A. Take notes while reading the text. Select main ideas and summarize them. Describe the elements of inventory holding cost.

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Inventory costs are one of the major logistics costs for a large number of manufacturing and retail companies, and they can represent a significant element of the total cost of logistics. There are many major cost trade-offs that can be made with all the other key logistics components. It is important to be able to understand what the key cost relationships are within a company. To do this, an awareness of the major elements of inventory cost is essential.

There are four principal elements of inventory holding cost. They are:

1. Capital cost: the cost of the physical stock. This is the financing charge that is the current cost of capital to a company or the opportunity cost of tying up capital that might otherwise be producing a better return if invested elsewhere. This is almost always the largest of the different elements of inventory cost.

2. Service cost: the cost of stock management and insurance.

3. Storage cost:the cost of space, handling and associated warehousing costs involved with the actual storage of the product.

4. Risk cost: this occurs as a consequence of pilferage, deterioration of stock, damage and stock obsolescence. With the reduction in product life cycles and the fast rate of development and introduction of new products, this has become a very important aspect of inventory cost. It is one that is frequently underestimated by companies. It is particularly relevant to high-tech industries, the fashion industry, and fresh food and drink.

Another important cost that needs to be understood is the reorder or the set-up cost for an individual product. The reorder cost refers to the cost of actually placing an order with a company for the product in question. This cost applies regardless of the size of the order. It includes the cost of raising and communicating an order, as well as the costs of delivery and order receipt. The set-up cost refers to the additional cost that may be incurred if the goods are produced specifically for the company. Here, the larger the order, the longer the production run and the lower the production unit cost of the items in question. Of course, orders for large amounts of a product will result in the need for it to be stored somewhere - at a cost! This is yet another classic logistics trade-off decision that needs to be made.

The final inventory-related cost is the shortage cost - the cost of not satisfying a customer's order. This cost is notoriously difficult to measure. It is used to try to reflect the penalty of not holding sufficient stock of a product, which may lead to lost profit due to lost sales, loss of future sales, loss of reputation and the cost of the urgent delivery of unsatisfied orders.

Different inventory requirements. There are some important differences in the way inventory requirements are determined that are related to the type of demand for the products in question. The nature of this demand should have an influence on the approach adopted to manage the inventory. One important way of differentiating between demand types is that of dependent or independent demand. The type of demand will have an influence on the nature of the inventory management technique chosen.

Independent demandoccurs where the demand for one particular product is not related to the demand for any other product. Consumer demand for a desktop computer is, for example, independent. Indeed, most consumer products are independent of the demand for other finished goods. This is an important distinction, because products with an independent demand necessitate the use of forecasting to help determine expected demand levels and associated inventory requirements. The EOQ approach is commonly used for products with independent demand.

Dependent demandoccurs where the demand for a particular product is directly related to another product. In the case of the desktop computer, for example, the demand for the power leads or the connecting cables would be directly dependent on the number of computers stocked as finished goods. Dependent demand can be classified in two ways. It may be vertical, eg the chip actually required in the production of the computer, or it may be horizontal, eg the instructional manual that is packed with the computer as a finished product. Typically, most raw materials, components and sub-assemblies have their demand dependent on the demand for the finished product. Because of this dependence, there is a far more limited requirement for the forecasting of the demand for these elements, as the actual needs are directly related to the finished product requirements themselves. MRP and MRPII systems are used for these elements.

One feature that has become particularly relevant in recent years concerns the nature of the demand requirement. Is it a 'push' system or a 'pull' system? A push system is the more traditional approach where inventory replenishment is used to anticipate future demand requirements. A pull system is where the actual demand for a product is used to 'pull' the product through the system. A push approach to inventory planning is usually based on a set plan that is predetermined according to certain rules of inventory reordering. This approach is a proactive one in the sense that it is planned on the basis of estimated, or forecast, demand for products from customers. The aim is to anticipate the extent and location of this demand and ensure that adequate stock is available in the right place at the right time. Typically, a push system is applicable for dependent demand and for cases where there are uncertainties in supply, source or production capacity limitations or the need to cater for seasonal demand. The EOQ method of inventory planning is based on the push approach.

The pull approach is a reactive one where the emphasis is on responding directly to actual customer demand, which pulls the required product through the system. The idea of a pull system is that it can react very quickly to sudden changes in demand. The pull system is most useful where there is independent demand and where there is uncertainty of demand requirements or of order cycle time. The most common form of pull system is JIT, as the orders are placed only when working stock is at such a level that a replenishment order is triggered. For many companies there is a need to adopt the concepts of both types of approach. Thus, hybrid systems are often used in practice.

The lead-time gap. One of the major reasons for the build-up of finished goods inventory is because of the long time that it takes to manufacture and deliver products. Ideally the customer would be prepared to wait the full amount of time that is required. If this were the case, there would be no need to hold any stock at all. This, of course, happens only rarely for special 'made-to-order' products. The vast majority of products are required either immediately, as for many consumer products at the point of sale in shops, or within a short timescale, as for industrial products and also for consumer products when the retailer orders them in the first instance from the manufacturer.

The total time it takes to complete the manufacture and supply of a product is often known as the logistics lead time. Customers are generally prepared to wait for a limited period of time before an order is delivered. This is the customer's order cycle time. The difference between the logistics lead time and the customer's order cycle time is often known as the lead-time gap. It is the existence of this lead-time gap that necessitates inventory being held. The extent of the lead-time gap, measured in length of time, determines how much inventory must be held. The greater the lead-time gap, the greater the amount of inventory that must be held to satisfy customer requirements. Thus, the more this gap can be reduced, the less inventory will be required. Recently there has been a move towards identifying different approaches for reducing this gap.

b. Explain the following concepts in English:

manufacturing	MRP
retail	MRP II
holding cost	push system
pilferage	pull system
deterioration of stock	replenishment
reorder	made-to-order
receipt	EOQ

c. Match terms:

1. total	a) time
2. unsatisfied	b) cycle
3. dependent	c) cost
4. lead	d) demand
5. order	e) order

d. Paraphrase using synonyms:

1. awareness	2. to underestimate
3. principal element	4. to be relevant
5. to produce	6. notorious
7. to occur	8. sufficient
9. consequence	10. determine
11. frequently	12. distinction
13. approach	14. ideally
15. to be proactive	16. vast majority
17. within a short timescale	18. to speed