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INVENTORY CARRYING COSTS IN SMALL BUSINESSES Kamal Abouzeid, Lynchburg College Fred Hebein, California State University-San Bernardino Norton E. Marks, California State University-San Bernardino ABSTRACT Inventory carrying costs, the costs associated with carrying a quantity of stored inventory, is a vital part of the information necessary for the logistics system to be optimized. While the significance of inventory carrying costs is widely acknowledged, there has been little effort on the part of researchers to evaluate the significance of inventory carrying costs on small businesses. In fact, it is not known whether small businesses properly estimate inventory carrying costs, or whether small businesses utilize such cost estimates when they are available. Unfortunately, but as anticipated, the preliminary results of a survey of small businesses indicate that most small businesses make little effort to know their inventory carrying costs. It is hoped that additional survey information can be gathered to reliably determine what proportion of small businesses gather and utilize estimates of inventory carrying costs, and to permit comparison between small businesses according to type, size, industry, and region. INTRODUCTION Since the mid 1950s, academicians and practitioners have written and discussed the costs of carrying inventory as part of the total logistics costs of the firm. Aspects of these vital costs have been described and evaluated from a variety of perspectives. And yet little has been written about the costs of carrying inventory in small businesses. Knowledge of inventory carrying costs is likely more important to the success of the small business than to the success of larger firms. In small business there is apt to be less room for lapses than might be the case in larger businesses. If inventory carrying costs are excessive in a division of a large company, perhaps another division might be able to offset that loss. In addition, larger firms are likely to have better access to capital and therefore can draw on those resources to offset a major problem in the cost of inventory. Small businesses seldom have the luxury of relatively easy access to capital. In fact, small businesses which suffer from excessive inventory carrying costs may well face bankruptcy. Leading authors in the logistics discipline, such as Coyle (1988), Lambert (1987), and Bowersox (1986), have emphasized the role of inventory carrying costs in the firm's logistics

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system. The studies cited or performed by these authors have been well researched and documented, but all have investigated inventory carrying costs from the perspective of either relatively large businesses or of an average of all sizes of businesses combined. Inventory carrying costs for small businesses have largely been ignored. SMALL BUSINESS COSTS Because the area of small businesses have largely been ignored, we have undertaken to research inventory carrying costs in small business. We are attempting to learn if small business owners/managers calculate inventory carrying costs, and if they do, what is basis of their calculations. We want to learn how these costs compare across regions, industries, management styles, sizes of firms, and so on. In general, knowledge of inventory carrying costs constitutes a vital part of management information necessary to optimize the logistics system. However, without specific and comparable measurement of inventory carrying costs relative to a target level,, knowledge of inventory carrying costs alone may not be sufficient to contribute either to the optimization of the firm's logistic system or to its total costs. For example, the objective of a firm' s logistics system usually is to minimize total costs given a specified level of customer service. The total costs include inventory carrying costs, transportation costs, warehouse throughput costs,order processing costs, and lot quantity costs. These total costs are, of course, dependent upon the configuration of the logistics system. To optimize the system, the component costs must be known and must be comparable. The wide variety of costing methods and the diversity of components included in inventory carrying costs often make cost comparison difficult. For example, the level of inventory carrying costs in a firm has been estimated according to various accounting methods (such as direct or absorption costing, each of which can be based upon actual or standard costs) or has been evaluated upon a purely theoretical basis, which usually has been some form of marginal economic analysis. The lack of a specific methodology by which to measure inventory carrying costs and the lack of an established preferred target level of inventory carrying costs, makes further discussion and research of the topic relevant, timely, and important to successful business operation. From the above, it is clear that several important decisions are, or should be, predicated on knowledge of the firm's inventory carrying costs. Basic questions concerning inventory strategy can be properly made only after knowledge of the firm's costs of carrying inventory. For

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example: + How much inventory should we carry? + Should the inventory be placed close to the point of purchase, close to the point of supply, or at some in-- process mid-point? + Should we institute a system of just-in-time supply? + Should we build field warehouses? + Should we divest ourselves of existing warehouses? + Should we use a form of premium transportation for our distribution? + Should we require our suppliers to use a form of premium transportation for in-supply? Inventory costs must be known if the logistics function of the firm is to provide management with input concerning the level of customer service which the firm chooses to offer. However, logistics management cannot provide proper input if they do not have a thorough understanding of their inventory carrying costs. Management must know how an increase in customer service will impact inventory carrying costs. Similary, they must know the cost interactions between lost sales and smaller levels of inventory, both of which will likely occur after a reduction in the level of customer service. PRELIMINARY FINDINGS While the significance of inventory carrying costs is widely acknowledged, the results of our preliminary survey reported in this paper suggest that many small businesses either never calculate their inventory carrying costs, may calculate them incorrectly, or may rely on guidance from people not trained to give them accurate information. To understand the current status of estimates of inventory carrying costs and how the estimates vary according to region, industry, and logistics configuration, we completed a telephone survey of ten small firms. In each firm we spoke with the department head of the logistics operation, the general manager, or the owner. Only two (20%) of the respondents had any formal training in logistics, distribution, or inventory management. Six (60%) had more than minimal experience in these areas, while two (20%) had extensive experience in one or more of them. As might be expected, those respondents who had neither training or experience in logistics, distribution or inventory management felt

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that they could not properly calculate the costs of carrying inventory. The majority of these managers asked their accountants to give them estimates, but then did not rely on the figures they received. CONCLUSIONS Based upon the preliminary findings, it appears that small business management does not gather and/or utilize important information regarding inventory carrying costs. Many noted authorities including [Lambert 1987], [Coyle 1988], and [Bowersox 1986] have stated that inventory carrying costs are among the most significant costs of the firm's logistics system. In general, knowledge of inventory carrying costs, those costs associated with carrying a quantity of stored inventory, constitutes a vital part of management information necessary to optimize the logistics system. The preliminary research indicates that small business management does not estimate inventory carrying costs and is therefore unlikely to optimize the business logistics system. On the other hand, it is unlikely, that knowledge of inventory carrying costs alone will provide much help to small businesses in developing logistics systems that are more competitive. The small business manager needs a simple gauge or means of comparison to assess the relative competitiveness of his logistics system. For example, if a business manager knew the typical level of inventory carry costs according to firm size, type, industry and geographic region, the manager may be able to make better judgments about how efficient his business operations are. In the research underway, it is hoped that specific and comparable measurements of inventory carrying costs according to industry, firm size, type, and region can be developed. These estimates would provide a target level of inventory carrying costs that would allow the small business manager to more readily assess the efficiency of his logistics operation relative to competitors. Given the competitive pressure on small business to minimize costs and to improve customer service, it is important that small business managers have the vital information necessary to optimize their logistics system.

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REFERENCES Bowersox, Donald J., Closs, David J., & Helferich, Omar K. 1986. Logistical Management, New York, NY: Macmillan. Coyle, John J., Bardi, Edward J., & Langely, C. John Jr. 1988. The Management of Business Logistics, St. Paul, MN: West Publishing. Stock, James R., & Lambert, Douglas M. 1987. Strategic Logistics Management, Homewood, IL: Irwin.

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