Backorders

What Is Backorders?

A backorder occurs when a customer places an order for a product that is currently out of stock but which the company fully expects to fulfill once new inventory becomes available. In essence, it represents an unfulfilled customer order that is pending receipt of goods from a supplier or production. This situation is a common occurrence within Supply Chain Management, highlighting the intricate balance between Demand Forecasting and available Inventory Management. While backorders indicate a temporary stockout, they differ from lost sales, as the customer has committed to the purchase and is willing to wait. Businesses strategically use backorders to capture sales, even when facing temporary shortages, thereby avoiding a complete loss of revenue.

History and Origin

The concept of managing unfulfilled orders, which is what backorders represent, is intrinsically linked to the evolution of commerce and Logistics. Early forms of trade, dating back thousands of years to ancient trade routes like the Silk Road, relied on rudimentary methods for tracking goods and managing discrepancies between what was promised and what was immediately available. As the Industrial Revolution spurred mass production and more complex distribution networks, the need for systematic ways to handle delayed or future deliveries became apparent¹¹. The formalization of processes surrounding Supply Chain and inventory control gained significant traction in the 20th century, particularly with the advancements in transportation and the application of industrial engineering principles. The modern understanding of "supply chain management" as an integrated business strategy emerged in the 1980s, influenced by the advent of information technology and enterprise resource planning (ERP) systems, which allowed businesses to better track procurement, production, and distribution⁹, ¹⁰. Within this structured environment, backorders became a defined status, allowing companies to manage customer expectations and future production commitments more systematically.

Key Takeaways

• Backorders represent customer orders for products that are temporarily unavailable but are expected to be fulfilled in the future.
• They allow businesses to retain sales and avoid losing customers, even when facing temporary inventory shortages.
• Effective management of backorders is crucial for maintaining Customer Satisfaction and loyalty.
• High volumes of backorders can strain Cash Flow and increase operational costs.
• Backorders often reflect strong product demand, but also highlight potential inefficiencies or unexpected disruptions in the supply chain.

Interpreting Backorders

Interpreting backorders involves assessing their volume, duration, and the underlying reasons for their occurrence. A low number of backorders might suggest effective Inventory Management and sufficient stock levels, or conversely, a lack of demand. However, a growing number of backorders can signal strong product demand or a mismatch between supply and demand. For businesses, a manageable level of backorders can be a positive indicator of popular products, demonstrating that customers are willing to wait. Conversely, a consistently high volume of backorders or long Lead Time for fulfillment often points to issues such as inadequate Demand Forecasting, production bottlenecks, or supply chain disruptions. Monitoring backorder trends can provide valuable insights into market demand and the health of a company's production and distribution capabilities.

Hypothetical Example

Consider "TechGear Inc.," a company that sells high-end noise-canceling headphones. TechGear launches a new model, the "SoundBarrier X," which receives unexpectedly high demand following rave reviews. Their initial production run of 10,000 units sells out within a week.

Despite being out of physical stock, TechGear decides to allow customers to place orders for the SoundBarrier X as backorders, estimating a two-week delay for the next shipment. On Monday, 5,000 customers place backorders, committing to wait for the headphones. This means TechGear has successfully captured $1,500,000 in sales (5,000 units x $300/unit) that would otherwise have been lost if they simply marked the item as "sold out." The company immediately communicates the estimated two-week Order Fulfillment timeline to these customers. By allowing backorders, TechGear Inc. not only retains these sales but also gains clearer insight into the sustained demand, which can inform future production planning and Working Capital needs.

Practical Applications

Backorders are a critical metric in various sectors, particularly in Manufacturing and Retail. They provide insights into market demand, production capacity, and supply chain efficiency. For economists and analysts, aggregate backorder data can serve as an important leading Economic Indicators. For instance, the U.S. Census Bureau's Manufacturers' Shipments, Inventories, and Orders (M3) survey regularly collects data on "unfilled orders" (synonymous with backlogs or backorders) to gauge the health of the domestic manufacturing sector⁸.

A prominent real-world example of backorders impacting multiple industries was the global semiconductor chip shortage that began around 2020. This shortage led to widespread backorders for products ranging from automobiles and consumer electronics to home appliances. Manufacturers across various sectors had to contend with significant delays in receiving critical components, resulting in prolonged delivery times for end consumers⁶, ⁷. For example, the National Association of Manufacturers (NAM) reported that this shortage caused some backordered products to have delivery dates up to a year away, highlighting the ripple effect through global supply chains⁵. Businesses used backorders to manage customer expectations and keep sales channels open despite the severe supply constraints.

Limitations and Criticisms

While backorders can help retain sales, they are not without drawbacks. A primary criticism is their potential to lead to significant Customer Dissatisfaction. Customers expect timely delivery, and delays due to backorders can result in frustration, negative reviews, and a decrease in customer loyalty⁴. Research suggests that, on average, a backorder delay can decrease customer orders by 2.1% in the subsequent year, with even greater reductions for longer delays³.

From an operational standpoint, managing a high volume of backorders can increase costs. Businesses may incur additional expenses for rush production, overtime, expedited shipping, and increased administrative efforts to track and communicate with customers about delayed orders². Backorders can also strain Cash Flow as revenue recognition is delayed until the product ships. Furthermore, they can complicate Inventory Management, potentially leading to excess inventory if companies overcorrect in subsequent production runs to avoid future shortages, a phenomenon sometimes associated with the "bullwhip effect" in supply chains¹. Effective Risk Management is crucial to mitigate these negative impacts and ensure backorders do not erode profitability or long-term customer relationships.

Backorders vs. Out of Stock

While often used interchangeably by consumers, "backorders" and "Out of Stock" have distinct meanings in business operations.

• Out of Stock: This term simply means that a product is currently unavailable for immediate purchase or shipment. When an item is "out of stock," a customer might not be able to place an order at all, or the system might indicate that the item is unavailable with no clear indication of when it will return. The business may not have committed to future supply, or the item might be discontinued.
• Backorder: This specifically refers to an item that is currently out of stock, but for which a customer has already placed an order with the expectation that it will be fulfilled once new inventory arrives. The company has a firm commitment to deliver the product, and the customer has committed to waiting. Backorders are typically associated with items that are still actively being produced or replenished.

The key difference lies in the order status: "out of stock" describes a product's current inventory state, while "backorder" describes the status of a specific customer's order for an item that is currently out of stock but will be supplied. A business might choose to allow backorders when an item is out of stock to preserve sales and gauge future demand, or they might simply show the item as unavailable.

FAQs

Why do businesses allow backorders?

Businesses allow backorders to capture sales that would otherwise be lost if a product were simply marked "out of stock." This approach helps maintain Profit Margins, provides a clear picture of ongoing customer demand, and can prevent customers from switching to competitors.

How do backorders affect a company's financial health?

While backorders retain sales, they can negatively impact a company's Cash Flow since payment for the goods may be delayed until fulfillment. Additionally, higher administrative costs, rush production expenses, and expedited shipping fees associated with backorder fulfillment can reduce Profit Margins.

Can backorders be a good thing for a business?

Yes, backorders can be a positive indicator of strong product demand and customer willingness to wait for a specific item. A manageable number of backorders can signal successful marketing or a highly desired product, allowing businesses to gauge market interest and adjust Production Planning accordingly.

What causes backorders?

Backorders typically arise from a mismatch between supply and demand. Common causes include unexpectedly high customer demand, Supply Chain disruptions (such as raw material shortages or transportation delays), production bottlenecks, inaccurate Demand Forecasting, or issues with supplier reliability.