It is no secret that companies have been keeping their inventories extremely “lean” in an effort to contain costs .But when sales are lost, there is a such thing as “too lean.”
I was recently reminded of this when I went to have my car tires replaced and my preferred retailer was out of my size of tires and couldn’t get them in before my state inspection was due to expire. So, I had to buy another set of tires from this retailer’s competitor.
Tires aren’t cheap – I spent about $700. I wondered if the tire retailer’s headquarters is calculating the cost of its stockouts in order to realize the need to improve its inventory levels. Calculating the cost of stockouts can be done using a formula like this:
CS = (NDOS x AUSPD x PPU) + CC
CS = Cost of a Stockout
NDOS = Number of Days Out of Stock
AUSPD = Average Units Sold Per Day
PPU = Price Per Unit (some use Profit Per Unit)
CC = Cost of Consequences
Cost of Consequences generally will apply only to stockouts of raw materials or subassemblies, not finished goods. These consequences includes costs associated with a production line that has been idled or must be switched over to accommodate another process due to the stockout. They can also include penalties payable to customers for failure to deliver on time.
Most experts agree that carrying costs – the downside of having extra inventory – are 18 – 35% of an item’s value for a year. This translates to 0.05% to 0.1% per day. Though profit margins are certainly tight in this economy, getting a sale is many times more profitable than avoiding inventory carrying costs.
The moral of the story is that, when it comes to inventory levels, be lean. But don’t be too lean. Stockouts negatively impact your organization’s revenue and put money in its competitors’ pockets.
To learn more about warehouse and inventory management, consider NLPA Learning’s online course “Profitable Inventory Management and Control.”
Stockout Costs: Beyond The Calculations