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Demand & Inventory Planning

A 2021 Guide to Demand Forecasting

Demand & Inventory Planning
May 12, 2021
8 min read
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Learn how businesses of all sizes can access accurate demand forecasting to make strategic decisions about their business.

What is Demand Forecasting?

Demand forecasting is the process of estimating the level of consumer demand for a product. Merchants decide how much inventory to buy based on demand forecasting models, and strategic businesses even determine the location of their inventory based on geographic demand. 

Accurate demand forecasting is important for avoiding both stockouts (resulting in missed sales opportunities) and having unsold inventory (leading to inventory obsolescence and high inventory carry costs).

Types of Demand Forecasting

There are several methodologies for forecasting demand. The method your business employs will be determined by the amount of sales history available, the length of your sales cycles, and your business goals. Below are a few common demand forecasting methods:

  1. Passive Demand Forecasting is best for very small or hyper-local businesses. It is based on a limited amount of historical data and makes broad assumptions. This method is not likely to support aggressive growth goals.
  2. Active Demand Forecasting takes into account not only historical sales data but also external market forces and trends. It’s best to employ active demand forecasting before making major changes to marketing tactics or expanding into a new market.
  3. Short-Term Projections are only meant to forecast demand for the next business quarter to business year. This method is used primarily to manage just-in-time supply chains and is best suited for businesses with a higher risk tolerance.
  4. Long-Term Projections are best for high-growth businesses with aggressive growth goals. A long-term projection will take into account increased market share over time and will determine capital expenditure and long-term marketing plans.

How to Accurately Forecast Demand

While it’s impossible to fully predict consumer behaviors (as evidenced by shortages during the COVID-19 crisis), there are several methods for forecasting demand. Most rely heavily on historical sales data, taking into account seasonality and industry trends. Young businesses that don’t have years of sales history to analyze may study competitor trends to make a qualitative estimate of their demand.

Historically, demand forecasting has been a high-level function and a time-consuming process that many small to mid-sized businesses may have foregone. However, with the introduction of AI and machine learning in the fulfillment space, SMB’s can have access to enterprise-level analytics without the need for costly consultative services or additional personnel.

Machine learning can automate the process of analyzing historical sales patterns to understand exactly when to re-order inventory, how much, and even where to stock inventory to get closest to geographic pockets of demand. In the video below, Ware2Go’s Director of Strategy, Samantha Smith, explains how new technology is helping businesses of all sizes access demand forecasting capabilities.

The Benefits of Accurate Demand Forecasting

1. Control shipping costs with a distributed fulfillment network

Understanding where your customers are located and accurately forecasting demand enables you to stock the right SKUs in the right quantity in the most optimal location before a consumer makes a purchase. This level of forecasting accuracy means you can meet your customers’ demands for 1- to 2-day shipping without depleting margins with costly solutions like next-day air.

2. Alignment Between Marketing and SKU-Readiness 

Poor demand forecasting leads to poor supply chain performance. A marketing campaign should geotarget audiences based on available inventory at the sku level. Otherwise customers will be subjected to stockouts and shipping delay, which will ultimately lead to lost revenue.

Sales are not the only measure of success for a marketing campaign. Emphasizing sales over customer experience or sku-level profitability can lead to back orders piling up while a replenishment order is shipped from the supplier. This results in a frustrating experience for customers and may leave you with leftover inventory in underperforming skus that will eventually become obsolete and further erode margins.

Instead, marrying your demand forecasting with your marketing efforts will enable you to squeeze the most ROI out of your marketing dollars without sacrificing on customer experience. By keeping a close eye sku-level performance, you’ll know which campaigns to turn off or ramp up.

3. Lower Inventory Carry Costs

Inventory turns really shouldn’t be longer than three months. Otherwise your inventory carry costs will begin to drag down your profitability, eventually ending with inventory obsolescence. Some merchants focus only on supplier discounts to create margin. They order more inventory than they can sell in a quarter to get the steepest volume discount, but end up letting inventory sit on the shelves of a costly storage facility for 6-12 months. By the time the inventory has sold, the storage costs have exceeded the amount saved through the supplier discount.

Accurate demand forecasting can be provided by the right outsourced fulfillment partner with a technology-first approach logistics. Using custom forecasting models, you strike the perfect balance between getting the best supplier discount possible without over-indexing on storage costs.

4. Profitable Seasonality

Some seasonal demand spikes are virtually industry agnostic. Most merchants expect seasonal spikes around the holidays and Amazon Prime Day. Sometimes stocking for these types of seasonal demands can feel like an educated guess. Merchants may reach the end of a holiday season feeling confident about sales velocity only to find that their sku-level profitability was down.

There is also an element of risk that you’ll have to determine for your business. Businesses with a higher tolerance for the risk of running out of inventory can fine-tune their inventory levels for the least amount of capital expenditure. Taking the high-risk approach yields the highest profits and frees up capital to invest back into other areas of your business. If your business has a lower risk tolerance, you can optimize your inventory levels to insure against stockouts. This low-risk approach requires greater capital expenditures but ensures a seamless customer experience. Once you determine your appetite for risk, you can choose the inventory level that will yield either the most profitable season possible or the most satisfying season for your customers.

Other businesses, however, may be surprised by seasonal patterns in their business. Whether due to weather, sporting events, or back-to-school, your customers may find more need for your product at different times of the year. Analyzing your sales cycles will help you identify seasonal trends, stock up accordingly, and have the confidence to align your marketing strategy with seasonal demand to double-down on profitability.

Demand Forecasting Examples

In order to accurately forecast demand, businesses with highly seasonal demand like winter weather gear will want to look at historical sales data, like exactly when demand began to spike in years past. They may also look at the average temperatures and weather patterns during demand spikes and compare those to long-term forecasts for the coming year. Long-term forecasts clearly work on many assumptions and don’t guarantee accuracy but can be helpful for making general predictions. The forecast should also take into account regional weather patterns to have inventory ready not only at the right time but also in the right place to best service their end customers.

A business that is less seasonal, like supplements and nutraceuticals, will want to forecast demand based on historical sales data and marketing strategy and growth plans. Past marketing campaigns can be analyzed to determine how much sales will increase with increased incremental marketing spend.

Demand Forecasting for SMB’s

Demand forecasting is no longer a function reserved for enterprise-level businesses. In fact, by partnering with a tech-focused 3PL or on-demand warehousing partner, businesses of all sizes can have access to custom reporting and analytics to help them make smarter decisions about their business.

The benefit that SMB’s have over large enterprises is their agility and ability to pivot in response to market changes. When that flexibility is paired with best-in-class demand forecasting, SMB’s will have a distinct advantage to grow their market share and compete in today’s quickly-changing marketplace.

Looking for demand forecasting capabilities for your business? Reach out to one of our in-house experts.

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