Ordering Costs

Ordering costs are associated with the process of purchasing inventory. These costs include costs associated with preparing the purchase order, postage, telephone calls to the vendors, setup costs if produced in-house, record-keeping and accounting costs, and material-receiving costs. These costs are also referred to as acquisition costs. Ordering costs are incurred each time the order is placed with a supplier. In general, ordering costs are fixed, and do not vary with the order size (the number of goods or items in an order). Therefore, the ordering costs per unit decrease as the order size increases.

Figure illustrates the cost tradeoff in inventory management that is considered while deciding on the size of a purchase order. In the figure, we can see that the annual carrying costs increase proportionately with increase in the order quantity. The annual ordering cost decreases with the increase in order quantity, as the number of orders decreases. So operations managers compute the total annual costs for various order quantities and then select the most economic order quantity (where the total annual cost is minimum).              

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