Thursday, August 21, 2008

Effective Inventory Management and Demand Forecasting

It is no secret that an accurate forecast of the future demand of a product is crucial in achieving the four "rights" of effective inventory management: that is, getting the right quantity of the right item to the right location at the right time. As we've discussed in previous articles, products with different patterns of usage require different forecasting methods. The forecast for items with recurring usage is usually based on four elements:
* Some sort of average of past usage.
* A trend derived from past usage.
* Future anticipated usage that is not revealed in past usage or trends.
* A forecast horizon reflecting when material ordered today can be received and the length of time for which inventory must be purchased.

If an item has recurring usage (that is, it is sold or used on a regular basis) we can test various formulas that apply different factors to each of the four elements to determine the best method of forecasting future demand of each item. But applying these elements to an item with sporadic activity (i.e. one that is not sold on a regular basis) produces strange results
It's easy to see that forecasting future usage of an item using an incorrect formula will result in stocking the wrong quantity of the wrong item in the wrong location at the wrong time. To achieve effective inventory management, it is essential to be able to differentiate between items with sporadic sales and those with recurring usage activity.

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