This article was updated in March 2023 to reflect current trends and new information.
Understanding and predicting customer demand is vital for businesses to avoid stock-outs, maintain adequate inventory stock levels and increase overall profitability. It also has a major impact on cash flow and liquidity.
In this article, we explore the ins and outs of demand forecasting: what it’s for, the benefits, and the best practices.
What is demand forecasting?
Demand forecasting is the process of estimating the number of products that customers will be willing to purchase in the future. It involves leveraging data and analytics about your product and the market to closely predict customer demand over a particular time frame.
What is demand planning?
“It is critical that organisations develop the right demand planning process to improve effectiveness…without a functioning process, obtaining a consensus-driven demand plan will prove extremely challenging.”
– Steven Steutermann, Research Vice President at Gartner
Demand planning refers to the use of forecasts and experiences in estimating demand for different items at different points in the supply chain.
Demand planning should work as an active part of your company’s resource planning system in order to forecast purchase and inventory requirements and predict customer buying habits. This ensures inventory stock levels are optimised while meeting customer demands.
Various information or inputs are necessary for effective demand planning so it can properly inform demand forecasting.
There are several types of inputs required, including:
- Historical sales data – using a two to five-year period is generally best practices for most systems in order to analyse sales activities and identify trends.
- Manufacturer forecasts – knowing what your supplier trends have been and will help in the analysis.
- Seasonal factors – carefully review all products for seasonal activity. Also, note if there are other factors besides the season that could be affecting the trend. For example, could a special event trigger a peak in sales?
- Constraints or business rules – does your business always purchase at certain levels to take advantage of a discount or reduce freight expenses? Are there limitations in warehouse space to consider?
Learn more: Supply Chain Planning Guide
5 benefits of demand forecasting
Demand forecasting is a critical component for many businesses, so let’s focus on some of the fundamentals that provide value.
Here are 5 major benefits of demand forecasting:
1. Meet customer expectations
When you have accurate demand forecasting, you will have the products your customers want, when your customers want them. Problems arise when you don’t have the right amount of inventory stock to meet demand. Customers get frustrated and you risk losing them if you cannot provide the product.
2. Decrease the cost of inventory
Demanding forecasting can also play a significant role in decreasing the amount of money spent on inventory. If the amount of inventory is accurately forecasted then you only need to have enough inventory space and employees to manage it.
Inventory costs can skyrocket when you have an excess of inventory stock and you bring too many people on board to look after it.
3. Minimise safety stock
Accurate demand forecasting can help you to prevent resource wastage such as obsolete or excess safety stock. Excess stock happens when inventory is ordered but not sold – for whatever reason – leading to financial wastage.
By forecasting demand accurately, you can mitigate the risk of ordering large amounts of unpopular products which have lost favour with your customer base.
4. Repeated success
By looking at historical sales data and trends as part of a comprehensive demand forecasting plan, inventory managers can look at what has worked in the past and repeat it where appropriate.
For instance, you may find that the previous summer sale brought in a lot of new customers. You can use this information to repeat the sale in the future.
5. Better cash flow
Accurate demand forecasting can have a dramatic impact on your use of working capital and the preservation of your cash flow. Having money tied up in excess stock can stress your company’s ability to make debt repayments and inhibits your investments in growth and development.
Demand forecasting best practices
Once the inputs we mentioned earlier are available, in order to effectively maximise your demand forecasting system results, follow these three key practices.
Include customers in your analysis
By factoring customer planning and forecasting information you can reduce forecast errors and have a more predictable demand model. Best industry practices use monthly or weekly inputs regarding customer inventory stock planning and also knowing in advance about promotional opportunities.
Often manufacturers and suppliers have additional insights and information about product availability that can improve your insights, particularly new product information can be valuable.
Apply demand sensing & shaping techniques
This approach examines demand from a more holistic view, grouping items into segments with common demand requirements. The shaping process can influence downstream supply chain activities and help to balance your inventory stock for the best ROI.
6 highly useful demand forecasting tips
When many businesses forecast demand, even the most studious companies will not get it 100 percent accurate, instead of perfection, the focus should be on minimising errors.
Here are some tips to help you get it right.
1. Strike a balance
Find the equilibrium between statistical modelling and collaborative forecasting. Using both of these methods helps improve accountability for the businesses ability to forecast demand more accurately and enables continuous improvement across the company.
2. Don’t just focus on historical data
Historical demand data is useful for establishing a baseline for forecasting future demand.
However, historical data is not always the best indicator of a company’s final demand. If you only consider what happened the previous year and neglect everything that is taking place in the current market, your demand forecast will be incomplete.
3. Identify significant factors and adapt
There are many factors such as economic, social, climate, and political, that can affect demand forecasts. These factors could be circumstantial or a more profound trend change.
For example, the use of technology can account for directly influencing consumer habits in a very important way. Each customer segment, also called demand flows, has its own purchasing behaviour.
Your business’ ability to adapt to changes will help you stay competitive.
4. Measure forecast accuracy at different levels
Demand forecasting may be undertaken at three different levels: the item, location and customer level.
Customer or sales forecast accuracy should be measured for continuous improvement and accountability. The appropriate place to measure for continuous improvement is in the sales and operations planning review process.
5. Account for lead times
As customer demand is at its highest point during the year in a business’ peak season, ensuring lead times are well accounted for is a no brainer.
However, it is important to note that if you have suppliers in other parts of the world you will need to factor in that lead times will have their own seasonality, such as cultural events like the Chinese New Year and Diwali, that can have economic implications of suppliers.
6. Monitor economic drivers
Economic drivers represent all the forces that generate opportunities or costs for your business.
In order to forecast more accurately, economic drivers need to be taken into account of beyond pure demand, especially for peak season.
Take for example, when considering two products with the same expected future demand, the final purchase order decision can be very different if one product is expected to be long-lasting, while the other is perishable – the demand levels might be equal but the respective inventory risks aren’t.