Stockout Costs: How to Calculate and Avoid Them

Stockout costs are two words most retail and e-commerce businesses dread hearing. You’ve put so much time, money and effort into creating products that fly off the shelves, you’ve created a customer experience that makes word of mouth a powerful marketing tool and the buzz around your business is like the sound of bees near pollen.

In an instant, everything changes. You run out of stock, customers get frustrated by the time it will take for their products to get to them, you miss out on sales and you lose some customers. Stockout costs are real and they can be heavy. That’s why it’s important to avoid stockouts at all costs.

Let’s explore what stockout costs are, how to calculate them, why they happen, the impact on your business and how to avoid them.

What are Stockout Costs?

Stockout costs refer to the revenue lost when inventory is no longer available for a customer to buy. They can be direct from missed sales or indirect from losing a customer, having to pay extra for quick deliveries or a dent in supplier relationships. Whether it’s from lost sales or affected internal processes, stockout costs can really hurt your business.

Calculating Stockout Costs

To calculate stockout costs, you need to know how much revenue that stock would bring in. To do that, work out your daily sales velocity (DV$) by dividing the total sales in currency units by the number of days your product was in stock over a specified period.

$$DV\text{\textdollar} = \text{total sales} \div \text{number of days product was stocked}$$

Now, you can multiply your DV by the number of days your product is out of stock for. This gives you a basic stockout cost but to get a real value, you need to add the indirect costs of stockout. This means considering possible refunds for canceled orders, lost goodwill from customers and operational costs if you decide to support customers with backorders.

$$\text{Stockout costs} = (DV \times \text{days out of stock}) \times \text{costs of supply}$$

Let’s take a simple example where there are no extra costs of stockout. You run out of green leather pants. Your DV for these pants is $560 and they’re out of stock for 10 days. Your simple stockout costs (without even mentioning the potential loss of loyalty from customers) is $5,600.

What are the Top Causes of Stockouts?

Inaccurate inventory forecasting is the main cause of stockouts but it’s not the only challenge.

Discrepancies in Demand Forecasting

Demand forecasting helps you accurately predict the number of sales you’ll achieve over a specified period. Lots of factors influence demand, which makes it hard to get it right without the right data and inventory planning software. This means, discrepancies can happen, which cause stockouts if you’ve planned for too little or overstocks if you’ve planned for too much.

📚Further Reading: Weeks of Supply: Is it Right For Your Business?

Production and Supply Chain Delays

You can’t plan for production and supply chain delays, but if they happen, you may not receive stock in time to meet demand. That’s why it’s important to have a backup plan for unexpected delays. Make sure you have a range of suppliers and you know exactly what their lead times are.

📌 Get Started: Be ready for anything. Access any metric with Singuli’s query panel for customer reports so you can quickly adjust to sudden changes.

Unexpected Spikes in Demand

What happens when a necklace you sell with a DV of $100 is worn by an Instagram influencer without you knowing? There’s an unexpected spike in demand. Suddenly, everyone wants that necklace but you haven’t planned for this. You might experience stockouts. Make sure you always have backup suppliers and software that can predict scenarios so you always expect the unexpected.

💡Pro Tip: Plan for multiple versions of the future with Singuli’s Scenarios. Ask “what if” and get answers immediately

Inaccurate Inventory Data

The information that comes out of inventory planning software is only as accurate as the information that goes in. If your inventory data is inaccurate, your demand forecasting will be too. It’s important to keep a close eye on your inventory and to have automated systems in place to make sure you don’t lose track. Of course, errors can be both human and system generated so you need to be aware of both, especially when choosing the right software.

💡 Pro Tip: Capture all relevant inputs with Singuli’s transparent, model-based forecasts.

Cash Flow Management

Not having enough cash ready to buy stock when you need it means you can’t meet demand and you’ll have stockouts. Cash flow problems can happen for many reasons but one of the most common comes from the opposite of stockouts: overstocks. You can overcome both of these challenges with the right inventory planning software.

📌Get Started: Optimize your inventory levels and reduce overstocks. Use Singuli to replenish the right amount of stock at the right time so your inventory costs stay low.

How Can Stockouts Impact Your Retail or E-Commerce Business?

As you’ve already learned, stockouts are problematic in numerous ways. Let’s go through them in more detail:

Lose Sales Revenue

The most obvious impact on your business is the loss of sales on the product that’s out of stock. As stated in the formula above, this is your DV multiplied by the number of days your product is out of stock for.

Disappoint Potential and Existing Customers

If you have a stockout and your competitor doesn’t, where do you think your customers will go? You might only lose them for this sale but if you keep having stockouts, you could lose them forever. Potential customers who are yet to have any sense of loyalty are less likely to give you a second chance. All of this adds up to a cascading effect of missed lifetime revenue.

Get Negative Customer Reviews

In the age of social media and instant gratification, negative reviews can cause even greater problems. You may never regain the trust of the customer who gives you a negative review and you may also lose out on new customers who won’t believe in your brand.

Affect Your Performance Marketing and Ranking Results

Performance marketing allows you to measure a direct return on your marketing investment. When you have stockouts, your return will be dented so trying to get the same revenue results will cost more, in other words, your CACs (customer acquisition costs) will increase.

📌Get Started: Understand what’s working and turn your performance marketing into a category level forecast with Singuli’s Performance Marketing.

Disrupt Cash Flow

Stockouts disrupt cash flow in a number of ways. You have to refund orders for products that are out of stock and with less revenue, you’ll have less to spend on new product development, sales and marketing.

Create FOMO and Future Sales

One potential benefit of a stockout is the feeling of missing out (FOMO) that comes with not being able to get what you want when you want it. It can boost future sales when used as a marketing tool. Picture a line of people outside of a store. You might not know what the store sells but you get a feeling that you should be there.

And with a prominent call to action (CTA) online, there’s potential to gain future sales because of stockouts. For example, you could add a static banner to your site that says something like, “Get on the waitlist to be notified when the customer-favorite [insert product name] are back in stock!” And the CTA button could say, “Don’t Miss Out!”. Using this tactic could encourage site visitors to act quickly because they fear missing out on the products everyone else seems to love.

This needs to be well thought through and you still need a good demand planning system so you stay in control.

How to Avoid Stockouts and Associated Costs

Avoiding stockouts isn’t easy but it’s possible with the right plan and the right software:

Always Have Safety Stock

One of the best ways to avoid stockouts is to have a minimum inventory threshold for safe operations. Safety stock gives you time to replenish so you can look after current demand and prepare for forecasted demand.

You work out safety stock by multiplying the maximum units sold per day by the maximum possible lead time for future products and subtracting the sum of the equivalent averages.

$$\text{Safety stock} = \left(\text{\scriptsize maximum daily units sold} \atop \overset{\times}{\text{\scriptsize maximum lead time}}\right) - \left(\text{\scriptsize average daily units sold} \atop \overset{\times}{\text{\scriptsize average lead time}}\right)$$

For example, your maximum daily sales on red shorts in size M is 30 units and the longest time a new delivery will take to arrive is 7 days. Your average sales for the shorts is 20 units and your average lead time is 3 days. This is what your calculation would look like:

$$(30\times7)-(20\times3) = 150(30\times7)-(20\times3) = 150$$

A more sophisticated and less costly approach involves treating demand and lead times as random variables and deciding on a service-level based safety stock figure. Instead of looking at the maximum daily units sold, you’d find a quantile level Q_x (e.g. 95 or 99%) so that x% of the time you’d experience demand at-most Q.

💡 Pro Tip: Cover future demand and include safety stock based on weeks of forward coverage with Singuli’s automatic replenishments.

Use Inventory Planning Software to Forecast Demand

There are many ways to forecast demand. A combination of ABC analysis, paid and performance marketing, size curve forecasts and other relevant, centralized data in the right inventory planning software creates a much better chance of forecasting success.

💡Pro Tip: Get a holistic view of your inventory data with Singuli’s Reporting & Analytics. Track not only inventory data, but also marketing, promotions, site traffic, historical sales and customer behavior. You’ll have all of your information in one place, ready to use in inventory forecasting and planning.

Choose the Right Inventory Forecast Method For Your Business

There’s more than one method to forecast inventory, whether it’s for replenishment or new products, it’s crucial to choose the right combination for your business. For example, you can look at qualitative data like one-to-one interviews, focus groups and social media conversations or quantitative data like historical sales.

Often a combination works best but your resources will determine the type of market research you can do and which other factors to consider that influence the methods you can use. With the right inventory software, you can enter all relevant data, including spikes in demand, marketing and seasonal trends and let it forecast for you.

📌Get Started: Every product has its own story. However your products are growing, whenever there’s a change, Singuli’s forecasting models will identify it and adapt accordingly.

Automate Reorder Points

Reorder points refer to the moment you place an order to replenish stock. It considers your demand, lead time and safety stock. You can work it out manually by calculating your lead-time demand and adding it to your safety stock but it’s quicker to automate with the right software. Plus, it eliminates human error.

📌Get Started: Use Singuli to make sure your inventory levels are just right. With reorders on autopilot, you’ll always purchase the right quantities to the SKU level and you’ll never miss out on a potential sale.

Do Routine Cycle Counts

Checking inventory is traditionally a once per year process. You analyze every item of stock during closed hours and note down anything that’s missing. This is a risky process as there are 364 days per year where your stock isn’t counted.

Cycle counts break down the process into chunks. Instead of one big count, you analyze a few products at a time, during working hours. You don’t have to close your store, and checking stock more often means you don’t miss anything.

📌Get Started: Issue and track POs, reorder on autopilot, forecast demand and optimize your inventory with Singuli.

Regularly Analyze Inventory Reports

Inventory reports tell you how healthy your inventory levels are and helps you analyze the risks of stockouts or overstocks. You can also use them to check what’s selling well, what needs a push and whether there’s been any loss or theft. Regular analysis keeps you up to date and gives you the means to act quicker if something goes wrong.

💡Pro Tip: Take advantage of Singuli’s detailed Reporting & Analytics to create a forecast that meets the strategic needs of your business.

Make Sure You Have Good Backup Suppliers

Suppliers aren’t infallible so you need to make sure you have a good back up, in case things go wrong. Most suppliers will tell you if they’re going to struggle to send inventory or if there will be a delay in lead times, especially if you have a good relationship.

And in this case, you may consider waiting patiently and adapting so you can continue working with a supplier you know and trust. But if you’re dealing with an unreliable and non-responsive supplier, going to a backup one can help keep the supply chain running smoothly.

💡Pro Tip: Maintain optimum stock levels and adjust to sudden changes by using Singuli to manage multiple vendors and products with different lead times.

Negotiate the Best Possible Payment Terms

Cash flow makes your business flow. When you have working capital, you can use it to buy emergency stock if needed, to mitigate losses because of refunds and to invest in marketing and sales. Negotiating longer payment terms with suppliers allows you to hold onto your working capital for longer.

How AI Forecasting Models Help Prevent Stockouts

AI demand forecasting models like Singuli combine multiple data sets to provide a more accurate forecast than traditional methods. One example of this is scenarios, which lay out a number of “what if” situations so you’re ready for supplier problems, spikes in demand, natural disasters, global pandemics and whatever else the world throws at you.

AI forecasting can also prepare you for a new product launch by taking a holistic view of data inputs and using relevant information to increase forecasting accuracy. Having a better forecast, using software to help manage supplier relationships and understanding the demand across multiple locations are just a few of the ways AI forecasting can help to avoid stockouts and their associated costs.

💡 Pro Tip: Create accurate forecasts to prevent stockouts using Singuli’s Advanced Demand Forecasting.

Avoid Stockout Costs

Stockout costs have a severely negative impact on business so you want to avoid them at all costs. With the right software and the right plan, you can. You know what stockout costs are, how to calculate them, what causes them, the impact on your business and how to avoid them. Now, you just need the right AI forecasting software to prevent them.

Stockout Costs FAQ

What’s the Difference Between a Stockout and a Shortage?

A stockout means you have no stock left whatsoever for a particular product. A shortage means a specific raw material or product isn’t available to anyone. Stockouts can sometimes be caused by shortages.

What’s a Stockout Rate?

A stockout rate is the calculation that tells you how many items are unavailable across your product sets. A poor stockout rate is a good reason to reassess your processes, logistics and the software you use.

Is a Stockout the Same as a Backorder?

Backorders are a solution to stockouts, although not having any stockouts is a better option. Stockouts mean you’re completely out of one or more SKUs and backorders allow customers to buy out of stock items for a later delivery date.

Why are Stockout Costs Difficult to Calculate?

Some areas of stockout costs are easier to calculate than others. If you know how much of a particular SKU you sell per day and how many days your SKU is out of stock for, you can easily calculate missed revenue. You can also calculate the costs of faster lead time charges by suppliers, dropship charges and other tangible expenses. The stockout costs that are harder to calculate come in the form of lost customers and damaged supplier relationships, which can cause long-term damage but can’t always be directly associated with one thing.

Is it Hard to Get Back on Track After a Stockout?

Stockouts are often unanticipated, which makes it hard to get back on track. They damage cash flow, which can cause a spiraling effect on future stock and can cause customers to lose trust and loyalty. It’s more than possible to get back on track but it’s easier to stay on top of things when you don’t have stockouts to begin with.