Shortage Series #1: What Are Shortages and Why Are They So Costly?

With bottlenecks in the supply of both goods and services running rampant post-pandemic, the term “shortages” is quite common to hear in the manufacturing industry. But what exactly are shortages and why are they such a big deal?

What are shortages?

In economic terms, shortages occur when the quantity demanded exceeds the quantity supplied. To be at market equilibrium, the quantity supplied must match the quantity demanded, so when this is not the case, it either results in a surplus or a shortage. In economics, there are three main reasons or causes of shortages—an increase in demand, a decrease in supply, or government intervention (price ceilings for example).

The graphs below illustrate these concepts. Demand slopes downward for a normal good because as the price increases, the demand for the product decreases. The opposite is true for supply, as the price increases suppliers want to produce and sell more. As the price changes, supply and demand move along their respective curves. 

Manufacturers think of shortages more as the actual lack of a part or product. Examples such as the chip crisis or the infamous toilet paper shortage of 2020 continue to pop up in the post-pandemic supply chain. Shortages also occur in the service industry, like the much-discussed shortage of long-haul drivers.

Shortage management involves reviewing on-hand inventory, supply, and demand, and adjusting the order schedule to ensure that production can continue. Without proper shortage management, shortages will continue to wreak havoc throughout the supply chain, costing companies extra in excess inventory, expediting fees, missed orders, and more.

What is the cost of a shortage?

The costs of shortages are typically measured in some type of opportunity cost—what was lost from not completing a sale or loss of future business. While the potential negative impacts are vast, there are three main costs of shortages. 

1. Loss of Sale

When a shortage occurs, the product is more likely to reach its end destination late. Some consumers or customers will wait out the later delivery time, but others will cancel their order and expedite the part or product from elsewhere, resulting in a lost sale. Lost sales have a more immediate cost associated with them because businesses are losing the money directly associated with that particular sale. 

2. Loss of Customer

When products or parts do not show up on time, it’s safe to say customers are not happy. Even so much as one late delivery can drive customers away to the competition. To recognize the cost of losing customers, companies cannot look at merely at one lost cost like loss of a sale, but all of the potential future purchases that customer would have made. 

3. Loss of Goodwill

The loss of goodwill basically amounts to the loss of a good relationship with a customer. While they may still buy from a company, they may not buy as much or as frequently. They are also less likely to recommend that company to their networks and will not likely carry that supplier as they move jobs throughout their career. 

The most substantial direct cost of shortages, however, is expediting. In order to prevent the loss of a sale, customer, or goodwill, companies expedite the parts from a different supplier. This typically allows the company to complete the sale on time but will cost extra in shipping and delivery fees.

How can companies fight shortages and build a more resilient supply chain?

LeanDNA’s Critical Shortages Battle Kit provides all of the resources needed to get a handle on shortages. Get exclusive access to effective best practices and information on prioritizing, preventing, and attacking shortages in the age of unpredictable demand.