The Problem – How many Black Holes are out there?
Purchase orders are the lifeblood of B2B commerce. For sellers they build the “top line” that drives their businesses. For buyers they initiate procurement of materials needed to make and sell their products. Millions of POs are placed every day.
Think, then about the multiple items on these orders. It’s common for businesses to place POs for multiple items. It’s the normal way buyers routinely purchase material from established suppliers.
Now picture all the items that become back orders. These are the items that the supplier can’t ship right away with the other items. Left to their own devices, suppliers ship the items they can and create back orders of the others – it’s their normal practice. Subsequently the supplier ships these items if and when they become available.
Aside from the problems back orders cause, most businesses gauge their frequency with the common service measurement called fill rate, or line item fill rate – the percent of items that can be filled right away. Most suppliers’ fill rates range between 80% and 95%. Some are better and many are worse. Whatever it is, the likelihood of an item not being back ordered is about the same as the fill rate.
The problem gets worse at the order level, however. On multiple line item POs the chance of having a back order grows because any back ordered item causes a back order on the PO. For example, if a supplier’s fill rate were 90%, the likelihood of a back order on a 10-line PO would be 65%!
That’s why the majority of POs create back orders in many companies. Their “order” fill is below 50%.
From an overall perspective, the breadth of back orders is about the same as the “un-fill” rate – the 5 to 20% of the items that are unavailable when the order is placed. It’s staggering to imagine the total amount of business tied up in back orders. Applied to a $10 trillion GNP, a 90% fill rate would suggest a nationwide back order of a trillion dollars!
That’s $1 trillion sitting there on back order at any point in time – sitting there all the time. A trillion dollars of business that both buyers and sellers would like to eliminate.
Back order black holes are everywhere!
Being aware – “SEEING” Black Holes and Why Light Doesn’t Escape
Let’s realize how businesses, particularly procurement functions, become aware of this problem – how they get notified of back orders.
Once in suppliers’ systems, orders are released and filled as possible. Suppliers’ eagerness to “recognize the revenue” motivates them to ship the items they can and back order the rest. So powerful is this motivation that at fiscal year ends, quarter ends, and even month ends, suppliers routinely lower their inventory availability hurdle and release even more partial orders so as to “make their numbers.” This drill guarantees ever more back orders.
Once shipped, does the supplier notify the buyer that items were not included? The supplier is actually encouraged to shut up. If notified, the buyer might cancel the back order. Worse, the buyer might try to buy the item(s) from a competitor. (After all, he did want them.) That competitor might actually have the item(s). Being satisfied by that supplier, the buyer might do more business with them next time.
In this way, disclosing that items were back ordered is often seen as “selling for your competitors.” Actually it is.
Salt in this wound comes further from some suppliers’ practice of waiting for the next order from the same buyer to ship back ordered items so as to save transportation costs.
When the supplier does make note of the partial shipment, they usually do so in a most passive way. The back ordered items are “X-ed” out on their picking list, which may next be seen at the buyer’s receiving dock.
Suppliers’ own self-interest spawns back order black holes and prevents light from escaping them.
Now consider what happens when the partial order is received – after, mind you, the time in which the material was expected has lapsed. Do many organizations have receiving functions that notify buyers that items on the PO were not received? Probably not. The supplier’s picking documents normally don’t list items they knew couldn’t be picked, so the packing list doesn’t acknowledge them either. In any case it’s the exception that receiving notifies purchasing of the back ordered items. It’s “receiving”, not “not received”.
So what does trigger awareness of the back ordered items? All too often it’s someone else recognizing that there’s a big problem. The production schedule won’t be met because a component they need is not there, or (as in every distributor’s business) a customer wants something you don’t have.
After this, the organization has to expedite the late material. In many companies this work consumes a liberal part of materials management’s day-to-day scramble – climbing out of the black holes they’ve been sucked into. Think of all the subsequent operational disruptions and cost consequences.
That’s how insidious these back order black holes have become. You’re leisurely cruising through your own purchasing space and boom! You’re caught in a black hole and don’t know it until someone else uncovers and reports it. After all, they are invisible.
Coping With Black Holes – Resisting Their Attraction
Most businesses contend with suppliers’ back orders with inventory – by carrying more of it. Almost all inventory systems incorporate an explicit link between safety stock and suppliers’ performance. (Ironically inventory management software providers tout this “feature” as the way “to solve” the back order problem!) In these systems lead-times and lead-time “variability” – both of which increase when back orders take place – are tracked, statistically measured and factored into safety stocks. The stock levels of all the supplier’s items increases proportionately.
In practical terms the increase is normally a few days’ worth – applying this method so broadly is expensive. But a few days increase won’t cover multi-day back orders.
Most inventory systems apply the approach at the supplier level. That is, the suppliers’ overall performance is assumed to apply to all their items. A few systems apply performance at the item/supplier level, sometimes at the item level. There are problems with all these approaches.
Think about the normal buyer-supplier relationship that involves several items. The real question is whether or not the back order of a specific item predicts future back orders of other items.
The cause of the back order typically relates to that item only – “our supplier was out of a component” of that item, “we had another customer take all our inventory” of that item. More often the reason for the back order is a random event that doesn’t suggest a pattern, particularly a pattern applicable to other items. As a matter of fact, the unavailable item usually comes back in stock and may never have the problem again suggesting that that item’s recent unavailability isn’t even applicable to its own future let alone that of other items!
In this fashion the increased inventory approach of coping with back orders is expensive, it’s applied indiscriminately to all the supplier’s items. Moreover, it doesn’t work very well covering, as it does, a few days of a multi-day back order. The breadth of this broad-brush approach makes it costly; its shallowness makes it ineffective. Black holes gobble up thin layers of whitewash no matter how costly it is to apply.
It’s a little like swatting flies in a china shop with a sledgehammer. You might get a few, but it’s expensive.
The Answer – Avoiding the Black Hole’s Clutches – Black Hole Killers
Black holes are black holes. Once you’re caught you’re caught. So the solution is to steer clear and avoid their clutches. This means not allowing back orders to occur in the first place.
Since the suppliers’ incentive is to keep you in the dark when you’re in a black hole, the way to avoid them is to do it yourself. Orders have to be placed with suppliers who make the commitment, suppliers who can say what their inventory availability is and who can make the shipping promise – “we have everything and we’ll ship it today.”
Prior to the internet, EDI and faxes, transactions over the phone promoted this kind of exchange. Now we’ve been thwarted by our passive electronic PO placement. Fortunately there’s a solution.
What’s needed is the capability for the buyer to place POs with suppliers who will ship as soon as possible. If some of the items are not available, then the buyer needs the capability to find another supplier or to split the PO between multiple suppliers.
Leading e-procurement software does just that. With it, the supplier posts its inventory availability, then quotes and accepts provisional orders, and finally fulfills the ultimate order. Buyers shop for availability online, split and place orders to responsive suppliers and avoid back orders.
The buyer kills the back order before getting caught in its black hole.
When you think about it, the seller wants to sell what they have in their inventory and the buyer wants to buy it. What could be smarter than connecting the two in a slick process that achieves both commercial objectives? The seller sells its finished goods inventory and the buyer gets what it wants, on time, eliminates its contingent (just-in-case) inventory, keeps some of the gain and passes the rest down the supply chain to benefit its customers with better service and lower prices.
Think about how much of the trillion dollar back order would vanish and all the subsequent business efficiencies.
If just ten percent of the procurement space you travel in contains black holes, you’ll gravitate toward them and get caught sooner or later. Get an e-procurement capability and kill ‘em, dead!