What are Backorder Costs

Backorder costs include cost incurred by a business when it is unable to fill an order and must complete it later. A backorder cost can be discrete, as in the cost to replace a specific piece of inventory, or implicit, such as the effects of poor customer service. Backorder costs are usually computed and displayed on a per-unit basis.

BREAKING DOWN Backorder Costs

Backorder costs are important for companies to track, as the relationship between holding costs of inventory and backorder costs will determine whether a company should over- or under-produce. If the carrying cost of inventory is less than backorder costs (this is true in most cases), the company should over-produce and keep an inventory.

The idea of backorder arises when a potential customer tries to place an order for a product, but the order cannot be fulfilled because the merchant doesn't have the product available for sale at that particular point in time. In this instance, the customer is usually told the product is "back ordered." Here, the customer may decide to pay and wait for the new product, or the customer could simply take their business to a competitor with the product on hand.

The unseen, implicit cost to backorders can be material. Customer service professionals can model these relationships under the rubric: customer experience. As an emerging field, customer experience is shedding light on new ways to meet customer demands in goods and services fields.

The combination of online retailing and real-time inventory management systems have greatly reduced the issue of backorder costs. Because online systems can rapidly source product, there's no real need to alert a customer that product is technically not on-site. In a sense, backorder costs is an issue for traditional bricks-and-mortar businesses, who may not be able to buy additional time to find a new product. Even then, most retailers have a process in place to save a sale. For instance, if a customer tries to buy an item at Walmart but the product is unavailable, it's not uncommon for Walmart to ship the product to the customer's front door in a couple of business days.