Activity: which costs move?
Chapter 1, Introduction to Inventory Systems
Work in threes. 20 minutes.
Names: ______________________________________________
The distributor. The distributor that stocks the mower deck belt placed 6,000 replenishment orders last year, carried $1,500,000 of inventory at cost on average, and stocks 2,000 items. It owns its building, which runs at about 70% of capacity. Its cost of capital is 7% a year. The controller hands you two budgets for the year.
Part A. Predict
The controller proposes the simple version: \(k\) is the whole purchasing budget divided by the orders placed, and \(i\) is the whole warehouse budget divided by the inventory carried. When you apply the marginality test, will your \(k\) and \(i\) come out higher or lower than the controller’s? Which will move more?
Part B. Sort the lines
Mark each line \(k\) (moves with the number of orders), \(i\) (moves with the value of stock held and how long it is held), \(f\) (moves with the number of items stocked), or none (moves with none of these). Be ready to give a reason for any line your group argued about.
| Line | Item | Annual | Goes in |
|---|---|---|---|
| P1 | Buyer time spent placing and expediting orders | $150,000 | |
| P2 | Buyer time on annual contracts and supplier negotiations | $60,000 | |
| P3 | Receiving dock, check-in and inspection of each receipt | $90,000 | |
| P4 | Purchasing manager’s salary | $95,000 | |
| P5 | Ordering system license, a flat annual fee | $24,000 | |
| P6 | Electronic order transmission, $1.00 per order sent | $6,000 | |
| W1 | Building depreciation | $120,000 | |
| W2 | Building utilities and security | $70,000 | |
| W3 | Inventory insurance, rated on declared value | $15,000 | |
| W4 | Obsolescence and shrinkage write-offs | $75,000 | |
| W5 | Picking and packing customer orders | $210,000 | |
| W6 | Cycle counts and catalog upkeep, about $12 per stocked item | $24,000 | |
| W7 | Cost of capital on the inventory | $105,000 |
Part C. Build the parameters
- Compute \(k\) in dollars per order and \(i\) per year from your sort. Then compute the controller’s versions.
- State \(f\) in dollars per item per year.
Part D. Keep the spindle kit?
The deck spindle kit sells 60 a year, costs $40 and sells for $46. It is ordered 30 at a time, twice a year, never runs short, and so averages 15 on hand. Should the distributor keep stocking it?
- With your parameters, compute its annual ordering cost, holding cost (with \(h = ic\)) and stocking cost \(f\), and compare their sum with the annual margin.
- Repeat with the controller’s \(k\) and \(i\). Does the decision change?
Part E, if you have time. The order quantity
Compute the economic order quantity \(\sqrt{2k\lambda/h}\) for the kit under both sets of parameters. By what factor do they differ, and why is that factor smaller than the factor between the two \(i\) values?
Exit ticket (tear off and hand in)
Name: ____________________
- State the marginality test for the holding cost in one sentence.
- True or false, and why: building depreciation is a real cost, so leaving it out of \(i\) understates what holding stock costs.