What is Carrying Cost? Definition & Manufacturing Examples

What is Carrying Cost?

Carrying cost (also called holding cost or inventory carrying cost) is the total expense associated with storing and maintaining inventory over a period of time. It encompasses every cost incurred because inventory is being held rather than immediately consumed or sold. For most manufacturers, carrying cost represents one of the largest controllable expenses in operations, typically ranging from 20% to 35% of the average inventory value per year.

Carrying cost is a critical input to inventory management decisions including economic order quantity calculations, safety stock optimization, and make-to-stock versus make-to-order decisions. Higher carrying costs favor smaller, more frequent orders and leaner inventory levels. Lower carrying costs make it more economical to hold larger quantities.

Understanding and accurately calculating carrying cost is essential because many manufacturers significantly underestimate it. When only warehouse rent is considered, the cost appears modest. When capital costs, obsolescence, insurance, taxes, shrinkage, and handling are included, the true cost is often two to three times higher than the initial estimate.

How Carrying Cost Works in Manufacturing

Carrying cost is composed of several components:

Capital cost (8-15% of inventory value). This is the largest component — the cost of money tied up in inventory. It includes interest on loans used to purchase inventory and the opportunity cost of capital that could be invested elsewhere. If a manufacturer has $2 million in inventory and its cost of capital is 10%, the capital cost is $200,000 per year.

Storage cost (3-8%). Warehouse rent or depreciation, utilities, material handling equipment, and warehouse labor. This cost varies significantly based on the type of inventory — bulk raw materials cost less to store than small, organized finished goods.

Obsolescence and deterioration (2-5%). The risk that inventory will become unusable due to design changes, shelf life expiration, technology advancement, or physical deterioration. This component is higher for industries with frequent product changes or perishable materials.

Insurance and taxes (2-4%). Property taxes on inventory (in jurisdictions that tax inventory) and insurance premiums covering inventory against loss from fire, theft, or natural disaster.

Shrinkage (1-3%). Losses from theft, damage, miscounting, and administrative errors. Even well-managed warehouses experience some shrinkage.

Handling cost (1-3%). Labor and equipment costs for receiving, put-away, picking, and cycle counting inventory that is being held.

Carrying Cost Example

A mid-size manufacturer has an average inventory value of $3.5 million. Their carrying cost components are:

This means the company spends $875,000 per year just to hold its inventory — before considering the cost of the inventory itself. Every $100,000 reduction in average inventory saves $25,000 per year in carrying costs.

If the company can reduce average inventory from $3.5 million to $2.8 million through better scheduling and demand planning, the annual carrying cost savings would be $175,000 — a significant improvement to the bottom line.

Why Carrying Cost Matters for Production Scheduling

Carrying cost creates a direct link between production scheduling and inventory investment. Every scheduling decision affects inventory levels — and every inventory dollar has a carrying cost.

Scheduling large production batches increases finished goods and WIP inventory, driving up carrying costs. Scheduling smaller, more frequent batches reduces inventory but increases setup frequency and may reduce throughput. The optimal batch size balances setup costs against carrying costs — this is the economic order quantity principle.

Production scheduling software like Resource Manager DB helps manufacturers find this balance by optimizing production sequences to minimize both setup time and inventory accumulation. Effective scheduling reduces the time materials spend as WIP — directly reducing carrying costs.

Make-to-order scheduling strategies minimize finished goods carrying costs by building only what customers have ordered. Make-to-stock strategies accept higher carrying costs in exchange for shorter customer lead times.

Related Terms

• Economic Order Quantity — the order quantity formula that balances carrying cost against ordering cost
• Safety Stock — buffer inventory whose carrying cost must be justified by stockout risk reduction
• Inventory Turnover — the rate at which inventory is consumed, inversely related to carrying cost impact

FAQ

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This term is part of our Manufacturing & Production Scheduling Glossary. Learn more about inventory management, scheduling, and manufacturing terminology.