An approach to estimate the back order penalty cost of a manufacturing company

Abstract

The classical inventory models solely rely on accurate estimate of the back order cost, with a view to establish economic order quantity (EOQ) that must be placed by a customer. Recognizing and quantifying the adverse effects of loss of customer goodwill owing to the inability of a raw material or product supplier organisation to meet customer demands should not only focus on direct penalty cost computation, but should also incorporate change in customers’ future demand owing to this backordering phenomenon. A lot of classical and mathematical approaches focused on the computation of the back order penalty cost coefficient; which gives an organisation a clue of the customer disappointment index, and not the estimated back order cost required for EOQ computation. In light of this, this paper proposes an approach that could be utilized to accurately compute the back order penalty cost of an organisation. The approach considers: (i) the number of times backordering phenomenon have occurred in an organisation, (ii) the decision a customer takes when backordering occur once or couple of times during the ordering phases of an organisation and (iii) myriads of penalties that a customer bestow on a raw material or product supplier organisation for backordering its order, to establish the backorder cost of this organisation. The approach proposed in this study serve as a useful information to suppliers in ascertaining the raw material backorder cost based on their customer responses to backordering, with a view to ensure sustainable raw material supply.