Lost sales cost (LSC) is the cost of the sales lost when we are not able to satisfy customer demand. The lost sales cost for an item is computed by multiplying its annual sales potential (i.e. sales that would have occurred if all demand was satisfied = AD x USP) by the portion of sales that we were not able to satisfy (1 – UFR) by the shortage factor (SF).
LSC = [AD x USP] x (1 – UFR) x SF
For example, if an item has an annual demand of 2,000 units per year; a unit selling price of $2,400 per unit; a unit fill rate of 90%; and a shortage factor of 40% then the lost sales cost is
LSC = [2,000 x $2,400] x (1 – .9) x (.4) = [$4,800,000] x .1 x .4 = $192,000 per year
In the figure the expected lost sales costs associated with a medium moving SKU were plotted vs. target unit fill rates and inventory investments required to achieve them. Note that expected lost sales cost declines from $245,568 per year at a target unit fill rate of 50% to $147 per year at a target unit fill rate of 99.95%.