Lost sales cost (LSC) is the revenue lost when we are not able to satisfy customer demand. The lost sales cost for an item is computed by multiplying the annual sales potential (i.e. sales that would have occurred if all demand was satisfied) by the portion of sales that we were not able to satisfy by the shortage factor.
- LSC = FAD x USP x (1 – UFR) x SF
In the equation, FAD stands for the forecast annual demand, USP stands for unit selling price, SF stands for the shortage factor, and UFR stands for the unit fill rate (the % of unit demand that is satisfiable from on-hand stock).
For example, if the annual demand for an item is 1,000 units; the unit selling price is $2.00; the unit fill rate is 90%; and the shortage factor is 50%; then the lost sales cost for the item is
- LSC = 1,000 units/year x $2.00/unit x (1 – 0.9) x 0.5 = $100/year.
The total lost sales cost is the sum of the lost sales costs for all items.
Lost sales cost and be pitted vs. inventory carrying cost to help determine optimal fill and turn rates.