Backordering in Materials Management refers to accepting customer orders for products you do not have in inventory and triggering the necessary materials management processes to acquire the raw material and components needed to manufacture these products.
When is backordering needed?
Think of this …
What’ll you do if you receive an order for a product you don’t have in stock?
Maybe your suppliers haven’t delivered on time. Or your manufacturing unit is behind schedule. Or the product is a runaway hit and is just flying off the shelves faster than you ever imagined.
Of course, you’ll do everything possible to make sure that you are never understocked (or overstocked, for that matter) but as you know, it can happen.
Then what? What do you do?
Do you accept new orders for the product that you don’t (yet) have in stock?
Or do you stop selling it altogether and risk losing customers to a competitor?
It’s in this scenario that backordering comes into the picture.
Let’s take a closer look at it.
- What is Backordering?
- How are Backordering and Materials Management connected?
- What causes backordering
- Benefits of backordering
- Risks involved in backordering
- Key Takeaways
What is Backordering?
Backordering is the process of accepting a sales order for a product that you currently do not have in stock.
Let’s say that you have an eCommerce store on Shopify, and you sell aromatic candles. You suddenly receive a large order for a particular type or candle and on fulfilling this order, you’re out of stock for that product.
Yet, instead of stopping accepting further orders for this product, you continue making it available in your store and you actively take new orders for it. This is Backordering.
And the sales order which you accept, for the product that you do not have in inventory, is referred to as a Backorder.
A Backorder will typically trigger a request to your supplier to send you additional stock of the sold-out product or if you manufacture in-house, it will launch the manufacturing process for the product.
It is in this latter scenario, where you manufacture the product in-house, that the link between Backordering and Materials Management becomes relevant.
How are Backordering and Materials Management connected?
Materials Management is a set of supply chain processes that involve the procurement, transportation, storage and utilization of materials needed in a manufacturing process.
So, in Materials Management we manage the flow of materials across the end-to-end value chain of a business – from the supplier to the warehouse to the factory to the physical or online store to the shipping company and finally to the customer.
So how are Backordering and Materials Management connected?
If you have a backorder, it means you have a customer sales order for a product you do not have in inventory. So, you need to either manufacture it or get it manufactured from someone else (eg you could outsource the manufacturing to an OEM or ODM).
To some degree, this can be seen as a failure of Materials Management for not having anticipated the need for materials to manufacture more products.
At the very least, Materials Management will be responsible for acquiring the necessary materials to make additional products so that you can fulfill your backorders.
What causes Backordering
Backordering can be a part of a deliberate strategy where you acquire products or manufacture only after receiving a customer order.
If you have reliable suppliers who can ship quickly on receiving your purchase order or if you have a manufacturing unit that can churn out a product fast enough once the customer order comes in and, most of all, if you have customers who are willing to wait for a while before receiving their product, then backordering can be a very good strategy with many benefits. We’ll cover these benefits later in the article.
But most companies prefer to keep sufficient products in inventory to always meet customer demand and never take the risk of running out of product. In fact, this principle is one of the key objectives of inventory management in most companies.
This means that when backordering happens, it is almost always not be design but a symptom of a problem.
The key unplanned causes of backordering are listed below.
Unexpected sales spike
A classic reason to go out-of-stock is to have an unexpected sales spike for a product so that the demand for the product outstrips the supply.
This can happen during the holiday season when a hot product suddenly exceeds your expectations and flies off the shelves.
Unexpected sales spikes can also occur in extreme weather – electric heaters can sell out in extreme cold weather; snow shovels can sell out just before snowstorms and portable fans can sell out just before a heatwave.
Tangentially linked to unexpected spikes in sales, is poor forecasting. The key objective of sales forecasting is to predict sales with sufficient accuracy to allow the organization to build or acquire enough products and to serve customer demand.
Poor demand forecasting can lead to excess inventory or running out of inventory. The latter can force you to accept backorders to not lose the customer to a competitor.
The transport of goods, especially long-distance transport, carries with it the risk of disruption to the supply chain.
Delays due to inclement weather, accidents, border closures, customs/immigration problems and strikes can easily cause delivery schedules to slip and customers’ orders to go unfulfilled on time.
In the meantime, if you continue to sell products which still in transit and so not yet in your possession, you’re accepting backorders.
Manufacturing Problems at the Supplier
A common cause for backorders is the delay in receiving parts, components or finished products from your suppliers.
The supplier could have genuine manufacturing problems.
Or they could have underestimated the time needed to fulfill your order.
Or they could have promised the same order to multiple clients just like you.
Either manufacturing and/or delivery problems at your supplier will in turn force you to accept backorders from your own customers.
Benefits of Backordering
As you’ve seen in the previous section, Backordering, when done as a deliberate strategy, can deliver many benefits. Here are some of them.
- Customize products for each customer
If you only order a product from your supplier or manufacture a product after receiving an order from a customer, you could consider customizing or personalizing that order.
Customization or personalization is a sure way to get higher customer satisfaction and repeat business.
- Higher revenue potential per product
If each order can be custom-made or some unique touch can be added, you can charge more for the product.
Let’s say you sell handmade ceramic coffee mugs which you make in your small factory. You could offer a premium service to put the customer’s photograph on the mug. Surely, you can charge more for each product sold.
- Reduce wastage
If you’re only building products to order, you only need to purchase enough raw material to fulfil the orders in hand. This will less wastage especially if any of the components or raw materials you need have a short lifespan.
- Lower storage requirements
Naturally, if you’re purchasing only as much raw material as you need for the orders you have in hand, you’re going to need less storage space.
- Improve cash flows
Backordering can improve your cash flows in two ways:
Your customer places the order first and probably pays upfront. So, you collect cash right away.
You then place an order with your supplier for the raw materials. But if you have payment terms of Net 30 or Net 60 in place, you don’t have to pay your supplier right away.
And now you get to keep the cash in your business for longer.
Risks involved in Backordering
- Unfulfilled customer orders
The biggest risk with backordering is not being able to fulfil the customer’s order. Worse, if you’ve collected payment, you’ll have to give it back and end up with an unhappy customer.
- Risk of losing customers
If you cannot fulfil a backorder and if the customer’s purchase was linked to an event – the holidays, a birthday, an anniversary, etc – chances are the customer’s going to go to your competitor who may have that product in stock.
The big risk here is that you could lose that customer to your competitor forever.
- Damage to brand image
Needless to say, if you have to pay back a customer because you couldn’t deliver a product as promised, your brand is going to take a hit. If it happens too often, your brand may never recover.
- Difficulty scaling
The benefit of carrying inventory is that you can sell products faster than you can acquire or manufacture them. You can scale your business by scaling inventory.
With backordering, however, since you only manufacture or acquire products after receiving an order, you’ll have difficulty scaling because now you will need to scale manufacturing on demand (very difficult) or scale the acquisition of a product from a supplier (also difficult).
- Backordering refers to accepting an order which you cannot immediately fulfil because you do not hold the ordered product in your inventory.
- Backordering in materials management involves triggered the appropriate materials management processes to order the raw materials needed to manufacture the out-of-stock products.
- Unplanned backordering can be caused by:
- unexpected sales spikes,
- poor forecasting,
- transportation/logistics problems or
- delivery problems with suppliers.
- Planned backordering can provide many benefits:
- Customization/Personalization of products
- Higher revenue potential for each product
- Reduction of wastage
- Lower storage requirements
- Improved cash flows
- Backordering (planned or unplanned) comes with risks. Customer orders can go unfulfilled which can mean lost customers, a damaged brand and cash flow constraints. Further, backordering can limit your ability to scale your business.
Conclusion: Backordering is a double-edged sword. If executed well, it can bring big benefits. But if it is forced upon you because of poor planning, it could really hurt your business.