8 factors to improve inventory demand forecasting accuracy
- What is inventory demand forecasting?
- The importance of forecasting accuracy
- Demand forecasting techniques for improved forecasting accuracy
Demand forecasting plays a critical role in inventory management. If you can accurately predict the future demand of the products in your warehouse, you can ensure you hold the correct stock to maximise sales potential and profit. However, producing an accurate inventory demand forecast is no mean feat. Read on for some top tips on demand forecasting techniques and best practice…
But first – let’s get a definition:
What is inventory demand forecasting?
Inventory demand forecasting is the process of predicting customer demand for an inventory item over a defined period of time. Accurate inventory demand forecasting enables a company to hold the right amount of stock without over or under-stocking, for optimum inventory control. Historical data trends and market knowledge of how demand can fluctuate are often used to forecast inventory demand.
The importance of forecasting accuracy
Ensuring demand forecasting accuracy should be a key responsibility for any conscientious inventory planner. In short, accurate demand forecasting helps you:
- Improve customer satisfaction – Customers have zero tolerance for out of stock scenarios. Ensuring product availability keeps positive reviews flowing.
- Optimise inventory levels – Setting safety stock levels based on accurate forecasts will prevent stock-outs without holding excess stock.
- Manage supplier lead times – By giving suppliers a forecast of your annual inventory needs, they can plan to meet your delivery deadlines.
- Prevent lost revenue – Out-of-stock scenarios lead to lost sales, not only for that product, but for companion items too.
Demand forecasting techniques for improved forecasting accuracy
There are many demand forecasting techniques a business can implement. These include both quantitative demand forecasting and (using historical demand data) and qualitative demand forecasting (based on more subjective opinions and insights). Let’s take a closer look:
1. Inventory demand types
If you analysed the historical sales data of every product in your warehouse, you’d find that the demand for different items varies considerably. Some will have consistently high demand over time, for others there could be sporadic or low demand.
In addition, as products move through their product lifecycle, from market entry, to maturity and decline, their demand types will keep changing:
An item’s demand type is important as it should be used to determine the type of calculation (or algorithm) you use for forecasting. It makes statistical sense to use a different equation to calculate the demand of a product with an erratic demand type, to one with slow demand.
Calculating your base demand is just the start of producing accurate demand forecasts. Below is an example of the different demand factors that can impact or inflate your normal base demand.
2. Inventory demand trends
The demand for your products will eb and flow as fashions change, new technologies replace old and social, economic and legal factors influence demand.
Products will also follow demand trends as they move through the product cycle. For example, in the growth phase, the trend in demand will be upwards, whilst in the decline phase, the trend will reverse.
Make sure you look out for such trends in your historical demand data and adjust your forecasts accordingly. There’s no point creating a forecast based solely on your base demand if items are following a specific trend.
3. Seasonality of demand
Almost every manufacturer, distributor or retailer can expect to see seasonal demand fluctuations for some of their product lines. Seasonal weather patterns, school holidays and annual traditions all have a seasonal influence on demand.
Understanding how these seasonal factors affect your customers’ purchasing habits will help you take advantage of peaks in demand and plan for the troughs.
Best practice is to keep seasonal demand factors separate from your base demand calculations. This keeps the data clean and easier to use for forecasting going forward.
4. Qualitative inputs
Whilst historical data provides a great basis for achieving demand forecasting accuracy, sometimes you’ll also need to consider more qualitative factors. These include future events and external market factors, such as sales promotions and competitor activity.
Make sure you input any sales and marketing insights you have into your forecasts to make them as accurate as possible.
5. Inventory demand forecasting outliers
Unusual demand outliers can be the result of known actions (sales promotions, large one-time orders, employee strikes etc) or unpredictable events (a competitor going out of business, natural disasters etc).
Take the time to analyse your inventory forecasting data to detect outliers, as they can significantly skew the accuracy of your forecasts. Any demand data – high or low – outside of the reasonable standard deviation of average demand needs to be identified. You then need to make a judgement call on whether it should be included in your demand forecasting calculations (if it’s part of a trend) or not (if it’s an anomaly in demand).
6. Inventory demand forecasting techniques for accuracy
Your demand forecasts are very unlikely to be 100% accurate. So, if you can calculate the level of error in your previous demand forecasts, you can factor this into future forecasts. If you can determine how uncertain a forecast is for a given business period you can make the necessary adjustments to your inventory management rules, such as increasing safety stock levels to cover uncertain periods of demand.
There are many formulas to help you measure forecast accuracy, or forecast error. The Mean Absolute Percent Error (MAPE) will calculate the mean percentage difference between your actual and forecasted demand over a given period. Whilst the Mean Absolute Deviation (MAD) shows the deviation of forecasted demand from actual demand in units. You can learn more about forecasting error here.
7. Demand forecast periods and reviews
The time period you choose for your demand forecast has a direct impact on the accuracy of your forecast. For example, a forecast looking at your inventory’s demand over the next two weeks is much more likely to be accurate than a forecast that looks 12 months out.
In addition, if markets are volatile, or an item’s demand pattern is erratic, you’ll need to review your forecasts on a much more regular basis than in slow markets or for slow moving products. If you begin to experience stockouts or see cases of excess stock, then you may need to adjust your forecasting intervals.
8. Consider inventory optimisation software
Accurate inventory demand forecasting is not a simple task. Especially if you want to track each sku and you have a large product portfolio. Demand forecasting also requires an accurate picture of the stock levels in your warehouse and your sales across each channel.
Inventory optimisation software offers a fast and accurate means of forecasting, no matter how complex or varying the demand. Whilst enterprise resource planning systems (ERP), warehouse management systems (WMS) and ecommerce platforms can offer a certain level of forecasting, investing in inventory optimisation software supports more complex demand forecasting requirements.
Systems such as EazyStock will ensure you have a tool to swiftly and accurately complete your complex demand forecasting requirements in order to reduce stock-outs, decrease tied-up capital and, most importantly, meet customer requirements.