Operations Management: An Integrated Approach, 5th Edition

RELEVANT INVENTORY COSTS

Inventory management policies have cost implications. Decisions about how much inventory to hold affect item costs, holding costs, ordering costs, and stockout (shortage) costs.

Item Costs

The item costs of a purchased item include the price paid for the item and any other direct costs for getting the item to the plant, such as inbound transportation, insurance, duty, or taxes. For an item built by the manufacturing company, the item costs include direct labor, direct materials, and factory overhead.

Item cost

Includes price paid for the item plus other direct costs associated with the purchase.

Holding Costs

Holding costs include the variable expenses incurred by the firm for the volume of inventory held. As inventory increases, so do the holding costs. We can determine unit holding costs by examining three cost components: capital costs, storage costs, and risk costs. Annual holding costs are typically stated in either dollars per unit ($3.50 per unit per year) or as a percentage of the item value (25 percent of the unit value).

Holding costs

Include the variable expenses incurred by the plant related to the volume of inventory held.

Capital costs

The higher ...