Reorder Point and Continuous Review Systems

Reorder Point and Continuous Review Systems: A Comprehensive CPIM Exam Guide

Introduction

The Reorder Point (ROP) and Continuous Review System form one of the most fundamental concepts in inventory management. Whether you are preparing for the CPIM exam or working in supply chain operations, understanding how and when to trigger a replenishment order is essential for maintaining service levels while controlling inventory costs.

Why Is This Important?

Inventory management sits at the heart of supply chain effectiveness. Organizations that fail to replenish inventory at the right time face two costly outcomes:

1. Stockouts – Running out of stock leads to lost sales, damaged customer relationships, expediting costs, and production downtime.
2. Excess Inventory – Ordering too early or too much ties up working capital, increases carrying costs, and raises the risk of obsolescence.

The Reorder Point system provides a precise, quantitative method for determining when to place a replenishment order. It is especially critical in environments where demand is ongoing and items need to be continuously monitored. For the CPIM exam, this topic appears frequently in questions related to inventory planning, safety stock, service levels, and order quantity decisions.

What Is a Continuous Review System?

A Continuous Review System (also called a Q-system or fixed-order-quantity system) is an inventory management approach in which the inventory position is monitored continuously (or at very frequent intervals). When the inventory position drops to or below a predetermined level — the Reorder Point (ROP) — a fixed quantity (Q) is ordered.

Key characteristics of the continuous review system:

• Fixed order quantity (Q): The same amount is ordered every time an order is placed. This is often calculated using the Economic Order Quantity (EOQ) formula.
• Variable order timing: The time between orders varies depending on the rate of demand.
• Continuous monitoring: Inventory levels are tracked in real time or near-real time (e.g., through barcode scanning, POS systems, or ERP systems).
• Reorder Point trigger: An order is placed when inventory position reaches or falls below the ROP.

What Is the Reorder Point (ROP)?

The Reorder Point is the inventory level at which a new replenishment order should be placed. It is calculated to ensure that enough inventory remains on hand to cover demand during the lead time required to receive the new order.

The basic formula when demand and lead time are constant is:

ROP = d × LT

Where:
• d = average demand per time period (e.g., units per day)
• LT = lead time (in the same time units as demand)

However, in the real world, both demand and lead time are variable. To protect against this uncertainty, safety stock (SS) is added:

ROP = (d × LT) + SS

This is the formula most commonly tested on the CPIM exam.

Understanding Safety Stock

Safety stock is the extra inventory held to buffer against variability in demand and/or lead time. The amount of safety stock depends on:

• Desired service level: A higher service level (e.g., 99% vs. 95%) requires more safety stock.
• Demand variability: Greater variability in demand requires more safety stock.
• Lead time variability: Greater variability in supplier lead time requires more safety stock.
• Lead time length: Longer lead times amplify the effect of demand variability.

The most common safety stock formula when demand is variable and lead time is constant is:

SS = z × σ_d × √LT

Where:
• z = the z-score (safety factor) corresponding to the desired service level (e.g., z = 1.65 for 95% service level, z = 2.33 for 99%)
• σ_d = standard deviation of demand per time period
• LT = lead time (constant, in the same time period as demand)

When both demand and lead time are variable, the formula becomes:

SS = z × √(LT × σ_d² + d² × σ_LT²)

Where:
• σ_LT = standard deviation of lead time
• d = average demand per period

This more complex formula accounts for the combined uncertainty of both demand and lead time.

The Complete ROP Formula

Putting it all together for the most common scenario (variable demand, constant lead time):

ROP = (d × LT) + (z × σ_d × √LT)

How the Continuous Review System Works: Step-by-Step

1. Set the order quantity (Q): Typically determined using the EOQ formula: Q = √(2DS/H), where D = annual demand, S = ordering cost per order, and H = holding cost per unit per year.

2. Calculate the Reorder Point (ROP): Using the ROP formula above, determine the inventory level that triggers a new order.

3. Monitor inventory position continuously: Inventory position = on-hand inventory + on-order inventory – backorders. Note that inventory position (not just on-hand) is compared to the ROP.

4. Place an order when inventory position ≤ ROP: When the inventory position drops to or below the reorder point, place an order for quantity Q.

5. Receive the order after lead time: The order arrives after the lead time period, replenishing stock.

6. Repeat the cycle: The system continues monitoring and reordering as needed.

Inventory Position vs. On-Hand Inventory

A critical distinction for the CPIM exam:

• Inventory Position = On-hand + On-order – Backorders – Committed/Allocated
• On-Hand Inventory = Physical stock currently available in the warehouse

The reorder point decision is based on inventory position, not just on-hand inventory. This prevents placing duplicate orders when a previous order is already in transit.

Continuous Review vs. Periodic Review Systems

Understanding the difference between these two systems is essential for the exam:

Continuous Review (Q-System):
• Inventory monitored continuously
• Fixed order quantity, variable order interval
• Reorder triggered at ROP
• Generally requires less safety stock
• Better suited for high-value (A-class) items

Periodic Review (P-System):
• Inventory reviewed at fixed time intervals
• Variable order quantity, fixed order interval
• Order-up-to level (target level) used instead of ROP
• Generally requires more safety stock (must protect over review period + lead time)
• Better suited for lower-value items or when ordering from same supplier

Worked Example

A company sells a product with the following characteristics:
• Average daily demand (d) = 50 units/day
• Lead time (LT) = 10 days (constant)
• Standard deviation of daily demand (σ_d) = 8 units/day
• Desired service level = 95% (z = 1.65)

Step 1: Calculate average demand during lead time
d × LT = 50 × 10 = 500 units

Step 2: Calculate safety stock
SS = z × σ_d × √LT = 1.65 × 8 × √10 = 1.65 × 8 × 3.162 = 41.74 ≈ 42 units

Step 3: Calculate ROP
ROP = 500 + 42 = 542 units

This means: when the inventory position drops to 542 units, a new order should be placed.

Key Relationships to Understand for the Exam

• Higher service level → Higher z-score → More safety stock → Higher ROP
• Greater demand variability → More safety stock → Higher ROP
• Longer lead time → Higher demand during lead time + More safety stock → Higher ROP
• Greater lead time variability → More safety stock → Higher ROP
• Reducing lead time → Reduces both average demand during lead time AND safety stock → Lower ROP
• Safety stock does NOT affect order quantity (Q); it affects when you order (ROP)

Common Assumptions in the Model

Be aware of the assumptions underlying the basic ROP model:
• Demand follows a normal distribution
• Lead time is known and constant (in the basic model)
• Orders arrive all at once (no partial shipments in the basic model)
• No quantity discounts are considered in the basic EOQ/ROP model
• Inventory is reviewed continuously

Practical Considerations

In real-world and scenario-based exam questions, consider:
• ABC Classification: Continuous review systems are often applied to A-items (high value) because they justify the cost of continuous monitoring
• Technology: Modern ERP and warehouse management systems make continuous review practical even for large numbers of SKUs
• Lumpy demand: The normal distribution assumption may not hold for items with intermittent or lumpy demand; other approaches (e.g., Poisson distribution) may be needed
• Dependent vs. independent demand: ROP is used for independent demand items; MRP is used for dependent demand items

Exam Tips: Answering Questions on Reorder Point and Continuous Review Systems

1. Memorize the key formulas: You must know ROP = d × LT + SS, and SS = z × σ_d × √LT. Practice calculating these quickly and accurately. Also know the combined variability formula for when both demand and lead time vary.

2. Watch the time units: A very common trap in exam questions is mismatched time units. If demand is given in units per week and lead time is in days, you must convert one to match the other before calculating. Always check this first.

3. Know your z-scores: The most commonly tested z-scores are: 90% = 1.28, 95% = 1.65, 97.5% = 1.96, 99% = 2.33, and 99.9% = 3.09. If a z-score table is provided, use it; if not, these values are typically expected knowledge.

4. Distinguish inventory position from on-hand: If a question asks whether to reorder, compare the inventory position (not on-hand) to the ROP. Remember: Inventory Position = On-hand + On-order – Backorders.

5. Understand the trade-offs: Many CPIM questions are conceptual. Be prepared to explain why increasing the service level increases safety stock and carrying costs, or why reducing lead time variability is often more impactful than simply increasing safety stock.

6. Don't confuse Q-system and P-system: Know which system uses ROP (continuous/Q-system) and which uses order-up-to level (periodic/P-system). Questions may describe a scenario and ask you to identify the system.

7. Remember that safety stock is about uncertainty: If there is no variability in demand or lead time, safety stock is zero and ROP = d × LT. Safety stock only exists to protect against variability. If a question states that demand and lead time are constant, do not add safety stock.

8. Apply the square root relationship: Safety stock increases with the square root of lead time, not linearly. This means doubling the lead time does NOT double the safety stock — it increases it by a factor of √2 (approximately 1.41). This is a frequently tested concept.

9. Read scenario questions carefully: Some questions will provide all the data you need; others will give you demand during lead time directly (rather than d and LT separately). Adapt your calculation accordingly. If given σ_DLT (standard deviation of demand during lead time) directly, then SS = z × σ_DLT.

10. Connect ROP to broader inventory strategy: Be prepared for questions that link ROP to total inventory costs, EOQ, service levels, ABC analysis, and supply chain strategy. The CPIM exam tests integrated understanding, not just formula recall.

11. Practice with different data formats: Some problems give weekly data, others daily or monthly. Some give annual demand. Practice converting between these formats so you can handle any presentation.

12. When in doubt, draw it out: Sketch a sawtooth inventory diagram showing the ROP level, lead time, safety stock, and order quantity. This visual can help you understand the relationship between variables and catch errors in your thinking.

Summary

The Reorder Point and Continuous Review System is a cornerstone of inventory management theory and practice. The system works by continuously monitoring inventory position and triggering a fixed-quantity order whenever that position reaches the reorder point. The ROP is calculated as average demand during lead time plus safety stock, where safety stock is determined by the desired service level and the variability of demand and/or lead time. Mastering both the quantitative calculations and the conceptual understanding of this system is essential for CPIM exam success and for effective inventory management in practice.