What is Consumption Based Planning and Ordering?

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Managing inventory appropriately is essential for businesses in the supply chain. Keeping the right amount of stock on hand allows businesses to meet customer demand while avoiding fees associated with excess stock, fueling profitability. For this to be the case, decision-makers need to use planning and ordering methods which lead to accurate stock levels.

One common method that’s often used is called consumption-based planning. This strategic approach to inventory management relies on historical data to dictate ordering needs and establishes reorder points based on when the stock falls below a certain level.

Consumption-based planning and ordering is useful for its simplicity and efficacy, but it also has certain limitations. To effectively deploy consumption-based planning and ordering in your organization, here’s what you need to know.

What is Consumption-Based Planning and Ordering?

Accurate ordering is a cornerstone of profitability, and inventory mismanagement (such as stockouts and overstocking) costs businesses around the world more than $1 trillion per year. Consumption-based planning and ordering is an approach to inventory management that focuses on aligning inventory levels with consumer consumption patterns using historical data. This data reflects how much of an item has been used or sold over a specific period, and is used to determine reordering points: when inventory hits a certain level, reordering is necessary.

The fundamental principle of consumption-based planning and ordering is to restock goods only when there is confirmed demand. When inventory levels hit a certain threshold, reordering is triggered. This reordering can be done manually or automatically.

Consumption-based planning (sometimes referred to as CBP) differs from other inventory management methods, such as material requirements planning (MRP), which focuses on production schedules and forecasts of future demand. In contrast, consumption-based planning and reordering prioritizes actual past usage data for individual items.

How Does It Work?

Consumption-based planning and ordering takes a simplified approach to inventory management, and typically uses the following workflow:

1. Data collection

Historical consumption data for each item is central to consumption-based ordering. This data might include past sales figures, usage rates, or any metric reflecting past consumption.

2. Setting reorder points

By analyzing past ordering, usage, and consumption data, consumption-based ordering establishes a reorder point for each item. This crucial level triggers a new order to avoid stockouts. The reorder point calculation considers factors like average usage over a set period (such as weekly or monthly) as well as the lead time (the amount of time it takes to receive a new order after it’s placed).

3. Order generation

While order generation can be manual, it’s often automatic. In this case, when the inventory level dips below the predetermined threshold, a new order is automatically triggered. Ideally, this ensures a steady flow of inventory and prevents stock disruptions, while minimizing the amount of work required from ordering managers.

Ultimately, consumption-based planning and ordering is conceptually simple, and it can be a quick and straightforward ordering method.

The Benefits of Consumption-Based Planning and Ordering

Consumption-based planning and ordering offers several advantages for organizations because it can streamline inventory management and improve overall business efficiency.

Some of the potential benefits of consumption-based planning and ordering include:

  • Simplicity of ease and implementation: Consumption-based planning and ordering is relatively straightforward, especially when compared to more complex inventory management methods. Setting reorder points based on historical data is less demanding than complex forecasting methods, for example. This makes consumption-based planning and ordering a user-friendly option, especially for businesses with predictable inventory levels or limited forecasting resources.
  • Reduces stockouts: When consumption-based planning and ordering is deployed correctly, it can help prevent stockouts. This is because it ensures your business always has the items your customers need when they need them, leading to higher sales and customer satisfaction. Keep in mind that stockouts impact 56% of shoppers around the world and that nearly 60% of US shoppers feel that stockouts impact their shopping behavior.
  • Lowers inventory holding costs: Consumption-based planning and ordering can potentially help optimize inventory levels, leading to lower inventory holding costs. By basing orders on actual usage data, you’re less likely to overstock on slow-moving items. This can lead to reduced excess storage costs.

Consumption-based planning can certainly be beneficial for businesses and decision-makers, especially when we consider simplicity and ease.

Potential Limitations to Watch Out For

While consumption-based planning and ordering can be simple and effective, it has certain limitations that you should be aware of, and it might not be the best fit for every type of business.

The potential drawbacks of consumption-based planning and ordering can include:

  • Limited accuracy for unpredictable demand: Consumption-based planning and ordering relies heavily on historical ordering data, and assumes future demand will resemble past patterns. This can be problematic for items and businesses with unpredictable demand fluctuations due to things such as seasonality, market campaigns, sudden trends, or economic fluctuations. Consumption-based planning and ordering might not adequately adjust for these variations, leading to inaccurate ordering
  • Potential for slow reaction times: Since consumption-based planning and ordering focuses on maintaining a minimum inventory level, it might not react quickly enough to significant changes in demand. For example, if demand suddenly drops (such as during a slow sales period), there’s the potential for excessive inventory, which can tie up capital and increase storage costs.
  • Doesn’t account for future events: Consumption-based planning and ordering doesn’t take into account future events such as upcoming promotions, marketing initiatives, or product launches that might significantly (and quickly) increase demand. If you experience a surge in sales for a specific item, consumption-based planning and ordering alone might not trigger orders in time to meet that demand.

Best Practices for Consumption-Based Planning and Ordering

Due to its specifications and potential limitations, consumption-based planning and ordering might not be the best choice for every business. It’s not a one-size-fits-all solution, and might be best suited for businesses with:

  • Relatively stable demand: While demand is never 100% stable, consumption-based planning and ordering excels for items with consistent historical usage patterns. This might include inventory such as office supplies, staple pantry items, or maintenance parts with predictable demand, for example.
  • Limited resources for inventory management: For businesses with limited resources or capacity for complex inventory management systems, consumption-based planning and ordering can offer a straightforward and user-friendly approach. It requires less data manipulation and forecasting when compared to other methods.

If you’re looking to deploy consumption-based planning and ordering in your business, here are some best practices to keep in mind:

  • Maintain accurate data: The accuracy of your reorder points hinges on the quality of your historical consumption data. Regularly review and update your data to ensure it accurately reflects current usage patterns.
  • Review reorder points regularly: Don’t set reorder points in stone and forget about them. Regularly review and adjust your reorder points based on changes in consumption patterns, lead times, and supplier performance.
  • Consider demand forecasting for volatile items: For items with significant demand fluctuations, you can combine consumption-based planning and ordering with a basic demand forecasting method to account for things like upcoming trends and seasonality. This can help mitigate stockouts during peak periods, and help you adjust levels to avoid overstocking.

By following these practices, you can leverage the strengths of consumption-based planning and ordering while mitigating its limitations, ensuring a more efficient and responsive inventory management system.

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