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Inventory planning is the process of determining the optimal quantity and timing of inventory for the purpose of aligning it with sales and production capacity.
Companies seeking to transform their supply chain for success should put inventory planning and forecasting near the top of their priority list. Those who don’t will use excuses such as “we know forecasts can be wrong,” or “it’s impossible to forecast in our industry.” Yet, most businesses are ultimately driven by a series of planned sales numbers. Some, unfortunately, are driven by more than one set of numbers (e.g., production’s view of sales demand as opposed to marketing’s view). This article describes the importance of forecasting and the importance of a structured demand planning process.
There are two main reasons.
The first is the need to develop one agreed set of numbers as a basis for the business plan.
The second is that routine monitoring of the variance between forecast and actual sales should drive safety stock policies for the business. The more accurate that you are able to make your forecasts, the less inventory you will need to cover fluctuations in demand. This in turn allows you to deliver higher customer service, better control of working capital, and higher profitability.
The Golden Rule is that “Increased demand forecast accuracy translates into increasingly perfect order fulfillment.”
Shorter time horizons make for more accurate forecasting.
One way for a business to increase relevance and effectiveness of forecasting is by reducing lead times as much as possible.
It is easier to forecast stock purchased in large quantities. For example, an ice cream seller can produce more accurate forecasts for ice cream cones than for individual flavors.
Dependent demand items should be calculated. For example, demand for motor cars should be forecast. Demand for tires should be calculated by multiplying the forecast for cars by five.
If forecasting resources are constrained, high sales value items should be forecast more regularly than low sales value items.
A demand planning process describes the activities that are required to develop one agreed organizational plan to drive sales, operations, and financial planning. The first stage of the process is to develop forecasts using statistical analysis and judgements. The second stage is to have management and stakeholder overview of the forecasts to ensure ownership but also to apply strategic requirements, business policies, and business knowledge. The forecasting process should be based on historical demand data and information from the market. It should also take into account one-off events and promotions.
Ideally, sales history should be based on demand history, not actual sales history. The reason is that sales history may reflect alternative product choices that customers were “forced” to accept due to stock outs rather than what they had preferred at the time of purchase.
Management and stakeholder review is critical for obtaining ownership. Overall, demand planning should be seen as a process involving experts who are supported by forecasting tools where appropriate, not the other way around.
The introduction of a demand planning process should be accompanied with the right measures. The way managers are measured can deliver undesired outcomes:
A sales manager who is measured on “beating budge”’ will tend to under forecast.
A production manager who is measured on “lowest unit cost” is driven to over forecast.
The key measure is forecast accuracy. A distribution manager who is measured on “no stock-outs” is driven to over forecast
A procurement person who is measured on “no shortages of materials” will tend to over forecast
The key measure is forecast accuracy.
There is a range of critical questions to be resolved by management in developing a demand planning process:
How many and which items are to be forecasted?
How far into the future are you forecasting? The minimum period should cover purchasing and manufacturing lead times.
What is the time period for stating forecast quantity? This can vary from months, weeks, or can fluctuate.
How frequently should the forecast be made? How frequently should the forecast be reviewed and revised?
What would constitute an acceptable level of forecast error?
The two critical reasons why organizations must have a formal demand planning process are to work with one agreed set of forecast demand numbers and to track forecast accuracy to drive inventory planning. Forecasting and demand planning are essential steps towards perfect order fulfillment.