Are backorders sabotaging your bottom line?

Backorders are often the bane of every inventory manager’s existence. It is a constant battle to manage the inventory flow to meet product demand. Effective inventory management is finding the delicate balance between backorders and overstocks that maximizes service and minimizes costs. Backorders are often preferred to overstocks because the associated costs are relatively invisible. They erode profits and growth by increasing operating expense and customer attrition.

Evaluating backorder costs allows accurate assessment of risk during the purchasing decision process. They include:

Shipping: Multi-line orders that include backordered items increase the shipping costs by requiring multiple shipments. To calculate the cost: (percentage of backorders)*(percentage of multi-line orders)*(annual sales)*(freight +packaging+labor).

Cancellations/lost sales: Most systems allow the tracking of cancellations. Lost sales are orders that are never placed and are much harder to track so they may have to be estimated. Be sure to check your abandoned carts and determine what percentage of them has out of stock items on it.

Returns: Sometimes items will be returned if accessories or coordinating pieces are backordered. The cost of processing these returns must be included with the backordered item.

Future Value: Every backorder has a negative impact on service and decreases the future value of a customer. This is magnified for consumable products. Presume a product will be consumed in eight weeks. If it is backordered for two weeks, then 25% of the next sale has been lost. Furthermore, the customer may have found a substitute product equally satisfying. This would cost the entire future value of that customer.

Make sure that your out of stock information is well defined and consistent on your web site. It will help reduce cancellations and expenses. For example, I recently placed an order for a clearance item on a well established company's web site. The item I ordered was listed as out of stock. The email promotion that drove me to the site stated that limited quantities were available and there would be no backorders. The out of stock information did not appear until I reached the final checkout view. So I went back and ordered a different color. When I returned to the final checkout, it showed the out of stock with 0.00 for the price and the new item as available. I completed the process and received my confirmation with both the out of stock item and the new item with $$ in the total. I called the company and discovered that the out of stock item was actually a backorder and would be shipped. I cancelled the substitute item and ended up a satisfied customer. But the company incurred the cost of my call because their information was inconsistent.

High demand items are the most likely to be backordered and have the lowest customer tolerance. Start with a focus on these items, expand to lower demand items, and watch the profits and sales increase!

Next Steps:

Read How to Improve Inventory Management

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