Abstract
Traditionally, Inventory Holding Cost (IHC) is assumed to be a combination of several costs and determined by the summation of these cost components. Several authors have suggested that the value of IHC ranges between 12-50% of the procurement cost of an item. However, due to the absence of a generally acceptable methodology, many practitioners still determine this percentage based on estimates, benchmarks and intuition. Giving considerations to this reality, a mathematical model to determine the value of IHC using systems dynamics approach was developed. IHC was viewed holistically to identify relevant quantities, their interactions (static or dynamics), behaviour and consequences. A Causal Loop Diagram (CLD) was developed to establish the relationship among these quantities. Thereafter, CLD was transformed into a Flow Diagram (FD). FD was used to formulate a set of systems dynamics equations to obtain IHC. The interaction among fraction of goods ordered per month (FOM), fraction sold per month (FSM) and fraction damaged per month (FDM) was simulated to obtain percentage values of IHC. The value of IHC obtained from the model and simulation analysis ranges between 22.58-25.39% of the item held in stock. Based on these results, it is concluded that the developed model can be used for simulation and system analysis of the holding cost component of an inventory system under different contextual settings.
Highlights
Inventory Holding Cost (IHC) is a variable cost and a required input in the computation of total inventory cost
Azzi et al [3] argued that IHC can be derived from the sum of storage and opportunity costs expressed as a percentage of the mean inventory investment
Lambert et al [5] reduced the categories suggested by Foster [4] into four, they asserted that IHC should include costs that vary with the quantity of inventory stored
Summary
Inventory Holding Cost (IHC) is a variable cost and a required input in the computation of total inventory cost. Miller [2] and Azzi et al [3] opined that the decision to ignore these components could be as a result of rigors and complexities associated with mathematical computations. Foster [4] suggested twenty-seven (27) cost components that should be summed to obtain total inventory holding cost, these components can be categorised into five (capital, storage space, handling equipment, inventory risk and inventory service). Azzi et al [3] argued that IHC can be derived from the sum of storage and opportunity costs expressed as a percentage of the mean inventory investment. Harding [6] classified these components into fixed and variable cost factors while Durlinger [7] opined that the components should be determined based on individual organisation
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