Aroha has realised that placing lots of small orders increases her ordering costs. But placing large but less-frequent orders increases her holding costs.
Aroha calculates demand, ordering costs, and holding costs, then uses our tool to work out the best amount of coffee beans to order each time.
Aroha calculates her demand
Aroha looks at last year’s sales figures and sees that her café needed about 1,000 bags of coffee beans to meet the demand for the coffees her customers bought. Her business is fairly steady, so she estimates that demand will be similar this year to last year.
Aroha’s demand = 1,000 bags per year.
Aroha calculates her ordering costs
Aroha then looks at delivery costs and admin costs. She also looks at the time it takes to place and handle an order and how much that costs in wages.
- Aroha’s supplier charges $8 for each delivery, including insurance.
- Aroha pays a fee to her supplier for the ordering software.
- She works out that every order she places and tracks using the software costs $2.
- Aroha calculates the time it takes her employee to place and handle the order.
- The dollar amount in wages is $5 per order.
Aroha’s total ordering cost = $15 per order.
Aroha calculates her holding costs
Aroha looks at the area used to store coffee beans. It’s about 2% of the café’s footprint. Aroha pays $100,000 in rent every year, so total coffee bean storage is $2,000 per year (2% x $100,000 = $2,000).
To work out how much it costs to hold a single bag of beans as inventory, Aroha divides the 1,000 bags of coffee beans (her annual demand) by the $2,000 storage. This works out to $2 per year to hold each bag.
If she hadn’t used the space for inventory, Aroha could have used the space for another table for customers. She calculates that missed sales opportunities her $3,000 per year. This works out to $3 per year to hold each bag.
Aroha also calculates that she spends $1,000 per year replacing inventory that gets damaged or goes out of date. This works out to $1 per year to hold each bag.
Aroha’s total holding cost = $6 per bag per year.
Aroha puts her calculations into the tool
Aroha currently orders 200 bags of coffee at a time, meaning she places 5 orders every year. Each bag of coffee costs her $50. The tool shows Aroha that the best amount to order each time is 67 bags. She’ll need to order more regularly — 15 times a year — but she’ll save $249 a year in ordering and holding costs.
More importantly, the tool shows that ordering wisely frees up $6,773 in cash. Because Aroha doesn’t need to hold this money back for her next order, she can use it for other things.
The tool also shows Aroha when she needs to reorder (her reorder point). It takes 3 days for ordered beans to arrive, and Aroha needs 3 bags of beans as a buffer in case the beans are delayed. The tool shows her that she needs to reorder when she has 12 bags of beans left.
Note that the tool and this case study use rounding where needed.