Stockout costs

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).

Common causes

Fig.1. Vendor Managed Inventory System (VMI) model

The most common reasons for product inavailability at the given time and quantity are:

• demand volatility
• inadequate stock level information
• supply chain disruptions.

1. 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.
2. 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.
3. 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.

Solutions

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).

Examples of Stockout costs

• Loss of sales: Stockout costs can manifest themselves in the form of lost sales when a customer is unable to purchase a desired item because of it not being available. This can result in the customer being unable to meet their needs and potentially causing them to switch to another brand.
• Opportunity costs: Stockout costs can also represent an opportunity cost, as the retailer is unable to capitalize on the potential sales if the item is not available. This can be especially damaging to a retailer if the item is in high demand and has a large profit margin.
• Customer dissatisfaction: Stockout costs can also be seen in the form of customer dissatisfaction. Customers may be frustrated when an item they have been looking for is not available, and this can result in them taking their business elsewhere.
• Increased labor costs: Stockout costs can also lead to increased labor costs for the retailer. This can be seen in the form of increased staff costs to handle customer inquiries and complaints, as well as increased costs associated with restocking the shelves.

Advantages of Stockout costs

Stockout costs can be beneficial for a business in certain cases. The advantages of having stockout costs are:

• Increased focus on forecasting and planning - Tracking stockout costs can help businesses focus on improving their forecasting and planning processes, which can help them better anticipate customer demand and manage inventory more effectively.
• Improved customer service - By tracking stockout costs, businesses can identify when customers are not able to find the products they need and can use that information to improve customer service.
• Cost savings - Tracking stockout costs can help businesses identify where they can save money by better managing their inventory and avoiding unnecessary stockouts.
• Improved supplier relationships - Tracking stockout costs can help businesses identify problems in the supply chain and collaborate with suppliers to ensure products are available when customers need them.

Limitations of Stockout costs

Stockout costs have several limitations. These include:

• Difficulty in accurately measuring the financial impact of stockouts on sales and profits. Stockouts can affect sales in various ways, such as reducing the availability of products, reducing customers’ satisfaction and loyalty, or increasing the cost of maintaining inventory. All of these can be difficult to measure in an effective and accurate way.
• Difficulty in determining the root cause of stockouts. Stockouts can be caused by a variety of factors, such as inaccurate forecasting, inefficient logistics management, or supplier-retailer communication problems. It can be difficult to identify the exact cause of a stockout, and this can make it difficult to address the issue in a timely manner.
• Difficulties in accurately predicting future stockouts. Stockout costs can be reduced by accurately predicting future stockouts and taking action to prevent them, but this is often difficult to do. Even with accurate forecasting, there is always some uncertainty about future stockouts, and it can be difficult to take effective action to mitigate them.

Other approaches related to Stockout costs

• One approach to reducing Stockout costs is to optimize the forecasting process. This can involve using advanced statistical or predictive analytics to better predict customer demand and plan for future inventory levels.
• Another approach is to enhance communication between suppliers and retailers. This includes having open lines of communication and clear protocols for ordering and re-ordering inventory.
• A third approach is to improve logistics management. This includes streamlining the supply chain with better systems and processes for getting inventory to the store shelves quickly and efficiently.

In summary, Stockout costs can be reduced through optimizing the forecasting process, enhancing communication between suppliers and retailers, and improving logistics management. By taking a proactive approach to these areas, organizations can minimize Stockout costs and maximize their profits.

Stockout costs — recommended articles

Inventory in transit — Ordering cost — Centralized purchasing — Merchandise inventory — External failure costs — ABC analysis — Overproduction — Prevention cost — Contract logistics

References

• 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