How can you measure the cost of inaccurate demand forecasting?

1 Why accuracy matters

Inaccurate demand forecasting can have serious consequences for your business. If you overestimate the demand, you may end up with excess inventory that ties up your capital, occupies your storage space, increases your handling and maintenance costs, and risks becoming obsolete or spoiled. If you underestimate the demand, you may face stockouts that result in lost sales, dissatisfied customers, damaged reputation, and lower market share. Either way, you are losing money and opportunities.

2 How to measure the cost

There are different methods to measure the cost of inaccurate demand forecasting, depending on the type and magnitude of the error. One common method is to calculate the inventory holding cost and the stockout cost for each product or category. The inventory holding cost is the sum of the cost of capital, storage, insurance, taxes, depreciation, and obsolescence for the excess inventory. The stockout cost is the sum of the lost profit, lost goodwill, lost future sales, and emergency orders for the unmet demand. By comparing these costs with the optimal inventory level, you can estimate the total cost of inaccurate demand forecasting.

3 How to improve accuracy

Improving the accuracy of your demand forecasting is an ongoing process that requires learning and adaptation. To enhance your accuracy, you should pick a forecasting method that fits your data characteristics, product life cycle, and business objectives. You can opt for qualitative or quantitative methods such as surveys, market research, trend analysis, regression, exponential smoothing, moving average, or machine learning. Additionally, you should collect and analyze data from multiple sources like sales history, customer feedback, market trends, competitor actions, seasonal patterns, promotional events, and external factors. You can use data visualization, statistical tools or software applications to help with the processing and interpretation of the data. Furthermore, you should update and revise your forecasts regularly to reflect changes in demand and supply conditions. Techniques such as forecast error measurement, forecast accuracy tracking or forecast adjustment can be used to monitor and improve your forecasts over time. Lastly, it’s important to collaborate and communicate with stakeholders like suppliers, customers, salespeople, production managers and inventory planners. Platforms such as CPFR or S&OP can be used to share information, align expectations and coordinate actions.

4 How to mitigate the risk

Even with the best efforts, you cannot eliminate the uncertainty and variability in demand forecasting, so you need to have contingency plans and strategies to mitigate the risk of inaccurate demand forecasting. To do this, you can maintain a safety stock or buffer inventory to cover unexpected fluctuations in demand or supply. You can also implement a flexible and responsive supply chain that can adapt to changes quickly and efficiently. Additionally, diversifying your product portfolio and customer base can reduce your dependence on a single product or market. All of these techniques, such as reorder point (ROP), economic order quantity (EOQ), lean, agile, hybrid supply chain models, just-in-time (JIT) production, vendor-managed inventory (VMI), dropshipping, product differentiation, market segmentation, and cross-selling can help increase your sales potential and customer loyalty while reducing inventory costs and lead times.

5 How to measure the benefits

By measuring the cost of inaccurate demand forecasting, you can also measure the benefits of improving it. You can use metrics such as inventory turnover, service level, fill rate, customer satisfaction, or profitability to evaluate the impact of your demand forecasting accuracy on your inventory management performance and business outcomes. By tracking and reporting these metrics, you can demonstrate the value of your demand forecasting efforts and justify your investments in data, technology, and people.

6 Here’s what else to consider

This is a space to share examples, stories, or insights that don’t fit into any of the previous sections. What else would you like to add?