Linking Forecasting with Operations and Finance. Bill Tonetti November 15, 2017 IIF Foresight Practitioner Conference

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1 Linking Forecasting with Operations and Finance Bill Tonetti November 15, 2017 IIF Foresight Practitioner Conference

2 About the Speaker Bill Tonetti Founding Member, Foresight Practitioner Advisory Board President & Co-Founder, Demand Works Company o o o Maker of solutions for forecasting, demand planning, inventory planning & optimization, capacity planning, and S&OP Used by over 400 corporations, including many well-known brands Global: Translated into 6 languages English, Spanish, French, German, Italian, and Japanese

3 Linking Forecasting with Operations and Finance Mechanics o Linking for safety stock planning and inventory optimization o Linking strategic with tactical plans o Linking sales with operations o Linking to financial plans Organizational Considerations o Building trust o Sales and Operations Planning process The Role of Systems in S&OP

4 Signs of Trouble We make to order so we don t need to forecast We don t use the sales forecast. It s always wrong and they only update it once or twice per year anyway. We did an analysis of our inventories a couple of years ago and decided to set our minimum inventories at about 30 day s of coverage. It takes us about a week to prepare the information for our S&OP meetings, and we almost always have to spend at least a few extra days re-planning with changed assumptions.

5 Safety Stock Safety stock is a function of the variability of demand during lead time Classical formulas don t require a forecast SS = z * SD Where: SS = safety stock z = the one-tailed z score SD = the standard deviation Or, if your calculating variances in a different time granularity than lead time SS = z * SD * SQRT(LT/DFP) Where: LT = lead time (expressed in days) DPF = days per forecast period

6 Trends and Seasonality SD fails to consider the portion of variability that can be explained by the model Therefore, most expert systems use RMSE (Root Mean Squared Error) instead of SD.

7 RMSE vs. SD SD 3 * RMSE This would cause SS to be overstated by nearly 300%

8 Events & Outliers Correcting for the above 4 weeks of promotional demand reduced RMSE from to (22%) o Results in a 22% reduction in computed safety stock!

9 Correcting for Outliers It s never a good idea to automatically throw out outliers. Correct when o You knew what caused the increase; o And, you knew it ahead of time, Don t correct when o It s just normal variation; o You don t know the cause; o Or, you didn t have prior knowledge. If you over-correct, then you ll under-stock.

10 The Fit Problem RMSE is a measure of fitted forecasts versus actuals It is not necessarily a measure of forecast accuracy Previous Forecast Why they re different? Fitted Forecast Actual Historic Demand o Statistical models often fit history better than they predict the future o User intervention can improve or degrade the forecast

11 Supply Variability It is mathematically possible to consider the variability of supply as well. o Calculate both the supply and demand variances; o Then add them; o Then take the square root. Variable lead-time o Options Increase the lead time in the equation to the average, or even peak lead time to calculate a conservative safety stock o This is one reason why it s important to separate the lead time that s used for safety stock optimization from the time fence that s used for planning Manage strategic inventories, which are time-phased increases to minimum inventories

12 Multi-Echelon You also need to forecast raw material usage in order to solve for service-based safety stocks for raw materials

13 Aligning Strategy with Tactics Strategic Mid-range to longrange Monthly or quarterly Aggregate o Product o Geography o Channel Monetary units Tactical Short-range to midrange Weekly (or daily) Detailed o Items o Locations o Customers Quantities

14 Aligning Sales with Operations Regions Customers Sales Product families Revenue Months Operations Plants Warehouses Items Units, cost Weeks

15 Example Sales Worksheet Working in dollars At product family level For a customer

16 Example Operations View Working in units By item & location By week

17 The Bill of Resources Materials Sales Forecasts Inventory Net Requirements Capacity Resource Assignments & Utilizations

18 Aligning with Finance Financial aggregations o Business unit o Country Monetary conversions o Price o Cost o Contribution/margin History must tie out with financial reports o Can t simply take unit history and multiply by fixed conversions Future plans must be able to reflect planned changes in prices and costs

19 Alignment Summary Aggregate and disaggregate (or prorate) o Time o Product, geographic, and channel dimensions Convert o Units of measure o Units to currencies Price, cost, margin Channel Customer Group Customer Sold-to Customer Ship-to Product Family Product Sub-Family Item Region Country Warehouse Sales View Product Family Channel - Region Spread monthly forecasts over weeks Prorate product families to items Prorate regions + channels to warehouses Convert $ to units OPNS View Item - Warehouse

20 Organizational Considerations Building trust o Forecast accountability is vital. o Performance must be measured and reported o Using the appropriate lags and actionable, operational levels of detail Aggregate forecast accuracy may not be correlated with accuracy at item-location levels, which is where production & procurement are planned and where inventory is held.

21 Organizational Considerations Basic S&OP Process o o o Monthly demand review Review previous action items o New products, launches, promotions, to-do s Review forecast accuracy and discuss key deviations Discuss and document key assumptions in current plan(s) o Mix, volume, and timing Monthly supply review Analyze feasibility of current demand plan Reconcile differences between detailed and aggregate plans Determine whether adjustments need to be made o Mid-term Changing vendor/plant assignments Strategic inventories Extra shifts, overtime o Long-term New plants, suppliers, manufacturing methods, machinery Executive review Present plan, recommended changes, and strategic/operational assumptions Assess and manage risk Seek approvals, as needed Discuss process issues/opportunities Does your company have a structured monthly process for aligning your organization and plans?

22 Systems for S&OP ERP Manage master data Transaction processing and Execution Repository for majority of corporate data Excel Ad hoc analysis Aggregate reporting and off-line distribution of information Whatever else that you don t have a system for S&OP Systems Align detailed and aggregate plans Utilize advanced analytical methods (forecasting, finite capacity, inventory optimizations, etc.) Enable collaboration (distribution and consolidation) Generate reports to support S&OP process

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