The importance of demand forecasting has been topic of discussion in economics and valuable books have been written on it over the years. However, within the supply chain context there are three types of forecasting, which are:
- Demand Forecasting: This is the investigation of the companies demand for an item or SKU, to include current and projected demand by industry and product end use.
- Supply Forecasting: Is a collection of data about the current producers and suppliers & technological and political trends that might affect supply.
- Price Forecast: This is based on information gathered and analyzed about demand and supply. Provides a prediction of short- and long-term prices and the underlying reasons for those ternds1.
Additionally, importance of demand forecasting can be short term, midrange, or long term. Typically, firms would use all three types of forecasting.
- Long-term Forecast: usually cover more than three years and are used for long-range planning and strategic issues. These will be performance in broad terms; that is sales by product line or division, throughput capacity by ton per period or dollars per period.
- Midrange Forecast: usually range from one to three years and address budgeting issues and sales plans. Again, these might predict more than demand.
- Short-term Forecast: are most important for the operational logistics planning process. They project demand into the next several months and, in some cases, more than a year ahead. These are needed in units, by actual items to be shipped, and for finite periods of time- monthly or perhaps weekly
Importance of Demand Forecasting in Supply Chain
1. Increasing Customer Satisfactions
In order to keep your customers satisfied you need to provide them with the product they want when they want it. This advantage of forecasting in business will help predict product demand. So that enough product is available to fulfill customer orders with short lead time and on-time.
The importance of Demand Forecasting is much higher in Made-to-Stock (MTO) , Assemble-to-Order (ATO) or JIT Supply Business.
2. Reducing Inventory Stockouts
The interesting thing is you need realize the Importance of Demand Forecasting even if you are working in JIT System or with long lead time suppliers like India or China. If you are buying from long lead time suppliers then you need to send a demand forecast so that suppliers can arrange raw materials in anticipation of actual customer orders.
In the case of JIT Systems, demand forecasting helps you to time your purchases to correspond to when sales need to be fulfilled. The less time inventory spends in the warehouse, the less money you’re paying to let it just sit there waiting to be sold.
3. Scheduling Production More Effectively
Forecasting is often compared to driving a car whilst looking in the rear-view mirror. The past gives a few clues about the future, but not enough to stop you from driving off a cliff. But in my opinion this is the best view you’ve got! If you look into the 5 Levels of Planning Hierarches most business should need robust SIOP and Master Scheduling to schedule production more effectively.
But I must emphasis the solution is not complex analytical software. The answer is this: Master the present before trying to predict the future. There are signals everywhere that point to how demand is changing. Adaptive manufacturers are watching and listening closely to the way customers consume their product. Respond and adapt to these changes, and you will depend less on prediction.
4. Lowering Safety Stock Requirement
A good demand forecasting process will have a direct impact in the planning of inventory levels, Link:
- Developing production requests to manufacturing operations
- Planning for new product launches
- Planning for promotional activity
- Planning for seasonal variations in demand.
If a business is using forecasting to plan any of the above scenarios then you don’t need to carry high safety stocks to manage those events.
5. Reducing Product Obsolescence costs
By identifying, repurposing or removing obsolete inventory the volume of inventory on hand will decrease. With this, both direct and indirect costs of keeping the obsolete inventory will be reduced. This closely links to reduced order sizes as a smaller volume of the inventory will be in stock and demand forecast accuracy. Having a standardized reliable way of forecasting demand will mean that excess stock is not ordered and this will reduce the chance of obsolete stock.
6. Managing Shipping Better
Nothing annoys me more than doing everything you can to make or buy a product so that it’s available to ship on-time yet the warehouse guys won’t ship, as they don’t have enough people. This drives me absolutely bonkers! For that reason the logistics guys are now part of the SIOP process and they have to tell me how many people they need in the following 3 months. To ensure we have enough capacity to ship material on time. This is one of the classic examples to demonstrate the importance of demand forecasting.
7. Improving Pricing and Promotion Management
In some businesses, multiple promotions running concurrently may result in the cannibalization of both promoted and non-promoted SKUs. Integrating distributor-level promotions and related forecasts will allow you to improve the flow of goods. It also achieves better results in terms of availability and stock fill rates. Similarly, improving the ability to forecast the impact price changes will have on both revenue and gross margin dollars, when timed well!
8. Negotiating Superior Terms with Suppliers
This blog explains 7 Tips for Negotiating the Best Deal With Your Suppliers, even though I don’t agree with heading “Sell Yourself as Someone Who Will Give Them a Lot of Business”, I do agree with the point that, “When negotiating with suppliers, make sure they know you are someone who will give them repeat business, over the long term”. And “And if you’re just starting out, provide them with a sales projections plan that is based on logic and research”. By doing that you are positioning yourself as a credible customer who wants to have a long-term relationship rather than one-off spot buy.
9. Plan Sales Strategies
If you can use demand forecasting to get a handle on either future revenue, plan production capacities or manage stockouts, you can also use the same information to help functions like Product Management, Marketing and Product Design. This will enable them to make decisions on promotions, pricing and purchasing. When working concurrently each will influences your company’s results positively.
You don’t need any special software or super algorithm to start forecasting, a simple Excel Spreadsheet forecast will do to start with. But in my humble opinion no one can deny the Importance of Demand Forecasting qualifications to benefit whatever business you are in.
Forecasting should not be a knee-jerk reaction of complaining to the supplier or shouting of the VP, there are plenty of more productive reasons to get into trouble to gather data, getting it into shape to analyze and create base demand forecast.
I have discussed few here. Which of these 9 reasons have you applied, and what results did you get? Do share with me!
- Leenders and Fearon, Purchasing and Materials Management, p.457
- Allan F. Ayers, “Forecasting: Art or Reality?” Transportation and Distribution”, 35, no. 6 (June 1994), pp. 29-30.