In marketing, carrying cost, carrying cost of inventory or holding cost refers to the total cost of holding

inventory Inventory (American English) or stock (British English) refers to the goods and materials that a business holds for the ultimate goal of resale, production or utilisation. Inventory management is a discipline primarily about specifying the sha ...

. This includes warehousing costs such as rent, utilities and salaries, financial costs such as

opportunity cost In microeconomic theory, the opportunity cost of a particular activity is the value or benefit given up by engaging in that activity, relative to engaging in an alternative activity. More effective it means if you chose one activity (for example ...

, and inventory costs related to perishability, ''shrinkage'' ( leakage) and insurance. Carrying cost also includes the

of reduced responsiveness to customers' changing requirements, slowed introduction of improved items, and the inventory's value and direct expenses, since that money could be used for other purposes. When there are no transaction costs for shipment, carrying costs are minimized when no excess inventory is held at all, as in a Just In Time production system. Excess inventory can be held for one of three reasons. Cycle stock is held based on the re-order point, and defines the inventory that must be held for production, sale or consumption during the time between re-order and delivery. Safety stock is held to account for variability, either upstream in supplier lead time, or downstream in customer demand. Physical stock is held by consumer retailers to provide consumers with a perception of plenty. Carrying costs typically range between 20 and 30% of a company's inventory value.

Definitions

The cost consists of four different factors: # The expenses of putting the inventory in storage #Salary and wages of workers #Maintenance in the long term #All utilities used in carrying the storage Moreover, the carrying cost will mostly appear as a percentage number. It provides an idea of how long the inventory could be held before the company makes a loss, which also tells the manager how much to order.

Why do companies hold inventory

Inventory is a property of a company that is ready for them to sell. There are five basic reasons that a company would need inventory. 1. Safety inventory This would act like a buffer to make sure that the company would have excess products for sale if consumer demands exceed their expectation. 2. Cater to Cyclical and Seasonal Demand These kind of inventory are use for predictable events that would cause a change in people's demand. For example, candy companies can start to produce extra sweets that have long duration period. Build up seasonal inventory gradually to match people's sharply increasing demand before Halloween. 3. Cycle inventory First of all, we need to go through the idea of economic order quantity (EOQ). EOQ is an attempt to balance inventory holding or carrying costs with the costs incurred from ordering or setting up machinery. The total cost will minimized when the ordering cost and the carrying cost equal to each other. While customer order a significant quantities of products, cycle inventory would be able to save cost and act as a buffer for the company to purchase more supplies. 4. In-transit Inventory This kind of inventory would save company a lot transportation cost and help the transition process become less time-consuming. For example, if the company request a particular raw material from overseas market. Purchase in bulk will save them a lot transportation cost from overseas shipment fees. 5. Dead Inventory Dead inventory or dead stock is consisting of different kinds of products that was outdated or only a few consumer requests this kind of product. So manager pulled them from store shelves. To reduce costs of holding this kinds of products, company could hold discount events or imply price reduction to attraction consumers attentions.

Ways to reduce carrying cost

Most businesses see profit maximizing as their primary objective. In order to reach higher profit here are some methods of reducing carrying cost. 1. Base the amount of stock held on the economic situation: The amount of stock held should be changed with consumers' demand, the situation of the industry and the

exchange rate In finance, an exchange rate is the rate at which one currency will be exchanged for another currency. Currencies are most commonly national currencies, but may be sub-national as in the case of Hong Kong or supra-national as in the case of t ...

of the currency. When the economy is in

recession In economics, a recession is a business cycle contraction when there is a general decline in economic activity. Recessions generally occur when there is a widespread drop in spending (an adverse demand shock). This may be triggered by various ...

or the currency depreciates, residents’

purchasing power Purchasing power is the amount of goods and services that can be purchased with a unit of currency. For example, if one had taken one unit of currency to a store in the 1950s, it would have been possible to buy a greater number of items than would ...

would decrease. 2. Improve the layout of the warehouse: Instead of renting a new place, the manager might consider about the idea of rearrange the layout of the warehouse that they owned. An inefficient layout may increase the

risk In simple terms, risk is the possibility of something bad happening. Risk involves uncertainty about the effects/implications of an activity with respect to something that humans value (such as health, well-being, wealth, property or the environm ...

of shipping the wrong products to consumers this would both increase transportation cost and become time-consuming. To improve the layout the company could either increase the reception area or apply segmentation. This will reduce the cost as well as increase labour's

productivity Productivity is the efficiency of production of goods or services expressed by some measure. Measurements of productivity are often expressed as a ratio of an aggregate output to a single input or an aggregate input used in a production proces ...

! 3. Build long-term agreements with suppliers: Signing long-term contract with suppliers may increase the supplier's financial security and the company may receive a lower price. This will become a win-win situation. Also the supplier might be willing to decrease the time period of delivery their products to the warehouse, for example from once a month to once a week. Hence, the company would be able to switch to a smaller warehouse, as they don't need to stock that much products at a time. Furthermore, this would also reduce the risks of loss and depreciation of the products. 4. Creating an effective database: The database should include things like retailer, date, quantity, quality, degree of advertising and the time taken until sold out. This will make sure that the future employees can learn from the past experience while making decisions. For example, if the manager want to hold a big discount event to clear the products that have been left in stock for a long time. Then he can go through the past data to find out if there is any event like this before and how was the result. The manager would be able to forecast the budget and make some improvements base on the past events’ record.

References

{{Reflist Inventory optimization Costs

Definitions

Why do companies hold inventory

Ways to reduce carrying cost

See also

Further reading

References