Answer Happy

1. What level of reliance should firms place on demand
forecasting and supply chain management technologies? Why?
2. Have you observed situations in your work or organizations
you know well where DF or SCM technologies have been used? How
effective are they? How can you guard against extremes or
misinterpretations?
READING GAZING AT THE CRYSTAL BALL BY RAM REDDY Disregarding Demand Forecasting Technologies during Tough Economic Times Can Be a Costly Mistake Caught up in the general disillusionment with IT in a downturn has been demand forecasting (DF) technologies. Many companies blame DF technologies for supply chain problems such as excess inventory. Pinning the blame on and discontinuing DF technologies is the equivalent of throwing out the baby with the bathwater. The DF misunderstanding stems from the fact that, despite sophisticated mathematical models and underlying technologies, the output from these systems is, at best, an educated guess about the future. A forecast from these systems is only as good as the assumptions and data used to build the forecast. Even the best forecast fails when an unexpected event-such as a recession-clobbers the underlying assumptions. However, this doesn't imply that DF technologies aren't delivering the goods. But, unfortunately, many DF and supply chain technology implementations have recently fallen victim to this mindset. DF is part science and part art (or intuition)-having the potential to significantly impact a company's bottom line. In this column, you'll find an overview of how DF is supposed to work, which you can compare with how most companies actually practice it. I'll conclude with suggestions on how to avoid common mistakes when implementing and using this particular class of technologies.
The Need for DF Systems DF is crucial to minimizing working capital and associated expenses and extracting maximum value from a company's capital investments in property, plant, and equipment (PPE). It takes a manufacturing company a lot of lead time to assemble and stage the raw materials and components to manufacture a given number of products per day. The manufacturing company, in turn, generates its sales forecast numbers using data from a variety of sources such as distribution channels, factory outlets, value-added resellers, historical sales data, and general macroeconomic data. Manufacturing companies can't operate without a demand forecast because they won't know the quantities of finished goods to produce. The manufacturing company wants to make sure all or much of its finished product moves off the store shelves or dealer lots as quickly as possible. Unsold products represent millions of dollars tied up in inventory. The flip side of this equation is the millions of dollars invested in PPE to manufacture the finished products. The company and its supporting supply chain must utilize as close to 100 percent of its PPE investments. Some manufacturing plants make products in lots of 100 or 1,000. Generally, it's cost prohibitive to have production runs of one unit. So how do you extract maximum value from your investments and avoid having money tied up in unsold inventory? DF and supply chain management (SCM) technologies try to solve this problem by generating a production plan to meet forecasted demand and extract maximum value from PPE, while reducing the amount of capital tied up in inventory. Usually, the demand forecast is pretty close to the actual outcomes, but there are times when demand forecasts don't match the outcomes. In addition to unforeseen economic events, a new product introduction may be a stellar success or an abysmal failure. In the case of a phenomenal success, the manufacturing plant may not be able to meet demand for its product.
Consider the case of the Chrysler PT Cruiser. It succeeded way beyond the demand forecast's projections. Should it have started with manufacturing capacity to fulfill the runaway demand? Absolutely not. Given the additional millions of dollars of investment in PPE necessary to add that capacity, it would've backfired if the PT Cruiser had been a flop. The value provided by DF and supporting SCM technologies in this instance was the ability to add capacity to meet the amended forecast based on actual events. Demand forecasts can and do frequently miss their targets. The point to underscore here is that the underlying DF and supporting SCM technologies are critical to a company's ability to react and respond in a coordinated manner when market conditions change. The manufacturing company and its supply chain are able to benefit from sharing information about the changed market conditions and responding to them in a coordinated manner. Despite best practices embedded in DF and SCM technologies to support this manner of collaboration, it plays out differently in the real world. How It Works in Real Life-Worst Practices A company prepares its forecast by taking into account data about past sales, feedback from distribution channels, qualitative assessments from field sales managers, and macroeconomic data. DF and SCM technologies take these inputs and add existing capacities within the company and across the supply chain to generate a production plan for optimum financial performance. There's been incredible pressure on executives of publicly traded companies to keep up stock prices. This pressure, among other reasons, may cause manufacturing company executives to make bold projections to external financial analysts (or Wall Street) about future sales without using the demand forecast generated from the bottom up. When the company realizes this disparity between the initial projection and the forecast, the forecast is changed to reflect the projections made by the company's officers, negating its accuracy.
The company arbitrarily sets sales targets for various regions to meet Wall Street numbers that are totally out of sync with input provided by the regional sales managers for the DF process. Even though the regional sales managers' input may have a qualitative element (art), they tend to be more accurate, given their proximity to the customers in the region. Unfortunately, the arbitrary sales targets make their way back to the supply chain, and the result is often excessive inventory buildup starting at the distribution channels to the upstream suppliers. Seeing the inventory pile up, the manufacturing company may decide to shut down a production line. This action affects upstream suppliers who had procured raw materials and components to meet the executive-mandated production numbers, which may cause them to treat any future forecasted numbers with suspicion. Most cost efficiencies that could be obtained through planned procurement of raw materials and components go out the window. It's very likely that the companies try to blame DF and SCM technologies for failing to provide a responsive and efficient supply chain, even though the fault may lie in the company's misuse of the technologies and not the technologies themselves. Guarding against the Extremes Earlier in this column, I said that DF is part art or intuition and part science. The art/intuition part comes in when subject-matter experts (SMEs) make educated estimates about future sales. These SMEs could range from distribution outlet owners to sales and marketing gurus and economists. Their intuition is typically combined with data (such as historical sales figures) to generate the forecast for the next quarter or year. During a recession, the SMEs tend to get overly pessimistic. The demand forecasts generated from this mindset lead to inventory shortages when the economy recovers. Similarly, during an economic expansion, the SMEs tend to have an overly rosy picture of the future. This optimism leads to inventory gluts when the economy starts to slow down. In both instances, blaming and invalidating DF and SCM technologies is counterproductive in the long run.
It's very rare that a demand forecast and the actual outcome match 100 percent. If it's close enough to avoid lost sales or create an excess inventory situation, it's deemed a success. DF and supporting SCM technologies are supposed to form a closed loop, with actual sales at the cash register providing a feedback mechanism. This feedback is especially essential during economic upturns or downturns. It provides the necessary information to a company and its supply chain to react in a coordinated and efficient manner. Don't let the current disillusionment with DF and SCM technologies impede the decision-making process within your company. The intelligent enterprise needs these technologies to effectively utilize its capital resources and efficiently produce to meet its sales forecasts. Ram Reddy is the author of Supply Chains to Virtual Integration (McGraw-Hill, 2001). He is the president of Tactica Consulting Group, a technology and business strategy consulting company.