Lead time, definition and formula

Lead time, definition and formula

By Joannès Vermorel, last revised December 2011

The lead time is the amount of time between the placing of an order and the renewed availability, after the receipt, of the goods ordered.

Lead time has very distinct meanings depending on the industry being considered. In this page, we are looking at lead time from the supply chain angle, i.e. as one of the key factor that needs to be taken into account in order to achieve inventory optimization. This angle is typically most useful for retailers and wholesalers.

In most businesses, inventory cannot be instantly replenished. Hence, in order to guarantee that the frequency of stock-outs remains sufficiently low, the demand planner needs to anticipate how much inventory will be consumed between now and the next replenishment, assuming that an order is passed right away. Indeed, while goods are in transit, the inventory will gradually get depleted.

Let's review a few examples that are typical in supply chain:
  • 1 day of lead time for next day delivery for stores replenished by a regional warehouse.
  • 1 week of lead time for a wholesaler ordering to a local producer.
  • 3 months of lead time for a manufacturer producing in Asia and having a warehouse in Europe or North America.

The longer the lead time, the higher the total inventory level. Indeed, total inventory includes both stock on hand but also stock on order. Longer lead time also increases the dependence of the ordering company on accurate forecasts. Indeed, when next day delivery is available, an erroneous order (too large or too small) can be fixed with 2 or 3 days by applying corrective measures. In case of overseas shipments, incorrect orders can penalize the company for 6 months or more.

Varying lead time

The classical safety stock model assumes that lead time is a constant that get factored into the calculation of the optimal reorder point. In practice though, lead times, when measured, are typically varying.

The first cause for varying lead time, when measured in calendar days, is that the supplier might have one or two closed days every week (ex: no delivery during the week-end) which can increase the (calendar) lead time of respectively one or two days. National holidays can exceptionally increase the discrepancy between calendar days and business days up to 3 or 4 days.

The second cause for varying lead time is stock-out on the supplier side. In this case, the supplier has to wait until her own inventory gets replenished to do the shipping. Depending on the lead time of the supplier herself, the supplier-side stock-out can cause a very significant increase of lead time compared to the usual situation.

Measuring the lead time

Since the lead time is not a constant, it’s usually important to keep track of the lead time for each order and receipt. First, it allows keeping an eye on the supplier performance; second, it allows to fine tune inventory levels.

Lokad’s gotcha: We have witnessed that some businesses do not properly match back-orders with receipts. As a result, for items that are ordered every day or so, when items are received, it’s unclear whether those items have been ordered the day before, or if it’s a late receipt from an earlier back-order. A precise matching between orders and receipts is the key to measure lead time and to build the supplier scorecard out of it.

Further reading

Get optimized sales forecasts with our webapp Salescast. Lokad specializes in inventory optimization through demand forecasting. Lead time management - and much more - are native features of Salescast.