Executive Briefings

Think You Know Your True Cost of Carrying Inventory? One Expert Urges You to Take Another Look

If inventory and pricing optimization is a science, there aren't that many scientists in the business world. Or so suggests John Brockwell, vice president in the Global Supply Chain Management Practice of JPMorgan Chase Vastera. Writing in a recent issue of the company's monthly newsletter, Brockwell says many companies don't take into account all of the factors needed to calculate true inventory carrying cost. They apply only the weighted average cost of capital as their carrying-cost rate, a number that averages between 10 percent and 12 percent, depending on the cost of debt (tied to interest rates) and equity. What they're missing, says Brockwell, is the cost of obsolescence, scrap, shrinkage, storage, taxes and utilities. Adding in those factors can triple the final number used to determine inventory carrying costs, and evaluate supply chain trade-offs. Techniques to improve operations include the elimination of nodes in the network, increasing visibility of product in the pipeline, greater reliance on just-in-time deliveries, and lean manufacturing concepts. By determining actual costs, companies can make more intelligent decisions as to which mode of transportation is right for a given shipment. They might even discover that airfreight is a cheaper option than low-priced ocean, when transit times are added to inventory expense. Warns Brockwell: "The constant search for lower unit price can lead to increased levels of inventory and higher working capital requirements."

Visit www.jpmorganchase.com/vastera.

 

If inventory and pricing optimization is a science, there aren't that many scientists in the business world. Or so suggests John Brockwell, vice president in the Global Supply Chain Management Practice of JPMorgan Chase Vastera. Writing in a recent issue of the company's monthly newsletter, Brockwell says many companies don't take into account all of the factors needed to calculate true inventory carrying cost. They apply only the weighted average cost of capital as their carrying-cost rate, a number that averages between 10 percent and 12 percent, depending on the cost of debt (tied to interest rates) and equity. What they're missing, says Brockwell, is the cost of obsolescence, scrap, shrinkage, storage, taxes and utilities. Adding in those factors can triple the final number used to determine inventory carrying costs, and evaluate supply chain trade-offs. Techniques to improve operations include the elimination of nodes in the network, increasing visibility of product in the pipeline, greater reliance on just-in-time deliveries, and lean manufacturing concepts. By determining actual costs, companies can make more intelligent decisions as to which mode of transportation is right for a given shipment. They might even discover that airfreight is a cheaper option than low-priced ocean, when transit times are added to inventory expense. Warns Brockwell: "The constant search for lower unit price can lead to increased levels of inventory and higher working capital requirements."

Visit www.jpmorganchase.com/vastera.