How to Measure Demand Forecast Accuracy

Introduction

Demand forecasting is the process of predicting future demand for a product or service. It is an integral part of a retailer’s strategic planning and execution. Forecasting helps retailers plan their inventory and supply chain, which are the backbone of their operations.

It allows you to better manage your inventory levels and consistently meet demand while only storing the inventory you need at a given period. For instance, when a product comes in stock, it's available for purchase by customers who want it—and not sitting on DC shelves gathering dust.

Forecasting also helps with pricing decisions: if you know what your customers are likely to buy at different times of year, then you can adjust your prices accordingly and maximize profits.

But keep in mind that forecasts will always be inaccurate to some degree. They are obviously important, but they are also inherently imperfect. A forecast’s value depends on how it can help retailers achieve other goals such as improved availability, reduced lost sales or more effective assortments.

“How Accurate Should Our Forecasts Be?”

A common question we get from our retailer customers is “How accurate should our forecasts be?”  While this sounds like a straightforward question, there is no simple answer to it.

The fact is that the answer changes for different retailers, products, and stores. For instance, forecast accuracy expectations for milk or tomato cannot be similar to a slow-moving item such as a screwdriver.

Therefore, retailers need to continuously and separately assess forecast quality to identify areas for improvement for different products and stores to better manage their inventory and reduce costs. But what factors affect forecast accuracy? How do you assess the quality of your forecast and improve it? Let’s find out.

What Is Forecast Accuracy? Why Does It Matter?

Forecast accuracy is the degree to which a forecast matches actual demand. Understanding and monitoring forecast accuracy is essential because it impacts how well your organization can meet customer needs and improve its business results: the more accurate forecasts, the better decisions.

Once you have a good demand forecasting system in place, you can

• Avoid stock-outs and minimize lost sales,
• Prevent aggressive and unnecessary markdown decisions,
• Shape your inventory and pricing strategies successfully,
• Get ready for future demand fluctuations,
• Remove previous noise and outlier demands,
• And do better merchandising planning.

What Affects Demand Forecasting Accuracy?

There are many factors that affect the forecast accuracy within a company both internal and external. When external market and economic conditions are outside of the company’s control and unknowable, the plans must be built upon a set up assumptions.

But first, it’s essential to know what type of demand forecasting technique is being used, how far in advance forecasts are made, and the amount of data available from historical periods.

Below is a list of these factors you need to consider when developing your demand forecasting strategy.

• Seasonality and special days,
• Promotion and markdown uplifts,
• Cannibalization effect,
• Inventory levels,
• Product substitutions,
• Competitors’ prices and activities,
• Market trends,
• Macro-economic factors,
• Local events,
• Weather,
• Characteristics of store locations and so on.