Carrying costs

SOURCE: Flickr user MattHurst

SOURCE: Flickr user MattHurst

In the for-profit world, there’s a category of expense called ”carrying costs,” which includes all costs involved in holding an asset (inventory, for example, which costs money even when it’s sitting in the stock room…insurance, security, spoilage, storage, finance, and such). The game in inventory-based businesses is to balance your carrying costs against the cost of not having that thing available when you need it.

If you hold inventory that never turns, you’ll eat your profits with carrying costs. But if you suddenly have a bump in sales and run out of inventory, you’ll lose all the profit you would have made.

As it turns out, there are a few good reasons for holding more stock than you can immediately sell, and for eating the carrying costs in the process. Among these reasons are the following types of stock:

  • Cycle Stock: Inventory you hold because you’ll need it to service expected sales, based on past experience.
  • Safety Stock: Inventory you hold in case of unexpected delays or problems in your supply chain…also called ”buffer stock”.
  • Speculation Stock: Inventory held in expectation of seasonal or increasing demand. If you’re betting that sales will increase, you can buy a bunch of extra stock, perhaps at a bulk discount.
  • Psychic Stock (my personal favorite): Inventory carried to stimulate demand through display. Customers can’t purchase what they don’t see (or usually don’t), and more stock increases the odds they’ll see it. Next time you’re in a grocery store, observe the shock-and-awe wall of Campbell’s soup. That’s psychic stock.

So, why am I sharing this lesson in inventory strategy? Because “carrying cost” is also a rather useful concept for any assets or capacity in an arts organization. As nonprofits, we are inclined to minimize our capacity to the absolute bone…few staff doing lots of work, buildings falling into disrepair, budgets that balance to zero every year instead of building a working reserve. Or, on the flip side, we build or buy assets without considering their carrying costs (massive new cultural facility, anyone?), and then wonder why we’re dragging so much weight.

As in the inventory business, carrying too few assets (staff, facilities, technology, savings) leaves us less able to absorb an unexpected shock, or to benefit from an unexpected opportunity. Carrying too many assets bleeds our energy through carrying costs, which also leaves us vulnerable, or slow, or distracted.

Also, as in the inventory business, there’s no single correct balance…it’s a matter of continual and intentional effort. It’s also a matter of designing our organizations so they can ramp up quickly and wind down quickly as external forces demand — through partnerships, good relationships with our suppliers, and nimble staff structures. And finally, what helps in all of this is better information, clearer thinking, and ever more brilliant guessing.

Suddenly, I want soup.