Saturday, November 14, 2009

How HP evaluates its Inventory Costs ?

We know of limited inventory costs, ie. Item costs, holding costs and shortage costs. In some cases, we also discuss about obsolescence costs.

HP did a study of its inventory related costs around end 90s and beginning 2000. To its dismay HP found that inventory costs were almost equal to the PC business' total operating margin and the conventional inventory holding costs accounted for just 10 % of its total inventory related costs. In a global scenario with global suppliers and global customers, there were some other interesting costs to be worried about.

In the scale of inventory related costs and presented in descending order , first comes the Component Devaluation Costs. When prices dropped for excess components which were with the company, the distribution channel and in the pipeline with the transporters, the company incurs a devaluation cost at all these points in the SC.

The Price Protection Cost is the cost incurred by the company when the prices have dropped after the items have been shipped to the retailers. All unsold items with the retailers are compensated for the difference in costs and sold in the markets. 

The third important cost is the Product Return cost. For all unsold items, HP gives a 100 % return to the distributors. 

The fourth important component is the Obsolescence costs. This is the cost of writing off the cost of unsold items in the inventory, after the life of the products has ended.

The costs listed above accounted for almost 90 % of the inventory related costs incurred by HP. It would be interesting trying to find how to counter these excessive inventory costs. 

Source G Callioni et al, "Inventory Driven Costs", Harvard Business Review, March 2005.

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