The costs of holding excess and stale inventory are well documented and understood; handling and storage costs, depreciation and shrinkage can easily eat into your profit. Less well understood, however, are the knock-on effects of having too little inventory. If your business carries too little inventory, there is a risk of running out of stock, missing a sale and missing out on cost efficiencies.
Low Inventory = Missed sales
Consumer demand can be difficult to predict; even the best forecasts rest on assumptions and demand can only be approximated. Many businesses carry a little extra stock than they expect to need in any given period to insulate against the risk of selling out. Although this has a cost, carrying some safety stock is important for many businesses – the rationale being that if you develop a reputation for running out of stock, your business will struggle to reach its full potential.
In the retail context, the worst outcome is missing a sale. Of course missing out on sales is something to avoid, but for manufacturers, keeping inventory too lean can have even worse consequences. When a product is complex and made up of a large number of distinct materials or parts, running out of one of those materials or parts can see the whole operation grind to a halt. Despite not being able to produce anything, the factory still faces many of the same operational costs. Worse still, the factory may fail to fulfill customer orders.
What are the flow on effects?
Whether you are a retailer, wholesaler or manufacturer, running out of stock can lead to unsatisfied customers. Customers are often not in a position to wait for their order to be fulfilled; whether the context is retail or B2B. Your customers need the item (or the stock) they ordered now, not next week. Naturally, unsatisfied customers are not loyal customers. Retaining a loyal customer base is easier than attracting a new one, so by driving away your best customers, carrying too little stock has the potential to slow your business’ growth, or even to shrink it.
Frequently being unable to fulfill customer orders will also damage your reputation among potential customers. For example, as a wholesaler, if a store was on the fence about signing on with you, they won’t think twice about partnering with your competitor if they hear through their networks that you’ll put their supply chain at risk.
Understocking can also have flow on effects within your organization. For example, point of sale and customer care staff absorb much of the ‘human’ impact when customers express dissatisfaction or frustration that their critical orders are not fulfilled and have to ring around to get an answer. Sales teams, whose remuneration is commonly performance based, may suffer from low morale if the business’ reputation for understocking is a frequent impediment to closing big sales.
What can be done to prevent understocking?
Preventing understocking involves looking at its root causes within your business. Do managers order too little stock on the basis of inaccurate forecasts? Is unreliability up the supply chain to blame? Has a lean or just in time methodology been taken too far? The appropriate response will depend on the cause you identify; for example, if poor forecasts or poor inventory management is a contributing factor, implementing sophisticated inventory management software may assist in getting things under control.
Article by Melanie Chan in collaboration with our team of Unleashed Software inventory and business specialists. Melanie has been writing about inventory management for the past three years. When not writing about inventory management, you can find her eating her way through Auckland.