How To Calculate Stockout Costs & Tips To Avoid Running Out of Stock
Happy customers fuel your business. But when you go out of stock, it not only results in lost sales but frustrates customers and slows your business' growth to a grinding halt.
Put yourself in your customer's shoes for a moment. Have you ever jumped on a site thrilled to buy a product only to discover there's a stockout? Did that brand ever revive that initial excitement for you? And did you eventually go back to buy that product when it was back in stock?
When your direct-to-consumer (DTC) brand experiences a stockout, your customers feel the same way.
Luckily, understanding why stockouts happen in the first place can make it easier to stay in stock. And if a stockout happens (even the best brands go out of stock sometimes), there are a few things you can do to keep customers happy and revenue flowing.
Let's walk through it.
What is a stockout?
A stockout, or out-of-stock situation, is when there's no inventory available to sell a specific SKU. And it can happen at any point in the supply chain. However, the most noticeable is when an ecommerce store goes out of stock.
Some retailers don't realize the damage stockouts can do to their brand reputation. After all, selling out is a good thing – right?
Sure, it means you're trying to prevent inventory aging and dead stock. But it also means that until you've replenished that inventory, the brand isn't making as much revenue. And if it happens often, stockouts can even wear down customer loyalty, driving people to buy from your competitors.
The real trouble is that, in recent years, stockouts have become more common. In fact, out-of-stock warnings in 2021 were up 172% from January 2020 and up 360% from January 2019. And a 2022 survey found that 71% of consumers expect to deal with stockouts at this point.
However, "expecting stockouts" doesn't mean that customers will wait until you're back in stock to shop. They won't. Instead, roughly 21-41% of customers will purchase a similar product from your competitor when you go out of stock.
How do stockouts impact your customers?
Perhaps needless to say, but stockouts lead to a bad customer experience. And it can disrupt the buying cycle.
This leaves customers with 4 options:
- Wait the stockout out
- Buy on backorder
- Pick something else
- Go elsewhere
1. The customer tries again later
If customers are super brand loyal or determined to get this product, they might wait for an item to come back in stock.
But admittedly, this won't be the majority of the people who hit your sold-out product pages.
Instead, most people will be disappointed or frustrated. Especially if you simply marked the product as "OOS." Like Target did this for their French Bistro Patio Stacking Chairs).
Here, Target misses 2 major opportunities to make this a better experience:
- They should have communicated that the item is sold out before the point of sale. Such as by also marking the product "sold out" on the previous listing page.
- They don't offer alternative next steps for purchasing this product, like getting a back-in-stock alert or buying on backorder.
Meaning, if a potential customer wants to wait out the stockout, it's their responsibility to check back in. Some people will forget to check back (or lose interest).
A few others will check back in a few times. But every time they do, and you're not in stock, these customers grow more frustrated and less patient.
Either way, what really happens is you lose out on many potential sales.
2. Customer orders on backorder
When a customer shows interest in your products, you ideally want to strike while the iron is hot. In other words, you want to convert that customer when they first hit that product page and think, "I'm going to buy this."
Selling on backorder makes this possible, even during a stockout. With backorders, customers can purchase sold-out items, then receive them when they're back in stock.
As a result, selling on backorder can be a huge win for businesses because your ability to make money isn't limited by your inventory or working capital. So, you keep revenue flowing even when out of stock.
But won't waiting possibly several weeks to receive their order be more frustrating for the customer? Not if you set clear communications on when the item will actually arrive.
Traditionally, stockouts mean a 0% conversion rate. But by selling on backorder and setting clear expectations, items convert at roughly the same rate as they do when that same item is in stock.
Why? Because the customer has all the information, they need to make an informed decision. And most of the time, they'll deem the product is worth waiting for if they've made it this far.
And tools like Cogsy make selling on backorder effortless. For instance, Cogsy ensured that the popular cookware brand Caraway could keep making money when home goods sales skyrocketed and the pandemic-related supply chain issues left them out of stock.
Here's how Cogsy works: As soon as an item goes out of stock, it transitions that corresponding product page to a backorder model.
Using the information on your purchase orders, Cogsy marks the estimated shipping date on the sold-out product page, in the customer's cart, and on their receipt. This way, there's no confusion about when a customer will get the item.
3. The customer purchases a similar product
While selling on backorder is a great stockout solution, it doesn't work if the customers are working with a deadline (like when they're buying a gift).
Luckily, you can always suggest similar products that might work just as well and on their timeframe. That way, customers aren't leaving your online store empty-handed.
For instance, if they're looking at a black shirt, maybe you recommend a few other black shirts. Or, if the product really is unlike anything else, perhaps you recommend a gift card instead.
Of course, these recommendations don't guarantee you'll still close the sale (and they're not as effective as selling on backorder). But it can be incredibly helpful to someone in a bind and drive conversion.
Amazon is a prime (no pun intended) example of this. Roughly 35% of the company's sales come from product recommendations, driven by what an algorithm thinks the customer will like.
The company doubles down on this in their grocery department, where it's unlikely a customer can wait for a back-ordered item. There, the vendor provides the option to replace the product if it's out of stock with a similar SKU. Such as organic free-range brown eggs, if they don't currently have free-range brown eggs. Or the customer can tell Amazon, "Don't substitute."
You can offer a similar experience using your sales data (no algorithm needed). Simply look at historical sales to see what SKUs are typically bought together. Maybe you offer that item as another option on the soldout product page.
Or use common sense to suggest a few substitutes. Just make sure whatever you're recommending is in stock, so you don't accidentally add more frustration.
4. The customer turns to your competitor
There are cases where even loyal customers try something new. And usually, those cases are when the experience is sub-par (a-hem, like during stockout) or they're shopping on a deadline.
In fact, 37% of customers will turn to another brand if you're out of stock (and 9% will abandon the purchase altogether). But only if this is the first offense. By your 3rd stockout, a jarring 70% will turn to your competitors.
And if the experience is really bad, 91% of customers will take their business elsewhere – and they won't come back.
But say you handle the stockout situation perfectly – you offer backorders and suggest substitutes. Unfortunately, there will still be a few customers that turn to your competitors. And roughly 65% of the time, it'll be when the customer needs that product urgently.
So, the best situation will always be to avoid stockouts in the first place.
What causes stockouts?
And the best way to stay in stock is by understanding the most common, nitty-gritty causes of stockouts.
Inaccurate demand forecasts
Misforecasting customer demand leads to trouble. That's because forecasts are how brands anticipate (and prepare for) a specific SKU's demand.
Most of the time, a brand's forecast is off for one of two reasons:
- They're using a top-down forecasting method, which wrongly assumes that revenue has a linear correlation with stock levels. Such as, if you want to 3x your profits this year, then order 3x as much stock.
- They're forecasting with Excel, which uses static data and is time-intensive to perform. Meaning, if by some minor miracle you don't have human errors (it's super unlikely), your final forecast will still be slightly out of date.
Discrepancies in inventory data
Inventory discrepancies are perhaps the most preventable stockout cause. Usually, they result from human errors, technical errors, or inventory shrinkage. And they can take shape as miscounting, delays in data syncs, or theft, respectively.
It's nearly impossible to restock to the optimal quantities without an accurate picture of your current inventory levels. Instead, you’ll almost always order too much (leading to excess inventory) or too little (leading to stockouts).
Unprecedented spikes in demand
Generally speaking, retailers know how seasonality affects demand and can prepare accordingly. For example, many brands plan to sell more outdoor furniture during warmer seasons (and stock more of it) because, historically, that’s always been the case.
But some things you can’t plan for – like when the pandemic drove ~52% growth in home goods sales seemingly overnight. Unlike seasonality, these unexpected scenarios can’t be anticipated. And they leave demand forecasts way off and brands unable to meet demand.
Supply chain disruptions
There is no one reason for today’s supply chain disruptions. It’s more like the perfect storm. For example, since the pandemic hit, we’ve seen:
- Factory shutdowns
- Backed-up ports
- Warehouse space shortages
- Warehouse worker shortages
- Truck driver shortages
- Rising inventory costs
And every delay these challenges cause in the manufacturing or transit process means it’s slightly longer until your replenishment arrives. And the more delays you face, the more likely you’ll sell out before you get that shipment.
Poor cash flow management
With ongoing supply chain issues and increased raw material prices, inventory is now more expensive to procure. And without freed-up working capital, everyday operations (like replenishing stock) become a great challenge.
Not to mention lead times are currently hovering around 6 months on average. So, brands are forced to place purchase orders earlier to avoid a stockout.
But they can’t place these orders without cash on hand. Most supplier terms will require that you pay for a portion of the purchase order up-front and the rest at net 60 days.
This means there are ~4 months where your capital is tied up in inventory you can’t sell yet. So, you’re not just risking a stockout but your business’s health (lacking capital was the #1 reason retailers shut down in 2021).
Stockout risk formula for calculating out of stock probability
The stockout risk formula helps calculate stockout probability, i.e. the likelihood of a product going out of stock.
stockout probability = [number of expected stockouts / the number of expected demand requests] * 100
For example, let's say you sell hiking shoes and have one super popular SKU. Your forecast projects that 500 people will want this model before the next shipment arrives. But until that next shipment, you only have 50 units of this SKU left.
In this case, you’re facing a really high risk of stockouts. Input these numbers in the stockout risk formula and you’ll get:
stockout probability = [(500-50)/500] * 100 = 90% probability of a stockout
4 biggest stockout costs & their impact on your business
Stockout cost refers to the capital loss a brand experiences as a result of a stockout. Simply put, if a product the customer wants to purchase is unavailable, the business loses a sale. This can result in a revenue decrease and an increase in operational costs.
1. Loss of revenue
You can't sell a product you don't have. As a result, sold-out products see a 0% conversion rate. And retailers lose out on nearly $1T in sales to stockout events each year.
2. Limited cash flow
When you're not pulling in revenue, it's harder to replenish inventory, develop new products, or grow your brand. That's because all these initiatives require funds up-front. And if stockouts are constantly hurting sales, these are funds you might not have. Meaning longer, more costly stockouts or even going out of business.
3. Reduced customer satisfaction
30% of consumers feel that stockouts negatively affect their customer experience. Many will even leave negative reviews about the disappointment. This can influence other happy or new customers' perceptions of your brand.
4. Waste of resources on damage control
Amid a stockout, your customer experience team is tied up, trying to:
- Address canceled orders
- Track replenishment
- Mitigate customer dissatisfaction
While this is happening, your team isn't working proactively or productively. Instead, you’re stuck reacting to angry customers, trying to do damage control.
Use a stockout cost formula to calculate your actual losses
For many ecommerce brands keeping a "lean" inventory makes sense. Storage costs add up, but how can you be sure that a stockout won't cost your brand more?
Easy – you calculate the stockout cost and compare it to your holding costs.
To calculate your stockout costs, use this formula:
stockout cost = [number of days out of stock average units sold per day price or profit per unit] + cost of consequences
Let's go back to the hiking shoe brand example. Say you sell one pair of shoes at $100 per pair. Your supplier will have your next shipment to you in 10 days. And you usually sell 50 pairs a day on average.
In this case, the cost of consequences isn't an issue because this variable accounts for costs associated with shortages of raw materials or slowed production lines. You'll exclude this variable from the scenario because you sell finished goods that you get from a supplier (not a manufacturer).
For this brand, stockout cost would be ~$50k for the 10 day stockouts: stockout cost = [10 * 50 * $100] + 0 = $50k.
With this number, you'll want to ask yourself: Will holding safety stock to avoid this stockout cost more than the stockout itself?
If yes, you'll want to avoid the stockout at all costs. If not, allowing your brand to go out of stock might make sense – just make sure you have a system to keep revenue flowing, like buying on backorder.
6 tips for avoiding stockouts
Avoiding stockouts might not always be possible (even the best brands go out of stock). But there are a few ways to radically reduce the risk of selling out, like centralizing your inventory data, investing in safety stock, and negotiating better payment terms.
1. Forecasting from the bottom-up
As I mentioned earlier, forecasts ensure that you order the right amount of inventory (not too much, not too little). And if your prediction is off, so will your inventory levels – which can quickly lead to a stockout or dead stock.
Luckily, bottom-up forecasting methods provide the most accurate demand projections by determining the brand's baseline inventory needs. Then, cautiously layer on a few key growth assumptions.
And with a forecasting tool like Cogsy, you can make the final forecast even more accurate. For instance, Cogsy considers past sales history, current inventory levels, and real-time trends to create bottom-up forecasts.
Then it tracks your brand's real-time performance against the projected demand. And as new information is introduced (like unexpected spikes in demand or supply chain issues), the tool automatically updates the projection accordingly. This makes the final forecast wildly more accurate than a human analyst could build.
2. Centralize your inventory data
Inventory management isn't easy if your inventory data is all over. For one, it makes it difficult to know which data is up-to-date. But it also takes up a ton of your team's time, searching for the information you need and updating your inventory in Google Sheets (or another spreadsheet tool).
That's where ops optimization platforms like Cogsy come in.
Unlike normal inventory management software, tools like Cogsy put all your inventory data in one place (historical and real-time, sold and unsold). And uses predictive inventory intelligence to take the guesswork and self-doubt out of your inventory planning.
This way, you can confidently make informed decisions using a single source of truth. And you can operate proactively because you'll be able to prepare for marketing events, seasonal spikes in demand, and routine reorder points.
3. Perform regular inventory audits
Inventory audits ensure inventory accuracy (or that you're working with inventory data that actually reflects your stock levels). That's because, most of the time, you won't know that your inventory shrunk until you take stock.
And while it might not get those missing items back, it can get ahead of a larger, more costly problem. After all, a few write-offs (while frustrating) are likely cheaper than a stockout.
For instance, say the optimal quantity of an SKU is 100 units. Right now, you have 15 units available. But there's a discrepancy in your inventory data, and it says you have 20 units available.
But by auditing your inventory, you would know that you're missing 5 units. So, not only could you actually replenish to the optimal 100 unit level. You could also start digging into where those 5 missing units went (addressing human issues, technical issues, or shrinkage head-on).
4. Invest in safety stock
Safety stock is extra on-hand inventory to cushion against unexpected demand surges. And its sole purpose is to prevent stockouts.
To calculate safety stock, use the following formula:
safety stock volume = [maximum daily sales * maximum lead time in days] - [average lead time in days * average daily sales]
Safety stock keeps you afloat a little longer than your regular inventory, so you don't go out of stock whenever demand picks up unexpectedly.
However, how much safety stock you need changes depending on the supply chain and demand (both have been turbulent lately). And it can be a time-intensive task for a human to constantly rerun this calculation.
Luckily, an ops optimization tool like Cogsy pulls historical sales data when calculating your optimal stock levels. This calculation naturally includes the right safety stock levels.
Then, the platform monitors those stock levels in real-time to ensure they stay within that optimal threshold so you avoid using up this backup inventory.
5. Vet backup suppliers
You'll probably work exclusively with your usual suppliers (this helps build meaningful relationships with your supply chain partners).
But what if your demand wildly increases and your supplier can't quickly scale to meet the new inventory needs? Or if the supplier increases their prices? The same goes for when there are hiccups in the supply chain. That's when having a few more vetted suppliers on speed dial (just in case) pays off.
You don't need to have a ton of backups. Just 1 or 2 suppliers whose rates and minimum order quantities work with your budget. You'll also want to proactively confirm that they can meet your inventory needs if needed.
6. Opt for extended payment terms
Paying for purchase orders months before you receive them ties up working capital and makes everyday operations a whole lot harder.
So, why not negotiate new payment terms that are in your favor? Ideally, these would be terms that allow you to order enough inventory to avoid a stockout and stagger invoice payments to free up cash.
Here's how you can do this:
- Using your forecasts, map out the timing and sizing of future POs and create production orders accordingly (Cogsy's Production Planning feature will do this for you)
- Ask your supplier to renegotiate terms, and share this production plan as leverage
- Commit to placing most of these mapped-out orders with them, but make it clear you won't provide a downpayment now
- In exchange, ask to split those POs into smaller, more frequent orders or to extend the window you have to pay for invoices
If your supplier says no, no biggie! You can always alternatively:
- Flip your cash conversion cycle by selling on backorder
- Rate shop with other suppliers or manufacturers
- Adopt flexible financing options with tools like Settle
How Cogsy helps you prevent stockouts
Cogsy is the ops optimization tool that empowers brands to avoid stockouts, increase revenue, and grow their brand. With it, you can:
Keep a pulse on your stock levels in real-time
It can be near impossible to avoid a stockout if you don't know what's happening with your stock levels.
Fortunately, Cogsy's platform is your single source of truth for all your inventory data (historical and real-time). This way, you always know what's happening with your stock levels, empowering you to make informed purchasing decisions.
Accurately forecast customer demand
Take the guesswork out of your purchase orders with increased forecasting accuracy. Cogsy uses your historical sales, current stock levels, and real-time inventory trends to create spot-on forecasts. That way, you can make a smarter operational plan and prepare accordingly.
Order optimal inventory quantities every time
Always get your purchase order in at the ideal time. With Cogsy's replenish alert feature, get a friendly reminder to stock up whenever your inventory levels are starting to get low.
We’ll even automate how you build optimized purchase orders, so POs are waiting for you when you get these alerts. All you have to do is check the PO and hit “Submit.”
Keep revenue flowing when stockouts happen
Selling on backorder has never been easier. Cogsy automatically adjusts the product page to a backorder model when your product goes out of stock.
This includes updating the product page, cart, and receipt to communicate when customers can expect their item. That way, customers feel confident in their buying decision (even if it comes with a wait), and you can keep revenue flowing.
Ready to say goodbye to costly stockouts? Chat with our team to see how Cogsy can help your brand avoid stockouts and generate more revenue.
Here are answers to common questions about stockouts.
What is a stockout rate?
The stockout rate calculates how many items are not available in your product offerings. And the metric provides insights into the quality of a brand's inventory replenishment process and supply chain management.
What is the difference between a stockout and a shortage?
A shortage is when a specific raw material or product isn't available to any brand, industry-wide. Meanwhile, a stockout is when a single brand is out of stock of a particular product. Stockouts are sometimes caused by shortages, but not always.
What is the difference between a stockout and a backorder?
Stockouts are an expensive inventory event where a brand is out of stock of at least one SKU. Meanwhile, backorders provide a solution for stockouts by allowing customers interested in this sold-out SKU to buy the item even though it's not yet available or ready to ship.