What are backorders and how should your business handle them?

Backordering is the process of selling inventory you don’t have in stock. Rather than turning customers away, backorders allow shoppers to purchase the item they want and receive it once the business restocks.

Making sales without sufficient stock isn’t ideal. However, backorders can help businesses navigate unexpected surges and shortages without losing customers—if the process is managed correctly.

Coming up, we’ll explore common causes of backorders, how to prevent them, and how to handle them like a pro.

What does backordered mean?

Backorders represent any amount of stock a business has sold but is unable to ship. This is also known as a company’s “backlog.” When a customer places a purchase order, they pay in advance and receive the shipment as soon as inventory is replenished. Think of it as an inverted IOU agreement.

Backorders are most common among product-based businesses, especially e-commerce retailers, but they can also be utilized in manufacturing, wholesaler, and distribution businesses. Backordering is undoubtedly a better alternative than losing a customer to a competitor via a stockout. But if inventory is consistently backordered, it’s a strong indicator that the company’s demand outweighs its supply and lacks a proper amount of safety stock.

What is backordering in materials management?

Materials management ensures that the flow of materials in a company aligns with consumer demands—this includes planning, organizing, and controlling. Materials management can get complicated if your inventory can’t match customers’ needs. In this case, you can take advantage of backordering.

This allows you to continue selling materials during a demand surge, even if you don’t have the inventory on hand. In such cases, backordering (rather than listing materials as “out of stock”) is vital to sustaining business operations.

Backorder vs. out of stock: What’s the difference?

These two terms are confused for each other, but there’s a critical distinction.

When a SKU is out of stock, there isn’t a scheduled date for restocking, and customers can’t order it. On the other hand, backordered products have a restock date so customers can get them eventually, even if it takes a while.

It’s the difference between “This product is unavailable” and “This item won’t ship until three weeks from now.”

Three causes of backorders

Some backorders are the result of faulty inventory management, but others are out of your control. Here are three common culprits:

1. Demand surges

Sudden spikes in demand can overwhelm your supply chain, leading to backordered items. For example, if your product makes it onto a “best-of” list in a popular publication or an influencer recommends it unexpectedly, you might find yourself with more orders than you can handle.

High demand can be especially problematic for businesses that use the just-in-time inventory management method. Since you only receive materials when they’re necessary for production—not before—you’re vulnerable to demand fluctuations.

2. Low safety stock

Safety stock is inventory that a business holds to mitigate the risk of shortages or stockouts. Keeping extra stock increases inventory carrying costs, but having too little inventory can result in backorders. Forecasting demand for products is helpful for inventory control, but safety stock is like having insurance if those forecasts are wrong.

3. Problems with suppliers and distributors

Let’s say you’re a clothing manufacturer. You’re predicting a busy holiday season, but the supplier for your raw materials is experiencing seasonal delays. Delays such as this can force you to backorder your finished goods until you get back in sync with your supplier.

Now that you know why backorders occur, let’s look at some ways to minimize them.

4. The bullwhip effect

The bullwhip effect (also called the Forrester effect) is a supply chain phenomenon in which demand fluctuation causes progressively bigger demand fluctuations at the wholesale, distributor, and manufacturer levels.

For example, let’s say a retailer normally sells ten units of a product. One day, the product goes viral and sells 200 units. In response, the retailer orders 500 extra units to stay ahead of the curve. Now, the businesses responsible for making or distributing the materials to make the product can’t keep up.

The bullwhip effect can cause an uptick in backorders, frustrated customers, and unreliable inventory forecasts.

How to calculate backorder rate

Backorder rate refers to the number of orders that cannot be filled when a customer places them. To calculate your backorder rate, simply divide the number of backorders by the total number of orders and multiply the result by 100 to see your answer as a percentage.

Let’s say a company had to backorder 17 out of 250 orders during one month. Their backorder rate would look like this:

(17 backorders) / (250 total orders) = 0.068

0.068 x 100 = 6.8% backorder rate 

Backorder rate is an important supply chain KPI because it indicates how well your inventory management practices are aligned with customer demand. Generally speaking, you should aim to keep your backorder rate as low as possible.

Now that you know how to measure backorders let’s look at ways to minimize them.

Four ways your business can prevent backorders

Sometimes, external forces can make backorders inevitable. But with the right tools and proper planning, you can stay ahead of the curve and keep your customer base happy.

1. Keep safety stock

Holding extra stock gives you emergency padding for unexpected supply chain disruptions. You can calculate exactly how much safety stock you need with the following formula:

(Max. Daily Usage x Maximum Lead Time) – (Average Daily Usage x Average Lead Time)

2. Establish reorder points for all products

Instead of relying on guesswork or hand-counting, reorder points tell you exactly when it’s time to restock products to maximize your carrying costs. Inventory management software like QuickBooks Enterprise alerts you when stock is running low and even lets you prioritize ordering products you need the most.

3. Closely monitor inventory levels

Conducting consistent inventory analyses keeps your supply chain running smoothly and increases efficiencies over time. With QuickBooks Enterprise, you can monitor stock levels in real-time, auto-generate reports, and ensure the proper inventory is in the right place at the right time.

4. Have backup suppliers

If a vendor can’t send your materials on time, having a backup supplier can minimize your risk of backorders.

5. Try cross-docking

For online retailers facing difficulty keeping products in stock, cross-docking can help you ship orders faster and more efficiently. Cross-docking is the act of transferring goods directly from a supplier to an outgoing order without putting the stock away.

If your backlog is growing, this time-saving technique can improve turnaround time, cut down on last-mile carrier costs, and get customers their orders faster.

How to manage backorders without losing customers

Imagine this: sales are booming and inventory is flying off the shelves. At first, it’s a dream come true, but soon you’ve emptied your warehouse, and there’s no more safety stock to fall back on.

Now what?

You can stop selling, which drives disappointed customers into the arms of your competitors—or you can accept backorders. Assuming you opt for the latter, here are three tips for salvaging those customers, even if you don’t have the inventory on hand.

1. Communication is key

Put yourself in the shopper’s shoes: if an item is backordered, you’d want a shipping date (or at least an estimate) and notifications if the product will arrive behind or ahead of schedule. You also wouldn’t want to make it to the checkout page before learning the item is backordered. Being proactive can help your reputation—and your bottom line.

2. Collect email addresses to stay in touch

If a shopper isn’t in a huge hurry, they might want to be notified when the product is no longer backordered. This is a crucial opportunity to capture their contact info and follow up when you’re restocked and ready to sell.

3. Create a product page for backorders

A separate backorder catalog for your online store can simplify the shopping experience and helps manage expectations. Rather than being caught off guard when certain items are backordered, shoppers can easily distinguish which products they can get right now and which ones will require a wait.

Final thoughts

In today’s get-it-now culture, customers expect their items to ship faster and more accurately than ever. As supply chains are pushed to the limit, backorders can keep cash flow steady for retailers.

Even Apple, one of the most beloved brands on the planet, deals with backorders. In 2017, the iPhone X sold out of its initial supply, and customers had to wait roughly six weeks to get the new smartphone. The key to success, of course, is clear, proactive communication.

You might not be able to prevent backorders permanently, but an end-to-end inventory management system can give you an edge over your competition.