Stockout Costs: How to Navigate The Financial Implications of Stockouts

Stockouts—when items are out of stock and unavailable for purchase—along with overstocks and returns are the main components of inventory distortion, which are both costly for your bottom line and frustrating for consumers. Stockouts not only result in immediate lost sales but may also have a lasting impact on customer loyalty and brand reputation. When customers encounter stockouts, most will simply switch to a competitor—and many may not come back to your brand.

According to a recent report by IHL Group, inventory distortion cost retailers a staggering $1.77 trillion in 2023, equivalent to 7.2% of all retail sales. What’s worse, the same report indicates that out-of-stocks increased 17.7% over 2022 in North America, highlighting the pressing need for better inventory strategies.

How will you take control of stockouts in your business?

Managing stockout costs effectively involves understanding their causes, calculating their financial impact on your cash flow, and implementing strategies to prevent them.

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Whether you're a seasoned ecommerce operations manager or new to the field, this article will equip you with the knowledge and tools to navigate the complexities of stockout costs and enhance your inventory management techniques. This blog will delve into what stockouts are, their causes, and their financial implications. We'll also provide tips on calculating and preventing stockout costs as well as solutions for managing these inventory challenges.

What is a stockout?

A stockout occurs when an item is unavailable for sale due to depleted inventory. This can happen for several reasons, including unexpected demand spikes, supply chain disruptions, backorders, or mismanaged inventory. The cost of stockouts are more than monetary; out-of-stocks not only result in lost sales but can also harm your brand's reputation and customer experience.

What causes stockouts?

Causes of stockouts fall into 4 main categories:

Demand Forecasting Errors

Incorrect predictions about future demand can result in insufficient stock levels. When businesses underestimate the popularity of a product, they may not order enough inventory to meet customer demand. Conversely, overestimating demand can tie up capital in excess inventory (in other words, unsold goods), leading to cautious future ordering that risks stockouts. Advanced analytics and historical sales data are crucial for improving the accuracy of demand forecasts and preventing stockouts.

Supply Chain Disruptions

Delays from suppliers or logistical issues can prevent timely restocking of products. These disruptions can be caused by a variety of factors, including transportation delays, natural disasters, or political instability. A single delay in the supply chain can have a ripple effect, causing significant gaps in inventory availability. Building strong relationships with multiple suppliers and having contingency plans in place can help strengthen your supply chain management.

Inventory Management Failures

Poor inventory tracking and replenishment practices can lead to unanticipated stockouts. Without a robust inventory management system, businesses may struggle to keep accurate records of stock levels and reorder points. This can result in either overstocking or understocking, both of which are detrimental to business operations. Implementing automated inventory management solutions can ensure timely reordering and real-time visibility over your inventory data.

Production Delays

Manufacturing issues can slow down the availability of products, leading to stockouts. These delays can be due to machinery breakdowns, labor shortages, or raw material shortages. When production schedules are not met, the downstream effect is felt in the form of empty shelves and lost sales. Companies can mitigate production delays by maintaining equipment, investing in reliable production processes, and diversifying their sources of raw materials.

How Stockouts Impact Your Business

Stockouts have several detrimental effects on ecommerce businesses:

Lost Sales and Revenue

Each stockout represents a missed sales opportunity. When customers are unable to find the products they want, they are likely to turn to competitors, resulting in immediate revenue loss. Over time, repeated stockouts can lead to a significant decrease in sales volume. Moreover, the lifetime value of a customer who switches to a competitor can be substantial, making the financial impact of stockouts even more severe.

Increased Operational Costs

Expedited shipping or emergency restocking efforts to rectify stockouts can be costly. When businesses have to rush orders to replenish out-of-stock items, they often incur higher shipping fees and additional labor costs. These unplanned expenses can quickly add up, cutting into profit margins and altering inventory costs. Additionally, frequent stockouts may necessitate investing in more sophisticated inventory management software or increasing safety stock levels, both of which require financial resources.

Customer Dissatisfaction and Damage to Brand Reputation

Repeated stockouts can erode customer trust and loyalty. Customers have high expectations for product availability and quick delivery in the era of instant gratification thanks to the Amazon Effect. When these expectations are not met, customers may become frustrated and seek alternatives. Negative experiences with stockouts can lead to negative reviews and word-of-mouth because, further damaging the business's reputation and deterring potential customers. When a business consistently fails to provide products when needed, it can create a perception of unreliability. This damaged reputation can be difficult to repair, and the long-term impact on brand equity can be significant.

How to Calculate Stockout Costs

Understanding the financial impact of stockouts is crucial for inventory optimization. Here's a basic formula to help you calculate stockout costs:

Stockout Cost = (Lost Sales × Profit Per Unit) + Emergency Restocking Costs + Expedited Shipping Costs

  • Lost Sales: Estimate the number of lost sales due to the stockout.
  • Profit per Unit: Calculate the profit you would have made per unit sold.
  • Emergency Restocking Costs: Include any additional costs incurred to restock the item quickly.
  • Expedited Shipping Costs: Factor in the costs of faster shipping to replenish stock.

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Expert Tips and Strategies for Preventing Stockouts

To minimize the risk of stockouts, consider this Top 10 list of strategies to aid your inventory planning:

Improve Demand Forecasting

Use advanced analytics and historical sales data for accurate demand planning. Implementing machine learning (ML) algorithms and artificial intelligence (AI) can help identify patterns and trends that might not be evident through traditional forecasting methods. Regularly updating forecasts based on real-time sales data ensures that your inventory levels align with current demand.

Enhance Supplier Relationships

Build strong relationships with suppliers to ensure timely deliveries. Regular communication with suppliers can help you stay informed about potential delays or issues in the supply chain. Establishing long-term contracts with key suppliers can also secure favorable terms and priority treatment during peak seasons.

Implement Robust Fulfillment Software

Use systems like Extensiv's platform to track inventory levels and automate replenishment. These systems can provide real-time visibility into inventory across multiple locations, reducing the chances of stock discrepancies. Automated alerts for low stock levels ensure that reorder processes are initiated well before a stockout occurs.

Diversify Supply Sources

Have multiple suppliers for critical items to mitigate the risk of supply chain disruptions. Relying on a single supplier can be risky; if they face an issue, your entire supply chain can be affected. By diversifying, you can ensure a more stable supply of products, even if one supplier encounters problems.

Use Safety Stock

Maintain a buffer stock of high-demand items to cover unexpected demand spikes. Safety stock acts as a cushion against variability in supply and demand, helping you meet customer orders even when forecasts are slightly off. The amount of safety stock needed can be determined based on the variability of demand and lead times.

Conduct Regular Inventory Audits

Periodically check your inventory to ensure that records match physical stock. Regular audits help identify discrepancies stemming from a variety of causes, like human error, early, allowing you to address potential issues before they lead to stockouts. These audits also help in maintaining the accuracy of your inventory management system.

Leverage Technology for Demand Sensing

Utilize technologies that analyze real-time data from multiple sources (like social media, market trends, and weather forecasts) to predict demand fluctuations more accurately. Demand sensing helps businesses respond quickly to changes in customer demand, reducing the likelihood of stockouts.

Implement Vendor-Managed Inventory (VMI)

Allow suppliers to manage your inventory levels based on agreed-upon stock levels and demand forecasts. VMI can streamline the supply chain, improve stock availability, and reduce the burden of inventory management on your team. This collaborative approach ensures that both you and your suppliers are aligned on inventory needs.

Enhance Communication Across Departments

Ensure that sales, marketing, and inventory management teams communicate effectively. When marketing plans a promotion, the inventory team should be aware to prepare for potential spikes in demand. Cross-departmental communication helps in aligning inventory levels with business activities.

Monitor and Adjust Reorder Points Regularly

Set and periodically review reorder points based on lead times, demand variability, and current stock levels. Adjusting reorder points helps ensure that orders are placed at the right time, reducing the risk of stockouts. Use historical data and forecasted trends to inform these adjustments.

By implementing these strategies, businesses can significantly reduce the risk of stockouts, ensuring a more reliable supply of products to meet customer demand. Adopting a proactive approach to inventory analysis and management not only enhances operational efficiency but also boosts customer satisfaction and overall profitability.

Prevent Stockout Costs with Extensiv

Extensiv offers comprehensive solutions for brands to help you manage your inventory and prevent stockouts. Our platform provides real-time inventory tracking, advanced demand forecasting, and seamless integration with your supply chain processes. By using Extensiv, you can reduce stockout risks, improve customer satisfaction, and boost profitability.

Request a demo today to learn more!

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Stockout Cost FAQs

Why are stockout costs important to consider?

Stockout costs are critical because they directly affect your sales, customer satisfaction, and overall profitability. Understanding these costs helps in making informed inventory management decisions.

What strategies can businesses use to recover from stockouts?

Businesses can recover from stockouts by improving their demand forecasting, diversifying suppliers, maintaining safety stock, and using robust inventory management systems.

What are some examples of industries affected by stockouts?

Industries such as ecommerce, retail, manufacturing, and healthcare are heavily affected by stockouts due to their reliance on timely product availability.

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