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Main Findings
Backorders are orders for products that are not in stock at the time of purchase but are expected to be available in the future. Backorders can be a sign of high demand, low inventory, or supply chain issues. Backorders can be measured by the backorder rate, which is the percentage of orders that are delayed due to backorders.
Backorder is a term used to describe a situation where a customer orders a product that is not currently available in stock.
The product may be in production, in transit, or out of supply from the manufacturer or supplier. Backorder implies that the product will be delivered to the customer at a later date, once the inventory is replenished. Backorder is also known as backlog, as it represents the number of unfilled orders that a company has.
Why backorder?
Backorder can occur for various reasons, such as unexpected demand, supply chain disruptions, inventory mismanagement, or strategic decisions. Some of the benefits and drawbacks of backorder are:
Benefits
- Backorder can help a company maintain customer loyalty and satisfaction by offering to wait for the desired product instead of canceling the order or switching to a competitor.
- Backorder can help a company reduce inventory costs and risks by holding less stock and avoiding overstocking, obsolescence, or theft.
- Backorder can help a company generate positive word-of-mouth and marketing buzz by creating a sense of scarcity and exclusivity for its products, especially if they are new, popular, or innovative.
Drawbacks
- Backorder can hurt a company's reputation and customer satisfaction by causing delays, frustration, uncertainty, or dissatisfaction with the product or service quality.
- Backorder can hurt a company's cash flow and profitability by delaying revenue recognition, increasing operational costs, or losing sales opportunities to competitors who can fulfill orders faster.
- Backorder can hurt a company's efficiency and productivity by creating bottlenecks, inefficiencies, or errors in the order fulfillment process.
Formula
There is no universal formula for calculating backorder, as different companies may use different methods and metrics to measure it. However, some common ways to express backorder are:
Backorder rate
The percentage of orders that are on backorder out of the total orders received or processed in a given period. A lower backorder rate indicates better inventory management and customer service.
Backorder level
The number or value of units or orders that are on backorder at a given point in time. A higher backorder level indicates higher demand or lower supply for the products.
Backorder days
The average number of days that it takes to fulfill a back ordered order from the time it is placed to the time it is shipped or delivered. A shorter backorder days indicate faster order fulfillment and customer service.
How to calculate
To calculate backorder rate, level, or days, one needs to have data on the following variables:
- Total orders received (TOR): the number or value of orders that a company receives from customers in a given period.
- Total orders processed (TOP): the number or value of orders that a company processes (i.e., confirms, picks, packs, ships, or delivers) in a given period.
- Total orders shipped (TOS): the number or value of orders that a company ships or delivers to customers in a given period.
- Total orders on hand (TOH): the number or value of orders that a company has in its inventory at a given point in time.
- Total orders on backorder (TOB): the number or value of orders that a company has not yet shipped or delivered to customers at a given point in time.
Using these variables, one can calculate the backorder rate, level, or days as follows:
- Backorder rate = TOB / TOR * 100% (for a given period)
- Backorder level = TOB (at a given point in time)
- Backorder days = TOB / TOS * Number of days in period
Examples
To illustrate how backorders work, let's look at some examples of different scenarios.
Scenario 1
A customer orders 10 units of product A from a retailer, but the retailer only has 8 units in stock. The retailer informs the customer that 2 units are on backorder and will be shipped as soon as they are available from the supplier.
The customer agrees to wait for the backordered units. The retailer records 8 units as sales and 2 units as backorders in its accounting system.
Scenario 2
A customer orders 5 units of product B from a retailer, but the retailer has none in stock. The retailer informs the customer that the product is on backorder and will be shipped in two weeks when the next batch arrives from the manufacturer.
The customer agrees to wait for the product. The retailer records 5 units as backorders in its accounting system.
Scenario 3
A customer orders 3 units of product C from a retailer, but the retailer has none in stock. The retailer informs the customer that the product is out of stock and will not be restocked in the foreseeable future. The customer cancels the order. The retailer records no sales or backorders in its accounting system.
Limitations
Backorders can have some drawbacks for both sellers and buyers, such as:
Customer dissatisfaction
Customers may be unhappy with the delay in receiving their orders, especially if they are not informed upfront or if the delivery date is uncertain or changes frequently. This may lead to cancellations, refunds, negative reviews, or loss of loyalty.
Inventory management challenges
Sellers may have difficulty forecasting demand, replenishing stock, allocating resources, and coordinating with suppliers when dealing with backorders. This may result in excess inventory, stockouts, higher costs, or missed opportunities.
Competitive disadvantage
Sellers may lose customers to competitors who have the same or similar products in stock and can deliver them faster or cheaper. This may affect their market share, revenue, or reputation.
Conclusion
Backorders are orders for products that are not in stock at the time of purchase but are expected to be available in the future. Backorders can be a sign of high demand, low inventory, or supply chain issues.Â
Backorders can have advantages and disadvantages for both sellers and buyers, depending on the nature, number, and duration of the backorders. Backorders can be measured by the backorder rate, which is the percentage of orders that are delayed due to backorders.
References
- Backorder: Definition, Causes, Example, Vs. Out-of-Stock - Investopedia: https://www.investopedia.com/terms/b/backorder.asp
- Back-order Definition & Meaning - Merriam-Webster: https://www.merriam-webster.com/dictionary/back-order
- Backorders Defined: What It Is, Causes, & Solutions | NetSuite: https://www.netsuite.com/portal/resource/articles/inventory-management/backorder.shtml
- Metrics that Matter: Backorders | QAD Cloud ERP Blog: https://www.qad.com/blog/2018/09/metrics-matter-backorders
- Backorder Costs: What it Means, How They Work - Investopedia: https://www.investopedia.com/terms/b/backordercosts.asp
- Backorder: Meaning, Best Practices, Solutions: https://www.unleashedsoftware.com/blog/backorder
FAQ
The main risk associated with backordering is the potential loss of customers. If customers have to wait too long for their orders, they may cancel their orders and go to a competitor.
Companies can mitigate the risks associated with backorders by maintaining a safety stock, improving their demand forecasting accuracy, and communicating transparently with customers about expected delivery times.
Backordering can help reduce a company’s inventory carrying costs because it allows the company to keep less inventory on hand. However, it can increase costs related to customer service and order management.
Yes, backordering can be a strategic decision. Some companies intentionally maintain a backorder policy for certain products to reduce inventory costs, especially for items that are expensive to produce or store.
Backordering and JIT inventory management are both strategies to reduce inventory carrying costs. However, while JIT aims to synchronize production with demand to minimize inventory, backordering allows a company to take orders for products that are not currently in stock.
