Backorders are the bane of many an inventory manager’s existence. Effective inventory management is finding the delicate balance between backorders and overstocks that maximizes service and minimizes costs. Backorders are often preferred to overstocks because the associated costs are relatively invisible. Nonetheless, backorders have their costs. They erode profits and growth by increasing operating expense and customer attrition.
Evaluating backorder costs allows accurate assessment of risk during the purchasing decision process. The costs include
shipping. Multiline orders that include backordered items increase the shipping costs by requiring multiple shipments. Here’s a formula to calculate the cost: percentage of backorders x percentage of multiline orders x annual sales x (freight + packaging + labor)
cancellations/lost sales. Most systems allow the tracking of cancellations. Lost sales are orders that are never placed and are much harder to track, so you may have to estimate them. Be sure to determine the percentage of your abandoned online shopping carts that have out-of-stock items in them.
returns. Sometimes items will be returned if accessories or coordinating pieces are backordered. You must include the cost of processing these returns with the backordered item.
future value. Every backorder has a negative impact on service and decreases the future value of a customer. This is magnified for consumable products. Presume a product will be consumed in eight weeks. If it is backordered for two weeks, then 25% of the next sale has been lost. Furthermore, the customer may have found a substitute product equally satisfying. This would cost the entire future value of that customer.
Make sure that your out-of-stock information is well defined and consistent on your Website. It will help reduce cancellations and expenses. For example, I recently placed an order for a clearance item on a well-established company’s site. The item I ordered was listed as out of stock. The e-mail promotion that drove me to the site stated that limited quantities were available and there would be no backorders. The out-of-stock information did not appear until I reached the final checkout view. So I went back and ordered a different color. When I returned to the final checkout, it showed the out-of-stock with 0.00 for the price and the new item as available. I completed the process and received my confirmation—which showed me being charged for both items. I called the company and discovered that the out-of-stock item was actually a backorder and would be shipped. I cancelled the substitute item and ended up a satisfied customer. But the company incurred the cost of my call because its information was inconsistent.
High-demand items are the most likely to be backordered and have the lowest customer tolerance. Start with a focus on these items, expand to lower-demand items, and watch the profits and sales increase!
Debra Ellis is president of Barnardsville, NC-based operations consultancy Wilson & Ellis Consulting. She is also one of the faculty of MCM Live, a two-day event from MULTICHANNEL MERCHANT magazine that will show you the whys and hows of implementing a multichannel strategy that’s right for your business. MCM Live will be hitting New York on June 1-2 and San Francisco on Oct. 5-6. For the complete agenda and more information, visit www.mcmlive.com.