Supply Chain Best Practices: Demand Forecasts, Anticipated Lead Time and Safety Stock
Published: July 15, 2016
Supply chain cooperation cannot be successfully accomplished without sharing information. This information includes:
- Demand forecasts
- Anticipated lead times
- Safety stock quantities
Demand Forecasts Best Practices
The five elements of an accurate demand forecast are:
- Past usage of the product (excluding any usage that results from CPFR information – It is important that you don't count information from a customer twice)
- Trends – Is usage increasing or decreasing in popularity over time?
- Seasonality – Is usage predictably higher or lower during certain time of the year?
- Upcoming promotions or events
- Industry and market knowledge provided by sales, management and other sources
Often a "total forecast' will be the sum of collaborative forecasts from certain customers and the results of a formula which utilizes these five elements. Calculating an accurate forecast may seem like a complicated process. But it doesn't have to be. Start by monitoring the accuracy of your current forecasts by using the formula:
The absolute value of (Actual Usage – Forecast) ÷ The smaller of the Forecast or Actual Usage
Examine those products with a high forecast error (maybe greater than 50% - 75%). For each of these items ask:
- Was usage of the product affected by activity that probably will not reoccur?
- Is the product experiencing the start of a new sales trend?
If neither of these conditions is true you need to look at the information and formula you are using to calculate the forecast and determine if there is a better way to predict future demand of the product. Be sure to share your forecasts with your suppliers to help them better predict how much product they need to produce to fulfill your needs.
Anticipated Lead Times Best Practices
Accurate forecasts are an important element in achieving the goals of effective inventory and supply chain management. But you also have to know when to place a replenishment order. Anticipated lead times represent the amount of time it will take you to replenish your inventory from the primary source of supply. An accurate forecast and knowing your anticipated lead time allows you to calculate an order point (or minimum stock quantity) for each item. For example, if you have a forecast of two pieces per day and a lead time of seven days you should reorder a product when there are no less than 14 pieces left in inventory (i.e., 2 pieces per day * 7 days = 14 pieces). If you reorder the product when there are less than 14 pieces in stock you will probably experience a stock-out before the replenishment arrives. An accurate lead time is comprised of four elements:
- The time it takes you to place an order
- The time it takes the vendor to process the order and ship the material
- The time it takes to ship the material to your warehouse
- The time it takes you to prepare the stock receipt for sale or use
As with the forecast, it is important to analyze the accuracy of lead times. A best practice is to utilize a report that informs the buyer if the lead time associated with a stock receipt that just arrived is:
- 50% greater than the existing anticipated lead time
- 50% less than the existing anticipated lead time
- More than a week early or a week late
The buyer should contact the vendor to determine if this exceptional lead time was caused by factors that will not reoccur or is representative of how long it will take to obtain the product in the future. This helps to ensure that you place the next replenishment order at the right time. Again, questioning your supply chain partners and sharing information benefits everyone. If a vendor's lead times are continually inconsistent you probably want to see if you can buy similar products from another supplier. Reliable sources of supply are critical for your long term success.
Safety Stock Best Practices
No matter how much effort you put into calculating an accurate prediction of future demand, it is still an estimate. There is a chance that you will sell more than you forecast. There is always a possibility that you will experience a delay in receiving a replenishment shipment. For this reason, it is a good idea to maintain some additional inventory or "safety stock," especially for items that are critical to your customers or operations. Safety stock is reserve inventory maintained to avoid stock-outs due to unexpected demand or delivery delays. Calculating the most accurate forecast possible and maintaining anticipated lead times that reflect how long it will take to obtain material allows you to keep less safety stock while delivering superior service to your customers.
One of the best ways to determine appropriate safety stock quantities is to base the calculation on the average deviation or "difference" between the forecast and actual usage as well as the average deviation between the anticipated and actual lead times. You will maintain more safety stock for items whose usage and lead times are hard to predict. Lowering your safety stock quantities reduces your overall inventory investment. The results usually lead to increased profitability and success.