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Improve Demand Forecasts by Leveraging the Retailers Forecasting and Replenishment System

James Ratliff Consultant Observed Demand (former Inventory Manager, Kmart)


http://www.linkedin.com/in/jamesratliffprofile

Abstract
Retailers are demanding that vendors help streamline inventory at both the distribution center and store level. Usually, the retailers forecasting and replenishment system generates orders based on the observed demand which is current deseasonalized demand plus trend plus predictable seasonal fluctuations. For several years now, INFOREM (Inventory Forecasting and Replenishment Module) has been the replenishment application of choice by many retailers, such as Walmart, Target, Kmart, Safeway, etc. Understanding key INFOREM forecasting concepts will lead to the development of more accurate vendor demand forecasts. During this presentation learn the important concepts that drive INFOREMs forecasting process.

Introduction
Why even discuss INFOREM specifically?
Some of the largest retailers use INFOREM to replenish hundreds of stores. Below is a short list of retailers including 2008 Sales and number of stores*
Wal-mart Target Safeway Macys Kmart Kohls $405.607 billion $64.948 billion $44.104 billion $24.892 billion $18.0 billion (Est.) $16.389 billion 7,262 stores 1,591 stores 1,743 stores 853 stores 1,360 stores (Est.) 929 stores

Total Combined 2008 Sales = $573.94 billion Total Combined Stores = 13,738 stores
*Note: Number of stores is from Store Magazine Top 100 Retail List 2008 published in its July 2008 issue at http://www.stores.org/pdf/08TOP100.pdf.

Agenda
Background Forecasting Concepts Ordering Concepts How can the retail vendor apply these concepts?
Demand Planning Simulation Working with the retailers replenishment team

Background
Merchandise Planning & Allocation
Long Term Demand & Supply Planning
Sales, GM, and Inventory Turns Goal Driven

Medium Term Demand & Supply Planning


Review Monthly (Enter New Orders Monthly) Production and/or Import Lead Time Driven

Short Term Demand & Supply Planning


Review Weekly (Enter New Orders Weekly) Ship Lead Time Driven ATS commitments and STA Dates

Background
Goal is to improve Forecast Accuracy
Forecast Error (MAPE) with One-Month Lag
Industry Bulk Chemicals Consumer Goods High Tech Range 24% to 10% 40% to 14% 45% to 4% Median 11% 26% 28%

Source: Lora Cecere, Debra Hoffman, Roddy Martin, and Laura Preslan, AMR Research, AMR Benchmark Analytix data in The Handbook for Becoming Demand Driven, July 2005.

Background
INFOREM
Acronym for Inventory Forecasting and Replenishment Module Created by IBM in the 1970s Probable offspring of IBMs 1966 IMPACT Inventory Program & Control Techniques INFOREM Purchased by i2 Technology in 2000 Update: JDA Acquires i2 Technologies January, 2010; JDA owns rights to INFOREM

The

INFOREM
Policy

system
DDU FEX RDR Policy File

Retailer Item Records

AUX

Build Transfer Record

INFOREM Calculations

Retailer Data Orders

Outputs

Recycle Aux

Batch Processing Steps

Agenda
Background Forecasting Concepts Ordering Concepts How can the retail vendor apply these concepts?
Demand Planning Simulation Working with the retailers replenishment team

The INFOREM Forecast Formula

DD X BI = Sales Forecast
DD is Deseasonalized Demand BI is the Base Index

The INFOREM Forecast Formula


Deseasonalized Demand (DD) is INFOREMs technical name for an items average rate of sales per week The DD is dynamic in that it adjusts to meet retail trends experienced at the store level The Base Index is a number that represents the level of sales expected in a given week compared to the average The Base Index is not dynamic and has to be manually changed periodically

The INFOREM Forecast Formula


An Items Store Graphical Profile Item Profile
2.5

2.0

1.5

Base Index
1.0 0.5 0.0
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 40 41 42 43 44 45 46 47 48 49 50 51 52

Fiscal Week

The INFOREM Forecast Formula

DD X BI = Sales Forecast
DD is Deseasonalized Demand BI is the Base Index

Calculating a New DD
Output Old DD Input CPS Step 1 Bypass Codes No Update No Update / Update ? Step 2 Update Demand Filter Limits No Update

No Update / Update ?

Update
Final New DD Output DD Change Restrictions Step 4 New DD Input / Output DD Update Step 3 VRS

Calculating a New DD
Output Old DD Input CPS Step 1 Bypass Codes No Update No Update / Update ? Step 2 Update Demand Filter Limits No Update

No Update / Update ?

Update
Final New DD Output DD Change Restrictions Step 4 New DD Input / Output DD Update Step 3 VRS

Calculating a New DD
Output Old DD Input CPS Step 1 Bypass Codes No Update No Update / Update ? Step 2 Update Demand Filter Limits No Update

No Update / Update ?

Update
Final New DD Output DD Change Restrictions Step 4 New DD Input / Output DD Update Step 3 VRS

Calculating a New DD
Output Old DD Input CPS Step 1 Bypass Codes No Update No Update / Update ? Step 2 Update Demand Filter Limits No Update

No Update / Update ?

Update
Final New DD Output DD Change Restrictions Step 4 New DD Input / Output DD Update Step 3 VRS

Step 3 DD Update Calculation


Deseasonalized Demand Update (DDU) process performs three primary functions in creating a new DD:
1. Deseasonalizes current period sales (CPS) 2. Calculates forecast error 3. Calculates a new DD

Step 3 DD Update Calculation


1. Deseasonalizes current period sales (CPS)
DD Update process begins by deseasonalizing the current period sales (CPS). Dividing CPS by the Base Index (BI) for that week to establish a current DD (CDD)

CDD =

CPS BI

Step 3 DD Update Calculation


2. Calculates forecast error Apply a weighting (Alpha) to both the old DD and
CDD to calculate the new DD

is a product of forecast error


DD Update uses a Tracking Signal to determine when needs to be increased or decreased

Step 3 DD Update Calculation


2. Calculates forecast error
Tracking Signal = TSt = MSDTSt MADTSt

where .1 < TS < .9 and | | denotes absolute value MSDTSt = Mean Signed Deviation for Tracking Signal (mean forecast error) MADTSt = Mean Average Deviation for Tracking Signal (mean absolute forecast error)

Step 3 DD Update Calculation


2. Calculates forecast error
MSDTSt = * (CDDt old DDt) + (1 - ) * MSDTSt-1

MADTSt = * |CDDt old DDt| + (1 - ) * MADTSt-1


= Beta, smoothing constant often 0.1 or 0.2
Trigg, D.W. Monitoring a Forecasting System. Operational Research Quarterly15, 1964, pp. 271-74.

Step 3 DD Update Calculation


2. Calculates forecast error
Damping factor (DAMP) is an assigned value from .1 to .9 that modifies the Tracking Signal (TSt) used in producing the smoothing rate t t is set to equal the TSt times DAMP for each update; value from .1 to .9

t = TSt x DAMP
Trigg DW, Leach AG. 1967. Exponential smoothing with an adaptive response rate. Operational Research Quarterly 18: 53-59.

Step 3 DD Update Calculation


3. Calculates a New DD
Variable Response Smoothing (VRS) or Adaptive Response Rate Exponential Smoothing (ADRES) or (ADRRES) is used to calculate the New DDt+1

New DDt + 1 = t * CDDt + (1 t) * old DDt

Calculating a New DD
Output Old DD Input CPS Step 1 Bypass Codes No Update No Update / Update ? Step 2 Update Demand Filter Limits No Update

No Update / Update ?

Update
Final New DD Output DD Change Restrictions Step 4 New DD Input / Output DD Update Step 3 VRS

Calculating a New DD
Output Old DD Input CPS Step 1 Bypass Codes No Update No Update / Update ? Step 2 Update Demand Filter Limits No Update

No Update / Update ?

Update
Final New DD Output DD Change Restrictions Step 4 New DD Input / Output DD Update Step 3 VRS

Summary of Steps to Calculating a New DD


Step 1: Bypass codes are used to qualify the incoming sales data Step 2: Demand Filters are used to audit the sales data for reasonableness Step 3: Deseasonalized Demand Update (DDU) calculates a new DD

Step 4: DD Change Restriction puts in place limits to regulate the up and down movement of the DD

Agenda
Background Forecasting Concepts Ordering Concepts How can the retail vendor apply these concepts?
Demand Planning Simulation Working with the retailers replenishment team

The

INFOREM
Policy

system
DDU FEX RDR Policy File

Retailer Item Records

AUX

Build Transfer Record

INFOREM Calculations

Retailer Data Orders

Outputs

Moment of Truth

Recycle Aux

Batch Processing Steps

Order Forecasting Topics


Order Paths Order Generation Rules Calculating Order Quantities Safety Stock

Order Paths
Independent SKU
Non-Flow Flow JIT

Group of SKUs
Vendor Direct

NonAggregate DC Orders

Aggregate

Aggregate

DC Orders

DC Orders

Store Orders

Store Orders

Order Paths
Group of SKUs Independent SKU
Vendor Direct

Non-Flow

Flow

JIT

NonAggregate DC Orders

Aggregate

Aggregate

DC Orders

DC Orders

Store Orders

Store Orders

Order Paths
Independent SKU
Non-Flow Flow JIT

Group of SKUs
Vendor Direct

NonAggregate DC Orders

Aggregate

Aggregate

DC Orders

DC Orders

Store Orders

Store Orders

3Tier Distribution System


Tier 1

Tier 2 Retail Vendor Tier 3

Stores
Legend
National DC Regional DCs Tier 2 Regional DCs Tier 3

Order Forecasting Topics


Order Paths Order Generation Rules Calculating Order Quantities Safety Stock

Order Generation Rules


INFOREM provides six order generation rules An order generation rule is a set of rules used to determine when to order and how much to order The rules are called Forecast Types and are:
Minimum / Maximum FT U Order Point / Order Up To Level FT O Presentation Stock / Slow Seller FT J Time Supply FT T Fixed Order Quantity FT F End of Season FT E

Order Generation Rules


INFOREM provides six order generation rules An order generation rule is a set of rules used to determine when and how much to order The rules are called Forecast Types and are:
Minimum / Maximum FT U Order Point / Order Up To Level FT O Presentation Stock / Slow Seller FT J Time Supply FT T Fixed Order Quantity FT F End of Season FT E

Calculating Order Quantities


The Forecast Type chosen will determine: The Order Point
When to order?

The Order Quantity


How much to order?

Order Forecasting Topics


Order Paths Order Generation Rules Calculating Order Quantities Safety Stock

Calculating Order Quantities


Fixed Time Period Reordering
Idle State - Waiting for Demand

Loop 1

Loop 2
No
Has review time arrived?

Demand occurs - Unit withdrawn from inventory

Yes

Compute Inventory Status Avail = OH + OO - CMSTK

No
End Is Avail < OP? Yes Compute OUTL Compute OQ End Compute Order Point (OP)

Calculating Order Quantities


Fixed Time Period Reordering
Idle State - Waiting for Demand

Loop 1

Loop 2
No
Has review time arrived?

Demand occurs - Unit withdrawn from inventory

Yes

Compute Inventory Status Avail = OH + OO - CMSTK

No
End Is Avail < OP? Yes Compute OUTL Compute OQ End Compute Order Point (OP)

Calculating Order Quantities


Fixed Time Period Reordering
Idle State - Waiting for Demand

Loop 1

Loop 2
No
Has review time arrived?

Demand occurs - Unit withdrawn from inventory

Yes

Compute Inventory Status Avail = OH + OO - CMSTK

No
End Is Avail < OP? Yes Compute OUTL Compute OQ End Compute Order Point (OP)

Calculating Order Quantities


Fixed Time Period Reordering
Idle State - Waiting for Demand

Loop 1

Loop 2
No
Has review time arrived?

Demand occurs - Unit withdrawn from inventory

Yes

Compute Inventory Status Avail = OH + OO - CMSTK

No
End Is Avail < OP? Yes Compute OUTL Compute OQ End Compute Order Point (OP)

Calculating Order Quantities


Fixed Time Period Reordering
Idle State - Waiting for Demand

Loop 1

Loop 2
No
Has review time arrived?

Demand occurs - Unit withdrawn from inventory

Yes

Compute Inventory Status Avail = OH + OO - CMSTK

No
End Is Avail < OP? Yes Compute OUTL Compute OQ End Compute Order Point (OP)

Calculating Order Quantities


Fixed Time Period Reordering
Idle State - Waiting for Demand

Loop 1

Loop 2
No
Has review time arrived?

Demand occurs - Unit withdrawn from inventory

Yes

Compute Inventory Status Avail = OH + OO - CMSTK

No
End Is Avail < OP? Yes Compute OUTL Compute OQ End Compute Order Point (OP)

Calculating Order Quantities


Fixed Time Period Reordering
Idle State - Waiting for Demand

Loop 1

Loop 2
No
Has review time arrived?

Demand occurs - Unit withdrawn from inventory

Yes

Compute Inventory Status Avail = OH + OO - CMSTK

No
End Is Avail < OP? Yes Compute OUTL Compute OQ End Compute Order Point (OP)

Calculating Order Quantities


OP/OUTL Forecast Type O
Order Point Definition OP = FCST(RTF*RT + LT) + SSTOCK or CSTOCK
(which every is greater)

When to order? If AVAIL < OP

AVAIL (Available Inventory) = OH (On Hand) + OO (On Order) - COMSTK (Committed Stock) COMSTK refers to store orders that are committed for various reasons i.e. Promotional Allocation RTF (Review Time Factor) - A default value of .5 is usually used RT (Review Time) - Number of days between INFOREM reviews LT (Lead Time) - Number of days between order review and goods being available for sale ( store level) or distribution (DC level) SSTOCK (Safety Stock) - Amount of merchandise kept to protect against out of stock condition CSTOCK (Counter Stock) - The minimum amount of product you want to have on hand when the next order arrives (presentation)

Calculating Order Quantities


OP/OUTL Forecast Type O
Order Up To Level Definition OUTL = FCST(LT + OSTRAT) + SSTOCK or CSTOCK
(which ever is greater)

How much to order? OQ = OUTL AVAIL (rounded to pack)

LT (Lead Time) - Number of days between order review and goods being available for sale ( store level) or distribution (DC level) OSTRAT (Order Strategy) - Number of days an order quantity should last upon
receipt

SSTOCK (Safety Stock) - Amount of merchandise kept to protect against out of stock condition CSTOCK (Counter Stock) - The minimum amount of product you want to have on hand when the next order arrives (presentation) OQ (Order Quantity) AVAIL (Available Inventory) = OH (On Hand) + OO (On Order) - COMSTK (Committed Stock)

Order Forecasting Topics


Order Paths Order Generation Rules Calculating Order Quantities Safety Stock

Safety Stock
Safety Stock is an additional layer of inventory added to a store order point to cover forecast variance to actual sales in order to prevent store out of stocks

The Mean Absolute Deviation for Safety Stock (MADSS) is the average difference between forecasted demand and actual sales Safety Stock is controlled by forecast errors, service level objectives, and lead time variations

Agenda
Background Forecasting Concepts Ordering Concepts How can the retail vendor apply these concepts?
Demand Planning Simulation Working with the retailers replenishment team

Demand Planning Simulation


Order Paths
Independent SKU Group of SKUs

Non-Flow

Flow

JIT

Vendor Direct

NonAggregate DC Orders

Aggregate

Aggregate

DC Orders

DC Orders

Store Orders

Store Orders

Demand Planning Simulation


3-Tier Distribution System
Tier 1

Tier 2
Retail Vendor Tier 3

Stores
Legend
National DC Regional DCs Tier 2 Regional DCs Tier 3

Demand Planning Simulation


3-Tier Distribution System
Tier 1

Tier 2
Retail Vendor Tier 3

Stores
Legend
National DC Regional DCs Tier 2 Regional DCs Tier 3

Demand Planning Simulation


Spreadsheet Simulation Key assigned values and weekly calculated values in the Aux File and Policy File at the store level and/or DC level that some retailers provide through its internet portal
- Deseasonalized Demand (DD) - Base Index (BI) - Lead Time (LT) - Review Time (RT) - Order Strategy (OSTRAT) - Available Inventory (AVAIL) - Counter Stock (CSTOCK) - Safety Stock (SSTOCK) - Order Point (OP) - Order Up to Level (OUTL) - Service Level (DSER) - Committed Stock (COMSTK)

Demand Planning Simulation


Using the systems forecast, replenishment, and order settings, week one DD is calculated and a 13 week forecast for sales, inventory and orders are calculated as shown in the spreadsheet below and ...

Demand Planning Simulation


the spreadsheet chart below.

Demand Planning Simulation


After 13 weeks of calculating a stabilized new DD every week, the replenishment settings begin to destabilize due to out of stocks. Clearly, this store did not have enough weeks of supply.

Demand Planning Simulation


Adding safety stock or counter stock would probably stabilize the system. How much safety stock or counter stock do you add to the store?

Agenda
Background Forecasting Concepts Ordering Concepts How can the retail vendor apply these concepts?
Demand Planning Simulation Working with the retailers replenishment team

Communicating with the Retailers Replenishment Team


Causes of Forecast Error
There are many internal and external factors that have an impact on forecast error.
Bad Profile Improper INFOREM settings Lead Time Variance Unit Integrity Poor Sister Item Product Availability External Market Conditions Merchandise Display

Agenda
Background INFOREM Forecasting Concepts INFOREM Ordering Concepts How can the retail vendor apply these INFOREM concepts?
Demand Planning Simulation Working with the retailers replenishment team

End
Email me at james.ratliff@observeddemand.com
Or Visit my website at www.observeddemand.com Or call me at 312-330-2889 Check out my profile at LinkedIn.com
http://www.linkedin.com/in/jamesratliffprofile

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