Page 155 - DMGT523_LOGISTICS_AND_SUPPLY_CHAIN_MANAGEMENT

Logistics and Supply Chain Management

Notes What are the costs identified with inventory? The costs generally associated with inventories
are shown in Figure 7.2 and each component of this cost is described below.

Figure 7.2: Total Inventory Costs
600

500
Cost of Stocking a Material ( `) 300 Total Inventory Total Inventory Costs
400
Minimum
Costs
Carrying Costs
200

100 Stock-out Costs
Procurement Costs/Set-up Costs
EOQ
0 200 400 600 800 1000
Source: Upendra Kachru, (2010), “Exploring the Supply Chain,” Excel Books

7.2.1 Average Inventory

Average inventory is defined as half the batch size plus safety stock.

Average inventory = (Order quantity + Safety stock)/2
The assumption made is that at any point in time, the cycle stock (stock planned to be used
excluding safety stock) is on an average half the recipient quantity i.e. it is half-way in-between
the receipt quantity and zero left. The practical implication of this is that it reduces order
quantity and the average cycle stock by half. If a part is manufactured in smaller batches, the
inventory goes down.

Notes Safety stock is determined from such factors as customer service level required,
demand variability and replenishment lead-time. Once the customer service level required
is agreed upon, safety stock is calculated.

7.2.2 Holding (or Carrying) Costs

The very fact that an item is held in stock accrues cost. These are the real costs to hold inventory.
Such costs are called inventory holding costs or carrying costs. This broad category includes the
costs for:
 Storage and Handling: This includes the total warehousing facility. This is typically 6
percent. It is estimated that the total cost to the company is 35 percent per annum of the
value of inventory held, or 3 percent a month.
 Insurance: Insurance accounts for a portion of the inventory costs. Since it is better to be
safe than sorry, companies generally get the material insured. It generally works out to 1
percent.

 Pilferage and Spoilage: This accounts for anything from 2 percent upwards, depending on
the industry and the type of inventory that is being carried.

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