Stockout Costs and Effects on the Supply Chain

a woman taking Inventory in a stockroom.

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One of the worst things that can happen to a business is to have a stockout. This means that with no inventory of a certain item, production has to be stopped or a customer order will not be fulfilled. For a warehouse or inventory manager it is a scenario that they most dread and with it comes a significant cost to the company. An optimized supply chain will help you supply your customers with what they want, when they want it - and prevent stockout situations.  

Effects of a Stockout

The basic scenario for a stockout is when an item that is to be used for a customer's order or for a production order is not in stock when required. If an item is not available for manufacturing then it may be possible to change the production schedule, although there is a significant cost in this due to the changes in a machine, teardown costs, resource changes, plus the time involved in carrying out all the changes. If an item is not available for a customer order then four possible effects can occur.

  • Customer agrees to wait for the item - If the item is vital to the customer, then they may be prepared to wait. Despite the goodwill of the customer, there may be significant damage to the customer's satisfaction level.
  • Customer backorders the item - Not as ideal as when the customer agrees to wait for the order to be complete, but the order is still being fulfilled. Nevertheless, the customer's satisfaction level is still significantly reduced.
  • Customer cancels the order - If the customer is able to obtain the item from another vendor or does not need the item immediately, then the customer can cancel the order. It is still possible that the customer will order from you in the future, but their customer satisfaction level has been damaged.
  • Customer cancels the order, and is no longer a customer - This is the worst-case scenario of a stockout. However, if a customer is unhappy with the communication or information supplied by the vendor then they may be willing to cut all ties and work with another vendor.

Cost of Back Ordering

If a customer is unwilling to wait for their order to be fulfilled then they could backorder the item. This will mean that the vendor will incur some costs due to the stockout.

There are increased order processing costs as the customer service staff amends the order to create a new suitable delivery date. In addition, there may be additional shipping charges if the order was part of a larger delivery, then the backorder will require special transportation.

As a means of stimulating some much-needed customer satisfaction, the vendor can also agree to expedite shipping at their expense or offer the customer free shipping or a discount on the order.

Cost of Cancelled Orders

If a customer decides to cancel their order due to the stockout then they have probably found an alternate vendor for the item. Many companies will ensure that they have more than one source of supply for their key items; therefore, it may be easier to order from the alternate than to wait for the order to be completed.

For the vendor, a canceled order can be costly, not only in lost profit but in the purchase of raw materials or parts that were brought in or on order for the customer's order. Obsolete, slow-moving or unusable inventory costs money - not just due to its purchase price, but also in inventory carrying costs.

There is also the cost involved in trying to minimize customer dissatisfaction, either by offering incentives for them to order from the vendor again or in marketing to reduce any negative posts that may have been made on social media.

Cost of Losing a Customer

Losing a customer to a stockout is the worst outcome, and comes with it the highest cost to the vendor. By a customer no longer placing any order with a vendor, every order is a cost that has to be considered. If a customer was a major purchaser of goods then the cost could be severe and put the vendor in financial difficulty. There is also the cost of trying to find new customers to replace the order that would have been placed.

Updated by Gary Marion