Inventory holding costs are a common fee businesses incur when storing inventory in a warehouse.
While it is a largely unavoidable cost of doing business, if you’re not careful or don’t understand how to optimize storage and inventory turnover, you could can end up getting overcharged because your storage solution doesn’t have a clear fee schedule or because your inventory forecasts didn’t go to plan.
In this article, you’ll learn which types of storage solutions come with inventory holding costs, how to calculate your inventory holding costs, and tips for finding a warehousing solution that is most cost-effective for your needs.
What is inventory holding cost?
Inventory holding cost is the sum of all costs involved in storing unsold inventory, including warehousing, insurance, labor, transportation, depreciation, shrinkage, obsolescence, and opportunity costs.
How to calculate your inventory holding cost
Calculating inventory holding cost is relatively easy, as long as you’ve determined your storage, employee, opportunity, and depreciation costs:
- Storage costs include all costs associated with physically storing your inventory, such as warehousing or storage rent, utilities, and insurance.
- Employee costs mainly consist of salaries or wages for warehouse employees who maintain the building, manage and audit inventory, and fulfill orders.
- Opportunity costs are intangible, and represent the cost of holding dead stock instead of other, more profitable products.
- Depreciation costs, also intangible, are the costs incurred as your inventory’s value naturally depreciates over time, and as products become progressively obsolete.
Calculate those subtotals, add them together, and then divide that sum by the total value of your annual inventory (the combined average value of all inventory that you move in a year).
That number, when expressed as a percentage, is your inventory holding cost.
Together, the holding cost formula looks like this:
Inventory Holding Cost = (Storage Costs + Employee Salaries + Opportunity Costs + Depreciation Costs) / Total Value of Annual Inventory
Where you’ll encounter holding costs
Running your business out of a garage, living room, or basement temporarily keeps your holding costs to a minimum, as you’re utilizing space that’s already at your disposal.
But once your business and inventory outgrow the space you have at home, you should be prepared to increase holding costs that are core to most inventory storage options.
Here are three common storage solutions for ecommerce warehousing that involve holding costs.
Warehouses are large storage spaces (typically at least 1,000 square feet) that business owners can lease, buy, or build for the purpose of storing their inventory.
Depending on what kind of inventory you stock, you might need a warehouse with special features like temperature control that will likely increase your holding costs.
Storage units or facilities
When you can’t fit your products in your house any longer, temporary storage units can be rented or bought to hold inventory.
Though they are typically much smaller than warehouses, individual storage containers or units in a special storage facility are suitable options for companies growing quickly, or those that are in the middle of a transition.
They are designed for all aspects of the order fulfillment process to occur, and are not limited to storage only.
It is important to note that a fulfillment center is not the same as an on-demand warehousing solution, or a marketplace that matches empty, available warehouse space to businesses that need a short-term storage option.
Instead, fulfillment centers are managed by a single operator that not only stores a business’s inventory for them, but also picks, packs, and ships their orders in a consistent manner (even across multiple locations using the same technology, processes, SLAs, and support).
How much are holding costs on average?
Holding costs can vary greatly depending on different factors, such as:
- The location of the warehouse (whether it’s in an urban or rural area)
- The size of the products being stored (it may be more expensive to store large or even heavy items compared to small items)
- The number of SKUs you sell (the more products you sell, the more storage you need and higher costs you’ll have)
- The number of units you have to store (if it’s a year’s worth of inventory or a month’s worth)
- How quickly inventory turns over or sells through (if it’s a hot-seller that’s only briefly in the warehouse or a slow-mover that collects dust)
- The type of orders you have (DTC with few units per order or B2B that requires high pallet storage)
- Whether the facility is purely for storage or offers other services for a premium
These nuances and their effect on pricing make it hard to calculate an average cost per square foot for product holding.
In general, though, holding costs usually make up 20%-30% of a business’s total cost of inventory, with the other 70%-80% consisting of cost of goods sold and ordering cost.
What does fair holding cost pricing look like?
Finding an inventory storage solution that comes with fair holding costs is essential to your business’s long-term profitability, but the cheapest storage solution won’t always be the best for your business. In other words, what’s best for one business will be different for another.
You must take several factors into consideration before committing to a storage solution, so be sure you consider these crucial features when evaluating a warehousing or storage service.
No hidden fees
If you work with a warehouse or distribution center where you find a new type of fee added every month, you may want to look elsewhere. These fees eat into your business’s bottom line and only expand as your inventory multiplies, so find a partner whose pricing is transparent from the very beginning.
- A set monthly charge for each pallet, shelf, or bin to store each product
- A single flat rate for receiving inventory
- A single fulfillment cost per order that includes picking, packing, packaging materials, the shipping label, and tracking once it’s in the carrier’s hand).
Some 3PLs require monthly minimums or additional line items that aren’t apparent at first. Learn more about 3PL fulfillment costs here.
Only pay for storage you use
Many businesses overpay for storage they don’t need, unnecessarily inflating their inventory holding costs. Consider this if you run your own warehouse:
- You will likely over-pay for holding costs at the beginning as it will take time to grow into the warehouse and it’s a continuous fixed cost rather than a variable pay-as-you-go cost.
- Then, once you outgrow that space and need to expand into a larger warehouse, you’ll need to pay more for a larger storage space but also get new racks, equipment, and other infrastructure to utilize the bigger space.
With a 3PL like ShipBob, you not only get our best-in-class technology and fulfillment services but:
- You only pay for what you use, even as volume fluctuates throughout the year or as you expand your product lines.
- Our staff is trained to store your goods in as small a space as possible so that your storage is both efficient and cost-effective.
- You are sent a detailed line item of every storage fee billed to their account for a transparent look at storage costs.
- You get access to analytics with detailed breakdowns of your average cost per unit stored, average units on hand, and other metrics related to warehousing costs.
Insights into demand planning for accurate inventory purchasing
Businesses have a couple options when it comes to purchasing or manufacturing inventory:
- Purchase a bulk quantity of inventory, pay high holding costs until they sell through it, and risk not being able to sell it all or have products expire or become obsolete.
- Purchase smaller batches of inventory to lower holding costs, reduce risk, and order more in time before they face stockout costs.
To do the second option, businesses must understand demand forecasting so they can accurately anticipate which inventory items they’ll need, when, and where, to help to minimize inventory holding costs. They need to calculate economic order quantity (using the EOQ formula) to lower holding costs in the future.
With ShipBob’s integrated software for order and inventory management, you can view inventory levels, track historical sales data, receive inventory reports on trends, optimize storage locations to further reduce costs, and much more.
Improve inventory management with ShipBob
At ShipBob, we strive to keep holding costs low for our customers by optimizing their inventory management through technology.
You will have access to a single, intuitive platform designed to provide real-time visibility into your supply chain, so that you can track your inventory levels and avoid unnecessary overstocking.
ShipBob’s technology also lets you:
- Set reorder point notifications for each SKU.
- Automatically get notified when stock is low and report on trends to help accurately forecast inventory.
- Access insights in our free analytics tool so you can see your average cost per unit, fulfillment KPIs, shipping performance, logistics costs, and other inventory allocation tools that help you answer critical questions and better manage your inventory.
To request a fulfillment quote from ShipBob to see if we’d be a good fit for your business, click the button below.
Inventory holding cost FAQs
Inventory holding cost is not the most exciting concept, but understanding it is critical to your business’s profitability. To help you cut to the chase, here are our answers to some of the most common questions about holding costs.