Believing business forecast for your company.

This week I read of a company supplying materials into the American building and construction industry which has severely overestimated the strength and speed of the national recovery in building activity.

The CEO forecast and the Board accepted that US housing starts would rise by between 15 and 18 percent against the previous year’s starts. However, the increase ranges between 6 and 8 percent. It’s not a good look for management, but what is the likely effect on the company’s supply chains and costs?

Within the company, the high forecast identified a need to increase production and warehouse capacity of current facilities; also the need to build new factories and DCs over the next three years. This decision will require substantial capital expenditure that cannot be used elsewhere in the business..

Increasing capacity and building new factories is a project requiring full time project management skills. Unfortunately, too many companies see it as a part time job for the current executive team and it appears this business took the same approach. They did not handle the once-off ramp-up of capacity adequately, therefore production efficiency dropped.and unit costs increased.

Behind this tale of woe is the situation of high production schedules (with overtime or additional shifts?), probable increases in inventory levels and suppliers given inflated forecasts and orders. The total cost was a reduction in net profit of 80 percent on the previous year’s results.

Good forecasts will save your business money

How this company got its forecast so wrong was, of course, not explained, but could the CEO have pushed the demand analysts to be overconfident in their forecasts? I experienced a similar situation at a company that made products for the building and construction industry. The CEO and Sales Director pressured the demand analyst to provide optimistic forecasts, even though the sales managers knew they were unachievable – it was all to do with annual bonuses.

Instead, for planning the factories and contracting with suppliers I used the analyst’s more honest forecasts. These were by product type within their group, with an optimistic and pessimistic range and incorporating probabilities for each that reflected the likelihood of the forecast occurring.

Using these forecasts, BOM items with long lead times were acquired at the optimistic forecast level. Easily obtained items were acquired at the pessimistic forecast level, with provisional orders to increase the volume to the optimistic level at short notice. For inventory planning and production schedules the same approach was used.

As the forecasts assumed that historical patterns of demand would continue into the future, the actual demand was tracked on control charts to identify the trend and variability. The cycle, seasonality and randomness patterns were also recorded. This ensured the results were tracked within the calculated limits and action taken when the charts showed an ‘out-of-control’ situation.

So, if the demand analyst is not a part of your supply chain team, get them on-side to provide you with honest views and probabilities of the future. It will make your life easier and save your business money.