What are stockout costs and how do you avoid them?

Every business knows that inventory optimization is essential to their success. Having the right item available when and where people want to buy means happier customers and more revenue. But what about the opposite, when you run out of stock? That doesn’t just leave potential customers unhappy. There’s a real, tangible cost to stockouts. Having too little of an item in stock or running out of a needed material altogether can mean financial losses for your company. 

Fortunately, you don’t have to resign yourself and your business to suffer these losses. There are ways to leverage business analytics to calculate and minimize the impact of stockout costs on your business. In this post, we’ll explore what stockout costs are, how to calculate them, the consequences of stockouts, and present strategies that you can implement today to help protect your business against them.

What are Stockout Costs?

Stockout costs are both direct and indirect expenses incurred by a business when it runs out of stock. Left unaddressed, these costs can have a significant impact on a company's margins, revenue, and profitability. Direct stockout costs are expenses that are related to the loss of sales due to stockout. These costs include lost sales revenue, reduced profit margins, and increased supply chain and shipping costs to rush orders. In addition, direct stockout costs may include lost productivity and the cost of handling customer complaints, since your team is spending time addressing an avoidable customer issue instead of moving your business forward. 

Indirect stockout costs, on the other hand, are expenses incurred by the business that are not directly related, but still stem from, to the loss of sales due to stockout but are still. These costs include the cost of carrying excess inventory, additional storage costs, and the cost of expediting replenishment orders. Indirect costs can also include damage to a company's reputation due to poor customer service and an inability to meet customer expectations

The consequences of stockout costs on your business

When you don’t have an adequate inventory, it can result in several negative consequences for your business. These include:

Loss of sales revenue

When a business runs out of stock, it can no longer fulfill customer orders - in other words, literally leaving money on the tableThis leads to a loss of sales revenue, as customers will go elsewhere to find the product they need. Not only does this impact the business's immediate sales revenue, but it also affects their reputation, which can have a long term impact on business. 

Damage to customer relationships

Customers who cannot find the products they need may become frustrated and choose to take their business elsewhere. This can lead to an increase in customer churn, decreased brand loyalty, and damage to the company's reputation that scares away other customers and prospects. Additionally, customers who have had negative experiences with out-of-stock items may be less likely to return to the business in the future.

Increased costs

When a business runs out of stock, they may need to pay rush fees or expedited shipping fees to restock their inventory quickly to meet their customer obligations. Additionally, if the business needs to source materials from a new supplier, they may need to pay higher prices or experience longer lead times. This can shrink margins and have a material impact on revenue.

How to Calculate Stockout Costs

Calculating stockout costs can be a complex process, but it is essential for businesses to understand how a stockout will impact their bottom line. The following steps can be used to calculate stockout costs:

Step 1: Determine the Cost of Goods Sold

The first step in calculating stockout costs is to determine the cost of goods sold (COGS). COGS refers to the cost incurred by the business to produce and sell its products, and includes direct costs, such as the cost of raw materials and labor, as well as indirect costs, such as overhead.

Step 2: Calculate the Cost of Lost Sales

Once COGS has been determined, the next step is to calculate the cost of lost sales due to stockout. This can be done by multiplying the average daily sales revenue by the number of days that the product is out of stock. For example, if a business typically sells $1,000 worth of a product each day, and the product is out of stock for five days, the cost of lost sales would be $5,000.

Step 3: Add Up the Additional Costs

As mentioned, stockout costs go beyond simply the cost of lost sales. The third step is to add up the additional costs incurred due to stockout, such as expedited shipping costs, lost productivity, and customer service costs. These costs will vary depending on the specifics of your business and the circumstances surrounding the stockout, but are critical for step four.

Step 4: Calculate the Total stockout Costs

Once you’ve gathered this information, you’re ready to calculate the total stockout costs by adding the cost of goods sold, the cost of lost sales, and the additional costs. This will give the business a better understanding of the true cost of stockout and can help them make informed decisions about inventory management.

By taking the time to calculate your stockout costs, you can gain insight into how effective your inventory planning is and make adjustments if needed. This will help ensure that you are able to meet customer demands and maximize profits.

5 ways to minimize and avoid stockout costs

Having the right stock isn’t always easy, but there are several strategies that you can use to minimize and avoid stockout costs. These include:

1. Optimize inventory management 

One of the most effective ways to minimize stockout costs is to optimize inventory management. This includes tracking inventory levels regularly and forecasting demand to ensure that enough stock is available to meet customer needs.

2. Use data analytics and forecasting tools

Data analytics and sales forecasting tools like ThoughtSpot can help businesses predict future demand and adjust inventory levels accordingly. This can help to prevent stockout costs by ensuring that enough stock is available to meet customer needs. These tools are most effective when business people, such as merchandiser and inventory managers, can engage with the data themselves so they can find insights and take action before a stockout occurs.

An inventory forecast from January 1st to July 17th.

3. Establish relationships with multiple suppliers

Establishing relationships with multiple suppliers can help businesses to mitigate stockout costs. If one supplier is unable to fulfill an order, the business can turn to another supplier to fulfill the order without delay. By using supply chain analytics, companies can also effectively manage all their different vendor partners while ensuring they avoid stockouts.

4. Develop a backup plan

Developing a backup plan can help businesses to respond quickly if they experience a stockout. This may include identifying alternative suppliers or developing a contingency plan for unexpected demand spikes.

5. Invest in AI-Powered Analytics

Investing in AI-Powered Analytics can help businesses to streamline their inventory management processes and reduce the likelihood of stockouts by enabling business domain experts to engage with data directly, or having artificial intelligence push relevant insights that can help avoid a stockout before users even know to ask. This may help augment an inventory management system or in using automation to reorder inventory automatically.

Protect your business from stockouts

Stockouts can have a severe effect on companies, especially those dealing with just-in-time inventory. Smart, proactive strategies can help protect your business from this significant threat. Invest strategically in labor and technology, anticipate customer demand and plan appropriately for the short and long-term. Further, get to know supplier timetables in advance so that you don’t buy too much stock or too little stock at once – it’s all about balance and understanding how scale works. As long as you empower your team to use data to manage your inventory properly and put the right systems in place, you can avoid costly miscalculations in supply levels (and losses of both time and money). Start a ThoughtSpot free trial today to see how AI Analytics can help you avoid stockouts and make smarter data-driven decisions easier than ever!