The Accuracy Trap

Forecast accuracy is important, but enterprises must look beyond it to realize their demand and supply chain objectives.

Forecast accuracy is important, but enterprises must look beyond it to realize their demand and supply chain objectives.

It's easy to fall into the accuracy trap. Once companies start using demand-planning tools to predict customer demand, they can quickly become obsessed with achieving the perfect forecast. Convinced that the perfect forecast is the only key available to unlock the door of supply chain success, they become focused on building sophisticated forecasting techniques and gathering market intelligence to produce exemplary forecasts.

But in doing so, precious time and resources can be wasted striving to develop the unattainable perfect forecast while overlooking other areas that can be leveraged to achieve their enterprise objectives. Accurate forecasting should not be both a means and an end, since accurate forecasting in and of itself does not deliver an enterprise what it is really looking for — profitability.

Demand forecasting is one of the cornerstones of best practice supply chain management. Scattered spreadsheets containing best guess estimates for sales are gradually being replaced by sophisticated software tools that use historical sales figures, ordering patterns, market trend data and promotion plans to calculate long- and short-term statistical forecasts. Market leading companies around the world have demonstrated how effective demand forecasting can lead to incremental revenue gains from customer-service-level improvements and substantial cost savings from stock reductions and supply chain efficiencies. However, with ever increasing variability in the marketplace, many organizations find themselves with poor demand forecasts and missed supply chain objectives — despite their investments in forecasting excellence.

Why is it so difficult to generate accurate forecasts? Manufacturers and retailers are constantly competing to win customers with frequent new product launches based on the latest technologies and design trends. In addition, they offer customized products and use heavy price and promotional activity to influence consumer choice. The result is a rapidly changing demand signal that can defy even the best demand analysts and forecasting algorithms.

Despite these circumstances, many companies fall into what could be called the accuracy trap. They believe that attainment of their supply chain objectives is contingent upon high forecast accuracy for all their products and remain stuck in a trap where they devote more time, resources and software on the unattainable perfect forecast. This kind of singular focus causes companies to miss the opportunity to achieve their objectives by focusing their efforts in areas beyond accurate forecasting.

In the real world, the perfect forecast is an impossible — and unnecessary — business goal. Plans will inevitably struggle to stay in sync with the latest customer demand, leading to gaps between actual demand and planned demand. The focus should not just be on accurate forecasts but should also include a process for reacting more quickly and effectively to changes in demand. Particular attention should also be paid to the implementation of alternative manufacturing (e.g., build-to-order), marketing and inventory strategies for products whose demand is so variable that it can never be forecasted accurately. Strong collaborative relationships among manufacturers, retailers and suppliers should also be developed to help manage demand in a more effective manner. The ultimate objective should shift from forecast accuracy to achieve the business goal, which is higher revenue, reduced costs and improved profitability.

A first step in this direction is to recognize that the demand forecast provides the start of a continuous sales and operations planning process, and should not be taken as the final plan that drives the organization. The latest demand forecast must be matched against supply availability and financial goals to develop an agreed-upon one number plan that reflects the realities of the organization's ability to ship customer orders while meeting revenue and cost objectives. Continuous monitoring and analysis of the latest demand signal, demand forecast, and available supply against this one number plan should be undertaken to understand variances and devise corrective actions. Companies have a range of business levers at their disposal (such as price, promotion and order lead time), which they can use to take corrective action and keep the company focused on its corporate goals of increasing market share and revenues. This information should also pass to the senior management team on a regular basis, allowing for the adoption of company policies that enable rapid response to opportunities and risks.

So where does forecast accuracy come into play? Forecast accuracy should not be used as an arbitrary pie in the sky goal but rather as a vehicle for understanding demand behavior and the organization's ability to predict that demand. This understanding brings with it the opportunity for organizations to develop optimized manufacturing, marketing and inventory stocking strategies and to tune the demand forecasting and sales and operations planning processes accordingly so they are in sync with forecast accuracy. Organizations can now be aware of what can be forecasted accurately and what can't, enabling them to adjust their process and strategy accordingly as well to free up resources to focus their efforts in areas where they can have the most impact.

Yes, accurate forecasts should be a focus for any organization — the more accurate the forecast, the more solid the foundation for effective sales and operations planning. And organizations should be continuously striving to increase accuracy for those products that have demand behaviors that can be forecasted with precision. But keep out of the trap. Successful demand management means understanding what can be forecasted accurately and more importantly, understanding what can't. This enables organizations to develop the right processes and policies to minimize disruptions to the supply chain and realize what they are ultimately looking for profitability.

About the Author: Karen Laucka is a Marketing director at i2 Technologies.