Clear Vision

12 Strategies to Improve Your Forecast Quickly

My most recent white paper can be found here - Download White Paper - 12 Strategies to Improve Your Forecast Quickly

Executive Summary -

The top item on the agenda of your company’s CFO right now is most likely working capital optimization. With the current credit crunch and spending reductions, financial managers are charged with finding ways to quickly cut expenses and reduce exposure to risk.

According to a recent Aberdeen Group report, the top method to reduce the intense pressure on working capital is through inventory reduction and the number one tool used to reduce inventories (70% of companies) is improving forecast accuracy.

Your peer companies probably already have an understanding that information costs less than inventory and they are willing to invest in information to significantly reduce their inventories.

Because forecasting is the top box in the supply chain flow chart, an improvement in accuracy touches almost every area of the company and quick progress can be seen in a variety of measurements including order fill rates, expedite reductions, margin improvements, logistics costs, and customer satisfaction. The proposition for improving forecast accuracy nearly always makes sense and if done properly requires substantially less working capital than inventory investment, making a forecast improvement project an easy decision.

This white paper examines and recommends 12 techniques for improving forecast accuracy with the goal of significantly reducing inventories, increasing gross margins,and improving order fill rates.

Lessons Learned from Past Recessions

I’m going to start a series on lessons learned from past recessions that will hopefully introduce you to what to expect in a recession and how it might impact your company.  This week, I’m starting with a list and brief history of recessions in the United States starting with the Great Depression.  The list below comes from Wikipedia.  For more information, please see - http://en.wikipedia.org/wiki/List_of_recessions

I am thinking that an understanding of the past will give us some context to view our current economy.

Great Depression – 1929-39, 10 Years

Stock markets crashed worldwide, and a banking collapse took place in the United States.  This sparked a global downturn, including a second, more minor recession in the United States, the Recession of 1937.

my note: during the Great Depressions, unemployment reached 25.7%.  A full quarter of those that were eligible to be employed could not find jobs.  If you are reading articles or listening to politicians who are comparing our current recession, please use caution.  While our current unemployment rate of 7.4% is bad and people are hurting, it would take a 50% increase in that number to reach 11%....which is still not half of the Great Depression.

Recession of 1953 – 1953-54, 1 year

After a post-Korean War inflationary period, more funds were transferred into national security.  The Federal Reserve changed monetary policy to be more restrictive in 1952 due to fears of further inflation.

Recession of 1957 – 1957-58, 1 Year

Monetary policy was tightened during the two years preceding 1957, followed by an easing of policy at the end of 1957.  The budget balanced resulted in a budget surplus of 0.8% of GDP in 1957 to a budget deficit of 0.6% of GDP in 1958, and then to 2.6% of GDP in 1959.

Recession of 1960, 1960-61, 1 year

After President Kennedy’s January 1961 call for increased government spending to improve the Gross National Product and to reduce unemployment, the 1960 recession ended in February.

1973 Oil Crisis, 1973-75, 2 Years

A quadrupling of oil prices by OPEC coupled with high government spending due to the Vietnam War led to stagflation in the United States.

Early 1980’s Recession, 1980-82, 2 Years

The Iranian Revolution sharply increased the price of oil around the world in 1979, causing the 1979 energy crisis.  This was caused by the new regime in power in Iran, which exported oil at inconsistent intervals and at a lower volume, forcing prices to go up.  Tight monetary policy in the United States to control inflation led to another recession.  The changes were made largely because of inflation that was carried over from the previous decade due to the 1973 oil crisis and the 1979 energy crisis.

my note: I am seeing most economists and authors compare our current recession to the economy that Reagan inherited which was lengthened by the tight fiscal policy of his government.

Early 1990’s Recession, 1990-91, 1 Year

Industrial product and manufacturing-trade sales decreased in early 1991.

Early 2000’s Recession,  2001-03, 2 years

The collapse of the dot-com bubble, the September 11^th attacks, and the accounting scandals contributed to a relatively mild contraction in the North American economy.

Late 2000’s Recession, 2007-Present, ongoing

The collapse of the housing market led to bank collapses in the US and Europe, causing the amount of available credit be sharply curtailed.

 

Looking at the dates and lengths, we are experiencing a significant downturn about every decade and the length of each (outside of the Great Depression) is 1 t o2 years.

Dr. Ray Perryman - The End of the Beginning

We are now fully engaged in a new year and hopefully it will end on a up note....and very different from 2008.

I ran across the weekly column of world reknown economist, Dr. Ray Perryman, who noted that our current recession is at the "end of the beginning."  The shock of realizing and then entering a recession is over and we seem to be going about the business of dealing with the impacts.  The economist further notes that we have probably not yet reached the bottom and will most likely see more terrible news - disappointing corporate reporting and layoffs. 

However, there are signs of the beginning of a turnaround.  In particular, Dr. Perryman notes - "Credit is beginning to flow again. The key gauges of interbank lending are looking up, which is the critical first stage in restoring a semblance of normalcy to the system. The demand for mortgages is rising, and business financing is again becoming available. Investors are beginning to see the opportunities that inevitably arise from economic disruptions and to set up mechanisms to capitalize. Even consumers are starting to spend a bit more than anticipated." 

Peering into the depths of the recession, it appears that there is a bottom.  We have not yet reached it and will still see more bad news but perhaps in mid 2009, we can find the firm ground to begin buiding up again.

Source Used - Ray Perryman, Weekly Column > Archive > January > January 2, The End of the Beginning (sorry no direct link)  

Collaborative Forecasting

Best Practices in Forecasting Series 

Forecasts should be collected from the bottom, rolled up, and then reviewed from the top-down.   Best practice processes start with a solid statistical forecast that is modified by individual sales people who have direct knowledge of customer plans. 

 These sales people should have access to make changes for their customers and their volumes.   Once the forecast updated at a granular level, it should be rolled up into categories and represented in ways that make sense to experts within your company.  Sales Managers should look at category totals for a region or channel in dollars to see if they make sense.  Supply Chain managers should look at units by manufacturing facility or department to determine validity.  Financial managers should check in dollars and modify appropriately.

 Each of these internal experts should be able to review and modify at a higher level in the hierarchy and then have their changes roll down to a lower level.  When changes are made, your forecasting system should have a full audit trail that annotates the change and allows users to input their reasons for making the change.

 

New Product Forecasting

New product introductions are the lifeblood of many organizations.  Consumers expect new, better, bigger, best.  Retailers are looking for their manufacturers to provide new and interesting products for their customers and new product planning and introductions receive a white hot spotlight of attention for multiple companies in their respective supply chains.

Forecasting new product requirements is a special challenge because of a lack of history and a big question mark about consumer or industrial acceptance for new products.  Thankfully, there are sophisticated methods for accurately predicting demand.  As you know, the more accurate your prediction at the point of use or point of sale, the greater revenue and smaller cost you will incur in the process.

Chaining has been a popular forecasting method to predict a demand curve.  The example below comes from a consumer packaged goods company that is introducing a product that will be set across a retail supply chain and have a large introduction and then decreasing demand that settles into regular replenishment.  In chaining, a new product borrows the history of similar items or a control group of items by associating the new item being introduced with similar items at their respective introductions.  This works very well to determine a demand curve but loses some of its luster when attempting to produce the height of the curve or an understanding of total demand.

Attribute forecasting successfully accomplishes predicting total demand (the height of the curve) by borrowing the attribute components of other items.  For example, if you are selling a steel red wagon, each of those characteristics are attributes that can help predict demand.  The color, the material, and the product type are all components of demand that can be used to help predict demand for red wagons made of plastic.  The process to do attribute forecasting relies on decomposition of attributes which relies on regression analysis to determine how much each attribute contributes to total demand.

For more detailed information about attribute forecasting,  you can get your fill with this white paper provided by the Journal of Textile and Apparel.

Bad Ideas in Forecasting - Using Spreadsheets

I ran across an interesting warning in the white paper “Are Spreadsheets Sabotaging Your Profits?”  by Brown, Smith, Wallace Consulting.

“A detailed study by Panko (2000) revealed that many companies are using highly error-prone spreadsheets to perform numerous functions.  According to research over a long period of time, Panko has proven that spreadsheet errors are common and result in meaningful, harmful business impact.”

This study of companies of all sizes using spreadsheets for critical business functions found error rates from 24 to 85%.  As the white paper notes, spreadsheets are so commonplace and accessible to every business user that releases and iterations are managed by functional professionals and not technical managers who are used to version control, testing, and security.  While spreadsheets may be perfectly acceptable when first built, changes and additions over time lead to continuity issues.  Worse, if spreadsheets change hands from one business user to another, a poor understanding of underlying calculations and chaining can lead to serious problems.

It goes on to note that utilizing spreadsheets in a non-controlled manner “will not pass muster with auditors evaluating Sarbanes-Oxley compliance.”

I’ve held on to another white paper for months that notes errors in Excel’s statistical calculations, specifically in the areas of regression, random number generation, and distributions - http://www.forecastingprinciples.com/paperpdf/McCullough.pdf

The danger in utilizing spreadsheets for forecasting lies in the volume of data, frequent updates, complex calculations, and chaining requirements involved in the process.  I have evaluated well known, name brand companies see real problems with spreadsheet errors caused by cells that were not correctly referenced from one sheet to another and calculation errors.

I recommend all size companies stay away from spreadsheets when performing sales forecasting and utilize well written and supported software that fully integrates into their planning and business systems.

Computing Cloud Riding on Ocean Waves?

Here is a fascinating read from Economist.com this morning about the Computing Cloud –

"IT is almost as easy as plugging in a laser printer. Up to 2,500 servers, in essence, souped up personal computers, are crammed into a 40 foot (13metre) shipping container. A truck places the container inside a bare steel and concrete building.  Workers quickly connect it to the electric grid, the computer network and a water supply for cooling. The necessary software is downloaded automatically. Within four days all the servers are ready to dish up videos, send emails or crunch a firm’s customer data.

This is Microsoft’s new data centre in Northlake, a suburb of Chicago, one of the world’s most modern, biggest and most expensive, covering 500,000 square feet (46,000 square metres) and costing $500m.  One day it will hold 400,000 servers.   The entire first floor will be filled with 200 containers like this one. Michael Manos, the head of Microsoft’s data centres, is really excited about these containers. They solve many of the problems that tend to crop up when putting up huge data centres:  how to package and transport servers cheaply, how to limit their appetite for energy and how to install them only when they are needed to avoid leaving expensive assets idle."

The next constraint for data centers is consumption of electricity and moreover, cooling of the individual computers –

"But cheap electricity is only one, albeit important, criterion for choosing the site of a data centre. Microsoft currently feeds 35 sets of data into an electronic map of the world, including internet connectivity, the availability  of  IT workers, even the air quality (dry air makes a good coolant), to see where conditions are favourable and which places should be avoided.  Apparently, Siberia comes out well.

Google, for its part, seems to be thinking of moving offshore.  In August, it applied for a patent for water-based data centres.  “Computing centres are located on a ship or ships, anchored in a water body from which energy from natural motion of the water may be captured and turned into electricity and/or pumping power for cooling pumps to carry heat away,” says the patent application.".

I recently read an article about using the motion of ocean waves to generate electricity and after reading this article, I am picturing offshore data centers producing their own electricity and pumping ocean water for cooling, while managing and storing email, running your ERP transactions, and online videos of Jessica Simpson for your employees…….what a world.

Phew! Consumer Confidence does not Equal Consumer Spending

Just a quick heads up in case you missed another article I wrote on leading indicators.  If you are watching Consumer Confidence as an indicator for where your business might be headed, you probably need a clean pair of shorts.  Confidence is that low.  In fact, the Conference Board says that Consumer Confidence is at an all time low, since the base year of 1985.

The good news is that there is NO correlation between consumer confidence and consumer spending.  Spending correlates with household income, household "feelings" of wealth, and access to credit....which is another story altogether.  Oh, whoops.  Let me get you a clean pair of shorts.

 

5 Inexpensive Ideas to Optimize Working Capital This Month

 

Given today’s economic headlines, more than 70% of managers have inventory reduction as their number one priority for 2008 and into 2009.  Manufacturers, especially companies under $1B, cannot quickly sell off machine assets and are reticent to reduce labor.  So, that leaves inventory in the middle.

Knowing this, I have some ideas to quickly reduce inventories:

1.     Sell off excess and obsolete inventories now.  You are already incurring reduced margin and something akin to a 25% carrying cost on this inventory.  The margin hit is already in place because of variable costs.  You will take no more hit by reducing prices by an amount equal to variable carrying costs (insurance, taxes, material moves, any rented space, etc).  Also note that expectations for your financial statements right now are probably fairly low, making now a good time to take a hit.

2.     Focus on forecast improvements.  Recent surveys note that this is the number one tool that managers are utilizing to optimize working capital.  Please note that there is an immediate benefit to investing in forecast improvement. Better forecasting usually results in reduced Purchase Accruals as purchasing for ‘just in case’ inventory is reduced.  Better forecasting will result in a better looking P&L during your next reporting period.

3.     If you are using spreadsheets for forecasting, make a change.  Studies note that 85% of spreadsheets used for forecasting contain errors (for a variety of reasons) that lead to significant forecasting problems.  Additionally, almost no managers utilizing spreadsheets are able to separate causal demand (like the economy) from history.  They rely almost exclusively on past history and personal (albeit cloudy right now) judgment about the future.

4.     Renegotiate minimum purchase quantities with your vendors.  A portion of inventory is excess because a vendor required you to purchase 1,000 when you only needed 100.  Ask your Purchasing executive to survey the buyers to determine where this imbalance exists.  This is typically built up one item at a time over time.  Look across the board and use any broad leverage you have to ask vendors to go back to reduce minimums.  Use the economy and your shared concerns about the future as leverage.

5.     For manufacturers, focus on inexpensive setup reductions and share your ideas with your vendor.  Just like your vendor is building in large quantities and forcing you to buy large minimums, your equipment setups probably dictate large minimums.  Reducing setups, increases local factory utilization measurements, and reduces inventories.  For more detail send copies of Shideo Shingo’s SMED System: Single Minute Exchange of Die to your manufacturing and special projects managers and your vendors.  I know I have recommended this before but it I receive no royalties from sales of this book…..maybe I should ask for something….Pennies of setup reduction investment return dollars.

Your Commodities Are Falling

Credit has tightened but relief should be on the way with decreases in commodities pricing and a coordinated effort by central banks in the US and Europe to loosen credit. 

Your business should be seeing some type of relief to revenue and margin in two ways from the recent decreases in commodities pricing.  A decrease in metals, foodstuffs, and oil over the last two months means lower raw materials pricing for you or your vendors which should translate to decreased inventory acquisition cost and an opportunity for better margins.  Take these charts to your Purchasing Execs to review those commodities that apply to your business. 

Likewise, for company's with products that are eventually sold to consumers, decreases in foodstuffs and oil has a direct relationship to your end users' pocketbooks.  The shrinking disposable income of the consumer will be looking better.  The flip side to this will be fear caused by media reports of a declining economy.

If your business buys steel, copper, aluminum or most other metals, you should be seeing a major drop in product pricing.  After significant increases over the last three years, metals has returned to pricing close to what we knew 3 years ago.     

Likewise, oil pricing (West Texas light sweet crude) has dropped by more than $50 / barrel since a high in July and pricing is expected to stabilize between $90 and $100 through the end of the year.  Even this morning, oil fell to $63/barrel in spite of an OPEC decision to drop production by 1.5 million barrels/day.  Over the next few weeks, you should be expecting decreases in transportation quotes or at least in your fuel surcharge accesorials.

Fun with Consumer Spending , Stock Markets, and Housing Bubbles

Given, the events of the last week in the US Stock markets, it is appropriate to expand on a thought I had back in August.  3 Major Indicators notes that consumer spending drops 3 to 6 cents for every $1 decrease in a person’s portfolio and drops 2 to 4 cents for every $1 drop in home value.  People spend more when the feel wealthier and less then they perceive risk to their sense of wealth.

What does that mean given the $7.5 trillion loss in stock prices in the last month to the DOW index?  It could mean $337 billion less revenue at the consumer level.  When you add a $6 trillion loss in housing stock, another $180 billion is not available for a total over $500 billion in less spending.  And this is just based on people’s perception of their own personal wealth.  Other factors such as unemployment and discretionary income will also come into play here to further drive down consumer spending.

$500 billion.....that's a 3.6% decrease in GDP.

Another major factor that I believe will depress consumer spending is Americans’ penchant for spending more than they earn giving us a negative savings rate.  The tight credit market will decrease the opportunity to spend on credit and force more Americans to live within a budget.  For the long term, a negative savings rate will certainly lead to greater risk in the economy as this article predicted 2 years ago.  While consumers will be learning a hard lesson over the next 6 months, spending will be further depressed.

Obviously, less revenue at the top of a supply chain trickles down through all of the partners.

If you are tracking the relationship between the stock market and consumer spending, you probably want to know where the whole thing is headed.  Right now, I’m reading articles like this one from the Boston Globe noting that signs are showing that we may be at the bottom.  But as the author notes “it’s anyone’s guess.”