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

inventory Inventory (British English) or stock (American English) is a quantity of 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 ...

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

opportunity cost In microeconomic theory, the opportunity cost of a choice is the value of the best alternative forgone where, given limited resources, a choice needs to be made between several mutually exclusive alternatives. Assuming the best choice is made, ...

, and inventory costs related to perishability, shrinkage, 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 Safety stock is a term used by logistics, logisticians to describe a level of extra inventory, stock which is maintained to mitigate the risk of stockouts, which can be caused, for example, by shortfalls in raw material availability or uncertainty ...

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, or upkeep,Harding, M. L.
Calculating the Carrying Cost of Inventory
89th Annual International Supply Management Conference, April 2004, accessed 31 May 2024 during the inventory period #All utilities used in carrying the storage. Costs associated with staff whose roles are mainly concerned with inventory, including inventory managers and controllers, stockkeepers, material handlers and cycle counters, should be included. The carrying cost usually appears as a

percentage In mathematics, a percentage () is a number or ratio expressed as a fraction (mathematics), fraction of 100. It is often Denotation, denoted using the ''percent sign'' (%), although the abbreviations ''pct.'', ''pct'', and sometimes ''pc'' are ...

. 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 kinds of inventory is used for predictable events that would cause a change in people's demand. For example, candy companies can start to produce extra sweets that have a long duration period. Build up seasonal inventory gradually to match people's sharply increasing demand before Halloween. 3. Cycle inventory Cycle inventory reflects the concept of an

economic order quantity Economic order quantity (EOQ), also known as financial purchase quantity or economic buying quantity, is the order quantity that minimizes the total holding costs and ordering costs in inventory management. It is one of the oldest classical pro ...

(EOQ). EOQ is an attempt to balance inventory holding or carrying costs with the costs incurred in ordering or setting up machinery. The total cost will minimized when the ordering cost and the carrying cost are equal to each other. When customers order a significant quantity of products, cycle inventory would be able to save costs and act as a buffer for the company to purchase more supplies. 4. In-transit Inventory This kind of inventory would save the company a lot of transportation costs and help the transition process become less time-consuming. For example, if the company requests a particular raw material from an overseas market. Purchase in bulk will save them a lot of transportation cost from overseas shipment fees. 5. Dead Inventory "Dead inventory", or "dead stock" consists of stock that is outdated or where only a few consumers request this kind of product. Such stock is likely to have been withdrawn 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. To reach higher profit here are some methods of reducing carrying costs. 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 ...

of the currency. When the economy is in

recession In economics, a recession is a business cycle contraction that occurs when there is a period of broad decline in economic activity. Recessions generally occur when there is a widespread drop in spending (an adverse demand shock). This may be tr ...

or the currency depreciates, residents’

purchasing power Purchasing power refers to the amount of products and services available for purchase with a certain currency unit. For example, if you took one unit of cash to a store in the 1950s, you could buy more products than you could now, showing that th ...

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 environ ...

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 proce ...

! 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 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.

Definitions

Why do companies hold inventory

Ways to reduce carrying cost

See also

References

Further reading