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Finally, there is the opportunity cost, which refers to how the income tied up in the inventory could have been utilized.
The best way for Seismic Testing to reduce its inventory costs would be to utilize a lot-by-lot ordering system. It is noted that the explosive is specialized and difficult to obtain. The difficulty could be reduced by entering an agreement with a supplier, where the supplier agrees to supply a certain amount of the explosive on an ongoing basis. This would then be delivered and paid for on a lot-by-lot basis based on an agreed payment amount, rather than being delivered and paid for in bulk. The lot-by-lot delivery would reduce the opportunity cost, since Seismic Testing would be paying for the material as they need it, rather than far in advance. Seismic Testing would also reduce its storage costs, since it would not need to store large amounts of the explosive. This would create cost savings because it would require a smaller storage area to maintain...
In addition, the explosives would be stored for a shorter period, which means that fewer safety checks would not to be carried out. The smaller storage amount would also reduce insurance costs. Finally, this solution would also reduce the costs involved in sourcing and purchasing the explosives. This saving occurs because the supplier would be responsible for sourcing the explosive, which reduces Seismic Testing's workload.
Overall, this consideration shows the high costs associated with storing a large amount of inventory, especially for a dangerous product such as explosives. This also shows how costs can be reduced by utilizing a more effective supply strategy.
References
Lockyer, K., Muhlemann, A., & Oakland, J. (1988). Production and Operations Management. London: Pitman.
Schermerhorn, J.R. (1989). Management for Productivity. New York: John Wiley & Sons.
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