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Determining the Total Cost of Inventory Management

 This week’s blog will continue our discussion of determining total cost of inventory management. Previously we identified three key cost factors to measure prior to the launch of any significant Inventory management strategy. To refresh your memory, they are:

  1. Inventory Cost
  2. Process Cost
  3. Procurement Cost

This week we will look more closely at procurement costs.

Procurement costs are, most obviously, the cost required to get the product that you need to keep your business running. It might include process costs, shipping costs, or the actual cost of the inventory. Is this starting to sound familiar?

Actual cost of goods – The actual cost of the inventory is what most people think of when they hear the phrase “procurement cost”. Most companies have procurement specialists that have perfected the art of obtaining product at the absolute best costs. You may want to take a look at some of the other creative “add on’s” that they might be able to negotiate for you such as reduced/free shipping, tracking and reporting certain costs/measurements for you (especially those that can help you measure the cost of your inventory!), or providing additional inventory management services.

Process Costs – Below are some of the questions you might ask to identify some of those “soft” costs associated with procurement processes. These questions may also generate ideas of items/services your procurement manager might use to negotiate with or negotiate for in discussions with your vendors.

  • How much does it cost you to generate a PO?
  • What is the cost to receive each PO?
  • How many PO’s do you generate and process on a daily/weekly basis?
  • Is there a way to do reduce the number of vendors that you deal with?
  • Can you negotiate summary billing with your key vendors?

Shipping Costs – By shipping costs, what I really mean is delivery costs; the cost to deliver the PO to the vendor as well as the cost to have that product delivered to you. Have you explored ways to reduce or eliminate some of these costs?

One more issue to consider when you are looking to reduce procurement costs is why the demand for the product is being generated. Demand can be generated for a number of reasons, some legitimate and some require a more controlled process before being acted upon.

Demand can be generated through:

Depletion – an inventory item being used, ex: part is needed to fix something, or part is transferred to another location

Misallocated – checked out and not used but not checked back in, ex: the part they thought they would need wasn’t needed for the job and it was too much trouble to check it back in or the project was finished and all of the stuff from the jobsite was dumped in the “overflow” storeroom (Be alert!)

Consumption – increased usage requirements, ex: there are more people pulling on your inventory, people are ordering extras to keep on hand because there are frequent out of stocks, ie: hoarding, or your demand for your services is increasing

Other – This is my favorite area to explore before ordering additional product. It often involves “buying around” the inventory process. Examples would include (but may not be specifically stated in this way);

  • I have made friends with the Vendor and am willing to buy from them at all costs, especially if it isn’t my money I am spending…
  • I can control what and when I get it better than my procurement manager if I generate the PO myself…
  • The price is lower at xyz vendor, so why would I possibly want to buy it from the source my Manager has identified (Can’t see the big picture, like negotiated rebates, consolidating suppliers, etc.)
  • I have this deal on the side with xyz vendor …
  • Nobody understands what I need, so I will just take care of things myself… (No one is going to tell me what I can and can’t do.)
  • They always get the wrong stuff or don’t have what I need when I want it (notice I said want, not need).
  • Christmas is coming and I need batteries for the kids’ toys…

Now I know these things would never happen in any of your companies, and if they do, maybe it’s OK with you and you consider them to be perks of the business, but you should be aware of them and consider them in your costs. Implementing systems and processes that control these factors will reveal where they are occurring and help you quantify their impact.

As always, PM2 stands ready to assist you with any or all of your inventory management challenges. Just give us a call at (813) 249-0834 or visit our website at

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