Benefits of Market Driven Demand Planning Approach
Improving service while reducing costs
With customer expectations rising companies are pushed to focus more on customer service. They need to realise that this service comes at a certain cost, like extra inventory or extra capacity. As margins are shrinking increased costs are often not an option and improving operational performance is the best alternative. However, for most companies this is a hard nut to crack in a globalised economy with long supplier lead times and high market volatility. As we will illustrate using a recent case of a steel manufacturer, we believe a good demand planning process is one of the keys to improving customer service while reducing operational costs
A best practice demand planning framework
Best practice demand planning processes consist of two steps. In the first step, statistical techniques are used to generate a "base" forecast. In the second step, sales, marketing and product development add information to that base forecast. Skipping the first step can result in a waste of valuable time. To create a base forecast sales people will on an individual basis try to mimic their sales budgets in the forecast. Budgets are often a higher level of aggregation in the product hierarchy. This makes the translation into operational forecasts a cumbersome task. Statistical methods are far more efficient in executing this task. They know how to incorporate the last period’s sales, how to detect and extrapolate seasonality, how to incorporate leading indicators... Providing a good statistical base forecast will increase the commitment of sales and marketing as it makes their role in the process more focused and more efficient.
Some companies try to skip the second step. Supply chain or production departments may distrust sales and marketing and try to predict the market themselves. This is plain self-deception. Supply chain or production cannot be the owner of the forecast. Sales needs to understand that its responsibility does not stop by selling products or services but it has a role, as the owner of the forecast information in controlling costs and service in the supply chain.
A forecast will always be wrong. But as we'll illustrate improving the forecast accuracy is beneficial to both costs and service.
A business case for improved demand planning
- Step 1: Simple statistics
Using simple statistical methods to generate a demand forecast based on historical data can be the first step in reducing the demand uncertainty. Simulations for a steel manufacturer have shown that by moving from a budget-driven process based on historical figures, (with an equivalent accuracy of 25%), towards a demand planning approach based on simple statistics (with a forecast accuracy of 35%), the uncertainty can be reduced before implementation.
This case shows that this reduction in uncertainty allows for a service level improvement of 4% resulting in less lost sales and an inventory reduction of 5% based on the right inventory levels for the right product.
- Step 2: Advanced statistics
In a volatile market, more advanced statistical methods will yield better results as they take into account trends and seasonal effects. Using advanced statistics may be more difficult to understand and often requires an expert in house if you want to avoid a ‘black-box’ feeling. Typically it requires the purchase of a software package. Nevertheless, detailed case calculations have indicated that this could increase the accuracy of your forecast drastically, allowing inventory reductions to a more optimal level for both finished goods and raw materials. Service will be further improved as stock-outs are limited, resulting in less lost sales or the possibility of allocating inventories to A-customers. Forecast simulations for the case in question resulted in an average forecast accuracy of 55%, for an improvement on service level of 9% and a reduction of inventory costs of 10%.
- Step 3: Introduce Market Intelligence
However generating a statistical forecast can only be a start. The real benefits are in collaboration with the sales team to come to efficient demand shaping. Their market knowledge and information from key customers can create a tight feedback loop from the actual market activity to the demand assumptions and plans. This market-driven process will result in a single demand forecast, adjusted and validated by the company sales team. This validation process can take place on item level or on more aggregated levels, like product families or geographical markets. Though often a manual forecast adjustment process, the benefits from the improved forecast accuracy on service and inventory are convincing. Case simulations and input from sales people showed that this market-driven process results in forecast accuracies of 70% and higher. For this steel manufacturer implementing a market-driven demand planning process provides improvement of the customer service level of 20% and a potential reduction of inventory costs of 20% compared with the current situation. This demonstrates the negative impact on customer service and inventory levels when each functional area has its own version of demand forecast truth.
- Step 4: Continuous Improvement
Finally continuous improvement and monitoring of the forecast accuracy will allow even more forecast performance improvements. Therefore it is important to create an awareness of the impact of poor forecast accuracy and to measure the forecast performance.
The majority of companies have some form of demand forecasting system in place, however, they need to focus on becoming demand-driven in their approach. This means that the company needs to focus on capturing the real customer demand, an approach where the engagement of sales in the process must be ensured at all times. The demand planning process should align the goals of the sales department with the demand planning department with respect to forecasting metrics. With an improved market-driven demand planning process companies are now able to further optimize inventory levels and furthermore improve service. Simulations for a steel manufacturer show convincing benefits with a 24% increase of the company service levels while reducing inventory costs by 22%.
What MÖBIUS can do for you
MÖBIUS can assist you in building your business case for demand planning improvements. Based on your company specific sales history, we can assess the improvement potential in both inventory and service for introducing simple and more advanced statistical techniques, involving sales and marketing in the demand planning process.