A SYSTEM DYNAMICS MODEL TO DETERMINE THE VALUE OF INVENTORY HOLDING COST

Abstract

Traditionally, Inventory Holding Cost (IHC) is assumed to be a combination of several costs and determined by the summation of these cost components. Several authors have suggested that the value of IHC ranges between 12-50% of the procurement cost of an item. However, due to the absence of a generally acceptable methodology, many practitioners still determine this percentage based on estimates, benchmarks and intuition. Giving considerations to this reality, a mathematical model to determine the value of IHC using systems dynamics approach was developed. IHC was viewed holistically to identify relevant quantities, their interactions (static or dynamics), behaviour and consequences. A Causal Loop Diagram (CLD) was developed to establish the relationship among these quantities. Thereafter, CLD was transformed into a Flow Diagram (FD). FD was used to formulate a set of systems dynamics equations to obtain IHC. The interaction among fraction of goods ordered per month (FOM), fraction sold per month (FSM) and fraction damaged per month (FDM) was simulated to obtain percentage values of IHC. The value of IHC obtained from the model and simulation analysis ranges between 22.58-25.39% of the item held in stock. Based on these results, it is concluded that the developed model can be used for simulation and system analysis of the holding cost component of an inventory system under different contextual settings.