13/6/2021 Demand Forecasting Is Always Wrong: Three Ways To Thrive With Forecast Ambiguity

Apr 27, 2021, 08:40am EDT | 185 views

Demand Forecasting Is Always

Wrong: Three Ways To Thrive
With Forecast Ambiguity
Patrick McDonald Forbes Councils Member
Forbes Technology Council COUNCIL POST | Membership (fee-based)
Innovation

Director of data science at Wavicle Data Solutions. Driving client value

through data science and advanced analytics.

KLAUS VEDFELT

Many people think that if they can just get the forecast right, all their
supply chain problems will go away. As a data scientist who has been
working on demand forecasting for companies in multiple industries for
over 20 years, I've come to the realization that we are never going to get
the forecast precisely right.

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13/6/2021 Demand Forecasting Is Always Wrong: Three Ways To Thrive With Forecast Ambiguity

There's always going to be inherent uncertainty in the demand for

products and services, which will cause us to get the forecast wrong.
While this may sound counterintuitive and a bit pessimistic, I’d like to
offer three things you can do to account for ambiguities, maximize the
accuracy of your forecast and make decisions accordingly.

1. Recognize and accept that uncertainty is a fact of life in

demand forecasting.

Think back to the beginning of 2020, for example. Who could have
predicted there would be such a sudden, dramatic rise in demand for face
masks and hand sanitizers? Who could have foreseen the interruptions in
the supply chain that led to severe shortages of certain goods in grocery
stores? And how could the travel and hospitality industries have known
there would be such a monumental decline in business?

Yes, the pandemic has been an extraordinary example and something that
fortunately does not happen very often. Still, many far less impactful
events and activities occur regularly within supply chains and with
consumer preferences, which affect forecasts: Orders get canceled, new
orders come in, supplies get delayed or production problems delay
shipping, to name a few.

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Having accepted this unavoidable uncertainty, the next step is to develop

the forecast with them in mind. 

2. Use stochastic analysis to optimize forecast value.

Essentially, what we’re trying to do with the forecast is:

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1. Avoid ordering too much of a product or raw material, resulting in

overstock.

2. Avoid ordering an insufficient quantity of product or raw material and

losing out on sales due to stockout or production delays.

Too often in forecasting, we use the standard deviation of the demand — a

standard bell curve — to make decisions based on the average. This works
with a simple forecast. When lead times are high and there is volatility of
demand, replenishing stock takes too long and overstocks leave you with
expensive inventory. You may be leaving money on the table.

Fortunately, there are ways to increase the accuracy of forecasts so that

they are of greater value to the business.

Looking at forecasts from the perspective of stochastic analysis, also

referred to as scenario analysis, allows us to better optimize inventory
decisions. This is the process of analyzing future events by looking at
alternative possible outcomes. It doesn’t attempt to show a precise view of
the future but instead presents multiple alternative future developments.
As a result, analysts can see a range of possible future outcomes and
calculate the optimal inventory.

One way organizations may handle this is by doing a simulation. Start

with a standard distribution curve, run 10,000 demand estimates from
that distribution and calculate profit and loss for each one. By averaging
this across the range of demand estimates with constrained inventory, we
get a better idea of the optimal level of inventory.

Stochastic analysis doesn’t rely on a discrete forecast (expected values)

based on historical data, observations and assumptions. Instead, it
considers a range of possible developments and the likelihood of
occurrence that could affect future outcomes.

Hedge funds do this very well. They use stochastic analysis to determine
what the probability distribution looks like for the future price of an
investment and use that distribution to evaluate the likelihood that they
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will make money on a particular trade. That’s how they look over a
portfolio and make sure they’ve hedged in a way that they think
minimizes risk and maximizes profits.

Being able to make decisions based on this intricate probability structure

is more complex but will give you a better result than building to the
discrete value for the forecast.  

3. Measure outcomes and make improvements.

Forecast accuracy should improve with investment and time. If you’re

truly committed to this, it’s important to measure actual results against
your forecasts so you can continually improve your process and models.

Many organizations know that their forecast is not accurate, but they
often don’t know why or by how much. It could be that they don’t
measure how inaccurate their forecast is, or they may be using the wrong
metrics or overly sensitive metrics. For example, they might have a bias
that leads to an overestimate of demand or a bias that leads to an
underestimate, neither of which is good from a forecasting standpoint.

Just having the discipline to do the required measurement can be a

challenge, but it’s worth the time and effort. By measuring results more
closely, we can gain a better understanding of the biases that might be
built into predictive models, and how they affect accuracy.

The forecast may be 'sort of' wrong, but we can live with that!

Getting a forecast right is something you’re just not going to be able to do.
That doesn’t mean you don’t forecast. It means you understand and work
within the limitations of the capability.

Remember, what we should be doing with forecasting is measuring the

inherent uncertainty of demand. We won’t be able to eliminate the
uncertainty; we’re trying to minimize it and manage accordingly.

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13/6/2021 Demand Forecasting Is Always Wrong: Three Ways To Thrive With Forecast Ambiguity

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Patrick McDonald

Director of data science at Wavicle Data Solutions. Driving client value through data
science and advanced analytics. Read Patrick McDonald's full executive profile
here.… Read More

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