Forecasting plays a significant role in the sales and operational planning (S&OP) of a company; it can underpin the strategy for how a company runs their business. It serves as an important process to project, balance and look after supply and demand. Ultimately, S&OP can help a company reach their goals and help them get back on track if something isn’t going to plan.
Often these large-scale planning processes will be filled with new modes of integration and terminology that can become confusing or unclear. Constrained forecasts and unconstrained forecasts frequently fall into this category. Understanding the difference between constrained and unconstrained is paramount for executing the S&OP process. Let’s break down the main differences between the two forecasts and see how each can benefit from the planning process.
During the S&OP, the process is initiated with the demand signal. The unconstrained forecast is built from the true demand potential that exists when conducting your forecast. This forecast does not account for any constraints that could have an impact. These constraints could include capacity, materials, storage for inventory stock, and the amount of cash-flow the company is operating with. Essentially, the unconstrained forecast provides an assessment of anticipated sales volumes that are not impacted by the supply capacity.
Let’s look at a basic unconstrained forecast for a hairbrush company. The hairbrush company says they have capacity to produce 250,000 hairbrushes a month. However, the demand signal may indicate that there is demand for 450,000 hairbrushes per month. Therefore, the unconstrained forecast will show 450,000 hairbrushes per month.
On the other hand, constrained forecasts consider the operational capacity and constraints of a business. These operational factors will highlight realistic impacts that an unconstrained forecast does not account for. This forecast will compile information about capacity, materials, storage for inventory stock and cashflow. It then applies it to the forecast which yields a more realistic and achievable forecast.
In the example above, the unconstrained forecast was 450,000 hairbrushes per month. However, currently the company has the capacity to only produce 250,000 hairbrushes a month. This realistic production number considers the current capacity of their production line and where they can store the inventory stock once it leaves the production line. It puts a cap on the forecast numbers because that’s all they can realistically manage in the business.
Do we need both?
Lots of companies find it helpful to divide and measure the gap between the unconstrained and constrained demand forecasts. If the distance between the two is significant, it can signal a lost opportunity to realise sales that go beyond the current capacity. Companies should look closely at unconstrained forecasts to gauge demand signals and look to a constrained forecast to decide what is realistic. A constrained forecast can be used for financial purposes, while an unconstrained forecast is often used to set pricing.
In the previous example, the unconstrained forecast indicated 450,000 hairbrushes were in demand per month, but the company was constrained to 250,000. That’s nearly 200,000 hairbrush sales that the company is missing out on. The insight from the unconstrained forecast can encourage management to increase their output capacity and mitigate current constraints more effectively.
Article by Melanie Chan in collaboration with our team of Unleashed Software inventory and business specialists. Melanie has been writing about inventory management for the past three years. When not writing about inventory management, you can find her eating her way through Auckland.