Stock-out cost

Inventory refers to the stock of products held to meet future demand. Pharmacies hold inventory to guard against fluctuations in demand, to take advantage of bulk discounts, and to withstand fluctuations in supply (e.g., late deliveries) (West, 2003). There are four costs associated with having inventory acquisition costs, procurement costs, carrying costs, and stock-out costs (Carroll, 1998 Huffman, 1996 Silbiger, 1999 Tootelian and Gaedeke, 1993 West, 2003). 

The Reliable Hardware Store sells electric pumps. The supplier lead time is one week. Each pump costs Reliable 100. Annual inventory carrying cost is 25% of the investment. If Reliable stocks out, it will fill demand by buying the required pumps elsewhere at an additional cost of 20, that is. Reliable s cost would be 120. Reliable s planned probability of in stock is 91.2%. 

Thus, for the problem faced by Steco, a retailer of titanium rods. Weekly demand for these rods follows a normal distribution with a mean of 100 units and a standard deviation of 5 units per week. These rods cost 5 each and the cost of holding a rod in inventory for a year is 20% of its cost. The cost to Steco to place an order for replenishment is 25/order. Delivery lead time is one week. Management wants a less than 6% probability of stocking out. Assume 50 weeks per year. 

This is because in most studied planning problems stock outs are not allowed at all and, hence, shortages are explicitly prohibited. See MirHassani (2008) or Cafaro and Cerda (2008) for examples where both costs are considered. Note that in Cafaro and Cerda (2008) shortages are defined as tardily delivered batches. 

Primary purpose Supply predictable demand efficiently at the lowest possible cost Respond quickly to unpredictable demand in order to minimize stock outs and obsolete inventory... 

A Harvard Business School study in 2007 reported that the consumer goods industry carries, on average, 11 weeks (77 days) of inventory and retailers carry 7 weeks (49 days) of inventory. In spite of that, the stock-out rate in the retail industry averages nearly 10% Note that, increasing the days of inventory is one means of attempting to increase customer responsiveness, but this increase would come at the expense of additional supply chain cost. 

Cost of inventory and stockout. The cost of carrying inventory is 2 per unit per month, and the cost of stocking ont is 5 per unit per month (see Table 8-3). f and St represent the units in inventory and the units stocked out, respectively, in Period t. Thus, the cost of holding inventory and stocking out is... 

In this section, we focus on products such as detergent that are ordered repeatedly by a retail store such as Walmart. Walmart uses safety inventory to increase the level of availability and decrease the probability of stocking out between successive deliveries. If detergent is left over in a replenishment cycle, it can be sold in the next cycle. It does not have to be disposed of at a lower cost. However, a holding cost is incurred as the product is carried from one cycle to the next. The manager at Walmart is faced with the issue of deciding the CSL to aim for. 

We can thus deduce that the imputed cost of stocking out (using Equation 13.6) is given by... 

A manager can use the previous analysis to decide whether the imputed cost of stocking out, and thns the inventory policy, is reasonable. 

Green Thumb, a manufacturer of lawn care equipment, has introduced a new product. Each unit costs 150 to manufacture, and the introductory price is 200. At this price, the anticipated demand is normally distributed, with a mean of /u = 100 and a standard deviation of cr = 40. Any unsold units at the end of the season are unlikely to be valuable and will be disposed of in a post-season sale for 50 each. It costs 20 to hold a unit in inventory for the entire season. How many units should Green Thumb manufacture for sale What is the expected profit from this policy On average, how many customers does Green Thumb expect to turn away because of stocking out ... 

After a company has a handle on the amount spent on holding and ordering costs, it can calculate an optimal order quantity that minimizes these costs. In addition, it can calculate how often to order the optimal quantity. These ideas feed into reorder points. To what point can inventory decline before an order must be placed to minimize stock-outs and risk losing sales ... 

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