Tuesday, March 8, 2011

Inventory Cost

What is inventory cost?

Inventory cost is made up of the following factors

  1. The value of the money invested in inventory. 
  2. The value of the space and other costs associated with storing inventory.
    1. Square footage value or cost.
    2. Heat, light, racking, insurance, handling equipment.
    3. Unique storage requirements for certain materials. 
  3. The costs associated with the managing of the inventory.
    1. Systems, warehouse personnel.
  4. The costs associated with physical storage.
    1. Damage, Pilferage,
    2. Obsolescence,
    3. Shelf life expiration, or physical deterioration to the product.
  5. Potential depreciation in value of the materials
Each commodity will have its own inventory cost which is the combination of two things. The value or cost of money that is required to purchase the inventory plus the costs associated with 2 through 5 above.

Because of the high cost of Inventory attention has been placed on managing the supply chain to reduce the total cycle time and reduce the levels of inventory carried at the different points in the process.  You would also look at inventory cost in make / buy decisions as you need to take the cost of all the raw materials inventory into account in any "make" alternative.

In negotiating, there are two types of inventories you need to be concerned with. The first is inventory that is caused by the Supplier’s position on a number of things such as:

  • Lot sizes
  • Minimum order quantity.
  • Minimum purchase commitment.
  • Limitations on cancellation or rescheduling.
  • Extended lead times.
  • Forced end of life buys, etc.

 All are tactics that force you to purchase more products than you need and carry it in inventory. When a Supplier wants to try to force you to make these purchases, remind them of the fact that it will add the inventory carrying cost to the amount of the purchase, and that may make them no longer competitive.

The second type of inventory cost you need to be concerned is just as important and can be even more substantial. This is the inventory that is driven by the Supplier’s performance. For example:
If the supplier ships short, late, or inconsistently or the supplier has a quality problem
It requires you to carry increased safety stock inventory
In there are warranty failures or reliability problems
It requires you to carry increased spare parts inventory
If there are delays in getting products replaced when needed
It requires a higher safety stock or spare parts inventory

Anything that forces you to carry more inventory, adds to your cost. In negotiating with Suppliers the approach should be that the price you pay is based on the assumption that they will meet the committed levels of performance.  If your costs increase because off their problems, they need to either correct the problem or reduce their price to offset those increased costs.