The function of inventory planning is to order the right quantity of any given product at the right time. But how exactly does one know what the right quantity even is? Sure you can look at how you’re actually selling, but inventory forecasting is more than just re-ordering inventory off a rate of consumption. And what happens when you don’t have any actual sales to analyze? In this post we’ll cover some popular approaches to demand forecasting and how you can select the right one for your business.
Fundamentally, there are two main approaches to forecasting: bottoms-up and tops-down. They represent the ideology of starting with the smallest amount of information and working your way up (and vice versa). Within this framework, there are various techniques of forecasting ranging from qualitative techniques, to time series analysis and finally, casual models. To break it down:
While these three methods represent the different data points, the approach of working tops-down or bottoms-up considers the factors impacted by these data points. The factors below are the things that need to be assessed by the data points to create a sound forecast. For the remainder of this article, we’ll be focusing on these factors.
You may have heard this phrase in a more social atmosphere, but forecasting gives this celebratory term a whole new meaning. A bottoms-up approach to forecasting considers the most minute detail first, and then works its way up. Typically, it is associated with forecasting the amount of units to be sold for a single SKU, multiplied by its selling price. However, this logic can also apply to selling locations and channels, sales associates, customers, and marketing promotions and events. The benefit of using this approach is its feasibility in modification when factors change.
If you have 5 retail stores that generate $100,000 each, you would estimate generating $500k in total. But if one store closes, you would change that forecast to $400k. This is the bottoms-up approach in its simplest form.
For some individuals, the purpose of a forecast is to set a standard for evaluating performance. In which case, one would have to omit the impact of the factors mentioned above as these are meant to change patterns and relationships. And so if the objective is to measure the impact of these factors, say a new store or promotion, then a special focus should be made on quantifying the impact of each factor.
Some businesses operate with more than one prediction of future sales. The terms “forecast”, “plan”, “budget”, “estimate”, and “goal” can all be used interchangeably or to represent different ideologies. For example, a retailer can forecast $500k in sales for 5 stores, and have a separate estimate for projecting the impact of running various promotions in each of them.
As you may have guessed from the term itself, a tops-down approach to forecasting means starting from the top and working your way down. This approach may be favored as it takes a more holistic approach, taking into account what could be possible rather than what has been. There are several factors that influence this methodology:
New products should be factored in both a tops-down and bottoms-up approach. Similar to a new business, a new product or category can add to the industry and take away market share, thus bringing in new customers and demand. It can have its own advertising channels and therefore generate its own tops-down forecast. But you can also take a bottoms-up approach by analyzing previous like product introductions and incremental demand from existing customers. The two approaches should be combined and adjustments should be made for cannibalization prior to finalizing the forecast.
The simple answer is - both. Better forecasting starts with proper use of the techniques. Ideally, you’d be able to do both types of forecasting, have them challenge one another, poke holes, ask questions, and set up parameters for assessing each contributing factor. However, you may want to weigh more heavily on a particular method based on your answers to the following questions:
Fuse’s forecasting tools combine and automate these factors so that you can be more efficient and accurate with your forecasts. To learn more, schedule a call today.