Shortage costs definition
/What are Shortage Costs?
Shortage costs are those costs incurred by an organization that cannot meet demand because it has no inventory in stock. These costs include the loss of business from customers who go elsewhere to make purchases, the loss of the margin on sales that were not completed, and overnight shipping costs to acquire goods that are not in stock. These costs also trigger additional administrative costs to deal with rush inventory replacement orders, as well as customer contacts to placate them or convince them to purchase alternative products. A further loss that is less quantifiable is the loss of future business from customers who have decided to permanently take their business elsewhere.
Shortage costs are a major consideration when deciding upon how much inventory to keep in stock, especially for organizations that compete based on high levels of customer service.
Example of Shortage Costs
An example of shortage costs can be seen in a retail store during the holiday shopping season. Imagine a popular electronics store runs out of stock of a highly sought-after gaming console right before Christmas. Here are some examples of shortage costs the business might incur:
Lost sales. Customers who cannot find the console in stock may take their business to competitors, resulting in immediate lost revenue.
Customer dissatisfaction. Disappointed customers might leave negative reviews, damage the brand’s reputation, and reduce long-term customer loyalty.
Expedited shipping costs. To fulfill backorders or restock quickly, the business may need to pay extra for rush shipments, thereby increasing operational expenses.
Lost cross-sales. If customers intending to buy the gaming console also planned to purchase accessories or games, those sales are lost too.
Opportunity costs. The inability to fulfill demand means the company misses out on capitalizing on the peak shopping period.
These costs highlight the importance of effective inventory management and demand forecasting to minimize shortages.
Terms Similar to Shortage Costs
Shortage costs are also known as stockout costs.