- On 03/01/2021
Demand forecasting can be a practical, useful, and effective strategic planning tool when applied in the right way
A common motivation for developing sales forecasts is to drive strategic business planning decisions in the areas of staffing, capital investment, and supply chain management. Some of the challenges that many manufacturers face when attempting to establish these strategic planning capabilities include:
- Making routine sales forecasting practical
- Ensuring that sales forecasts adequately characterize over-the-horizon customer demand
- Effectively applying sales forecasts to inventory and production capacity planning
These challenges are often addressed through a formal strategic planning process referred to as Sales, Inventory, and Operations Planning (SIOP) or, in the alternative, more widely used, and abbreviated vernacular, Sales and Operations Planning (S&OP).
Regardless of how formalized or mature your strategic planning processes may be, there may still be challenges in establishing a repeatable and sustainable way to translate sales forecasts into effective and actionable operating plans.
The Myth of Forecast Accuracy
There is the old refrain that “forecasts are always wrong”. This is certainly to be expected since none of us can see perfectly into the future. While it may be intuitive and compelling to characterize forecasts as being “accurate” or “inaccurate”, it is more productive to think of how actual demand deviates from the forecast.
It is possible for a forecast to be over- or under-stated in a particular period but still be useful and effective for driving inventory and production planning. The key is to focus more on measuring and working to eliminate inherent forecast biases because that is what can lead to adverse financial impacts and missed revenue opportunities over time. The pursuit of forecast “accuracy”, conversely, can lead to “market timing” approaches that are more successful at inducing volatility into production planning processes than they are able to effectively drive inventory and production. This counterproductive approach of frequently updating forecasts generally requires more work but does not provide any corresponding practical benefits.
An Overemphasis on Forecast-Driven Inventory Planning
One of the implications of taking the “market-timing” approach to demand forecasting is the frequent updating of target inventory levels that must follow. This is particularly problematic for products and markets where demand is uneven and sporadic with alternating demand spikes and periods of inactivity. Just as it takes extra work to adjust demand forecasts, it also requires extra work to continuously adjust inventory planning parameters accordingly. The question is to what end is this useful?
The purpose of inventory (as it relates to finished goods) is to provide a buffer between customer demand and production so as to absorb fluctuations in demand. This does not mean that you have to hold lots of inventory in order to be able to simplify or relax your forecasting regimen. Fortunately, there are effective and reliable techniques for inventory optimization that are independent of customer-provided forecasts. In fact, we have found that inventory can almost always be reduced by 20% or more while at the same time improving order fulfilment rates to 95% to 99% even in environments where customer demand is sparse and uneven.
Proper inventory planning is possible often without the need customer-provided forecasts. This is good news since you have control over the quality of your inventory planning, whereas you do not have control over the quality of your customers’ forecasts.
I am in no way saying that customer forecasts should never play a role in inventory planning as there are certainly occasions in which customer input is critical. However, more often than not, a supplier’s own inventory planning, when based on sound materials management principles, is the most important tool in the toolbox for economically meeting customer demand, sometimes without the need for customer-generated forecasts.
A Customized Approach to Strategic Demand and Operations Planning
Altemir Consulting can assist manufacturers and distributors establish the essential elements of a strategic and coordinated Sales and Operations Planning (S&OP) program that embraces and resolves the supply/demand dynamics of your business, including:
- Effective and practical sales forecasting
- Optimized inventory planning
- Capacity planning protocols
- Cash flow planning processes
- Capital planning
- Staff planning
- Supply chain planning