Letter: Take a Realistic Forecast Before Deciding to Buy Overstock
In my 30-plus years of experience, I have seen time and again many people - especially for long lead time items - will say something like, "This is a long lead time item from the Orient" (usually with a large minimum, e.g. 1,200 units), and they therefore will plan and forecast that quantity, when if they used my rule might realistically say, "I think I can only sell 500, so does it make sense for me to buy 1,200 to sell only 500?" Conversely, for a short lead time item, they might only forecast 500, thinking, "I can get back into this in two weeks, so I don't have to forecast the item as high."
Let's say their "realistic" forecasts come true, what happens then? The long lead time item sells only 500, thus they now have the added cost of overstock (decreased warehouse efficiencies, cost of liquidation, etc.). Had they taken the realistic approach upfront, they might have decided either to drop the item or select a more profitable item (as the cost of the overstock has outweighed their sales). And the short lead time item is constantly being chased for back orders, also increasing their cost of doing business and customer dissatisfaction.
The idea behind my suggestion is to have them take realistic views of their item plans and forecasts and then make the decision to knowingly buy the overstock or not (had the "real" forecast been 1,000, buying potentially 200 pieces of overstock might make perfect sense considering any margin of forecasting error and the cost of any overstock liquidation, etc.) versus the example I mentioned above. On the other hand, they would have bought the shorter lead time item closer to forecast, thus avoiding the costs of back orders.
In addition to the potential overstock and back-order costs, they would also be impacting their cash flow as they would have purchased the overstock for the long lead time item and yet would still have to spend their buying dollars twice, so to speak, as they would certainly chase and buy the back-order quantities. So from a true "open to buy" control, they would have been over budget.
George J. Mollo Jr., GJM Associates Inc., email@example.com