, have the products arrive, and finish production with a couple of days to spare.
What Is Lead Time In EOQ Model?
Lead time is rarely accounted for in the EOQ model because it’s impossible to standardize lead times across industries. That being said, it’s necessary to incorporate lead time into your EOQ whenever possible.
Lead time is the minimum time needed between placing an order and receiving it. Therefore, lead time in the EOQ model is the maximum amount of lead time acceptable to keep inventory holding costs low.
How Does Lead Time Affect Cost?
Lead time affects cost by changing the value of in transit inventory. The higher the value or more time inventory spends being shipped, the greater it costs. The lower value or less time inventory pays in transit, the less it costs.
For example, 15 units of a product that are only in transit for a week have a much lower transit cost than 500 units of a product that’s in transit for three weeks. Lead time is directly related to expense because the more time passes between ordering materials and selling the products, the more it costs you.
What Are the Pros of Short Lead Time?
The main benefit of short lead time is that it helps businesses liquidate their assets quicker. This helps start production of new items without the need of big inventory. Another reason why you should aim at short lead time is the fact that it will save you on inventory costs. Companies with shorter lead time are also more flexible. It's much easier to re-arrange your processes compared to production cycles that are long.
What Are the Cons of Short Lead Time?
Having a short lead time usually means smaller profit margin. The reason behind that is that you need to sell and liquidate your inventory which is done with higher marketing expenses. Furthermore, in order to speed up the manufacturing process, a business needs to have modern equipment. Short lead time might be good for the business but it can be achieved with reduced product quality. Understandably, that's not a good long-term strategy for any business. An additional con of aiming for a short lead time is the fact that it can be stressful. Pressure and high production quotas for employees reflect on their happiness and increase the human error factor.