What is the process of managing inventories in such a way as to minimize costs including both holding costs and potential stock out costs?

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Ever been excited to come across the product you’ve been looking for online only to discover it’s out of stock? We’ve all been there. As a customer, it can be a huge letdown. For an ecommerce business, it’s a surefire way to lose revenue. 

When a shopper visits your online store, they are often looking for a specific product to purchase right away. By keeping products in stock, you can capitalize on those visiting your store in the moment. But if products are constantly out of stock, it can cause a big dip in potential sales, drive customers away, and ultimately stunt business growth.

In this article, we’ll go over what causes stockouts and how to prevent them from impacting long-term business growth. 

What is a stockout?

A stockout is when inventory becomes unavailable, preventing an item from being purchased or shipped, resulting in a loss in sales. The costs of a stockout can impact a business both in the short term and the long term.

What are stockout costs?

Stockout costs is the capital lost from inventory that has become unavailable for the customer to purchase. When a customer cannot buy something because it is not in stock, the business loses money. This is especially detrimental to a business if there is no indication on when the item will be back in stock and available for purchase.

What causes stockouts?

Stockouts happen for a variety of reasons. Factors such as underestimating customer demand, major supplier delays, and a lack of funds to purchase new inventory can all lead to products being out of stock. 

Many times, stockouts are inevitable and out of your control. For instance, production delays, delivery issues, unpaid invoices, or human error can all impact inventory levels. If these types of delays happen often, you’ll need to consider switching to a different supplier or find other ways to improve supply chain management, like partnering with a third-party logistics (3PL) provider and using tools to help with inventory forecasting. 

Stockout costs: 3 ways it affects your business

Stockouts can significantly impact a customer’s experience, and they are something you will want to focus on avoiding. Stockouts create disappointment and frustration, not only for you as a business owner but for the customer who is ready to buy and may need your product quickly. Ultimately, it leads to a loss in revenue and can potentially damage your brand’s reputation.

1. Losing a customer to a competitor

Think about what it costs to attract a single customer to your online store. If you have a stockout, not only will you see a major drop in conversions because there’s nothing to buy, but the customer will most likely purchase from a competitor that has the item currently in stock. And they may continue to purchase from the competition again in the future. 

After a bad shopping experience due to stockouts, the chance of the customer returning to your store later is slim. Did you know that 91% of customers aren’t willing to engage with an online store in light of a bad experience? It’s no doubt that stockouts can take a huge toll on potential business growth. 

If an out-of-stock product is hard to come by, some customers are willing to subscribe to back-in-stock notifications, which is a great strategy to alert and encourage customers to purchase when items are back in stock. But even so, this doesn’t guarantee a sales conversion in the future.

2. Paying for a canceled order

It’s one thing for a customer to know a product is out of stock before they attempt to purchase it, but it’s another thing when a customer makes a purchase only to find out the item is unavailable. This occurs when inventory is poorly managed and stock counts are inaccurate. 

If this happens, you’ll have to get in touch with the customer with the bad news and offer a refund. The cost of canceled orders can add up over time.

3. Negative reviews

Negative customer reviews and poor customer satisfaction can make or break your ecommerce business. If customers regularly see your product is out of stock, they may leave negative reviews on your site or third-party review sites. Potential customers can see these reviews and may perceive your brand as unreliable. Your negative reviews provide an advantage for brands selling similar products, giving them insight into what your brand is underdelivering on, so they capitalize on it. 

How to prevent stockouts from costing your ecommerce business

Avoiding an out-of-stock situation is critical for direct-to-consumer brands. Customers can look up alternatives in a matter of seconds if your products aren’t readily available. Not only do you lose sales and decrease your average order value, but you may also lose potential and returning customers for good, impacting your customer lifetime value.

To avoid stockouts from impacting the success of your business, here is what you can do.

Calculate your safety stock

Safety stock is the excess product you keep on hand in case of an emergency or retail supply chain failure that causes a drop in inventory levels. To accurately calculate safety stock, you will need the following for each SKU: 

• Maximum daily usage
• Maximum lead time
• Average daily usage
• Average lead time

Once you have the inventory data for each SKU, follow the steps below:

Step 1: Calculate your max: (maximum daily usage x maximum lead time) 

Step 2: Calculate your average: (average daily usage x average lead time)

Step 3: Subtract the average number from the maximum number for a complete safety stock calculation: (Maximum daily usage x maximum lead time) – (average daily usage x average lead time)

Here’s an example of how it works in practice:

• Company A can has sold as many as 20 units of dog food in a single day (maximum daily usage) 
• It has taken up to 20 days for the product to be shipped from the manufacturer to a fulfillment center (maximum lead time in days)
• Company A sells an average of 10 units of dog food a day (average daily usage)
• On average, it takes about 15 days to get the dog food delivered to a fulfillment center (average lead time in days) 

So for Company A, their safety stock levels would be:

(20 x 20) – (10 x 15) = 250

This means Company A would need to have about 250 units of dog food safety stock available at any time. With 250 units of safety stock, selling about 10 units of dog food each day (70/week) means they have enough stock for about 3.5 weeks.

Note: The maximums should be adjusted for seasonality, including if you forecast higher demand (e.g., for major Black Friday/Cyber Monday promotions) or expect major shipping delays (e.g., Chinese New Year shutdowns).

Click here for more on how to calculate safety stock.

Forecast future demand

Planning for demand can be tough, but it’s not impossible. By using historical inventory data to predict future sales trends, you can make better decisions on how much inventory you need in stock at a given time. 

For instance, you can use data such as the amount of product you sold during a specific season versus a specific day (like a holiday) to make decisions on when you’ll need to order more inventory than usual. Similarly, if demand for your product decreases (e.g., travel products during the COVID-19 pandemic), you may need to plan for a stock reduction and have less safety stock available to avoid having too much working capital tied up in inventory. 

If you’re using multiple warehouses to store inventory, you can use historical data by location to optimize stock levels per location based on demand.

Recognizing these types of trends will help you prepare for a change in sales while optimizing inventory control and inventory storage on the operations level. 

“Between shipping new collections for wholesale earlier in the year and Q4 madness for direct-to-consumer sales, we’ve been able to get through our heaviest seasons while staying ahead of production using ShipBob’s inventory forecasting tools — even as our order volume more than quadrupled in less than a year.” 

Ryan Casas, COO of iloveplum 

Invest in inventory management

Forecasting future demand is just one aspect of inventory management. You must ensure the right inventory levels are available to not only meet customer demand but also budget costs. 

Not having enough inventory to fulfill orders and meet customer demand is one thing, but you also don’t want to have  too much inventory, which can lead to higher inventory carrying costs as well as “dead stock” or outdated inventory that can’t be sold (i.e., it’s expired, obsolete, or out of season). 

Without proper inventory management, you’ll inevitably see a negative impact on your bottom line. Fortunately, managing your inventory doesn’t have to be hard. You can either invest in inventory management software or, even better, you can store your inventory with a tech-enabled 3PL like ShipBob that provides built-in inventory management tools along with robust order fulfillment services. 

“We have access to live inventory management, knowing exactly how many units we have in each fulfillment center. It not only helps with our overall process in managing and making sure our inventory levels are balanced but also for tax purposes at the end of the year. ShipBob simplified the entire process for our accountants and for us.” 

Matt Dryfhout, Founder & CEO of BAKblade

How tech-enabled 3PLs use inventory data to maintain optimal stock and mitigate stockout costs

Unlike using manual inventory sheet templates, many ecommerce businesses partner with a tech-enabled 3PL like ShipBob that makes it easy to track inventory levels at any given time. With ShipBob, you can automate reorder points, view inventory counts in real-time at the SKU level, and run reporting on inventory trends and forecasting to ensure you never run out of stock again. 

“So many 3PLs have either bad or no front-facing software, making it impossible to keep track of what’s leaving or entering the warehouse.

On the supply chain side, I just throw in what we placed at the factory into a WRO in the ShipBob dashboard, and I can see how many units we have on-hand, what’s incoming, what’s at docks, and so on. I can see all of those numbers in a few seconds, and it makes life so much easier.”

Harley Abrams, Operations Manager of SuperSpeed Golf, LLC

ShipBob also offers a free analytics reporting tool that provides insights into fulfillment performance, shipping, demand forecasting, logistics costs, and inventory allocation.

To maintain optimal stock, you’re given the inventory data needed to answer questions like:

• How much inventory do I currently have on hand at each ShipBob fulfillment center?
• What were my historical stock levels at any point in time in any location?
• How many days do I have left until a SKU will be out of stock?
• By when do I need to reorder inventory for each product?
• If I run a promotion or flash sale on my store, how will this affect my available inventory levels?
• And more!

“ShipBob’s analytics tool is really cool. It helps us a lot with planning inventory reorder quantities, seeing when SKUs are going to run out, and we can even set up email notifications so that we’re alerted when a SKU has less than a certain quantity left. There is a lot of value in their technology.” 

Oded Harth, CEO & Co-Founder of MDacne

Conclusion

Preventing stockouts should be a high priority for your ecommerce business. The best thing you can do is focus on optimizing your supply chain so you can better manage inventory and prepare for future demand. 

“Another ShipBob integration I love is Inventory Planner. It saves me hours every week in Excel spreadsheets, and I can raise a PO in minutes when it used to take me hours. For every order I placed for years, I was ordering too much or not enough. Between inventory forecasting tools and the ability to auto-create WROs, we don’t have stockouts much anymore. I sleep better at night.”

Wes Brown, Head of Operations at Black Claw LLC

By partnering with a tech-enabled 3PL like ShipBob, you’re given the retail fulfillment expertise, technology, and inbound and outbound logistics support you need to get products to your customers’ doors quickly.

“We have a Shopify store but do not use Shopify to track inventory. In terms of tracking inventory, we use ShipBob for everything — to be able to track each bottle of perfume, what we have left, and what we’ve shipped, while getting a lot more information on each order.”

Ines Guien, Vice President of Operations atDossier

Learn about ShipBob’s robust fulfillment center network and proprietary technology by clicking below to request a fulfillment quote. 

Stockout costs FAQs

What is the difference between a stockout cost and a shortage cost?

A shortage refers to a general shortage of goods, where a stock out refers to a specific item unavailable in inventory. A stockout can occur when there was lack of ordering, lack of capital to order, customer demand, or items on backorder. 

Why are stockout costs difficult?

Stockouts can have a heavy impact on your business. Costs include lost inventory which could lead to lost sales. This could last until there is a stock replenishment. Stockouts often go unanticipated, which could lead to difficulties when trying to get back on track.