When it comes to things that you need to get right in order to be able to run a successful business, managing your inventory carrying costs is certainly high up on the list. Carrying costs are what you pay in order to hold onto your inventory from the time it gets delivered to you to the time you ship it to your customer. They are made up of four broad categories: capital or financing costs; storage space costs; inventory services costs; and inventory risk costs. Defining exactly what kinds of expenses are included in these categories is a topic in itself, but the purpose of the discussion below is to emphasize exactly how essential keeping a hold on these costs is to the success of your business, and what you can do about it.
A large and underestimated cost
On the face of it, the cost of carrying inventory does not stand out when it comes to key expenses of a business: often costs like wages, raw materials, and rent come to mind first. Yet for many businesses, inventory is the largest asset, and it is generally accepted that annual carrying costs alone represent 25% of the value of inventory on hand, and could be up to twice as much depending on the industry.
Many sub-costs to manage
One reason carrying costs can be difficult to manage is that there are so many costs to keep track of. For example, within the inventory services category alone there is: lighting, ventilation, heating (depending on the type of inventory), security costs, and warehouse staffing costs, just to name a few. Inventory risk costs are similarly diverse: you must account for the risks of theft, obsolescence, expiry, and of inventory otherwise being damaged while in storage. Additionally, some costs can be easily overlooked, for example the opportunity cost of carrying inventory. This is part of capital costs, and essentially considers what else you could be doing with your inventory if it wasn’t tied up in inventory, and valuing what this missed opportunity could be worth to your business.
Relevance to decision making
Because inventory costs are so diverse and potentially a significant portion of your total expenses, your strategic decisions need to take them into account. For example, you will have to decide which storage spaces will be most cost effective for the type of inventory you hold. Too much space means wasted rent, and a poorly maintained facility may mean higher costs through ensuring your inventory is in good condition (ventilation, heat etc.). You will also have to balance decisions about carrying costs against other costs. For example, a city-fringe warehouse may be cheaper in terms of rent, but this might mean you pay more in logistics costs because it is out of the way.
So what should I do now?
Now that the importance of carrying costs has been established, you may ask what you can do to ensure these costs are given due consideration in your business set-up. A good first step is to record every carrying cost you have to pay, and quantify these costs (although for some, such as risk costs, you will likely have to make estimates). Make sure to include all expenses. From there, you can ask yourself: which costs are taking up too much of my total expenses? Which costs is there a clear opportunity for a reduction? Prioritize what is most important to you first, and eventually you will be able to work your way through all of these costs to hopefully run a more efficient operation.