The true cost of understocking

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In an increasingly competitive marketplace, businesses are often trying to make themselves ‘lean’, attempting to minimize costs across all areas, including inventory. Practices such as “just in time” inventory have become popular, where inventory comes in just as it is needed, so a business can hold the least stock possible. Although running a lean business can be an important goal, it will only benefit your business if done in the right way. If not properly accounted for, understocking can be very wasteful and ruin any business in a short space of time.

Understocking Cost vs benefit

Minimising inventory is useful because it allows businesses to save on holding costs. There are many costs to holding inventory: financing costs, storage rent, warehouse staff, lighting, ventilation, security, to name a few, and when added up these costs make up a significant portion of the cost of inventory. Keeping inventory to low levels may allow your business to reduce these costs, but as with any business strategy, doing so will only be worthwhile if the cost outweighs the benefit.

Difficult to measure, no less important

The knock-on effects of understocking are sometimes understated when compared to holdings costs because they can be hard to quantify. Holding costs for the most part can be measured: you just need to look at your last bill for rent, power, or security. Comparatively, it is difficult to measure the cost of a lost sale. You will likely never know how many customers truly would have bought your product if it had been in stock – the fact that a customer has inquired whether an item is in stock is no guarantee they would have bought it, and then if they would have come back to buy more another time. However, while hard to measure, such costs cannot be ignored.

The downside of customer choice

The fact that today’s marketplace is becoming more and more competitive has implications beyond the need to cut costs. Because a consumer may now buy an item not only in a physical shop, but also at a large online store like Amazon, on buy-sell groups on Facebook, or from a specialist online dealer halfway across the world, it means that there are so many alternatives a customer can go to if your product isn’t available. It’s so much easier to lose customers today: a single bad experience can be fatal. And just as this wide customer choice makes it easier to lose customers, it makes it much harder to gain them back as well.

A different type of wastage

Some businesses go to great lengths to get products in store in order to avoid customers going elsewhere. For example, manufacturers can pay their employees overtime and retail stores can pay for more expensive shipping methods to get goods to arrive faster. These costs can be seen as wastage because they are costs that would’ve been avoided if the item were simply in stock. You may find such wastage acceptable if this happens rarely, but if such occurrences are not just “one-offs” the wastage likely eliminates any benefit gained from minimising inventory in the first place.

Furthermore, if you choose to stock low amounts of inventory, you lose the opportunity to receive bulk discounts, or stock up on inventory when the price is low. Missing out on these opportunities can also be seen as wastage.

As with many things in business, your inventory management practice should be determined by weighing up the costs and the benefits. If your savings on holding costs justify running your business with low inventory, then by all means do so. Just be sure to consider the true cost of understocking. Costs such as lost customers or lost purchasing discounts can be harder to measure than holding costs, but they are still there. Factoring these into your decision-making will let you hold the right amount of inventory for your business.

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Jorge - Unleashed Software

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