"Our forecasts are pretty good."
Maybe they are. But do you know what the gaps between forecast and actual are costing you? Most businesses track forecast accuracy as a percentage but never translate that into dollars. They should.
The Two Directions of Forecast Error
Forecasts miss in two directions, and each direction creates different costs:
Underforecasting → Stockouts
When demand exceeds forecast, you run out of inventory. Costs include:
- Lost sales (immediate revenue)
- Lost customers (long-term value)
- Expedited shipping to replenish faster
- Rush production charges from suppliers
- Channel-specific penalties (Amazon ranking, retail chargebacks)
Overforecasting → Excess Inventory
When forecast exceeds demand, you're stuck with product. Costs include:
- Working capital tied up in inventory
- Storage and warehousing costs
- Product deterioration or expiration
- Markdowns to clear excess
- Write-offs for obsolete inventory
Most businesses experience both—overforecast some SKUs, underforecast others—even when aggregate accuracy looks acceptable.
Calculating Stockout Costs
Lost Sales Revenue
The most direct cost. For every unit you couldn't sell due to stockout, you lost that revenue.
Lost Revenue = Units Stockout × Selling Price
But this understates the true impact...
Lost Profit Contribution
Revenue isn't profit. What matters is the margin you lost.
Lost Profit = Units Stockout × Gross Margin per Unit
Example: 500 units stockout × $15 margin/unit = $7,500 lost profit
Customer Lifetime Value Impact
Not every customer comes back. Some go to competitors and stay there.
If 20% of stockout events lose the customer permanently:
LTV Lost = Stockout Customers × 20% × Customer Lifetime Value
Example: 500 units from ~200 customers × 20% lost × $300 LTV = $12,000
Expedited Shipping Costs
When you rush to replenish, you pay premium freight.
Extra Freight = (Expedited Cost - Standard Cost) × Units Expedited
Amazon-Specific Costs
Stockouts on Amazon tank your search ranking. Recovering that ranking can take weeks of suppressed sales even after inventory returns.
Amazon Ranking Recovery = Weeks to Recover × Weekly Sales Shortfall × Margin
Retail Chargeback Costs
Failing to fill a retail order triggers chargebacks—often $25-50 per occurrence plus percentage of order value.
Chargeback Cost = Number of Violations × Average Chargeback Fee
Total Stockout Cost
Add them up:
Total = Lost Profit + LTV Impact + Extra Freight + Ranking Recovery + Chargebacks
For a single stockout event on a hero SKU, total cost can easily reach $20,000-50,000 or more.
Calculating Excess Inventory Costs
Carrying Cost
The cost of holding inventory includes:
- Capital cost (your cost of money tied up in inventory)
- Storage cost (warehouse space per unit)
- Insurance and taxes
- Shrinkage and damage
Industry rule of thumb: carrying cost is 20-30% of inventory value per year.
Annual Carrying Cost = Excess Inventory Value × Carrying Cost Rate
Example: $100,000 excess inventory × 25% = $25,000/year carrying cost
Markdown Cost
To move excess inventory, you typically discount it.
Markdown Cost = Units Sold on Markdown × (Regular Price - Sale Price)
Example: 2,000 units × ($25 - $15) = $20,000 markdown cost
Write-Off Cost
Inventory that doesn't sell even at markdown gets written off.
Write-Off Cost = Unsold Units × Cost Basis
Example: 500 units × $12 cost = $6,000 write-off
Opportunity Cost
Cash tied up in excess inventory could be invested elsewhere—in inventory of products that actually sell, in marketing, in growth.
Opportunity Cost = Excess Inventory Value × Opportunity Return Rate
If you could earn 15% ROI elsewhere:
Example: $100,000 excess × 15% = $15,000/year opportunity cost
Total Excess Inventory Cost
Total = Carrying Cost + Markdown Cost + Write-Offs + Opportunity Cost
Excess inventory from overforecasting can easily cost 30-50% of the inventory's value over time.
Quantifying Your Forecast Error Cost
Here's a framework to estimate your annual cost:
Step 1: Calculate Stockout Volume
Sum units lost to stockouts over the past year. Your inventory system or sales data should capture backorders, cancelled orders, or estimated lost sales.
Step 2: Calculate Excess Inventory
Identify slow-moving inventory—typically units with 90+ days on hand relative to their sales velocity.
Step 3: Apply Cost Factors
Use the formulas above to translate volume into dollars.
Step 4: Total the Impact
Add stockout costs and excess inventory costs for total forecast error cost.
Example Calculation
Stockout costs:
- 5,000 units lost × $12 margin = $60,000 lost profit
- Customer LTV impact: $15,000
- Expedited shipping: $8,000
- Amazon recovery: $10,000
- Retail chargebacks: $5,000
- Total stockout cost: $98,000
Excess inventory costs:
- $200,000 excess value × 25% carrying cost = $50,000
- Markdowns: $30,000
- Write-offs: $10,000
- Opportunity cost: $20,000
- Total excess cost: $110,000
Total forecast error cost: $208,000/year
The ROI of Better Forecasting
With total cost quantified, you can calculate ROI for forecasting improvements.
Example ROI Calculation
Current forecast accuracy: 70%
With better tools and processes, achievable accuracy: 82%
Improvement: 12 percentage points (17% relative improvement)
If forecast error costs $200,000/year and improvement reduces that proportionally:
Annual savings: $200,000 × 17% = $34,000
If the forecasting tool costs $12,000/year:
ROI = ($34,000 - $12,000) / $12,000 = 183%
This is why forecasting investments often pay for themselves quickly.
Tracking Forecast Error Costs
Build ongoing visibility into error costs:
Stockout Dashboard
Track by SKU:
- Days out of stock
- Estimated lost units
- Lost revenue at selling price
- Stockout cause (forecast error? supplier delay? demand spike?)
Excess Inventory Report
Track by SKU:
- Units on hand vs. 90-day demand
- Days of supply
- Age of inventory
- At-risk inventory (slow-moving, approaching expiration)
Monthly Cost Review
Sum up monthly:
- Total stockout costs (with estimates where needed)
- Total carrying costs on excess
- Markdowns and write-offs
- Trend over time
Key Takeaways
- Forecast errors cost real money in both directions
- Stockout costs include lost profit, LTV damage, expedited shipping, and channel penalties
- Excess inventory costs include carrying, markdowns, write-offs, and opportunity cost
- A single hero SKU stockout can cost $20,000-50,000 or more
- Excess inventory typically costs 30-50% of its value over time
- Quantifying costs makes the ROI of better forecasting concrete
- Track error costs monthly to build visibility and accountability
Frequently Asked Questions
Q: What's worse—stockouts or excess inventory?
It depends on your margins and customer dynamics. High-margin products with repeat customers: stockouts are very expensive. Low-margin commodities with price-sensitive customers: excess inventory and resulting markdowns hurt more.
Q: How do I estimate lost sales during stockouts?
Use historical velocity from periods when you were in stock. If you normally sell 100/week and were out for 2 weeks, estimate 200 lost sales.
Q: What carrying cost rate should I use?
20-25% is typical for most CPG businesses. Include capital cost, storage, insurance, and shrinkage. If you don't know your exact rate, 25% is a reasonable estimate.
Q: How do I track stockout costs on Amazon?
Amazon provides data on suppressed buy box and lost sales estimates in Seller Central. Also track weeks to recover rank and sales velocity after returning to stock.
Q: Is it worth investing in better forecasting if my error rate is already decent?
Quantify your current error cost first. Even "decent" forecast accuracy (70-80%) can cost significant dollars that improvement would save. Do the math before deciding.