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Inventory Policy Cost™

The inventory policy cost (IPC) for an item is the sum of inventory carrying cost and lost sales cost for the item. It strikes a balance between the financial costs and benefits of inventory availability.

IPC = ICC + LSC

One way to play the inventory game is to set unit fill rate and inventory turn rate targets to minimize inventory policy cost. Inventory policy costs for target fill rates ranging from 50% to 99.95% for two food and beverage SKUs are provided in the figures below. The SKU in the first figure  is a medium moving SKU with a low forecast error and a short leadtime. The minimum inventory policy cost is $15,578 at a target unit fill rate of 99.95% and a target turn rate of 12.4 with an associated target inventory investment of $51,109. The same computations for a slow moving SKU with a higher forecast error, longer leadtime, and smaller unit gross margin are provided in the second figure. The minimum inventory policy cost for that SKU is at a target unit fill rate of 90% with a target turn rate of 4.0.

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