What is a Backorder?
Backorder is a customer order that cannot be filled when presented, and for which the customer is prepared to wait for some time. The percentage of items backordered and the number of backorder days are important measures of the quality of a company’s customer service and the effectiveness of its inventory management.
When a customer places an order for an item that is not currently in stock, the customer may be informed it is on backorder and can still make payment with the promise of future delivery. Items available on backorder may indicate a date when they will be back in stock. These items will be planned for receipt from the supplier and a customer delivery date will be determined based on supplier lead time.
Backorders occur for several different reasons:
- Demand exceeds supply due to seasonal trends, marketing, or emergency
- Bad weather or other road conditions impede timely transportation
- Political upheaval in a foreign country (in cases of international imports)
- Poor planning around lead time from supplier
- Supplier production/delivery problems
Backorders represent any amount of stock a company’s customers have ordered but have not yet received because it currently isn’t available in stock.
Just because they may lack a supply of inventory, that doesn’t mean companies can’t operate on backorder. In fact, companies can still do business even if they don’t have inventory on the books. Keeping products on backorder helps boost demand, retain and increase the customer base, and creates value for their products.
A company’s backorders are an important factor in its inventory management analysis. The number of items on backorder and how long it takes to fulfill these customer orders can provide insight into how well the company manages its inventory. A relatively manageable number of orders and there a short turnaround time to fulfill orders generally means the company is performing well. On the other hand, longer wait times and large backorders may be problematic.
Carty Inc. is a firm that manufactures and markets Carty, a brand of women shoes. At Christmas time, many women tend to purchase additional shoes. They want to buy new shoes for themselves but also for their friends and relatives.
From January to November, Carty Inc receives an average of 1,500 pair of shoes ordered per month. But in December, the number can go as far as 3,000 pairs. Since the productive capacity is only 2,500 pairs per month, the company used to have severe conflicts to satisfy demand at Christmas season.
Many customers were unhappy and tried other brands. In order to solve this issue, the firm decided to produce in advance part of the expected demand for December. The most popular items are now over-produced and stocked during September, October and November.
In this way, the firm now can fulfill around 95% of the required items in December thanks to a successful backorder management strategy.
Advantages of Backorders
The term backorder may conjure up negative images, but there can be positives to businesses that have these orders on the books.
Keeping a large supply of stock requires storage space, which, in turn, requires money. Companies that don’t have their own storage centers have to pay for services to hold their inventory. By keeping a small amount of stock in supply and the rest on backorder alleviates the need for excess/extra storage, and therefore, reduces costs. This cost reduction can be passed on to consumers, who will likely return because of a company’s low prices. This is especially true when sales and demand for certain products is high.
Problems with Backorders
If a company consistently sees items in backorder, this could be taken as a signal that the company’s operations are far too lean. It may also mean the company is losing out on business by not providing the products demanded by its customers. If a customer sees products on backorder—and notices this frequently—they may decide to cancel orders, forcing the company to issue refunds and readjust their books.
When an item is on backorder, a customer may look elsewhere for a substitute product, especially if the expected wait time until the product becomes available is long. This can provide an opportunity for once loyal customers to try other companies’ products and potentially switch their loyalties. Difficulties with proper inventory management can lead to the eventual loss of market share as customers become frustrated with the company’s lack of product availability.
5 tips for minimizing backorders
While backorders are dreaded, unplanned, and sometimes inevitable, there are certain measures you can take to reduce the likelihood of them occurring.
1. Set safety stock
Do your best to forecast demand and sales orders by setting a safety stock point that is high enough to cover unusual demand or supplier problems. Keeping excess stock on hand, paired with real-time inventory tracking and proactive inventory replenishment can help prevent you from running out of any given SKU.
2. Calculate and set reorder points
A reorder point is the minimum quantity of any SKU that a business should have on hand before they need to reorder more product from their manufacturer. The reorder point formula is simply adding up your lead time demand and safety stock in days.
Ecommerce fulfillment providers like ShipBob have built-in technology that let you easily calculate and establish reorder points for each product and also alert you when it’s time to get more inventory to their warehouses. Reorder points kick in once your stock hits that predetermined level to help prevent backorders.
Of course, you need to account for any major upcoming promotions, flash sales, media coverage, and product launches as well as use historical order data and increase your reorder quantity if you plan on selling faster than normal. For example, it you double sales every Cyber Monday, you will need to order more inventory and/or order additional inventory quicker or risk losing sales on the hottest buying day of the year.
3. Regularly view inventory levels of popular items
Popular items may sell out quickly, so make sure you keep an eye on their specific stock levels. In the world of ecommerce, nothing ever goes 100% according to plan, so be sure to keep close tabs on inventory to inform purchase order decisions.
4. Have multiple suppliers
Working with multiple suppliers has its advantages, as backups can become available in the event that your primary manufacturer can’t produce in time.
5. Order more product
The right amount of safety stock makes the best use of your inventory storage system and capital. You could always avoid stockouts by ordering huge amounts of product, but that can also clog up your storage space, increase your inventory carrying costs, and tie up money you could be spending more strategically, elsewhere.
Note: The carrying cost of inventory will depend on your products and storage needs, your total number of SKUs, your location, your inventory turnover rate, and whether you keep fulfillment in-house or outsource it. Calculate how much more money it would cost you on top of the per-unit price on the purchase order.
Some customers will accept that they must wait for backordered items; others (e.g. holiday shoppers) may look elsewhere if their need is immediate. The best way to handle backorders is not to have any. Managing your business in a joined-up and coherent manner is important. This means having a good ‘information system’ is of paramount importance. You need good, timely and accurate data for decision making. Having a system that is aware of seasonal trends is important for any business selling products, as is managing your supplier performance. Running out of products at a time when the selling potential is greatest is unforgivable, unacceptable and must be avoided at all costs.
An essential part of backorder management is managing inventory flow around supplier lead time and adapting purchase order behavior according to real-time information.