forecasting_rep 1/13/06 8:26 AM Page 16

STRATEGY

Three Forecasting Building Blocks

for Supply Chain Excellence

T
RICK HOOLE AND SHRUTI MANDANA

he ability to accurately predict customer impact on overall supply chain performance. It is

demand is at the heart of every companys
effort to achieve superior supply chain
performance. Research based on data
from PRTM Management Consultants
benchmarking subsidiary, The Perform-
ance Measurement Group (PMG), reveals that
forecasting performance can have a powerful
no surprise that Best Performing companies
those that have achieved superior business per-
formance across key supply chain metricsalso
achieve 20 percent higher unit forecast accuracy
than average performers. (Best Performing com-
panies are defined as the top 20 percent of com-
panies achieving the highest index score across
forecasting_rep 1/13/06 8:26 AM Page 17

Forecast accuracy is a critical element of supply chain management, but it

is an area that continues to challenge most companies. By putting in place
three key building blocksa metrics framework, appropriate processes
and incentives, and a demand-driven supply chaincompanies can
improve their forecasts, and their overall supply chain performance.

the following metrics: delivery performance, fill duction and distribution are based on long- and
rate, finished good inventory, and profitability.) short-term forecasts. The distribution of perform-
Further analysis also demonstrates a strong ance levels within the survey population is normal-
correlation between forecast accuracy and cus- ly dispersed, with nearly half the population self-
tomer facing metrics like order fill rate perform- assessed as average performers, flanked by almost
ance, on-time delivery performance, and inven- equal tails of above average and below average
tory turnover. However, while such benchmark performers. This reinforces the hypothesis that
data tells us what benefits can be achieved while forecast accuracy is a critical element of sup-
through improved forecast accuracy, it does not ply chain management, it is an area that continues
answer the million-dollar question of how this to challenge most companies.
can be realized. However, the study indicates important forecast-
In an attempt to understand and further explore ing management practice trends that distinguish
how, in the quest for the ever elusive accurate Supply Chain Performance Impact FIGURE 1
forecast, companies measure and
manage forecast accuracy perform-
ance, a recent study was conducted
Smallest
by PRTM and Chief Supply Chain
Return on
Officer (CSCO) magazine. Forecast
Investment
Nearly 40 companies submitted Accuracy Forecast
forecasting practice data through Metric Methodology
an online survey hosted by PMG. Programs Supply Chain
Consumer product companies composed the Forecast Excellence
bulk of the response. However forecast per- Process Programs
formance data from chemical, electronic Improvement
equipment, telecommunication equip-
ment, medical devices, industrial, and
automotive industry segments were Highest
also included. Return on Reduce Dependency
Almost 70 percent of the sur- Investment on the Forecast
veyed companies employ a make-
to-stock manufacturing strategy, Supply Chain
where decisions related to pro- Performance Impact
forecasting_rep 1/13/06 8:26 AM Page 18
STRATEGY
above average performers from their
average and below average peers. In
essence, the study confirms three
essential building blocks of a supply
chain excellence program targeted at
improving forecasting effectiveness and
accuracy:
1) Design and deploy an effective
metrics framework to measure fore-
cast performance.
2) Implement forecast process
improvements utilizing behavioral
incentives and other methods to
improve forecasting accuracy.
3) Create demand-driven supply
chains that reduce dependence on
the forecast.
These three practices are the founda-
tional elements to achieving break-
through improvements in supply chain
performance.
Design and Deploy
An Effective Metrics
Framework
The first step to any improvement
program is to establish an effective
measurement framework, equipped
with a yardstick to assess perform-
ance. To understand the forecasting
performance measurement frame-
works adopted by leading companies,
the survey examined how various
measurement criterialevel of prod-
uct aggregation, frequency of forecast
updates, time buckets used, and num-
ber of periods measuredare used to
construct the forecast accuracy met-
ric. In general, above average per-
formers are distinguished from their
average and below average counter-
parts on numerous criteria:
a) Product level and product classes
forecasted:
Above average performers are more
likely to measure accuracy at all levels
in the product structure (SKU, Sub-
Documenting Forecast Accuracy Assumptions
100
90%
80
% of Respondents
60
40
20
0
Above Average
FIG 2: MOST COMPANIES document forecast accuracy assumptions, as shown above.
family, and Family), but focus to a
greater extent on higher levels of prod-
uct aggregation. Additionally, while the
majority of companies use a unit vol-
ume weighted approach to report
forecast accuracy at an aggregate level,
above average performers are more
likely to use dollar volume as the
weight to report forecast accuracy
across multiple products or product
lines. Using a weighted average based
on actual revenue limits the influences
of low cost and high unit volume mod-
els on the aggregate metric while link-
ing forecast accuracy performance
more closely with other dollar based
metrics such as inventory performance
or lost profit margins due to stock outs.
b) Forecast time buckets
and horizons:
Survey results demonstrate that above
average performers are more likely to
focus resources on developing highly
flexible demand management capabili-
ties as compared with their below aver-
age counterparts. The above average
performers are more inclined to meas-
ure forecast accuracy in monthly rather
than weekly time buckets, allowing
frequent updates as new information
becomes available, thereby incorporat-
ing flexibility into the forecasting sys-
tem. Using monthly forecasting buck-
75%
63%
Average Below Average
ets, supplemented with intermittent
updates, these companies are better
able to generate a quality forecast,
while at the same time satisfying the
information requirements of manufac-
turing and procurement. The excep-
tion to this finding is in the consumer
electronics industry, where short prod-
uct life cycles and highly variable
demand often necessitate a weekly
forecast update and supply/demand
balancing process.
c) Forecast Horizon:
Most companies, including above aver-
age performers, report forecasting at
least six months out, in order to afford
better trend visibility, long-term capac-
ity planning, and planning for long
lead time raw materials.
d) Number of periods measured:
While the majority of respondents uses
a single forecast iteration to measure
accuracy, above average performers are
more likely to use a multipoint met-
ric, comprising up to four measurement
points on average, and weighted appro-
priately to report forecast performance.
Implement Forecast
Process Improvements
With Behavioral Incentives
The second step to improving forecast
accuracy performance is emphasizing
forecasting_rep 1/13/06 8:26 AM Page 19
process design and execution excel-
lence. Our survey results yield com-
pelling findings related to the use of
specific process improvement tech-
niques and organizational enablers.
a) Use statistical tools effectively:
Statistical tools, appropriately applied,
add both integrity and efficiency to the
forecasting process. Survey results indi-
cate that while, overall, 56 percent of
the respondents create a statistically
generated forecast, the vast majority of
companies with above average forecast
accuracy employ such a tool. The
above average performers primarily
focus on measuring forecast accuracy
at higher levels of aggregation, while
utilizing statistical tools to drill down
and develop forecasts at the SKU level.
Most (70 percent) of above average
performers use statistically generated
forecasts that are modified by only 10
percent to 25 percent for most units
forecasted. This top-down approach
takes advantage of higher sales forecast
accuracy at the aggregate product fam-
ily level and provides a more effective
way to gain accurate, meaningful,
unbiased market intelligence from the
sales force. Consequently, sales man-
agement can concentrate on adjusting
statistically generated baseline forecasts
as opposed to producing forecasts from
scratch, allowing them to focus on
what they do bestselling.
b) Document and measure accuracy
of forecast assumptions:
While most companies surveyed doc-
ument forecast accuracy assumptions
(see Fig. 2), only a handful of compa-
nies routinely measure the accuracy
of these assumptions (see Fig. 3). A
forecast is only as good as the
assumptions it is based upon. This is
particularly important in those
industry segments characterized by a
high incidence of event based
demand swings associated with sea-
sonality, promotional campaigns,
competitor actions, new product
launches, and variable buying pat-
terns. According to the survey find-
ings, virtually no below average per-
formers and only one in five average
performers measure the accuracy of
their assumptions. Conversely, twice
as many above average performers
include forecast assumption accuracy
as a critical component in the
demand planning process.
c) Make improved forecasting
performance a formal part of sales
management performance
expectations:
An important driver of forecast per-
formance is the ability to successfully
motivate the sales team to apply its
best efforts at creating accurate, unbi-
ased forecasts.
Survey findings indicate that after
seasonality, the top business factor
influencing forecast accuracy is inter-
nal sales performance metrics. While
60 percent of above average performers
indicate that accurate forecasts are a
key component of sales objectives, and
use forecast accuracy to evaluate job
performance, only 38 percent of aver-
age and 25 percent of below average
performers indicate that forecast accu-
racy is tied to sales performance com-
Measuring Accuracy of Assumptions
50
40 44%
% of Respondents
30
20
10
0
Above Average
FIG 3: VIRTUALLY NO BELOW AVERAGE PERFORMERS and only one in five average performers
measure the accuracy of their assumptions. Conversely, twice as many above average performers
include forecast assumption accuracy as a critical component in the demand planning process.
STRATEGY
pensation (see Fig. 4). Clearly, compa-
nies that align responsibility and
accountability achieve superior per-
formance levels.
Techniques adopted by companies in
driving sales and marketing forecast
accuracy include creating incentives
and tying some appropriate portion of
compensation to forecast performance.
Several companies today incorporate
demonstrated forecast accuracy as a
reward element of the sales bonus
structure and Management by Objec-
tive (MBO) plan. Punitive practices
also exist. Some of these include the
charging of excess inventory costs (due
to over-forecasting by sales) back to
the business unit and using forecast
performance at the district or region
level to determine product allocations
in times of tight supply.
d) Decouple forecasting from
other performance goals that might
cause the introduction of bias:
Not surprisingly, companies that can
create unbiased unit level forecasts
(that reflect a true independent view of
demand) demonstrate higher levels of
satisfaction with their forecast per-
formance. Survey findings indicate
that these companies are more likely to
19%
0%
Average Below Average
forecasting_rep 1/13/06 8:26 AM
STRATEGY
Forecast Accuracy Tied to Job Performance Evaluation
60
60%
50
% of Respondents
40
30
20
10
0
Above Average
FIG 4: FEWER AVERAGE AND BELOW AVERAGE companies tie forecast accuracy to sales performance
compensation.
employ a specialized demand manage-
ment group, whose performance met-
rics are tied to delivery performance
and inventory targets in addition to
forecast accuracy. These stand-alone
forecasting groups minimize the intro-
duction of forecast bias by distancing
themselves from the sales execution
plan. They focus on gaining cross-
functional alignment and continuously
improving the forecasting process.
Reduce Dependence
On the Forecast
Finally, PRTMs experience in this area
and prior research confirm that top-
performing companies achieve substan-
tial benefits through supply chain
excellence programs designed to reduce
dependency on forecasts. By creating
demand-driven supply chains with real
time visibility (extending beyond the
enterprise into customer and supplier
supply chains), companies can achieve
a strong competitive advantage.
Research conducted by PRTMs bench-
marking subsidiary, PMG, confirms
that the level of operational and tech-
nological maturity of an organization is
directly related to its ability to facilitate
Reprinted with adaptations from Chief Supply Chain Officer Magazine, November 2005, www.cscomagazine.com,
Copyright 2005 by Helmers Publishing, Inc., 1283 D Main St., Dublin, NH 03444, All Rights Reserved
Page 20
38%
25%
Average Below Average
cross-enterprise collaboration with sup-
ply chain partnersa critical factor
which, in many cases, distinguishes the
winners from the losers. Mature com-
panies accurately forecast their own
customer demand, as well as having
visibility into their customers invento-
ries and sell-through data. This visibili-
ty provides important leverage in a sup-
ply chain landscape characterized by
short product life cycles, customer
uncertainty, and variable buying pat-
terns. Cost of obsolescence can be
formidable in industries where invento-
ry does not age gracefully, accounting
for almost three percent of revenue.
Other proactive demand manage-
ment practices adopted by companies
to reduce their dependency on the
forecast include demand-shaping ini-
tiatives that focus on a sell what we
have approach. By changing order ful-
fillment lead times, initiating pro-
motional campaigns, and adjusting
pricing and feature/option availabil-
ity, companies are able to shift
demand to meet commitments and
manage their sales plan by shaping
demand to sell what they have.
On the supply side, pull-based
manufacturing strategies such as
postponement techniques delay pro-
duction and distribution decisions
until true customer demand can be
more accurately ascertained.
Challenges and Implications
The age old concept of consumer
sovereignty resonates more than ever
in todays markets. In a bid to gain
greater wallet share, shrinking product
life cycles, proliferation in product
variations, and promotion-oriented
marketing campaigns drive complexity
in most product portfolios. Unpre-
dictable demand, coupled with
increasing expectations for fast and
reliable service, constantly test the
resilience of supply chains. Companies
that fail to configure their supply
chains to meet this challengewhile
also reducing excess capacitywill
have difficulty translating top-line
growth into bottom-line performance.
Developing an end-to-end demand-
driven process architecture guided by
accurate and timely information, a
robust measurement framework, and
an organizational design incorporating
actions and accountabilities, is key to
both the success of the supply chain
and the larger organization. CSCO
RICK HOOLE is the lead director, Supply Chain
Management Practice, Eastern U.S. and
Europe, with PRTM Management Consultants.
SHRUTI MANDANA is Supply Chain Product
Line Manager with The Performance Measure-
ment Group, L.L.C.