Have you browsed through so many pages in an e-commerce portal and finally decided on the garment you want to buy – just to realise that it is not available in your size? How frustrated would you be? Would you visit the store again in future to check for the availability or order through another portal?
Yes, customers decide when to buy and where to buy. But they expect the product to be waiting in the shelf when they want to buy. The customer mostly doesn’t wait or pre-order, but goes to a competitor’s site to buy the product even at a slightly different price.
It is very difficult to gain the customer back and the cost of a ‘stock out’ is huge (and difficult to quantify too). The cost of a stock out includes the cost of back order (if any), cost of lost sales, cost of lost customer and future sales. If we have a fair idea on the customer acquisition cost and the customer life time value in our business, we know how huge it is to lose a customer from an inventory issue!
It is imperative to have a real time view of our ‘available to promise’ and keep replenishing the inventory periodically. But it attracts the costs to hold and store the inventory. Carrying costs includes the capital incurred in buying the inventory, storage costs (warehouse rents, utilities, inventory movements, insurance) and the risk costs too.
The other alternative is to order less to reduce carrying costs, but order often. But it incurs ordering costs right from factory orders, purchase order till the frequent transportation costs.
Both carrying and ordering costs are inversely proportional and it is important to identify a balance between them. The technical term for their intersection is called as ‘Economic Order Quantity’. Even though we don’t need to plot the graphs to identify this number, we need to have an idea of the order quantity where the storage costs roughly equals to the ordering costs.