E&OE is looking to reduce its inventory costs for all its products. The company realizes that its inventory depends on the setup costs of its various products. How do setup costs affect E&OE's inventory costs?

What will be an ideal response?

As inventory draws down, management must know at what stock level to place a new order. The company needs to balance order-processing costs and inventory-carrying costs. Order-processing costs for E&OE consist of setup costs and running costs (operating costs when production is running) for the item. If setup costs are low, E&OE can produce the item often, and the average cost per item is stable and equal to the running costs. If setup costs are high, E&OE can reduce the average cost per unit by producing a long run and carrying more inventory. The larger the average stock carried, the higher the inventory-carrying costs.