Holding Costs Guide
Inventory holding costs are a common fee businesses incur when storing inventory in a warehouse.
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.
So, what do you want to learn?
- What are inventory holding costs?
- How to calculate your inventory holding cost
- Where you’ll encounter holding costs
- How much are holding costs on average?
- 6 tips to reduce holding costs
- What does fair holding cost pricing look like?
- Improve inventory management with ShipBob
- Inventory holding cost FAQs
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What are inventory holding costs?
Inventory holding costs are the sum of all costs involved in storing unsold inventory. Inventory holding costs are calculated as part of the total inventory costs within a single supply chain. Costs include warehousing, insurance, labor, transportation, depreciation, inventory shrinkage, damaged or spoiled inventory, obsolescence, and opportunity costs.
How to calculate your inventory holding cost
There are various ways one can think about and calculate inventory holding cost. We’ll walk through both simple and detailed conceptions of inventory holding costs, and examples of each.
Simple storage costs
The simplest conception of inventory holding cost is that it is just the cost of holding inventory. While this is an oversimplification and doesn’t quite capture the whole picture, it does provide a useful starting point for merchants, and can help you think about inventory expenses in new ways.
A business outsources to a 3PL for storage, paying a fee for every bin, shelf, and pallet that that is used for their inventory.
Those storage costs would qualify as inventory holding costs. In this case, inventory holding costs would be extremely easy to calculate (as they would be equal to the storage fees paid to the 3PL).
A different business handles their own warehousing, and pays expenses such as rent, utilities, insurance, security, labor, and racking structures themselves.
In this case, those expenses would also be considered inventory holding costs. However, calculating holding costs in this case is trickier; if, for instance, only a certain amount of square footage in a warehouse is devoted to storage (while some space is used for offices, break rooms, etc.), rent for that space would not be considered part of the holding costs.
Detailed holding costs
A more detailed way of calculating inventory holding costs is through a formula that factors in storage, employee, opportunity, and depreciation costs.
Together, the holding cost formula ends up expressed as a percentage of the total value of your inventory, and looks like this:
Inventory Holding Cost = (Storage costs + Employee salaries + Opportunity costs + Depreciation costs) / Total value of annual inventory
- 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.
An art supply store sells three different products: paint brushes, easels, and canvases. Over the last year, the business held 100 units of each product, adding up to 300 units in total inventory. The business wants to calculate their inventory holding cost for the past year.
First, the business looks over its records and discovers the following:
- Annual inventory value: $100,000
- Storage costs (rent, utilities, and insurance): $20,000
- Employee costs (employee wages): $30,000
Next, the business must calculate its opportunity cost — or, in other words, the amount of money they could have made if they had gone through an alternate scenario. By the end of the year, the business sold through all 100 units of each product, making $100,000 in revenue; but while the easels barely sold out in time, the canvases (their most popular product) were already on backorder for the next year. If the business had optimized their inventory to carry 100 brushes, 50 easels, and 150 canvases, they could have made $115,000. Therefore, the art store’s opportunity cost is calculated as follows:
Opportunity cost = Return from unchosen scenario – Return from chosen scenario
Opportunity cost = $115,000 – $100,000
Opportunity cost = $15,000
Then, depreciation must be calculated. The art store determines that this past year, their inventory cost $40,000 to make and had a lifespan of 2 years. The salvageable cost at the end of those 2 years would be 20,000. With this information, they calculate inventory depreciation like so:
Depreciation = (Cost to make goods – Salvageable value) / Inventory lifespan
Depreciation = ($40,000 – $20,000) / 2
Depreciation = $20,000 / 2
Depreciation = $10,000
Finally, having all the necessary data, the art store can calculate its inventory holding cost for the past year:
Inventory holding cost = (Storage costs + Employee salaries + Opportunity costs + Depreciation costs) / Total value of annual inventory
Inventory holding cost = ($20,000 + $30,000 + $15,000 + $10,000) / $100,000
Inventory holding cost = .75, or 75%
In this case, the art store’s inventory holding cost is extremely high. Typically, inventory holding costs should only be equal to about 20-30% of your inventory’s annual value.
With this in mind, the art store should consider ways to lower their inventory holding costs, such as better forecasting demand, cutting back on unnecessary warehousing space, or outsourcing to a 3PL for help managing 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 a part of most other 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 to house all aspects of the order fulfillment process, 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?
In general, 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.
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
6 tips to reduce holding costs
You calculate your inventory holding costs, and realize they’re way too high — what do you do next? Here are a few best practices to implement in your ecommerce business that can help you lower your inventory holding costs.
1. Optimize inventory levels to avoid overstocks
Having too much of a particular SKU can drive your business’s holding costs through the roof, and drive your profitability down. Ideally, your business should hold enough inventory to meet customer demand, and enough safety stock to tide you over until you replenish, but not so much that you’re left with deadstock.
To avoid overstocking, you’ll need to optimize your inventory levels. Try:
- Calculating safety stock levels, economic order quantities (EOQs), and reorder points for each SKU, so that you don’t accidentally reorder inventory too early.
- Improving your demand forecasting technique, so that you stock more of high-demand products and less of unpopular ones.
- Adopting an inventory management system (or IMS) that tracks your inventory’s movement through the supply chain, and that provides visibility into holding costs, inventory turnover, and sales trends.
2. Get rid of dead stock
Dead stock (inventory that is obsolete, expired, defective, or otherwise unsellable) is a common culprit of inflated holding costs. Moving it out of your warehouse is essential to reducing storage costs, and will make room for more profitable inventory.
If possible, try getting rid of deadstock in a way that allows you to recoup some of your loss. Putting deadstock items on sale or bundling them with popular items earns back part of your initial investment, and including them as a free gift in an order at least adds delight and value to the customer’s unboxing experience.
Alternatively, you can donate deadstock to charity for an inventory write-off.
3. Reduce inventory turnover times
Keeping inventory moving through your supply chain is key to minimizing holding costs. Besides stocking up on products that have traditionally had high turnover (and carrying fewer slow-moving products), you can also try purchasing smaller quantities of stock more frequently to facilitate more turnover.
If turnover is slow due to a lag in sales, offering promotions and deals is a good way to spark new interest and move out older inventory.
4. Improve warehouse space usage practices
High holding costs may just be a result of poorly managed warehouse space. By reorganizing your warehouse layout for maximum spatial efficiency, you may be able to reduce the amount of square footage you have to rent.
Research different inventory storage models and warehouse racking systems that make sense for your inventory, and see if you can redesign your inventory storage to optimize your space.
Make sure you keep warehouse workflows, workstations, and picking efficiency top-of-mid throughout this process, as you want a storage system that streamlines warehouse operations, rather than complicating them.
You can also outsource to a logistics provider to get access to expertly organized warehouses in strategic locations, and ditch purchasing and managing your own warehouse altogether.
5. Automate inventory/warehouse management
More often than not, holding costs are high because humans are forgetful: you might forget about inventory taking up shelf space, forget to perform warehouse audits, or forget when you last reordered inventory (leading you to overstock).
Implementing automations within your supply chain can help you keep on top of your inventory management, and even increase efficiency and order accuracy. Consider investing in an IMS or WMS that include automations allowing you to:
- Receive reminders when a SKU hits its reorder point
- Track inventory from receiving to storage to fulfillment, and update inventory counts instantly
- Process orders and send them to the most strategically located fulfillment location with the necessary stock
- Optimize picking routes to minimize picking errors and increase fulfillment speed
6. Find a fair inventory storage solution
Optimizing your holdings costs can be a long process, and may not be the most effective use of your time.
Outsourcing inventory storage and warehousing to a logistics service provider like ShipBob provides a massive shortcut to scalable storage, and is often a more cost-effective solution than purchasing and running your own warehouse.
Depending on your price range, a 3PL provider can also provide value adds beyond storage, such as easy-to-use software and analytics tools, ready-made integrations with your existing tech stack, inventory distribution capabilities, and more.
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 global logistics platform 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 production 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 retail 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.
Are holding costs and carrying costs the same?
Inventory carrying costs and holding costs are essentially the same thing. Both terms refer to the sum of all costs related to storing unsold inventory, and you use one formula to determine that sum.
How do holding costs work?
Holding costs can come in a variety of forms, including rent or storage fees, employee compensation, inventory depreciation, and opportunity costs. These costs can vary greatly depending on on what inventory storage solution you have, where it’s located, the other services offered in conjunction with storage, and how much inventory you need to store. Be wary of some storage solutions that may spring hidden fees on their customers, and seek a solution that offers transparent pricing.
How do I calculate inventory holding costs?
To calculate your inventory holding costs, first determine your storage, employee wages, inventory depreciation, and opportunity costs. Add these amounts together, and divide that number by the total value of your annual inventory. The resulting number, expressed as a percentage, is your inventory holding cost.