What Is a Backorder?
A backorder is a retailer's request to a supplier or wholesaler for additional stock of a sold-out item to satisfy an outstanding customer order.
Analysts closely watch the number of pending backorders that a retailer has. It may be an indication of a runaway bestseller. On the other hand, it may suggest poor inventory management.
Understanding the Backorder
In the retail business, a large number of backorders indicates that customer demand for a product or service exceeds a company's capacity to supply it. Total backorders, also known as backlog, may be expressed in terms of units or total dollar value.
A retailer can only estimate the number of items needed in inventory to satisfy customer demand. If demand exceeds supply, a retailer reorders the product, individually or in bulk, to satisfy backorders and to restock store shelves. The retailer typically offers to ship the goods to customers when backorders are fulfilled.
In the worst case scenario, the product is not immediately available at the source. The manufacturer may lack the raw materials needed to step up production. The supplier must wait until the manufacturer can produce the goods. In such cases, the supplier has submitted backorders to the manufacturer to fulfill a retailer's backorders from customers.
When Backorders Pile Up
Analysts monitor how well a company manages its inventory by measuring its backorders. A company with too many backorders may force its customers to go to competitors, leading to a loss of market share and lower than anticipated revenues for the company.
The costs of fulfilling backorders must be balanced against the costs of maintaining a high level of inventory.
Including the intangible costs associated with lost customers and sales, a company with a large number of backorders may also face an increase in tangible costs. The company may have to pay a premium to get the delivery on time and may have to take on the additional cost of shipping the goods to its customers. The company may have to pay employees overtime to deal with the backorders as they come in.
The Just-in-Time Strategy
The added costs involved in fulfilling backorders is balanced against the added costs of storing plentiful inventory. For a company that uses the just-in-time (JIT) inventory management approach, backorders are normal. Such businesses only order inventory as it is required.
However, these companies and many others experience an increase in backorders during the holiday period or when they have a product that is unexpectedly in high demand.
Companies have to walk a fine line in managing their backorders. High levels of backorders indicate strong customer demand. On the other hand, there is a risk that customers who can't get what they want immediately will shop elsewhere. This is less of a risk for innovative products with strong brand recognition in areas such as technology. The person who wants the latest iPhone is not going to go elsewhere and buy a Samsung.
- A large number of backorders indicates an unexpectedly high level of demand for a product.
- To analysts, a retailer with too many backorders may be showing a poor grasp of inventory management.
- Backorders tend to pile up in the holiday season.
- The risk is that customers offered a backorder may opt to shop elsewhere.
Manufacturers also have an incentive to keep an eye on backorders, since large numbers signal high demand for a product. Unfortunately, backorder numbers are something of a lagging indicator for manufacturers. It tells them only that they underestimated demand in the first place, and it may be too late to correct the problem.