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Linking Demand Planning
Linking Demand Planning
Based on this poor performance, the business implemented a process whereby the
sales forecast was used to establish an inventory plan. The actual sales and inventory
were compared to plan and a meeting was held every two weeks between the product
development, marketing, sales and Supply Chain functions. The result was improved
demand-supply balancing in both quantity and timing. Chart 1 explains further sales,
production and inventory, and Chart 2, planned and actual inventory.
Notice Article 551 in Table 2 has both high volume and high variance in demand.
Collaboration with the customer resulted in a stocking policy to ensure product
availability at the point of order. Here the customer provided an order schedule. In this
case Article 552 was being forecasted using a 3-month moving average. The result was
being out of stock in some months and having excess inventory in others. Chart 3
depicts the actual demand for this article.
After collaboration between Supply Chain, Sales and Marketing, it was decided to place
the article on make-to-order status. In addition to the erratic demand pattern this article
requires a unique raw material in production and the risk of producing this article to
stock is high.
As shown in Chart 4, the resulting statistical safety stock performs well based on
historical sales. Statistical safety stocks assume the sales data is normally distributed
(bell curve). In this example, the average sales are 498 units and the standard deviation
of sales is 57. This yields a Coefficient of Variance of 0.12 (57/498). As mentioned
before, CoV’s of less than 1.0 indicate that variation approximates normal distribution
and use of statistics based on normal distribution is a valid approach. Next we will look
at an example of erratic demand versus safety stock level.
Erratic Demand & Safety Stock
Inventory
For some businesses, many items have demand patterns that are difficult, if not
impossible, to forecast. Chart 5 gives such an example.
The CoV test indicates bell curve statistical techniques are not valid in this case. CoV is
greater than 1.0. If statistical safety stock is used, both over-stocks and stock-outs will
occur. In that case, the best solution is to place it on a make-to-order policy. However, if
the customer insists on the supplier keeping some stock, the best solution would be to
maintain a minimum safety stock of 1,500 units. This covers demand for ten of the
twelve months. For the two months when demand far exceeds average, the options are
advance warning from the customer, expediting by the supplier or longer delivery lead
time.
A key point is that the actual demand pattern can help in developing a stocking policy.
So often I have been told by planners they just use re-order point based on average
demand for those items with erratic sales. Of course, re-order point was created to
handle items with stable demand and random variation and does not work well for
patterns like this one.
The use of forecast error or demand variance in safety stock calculations often gets a
bad reputation because the tool is applied to items with erratic, non-normal demand
patterns. Use of the CoV data and inspection of the demand pattern can help to ensure
statistics is used but not abused.
The red numbers represent how much inventory was planned due to over-forecasting
these products. The inventory totals over $1.8M for this month. The other items were
under-forecasted resulting in schedule changes or stock-outs. In this case, the stock-
outs did result in customer backorders. This business offers dozens of finished goods
line items and exception reports are used to prioritize improvement efforts.
Summary
The Supply Chain function is usually accountable for inventory management. They
should ensure this includes new product inventory management and work with
Marketing & Sales to get inventory plans in place. One aspect of product portfolio
management is the evaluation of demand volume and variance. Supply Chain should
ensure this analysis is performed periodically and that Marketing and Sales participate
in review of the data. Decisions regarding whether to stock the product and how to
ensure availability if stocked need to be a team effort.
For items with reasonably normal demand patterns, Supply Chain should link safety
stock quantities to demand variance or forecast error. Excess and slow-moving
inventories should be monitored routinely; this can help to identify when stocking
policies and safety stocks need a review. If items with erratic demand patterns must be
made-to-stock, Supply Chain must work with Marketing and Sales to decide what
stocking policy is required. It is best not to provide an invalid statistical forecast but
rather identify items which require decisions based on informed judgment. The use of
exception reports such as “top ten” forecast errors, or “worst ten” over stocks each
month is a better practice. Also, the use of the ABC principle to ensure resources are
focused on those items that significantly impact the bottom line is very important. The
“C” items provide more challenges for both demand planning and inventory control but
usually represent a small percentage of revenue.
In closing, Supply Chain must take the lead to integrate new product planning and
product portfolio review in the S&OP process. Seldom are marketing and sales held
accountable for the inventory and cost issues for mistakes in these processes. Demand
planning and Supply Chain are accountable for linking actual demand patterns to safety
stock decisions. They must also routinely perform inventory analyses (e.g., slow
moving, excess, obsolete) to identify priorities and the need for change. Supply Chain
serves as the link between Marketing, Sales, Finance and Operations to better balance
service-cost-inventory.
This article originally appeared in the Spring 2020 issue of the Journal of
Business Forecasting. Click here to become an IBF member and get the journal
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