Faced with an out-of-stock notification, many consumers will simply click over to a competitor’s site. For some retailers, the answer is to use backorders, where a desired item that is still in production but currently out of stock is promised to ship in a set timeframe.
The customer gets the item, the retailer makes the sale. Win/win.
Backorders can be tricky, though. If you end up being unable to fulfill the order, the customer may be more irritated than if you had just marked the item as out of stock. And, managing backorders can be a headache for finance and logistics teams.
So are backorders right for your business? Maybe. Here are items to consider.
What Is a Backorder?
A backorder is generated when an order can’t be fulfilled at the time of purchase because the item is not in the seller’s current inventory. However, the item is still in production or available from the distributor.
Also known as a backlog, a backorder indicates that demand for a given product exceeds what the seller produced or ordered. That could be a function of poor planning, overly strict policies on safety stock or an unforeseeable spike in demand for an item.
Avoid allowing backorders on inexpensive or commodity products that customers can readily purchase elsewhere. Where backorders are offered, make sure the profit margin makes the extra logistical effort worthwhile and that you can fill those requests promptly. The amount of time it takes to get a backordered item to the customer depends on a number of factors.
Backorders vs. Out of Stock
An item is out of stock when the seller doesn’t have the item in inventory and has no sure date to restock, or the item is seasonal or a limited run. Backordered items are expected to be available in a reasonable timeframe.
How Backorders Work
When a company takes orders — and potentially payments — for products that are not in stock, it is accepting backorders.
Once backorders are accepted, the inventory management system converts them to purchase orders and sends them to the appropriate internal department, vendor or distributor. Customer service teams should provide buyers with an estimate of when they can expect their orders and how payment will be handled.
Retailers may choose to have the supplier drop ship items direct to customers, or the retailer may take delivery of the items, translate the backorders to sales orders and ship the items to customers after charging the customer’s account, if applicable.
For a limited number of SKUs at a manageable volume, this is not an overly complex process. Problems mount, however, when the number or quantity of backordered products multiply or when retailers have a lot of manual order processes and must match each purchase order with a current sales order when completing the fulfillment process.
What Is the Purpose of Backorders?
Backorders may benefit companies in a few ways. Retailers with limited warehouse capacity may not be able to hold a large amount of stock, but if they can confidently track availability of items from suppliers, they can avoid overcrowding and incurring excess storage costs while confidently accepting backorders.
Sometimes, companies see an unexpected surge in demand for a product. Again, depending on visibility into availability of additional stock, accepting backorders allows the retailer to make those sales and keep customers happy.
Small suppliers that drop ship most or all of their items often take backorders as a matter of course and place an order with the supplier only once backorders reach a certain threshold. These companies avoid inventory carrying costs altogether.
How Backorders Affect Supply Chains
Backorders affect supply chains because they place additional burdens on distributors and manufacturers. When fulfilling backorders, suppliers need to produce or procure additional backordered stock in addition to their normal inventory. If there isn’t enough product to fulfill these orders, the burden is shifted up the supply chain, or retailers are forced to cancel backorders.
These sudden demand fluctuations can end up causing what’s known as a “bullwhip effect,” an overcorrection of the supply chain. The farther an entity is removed from the source of the backorder demand, the more uncertainty is introduced. Overseas suppliers at a distance from retailers, for example, are unlikely to receive timely information on what caused the backorder situation. That may cause them to hedge by increasing production to ensure they can meet downstream demand — even if the backorders were the result of a fluke, like a heatwave in October leading to people hunting for AC filters. Thus, total supply chain costs increase, and retailers may actually end up with excess inventory.
What Causes Backorders?
Addressing the causes of backorders is the first step in preventing — or at least minimizing — them. Let’s take a look at some of the common reasons for backorders, which in a sense are all symptoms of inaccurate forecasting and that can in turn be cured by improved inventory forecasting:
- Unusual demand or demand exceeds supply: Holiday seasons or other unforeseen circumstances, like extreme weather, may lead to unusual purchasing. For example, our heat wave, or when a hurricane warning leads to an uptick in orders for generators, leading to backorders.
- Inaccurate forecasting: Less accurate forecasts could lead to low safety stock and a higher chance of backorders.
- Supplier or manufacturing issue: Supply chain challenges, such as factory shutdowns or raw material shortages, can lead to items being unexpectedly out of stock.
- Delayed orders: Companies that order based on safety stock formulas and require manual review of purchase orders may run into restocking delays, only to experience a sudden surge of orders. Delays may also happen when the company’s upstream supplier hasn’t replenished its usual stock, leading to backorders.
- Human errors: An employee may enter an order as a backorder even if the item is available. Or, worse, a retailer may accept a backorder even though the item is out of stock. This may happen because of error or because of lag time in inventory updates.
- Warehouse management discrepancies: Warehouse management refers to all the processes involved in daily warehouse operations — and it’s a lengthy list. A glitch in an inventory management system may provide inaccurate data, or a breakdown in data entry may lead to stock being miscounted or misplaced.
How to Account for Backorders
Even with the right inventory management systems in place, backorders typically require special accounting and customer service processes because the company has to inform buyers about the backorder, when they will be charged and when to expect delivery.
A company’s backlog is usually conveyed as a subcategory of sales, as a dollar figure or by the number of units sold or ordered. Rather than considering it as a completed sale, the backorder will be recorded as such on the company’s books. That’s so the company doesn’t have to go back and reconcile their accounting records if the customer cancels the order, or if the company can’t acquire the stock.
Once a backorder is recorded, the company places the order. When items are received, the company follows through, delivering the product based on the customer’s purchase order. Alternately, items could be drop shipped directly. The sale will then be recorded and marked as complete.
It’s important for companies to calculate backorder rates, among other vital inventory KPIs and metrics, like forecast accuracy and time to receive.
The backorder rate KPI measures what portion of customers’ total orders are for items that are backordered, which means a delay in delivery. It shows how well a company stocks in-demand products.
Calculate the backorder rate with this formula:
Backorder Rate = (# delayed orders due to backorders / total # orders placed) x 100
Managing Fulfillment of Backorders
The best way to manage backorders is not to need to accept any. Realistically, however, most sellers will run into this situation. This is where an order management system can pay for itself by ensuring you don’t alienate customers, providing accurate and real-time data to help with decision-making and compiling insights based on seasonal trends to forecast supplier performance and predict surges in demand.
Businesses that are able to manage inventory flows around supplier lead time and adapt purchase orders based on real-time data can avoid running out of products, especially when selling potential is highest.
When you must fulfill backorders, use a 5 step process:
Make good — consider whether to thank affected customers for their patience with a shipping upgrade or by including a low-cost item at no charge.
Notify the customer of the expected delivery date range. Check whether the customer has placed another order with which you could bundle the backordered item.
Shift backorder to sales order and authorize shipment.
Process payment or issue an invoice.
Ship item and close sale.
But don’t stop there. If you see a significant number of backorders, consider recalculating your reorder points, setting a higher safety stock threshold or rethinking your inventory forecasting process.
Advantages of Backorders
Positive reasons to offer backorders include increasing sales and adding some flexibility for small businesses.
Other advantages include:
- Offers market insights: Backorders act like customer surveys, indicating what kinds of products buyers want, and when they’re in the highest demand.
- Improved cash flow: Companies that avoid holding excess stock, with the associated costs, free up cash for other priorities. In some industries, less inventory also translates to reduced taxes.
- Minimizing storage and other inventory costs that come with holding extra stock.
Disadvantages of Backorders
Backorders do have some significant downsides that can cost your company. These include:
- Losing out on business: Customers may not want to wait, or trust the company to fulfill their orders, causing them to cancel and purchase elsewhere.
- Loss of market share: If customers frequently encounter backorders or must wait a long time for fulfillment, their loyalty to your brand may wane, and they could turn to other brands.
- Increased complexity: Backorders increase the chances of a company having to resolve customer service issues, such as trying to update expired payment information.
Finally, a major pros/cons pivot point for backorders is inventory carrying costs. A company that sells mainly inexpensive, small, non-trendy items may not worry as much about obsolescence, space or tying up capital and thus can keep more stock versus, say, a company that sells large appliances.
Best Practices for Backorders
Some backorders are unavoidable, but it’s a best practice to minimize them and thus limit the chances of a bullwhip effect negatively affecting your supply chain, as well as other challenges like disappointed customers, longer fulfillment intervals and added back-end complexity.
Gather as many of a customer’s backordered items as possible before notification, shipping or billing.
Set a time limit on how long backorders will be kept open and active. What that timespan is depends on the business, but 30 days is average.
Make every attempt to acquire the backordered items within that timespan, even if it means a higher cost of goods and/or manual processes.
Notify the customer promptly if an item can’t be shipped within the time limit, and make an entry in your CRM to email if the item does become available in the future.
Other best practices you can implement:
Communicate with your supply chain partners — open lines with both upstream and downstream partners means fewer assumptions and fewer chances of overestimating or underestimating demand.
Educate employees on the downsides of backorders and the need to go the extra mile in terms of customer service.
Five Tips to Minimize Backorders
Minimizing backorders is doable if you use the right combination of business processes and technology. Steps you can take:
1. Know what your customers want — and need: By prioritizing inventory items by importance to customers, you can be selective about increasing safety stock. For example, a restaurant owner will be less understanding about potatoes being backordered versus an exotic fruit. And since the cost of carrying plenty of spuds is low, there’s little reason to ever be out. On the other hand, if your largest customer’s most popular dish requires an expensive and hard-to-find ingredient, and too many backorders will cause it to seek another supplier, you’ll want to have a dependable supply chain.
2. Look for real-time data and reporting: Ensuring that data is accurate and reported in near-real-time ensures two things: That your warehouse will be notified to restock items in a timely manner, lowering the chances of delays in purchasing that lead to backorders. And that customers can be notified promptly — ideally at time of purchase — that an item is backordered, so they can choose whether to keep it in their carts.
3. Set system triggers: These can range from simple alerts when stock is low all the way to automated alerts to customers on the status of their orders or to let them know that a new shipment of a frequently purchased item has arrived.
4. Develop backup or contingency plans: When an item is backordered, smart sellers do whatever it takes not to disappoint valued customers. This includes sourcing local suppliers or even purchasing the item elsewhere at retail.
5. Diversify suppliers: Manufacturers or suppliers can also hit peak demand, planned or unplanned. Ordering from a wide variety of sources is just good supply chain management, which begins with timely purchase orders and cycles through performance tracking, including productivity, costs, fill rates, on-time delivery and customer satisfaction.
Customer Service & Backorders
Keeping customers happy during backorder situations is key to keeping them coming back.
They’ll expect to receive timely updates and be kept in the loop about delays or changes. Being proactive with communications will maintain your company’s reputation. Specific action steps include sending out emails regularly, providing an estimated arrival time and updating customers on any events that may accelerate or delay their shipment.
If you collected a deposit or full payment and the customer cancels, process the refund promptly.
Track Stock and Manage Backorders With NetSuite
ERP software can help your company automate much of the automate much of the supply chain and inventory management process and manage backorders. More specifically, it can help with demand planning, using historical data to plan your inventory around meeting customer demand and special events like sales or promotions.
Using software can help you create a sustainable roadmap for your fulfillment process, from ordering products to receiving and shipping them. It can even help you automatically place purchase orders with your suppliers, decreasing backorder times.
Q: How long is a backorder?
A: The length of time for backorders will vary depending on factors such as whether they are in stock with your distributor or supplier, when you order the items and the time it takes to ship the order to your warehouse. The critical thing to remember is that you need to clearly communicate to customers when they can expect to receive their purchases.
Q: Why do backorders occur?
A: Backorders generally happen when demand exceeds supply, whether that’s due to a successful marketing campaign or seasonal trends. They could also occur when there is a disruption in the supply chain due to unforeseen circumstances such as extreme weather, challenges with transportation, political upheavals, a shortage of raw materials or a supplier going out of business.