Inventory Forecasting 101
One of the most enjoyable aspects of working is we get to learn new stuff — constantly, almost every day. Sometimes a blog post is all you need to gain a basic understanding of a specific topic… for instance Inventory Forecasting. If you need to learn more, we’re fortunate to have an abundance of online learning options available today, such as: MIT OpenCourseware, Coursera, The Iron Yard, udemy.com.…there are so many options!
In a past post, I covered finding the right forecasting software. This post covers what I learned about inventory forecasting during that project. If you do forecasting for a living, this article is NOT for you (feel free to tell me what I’ve missed). But for those of you in IT or executive management, having a general knowledge of forecasting may be helpful (at the very least, knowledge is never a bad thing). So, here we go…
I decided to use a forecasting software replacement project as an opportunity to learn more about the ins and outs of inventory forecasting. This post will just cover the basics. And we’ll begin by providing some context — this company has approximately:
- 8,000 active products
- 1,000 active vendors
- 2,000 active customers
- 100,000 units shipped per day
The company is a distributor who buys and sells products all day, every day. Profitability is based largely on buying deals and the price at which products are sold, but there are other factors that can improve margins and cash flow as well, such as inventory turns and control of lost sales. That’s exactly where forecasting software can help.
Forecasting Software 101
Why do companies use forecasting software? To save money, increase revenue, and optimize profits. How does forecasting do this? There are many answers to this question, but here’s a summarized version: By allowing your buying group to purchase the best deals, by minimizing your inventory carrying costs, and by minimizing lost sales/maximizing product sales. Let’s look at these areas in more detail.
Get the Best Deals
There are a bunch of scenarios that fall into this money-saving category, such as:
- Min/max – Some vendors may have requirements around minimum or maximum (weight, quantity, whatever). If you order outside of their requirements, you may pay more.
- Bracket levels – Defines multi-level pricing. Quantity-based discounts fall into this category, but it also may include regular/net costs, volume, etc.
- Lead times – Most vendors have established lead times that define how long it will take to receive the product once you have ordered it.
- Replenishment frequency – Some products benefit from daily replenishment, while others may benefit from weekly, monthly, or on-demand. Vendors may give discounts for certain frequency commitments.
- Vendor deals – Vendors may offer deals such as buy one/get one (BOGO), combo deals, seasonal specials, or any other format for moving certain products.
Minimize Inventory Carrying Costs & Minimize Lost Sales
Proper inventory management involves careful balance. If you carry too much inventory, your carrying costs are high. And if you run out of inventory you end up with lost sales. Inventory carrying costs and lost sales are two sides of the inventory control challenge.
Forecasting software helps you find that balance by helping track a myriad of variables, such as:
- Lead Time Forecasting = Some vendors have consistent lead times, while others just guess. If lead time is uncertain, you should increase safety stock, covered next.
- Safety Stock = Helps avoid possible out-of-stocks when bad things happen, such as a delivery date being missed.
- Order Cycle Analysis = Number of days between ordering. Try to find the optimal combination to minimize carrying cost and acquisition cost. Too much inventory on hand and/or having inventory you don’t need will increase your carrying cost. Ordering at the last minute and/or placing special orders will increase acquisition cost. Of course, running out of inventory should also be avoided since this will result in lost sales (missed revenue) or backorders (higher costs).
- Service Level Targets = Typically tracked as a percentage. For example, 98% means that 98% of the time, the product is available to customers. Another way to think about this is 2% of the time we’re willing to have this product be unavailable. Setting this to 100% may ensure the product is always available, but it may also cause you to keep too much product on-hand, which increases your carrying costs. Unless you have a warehouse of unlimited size, you’ll need to set service levels to something other than 100% on most of your products.
If your company buys and sells products at a high volume, you will definitely benefit from forecasting software. Tracking all of the variables manually is difficult (at best) and will cost your company significantly more money in the long run (at worst). If you are looking for inventory forecasting software, check out my prior post on this subject.