Measuring and Mitigating the Costs of Stockouts

There is now an extensive theoretical literature investigating optimal inventory policies for retailers. Yet several recent reviewers have recognized that these models are rarely applied in practice. One explanation for the paucity of practical applications is the difficulty of measuring how stockouts affect both current and future demand. In this paper we report the findings of a large-scale field test that measures the immediate cost of a stockout and the impact on future demand. The findings confirm that the impact of stockouts extends well beyond the current order. Firms cannot hope to implement optimal inventory policies without measuring these long-run effects. The study also investigates the effectiveness of different responses that firms can offer in order to mitigate these costs. There is considerable variation in the effectiveness of these responses. Offering discounts to encourage customers to backorder rather than cancel their orders is widely used in practice but were the least profitable of the responses that we evaluated.