Calculating the Cost of a Stockout

From logistics, delays, product returns, and “spilled orders” to customer trust and brand loyalty.

Why do some customers keep coming back to the same brand? Chances are, it’s because that business delivers a promised level of satisfaction and fulfillment. Simply, its products are consistently available when its customers desire them. When customers buy from you, they’re placing trust that your brand fulfills their needs.

Customers start to lose faith when you can’t meet those expectations, whether due to stockouts or other fulfillment issues. They may even decide to take their business elsewhere. A study by Boston Consulting Group found that 43 percent of customers say they would leave a company after just one bad experience.

A recent report from Bain & Company, along with Earl Sasser of the Harvard Business School, also discovered that increasing customer retention rates by just five percent might lead to an increase in profits ranging from 25 percent to 95 percent. Correspondingly, when companies can reduce their customer churn rate by five percent, it results in a 25 to 125 percent increase in profits.

What can you do to maintain customer loyalty?

An excellent place to start is improving your supply chain and fulfillment processes to experience fewer product stockouts. Understanding stock availability levels – and your associated fill and cancel rates – is an important beginning. With this visibility, you may take steps to correct purchasing errors and improve forecasting, so products are consistently available when customers need them.

Quantify your stockout costs

Importantly, stockouts carry real and attributable costs that can be defined. These include: increased shipping costs, return costs, cancellation costs, lost revenue from  “spilled” orders (i.e., orders lost to stock unavailability), and, of course, the costs associated with customer attrition due to brand dissatisfaction.

In the simplest terms, excess stockouts occur when your inventory can’t cover the expected variability in your demand. . Inventory optimization is your buffer against the natural uncertainty of supply and demand.

Inventory_merchandising

Begin by considering:

Your stock availability rate

Stock availability or in-stock rate measures the percentage of expected demand that you have in-stock and available for sale.

For example, if a SKU has a daily forecast of 2 customer orders for every ten units, and there are 20 units in-stock, we count that item as “in stock” for that day, a 100% availability rate. Learn more about how to calculate in-stock rates here.

Your fill rate

Fill rate is the percentage of actual demand from customers that you were able to fill immediately from inventory on the shelf.

For example, if today two customers order a SKU at five units each, and there are only five units in stock, our fill rate is 50%. Learn more about how to calculate your fill rate here.

Your cancel rate

This is the percentage of demand canceled out of all demand. As you analyze your canceled orders over a set period of time, make sure to not count orders fulfilled later as cancels too.

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Local stockout considerations

Most people think of stockouts occurring only when there is no inventory available in their entire supply network (we would refer to this as a “global stockout”). Though “global stockouts” are problematic and certainly expensive, we find that “local stockouts” are just as insidious.

With a local stockout, the SKU is not available at the optimal distribution center closest to the customer. This means that at a minimum, the order will travel further, at higher cost, with longer delivery time and a higher chance of damage. More importantly, on multi-line orders, orders can become split into multiple shipments arriving over multiple days. This is not only more expensive – it’s also less convenient for the customer.

If your business does not permit splitting orders and instead holds orders to ship complete then an order will be delayed until the right item is in-stock at your local distribution center (which could have also required a one-off transfer from the facility that did have inventory). When local stockouts impact multi-line orders, the shipping and delivery time costs compound greatly.

Of course, a measurable percentage of delayed shipments resulting from local stockouts will be canceled during leadtime, adding both return shipping and other restock costs to the lost sale itself.

Moving beyond these tactical financial consequences, a more strategic calculation of stockout costs may be understood by quantifying what we call “spilled” orders – those sales lost when a customer chooses to NOT buy due to stock unavailability.

Calculating “spilled orders”

Quantifying the value of your spilled orders – orders lost when customers can’t buy unavailable products – represents the most significant portion of stockout costs.

Follow the three steps below for a designated range of SKUs to calculate this spill. (For organizations new to spill rate concepts, we recommend starting with a discreet product line, or perhaps a single vendor.)

1. Gather study data for a discreet inventory range and time period

• We’d recommend compiling your daily available quantities for your SKUs for at least 30 days.

• For this same period, find your daily sales history for these SKUs.

2. Filter this inventory data to only include items that had days of available inventory for sale (in-stock days) as well as days without inventory available for sale (out-of-stock days).

• From your daily stock quantities, identify and include only those items with at least one global in-stock and one global out-of-stock day during your study period. Then correlate your daily sales histories for these same items. Combine your filtered sales and filtered inventory data for final calculations into a single data set.

3. Analyze your data to calculate spill cost and spill rate

• Calculate the average sales per day during your study period for each SKU when in-stock and when out-of-stock. The sales difference between in-stock and out-of-stock days is the spill cost for that item during the period.

• When you represent this sales difference between in-stock days and out-of-stock days as a percentage, you find your spill rate (the percentage of sales lost when out of stock) – an incredibly useful and powerful metric for your inventory optimization strategies.

What about intangible stockout costs?

Finally, it’s also essential to calculate the intangible costs associated with your stockouts, such as managing cancellations or backorders, as well as those related to diminished brand reputation.

Key factors to consider with cancellations include service calls, product returns, and unsaleable stock. For your brand, it’s crucial to quantify impacts on customer lifetime value too.

In our experience, these “intangible” costs typically range as high as 5% of revenue for high-stockout product lines.

Learn More

Adding it all up

It is without question that all businesses understand stockouts have a “cost” which includes additional shipping, customer dissatisfaction, return and cancellation processing, and lost revenue. However, having tangible data that explicitly states these stockout costs can be invaluable when designing inventory strategy. For example, to know that $1M in added inventory will increase fill rate by 5% and result in a $10M revenue bump makes the decision to add that inventory a no-brainer.

The focus of this blog has related explicitly to calculating spilled orders or lost revenue when out of stock because this is often the largest stockout cost, but the hardest to determine.

Here’s a simple example utilizing a $10 fixed cost for every spilled or lost order.

Inventory_Chart

As you can see with this analysis, the costs quickly add up. For an organization with $100M in inventory and a 50% spill rate, the financial impacts of just a 5% fill rate increase equate to $6M.

Optimization_results

Cost of Stockout: Dollars and sense

When stockouts occur, there are many costs, ranging from readily tangible additions for freight, shipping delays, and customer returns to measurable yet less apparent financial impacts from tarnished brand reputations and diminished customer loyalty.

Again, in our experience, just the brand and customer loyalty costs typically amount to nearly 5% of revenue for stockout product lines.

At Hydrian, we understand that stockouts carry real and attributable costs and that fully quantifying them is a vital first step for any business’s inventory optimization journey.

Powered by our proprietary AI tech built upon decades of experience, we begin with a no-cost Inventory Assessment.

Hydrian’s supply chain, analytics, and data-science experts then act as an extension of your team. Together, we develop achievable goals to optimize your inventory and work with you to accomplish them.

Let’s get started.

Inventory Optimization Done For You

There’s nothing else like Hydrian’s expertise, technology, strategy, and daily support.

If you feel like your inventory challenges are hopelessly out of control, Hydrian can help.

Managing variable supplier lead-times, dynamic demand, and snarled supply chains across broad distribution networks is immensely complex and typically involves a high volume of day-to-day inventory tasks.

Time and again, we hear that this daily volume quickly overwhelms strategic inventory considerations. We also know that few ERPs and purpose-built inventory optimization software packages provide the right reports to forecast what’s coming next.

The truth is: Inventory optimization is a complicated business.

However, we’re here to tell you that effectively managing your purchasing while delighting your customers is indeed achievable.

Hydrian’s team of experienced operational experts, data scientists, and proprietary AI technology, work together to augment your purchasing capabilities by providing operational strategy paired with daily actionable recommendations. Before you start a paid engagement, we start with a comprehensive, no-cost inventory assessment.

Our process works like this:

• Initial no-cost inventory assessment to deeply understand current performance

• Strategic inventory recommendations with bona fide ROI

• Daily actionable recommendations for managing your inventory, with weekly or monthly delivery of metric reporting to track progress.

It’s inventory optimization done for you, and you can get started here.

Better yet, with Hydrian, there are no new systems to buy, no new staff to hire, and no long-term contracts.

As we work together, your fill rates will go up, your customers will be happier, you’ll grow your company’s bottom line, and… you’ll finally get the help you need.

How do we get started?

Hydrian’s No-Cost Inventory Assessment

We start by gathering a standard set of data that includes inventory positions, sales, and receiving data readily available from any ERP via regular reports and exports. Our “integration-less” method means we accept the data we need from any system and in any format.

Because Hydrian’s data flow does not require any integrations or APIs, you continue to use your current systems with our service. There’s no new software to buy. No disruptive implementations. No systems investment of any kind.

We then unleash our powerful algorithms and data scientists to turn your data into insights that reveal current inventory performance, opportunities for improvement, and the associable ROI for your most pressing inventory challenges.

For example, one of the first parts of our analysis is what we call your “efficient curve.” This representation plots how your inventory investment, fill rate (or service level), and operational costs interact for your unique mix of products. The fundamental insight is the optimal inventory investment required to meet your fill rate goals.

Time and again, our customers tell us that seeing our free assessment begins the process of lifting the inventory weight off their shoulders because, for many, this presentation puts bounds around their world of possibility for fill rate, inventory investment, excess stock and much more. For the first time, their fulfillment and logistics woes seem truly solvable.

This analysis also helps remove the personal stress that many inventory pros feel as they tackle their jobs’ daily volume. No longer does the inventory onslaught manage you.

Contact us for your no-cost inventory assessment today!

Strategic Inventory Recommendations for You

Using your data in conjunction with our operational expertise, Hydrian is able to build and provide a set of strategic inventory directions.

We provide impactful strategy both as part of your initial assessment and – when you proceed with Hydrian for ongoing inventory optimization support – regularly throughout our service with you. (More about that below.)

Our strategic recommendations during the no-cost assessment include:

• How to think about measuring excess inventory

The cost (revenue loss) of stockouts

• Insights into stock availability

• Plausible inventory sell-down strategies

• Considerations for managing current excess stock

Additional guidance such as:

• How to think about rebates

• How to think about moving to or improving a hub and spoke model

• How to think about where to open a new distribution center

The best part is that our assessment recommendations almost always result in a 5 to 10x ROI over our proposed fixed monthly fee to help you execute them. If we can’t forecast a 5 to 10x ROI for you, we’ll discontinue the sales process – no sense in spending both our resources if the juice won’t be worth the squeeze.

Once we begin working with you, the limits of our strategy recommendations are not contained to only the above. We help our customers with all purchasing-centric challenges.

Remember, with our initial, no-cost inventory assessment you incur no risk with Hydrian. Our team uses the data from your systems to deliver inventory optimization recommendations that make a real difference for your business.

If, for whatever reason, you decide not to proceed with Hydrian at this point, you’ve spent no money, but you’ve gained insights into your business you may not have otherwise seen.

That’s a pretty good deal.

So, what’s next?

Daily Actionable Recommendations.

When customers engage with Hydrian, they love that we become an extension of their teams.

We work with your teams every day by presenting daily actionable recommendations to help you achieve consistent peak inventory efficiency. Our consultants are even available to perform these tasks on your behalf, in your systems, if desired.

Hydrian’s algorithms span the breadth of your data feed to generate explicit purchasing, transfer, and inventory tasks. We share these daily actionable recommendations anyway you would like, but typically they come in two forms: (1) a direct upload into your purchasing system, and (2) an Excel spreadsheet which serves as a to-do list for your team, and supports recommendations already uploaded into your system.

Inventory_Spreadsheet

Your daily actionable recommendations typically include tasks for:

• Purchase orders

• Inventory transfers

• Excess and dead stock actions

Our customers often tell us that their favorite thing about Hydrian’s daily actionable recommendations is how they make their teams feel like they’re no longer alone. Because our daily tasks are specific and easily attainable optimization activities – and because we can even perform them for you – customers say it’s just like we’re an extension of their teams.

This leads to another powerful result.

When the heavy volume of inventory management becomes more automated and predictable with daily actionable recommendations, your team is liberated with more capacity for strategic planning. This force multiplier often builds additional optimization momentum as inventory teams become more efficient and more effective at their roles. Often this empowers our customers to take on other operational leadership projects and initiatives.

Get more info on DAILY ACTIONABLE RECOMMENDATIONS

Ongoing Goal-based Strategic Guidance

In addition to your daily actionable recommendations, we also deliver ongoing, strategic guidance for your inventory based on established inventory goals. Hydrian’s expert consultants will work with you to set these inventory goals, and to build custom reporting to help monitor progress.

Although we enjoy engaging with you tactically every day, we think it’s always highly valuable to make regular time to move beyond these daily tasks to focus on your broad strategy too. Regular check-ins will ensure that your strategies remain agile and current.

Hydrian’s Unique Approach to Inventory Optimization

Hydrian offers inventory optimization done for you, with provable ROI, no new systems to buy, and no commitment.

Hydrian’s strategic insights and daily actionable recommendations for your business are available as a fixed-price, month-to-month engagement with no long-term contract. Not only is your initial inventory assessment free, but we show your expected ROI upfront.

As we work together, you’ll experience:

• Higher revenue with lower stockouts

• Less deadstock

• More free warehouse space

• Lower logistics costs with fewer and shorter shipments

• Enhanced customer service and brand reputation

It’s inventory optimization unlike anything else on the market.

Let’s get started.