The True Cost of a Back Order
Have you thought about how backorders may be affecting your profitability? From analyzing our clients back order costs, this can range from $7 to $12 or more for each unit that goes into a back ordered status. I am sure you are asking yourself how can it be that much. Let’s take a look at what makes up the costs of a back ordered item.
For this example we will use a multichannel retail company that has a 15% back order rate, processed 250,000 orders last year with an average of 2.5 items per order or 625,000 units. With its 15% back order rate that equates to 93,750 back ordered items. If we use the low end of $7 per back ordered item that comes to $656,250 of profit right off the bottom line. You can figure this out for your own company by looking at what goes into making up the costs associated with a back ordered item as follows:
- A three minute average Customer Service call at $0.12 per long distance minute = $0.36
- $9.00 as the hourly wage, plus 20% added on for benefits = $10.80 an hour divided by 60 minutes and that multiplied by the 3 minute average Customer Service call we have = $0.54
- LD charge for the “Where is my order” (WISMO) call = $.36
- Pick, pack and ship labor costs at the same labor rate as the call center staff and estimate that it takes approximately 5 minutes of labor time to fulfill the back ordered item= $0.90
- Carton and void fill = $1.20
- Freight out = $4.00
You are trimming $656,250 of profit right off your bottom line. And if your costs are higher than in this example; your profit reduction is even greater.
There are several other costs that can be factored in such as: the costs to obtain a new customer, administrative overhead costs, the cost of processing returns, lost margin opportunities, and expedited freight costs to bring in back ordered items.
But the consequences of backorders aren’t just increased costs, they are damaging to your customer relationship. Customers may give you the benefit of a back ordered item once, but they will find other store fronts to shop or alternative items rather than wait for another back ordered item.
Look for ways to try and minimize backorders without dramatically increasing your inventory position such as:
- Develop strong vendor relationships and keep them informed of any changes in your delivery schedules.
- Look for ways to improve your inventory forecasting, whether you are using percent complete or rate of sale and average weeks of supply.
- If your inventory forecasting is not taking into consideration vendor lead time you run the potential to be out of stock before you can get the merchandise replenished. Are your lead times being maintained to reflect any vendor delivery changes?
- Better understand your merchandise statistics and the impact they have on your profitability.
- Develop a plan for liquidating overstocks to free up cash for purchasing better selling items.
- Develop reporting or look for packaged software designed to aid the re-buying analysis (the use of exception reporting and time-phased item forecasting).
FCBCO can assist you in analyzing and developing an inventory strategy that will reduce your back order rate and the costs associated with them. We urge you to contact Jeff Barry at 804-264-8040 or via email at jbarry@fcbco.com immediately to discuss.
F. Curtis Barry & Company is a national consulting firm for catalog, e-commerce, and retail businesses offering clients expertise in order management systems, warehouse management systems; warehousing and distribution; inventory management and forecasting solutions; and operational benchmarking for all business channels.
Please contact Jeff Barry to discuss your upcoming projects at jbarry@fcbco.com or 804-457-4028.