Forecasting Methods: Segmentation Of Products (E)
by Laurus Nobilis
 

Posted: Nov 2009

High forecast accuracy is the backbone of effective demand planning. High forecast accuracy enables proper planning of inventories. Right level of inventories enables optimal working capital engagement, fresh product, no stock-out, optimal flow of process and satisfied customer. Everything starts with forecast. If forecast accuracy is high, other business processes can be planned in a efficient manner.

Low and variable forecast accuracy leads to overall supply chain issues. The range of problems that can be caused with low forecast accuracy is really wide. Low forecast accuracy can cause high inventory levels. On the other hand, low forecast accuracy can lead to stock out and low service level.
 
 Consequently, low forecast accuracy is causing chain reaction across the supply chain. Due to fluctuation of sales versus demand the problems with distribution may occur, either as lack or surplus of capacity. The lack of capacity may lead to lower service level due to extended delivery lead time and extra cost of unexpected hiring of additional distribution capacity. The low utilization of distribution can cause increase of cost per units delivered and/or extra costs of penalties payment to third party delivery agents, due to lower delivery volume than it is agreed.

 
At same time additional warehouse costs are appearing. Underutilized warehouse is increasing the cost per units manipulated, since fixed costs are the same, whether the warehouse is full or empty. In case that the capacity of warehouse is insufficient due to demand higher then forecasted, it is causing additional costs of external warehousing and extra shipping and handling.

As it is obvious, the forecast accuracy is impacting the flow through whole supply chain. If forecast is low, than the whole downstream through the supply chain is inefficient. There are many things that can increase forecast accuracy. One of approach is segmentation of products during demand forecasting. 

One of common mistakes of demand planners is that they pay the same approach to forecasting all SKUs. This may be caused by the fact that demand planner is skilful with forecasting and statistical tools, but does not have sufficient understanding of the business. 

How can segmented approach assist to demand planner? The segmentation approach is grouping products into categories, according their sales volume and average forecast error. Different groups require different approach. 
 

Next: Forecasting Product Segmentation Matrix

Recommended Reading:

Demand Forecasting 
Forecasting Accuracy