In the fast-paced world of commerce and supply chain management, the term “backorder” holds significant importance. It’s a concept that affects businesses and consumers alike, influencing everything from customer satisfaction to a company’s bottom line. In this article, we will delve deep into what backorders are, why they occur, and how businesses can effectively manage them.
What is a Backorder?
A backorder occurs when a customer places an order for a product, but the product is temporarily unavailable in the seller’s inventory. This can happen for various reasons, including unexpected spikes in demand, production delays, supply chain disruptions, or inventory mismanagement.
In simpler terms, a backorder represents a promise to deliver a product to the customer once it becomes available again. It’s not a cancellation of the order but rather a delay in fulfillment due to inventory constraints.
How Backorders Work
Backorders are a common occurrence in the world of business and supply chain management. They represent a situation where a customer places an order for a product, but the product is not currently available in the seller’s inventory. Instead of canceling the order, the seller allows the order to remain open and promises to deliver the product to the customer at a later date when it becomes available again. Understanding how backorders work is essential for both businesses and consumers. Here’s a detailed explanation of the process:
1. Customer Places an Order
The backorder process begins when a customer places an order for a product through various sales channels, such as a physical store, an e-commerce website, or a phone call to a customer service representative. The customer selects the desired item and quantity and completes the purchase.
2. Inventory Check
Once the customer’s order is received, the seller checks the current inventory levels. If there are enough units of the product in stock to fulfill the order, the order can be processed immediately, and the product can be shipped or made available for pickup.
3. Insufficient Inventory
If there are not enough units of the product in stock to fulfill the customer’s order, a situation known as an “insufficient inventory” or “out-of-stock” occurs. This can happen for various reasons, including high demand, supply chain disruptions, production delays, or poor inventory management.
4. Decision to Backorder
When faced with insufficient inventory, businesses have a choice to make. They can either cancel the customer’s order and notify them that the product is unavailable, or they can choose to backorder the product. Backordering is a commitment to fulfill the order as soon as the product becomes available again.
5. Customer Notification
If the business decides to backorder the product, they must inform the customer about the situation. This typically involves sending the customer a notification that their order is on backorder, explaining the reason for the delay, and providing an estimated delivery date or timeframe.
6. Procurement and Production
The seller then takes steps to procure or produce more units of the product. This may involve contacting suppliers, manufacturers, or production facilities to restock the inventory. The timeline for replenishing the product can vary widely depending on the nature of the product and the availability of resources.
7. Shipping and Delivery
Once the product becomes available again, the seller fulfills the backordered orders in the order they were received. This often involves packing and shipping the product to the customer’s address. Customers may receive tracking information to monitor the progress of their delivery.
8. Customer Receives the Product
When the product arrives, the customer receives it as they would with any other order. They can then use the product as intended.
9. Post-Delivery Service
Good customer service continues after the product is delivered. Businesses may follow up with customers to ensure their satisfaction and address any issues or concerns that may have arisen during the backorder process.
10. Billing and Payment
Customers are typically billed for the backordered product at the time of the initial order, regardless of when the product is actually delivered. If the customer paid using a credit card, their card may be charged when the order is placed.
The purpose of backorders is to manage and fulfill customer orders for products that are temporarily unavailable in a company’s inventory. While backorders may seem like an inconvenience, they serve several important purposes for both businesses and customers:
The primary purpose of backorders is to prevent the loss of potential sales. When a product is temporarily out of stock, businesses can still accept customer orders rather than turning them away. This allows companies to capture demand even when they don’t have immediate inventory available.
Backorders can help maintain customer loyalty and prevent customers from seeking alternative suppliers when a product is temporarily unavailable. By committing to fulfill orders as soon as possible, businesses demonstrate their dedication to serving their customers’ needs.
Backorders are a crucial component of inventory management. They allow businesses to gauge demand for specific products, identify popular items, and adjust their production and procurement strategies accordingly. This helps prevent overstocking or understocking, optimizing inventory levels.
Accepting backorders can contribute to revenue generation. While the product may not be in stock at the time of the order, the business has secured a sale and will receive payment once the product is delivered. This can help maintain a steady cash flow.
In today’s competitive market, customers often expect businesses to offer backorders as a service. If a business consistently cancels orders when products are out of stock, it can lead to customer dissatisfaction and loss of trust. Providing a backorder option meets customer expectations for convenience and flexibility.
Supply Chain Efficiency
Backorders can be a signal to the supply chain that adjustments are needed. If a product frequently goes on backorder, it may indicate the need for increased production capacity, better supplier relationships, or improvements in demand forecasting.
By backordering products instead of canceling orders, businesses can avoid wasting resources, such as raw materials or production capacity. This aligns with sustainability and cost-efficiency goals.
Backorders offer an opportunity for businesses to maintain open and transparent communication with customers. They can provide estimated delivery dates, updates on product availability, and options for cancellation or substitution. Effective communication can enhance customer trust.
In highly competitive industries, refusing backorders can put a business at a disadvantage. Customers may choose competitors that offer backordering options, potentially leading to market share loss.
Fulfilling backorders efficiently and effectively can contribute to building long-term customer relationships. Customers who experience positive interactions during a backorder process are more likely to return for future purchases.
How Backorders Affect Supply Chains
Backorders impact supply chains by imposing additional responsibilities on distributors and manufacturers. When handling backorders, suppliers must generate or acquire extra inventory to fulfill the outstanding orders, aside from their regular stock. If there is an insufficient supply of products to satisfy these orders, the responsibility is transferred up the supply chain, or retailers may be compelled to cancel the backorders.
These sudden shifts in demand can trigger what is commonly referred to as a “bullwhip effect,” representing an overcompensation in the supply chain. As an entity becomes more distant from the source of the backorder demand, greater uncertainty is introduced. For instance, overseas suppliers, situated far from retailers, are unlikely to receive timely information explaining the cause of the backorder situation. Consequently, they might choose to be cautious by increasing production to guarantee they can meet downstream demand, even if the backorders arose from an anomaly, such as an unexpected October heatwave prompting people to search for AC filters. Consequently, the overall costs within the supply chain rise, and retailers may find themselves with surplus inventory.
The Causes of Backorders
Understanding the root causes of backorders is essential for businesses to address and mitigate them effectively. Here are some common reasons why backorders occur:
A sudden surge in customer demand can overwhelm a business’s ability to keep products in stock. This can be triggered by various factors, including seasonal trends, marketing campaigns, or unexpected events. When demand outstrips supply, backorders can occur as businesses strive to catch up.
Supply Chain Disruptions
Supply chains are vulnerable to disruptions caused by various factors, such as transportation delays, natural disasters (e.g., earthquakes, hurricanes), labor strikes, geopolitical tensions, or even a global pandemic. Any disruption along the supply chain can interrupt the flow of products, leading to temporary shortages and backorders.
Within a manufacturing process, delays can arise from machinery breakdowns, labor shortages, quality control issues, or changes in production schedules. These delays can hinder the timely replenishment of inventory, resulting in backorders.
Poor inventory management practices can contribute significantly to backorders. This includes inaccuracies in demand forecasting, inadequate safety stock levels, inefficient order processing, or misjudgments about the popularity of certain products. When inventory isn’t managed effectively, shortages can occur.
Problems with suppliers, such as unreliable deliveries, quality problems with raw materials, or capacity constraints, can disrupt the supply of components or finished products. This, in turn, can lead to backorders as businesses struggle to maintain their inventory levels.
Many businesses experience seasonal variations in demand. During peak seasons, they may face challenges in meeting increased demand promptly, resulting in backorders as they adjust to the spikes in orders.
Lead Time Variability
Variability in lead times, which is the time it takes for products to be delivered after an order is placed, can lead to backorders. Longer-than-expected lead times can lead to product shortages, catching businesses off guard.
Complex products with numerous components or variations can be more susceptible to backorders. Managing inventory for such items can be challenging, as it requires careful tracking and coordination of multiple parts.
Economic factors, including inflation, currency fluctuations, or changes in trade policies, can impact the cost and availability of goods. Such economic shifts can result in changes in supply and demand dynamics, leading to backorders.
Quality Control Issues
If a batch of products does not meet quality standards during inspection, it may need to be scrapped or reworked. This can cause delays in product availability, resulting in backorders.
Unforeseen events, such as a global pandemic, can have profound effects on supply chains. These events can disrupt the movement of goods, from manufacturing to distribution, causing widespread backorders as businesses scramble to adapt to the new normal.
Lead Time Mismatch
When there’s a mismatch between supplier lead times and customer demand, backorders can occur. Suppliers may not be able to deliver products quickly enough to meet immediate customer needs.
Limited Production Capacity
Businesses with limited production capacity may struggle to keep up with high demand, particularly during peak periods. This capacity constraint can lead to backorders when orders exceed what the business can produce in a given time frame.
Natural disasters like earthquakes, hurricanes, wildfires, or floods can wreak havoc on manufacturing facilities, warehouses, and transportation networks. Such events can disrupt supply chains, causing backorders as the affected areas recover.
Changes in regulations or compliance requirements can necessitate adjustments in production or distribution processes, potentially causing delays and affecting product availability.
How to Account for Backorders
Even when a company has implemented effective inventory management systems, handling backorders usually entails distinct accounting and customer service procedures. This is necessary because the company needs to communicate with buyers about the backorder situation, including when they will be billed and the estimated delivery date.
A company’s backlog is typically categorized within its sales records, represented either in terms of a monetary value or the number of units sold or ordered. Instead of treating it as a finalized sale, a backorder is maintained as a separate entry in the company’s financial records. This approach is adopted to avoid the need for extensive accounting adjustments if the customer decides to cancel the order or if the company encounters difficulties in obtaining the necessary stock.
Once a backorder is officially documented, the company initiates the procurement process. Upon receiving the items, the company proceeds to fulfill the order based on the customer’s original purchase order. Alternatively, items may be directly drop-shipped to the customer. After this process, the sale is recorded as completed.
For businesses, it’s crucial to calculate various inventory key performance indicators (KPIs) and metrics, including the backorder rate, forecast accuracy, and time to receive inventory.
The backorder rate KPI specifically gauges what proportion of customers’ overall orders contain items that are subject to backorders, indicating delays in delivery. This metric offers insights into how effectively the company manages its inventory for high-demand products.
You can compute the backorder rate using the following formula:
Backorder Rate = (delayed orders due to backorders / total of orders placed) x 100
This formula quantifies the extent to which backorders impact customer orders and helps businesses assess their inventory management performance.
Managing Fulfillment of Backorders
Preventing the need to accept backorders is the ideal approach. However, in practical terms, most sellers will encounter this situation. This is where an order management system can prove its worth by preventing customer alienation, offering accurate and real-time data to inform decision-making, and compiling insights based on seasonal patterns to anticipate supplier performance and forecast spikes in demand.
Businesses that can effectively coordinate inventory management with supplier lead times and adjust purchase orders based on real-time information can avoid product shortages, especially during periods of high sales potential.
When the necessity arises to fulfill backorders, follow a structured 5-step process:
- Demonstrate goodwill: Assess whether it’s appropriate to express gratitude to affected customers for their patience, potentially by offering a shipping upgrade or including a low-cost item at no extra charge.
- Inform the customer: Communicate the expected delivery date range to the customer. Additionally, check if the customer has placed another order that can be combined with the backordered item for shipping efficiency.
- Transition the backorder: Shift the status of the backorder to that of a sales order and authorize shipment.
- Payment processing: Complete the payment process or issue an invoice as necessary.
- Shipping and closure: Ship the item and finalize the sale.
However, the process shouldn’t end there. If a substantial number of backorders are occurring, it’s advisable to reconsider your reorder points, consider raising the safety stock threshold, or reevaluate your inventory forecasting procedures. This proactive approach can help minimize future backorder situations and enhance overall inventory management.
In the complex world of modern commerce, backorders are an inevitable challenge that businesses must face. Understanding the causes and consequences of backorders is the first step toward effective management. By implementing strategies such as accurate forecasting, safety stock management, and transparent communication with customers, businesses can minimize the negative impact of backorders and maintain a healthy balance between supply and demand. In doing so, they can enhance customer satisfaction, maintain their reputation, and achieve long-term success in today’s competitive marketplace.
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