Falling demand, unfortunately is a reality that most distributors are facing, or will face at some point in the near future. As of the time of this writing, late April 2020, the reality is that US Economy is likely already in recession, and will be for the next quarter or so. You just cannot take that much wind out the sails and expect that it won’t have a significant impact. It will.
Falling Demand Starts with Forecasting the Business
In times like this, it is more important than ever that a company realizes that all parts of the business are linked and have to work together to pull through difficult times. The first step is trying to gauge what the “new normal” is. That’s not always an easy thing to do, especially when emotions are running above normal, and clarity is not readily available.
I think of it kind of like a hurricane. You can clearly see that it is coming, but you don’t know exactly where the eye is going to hit. Hurricanes are forecasted using a “spaghetti model”. Essentially, this just means that several different models are put together, and then you can look at them all together to sort out the most likely range of paths.
A business forecast for a falling demand scenario could be done the same way. You will have a best case, a worst case, and all kinds of other models in between. These models will be based on your data, intuition, internal discussions, etc. Make several different models and then put them all together.
Once you have the models built and graphed, it’s time to pick a path and take your best guess where the eye of the storm is going to hit. In this case, the “eye” is the bottom of the downturn. You need to make a guess at the depth and the timing. This can be a simple as drawing a line through the chart and saying “this is what we are going with”. From this model, you can now begin to start looking at how those assumptions impact all aspects of your business, most importantly cash flow and inventory.
Applying Your Falling Demand Model to Inventory
With your business roadmap complete, it is now time to figure out how the falling demand is going to affect the inventory. It will most definitely not be a 1 to 1 relationship. Your current inventory profile is based on historical demand, and a big piece of this reset process is going to be based on inventory levels adapting to a lower demand profile. This can be tough because the purchasing and replenishment is going to feel like it dropped off to nothing for some period of time as you burn off the extra stock.
Lead Time Horizon Based Systems
If you are using a demand based forecast system, for example one that uses a forecast applied to lead time & safety stock, then you will want to upload forecast overrides for each month that your business model covers. If a given month’s forecast is off by 20%, then reduce the forecasted usage by 20% for that month. Repeat this for each month.
Remember that usage is a reflection of your sales, so the reduction in the forecast should be the same as the reduction in sales on a percentage basis. This assumes that your selling price and margin will be the same. If you are forecasting changes in average selling price, then your usage adjustment needs to account for this too. In other words, if there will be selling price erosion, a 20% drop in revenue may only lead to a 15% drop in units sold, since they are selling at a lower price. Plan accordingly.
Min/Max Based Systems
If you are using a min/max based inventory system, then you will want to revise those min/max settings down accordingly. I typically approach this by setting min/max levels around having some number of days of stock on hand. If I want to keep between 2 and 3 month’s stock on hand, then I would look at the forecasted usage for the item for a month, and set the min to 2 times that number, and the max to 3 times the number.
Keep Adjusting the Model for Falling Demand
Hurricanes are not forecasted once and then left alone until landfall. Things constantly change and the models have to be constantly updated to adjust for the new data. The sales and usage data that results from your plan feeds your business forecast model as needed. This helps balance your inventory investment and your ability to service customers.
Review your model each month, and see if the actual results roughly align with the forecast. If the forecast and results are pretty much in parity with each other, then keep going. However, the more likely scenario is that it is going to be off some. Be realistic about why there is a deviation. Was it a one-off order, like from a competitor trying to supplement their inventory? Whatever the case, re-evaluate and adjust the falling demand model as needed.
Don’t be discouraged if your forecasts are way off. There’s not a road map for this. Just adjust and keep moving forward. Manage the exceptions and stick with your plan.
Closing Thoughts on Falling Demand
Dealing with falling demand challenges the best of our abilities. The ability to remain objective and focused helps keep things moving in the right direction.
Create several models of what you think could happen. Next, find the path through those models that makes the most sense. Review and adjust monthly as needed to keep the forecast aligned with reality. It is also important to communicate what’s happening to your key suppliers. Don’t leave them in the dark, they are the first ones who feel the effects of your falling demand plans.