Page 157 - DMGT523_LOGISTICS_AND_SUPPLY_CHAIN_MANAGEMENT

Logistics and Supply Chain Management

Notes Inventory Ordering Costs are those costs that are incurred in the purchase cycle are called
procurement costs or inventory ordering costs. Ordering costs have two components:
(a) One component that is relatively fixed, and

(b) Another component that will vary.
Table 7.2: 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,
 Office rental and equipment costs order forms)
 Fixed costs of vendor development  Running costs of IT systems
 Receiving and inspection costs
 Variable costs of vendor development

Source: Upendra Kachru (2010), “Exploring the Supply Chain,” Excel Books

The fixed and variable components of the ordering or procurement costs are shown in Table 7.2.
Referring back to Figure 7.2, it will be seen that inventory ordering costs decrease increasingly
with the increase in inventory. This can be explained if we are able to clearly differentiate
between those ordering costs that do not change much and those that are incurred each time an
order is placed.
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 places orders 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, and which would probably not are the fixed costs.
There are costs incurred in maintaining and updating the information system, developing
vendors, 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.

Did u know? Though vendor development is an ongoing process, it is also a very expensive
process. 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.
Clearly, the fixed costs related to procurement or order placement are significantly greater than
the variable costs associated with placing orders.
7.2.4 Setup (or Production Change) Costs

Ordering costs are incurred in the purchase cycle, while set-up costs are incurred in the
manufacturing cycle. Therefore the set-up cost is actually represented by the inventory ordering
costs. These two costs are considered to be exclusive.
For manufactured items, the equivalent cost is known as Set-Up. In the case of subassemblies, or
finished products that may be produced in-house, the costs associated with changing
over equipment from producing one item to producing another is usually referred to as setup
costs.

152 LOVELY PROFESSIONAL UNIVERSITY