Inventory Carrying Costs Formula

Customer spend in online retail is expected to be over $300 Billion in 2010. With brick-and-mortar and online retail combined, we’re looking at well over $300 Billion in spend in 2010. Indeed, a big business.

This article looks into the real and true costs of inventory, by looking at the inventory carrying costs formula. No, not the “inventory” in service operations, but actual hard goods, stuff that sits in a warehouse or stuff that flows through a supply chain.

A common component of the retail value chain is the Fulfillment Center, which holds inventory that is either shipped directly to the customer (for online retail) or transported to brick-and-mortar stores to replenish their inventory. This part of the supply chain is complicated and represents a large part of the cost of doing business in retail.

In Retail (online and brick-and-mortar), the majority of the assets are in the form of inventory, with the hope of selling that inventory for a more liquid asset – cash – and for more than what was paid for it. But, this view is near-sighted because looking at the cost of inventory (COGS) and what that inventory was sold for (Gross Margin) doesn’t tell or capture the full story of the cost of that inventory.

Inventory Carrying Costs

Moving away from conventional accounting methods for inventory, I propose using the standard inventory metric we call Inventory Carrying Costs (ICC) – a metric that some or most retailers with fulfillment capabilities do not yet use or understand:

Where,

C: Capital
T: Taxes
I: Insurance
W: Warehouse Costs
X: Shrinkage
S: Scrap
O: Obsolescence Costs
R: Recovery

Why is this important?

Customer Experience is about experience up-and-down the value chain: from the site, to ordering the product, to receiving the product, and to interactions with customer service. The customer will remember her experience – in all the points of interaction with the company.

In order to provide the Customer Experience our customers demand of us, requires that we get our house in order and eliminate waste and avoidable costs. A good place to begin are to attack the variables above. In other words, when we reduce Warehouse Costs, Shrink, Scrap, Obsolescence, and Recovery (which includes Customer Service, win-back campaigns, and Returns), we will be fundamentally improving our cost structure and improving the customer experience.