Question

Explain the tradeoff between setup cost and carrying cost.

Answer 1

First, we will get familiar with setup cost and carrying cost later we will discuss the tradeoff between the two.

Setup cost as the name explains it is the cost which is incurred while setting up any inventory or equipment. The cost incurred as buying, moving, scheduling, recording, labouring etc of an inventory or equipment.

Carrying cost is the cost which is incurred while keeping an inventory or equipment. This means that we give rent for its storage in warehouse where we keep inventory or equipment, till the time we use it we incur costs in its maintenance, insurance, perishability etc.

Regarding the question i.e. tradeoff between the setup cost and carrying cost is totally opposite. As the orders goes up the setup cost increases lowering the carrying cost. We will understand with one example i.e. increase in number of orders. If we receive more orders then the material purchase, bill receivables, work load, etc increases but the warehouse, workplace, its rent, storage remains the same as previous.