Page 115 - DMGT525_MATERIALS_MANAGEMENT

Materials Management

Notes 8.1.1 Holding (or Carrying) Costs

It costs money to hold inventory. Such costs are called inventory holding costs or carrying costs.
This broad category includes the costs for storage facilities, handling, insurance, pilferage,
breakage, obsolescence, depreciation, taxes, and the opportunity cost of capital. Obviously, high
holding costs tend to favour low inventory levels and frequent replenishment.

There is a differentiation between fixed and variable costs of holding inventory. Some of the
costs will not change by increase or decrease in inventory levels, while some costs are dependent
on the levels of inventory held. The general break down for inventory holding costs has been
shown in Table 8.1.

Table 8.1: 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

Source: Uddin. Jahir (2010). “Materials Management”. Excel Books Pvt. Ltd.

8.1.2 Cost of Ordering

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

 One component that is relatively fixed
 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:

Table 8.2: 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, 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

Source: Uddin. Jahir (2010). “Materials Management”. Excel Books Pvt. Ltd.
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

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