What is Stockout Cost?

Stockout cost is the lost income and expense associated with a shortage of inventory. These costs can be substantial, because they represent lost sales and a loss of customer goodwill. It is extremely difficult to convince customers to come back once they lose faith in a business, so the related customer re-acquisition cost can be wildly more expensive than what it would have cost to keep a sufficient amount of inventory in stock.

The stockout cost can arise in two ways, which are noted below. It is not always easy to discern the stockout costs incurred by a business. This is because lost sales do not appear on its income statement, and the costs associated with rush purchases are usually buried in the cost of goods sold line item.

Sales-Related Stockouts

When a customer wants to place an order and there is no inventory available to sell to the customer, the company loses the gross margin related to the sale. In addition, the customer may be lost permanently, in which case the company also loses the margins associated with all future sales.

Internal Process-Related Stockouts

When a company needs inventory for a production run and the inventory is not available, it must incur costs to acquire the needed inventory on short notice. For example, the firm may need to pay a rush fee and overnight delivery charges to obtain the inventory. In addition, the production planning staff must scramble to adjust the production plan, advancing some other job in the schedule to replace the job that cannot be run until the required inventory has been received.

How to Avoid Stockouts

A business can avoid stockout issues by maintaining a high level of inventory record accuracy and a reasonable safety stock level that is adjusted to match ongoing changes in customer demand. A good way to maintain excellent inventory record accuracy is by starting an ongoing cycle counting program, where a small part of the inventory is counted every day, with any underlying issues being investigated and corrected on an ongoing basis.

Another option is to continually reforecast sales, to have an early warning of shifts in customer demand. This should involve front-line sales staff, who are most attuned to what customers want.