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Getting lean with inventory
Dennis Lord
I've encountered many purchasers who wonder how much it really costs to carry purchased inventory. I usually reply with the golden rule: Inventory carrying cost is around 25 per cent of the annual on-hand inventory value—a heavy beast of burden indeed.
It's a common misconception that holding purchased inventory in the warehouse and factory is cost free. But in actual fact, if your annual inventory value is about $1 million, the golden rule 25 per cent, says it would cost $250,000 per year to carry it!
What is inventory carrying cost?
Carrying costs come in two flavours: capital and non-capital. ere's the breakdownCapital costs include the interest on the money you invested in your inventory, and the return you could expect if you invested in something other than inventory.
Non-capital costs may vary according to the company, its product, and location. They include risk costs, storage space costs, and service costs. Risk costs generally include obsolescence, damages, and pilferage. They're the largest component of non-capital costs.
Storage space costs include the floor space used to store inventory, plus the workers, and equipment used to handle it. Service costs include expenses such as insuring your inventory, security, fire protection and even taxes.
The golden rule of inventory carrying cost (25 per cent) breaks down like this:
• Capital cost: 15 per cent
• Non-capital costs:
• Risk costs: Six per cent
• Storage space costs: Two per cent
• Service costs: Two per cent
What can purchasing do?
The purchasing department obviously plays a key role in ensuring inventories stay within control. First and foremost, buyers must observe the prime commandment of purchasing and inventory management: Deliver the right product and quantity to the correct place at the right time. They must also maintain excellent customer service levels without carrying excess and obsolete inventory.
To achieve this, purchasing must move away from the traditional minimum lot purchases, full truckload deliveries, and a multitude of suppliers for the same product. The new way involves making purchasing leaner, developing supplier relationships, and just-in-time deliveries.
Lean purchasing is about obtaining an ideal balance between inventory investment and customer service levels. It provides tools to maintain inventory accuracy, generate more reliable forecasts, and calculate realistic lead times. It also helps maintain optimal customer service.
Dennis Lord is executive director of IMS Consulting. He may be reached at (647) 244-2624 or dennis@imsconsutling.ca or www.inventoryguru.com
Editor's note: More articles and research on lean procurement (often referred to as e-procurement), may be found at various web sites, including:
www.lean.org Lean Enterprise Institute (search for lean procurement articles)
www.ism.ws The Institute for Supply Management
www.bettermanagement.com An extensive library of lean procurement and supply chain articles
www.globalbestpractices.com A PricewaterhouseCoopers research site
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