Forecast measurement and evaluatio

Forecast Measurement and Evaluation
by George Palmatier
The Oliver Wight Companies
Introduction
As companies improve planning and control
through the implementation of such processes as
Sales and Operations Planning (S&OP) and Demand
Planning, the issue of forecast accuracy always
surfaces. The following questions often arise:
• How should we measure forecast accuracy?
• How good aforecast should we expect?
• How do we measure the effectiveness of
our demand planning process?
The following is a discussion of forecast measurement
and forecast evaluation. It is offered as a
benchmark and as a stimulus to further communication
in this important area.
The Importance of Forecasting
Companies striving for operational excellence and
a competitive advantage realize the keyrole forecasting
has upon the ability of a company to satisfy
its customers and to simultaneously manage its
resources. Effective forecasting helps management
resolve the dilemma of more demanding customer
requirements and greater shareholder expectations.
To resolve this dilemma, managers are expected to
provide better customer service with fewer resources.
In this environment, theimportance of
effective forecasting is increased.
In manufacturing and distribution companies, a
forecast is not simply a projection of future business;
it is a request for product (or a request for resources
to ensure supply of a product). In simple terms, this
is how the forecast works: If a product is in the
forecast, you can expect the product (or resource) to
be available; if it is not in theforecast, you should
not expect the product to be available.
With this concept of a forecast as a request for
product, forecast accuracy becomes crucial to
ensuring satisfactory, or exemplary, customer service.
For example, when a product has not been
requested to satisfy customer needs, poor customer
service results. Forecast accuracy also becomes
critical to the proper utilization ofresources. For
example, when product is requested and not sold or
the sale is delayed, resources have been tied up
unnecessarily. When a product has not been forecasted
but the company must still meet the customer
demand, often this is accomplished at a
considerably higher cost — a poor use of resources.
Why Measure Forecast Accuracy?
First and foremost, we need to measure forecast
accuracyif we wish to improve. Measurements are
used to make improvements to the specific forecast
as well as to the demand planning process.
An effective demand planning process measures
forecast accuracy in different ways for different
purposes. A detailed measure of forecast accuracy at
the item level identifies individual products that are
outside an established tolerance. This enables us toreview - and correct - the individual product forecasts.
The earlier a significant forecast error is
identified, the quicker we can respond to the real
market demand.
Aggregate measures at a product family level are
used to determine whether there is a problem with
the total (aggregate) product forecast. When a
problem surfaces, a more detailed forecast review
can be initiated. An aggregatemeasure is also used
as an indicator of the quality of the forecast. It
answers the following questions: Is the forecast
reliable? Is the forecast getting better or worse?
Does the demand planning process need attention?
The aggregate forecast is the sum of the individual
item forecasts. As such it also serves as a test for
reasonableness. Further, it is used to quantify the
overallmarketing, sales and business plans.
A recurring forecast problem is an indication of a
poor demand planning process or, possibly, a tremendously
uncertain market. If the company has an
effective demand planning process and significant
product forecast errors persist, then a review of
tactics and strategies to deal with the uncertainties
is required.
Since actual customer demand will almost...