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Lead Time Definition & Formula | What Is Lead Time?

By
Joshua Weatherwax
Table of Contents

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 act 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. Read on to learn what exactly lead time is, how to calculate it, and some ways you can keep yours low and grow your sales. It's an important part of our inventory control guide and a vital metric for any successful order management specialist.

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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.

Product Lead Time

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. This essentially starts the clock on production and is the first important number when measuring lead time. Any actions taken between ARO and the delivery of goods are a part of the lead time for that order.

Why Long Lead Time Is Bad

Long lead time can cause a number of problems that interfere with a business being able to fulfill orders. No matter where a business is in the supply chain, lead time issues are a headache. With uncontrolled lead time, it is impossible to ensure you purchase the optimal economic order quantity.

For retailers, long lead time means a loss of sales and angry customers. On the manufacturing front, 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 fulfillment capability. The most important factor when trying to reduce lead time is to look 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 issues with your supplier. If they can’t get it under control, it may be time 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 goods you need. 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 amount of 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.
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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, 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 lead time formulas from above, let's take a look at an example of how to calculate lead time. For this, we'll be a food producer looking to calculate their lead time for an order of 1000 cans of tuna.

First, we can look at previous data the company has 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. This can be estimated based on previous shipments or an external shipping company will provide it. Here we'll say it will take one week to ship.

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

We discover 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.

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Take Us to Your Leader

Uncontrolled lead times can have drastic effects on a business. From loss of sales to halted production runs, keeping lead times minimal can save a business thousands of dollars. The most important thing for anyone trying to manage inventory is to track average lead times and act quickly when any variances are found.

Using the inventory tracking tools and formulas above and doing a regular inventory audit, you can keep your business operating smoothly, avoid surprise inventory shrinkage, and focus on increasing sales and revenue.

Frequently Asked Questions About Lead Time

Lead time is one of the most difficult 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 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 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 the following: a buyer is informed of their company’s production deadline in six weeks. They research suppliers and find one that has a lead time of two to two and a half weeks. This gives them enough time to place the order, have the products arrive, and finish production with a couple days of time to spare. 

What is lead time in EOQ model?

Lead time is rarely accounted for in the economic order quantity (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 amount of 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 lower value or less time inventory spends in transit, the less it costs. The higher value or more time inventory spends being shipped, the greater it costs. 

For example, 15 units of a product that’s only in transit for a week has a much lower in transit cost than 500 units of a product that’s in transit for three weeks. Lead time has a direct relationship with expense, because the more time passes between ordering materials and selling the products, the more it costs you.