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A Methodology for Calculating Inventory Carrying Costs
Abstract
Inventory carrying costs represent one of the highest costs of distribution. Although they are a necessary input to the design of logistical systems, such costs are ignored by many companies and when they are used usually represent estimates or industry benchmarks. The authors present a methodology designed to provide managers with a practical framework for determining the costs of carrying inventory.
... Obviously, logistics processes influence each of these costs, i.e. inventory carrying costs depends on activities like inventory management, packaging, reverse logistics, etc. (Lin et al., 2001). Order processing related to costs to issue and close orders (La Londe and Lambert, 1977). While procurement is the cost to purchase the necessary components/raw materials or services to ensure that the logistics activites will be correctly operating. ...
... Warehousing costs are different from inventory carrying costs and can change depending whether the warehouse is leased or owned. If owned, warehousing costs can be considered as a combination of throughput and storage costs (La Londe and Lambert, 1977). Storage costs should be part of inventory carrying costs. ...
... Concerning manufacturing, this activity includes costs like depreciation value of machines, labor, maintenance and rework costs (Beamon, 1999). Furthermore, other important costs to examine include set up and preparation of production lines (La Londe and Lambert, 1977). Finally, distribution costs can be assigned to individual functions that take place in distribution, hence warehousing, handling, storing and transportation (Beamon, 1999). ...
The circular economy promotes the reuse of waste and recycling processes in agroindustry. Literature has focused on the development of frameworks related to the evaluation of environmental improvements brought by the biomass and biofuel supply chains. However, there is still a gap related to comprehensively understanding the costs of these supply chains. In this paper, the concept of Integrated Biomass Logistics Centers (IBLCs), developed in a European research project, is framed into a supply chain recycling wastes frm the agricultural sector and producing bio-commodities and/or intermediate bio-based feedstocks. In particular, this study, by using SCOR and Activity Based Costing, proposes an integrated framework to comprehensively evaluate costs of IBLCs' supply chains.
... In contrast to SCF, stock keeping has been discussed by researches and practitioners for many years and literature on this topic is multifaceted. Various authors provide an overview on different costs and risks related to stock keeping (La Londe and Lambert, 1977;Nyen et al., 2007;Olayinka, 2010). However, these studies mainly address the material flow and handling. ...
... Publications on stock keeping risks are very scarce. Although material related risks, such as damage, pilferage, relocation, and obsolescence (La Londe and Lambert, 1977), are sporadically considered in inventory management literature, a holistic overview, especially on financial risks, is missing. Whereas inventory management literature mainly focused on how to reduce the stock keeping costs by optimizing order quantities considering various aspects (e.g., demand uncertainty (Gupta and Maranas, 2003), general investment risks (Cachon, 2004), the value of cooperation (Cachon and Zipkin, 1999)), just few studies have considered financing and the risk transfer related to financing as a degree of freedom. ...
Due to the increasing worldwide competition and the desire to enter new markets, a growing number of manufacturers have to cope with globally dispersed customer and supplier networks. Not only does the globalization cause an increased number and complexity of buyer-supplier relationships, extended lead times, and supplementary inventory buffers, but also higher capital commitments and increased financial risks. However, the allocation of these additional costs and risks along the supply chain is often found to be suboptimal from a supply chain perspective. A collaborative strategy on how to distribute the financial burden and risks along the supply chain optimally would both enhance supply chain stability and reduce the overall supply chain costs. Although various concepts are discussed in literature, an overview on potential benefits and risks to be addressed is so far missing. Hence, the purpose of this paper is to inform upon the key factors to be considered when collaboratively financing inventories, and on how these factors correlate. Identifying the different conditions that enable or restrict the application of supply chain finance in practice, the paper provides valuable insights for both, researchers and practitioners.
... The first type is the costs of holding inventory that increase with inventory levels. Inventory holding costs include investment opportunity costs, physical storage costs, staffing costs, inventory service costs (e.g., insurance and taxes) and inventory risk or depreciation costs (e.g., obsolescence or theft of inventory) (La Londe & Lambert, 1977). The second type is stockout costs, which are high when the inventory levels are low, or the sales levels (and thereby target inventory levels) are high. ...
We study the role of inventory in corporate resilience to Covid‐19 in 2020, which triggered exogenous shocks to consumer demand, commodity prices and supply chains. Unexpected drops in consumer demand and commodity prices increase the costs of inventory. Conversely, inventory holdings can buffer against supply disruptions. Empirically, US firms with higher inventory experienced more negative stock market responses early in the crisis due to falling consumer demand. However, since May 2020, inventory has become valuable as a hedge against supply disruptions, improving firm performance. During Covid‐19, unlike other crises, inventory played a unique role as a hedge against supply disruptions.
... Thus, departments that are credit prone have a larger inventory investment than is indicated by the GMROI formulation and contribute less to the financial performance of the organization. LaLonde and Lambert (1977) have examined four components of inventory carrying costs: (1) capital c~sts, ...
A residual income analysis (RIA) approach for planning and evaluating the efficacy of merchandising decisions is developed in this paper. This approach is an improvement on the familiar and popular gross margin return on investment (GMROI) criterion, since it rectifies the weaknesses while retaining the strengths inherent in the latter. The applications of RIA for allocating funds and for evaluating merchandising decisions are discussed and illustrated.
... Furthermore, there are other aspects of inventory holding costs that are used in practice like storage space, equipment and overhead (Anonymous, 2005). The most extensive list is proposed by La Lambert (1975 and1977) who propose the aspects mentioned by Silver et al., Anonymous and Timme and Williams-Timme. To minimize the costs of spare part procurement it is important to accurately determine the inventory holding costs per part. ...
“Push” marketing strategies can create additional profit opportunities within the marketing channel. This paper describes a method that provides marketing managers with information on the profit impact of various marketing mix strategies. A study is described in which high yield “push” strategies are identified.
After studying this chapter, you should be able to:
justify which costs are relevant and should be included in the calculation of the economic order quantity (EOQ);
calculate the EOQ using the formula and tabulation methods;
determine whether or not a company should purchase larger quantities in order to take advantage of quantity discounts;
calculate the optimal safety stock when demand is uncertain;
describe the ABC classification method;
explain just-in-time purchasing and list the benefits arising from adopting JIT concepts.
Numerous organizations are currently facing inventory management problems including distributing inventory on time and maintaining the appropriate inventory level to satisfy the end user. Organizations understand the importance of inventory accuracy as any error will increase the purchasing and holding costs affecting investment decisions. Lack of information about effective measures that will allow management to make important business decisions motivated this research to identify a decision criterion for warehouse management. A feasible solution of calculating the carrying cost ratio from purchasing and holding cost is the main objective of this thesis. The carrying cost ratio will allow managers to make critical decisions on supply-chain management. Similar to the carrying cost ration, this thesis also provides a methodology for warehouse management using inventory turns that can be used to identify obsolete inventory. Friedman’s Rank test was performed to validate the decision using primary turns for the dataset obtained from a local hospital. Recommendations have been made to the hospital to facilitate their supply chain that will result in the reduction of excessive inventory. A reduced carrying cost ratio demonstrates consolidating commodities into fewer facilities. The future benefits for the current organization include a reduce building and facility costs, decrease in annual operating budgets, reduction in warehouse operational cost, improvement in labor productivity, warehouse space utilization, and establish performance measures. In conclusion, findings from this research will allow organization to move towards the one-echelon model known as Just-In-Time (JIT) system.
Over the past six decades, numerous analytical models have been developed to determine optimal inventory levels. These models predict that inventories carried by a retailer should be a function of the product variety carried by the retailer, distribution system characteristics, economies of scale, etc. A few recent empirical studies have explored the impact of some of these factors on aggregate inventories at U.S. retailers. Building on these works, this study empirically explores the role of key factors such as product variety, number of stores, and number of warehouses in explaining inventory levels at U.S. retailers using data obtained from both primary and secondary sources. We find that variety as measured by the number of stock-keeping units carried and number of stores is associated with higher inventories, whereas scale economies are associated with lower inventories. We do not find the number of warehouses to be significant in explaining inventory levels. Increased demand fluctuations are also associated with higher inventories, although the effects are less robust. The significant variables together with retailer segment identifiers explain a substantial fraction of the variance in inventory levels and can be potentially useful to managers in benchmarking their inventory levels.