MANAGING PRODUCTS VIA DEMAND
VARIABILITY AND BUSINESS IMPORTANCE
By Richard Herrin
Since every company has produc-
tion capacity and working capital
constraints, they cannot maintain
the same flexibility and service
levels across the complete prod-
uct portfolio … forecasters should
devote most of their efforts to
products that are low in fore-
castability but high in business
importance … forecasts improve if
done on an aggregate level.
T
he main objective of Sales and
Operations Planning (S&OP) is
to deliver operating plans that
balance supply and demand in such a
way that production assets are efficiently
utilized, customer service targets are
met or exceeded, and working capital
requirements are minimized. For optimal
results, the organization must quantify
uncertainty in forecasted demands. The
S&OP process accounts for demand
uncertainty by managing a balance among
supply flexibility, customer service
levels, and inventory. Since almost all
companies have production capacity and
working capital constraints, they cannot
maintain the same flexibility and service
levels across the complete portfolio of
products. Therefore, the S&OP must use
segmentation strategies. The segmentation
strategy is best achieved by categorizing
products into quadrants based on demand
variability (forecastability) and overall
importance to the business.
There are several different ways
to measure forecastability. The most
important among them are:
6 THE JOURNAL OF BUSINESS FORECASTING, SPRING 2007
1. Confidence Interval
2. Coefficient of Variation (CV)
3. Coefficient of Determination (R2)
4. Mean Absolute Percent Error (MAPE)
Confidence Interval: There is a standard
method for computing the safety stock
based on the desired customer service,
deviation (forecast error), and lead time.
RICHARD HERRIN
Mr. Herrin works for Syngenta’s
North American region where he is
responsible for implementing best
practices in forecasting and demand
management. He is currently leading
a project to implement statistical
forecasting. His early career was spent
in production operations and Sales and
Operations Planning. He holds a BA in
Chemistry from Jacksonville University,
a BA in Chemical Engineering from the
University of Florida, and an MBA from
the University of North Carolina. He is
also a Certified Professional Forecaster.
(For the calculation of safety stock, read
my article “How to Calculate Safety Stock
for Highly Seasonal Products,” published
in the Summer 2005 issue of the Journal.)
Based on experience, you can set a target
of safety stock for a given set of customer
service and lead time. Let’s say that the
target is 2,500 units. Then, if the safety
stock of a certain product comes to more
than 2,500 units, it is unforecastable;
if it comes to 2,500 units or less, it is
forecastable.
Coefficient of Variation (CV): This shows
the percent of variation in the data around
the mean. The more variations in the data,
the more difficult it is to forecast. Here
you can set your own number, say, 80%.
If a product has a coefficient of variation
of 80% or more, it should be designated as
an unforecastable product. Otherwise, it
should be labeled as forecastable product.
Coefficient of Determination (R2): The co-
efficient of determination can be computed
from the actual and forecast data. It gives
an indication how closely the forecasts
are related to the actual numbers. It varies
between 0 and 1. The closer it is to 1, the
easier it is to forecast. Here again, you can
set your own target, say, 0.70. This means
that any product with a R2 of 0.70 or less
is unforecastable, and anyone with a value
of more than that is forecastable.
Mean Absolute Percent Error: This is
an average error with signs ignored. Here
again, you can set your own error target;
let’s say it is 20%. This then means any
product that gives a MAPE of 20% or
more is unforecastable; one that gives less
is forecastable.
 At Syngenta, we use a combination of
two different criteria. One is R2 and the other
FIGURE 1
is MAPE. Any product that has R2 of 0.70
or higher and a MAPE of less than 100% PRODUCTS BY IMPORTANCE AND VARIABILITY
is designated as a forecastable product
(For highly seasonal products, weighted
MAPE is more useful than MAPE). If
this criterion is not met, we aggregate the Q2 Q1
product to a different level (say, category). Stable Demand Stable Demand

High
At a higher level of aggregation, products and and
generally become forecastable.
Low Importance High Importance

Forecastability
The importance to business of each
product is based on a number of criteria
including sales volume, profitability, and
the stage of life cycle the product is in.
We have a weighting system that gives
a weight to each of these elements for a Q3 Q4
product and then sums them to find the Low Variable Demand Variable Demand
total weight for that product. and and
Low Importance High Importance
In Figure 1, Quadrant 1 has products with
stable demand and high business importance;
Quadrant 2, products with stable demand
and low importance; Quadrant 3, products Low High
with variable demand and low importance; Business Importance
and Quadrant 4, products with variable
demand and high importance.

This approach allows planners to FIGURE 2

differentiate supply and demand planning RESULTS OF CATEGORIZATION
processes to develop plans that efficiently
utilize production assets, exceed or meet
customer service targets, and minimize
15% of all products 85% of total
working capital requirements.
sales dollars sales dollars

RESULTS OF THE
CATEGORIZATION 14% of all products 31% of all products 45% of all products
High

9% of total sales dollars 50% of total sales dollars 59% of total sales
Forecastability

We categorized about 1,000 finished

products that are forecasted by month.
The results shown in Figure 2 indicate that
45% of all the products are most important
to the business and are highly forecastable. 17% of all products 38% of all products 55% of all products
Low

They bring in 59% of total sales. Among 6% of total sales dollars 35% of total sales dollars 41% of total sales
the other 55% of products, only 35% of
them are important to business and require
the most attention from the forecaster.
Low High
BUSINESS STRATEGY Business Importance
FOR MANAGING
DIFFERENT ITEMS Note: Forecastability results were determined by product and by month.

After all the items were sorted out by

THE JOURNAL OF BUSINESS FORECASTING, SPRING 2007 7

quadrant, we developed our best strategy
for managing items of each quadrant.
Products in Quadrant 1 (Q1): Products in
this quadrant have a stable demand and are
of high importance to the business. Since
they have a stable demand, they are easy
to forecast. The strategies we developed
for these products are as follows:
1. Since these products are easy to
forecast, we generate a statistical
baseline forecast at a 90% confidence
interval. Confidence interval tells
us how the forecast can vary at
different levels of confidence. For
example, if the forecast is 100 units,
we can say that at a 95% level of
confidence (if we want to be right
95 times out of hundred), the actual
will be as low as 85 units and as
high as 115 units. Forecasts of items
in this quadrant are based on the
assumption that future demand will
follow the same historical patterns.
If and when salespeople feel that
the demand pattern of a given item
will be significantly different from
the historical pattern, they can
overwrite its statistical baseline
forecast. If the override is outside the
bounds of the confidence interval,
they must give the reason why. It
may be that the assumptions made
in preparing forecasts are not valid.
Whatever the reason it should be
well documented.
2. Since the demand for these products is
stable, production doesn’t have to be
very flexible and we can reserve spare
capacity for products in Quadrant 4
(which are of high importance but
their demand is highly unstable).
For these items, we schedule enough
production to cover a minimum of
three-month forward demand.
3. Forecasts are prepared by items and
are updated quarterly.
4. On these products we target a
customer service level of 90% or
higher.
THE JOURNAL OF BUSINESS FORECASTING, SPRING 2007
Products in Quadrant 2 (Q2): The pro-
ducts in this quadrant have a stable demand
(thus they are easy to forecast) but are of
low importance to the business. Below is
how we manage these products.
1. We generate statistical baseline
forecasts as well as their confidence
intervals. If, at any given time,
salespeople feel that the demand
pattern of a given item will be
significantly different from the
historical pattern, they can overwrite
its statistical baseline forecast as
long as it is within 90% confidence
level. For any change beyond that
confidence interval, they must
give the reason why, and need the
approval of S&OP.
2. Forecasts are updated at least
quarterly.
3. Since these products are highly
forecastable, the economy of
production rather than flexibility is
more important. Here the emphasis
is on minimizing the cost. As such
they are produced in large lots. We
produce these products once or twice
a year during the off season when
idle capacity is available.
4. On these products we provide
customer service levels of 90% or
less.
Products in Quadrant 3 (Q3): Products
in this quadrant have a variable demand
(thus they are difficult to forecast) and
are of low importance to the business. We
manage these items as follows:
1. Since these items are very difficult to
forecast, their forecasts are not quite
meaningful for actual replenishment.
For them, we optimize cost over
flexibility in the supply chain. Supply
will produce the most cost-efficient
production volumes and commercial
will have the task of selling up to
but not beyond this volume. We
also try to supply these products on
a make-to-order basis or through
VMI processes. If any product in this
quadrant is very costly and disruptive
to manufacturing, we try to phase it
out.
2. Forecasts are prepared at an aggregate
level, and then blown down to a
lower level of detail, using historical
ratios.
3. The emphasis here is on supply plans
that minimize the cost. Products are
produced in large lots approximately
once a year.
Products in Quadrant 4 (Q4): These
products have an unstable demand (thus
they are difficult to forecast) and are
of high importance to the business. We
manage these products as follows:
1. Products in this quadrant are, by
nature, very difficult to forecast. We
try to improve their forecast through
intensive collaborative efforts (work-
ing with our customers) and/or throu
gh aggregation. Forecasts generally
improve when they are forecasted
on an aggregate level. So to improve
their forecasts, we can either
aggregate them at a higher level (e.g.,
at a category level instead of product
level), forecast them over longer-
time horizons (e.g., quarterly instead
of monthly), or use a combination
of both. We often prepare their
forecasts at an aggregate level and
then allocate down among different
products using either their historical
ratios or an agreed product mix.
2. For these products, we maintain
maximum production flexibility so
that we can respond to short-term
changes in demand. In season, such
products are produced on a monthly
cycle. Flexibility can be achieved
either by carrying excess safety
stock or by having idle capacity
available to produce quickly on short
notice. We wind up having a trade off
between higher safety stock and idle
capacity available (ability to adjust
production quickly to demand).
9
 3. We target customer service on these
items at 90% or higher.
CONCLUSIONS
By categorizing products on the basis of
forecastability and business importance,
we can optimize demand and supply
plans and ensure customer service targets
are met with minimum working capital
investment. S&OP should set the targeted
customer service levels and the business
importance criteria. If the plans result
in average inventory projections that
are above the targeted working capital
level, S&OP should address it by either
reducing customer service targets (lower
safety stock, higher back order, higher risk
of stock out), by increasing production
capacity (reduced cycle inventory,
increased capital assets), or by reducing
demand variability (via pricing, promotion,
etc.). If these options are not acceptable,
the S&OP should raise the targets in line
with the current projections.
The highest level of forecast accuracy
can be obtained by implementing pro-
cesses that combine statistically generated
forecasts with the practical experience of
sales and marketing personnel. We use
time-series based statistical forecasts as
a starting point and allow management
to overwrite with additional market
intelligence (judgmental input). Judgment
forecasts within the statistical range
(confidence interval) are not challenged.
If they go beyond the accepted confidence
interval they should be challenged. If
accepted, the revised forecasts should
be documented along with reasons for
changing. Forecasters should devote
most of their efforts to products that
are low in forecastability but high in
business importance. Products that
are low in forecastability and low in
business importance should be managed
less frequently (quarterly or annually).
Products that are highly forecastable
should not be revised unless the forecaster
has information on significant changes in
their demand drivers. These changes must
be documented. g
(richard.herrin@syngenta.com)
10
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