Inventory holding costs measurement

Inventory Holding Costs Measurement: A Multi-Case Study

ByPushpesh Pant, Atanu Dey,

Sandeep Kr. Singh, Rahul Mondal

A Presentation on

© 2017 by Pushpesh Pant

05/03/2023 2

Flow of Presentation• Introduction• Scopes & Objectives• Methodologies– Approach-A– Approach-B

• Result & Discussion• References

ISE | IIT Kharagpur.

05/03/2023 ISE | IIT Kharagpur. 3

Introduction• Holding cost is money spent to keep and maintain a stock

of goods in storage.

• Holding costs include rents for required space, equipment, material; insurance; security; cost against depreciation etc.

• Total inventory carrying cost computation is a relevant factor in several situations, i.e. in warehouse investment decisions and in any situation in which efficient inventory management is a priority (Cattani et al., 2011).


Cont…• For inventory theorists and practitioners, it is common

practice to include in the holding cost rate an opportunity cost rate by applying the discounted cash flow approach. Such approach allows roughly incorporated the cost of capital in an average cost (AC) inventory model (Grubbstrom, 1980).

• Inventory costs extend well beyond the capital cost of materials, including both evident and hidden costs, which means out-of-pocket holding costs (Knod, 1997).


• Common assumption that the holding cost parameter is a constant and is expressed as a percentage of the product value. This approach is based on the assumption that capital cost makes up most of the cost (Singhal, 1990).

• Berling and Rosling (2005) suggests a computation method based on an activity-based costing concept, where cost drivers are the amount of activity used to store one unit of product.

• Alfares (2007) considers storage-time dependent holding cost, where cost is an increasing function of the time spent in storage. This approach is definitely suitable in case of deteriorating and perishable items such as food, but might not necessarily work in different situations.

Cont…


Scopes and Objective• Warehouse activities get progressively more automated

(AS/RS), the need for specific guidelines to measure holding costs becomes more urgent.

• Automated warehouses are different from traditional manual or semi-automated warehouses, where costs are mostly linked to labor and other variable costs.

• To present a multiple case study to explore the cost variables included in the inventory carrying cost computation in various contextual settings, and derive useful suggestions and considerations for practical application.


Cont…

• To illustrate the inventory holding cost rate computation, when different kind of warehousing systems are applied.

• To understand how the holding cost parameter is currently computed by industrial managers.

• How much the difference between manual and automated/automatic warehousing systems impacts on the inventory cost structure definition.


Methodology• Ten different Italian SMEs (located in the north-east part

of the country) are directly studied in order to define all costs associated to inventories and measure total inventory carrying costs.

• Subdivided in two different working groups: the five companies operating with traditional manual warehousing systems in one group, and the five companies with highly automated warehousing environments in the second group.

• Operation managers and executives involved by the authors for brainstorming to identify the most important influencing variables due to measure the total cost of holding inventories.


• Ten participants were involved, one for each company engaged in the study.

• Group turned out to be pretty heterogeneous in terms of age, experience and length of service.

• Session was lead by a facilitator, which is one of the author; other two authors played a secretary role, grabbing and writing down ideas and opinions coming out along the session.

• The session lasted about three hours; after the session each participant was asked by the facilitator to list the most important influencing variables due to measure the total cost of holding inventories.

Cont…


• It helps in identification of two different perception of cost structure for manual and automatic warehousing.

• Results from brainstorming were used by two different working groups: – The first related to the five companies operating with traditional

manual warehousing systems.– The second one related with highly automated warehousing

environments.• Figure 1 shows the framework of multi-case analysis.

Cont…


Figure 1


• Three kinds of influencing variables have been taken into account during the group discussions:

1. Expert opinion on inventory cost computation and cost structures which consist mainly of three items: initial investment on a warehousing system, system operating costs, directly linked to all daily warehousing activities and financial risk related to the monetary value.

2. Type of warehousing system use in the company: manual warehousing, automated warehousing and automatic warehousing.

3. Future mission of the company and operation managers, needs.


Approach A

• Manual warehouse is considered.• Cost structure is subdivided in three parts: evident costs,

semi-evident costs and hidden costs.• Part of the total inventory costs are easily quantifiable,

and most of them are sunk and hidden in other costs, not directly attributable to inventories.

• In several manual warehousing systems, semi-evident and hidden costs play a relevant role in estimating the global costs and for this reason they must be accurately estimated and correctly allocated to the storage system.

Cont./-

Cont…



Approach B• Automated warehouse is considered.• Automated warehousing provides several advantages, like

the elimination of machine operators, reduction in floor space utilization, and higher return on investment, without taking into account, reduced training times, higher inventory security and less product damage.

• In automated and automatic warehousing systems operational costs are additionally reduced with the introduction of standard PC-based supervisory control, which provides higher accuracy than bar code systems usually adopted in manual environments.

• Well-integrated Warehouse Management System Software (WHMS), reduces product deterioration and its connected expenses.

Cont…


• Cost structure is subdivided only into two parts: investment and operating costs. Capacity costs reflect the total amount of storage capacity purchased (and not always utilized) in the medium-long period, and cannot be modified during the year.


• In Approach B, the total storage costs are expressed as a ratio of the storage capacity of the systems (in other words, the number of pallet positions/SKUs available in the medium-long term).

• Obsolescence costs have been approximated to zero under the assumption of a higher inventory turnover.

• Opportunity costs should be calculated in the same way as for the Approach A and expressed as a percentage of the pallet/unit value stored in the warehouse, but are not directly added to the storage cost portion.

Cont…


Result & Discussion• The main findings of the first empirical analysis focussed on

manual warehousing systems are followings:

– Inventory holding cost parameters range between a minimum of 21.9 and a maximum of 32.9 percent of the inventory value on hand.

– It seems almost impossible to reach standard percentage ranges for each cost. Holding costs should not always be based on industry averages, but calculated case by case in accordance with specific business and warehousing system.

– Semi-evident and hidden costs are equal or even higher than evident costs.


Cont…• The finding in the second empirical analysis focussed on

AS/RS warehousing systems the following:

– The annual storage cost parameter ranges between 34.8 and 70.8 per pallet position as inverse function of the warehouse storage capacity.

– Annual investment costs represent about the 85 percent of total annual storage costs.

– The use of standard ranges of variation for each cost seems justified.


Appendix




Reference• Alfares, H.K. (2007), “Inventory model with stock-level dependent demand rate and variable

holding cost”, International Journal of Production Economics, Vol. 108 Nos 1-2, pp. 259-265.• Azzi, A., Battini, D., Faccio, M., Persona, A. and Sgarbossa, F. (2011), “Innovative travel time

model for dual-shuttle automated storage/retrieval systems”, Computers & Industrial Engineering, Vol. 61, pp. 600-607.

• Clendenen, G.W. and Rinks, D.B. (1996), “The effect of labour costs holding costs and uncertainty in demand on pull inventory control policies”, Int. Journal of Production Research, Vol. 34, pp. 1725-1738.

• Gaither, N. (1996), Production and Operations Management, Duxbury Press, Belmont, CA.• Grubbstrom, R.W. (1980), “A principle for determining the correct capital costs of work in

progress and inventory”, Int. Journal of Production Research, Vol. 18, pp. 250-271.• Harris, E.W. (1990), “How many parts to make at once”, Operations Research, Vol. 38, pp.

947-950.• Lee, H.L. and Billington, C. (1992), “Managing supply chain inventory: pitfalls and

opportunities”, Sloan Management Review, Spring, Vol. 33 No. 3, pp. 65-73.

