Page 238 - DMGT501_OPERATIONS_MANAGEMENT

Operations Management

Notes

Fixed and Variable Holding Costs
Fixed costs Variable cost
Capital costs of warehouse or store Cost of capital in inventory
Cost of operating the warehouse or store Insurance on inventory value
Personnel costs Losses due to obsolescence, theft, spoilage
Cost of renting warehouse or storage space
9.2.2 Cost of Ordering

Although it costs money to hold inventory, it also, unfortunately, necessary to replenish inventory.
These costs are called inventory ordering costs. Ordering costs have two components:

1. One component that is relatively fixed, and
2. Another component that will vary.

It is good to be able to clearly differentiate between those ordering costs that do not change much
and those that are incurred each time an order is placed.

The general breakdown between fixed and variable ordering costs is a follows:

Fixed and Variable Ordering Costs

Fixed costs Variable costs
Staffing costs (payroll, benefits, etc) Shipping costs

Fixed Costs on IT systems Cost of placing and order (phone, postage, order forms)
Office Rental and equipment costs Running costs of IT systems

Fixed Costs of Vendor Development Receiving and inspection costs
Variable Costs of Vendor Development

One major component of cost associated with inventory is the cost of replenishing it. If a part
or raw material is ordered from outside suppliers, and orders are placed for a given part with
its supplier three times per year instead of six times per year, the costs to the organization that

would change are the variable costs, generally not the fixed costs.
There are costs incurred in maintaining and updating the information system, developing
vendors, and evaluating capabilities of vendors. Ordering costs also include all the details, such
as counting items and calculating order quantities. The costs associated with maintaining the
system needed to track orders are also included in ordering costs. This includes phone calls,
typing, postage, and so on.
Though vendor development is an ongoing process, it is a very expensive one. With a good
vendor base, it is possible to enter into longer-term relationships to supply needs for perhaps the
entire year. This changes the “when” to “how many to order” and brings about a reduction both
in the complexity and costs of ordering.

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