Holding costs

Holding costs are the costs incurred to store inventory. There are a number of different costs that comprise holding costs, including the following:

  • Depreciation. The company incurs a depreciation charge in each period for all storage space, racks, and equipment that it owns in order to store and handle inventory. This can be a substantial charge if the company has invested large amounts in automated storage and retrieval systems.
  • Insurance. The company should have insurance coverage for all of its inventory asset. If so, the cost of insurance related to this coverage is a holding cost.
  • Obsolete inventory write-offs. If inventory is held too long, it may no longer be sellable. If so, it is written off as soon as it is designated as obsolete. This can be a substantial cost, especially in businesses where new products appear on a regular basis.
  • Personnel. The cost of the warehouse staff that relates to storage is a holding cost. This cost includes employee benefits and payroll taxes.
  • Rental space. The cost of warehouse rental space is a holding cost, and can be substantial if the storage systems in place do not make complete use of the cubic volume of the facility (making it necessary to rent a larger facility).
  • Security. If the inventory is valuable, it makes sense to have security guards, fencing, and monitoring systems in place, all of which are holding costs.

Many of the costs noted here cannot be traced to a specific unit of inventory. Instead, they are incurred for the entire inventory asset, and so will not vary to any notable degree if a small amount of inventory is added or deleted. Since there is no direct relationship between cost and quantity, holding costs are considered to be fixed, and so are allocated to inventory.

Holding costs tend to increase in companies that take advantage of volume discounts, since they buy in large quantities, which must then be stored for extended periods of time. Conversely, a business operating under the lean model will have a minimal amount of inventory on hand, and so incurs reduced holding costs.

Holding costs can be shifted back into the supply chain by having suppliers only deliver in small quantities. However, this just means that the same inventory is located elsewhere, so suppliers typically increase their prices to make up for the holding costs that they must now incur.

The aggregate amount of holding costs is used in the economic order quantity (EOQ) calculation, which attempts to balance ordering costs, holding costs, and usage levels to arrive at the optimum quantity of an inventory item to purchase.