The Monthly Metric: Back-Order Rate
Since the coronavirus pandemic engulfed the globe, procurement and supply chain operations have, in many ways, resembled a customer at a retail store looking at an empty shelf and inquiring if more product is in the back.
In this scenario, “back” represents backlogs and back orders. Both have spiked due to COVID-19, as product shortages and lengthening lead times mean more customers are waiting longer for orders. In recent months, two ISM® Report On Business® Backlog of Orders indexes achieved all-time highs: Manufacturing hit 70.6 percent in May, and Services reached 65.8 percent in June. (A reading above 50 percent indicates backlogs are growing; a lower number means they are declining.)
That’s not necessarily a bad thing: A backlog is the orders a company has received that have not shipped. When a customer’s shipping request date is missed — turning that backlog order into a back order — the situation becomes more problematic. The ideal back-order rate is zero, but few companies, even pre-pandemic, had supply chains that efficient.
A high back-order rate can result in slowing production, partial orders, missed revenue targets and, most importantly, disgruntled customers. “The consequences of back orders aren’t just increased costs or lower sales; they can damage your customer relationship,” Curt Barry, then-president of Richmond, Virginia-based operations and fulfillment consultancy F. Curtis Barry & Company, wrote in 2015. “Customers may overlook one back ordered item, but they will likely find other storefronts to shop or someone else’s similar product rather than wait for something from you again.”
Meaning of the Metric
Institute for Supply Management®’s ISM Glossary of Key Supply Management Terms defines back order as “items ordered but not shipped due to a stockout or some other reason. This is widely used as a measure of supplier performance and customer service,” for example, back-order rate and number of back-order days.
The back-order rate calculation is a simple fraction — the number of back orders as the numerator and total orders as the denominator — and fits on an inventory metrics dashboard that has become increasingly critical during the pandemic.
There are situations where back orders are an acceptable risk. Some customers will be patient with companies that have a good track record, especially for products that are in high demand. “You’re never going to totally eliminate back orders, nor should you try to because of the high inventory levels required,” Barry wrote. “Many types of businesses, especially B2B companies that can reorder often in a shorter period of time, get considerably higher initial order fill rates and have only a fraction of the back orders compared to B2C operations.”
High back-order rates can cause strains throughout a supply chain and are among the causes of the bullwhip effect. In the COVID-19 era, backlogs and back orders increased as many companies lacked the production and inventory capacity to respond to pent-up consumer demand as the economy regained steam. The winter storms in Texas and the Suez Canal blockage were among disruptions that further complicated matters.
Statistics and Strategies
According to research by F. Curtis Barry & Company, each back-order fulfillment can cost US$15 to $20, and the total expense is even greater if a partial order was already sent.
“Additionally, you lose any potential for shipping revenue that you may have earned,” F. Curtis Barry & Company president Brian Barry wrote on the consultancy’s blog. “Back-ordered items often have a higher return rate. There are additional costs for expediting or airfreighting back-ordered product, upgrading customer outbound shipments … to get the back orders there faster, and for inventory control personnel spending significant time expediting product.”
Strategies to limit back-order rate include (1) improving demand forecast accuracy, (2) identify reasons for stock outs and determine proper safety-stock levels, (3) communicating with suppliers on delivery schedules and how back orders impact the network, and (4) consider such options as third-party or consignment inventory.
Limiting back orders is important to McKinney, Texas-based Encore Wire Corporation, which just built a 720,000-square foot logistics service facility to help improve inventory performance. In a July earnings call, president and CEO Daniel L. Jones said that back orders have not been an issue: “(A) 100-percent order fill is a fantastic number and cures a lot of ills for us as a company — specifically, when you don’t want to have customers waiting or looking or calling or checking on back orders. We really, really don’t care for back orders.”
The recently opened facility, Jones added, is part of a production and distribution playbook that includes updated equipment and robust supplier relationships. “There have been a few hits and misses from a supply chain standpoint on some of the equipment and auxiliary equipment,” he said. “But for the most part, we’ve got fantastic vendors and great partners, and they’re doing what they can to take care of us.”
Cost savings is a perpetual mission for supply managers, and the pandemic has put a premium on customer service. Both objectives are hindered by a high back-order rate, making reducing it a crucial part of a company’s inventory-management plan.
To suggest a metric to be covered, email me at firstname.lastname@example.org.