A supply chain's optimization can be assessed by using at least two units of measure:
- Monetary value (dollars)
- Time (hours, days, weeks, months)
Also, you have to take into consideration:
- How much does your supply chain cost?
- How quickly is your supply chain able to supply your customers?
One way to make sure that your supply chain is able to deliver to your customers is to hold as much inventory as possible. But holding inventory means spending money. Investing in inventory can help your supply chain save you time—but is the holding that inventory a supply chain asset or a supply chain liability?
What Are Inventory Holding Costs?
The cost of your inventory can't be counted by simply figuring out how much you paid for that inventory. For example, if Product A costs you $15 and you have ten thousand of Product A, does that mean that your inventory holding costs are $15,000? No. The $15,000 that you spent to get those ten thousand pieces of Product A is just your starting point. Inventory holding costs include:
- Cost of warehouse space
- The utility costs of that warehouse space
Those are real costs associated with holding that inventory.
Inventory Holding Costs vs. Customer On-Time Delivery
If you want to guarantee that you'll be able to ship what your customers order the second that they order it, hold inventory. Lots and lots of inventory.
If you make sure that you have everything that your customers might possibly order ready—just in case a customer orders it, then you will likely have 100 percent on-time delivery.
However, spending all that money to make sure that you have that inventory may not be the most prudent supply chain move that you can make.
Inventory holding costs are a silent supply chain killer. When you master holding an optimized level of inventory (not too much, not too little), you can:
- Order as little inventory as possible from your suppliers
- Reduce your accounts payable by lowering your inventory purchases
- Shrink the size of your warehouse (square footage, utility costs, personnel/security)
Inventory Holding Costs and Inventory Turns
Inventory turns are an important metric within supply chain management and are an essential corollary to the question of inventory holding costs.
In supply chain management, not too many metrics can be described as "the higher the better" but that's the case with inventory turns. High lead times and the high cost of goods are examples where "the higher the better" do not apply.
Inventory turns are typically measured in "number of times you replenish your inventory in a year". One is a bad inventory turn number. That means you're holding 12 months worth of inventory at any given time.
Twelve is a much better inventory turn number. That means that you're holding about one month's worth of inventory.
Twelve—or generally lower—inventory turns per year means that you're:
- Selling your inventory more often
- Collecting from your customers more often
- Spending less every time you need to buy inventory
- Holding less inventory at any given time
- Lowering your inventory holding costs
And that's the way to do it. Lower your inventory holding costs by increasing your inventory turns.
How Do I Optimize My Inventory?
You can hold more inventory to help maximize customer on-time delivery—but those increased inventory levels come with increased inventory holding costs. And what spend more for warehouse square footage, insurance, utilities and security than you have to?
Use supply chain management tools to help drive inventory levels down—lowering your inventory holding costs at the same time.
You can drive your inventory lower by:
- Lead time management
- Customer demand management
- Supplier relationship management
By understanding and optimizing your supplier lead times, you can communicate those lead times to your customers. Using robust demand management, you can align your customers' orders with your suppliers lead times and drive inventory levels lower.
Next level supplier relationship management can even get you and your suppliers to balance inventory between supplier ownership and your own. If you can get your suppliers to hold stock for you, you may be able to pass those inventory holding costs on to them.