Five Costs of Low Inventory: How Being Too Lean Can Cost You

Most companies assume that lowering inventory levels is a good thing. These companies believe that reducing how much they hold within their warehouse will ultimately help them to lower costs. Unfortunately, it simply isn’t true. These companies fail to recognize that there are two main categories of inventory costs: There are costs that come from holding too much inventory and there are costs that come from not having enough inventory. Here are five reasons why low inventory counts are rarely, if ever, a good thing. 

1. Lost Sales: First to make our list is the most obvious cost of not having product on the shelves: Every time your company encounters a stock out, it ultimately loses a sale. Losing sales due to low finished good counts is a direct cost of managing inventory. In essence, it’s the costs of not having inventory. Remember, you have product available to sell. Without it you’re losing money. It’s just that simple. 

2. High Freight: What happens when you don’t want to lose the order, but also don’t have the inventory to make the sale? Simply put, you’ll rush in a shipment from your own vendor. Next, you’ll pay overtime to inspect, receive and label your product offering. These costs are higher if you’re a manufacturer.

Now, let’s see all these costs together. First, there’s an expedited freight cost to rush the shipment from your vendor. Second, there are additional costs of overtime to inspect and receive the parts. Third, there’s likely an additional expedite freight cost as you cover outbound freight in an attempt to salvage the customer relationship. Finally, you’ll probably see a higher cost due to the expedited surcharge your vendor charged you for jumping to the front of the line. These costs affect profit on sales. More importantly, they directly impact your bottom line.  

3. Lost Profit: Every sale you lose means you’ve lost profit, and in today’s economy, profit is everything. If you’re unsure of just how expensive it is to lose a sale, then just think about how much profit you’ve lost. Every product’s success or failure is defined by its gross profit on sales. If you’re not able to make that sale because you don’t have inventory, then you’re losing – it’s just the way it is. 

 

The above video explains how most companies ignore outbound freight costs when encountering inventory stock outs. However, it's a direct cost of not having inventory. Maintaining a Safety Stock is one way to guard against these out of stock situations.  

4. Lost Customers and Lost Market Share: Lose enough sales and you’ll lose customers. Lose enough customers and you’ll see your market share erode. Once this happens, your competitors will become entrenched at your customers’ businesses. They’ll be known as the vendor who had what the customer needed, when they needed it. They’ll easily become the vendor of choice and the first one your customers call when faced with an emergency. 

All inventory costs are driven by two main categories: There are costs of having inventory and the costs of not having inventory. For more information about these main costs, please see: Inventory Carrying Costs vs. Lost Sales: Both Destroy Your Bottom Line

5. Downtime: There’s nothing more costly to a company than to have a bunch of employees sitting around idle, waiting for something to do. Again, this is worse for manufacturers. It’s amazing to think that a manufacturer would allow a material shortage to occur, but it happens every single day. However, you don’t have to be a manufacturer to know that paying employees for doing nothing is simply a waste of money.

Missing out on a sale because inventory isn’t available doesn’t just impact your sales team: It impacts every employee that plays a role in your after-sales service and support. This includes the people who enter the order, those who ship it, and finally, those responsible for receivables collection. 

We could go on and on about the high costs of not having inventory. In the end, your company must find a balance between having just enough to cover sales and not so much that you lose out on sales. This rule applies for any company, regardless of its business model, its customers or its industry. 

Stock outs are directly related to how you manage inventory. These costs are measured in lost sales, high incoming and outgoing freight, lost market share, lost customers and finally, lost production time. Companies must continually find a balance having exactly what they need to cover demand and not so much that their costs erode profit. 

 

The video above and graph below explain exactly why it's so important to balance out high holding costs versus lost sales due to stock outs. You can read more by going to: The Customer Demand & Inventory Gap: The Bell Curve