Stockout costs (called also shortage costs) are costs caused by product shortages on the shelf. They may be an effect of wrong forecasting, supplier-retailer communication and/or logistics management. Lack of desired product in a shop might in some cases lead not only to abandoning the purchase by the potential customer, but also to loosing their brand commitment in the future (Waller 2013, p. 148).
The most common reasons for product inavailability at the given time and quantity are:
- The first of those reasons is believed to be the most difficult to overcome or reduce, because – as the only one of listed – is greatly dependent on neither supplier nor retailer and thus could be controlled by them just to some extent (i.e. by marketing efforts, promotion and price changes). Demand volatility might be a consequence of economical situation changes, trends or seasons. Those factors may vary depending on industry, as well as other aspects, resulting in low credibility of forecasting patterns. Some industries are particularly exposed to demand fluctuations, forcing retailers to maintain high stock levels all the time. Such a situation generates additional expenses and decreases efficiency of logistics systems.
- The second aspect is usually much easier to reduce. Stockout costs incurred becaue of incorrect or incomplete stock level information could be constrained by implementing coherent and clear register of inventory levels in warehouses. When the information provided is current and as accurate as possible, both supplier and retailer are able to monitor the situation and have access to data essential for delivering the product to the final customer on time, without unnecessary storage costs.
- Supply chain disruptions are situations deviating from the standard course of supply processes. They are often unpredictable and it may be challenging to prevent their negative consequences. Typical examples for logistics chain problems are delivery delays, goods damaged in transit and inconsistency of the delivered goods with the order. All of them could lead to stockout costs and inability to provide the right product in the shop.
It is important for the companies to develop a system of rules concerning all of the listed stockout reasons. Supplier and retailer should be aware of the problems that may occur and be able to react in time in order to minimize potential risks and their consequences (Lee, Cho 2014, p. 167).
Hidden costs of stockouts
Stockout costs are generated because of stochastic character of demand (Esfandiari, Seifbarghy 2013, p. 5792). Ordered quantities vary depending on too many aspects to be fully predicted, which is one of the most important reasons for warehouse surplus. In order to be able to ensure full product availability, stock levels have to be higher than average demand. Otherwise, the negative experience of potential clients could result in choosing a product of another brand – not only just once, but also (in some cases) changing their shopping habits. This creates another danger for the company; the stockout cost is in fact much higher than it might seem, because the customer could choose the product no more, resulting in future losses. The more precise company's forecasting systems are, the more optimal inventory levels management may be and – consequently – the costs of stockouts are lower. Effective forecasting and data analysis might help to predict the order quantity and stock level that will both be relatively safe and generate acceptable costs. Crucial is up-to-date inventory monitoring and clear guidelines for the warehouse and supplier emloyees.
One of the most popular solutions of the problem may be effectively functioning stockout-costs sharing model: VMI, also known as vendor-managed inventory. This system allows the supplier to monitor the inventory levels of contracted retailers in order to replenish inventories in accordance with JIT model. Partners using VMI are able to maintain smooth communication which may prove to be crucial when it comes to delivery times and effective forecasting. Such a cooperation has been existing on the American market since 1980s and was consequently enhanced and implemented in new countries. This way of stockout cost reduction requires precise data delivered to the system on time and updates on regular basis. The quality of both partners’ input is the condition determinating how effective cost reduction could be (Choi T-M. 2011, p. 497-498).
- Bottani E., Montanari R. (2010), Supply chain design and cost analysis through simulation, „International Journal of Production Research”, 48(10), 12-24.
- Choi T-M. (2011), Coordination and Risk Analysis of VMI Supply Chains With RFID Technology, „IEEE Transactions on industrial informatics”, 7(3), 497-498.
- Esfandiari N., Seifbarghy M. (2013), Modeling a stochastic multi-objective supplier quota allocation problem with price-dependent ordering, „Applied Mathematical Modelling”, 37(8), 5790-5800.
- Lee J. Y., Cho R. K. (2014), Contracting for Vendor-Managed Inventory with Consignment Stock and Stockout-Cost Sharing, „International Journal of Production Economics”, 151, 158–173.
- Liberopoulos G., Tsikis I., Delikouras S. (2010), Backorder penalty cost coefficient “b”: What could it be?, „International Journal of Production Economics”, 123(1), 168-174.
- Madadi A., Kurz M. E., Ashayeri J. (2010), Multi-level inventory management decisions with transportation cost consideration, „Transportation Research Part E: Logistics and Transportation Review”, 46(5),720.
- Waller M. (2013), The True Cost of Stockouts, „Progressive Grocer (India Edition)”, 92(7), 148–149.
Author: Joanna Możdżeń