Breaking Down Inventory Costs for Wholesale Distribution
- Inventory Costs: Types of Costs
- Reducing Inventory Costs: Best Practices
Ordering inventory to stock and sell involves inventory costs beyond the purchase price of each item; the process of buying stock and storing it has attached costs, and these are usually calculated as a percentage of the total stock value.
In the wholesale distribution of durable goods, these additional costs need to be managed to ensure the business remains profitable. If the business allows inventory processing costs to escalate, it is left with two possible outcomes: either profits shrink or prices have to be increased to maintain profitability. In the latter case, customers may take their business to cheaper competitors, reducing the viability of the operation.
For this reason, it is essential that businesses keep track of the extra costs involved in stock processing. Being able to identify and quantify individual cost-saving opportunities is key to controlling and reducing inventory costs. It is important that operations managers have insight into the entire supply chain – various stages of the supply chain have their own costs associated with inventory, and attempting to reduce costs in one area can result in increased costs elsewhere. Reducing inventory costs means striking the best balance throughout the entire operation.
Inventory Costs: Types of Costs
Broadly speaking, there are three types of cost associated with inventory:
Warehouse stock involves capital spent on storage premises, utilities, insurance and staffing; the greater the inventory, the higher these costs. There are also other costs associated with inventory. For example, the longer items are in storage, the higher the risk of inventory shrinkage and obsolescence. There is also the opportunity cost of capital tied up in stock (that is, money that is invested in stock therefore cannot be invested elsewhere in the company).
While it is tempting to reduce costs by taking a just-in-time (JIT) approach to procurement, this can lead to stock outs. This costs the business in lost sales opportunities and reduces customer confidence, resulting in lost recommendations and repeat business. In serious cases, the business may have to compensate customers for non-delivered items and associated costs.stock
In addition to the purchase cost of stock, there are other costs attached to procurement: the delivery cost of the stock, the manpower involved in transferring the stock to the warehouse and the need for a large procurement team to place orders.
As a rule, less frequent, larger orders can help to reduce these costs, as well as the costs associated with stock outs, but this can result in overstocking and tying up working capital. Furthermore, larger orders increase carrying costs. The aim of procurement managers is to ascertain the economic order quantity (EOQ) that achieves the most efficient cost to stock ratio.
Reducing Inventory Costs: Best Practices
With the entire supply chain is linked in wholesale distribution, it is essential that managers take a holistic approach to reducing the costs of inventory processing.
This involves having oversight at the business intelligence level; if there is sufficient real-time data to ensure that procurement can be linked to demand, order sizes can be tailored to customer orders.
Greater automation is key here; as well as reducing staffing costs, it enables real-time oversight of stocking levels, allowing managers to eradicate interruptions in the supply chain and optimize inventory. The data automatically generated by the system can also be used in demand forecasting to help the business adapt to seasonality and changes in demand.