Ordering Cost

Ordering Cost is the cost associated with ordering a new batch of materials.

It includes the following:

• Purchase Order Cost
• Labor cost
• Cost associated with payment to supplier
• Inspection of goods received
• Supplier invoice preparation cost

The Ordering costs that a business incurs increases with the number of orders placed. Ordering costs vary inversely with carrying costs. It means that the more orders a business places with its suppliers, the higher will be the ordering costs. However, more orders mean smaller average inventory levels and hence lower carrying costs.

Example:

Company XYZ is involved in special metal bar distribution to households and businesses through its network of pipelines. XYZ has only a few suppliers who produce these customized bars. The company advertised in 3 national and 2 international newspapers before placing a purchase order. This will cost $300,000 per order. The suppliers charge an amount of $1 million regardless of the size of order. The opportunity cost of staff time spent on drafting the tender documents is estimated at $200,000. Legal costs are $50,000. In each procurement XYZ hires a firm for inspection at a flat fee of $50,000. Bank charges an amount of $3,000 as documentation charges.

In this situation, XYZ ordering costs are $1,533,000 per order (advertisement costs of $300,000 + customization cost of $1,000,000 + opportunity cost of staff time of $200,000 + legal costs of $50,000 + inspection costs of $100,000 + bank charges of $3,000).

(Part of Education Series: Operations Management)

Also See: 

• Throughput Time
  
• Lean Six Sigma
  
• Logistics in Supply Chain Management
  
• Supply Chain
  
• Holding Cost
• Economic Order Quantity
  
• Limitations of Economic Order Quantity