Inventory Cathegories

Holding Cost

From Jay Heizer, Barry Render – Operations Management, 7th edition, Pearson&Prentice Hall, Pearson Education International, NJ, 2004, p 456

The table below shows the kinds of costs that need to be evaluated to determine holding costs. Many firms fail to include all of the inventory holding costs. Consequently, inventory holding costs are understated.

Category Cost (and Range) as a Percent of

Inventory Value

Housing costs (building rent or depreciation, operating cost, taxes, insurance) 6% (3-10%)

Material handling costs (equipment lease or depreciation, power, operating cost) 3% (1-3.5%)

Labor costs 3% (3-5%)

Investment costs (borrowing costs, taxes, and insurance on inventory) 11% (6-24%)

Pilferage, scrap, and obsolescence 3% (2-5%)

Overall carrying cost 26% (15 - 47.5% or even more)

Note: All numbers are approximate, as they vary substantially depending on the nature of the business, location and current interest rates. Any inventory holding cost of less than 15% is suspect, but annual inventory holding costs often approach 40% of the value of inventory.

Solving the Linear Programming Problem with MSExcel

The previous paragraphs illustrated the way to build a Linear Programming model in order to make decisions on the production plan at Lemnco. The model developed was:

[max] f = 20x1 +30x2 + 25x3

subject to: 0.6x1 + 0.8x2 + x3 ≤ 120

x1 + 2x2 + x3 ≤ 420

x2 ≤ 90

x1 ≥ 0, x2 ≥ 0, x3 ≥ 0.

The Linear Programming (LP) model looks good, but why do we need it and how to solve it?

In this paragraph we introduce several methods to use the model, from the simplest one ("naïve"), to the most sophisticated.

1. Naïve approach of the Test Problem

We first notice that the contribution to profit f can increase no matter how much if no constraints on the resources are imposed. For example, a mix of

x1 = 60 pieces of TA,

x2 = 50 pieces of TB,

x3 = 50 pieces of TC

contributed to profit with the amount

f = 20·60 + 30·50 + 25·50 = 3,950 lei.

Although, if the manager