Lead time forecasting: the 2nd essential step to expert demand planning
Welcome back to our ‘7 Essential Steps’ Series!
We hope you enjoyed last week’s post on demand forecasting. Today it’s onto the 2nd essential step of ‘getting it right’ in the purchasing process… Lead Time Forecasting!
Lead time forecasting is a critical and often overlooked component of demand planning and replenishment. For many retail and wholesale distributors, this is the first time you will put the words “lead time” and “forecast” together.
We don’t have a crystal ball for predicting long lead times [although, wouldn’t that be awesome?!] What we can do is get methodical about how we calculate safety stock in terms of lead times. This step will drive substantial results.
It makes a ton of sense when you think about it. With service and inventory performance at stake, why would you put tremendous resources into demand forecasting for your customers, and then simply ‘plug in’ a lead time value to describe your suppliers? Lead time forecasting intelligence needs and deserves the same level of sophistication as demand forecasting!
The days of shooting from the hip are in the past.
Get Off the ‘Worst-Case-Scenario’ Train!
An interesting and costly buying pattern has existed for decades. Analysts are very comfortable with a demand forecast that cuts through the middle of their demand history. However, when it comes to lead time, our profession historically has a habit of entering a worst-case scenario.
If the deliveries have been averaging 8 to 12 days, you are often more likely to see a 12-day lead time set rather than the average of 10.
At the same time, an item that historically sells between 50 and 150 will have a demand forecast of 100.
The first step of the lead time forecasting process is to treat the lead time value as a forecast, rather than a setting.
If you have this mindset, great results will follow.
Supplier and Item Lead Time Forecasting
A strong lead time forecasting process analyzes the main receipt history and offers a supplier lead time forecast, but also offers item-level lead time forecasting for those items that are being scratched or short-shipped frequently.
The need for unique item-level lead time forecasting typically varies by industry. Industries where suppliers have poor and inconsistent delivery performance — such as furniture distribution — will benefit from item-level lead time forecasting.
Just like in demand forecasting, gather as much lead time history as possible. Your data is extremely valuable. Years of lead time history and real-time analysis will allow you to put inventory behind the winning SKUs.
Similar to the demand forecasting process, there are 3 critical attributes of lead time forecasting: Lead Time Forecast, Lead Time Deviation, and Lead Time Seasonality. When done right, lead time forecasting delivers precision in all 3.
Lead Time Forecast
Start with the actual lead time forecast value, but don’t stop there. Offer as much history as possible. An intelligent forecasting method will tell you how much to use for each supplier and item. You can find this in today’s advanced cloud-native solutions for forecasting.
Lead Time Deviation
The deviation describes the reliability of the supplier and their performance.
Similar to the demand deviation, the higher the lead time deviation, the more safety stock will be required. This additional safety stock becomes part of the inventory operating expense and will negatively impact the profit of an item.
Your suppliers need to know, and so do you.
Suppliers need to realize that their consistency is just as important as their length of lead time. A lead time of 10 days that varies from 6 to 14 days will likely cause more inventory expense than a consistent lead time of 11 days. The extra safety stock will absolutely impact your inventory operating expense.
A note about the financial impact of long lead times… Yes, your lead time deviation will influence your safety stock needs. But so will the length of the lead time.
A lead time of 100 days will require a much greater safety stock amount than a lead time of 10 days. Purchasing for a time 3 months from now reduces your confidence in how much you will sell during that period.
In fact, of the various safety stock components, your lead time can have the most influence when the lead times grow to several weeks and beyond. When purchasing import items with a goal of achieving lower pricing, it is important to analyze the additional cost of the safety stock.
A warning… If you continue to set your lead times using the worst-case-scenario strategy, you are adding unneeded days of inventory. Three days of cushioned lead time results in 3 days of unneeded safety stock. This adds to your inventory, but is a monstrous misuse of cash!
If you know the value of 1 day of inventory, as most top-performing inventory management teams do, then you know the excess investment from cushioned lead times.
Lead Time Seasonality
Yes, your lead time deliveries also experience seasonal fluctuations. Seasonal changes in deliveries result from:
- Seasonal weather conditions
- Supplier plant shutdowns
- Employee vacations
- And plenty of other pains in the #$%!
In fact, it is often your own Receiving departments that cause these seasonal changes! Your safety stock calculations and processes need to read these seasons and help you react.
These key components need to be maintained ahead of time. Just like every component, lead time values need to be maintained ahead of time, as they influence the decision of ‘when to buy’ as much as they influence the obvious decision of ‘how much to buy’.
Common, Costly Pitfalls to Avoid
Many lead time forecasting habits have become common practice, but cause excess time and expense. Usually much more than organizations realize. As you move from good to great in lead time forecasting, work to remove these common lead time pitfalls:
- Buying with a cushioned lead time that describes a worst-case scenario & keeps unnecessary just-in-case inventory dollars.
- Not actually forecasting a lead time from receipt history, but buying with a static number based on vendor promises or gut feel.
- Using one vendor-level lead time number for all of the line’s items, even though some items have experienced occasional short-ships or other mishaps & require a unique item lead time.
- Not tracking or utilizing the historical deviation information of the item’s receipt history for proper safety stock building.
- When forecasting vendor/item lead times, using one single forecasting calculation, even though each item has unique receipt history characteristics.
- Overreacting to individual long lead time spikes & reacting by building up unneeded inventory.
- Not filtering promotional, or other special-order receipts, out of the lead time calculations, which could inflate the inventory.
- Not taking seasonal lead time patterns into account when buying.
If you are doing any of the above, be sure to check out what these pitfalls are costing your business. This Inventory ROI Calculator will show you.
Advanced Operational KPIs for Inventory Management
Advanced lead time forecasting will also provide numerous operational studies. Here are some of the KPIs that deserve study and action by your inventory management team:
The cost (to you) of increased supplier lead times
When suppliers suddenly struggle, and your lead time forecasting response is to move from 9 days to 14 days, there is a precise financial burden to the new normal.
For example, your forecasting tools should show that the change from 9 to 14 will add $100,000 to your inventory and $26,000 to your cost of carrying inventory. You are now carrying inventory that your supplier used to carry. They have transferred a cost to you. You need to redeem that cost in the form of pricing, a bill-back, or some other agreement.
Supplier’s performance – % service to you
If your mission and promise is to deliver 98% service to your customers, and your suppliers service you at 96%, you need great tools to visualize the impact of that.
Track, study and respond to this critical number. Know the overall number as well as the value for each supplier and DC. There should be a rolling supplier service % calculation and you should receive automatic alerts when the value changes. You will likely find seasonal changes in the number, which should lead to adjustments in replenishment.
Also, any value like this deserves a gap value.
Always know the current gap between your service to your customers and the supplier’s service to you.
Changes in the gap should trigger action!
Averages lines per PO
The size of the orders will influence your receiving schedules. As you make adjustments to your replenishment components, you have to watch for changes in the size of the orders. These changes can influence receiving schedules and patterns.
Lead time fluctuations by order size
When Receiving gets heavy, or vacations limit the labor pool, disruptions can occur. Receiving teams often respond in different ways, even in different DCs in the same company.
Based on goals they have to meet, you might find that large orders are pushed to the side for later, and those are the ones where lead times increase. However, another DC could do the exact opposite. Put your data to good work and build stories that help you take the right action.
Time-to-Shelf and Available-for-Sale
Another key value to measure is the Time from Dock Receipt until Available-for-Sale in your ERP’s on-hand value. This is another very beneficial gap value to monitor closely in each location. There are times when your lead time spikes are mainly the result of slowdowns inside the warehouse.
What Does ‘Textbook’ Lead Time Forecasting Look Like?
Top-performing inventory management teams invest time and resources in lead time forecasting just as they do demand forecasting. They are in a constant journey to enhance, refine and sharpen the accuracy.
Valuable results await on both sides. Teams will experience an inventory reduction by removing the cushion, and a service improvement by buying earlier on items with longer lead times.
Analysts should have the same degree of forecasting accuracy tools to monitor lead time trends and make changes.
Top inventory management teams also value collaboration. Integrated business planning with their suppliers leads to constantly getting the smartest, most accurate lead times possible. They offer purchase projections to help suppliers be prepared and in stock.
Results from Doing it Right
A 10-12% inventory reduction is common
A 10% to 12% additional inventory reduction has been measured consistently over the past few decades when companies add advanced lead time forecasting to their supply chain planning solutions. This analysis has been possible over the years as companies often activated this area months after their inventory solution went live.
For those companies whose service-level promise is higher than their supplier’s performance, lead time forecasting is the key to delivering on that promise.
Analytical tools can help build a bridge between supply chain planning, the warehouse and the transportation teams. Inventory planning often has the data and insights which their operational peers need.
The lead time component has often been referred to as the “sleeper component.” There is too much at stake to allow it to stay in a slumber.
Add robust lead time forecasting to your good-to-great journey and you will add to your bottom line!
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