Operations Manager: EOQBACK
EOQ with Backorders (EOQBACK)
Backorders are common in inventories held for resale to customers. The EOQ model can be modified to handle backorders by including one more cost, the cost per unit backordered. This cost is extremely difficult to assess. In theory, the backorder cost should include any special cost of handling the backorder, such as the use of premium transportation, and any cost associated with loss of customer goodwill. As a surrogate for the true backorder cost, most companies use the profit per unit.
The backorder model works well for companies who where financing the inventory is expensive. It is much less expensive to incur backorders and fill them when the EOQ arrives than it is to hold inventory. Of course, this is a risky policy and the backorder model must be used with caution. The model assumes that customers are willing to wait on backorders and are not lost to the competition. If customers are lost, then the model is inappropriate. There are other models that account for lost customers but they are rarely used in practice because of the risks involved.