The Monthly Metric: Backlog of Orders Index

For companies and supply managers, an order backlog can have varying implications — a sign of healthy demand or inefficiencies in a production process.

Often, the first step in determining such a cause or symptom is comparing performance against industry peers through benchmarking data, one of the biggest benefits of the ISM^® Report On Business^® to company executives and procurement organizations. It’s also a reason The Monthly Metric regularly focuses on one of the report’s subindexes.

This month, the Backlog of Orders Index is highlighted. It’s not one of the subindexes that directly factors into calculation of the composite Manufacturing PMI^® and Services PMI^® readings that are closely watched by economists and investors, but it can impact those subindexes that are. (The indexes that directly factor into the Manufacturing PMI^® calculation are New Orders, Production, Employment, Supplier Deliveries and Inventories; the Services PMI^® indexes are Business Activity, New Orders, Employment and Supplier Deliveries.)

“The Backlog of Orders Index is a critical indicator for both demand levels and supply chain performance and can be a predictive tool that helps people to anticipate changes in the economic landscape,” says Kristina Cahill, Report On Business^® and Research Manager at Institute for Supply Management^®. “When companies report higher backlogs, it suggests that they are receiving orders faster than they can fill them. This could indicate higher demand, or delivery issues and a shortage of raw materials, which will limit production.”

That’s been especially true in recent years, with coronavirus pandemic-related overordering, supply chain disruptions and demand volatility heavily impacting companies’ order backlogs. For example, backlogs factored into double-digit year-over-year growth rates for European auto sales last year. Meanwhile, disruptions and shortages can elevate backlogs even at companies with some of the most efficient supply chains in the world.

ISM’s Backlog of Orders Index can help a company find its place on the spectrum. “Supply managers can compare their own backlog data against the ISM Backlog of Orders Index to see how they stack up,” Cahill says. “A good understanding of all of the ISM^® Report On Business^® indexes is great way to better position your company competitively and make data-driven decisions that align with internal goals and external market conditions.”

Meaning of the Metric

The Backlog of Orders Index was added to the Manufacturing ISM^® Report On Business^® in 1993 and has been part of the Services ISM^® Report On Business^® since data collection began in 1997. In March, the Manufacturing Backlog of Orders Index registered 46.3 percent, the 18th consecutive month in contraction territory; the Services index dropped into contraction with a reading of 44.8 percent.

That’s largely been a product of sagging demand; the Manufacturing New Orders Index has been in expansion (a reading above 50 percent) just three times in the last 22 months. The Backlog of Orders and New Orders indexes should have some degree of correlation, Cahill says.

“There are interactions between Backlog of Orders and other indexes,” she says. “For example, if the New Orders Index is showing consistently high readings, meaning lots of orders are being placed, and production levels are not keeping up with new orders, you most likely will also see an increase in the Backlog of Orders Index.”

Cahill notes that as the manufacturing sector recovered from pandemic shocks in 2020 and ’21, the New Orders Index consistently registered above 65 percent. While lofty, the Production Index didn’t match that pace, in the high 50s or low 60s. That combination elevated Backlog of Orders, which reached an all-time high of 70.6 percent in May 2021.

Recently, with manufacturing demand and production cooling, the Backlog of Orders Index slid into a contraction period. Also, the Inventories Index has been below 50 percent for 14 straight months. The Production Index showed some resiliency during the manufacturing sector’s 16-month contraction period that ended in March, staying higher than might have been expected. A key reason: Many companies worked off backlogs left from overorders during the pandemic, said Timothy R. Fiore, CPSM, C.P.M., Chair of the ISM Manufacturing Business Survey Committee.

“In practice, supply managers often monitor these indexes together to gauge overall market conditions and to predict future trends,” Cahill says. “By doing so, they can make more informed decisions to optimize operations and anticipate supply challenges to better control their inventory and production planning.”

The Services Backlog of Orders Index has been in contraction territory for 15 of the last 22 months. (The services gauge is not as far-reaching; 44 percent of respondents in the March ISM^® Report On Business^® indicated their companies do not measure order backlogs.)

What’s an Ideal Backlog Level?

A “normal” Backlog of Orders Index number depends on industry conditions and economic circumstances, Cahill says. Conditions also are reflected in its historical extremes; as Manufacturing’s all-time highest reading was during the pandemic recovery period, the same is true for the Services Backlog of Orders Index, which hit 67.3 percent in October 2021.

Not surprisingly, both indexes’ all-time lows were during the Great Recession: 23.4 percent for Manufacturing in December 2008 and 36.5 percent for Services in February 2009. “(Those numbers) mirrored the economic downturn, reflecting a reduced demand for products and services and major challenges for companies attempting to maintain profitability,” Cahill says. “A moderate backlog suggests a healthy balance between supply and demand, so an ideal index number would reflect that scenario” in concert with other Report On Business^® data.

Generally, where the New Orders and Production indexes go, the Backlog of Orders Index follows, Cahill says. In January 2019, the Manufacturing data featured healthy gains in new orders and production, while backlogs were largely stagnant. Fiore suggested that was a sign of slacking demand, and the readings for the New Orders and Production indexes were lower in subsequent months.

“A situation where new orders are only incrementally increasing, production hikes are continuing upward and a decreasing backlog number is reported could signal an overestimation of market demand, a plateau of demand or a lack of interest from customers,” Cahill says. “It could also mean production is working through backlogs as new orders slow.”

As a result, the Manufacturing ISM^® Report On Business^® data for March could have an interesting aftermath, says Paul Lee, Director of ISM Research & Analytics. New orders increased modestly and production strongly in March, while the Backlog of Orders Index equaled its February reading. If raw materials are generally available (and they are), Lee says, backlogs should increase only if sales outpace production.

“New orders and production were up in January, which might have been an anomaly,” Lee says. “The indexes went into contraction territory in February but popped back up again in March. The next few months should give a clearer picture.”

To suggest a metric to be covered, email me at dzeiger@ismworld.org.

(Photo credit: Getty Images/Luchunyu)