A shorter lead time lowers the reorder point by weeks of demand, but stock on hand barely moves unless the supplier's spread shrinks too. The money is in the pipeline, and only on the right delivery terms.
Almost none of it comes off the warehouse shelf: the stock freed is pipeline, and only if you own it in transit. For part AF-7, cutting the mean lead time from 6 to 4 weeks lowers the reorder point by 3,800 units, but safety stock falls by only 120 units, while 3,680 units of pipeline stock, 105,248 EUR, disappear if the buyer owns the goods from dispatch. That is worth 11,479 EUR a year; on delivered terms, where the supplier owns the goods in transit, it is worth 638.
Worked in full in Supply Chain Management by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
Nearshoring, a faster lane or a supplier with spare capacity are usually sold on "weeks of inventory saved". The claim mixes three different stocks: the stock on hand, the stock on the water, and the stock on order. Only the first two cost money to hold, and a shorter mean lead time affects them very differently.
AF-7 is the filter element followed through the book. The split of the lead time into production and transit, and the delivery term, are added here for illustration.
| Input | Value |
|---|---|
| Mean weekly demand / standard deviation | 1,840 / 462 units |
| Lead time today: mean / standard deviation | 6 / 1.9 weeks |
| Of which production at the supplier / in transit (added) | 2 / 4 weeks |
| Title passes at dispatch, FOB (added) | yes |
| Lead time offered | 4 weeks, 2 in transit |
| Unit cost / order quantity | 28.6 EUR / 4,385 units |
| Holding rate: capital 7.4%, storage 3.1%, obsolescence 2.25%, insurance 0.65% | 13.4% |
| Holding rate in transit, no storage | 10.3% |
| Cycle service level / z | 98% / 2.0537 |
1. Safety stock. It depends on the spread of demand over the lead time, not on its mean:
σLT = √(L × σd² + d² × σL²)
6 weeks: √(6 × 462² + 1,840² × 1.9²) = 3,674.60; safety stock 2.0537 × 3,674.60 = 7,547 units
4 weeks: √(4 × 462² + 1,840² × 1.9²) = 3,616.05; safety stock 7,426 units
Excel: =NORM.S.INV(0.98)*SQRT(L*462^2+1840^2*1.9^2)
The mean lead time only touches the demand term, which is 9.5 per cent of the variance. The supplier's spread, the other 90.5 per cent, is untouched, so two weeks less lead time saves 120 units, 1.6 per cent.
2. Pipeline stock. Goods the buyer owns but cannot sell yet:
Pipeline = weekly demand × weeks in transit owned
Today: 1,840 × 4 = 7,360 units, 210,496 EUR
Offered: 1,840 × 2 = 3,680 units, 105,248 EUR
It is charged at 10.3 per cent, not 13.4, because goods on a ship do not occupy a warehouse. The 105,248 EUR released saves 10,841 EUR a year.
3. Cycle stock. Half the order quantity, 2,192 units, is set by order cost and holding cost and does not depend on the lead time at all.
4. The reorder point. Demand over the lead time plus safety stock: 11,040 + 7,547 = 18,587 today, 7,360 + 7,426 = 14,786 after. It falls by 3,800 units, but it is compared with stock on hand plus stock on order; the planner orders later, not less.
| Line | 6 weeks | 4 weeks | Freed |
|---|---|---|---|
| Cycle stock | 2,192 | 2,192 | 0 |
| Safety stock | 7,547 | 7,426 | 120 |
| Pipeline, owned in transit | 7,360 | 3,680 | 3,680 |
| Inventory owned, EUR | 489,030 | 380,343 | 108,687 |
| Holding, EUR a year | 59,005 | 47,703 | 11,301 |
| Lost margin on shortages, EUR a year | 11,129 | 10,952 | 177 |
| Annual saving, EUR | 11,479 |
Of the 108,687 EUR released, 97 per cent is pipeline. The annual saving is 0.12 EUR a unit on 95,680 units: the most the buyer could pay for the shorter lead time, all else equal, before the faster route destroys value.
A shorter route often brings a more regular one. If the lead-time standard deviation falls in proportion to the mean, from 1.9 to 1.27 weeks at 4 weeks, safety stock drops to 5,149 units and the saving doubles.
| Lead time | Safety stock, spread unchanged | Safety stock, spread in proportion | Pipeline, units | Saving a year, spread unchanged | Saving a year, in proportion |
|---|---|---|---|---|---|
| 6 weeks (today) | 7,547 | 7,547 | 7,360 | 0 | 0 |
| 5 weeks | 7,487 | 6,348 | 5,520 | 5,738 | 11,780 |
| 4 weeks | 7,426 | 5,149 | 3,680 | 11,479 | 23,565 |
| 3 weeks | 7,366 | 3,948 | 1,840 | 17,222 | 35,358 |
| 2 weeks | 7,304 | 2,744 | 0 | 22,968 | 47,170 |
With the spread unchanged, each week cut is worth about 5,740 EUR a year, almost all of it pipeline. Narrowing the spread is the bigger lever: keeping the 6-week mean and taking the standard deviation to 0.5 weeks frees 4,551 units of safety stock, 130,171 EUR, more than the whole 4-week offer. That trade-off is priced in how much more you can pay a reliable supplier.
Counting the fall in the reorder point as inventory released without asking where it sits. The 3,800 units are mostly stock on order: they were never in the warehouse, and the 1,840 a week that arrive under the new lead time are the same 1,840 that arrived under the old one. Valued at 28.6 EUR, the claim is 108,680 EUR. On FOB terms it happens to match the release, because the whole cut comes out of transit the buyer owns. On delivered terms the same change frees only 120 units of safety stock and 638 EUR a year, and so does a cut taken out of the supplier's production time, where the buyer owns nothing.
Check the delivery term before counting pipeline stock. Under DAP or DDP the supplier owns the goods until they arrive, and a shorter transit saves the supplier money, not you. That is a point to negotiate on price, not a working-capital gain to book.
The variance split behind step 1 and the full part data are in the free workbook for this case.
Pipeline inventory is stock you own but cannot use yet because it is in transit. It equals demand per period times the periods in transit: for AF-7, 1,840 units a week times 4 weeks at sea is 7,360 units, 210,496 EUR at 28.6 EUR. It counts only if title passes to you at dispatch; on delivered terms the supplier carries it.
Only a little when the lead time is erratic. Safety stock depends on the spread of demand over the lead time, and for AF-7 90.5 per cent of that variance comes from the 1.9-week lead-time standard deviation, which a shorter mean does not change. Going from 6 to 4 weeks cuts safety stock from 7,547 to 7,426 units.
The reorder point is compared with stock on hand plus stock on order, so it includes the demand expected during the lead time. Two weeks less lead time removes 3,680 units of that, and the reorder point drops by 3,800 units, from 18,587 to 14,786. Almost all of the drop is stock on order, not stock in the warehouse.
This article is one calculation from Supply Chain Management. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
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