A company’s inventory is a significant asset on their books, however, if frequent shortages or excess happens, it can become a significant liability, costing the business’ bottom line. It is imperative to manage inventory appropriately so that supply and demand are always balanced. However, all the inventory management techniques and software in the world will not solve the problem if forecasting is not done appropriately. For this, we must understand the nature of supply and demand constraints and how they affect Sales and Operational Planning (S&OP). We then can appreciate unconstrained and constrained forecasting, where they both shine and how they affect inventory procurement.
Supply and demand
A customer wants a product or service which creates demand, and a company seeks to supply this demand. This is a generic and rather simplified view, however, if we take it further, we can group different activities in a company into the supply or demand boxes and can see how they affect our forecasting.
Promotional activities and marketing form part of the demand activities of a company as this generates awareness and subsequent demand in the customer. When conducted appropriately, an optimum level of demand can be generated. Procurement, logistics and manufacturing form the supply side of the company where they work tirelessly to supply the demand created by the marketing department.
An unconstrained forecast exists at the start of the S&OP process and must have no supply constraints imposed on it. This type of forecast does not factor in supply constraints as it aims to generate a picture of what could happen in terms of demand and profitability if the company was able to fulfil every order every time with no issues. This is the ideal and where every company wants to be, however, the reality is that supply constraints exist and must be considered. So, we keep the unconstrained forecast and then we develop a constrained forecast from it.
This is the forecast which incorporates all the known supply constraints that exist for the company so that the end product is a realistic picture of supply and demand and what the company can feasibly manage in terms of fulfilling orders.
Integration of the two and the vitality of each
If a company finds that they will not feasibly be able to service the forecasted demand in the unconstrained forecast with their current resources and capabilities, they have a choice to make: either they can adapt their resources to increase their supply capability or they can adapt the demand plan so to reduce the unconstrained forecast to match their supply capability.
The importance of each forecast, unconstrained and constrained, comes to light in an Executive S&OP Meeting where supply, demand and future resources are being discussed. If you present only the constrained forecast, you certainly are giving the Executive Team a realistic picture, however, this provides no incentive to improve resources, scale up operations, increase supply and generate more income. What you should aim to do is provide them with a picture of what the company is and what the company can become to impress upon them the importance of supporting continued growth and resource provision.
Unfortunately, this can also swing the other way whereby if the unconstrained forecast shows no real gains in terms of profitability, then the Executive Team could choose to retract resources and downsize operations to focus resources on more profitable areas.
Whatever the outcome of presenting both a constrained and unconstrained forecast, it is vital to provide both to decision-makers. Together, they give a better representation of the current supply and demand, and future profitability.