Order too much and cash sits on a shelf. Order too little and you turn customers away. Which mistake costs more depends on your own numbers, so this guide shows the arithmetic with a worked example you can copy.
What each mistake costs
A stockout costs you the profit on every sale you could not make. Overstock costs you the expense of holding the extra units, plus any loss if you have to discount or write them off. Put both on a per-unit basis so you can compare them.
- Cost of one unit short: Selling price minus unit cost
- Cost of one unit extra, if it sells later: Your holding cost per month × months held
- Cost of one unit extra, if you clear it: Unit cost minus the clearance price, plus holding
- Cost of one unit extra, if it never sells: The full unit cost, plus holding
The example
Take a product that costs you $10 and sells for $25, so each sale earns $15. Suppose you estimate holding costs (storage, insurance, cash tied up) at $0.20 per unit per month. That figure is an assumption for this example. Work out your own from your storage and financing costs.
Now compare being 40 units short with being 40 units over.
| Scenario | Arithmetic | Cost |
|---|---|---|
| 40 units short | 40 × $15 | $600 in lost profit |
| 40 extra, sold at full price after 3 months | 40 × $0.20 × 3 | $24 |
| 40 extra, cleared at $8 after 3 months | 40 × ($10 − $8) + $24 | $104 |
| 40 extra, written off after 3 months | 40 × $10 + $24 | $424 |
Reading the result
In this example the stockout costs more in every row, but the gap narrows fast as the surplus gets harder to sell. The deciding question is what happens to the extra units.
- Steady sellers: Surplus sells next month at full price, so overstock is cheap and a stockout is expensive
- Seasonal or dated products: Surplus may be cleared at a loss, so the two costs move closer together
- Perishable or trend products: Surplus may be written off, and overstock can cost more than a stockout
What the arithmetic leaves out
The table counts what you can measure. Both mistakes have costs that are harder to put a number on, and you should weigh them even without a figure.
- Stockout: A customer who buys elsewhere may not come back, and ad spend keeps sending traffic to a product you cannot ship
- Overstock: Cash tied up in slow units is cash you cannot spend on products that are selling
Run it for your own products
Repeat the comparison for each product, or at least for each group that behaves the same way. Then let the result set how much buffer you hold.
- Stockout costs far more: Hold a larger safety stock
- Costs are close: Hold a small buffer and reorder more often
- Overstock costs more: Order lean and accept the occasional sellout
Doing this at scale
StockSense forecasts per-SKU demand from your order history using velocity, trend, seasonality and lead-time-aware safety stock, then recommends a reorder point, quantity and date. It ranks SKUs by revenue at risk, so you can see where a stockout would cost the most. See StockSense.