How to Use Order Fill Rate Versus Backorder as a Service Measurement

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Executive Summary

One can use backorders or the order fill rate.
We compare a recent paper and its use of backorder service measurement and why backorder is superior.

Introduction

The order fill rate is the most popular service level measurement method in supply chain management. However, there is another service level measurement based upon backorders. In this article, you will learn about the order fill rate versus the backorder. Backorder is a measurement that has advantages over the order fill rate. You will learn about backorder as a service level measurement.

Backorders or Order Fill Rate

The majority of early work on inventory optimization and multi echelon planning began in the late 1950s and now drives the best breed service parts planning software applications designed around backorders as a service measurement. This is because the research was primarily paid for by the Air Force and carried out by the RAND Corporation. The focus was squarely on solving the problem of managing military service parts networks.

Therefore, it is interesting to compare and contrast two quotations from research papers that focused on minimizing backorders. This first is from Craig Sherbrooke and his METRIC (an acronym for Multi-Echelon Technique for Recoverable Item Control) paper written in 1966.

Sherbrooke Explanation

This is how Sherbrooke explains his use of backorders over order fill rates in his paper.

“Order Fill Rate: defined as the fraction of demands that are immediately fulfilled by supply when the requisitions are received — concentrates nearly all stock at the bases. The result is that when a non order fill occurs, the backorder lasts a very long time. Similarly order fill rates behaves improperly in allocating investment at a base when the item repair times are substantially different. Consider two items with identical characteristics except that one is base-reparable in a short time, and the other is depot reparable with a much longer repair time. Assume that our investment constraint allows us to purchase only one unit of stock. In that case, the order fill rate criterion will select the first item, and the backorder criterion the second.

The fill rate possesses an additional defect. A fill is normally defined as the satisfaction of a demand when placed. But if we allow a time interval T to elapse, such as a couple of days, on the grounds that some delay is acceptable, the policy begins to look substantially different. As longer delays are explored, the policy begins to resemble the minimization of expected backorders.

In summary, the backorder criterion seems to be the most reasonable. The penalty should depend on the length of the backorder and the number of backorders; linearity is the simplest assumption. This is the criterion function most often employed in inventory models.” – Craig Sherbrooke

The Superiority of the Backorder Versus Fill Rates for Service Measurement

Sherbrooke explains that he considers backorders superior for his purposes of service measurement due to the following:

Order fill rates tend to concentrate stock at the bases (bases in Sherbrooke’s papers would correlate to DCs in industry-speak, with the depot being the regional DC or (RDC))
Order fill rates measure the satisfaction only at the point of initial delay and do not measure how late a fulfillment occurs.

Therefore Sherbrooke designed an algorithm as part of METRIC, a penalty that multiplies the backorder length by the number of backorders.

Leanard Laforteza states similar reasoning in his paper for selecting backorders as a service measurement for his paper designing a multi-echelon system for supplying Marine military deployments.

Leanard Laforteza on Fill Rate

“Fill rate is the percentage of demands that can be met at the time they are placed, while backorders are the number of unfilled demands that exist at a point in time. In commercial retail, if customer demand cannot be satisfied, a customer either goes away or returns at a later time when the item is restocked. the first case can be classified as lost sales while the second case creates a backorder on the supplier or manufacturer. In military applications, especially in most critical equipment, any demand that is not met is backordered. The backorder is outstanding until a resupply for the item is received, or a failed item is fixed and made available for issue.

These two principle measures of item performance – order fill rate and backorders – are related, but very different. Commercial retailers are more interested in order fill rate than in backorders because fill rate measures customer satisfaction at the time each demand is placed. Not only is fill rate easy to calculate, but it also helps retialers form a picture of how well they are meeting customer demand. Experience may tell them that a 90% fill rate on an item is not acceptable and will create customer complaints. On the other hand, backorders are not easy to compute as fill rate. Unlike commercial retail business, the military is not concerned with lost sales. The military measures performance not in terms of sales, but in terms of equipment availability.

In terms of supply support service measurement, we recommend tracking backorders. Although fill rate tends to have clearer meaning to commercial suppliers, the rate does not have the same meaning in militar applications. Using the concept of backorders, a unit can determine the status of its supply support not just when the order is placed, but up to the time the item was received.” – Leanard D. Laforteza

Here Laforteza does an excellent job explaining why backorders are more relevant for military applications than the order fill rate.

The Greater market for MEIO Applications

However, as the greater market for MEIO applications is civilian, vendors added order fill rates, and the order fill rate is not the dominant method of MEIO implementation. MCA Solutions, service parts planning vendor with a substantial military client base, can measure service level by order fill rate or availability (i.e., the uptime of equipment). However, while it does not measure the order fill rate by backorder, as do Sherbrook’s METRIC or Laforteza’s approach, MCA allows for the flexible setting of back ordering for different locations. MCA allows for the following settings:

All locations to have a backorder applied
Only the root locations to have a backorder applied
No locations to have a backorder applied (which is the default).

MCA describes its management of backorders in the following way:

“A Location is called backorderable if the unmet demand at that Location gets backordered at that Location and waits until the inventory is available at that Location. A Location is not backorderable (also referred to as lost-sales) if the unmet demand is passed to another Location or outside the supply chain. In backorderable models, preference is given to destinations that do not have enough inventory position to meet their child Location needs.” – MCA Solutions

Introduction to S, s-1 Inventory Policy

In several articles previously, the (S, s-1) inventory policy is discussed.

For this reason, it made sense to create an article that explains what it does and how it can be used to improve inventory management.

Wayne Fu wrote the following.

Muckstadt and the (S,s-1) Inventory Policy

In Muckstadt’s book, section 1.1.2 explains the (s, sS) inventory policy briefly.

Sis the normal reorder point
S is the order up to level.

When inventory position (which is on hand plus on-order minus backorder) falls to or below s, it triggers an order to raise the S’s inventory position.

(S,s-1) as a Specialized Form

(S, s-1) is just a specialized form of (s, S).
It is s-1 only. In section 1.2, Muckstadt states the fundamental assumption of his model.
He assumes the costs of parts are high enough to be managed by (S, s-1) policy. (S, s-1) An ordering policy says if the inventory level is one below (S-1), place an order to bring the inventory level to S.

It is very commonly used in long lead-time environments such as aerospace.

Author Thanks

I wanted to thank Wayne Fu for his contribution. I was not aware of many of the details described above, and I think this should be of interest to anyone who practices in this field.

Author Profile

Wayne Fu is a Senior Product Management in Servigistics. Wayne has worked in the service part planning domain with an operation management background for more than a decade. In Servigistics, he led the research and development of various areas like install-base (provisioning) forecasting, inventory optimization, and distribution planning. Currently, he is focusing on the effectiveness of forecast techniques in Last Time Buy.

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Conclusion

The service measurement selected must fit the application. The early MEIO research papers were centered around the military application and thus used backorders and backorder, which is often the number of backorders times the average backorder duration serves as a common service level measure. However, civilian applications require an order fill rate as the service level measure.

References

“METRIC: A Multi-echelon Technique for Recoverable Item Control,” C.C. Sherbrooke, RAND Corporation, 1966

“Inventory Optimization of Class IX Supply Blocks for Deploying in U.S. Marine Corps Combat Service Support Elements,” Leanard D. Laforteza, Naval Postgraduate School Monterey, California, June 1997

Principles of Operation, MCA Solutions, 2007