Managing inventory effectively is a significant challenge for ecommerce businesses, especially when facing the risk of stockouts. Recent surveys show that an alarming 71% of consumers expect to encounter items out of stock during their online shopping experience.
This blog post aims to demystify the probability of a stockout, provide you with a formula and calculation method, and offer preventive measures to avoid this dreaded scenario. Ready to take charge of your inventory management? Let's dive in!
Key Takeaways From This Article
- Stockouts, which occur when a business doesn't have enough inventory to meet customer demand, can lead to negative impacts such as lost sales and decreased customer satisfaction.
- Stockouts can be caused by factors like inaccurate demand forecasts, inventory data discrepancies, unanticipated spikes in demand, supply chain disruptions, and poor cash flow management.
- To calculate the probability of a stockout, use the stockout probability formula that considers factors like expected monthly demand and average lead time. By understanding this probability, businesses can make informed decisions about inventory management.
- Preventive measures for stockouts include improving demand forecasting accuracy, maintaining accurate inventory records, monitoring supply chain performance closely, managing cash flow effectively, and investing in safety stock.
Understanding Stockouts: Definition & Impact
A stockout occurs when a business does not have sufficient inventory to fulfill customer demand. This can have significant negative impacts on a company's operations and bottom line.
Definition of a Stockout
In the world of ecommerce and inventory management, a stockout occurs when a business runs out of a product or item it's supposed to have available for sale. Imagine you're managing an online store that sells smartphones. When customers visit your website and they see a message like, "Currently out of stock," it means that you've depleted your inventory of a particular smartphone model, and you can't fulfill any more orders for it at the moment.
Impact of Stockouts on Business
Stockouts hurt businesses in many ways. They can cause customers to shop elsewhere, which leads to loss of sales. As per the 2022 survey, 71% of customers expect stockouts and with this high number, a good amount are likely to turn to competitors.
The customer loyalty also takes a hit when stockouts happen often. It gives people bad shopping experiences and breaks down their trust in your store. If not managed well, stockouts could spell doom for an ecommerce business by causing a drop in market share and damaging the brand image.
5 Common Causes of Stockouts
Stockouts can be caused by various factors such as inaccurate demand forecasts, inventory data discrepancies, unanticipated spikes in demand, supply chain disruptions, and poor cash flow management.
1. Inaccurate Demand Forecasts
Bad guesses can lead to empty shelves. This happens when you don't know how much your customers want. You may think they will buy a lot. But then, they do not buy as much as you thought.
Or the other way around - you think they won't buy much and they end up buying a lot! These bad guesses are called "inaccurate demand forecasts". They can cause trouble for your store.
If you guess too low, you won't have enough stock on hand when shoppers come to buy. If you guess too high, some items will sit in the warehouse without selling. Either way, it's not good for business or customer happiness.
2. Inventory Data Discrepancies
Mistakes in inventory data can cause big problems. They make it hard to tell how much stock is on hand. This confusion may lead to a stockout, where there are no items left to sell.
It's crucial for businesses to keep their inventory records correct and up-to-date. Tools like inventory management software can help with this task by tracking all items in real time.
Regularly counting the stock also helps keep track of what's actually there, not just what the records say should be there. Being careful and precise with inventory data will help prevent unpleasant surprises like finding out too late that you've run out of a popular product!
3. Unanticipated Spikes in Demand
Unanticipated spikes in demand can be a major cause of stockouts for ecommerce businesses. These sudden increases in customer demand can catch businesses off guard, leading to inventory shortages and frustrated customers.
One important factor contributing to these spikes is the rise of online shopping, especially during events like flash sales or holiday seasons. In fact, there has been a significant increase in out-of-stock warnings over the past few years, with a 172% increase from January 2020 to 2021 and a staggering 360% increase from January 2019 to 2021.
It's crucial for ecommerce operators and owners to have strategies in place to handle these unexpected surges in demand effectively. By implementing real-time inventory monitoring tools, optimizing supply chain processes, and having backup suppliers ready, businesses can better prepare themselves and minimize the risk of stockouts caused by unanticipated spikes in demand.
4. Supply Chain Disruptions
Supply chain disruptions can cause major problems for ecommerce operators and owners. These disruptions occur when there are delays or interruptions in the delivery of necessary components or finished products.
This can lead to stockouts, where inventory runs out and customers are left empty-handed. To prevent supply chain disruptions, it's important to monitor the supply chain closely and make changes to vendors if delays persist.
By staying on top of potential disruptions, ecommerce businesses can avoid stockouts and keep their customers happy.
5. Poor Cash Flow Management
Poor cash flow management is one of the causes of stockouts in e-commerce businesses. When companies do not effectively manage their cash flow, they may face challenges in purchasing inventory and replenishing stock.
This can lead to situations where there is insufficient inventory to meet customer demand, resulting in stockouts. Additionally, poor cash flow management can also hinder a company's ability to invest in safety stock or backup suppliers, further increasing the risk of stockouts.
It's important for e-commerce operators and owners to prioritize effective cash flow management as part of their overall inventory control strategy to avoid potential disruptions and loss of sales.
Calculating the Probability of a Stockout
To calculate the probability of a stockout, use the stockout probability formula and consider factors such as demand for lead time and inventory data discrepancies.
The Simple Stockout Probability Formula
There are a number of ways to calculate the stockout probability of a certain product or variant, one of the simplest formulas is:
stockout probability = [number of expected stockouts / the number of expected demand requests] * 100
The formula calculates the stockout probability as a percentage based on the number of expected stockouts and the number of expected demand requests.
Here's an explanation of the formula:
- Stockout Probability: This is what you're trying to calculate. It represents the likelihood or probability that you will run out of stock (stockout) given a certain level of demand.
- Number of Expected Stockouts: This is the numerator of the formula. It's the estimated or expected number of times you anticipate running out of stock during a specific period, typically the lead time or the time frame you're considering.
- Number of Expected Demand Requests: This is the denominator of the formula. It's the estimated or expected number of customer requests or demands for the product during the same time frame.
- Multiplying by 100: This part of the formula is used to express the stockout probability as a percentage. When you multiply the result by 100, you convert it from a decimal or fraction to a percentage.
The idea behind this formula is quite straightforward. You're essentially looking at the ratio of how many times you expect to run out of stock (numerator) relative to the total expected customer demand (denominator), and then expressing that ratio as a percentage.
The most important part of this formula (and maybe the piece you're struggling to understand) is the number of expected stockouts. You only know this by calculating your customer demand for the product. Still confused? Let's look at an example...
Example stockout Probability
Let's say your company sells chocolate covered bananas and your most popular SKU/variant is the "classic choco banana with nuts". From looking at your demand forecast, you're projecting that you'll have demand for 1,000 classic choco bananas with nuts next month. Unfortunately you only have 500 units in stock right now, you've ordered more but they wont arrive until next month.
We can use the formula to calculate the "risk" or "probability" of a stockout occurring.
Stockout probability = ((1,000-500)/1,000)) * 100 = 50%
For the above example we're estimating that we have a 50% probability of a stockout occurring.
Other Methods for Calculating Stockout Probability
Poisson Distribution Approach:
The Poisson distribution is often used when demand is random and follows a Poisson process (i.e., demand events occur independently at a constant rate over time). In this case, you can calculate the probability of a stockout using the following formula:
P(Stockout) = 1 - ∑[P(X = k) for k = 0 to N]
- P(Stockout) is the probability of a stockout during the lead time.
- N is the available inventory.
- P(X = k) is the probability of selling k units during the lead time, which can be calculated using the Poisson distribution formula:
- P(X = k) = (e^(-λ) * λ^k) / k!
- λ (lambda) is the average demand rate during the lead time.
Normal Distribution Approach:
If you assume that demand follows a normal distribution and you know the mean (μ) and standard deviation (σ) of the demand during the lead time, you can use the cumulative distribution function (CDF) of the normal distribution to calculate the probability of a stockout:
P(Stockout) = P(X > N)
- P(Stockout) is the probability of a stockout during the lead time.
- X is a random variable representing the demand during the lead time.
- N is the available inventory.
- You can calculate P(X > N) using the Z-score formula:
- Z = (N - μ) / σ
- Then, look up the Z-score in a standard normal distribution table or use software/tools to find P(X > N).
It's important to note that these formulas make certain assumptions about demand patterns and lead time variability. In practice, you may need to adjust your calculations to account for specific factors like seasonality, trends, and other factors that can impact demand.
Additionally, modern inventory management systems and demand planning software like Yosoku.ai often use more advanced techniques, including safety stock calculations and service level targets, to manage the risk of stockouts effectively. These methods may involve stochastic modeling, simulation, and optimization algorithms to optimize inventory levels and minimize stockout probabilities.
Costs of Stockouts
Stockouts come with significant costs for businesses, including loss of revenue, limited cash flow, decreased customer satisfaction, and wastage of resources on damage control.
Loss of Revenue
Stockouts can have a significant impact on a business's revenue. When products are out of stock, customers may choose to purchase similar items from competitors instead. Research shows that approximately 21-41% of customers will look for alternatives when faced with a stockout.
This can lead to not only lost sales but also decreased customer loyalty and negative reviews. Additionally, businesses may incur refund costs if customers request their money back due to the unavailability of the desired product.
To prevent these financial losses, it is crucial for ecommerce operators and owners to effectively manage their inventory levels and ensure products are consistently available to meet customer demand.
Limited Cash Flow
One of the consequences of stockouts is limited cash flow. When a business experiences stockouts, it means they cannot sell their products due to unavailability. This leads to a loss of sales and revenue, which directly affects cash flow.
Customers may choose to purchase similar products from competitors when faced with stockouts, resulting in lost opportunities for the business. Additionally, back-ordering can incur additional costs such as second shipping fees, further impacting cash flow.
It is crucial for ecommerce operators and owners to monitor their inventory levels closely and ensure adequate stock levels to prevent limited cash flow caused by stockouts. By implementing effective inventory management strategies and monitoring supply chain performance, businesses can avoid this issue and maintain healthy cash flow.
Decreased Customer Satisfaction
When customers encounter stockouts, their satisfaction levels are likely to decrease. Out-of-stock warnings have seen a significant increase, which can negatively impact customer satisfaction.
Studies show that approximately 21-41% of customers will opt for a competitor when faced with a stockout, indicating a potential decline in satisfaction. Stockouts have the power to erode customer loyalty and drive them towards rival brands, resulting in decreased satisfaction.
In fact, if customers have a bad stockout experience, up to 91% of them will take their business elsewhere. Poor inventory replenishment is responsible for a large percentage (70-90%) of all stockouts, further exacerbating the negative effects on customer satisfaction.
Waste of Resources on Damage Control
Stockouts can be costly for businesses, especially in terms of the resources spent on damage control. When a stockout occurs, businesses often have to scramble to find alternative solutions to fulfill customer orders and minimize negative consequences.
This process can be time-consuming and expensive, as companies may need to expedite shipping or pay higher costs for last-minute inventory replenishment. Additionally, businesses may need to allocate extra staff or overtime hours to handle customer complaints and provide updates on stock availability.
In some cases, companies may also need to issue refunds or offer coupons as compensation for the inconvenience caused by the stockout. All these efforts require significant resources from the business that could have been better utilized elsewhere.
Preventive Measures for Stockouts
To prevent stockouts, ecommerce operators and owners can implement preventive measures such as bottom-up forecasting, centralizing inventory data, conducting regular inventory audits, investing in safety stock, and vetting backup suppliers. Of course you can also use a software like Yosoku.ai to help monitor, and prevent stockouts using AI.
Bottom-up Forecasting
One effective method to predict the probability of stockouts is bottom-up forecasting. This approach involves examining demand at a detailed level, such as for individual products or regions, and then aggregating that information to get an overall forecast.
By looking closely at specific factors that can affect demand, like customer behavior and market trends, ecommerce operators and owners can make more accurate predictions. Bottom-up forecasting allows businesses to take a proactive approach in preventing stockouts by identifying potential issues before they occur.
It's important for ecommerce operators and owners to regularly assess their inventory accuracy through methods like regular stock counts and using inventory management software. Additionally, monitoring the supply chain and making changes when persistent delays are encountered with vendors can also help prevent stockouts.
Centralizing Inventory Data
Centralizing inventory data is a crucial step in preventing stockouts and ensuring efficient inventory management. By consolidating all your inventory information into a single system or platform, you can easily track and monitor your stock levels across different locations and channels.
This helps you avoid the risk of stockouts by providing real-time visibility into product availability and demand. Accurate and up-to-date inventory data allows you to make informed decisions about when to reorder products, how much to order, and from which suppliers.
It also enables better coordination between departments like sales, marketing, and fulfillment, so everyone has access to the same reliable information. With centralized inventory data, you can reduce the likelihood of stockouts while improving customer satisfaction through timely order fulfillment.
Regular Inventory Audits
Regular inventory audits are crucial for effective inventory management. By conducting regular audits, ecommerce operators can ensure accuracy in their inventory records and prevent stockouts.
These audits help identify any discrepancies between recorded and actual inventory levels, which can be caused by human errors, technical issues, or even theft. By addressing these discrepancies promptly, businesses can avoid running out of stock and maintain efficient operations.
In addition to identifying inaccuracies in inventory data, regular audits also help ecommerce operators identify any misforecasting of customer demand. This helps prevent stockouts caused by underestimating customer needs.
Investment in Safety Stock
Investing in safety stock is a critical measure to prevent stockouts and the associated costs. Safety stock refers to the extra inventory that businesses keep on hand as a buffer against unexpected increases in demand or supply chain disruptions.
By having safety stock, ecommerce operators and owners can ensure that they have enough products available to meet customer demands, even during peak periods or unforeseen events.
Out-of-stock warnings have become more common in recent years, highlighting the importance of maintaining optimal levels of inventory. When products are out of stock, it can lead to customer dissatisfaction and potentially result in the loss of customer loyalty.
Therefore, by investing in safety stock, businesses can mitigate these risks and maintain a high level of customer satisfaction.
Poor inventory replenishment practices and supply chain issues are often causes of stockouts. It is crucial for ecommerce operators and owners to accurately forecast customer demand to avoid running out of products.
Misforecasting can lead to excess inventory or running out of popular items when customers want them most.
Vetting Backup Suppliers
To prevent stockouts and ensure the timely delivery of necessary components or finished products, it is crucial for ecommerce operators and owners to carefully vet backup suppliers.
This involves thoroughly evaluating potential suppliers based on factors such as reliability, quality of products or materials, lead times, and responsiveness to customer inquiries.
By having backup suppliers in place, businesses can avoid disruptions in their supply chain caused by delays or issues with primary vendors. Regularly monitoring the performance of backup suppliers and promptly addressing any concerns can help maintain a reliable inventory flow and reduce the risk of stockouts.
Conclusion
In conclusion, understanding and calculating the probability of a stockout is crucial for ecommerce operators to prevent disruptions in their business. By implementing preventive measures such as bottom-up forecasting, regular inventory audits, and investment in safety stock, businesses can minimize the risk of stockouts and maintain customer satisfaction.
It is essential to prioritize accurate demand forecasts, centralized inventory data, and efficient supply chain management to ensure optimal stock levels and avoid costly revenue loss.
With proactive strategies in place, businesses can minimize the impact of stockouts on their operations and provide a seamless shopping experience for customers.
FAQs
1. What does "probability of a stockout" mean?
The probability of a stockout means the chance that your business will run out of an item before you can restock. It includes factors like demand forecasts, lead times, and order frequency.
2. How is the inventory restocking done to prevent stockouts?
Inventory restocking involves setting optimal stock levels, using safety stock, placing timely purchase orders and regularly performing inventory audits.
3. Can having backup suppliers help in preventing a stockout?
Yes! Having backup suppliers helps ensure supply chain disruptions don't cause a shortage that leads to high costs from backordering or lost sales due to out-of-stock warnings.
4. How does poor cash flow management affect the likelihood of a Stockout?
Poor cash flow management can increase the risk of running out as it might limit your ability for replenishing stocks on time which directly affects Order Interval & Time Between Orders.
5. Are there tools available that help control and predict potential stockouts?
Yes! Platforms like Cogsy use predictive inventory intelligence to give real-time trends in market demand plus they have features such as replenish alert feature which assist businesses with Volume Management & Re-Ordering Planning.
6. Does selling on backorder reduce revenue loss from stocking shortages?
Selling on backorder lets customers buy items even when they're gone from warehouse shelves, so it can lessen losses due to empty stocks while helping maintain customer satisfaction.