Use of Volume-Variance Demand

Analysis in Planning Strategy

Formulation
By Alan L. Milliken

Shows how to combine volume

analysis with variance analysis
to determine the contribution of
a product to the companys profit
product with a high variance
because of seasonality and data
trend is statistically predictable
collaboration with a customer
helps to improve forecasts and
reduce inventory.

have begun to use ABC segmentations to

evaluate customers from the perspective
of total cost-to-serve and products on the
total cost-to-acquire basis. The latest use
of ABC volume analysis for products is in
combination with variance analysis.
Supply chain also has many uses for
variance analyses. For example, standard
deviation is a key input to statistical
safety stock calculations. In the past,

he downturn in the global economy

has encouraged firms to take a
closer look at their excess, slowmoving, and obsolete inventories and
assess why these exist. Cash is King in this
economic environment. Managements
bias toward lower inventory, even to the
point of sacrificing service and cost, has
resulted in much more pressure on supply
chain to find and correct the causes of
dysfunctional inventories. One means
of better identifying the inventory risks
associated with offering products on
a make-to-stock, off-the-shelf basis is
volume-variance demand analysis.

WHAT IS VOLUMEVARIANCE DEMAND

ANALYSIS?
Of course Paretos Law has been used to
identify the significant few for centuries.
Supply chain has performed ABC volume
analysis for decades. For example, ABC
segmentation has been used to assign
stocking policies or to determine cycle
count frequency. More recently, firms

Alan L. Milliken
Mr. Milliken is a business process
consultant and a member of BASF
Corporations Business Process Sol
utions team. He has extensive experience
in Operations Management at major
plant sites including production,
logistics, quality control, and training.
He has participated in several S&OP
implementations as a subject-matter
expert as well as a project facilitator.
He is CFPIM, CSCP, and CPF.

the evaluation of demand variation

was limited to the use of sophisticated
statistical techniques like R Squared or
Correlation of Coefficients to determine
how well a forecast related to the
historical data. Now, more and more firms
are using the Coefficient of Variation (CV)
to evaluate the probability of successfully
forecasting a historical demand pattern.

USING THE COEFFICIENT

OF VARIATION
In probability theory and statistics,
the coefficient of variation (CV) is a
normalized measure of dispersion of a
probability distribution. It is defined as
the ratio of the standard deviation to the
mean. Distributions with CV>1.0 are
considered high variance while those with
CV1.0 are considered low variance. For
example, assume the variance in a dataset
as defined by standard deviation is equal
to 100 units and the average for the same
dataset is 200. The coefficient of variation
(CV) would be equal to 100/200 = 0.50
and the dataset would be said to have
relatively low variance.
It is not a great leap of faith to accept
that in most cases if the variance is high,
statistical forecasting tools designed for
normal, bell-curve distribution may not
perform well. This is particularly true for
averaging and smoothing models, which
are the most used in practice. Therefore,
one use of CV analysis is to determine
the probability of forecasting a historical
dataset within a reasonable limit. Again,
most firms accept the threshold of CV>1.0

THE JOURNAL OF BUSINESS FORECASTING, SPRING 2010

table 1
USING CV TO DETERMINE IF BELL-CURVE
STATISTICS ARE APPLICABLE
Product No.

Jan

Feb

774410

874

968

Mar

Apr

May

944

970

Jun

Jul

Aug

Sep

Oct

849

502 663

681

1066

322

Nov

Dec

877

384

Std
Dev

Avg

COV

Stat
Fcst

SF
95%

SS
95%

SS
(DOS)

406

16

246

758

0.3 Yes

1.65

344069

80

80

30

90

140

160

30

90

130

90

66

220

54

100

0.5 Yes

1.65

90

27

381275

369

100

469

359

339

469 100

479

519

409

373

171

332

0.5 Yes

1.65

282

26

382653

50

109

111

488653

549 1447

1537

30

12

47

13

70

51

1.4 No

1.65

115

68

1098 1397 549

234

489130

389

579

359

160

539

381964

173

18

459

1437

858

1657

569

532

965

0.6 Yes

1.65

877

27

249

574

389

563

130

194

349

0.6 Yes

1.65

319

27

12

44

343

111

63

1.8 No

1.65

183

88

0 260
181

Notes: SF = Safety Factor; SS = Safety Stock; DOS = Days of Stock.

in segmenting those items that cannot be

forecasted with statistical forecasting
software.
In the dataset given in Table 1, two
products did not pass the CV<1.0 test.
Notice how erratic the demand is for these
two products. Also, notice how many days
of safety stock would be required if we
use statistics to determine the safety stock
quantity. Misapplication of statistical
techniques leads to excess or dysfunctional
inventories and higher costs.

Figure 1
VOLUME-VARIANCE MATRIX
High Demand

COMBINING VOLUME &

VARIANCE ANALYSES
Many firms combine volume analysis
(ABC) with variance analysis (XY) to
determine the contribution of the product
to the value of the firm (revenue, profit)
and the probability. Their forecasting soft
ware can provide a reasonable forecast to
control inventory and improve cash flow.
The results of an ABC-XY analysis
are usually displayed in a matrix chart
as well as a table of values. This helps to
relate what action(s) might be appropriate
based on the position of the product in the
matrix. Figure 1 illustrates the approach.
The ABC volume segmentations will be
dataset specific. Also, some firms prefer to
add a third segmentation to the X-axis and
have an ABC-XYZ matrix. This further

Collaborate with
customer for better
planning; if
seasonal pre-build is
based on
probability.

Use statistical
forecasting
techniques.

Hi-risk of
obsolete
inventory; Check
profitability;
Make-to-Order
Only

Aggregate forecast
& inventory if
feasible; consider
Make-to-Order

Low Demand
-0-

CV = 1.0

Low Variance

Y
High Variance

Coefficient of Variation = Standard Deviation of Period Demand or

Forecast Error/Average Period Demand
complicates the analysis and development
of the action plan. A comparison of days
invested in inventory to the volumevariance status of a product can help in
developing the action plan. For example,
many items with high relative days-onhand will be found in the CY (Low
Volume-High Variance) segment of the

matrix.

VOLUME-VARIANCE
ANALYSIS TO IMPROVE
THE SUPPLY CHAIN
Many firms still process all items
through their forecasting software and

THE JOURNAL OF BUSINESS FORECASTING, SPRING 2010

table 2
USE OF VOLUME-VARIANCE ANALYSIS TO DEVELOP STRATEGY
Example 1: Where only Bulk Product can be forecasted.
Mat- Bulk Mat- Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug 20- 20- Std COV
erial Pro- erial
Mos Mos Dev
Sum Avg
(Prod- duct Descr
Pkg)

1
10 Pkg
- 4
2
2
2
2
10 Pkg
1
3
10 Pkg
1
4
10 Pkg
- 3
2
4
1
2
5
10 Pkg
1
1
3
3
8
3
2
SUM 10 Bulk - 7
Example 2: Where Product-Package can be forecasted.

2
2

5
1
6

2
2

2
1
3

2
2

2
2
4

3
3

2
2
4

2
4
6

2
1
3

2
2

2
2

26
6
8
20
5
65

1
0
0
1
0
3

1
1
1
1
1
2

0.90
3.76
2.49
1.30
2.20
0.65

Mat- Bulk Mat- Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug 20- 20- Std COV
erial Pro- erial
Mos Mos Dev
Sum Avg
(Prod- duct Descr
Pkg)

6 N/A Pkg
5 5
2
2
2
2
2
4
2
Example 3: Material (Prod-Pkg) that should be Made-to-Order.

68

1 0.40

Mat- Bulk Mat- Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug 20- 20- Std COV
erial Pro- erial
Mos Mos Dev
Sum Avg
(Prod- duct Descr
Pkg)

N/A Pkg

pay for low volume-high variance issues

on the supply side in terms of expedited
costs or excess inventory costs. One
objective of using Volume-Variance
Analysis is to identify items for which
supply planning will be a challenge and
to discuss alternative actions for those
items.
Next are some actions that are driven by
the Volume-Variance Analysis:
Increase the price or remove the
product from the offering if it is not
profitable;
Place the item on make-to-order status
to avoid inventory risks;
Reduce the number of packages being
offered for the item;
Reduce the number of stocking
locations for the item; and
Collaborate with the customer to
replace estimates with knowledge.
Table 2 depicts how the use of Volume-

Variance Analysis in developing the

manufacturing strategy can result in lower
total cost and less inventory.
In the first example, the business was
offering the product in five different
package sizes each of which had low
volume and high variance in demand.
A decision was made to produce in bulk
against an aggregated forecast and offer
the packaged product on a packageto-order basis. As a result, safety stock
quantity was reduced significantly and the
risk associated with offering these items
on a make-to-stock basis was eliminated.
This concept is called postponement
in supply chain and is very effective in
reducing costs and inventory investment.
The second example displays a situation
where volume is sufficient and variance is
low enough to offer the product-package
combination on a make-to-stock basis
and forecast demand. The third example
presents an analysis that led to placing the
product-package combination on maketo-order status. The product was sold to

THE JOURNAL OF BUSINESS FORECASTING, SPRING 2010

12

1 1.47

one customer who had taken a total of 12

units over a 20-month period.

TIPS FOR USING VOLUMEVARIANCE ANALYSIS

This approach to assessing product
offerings, manufacturing strategies, and
planning techniques must be part of a
comprehensive system. Some cautions
regarding the role of this process in overall
planning and control follow.
CV will be high for seasonal and
trending data patterns but statistics
may be applicable. Here products
can be forecasted with a reasonable
amount of accuracy even though CV is
high. Therefore, CV analysis must be
complimented by a review of demand
patterns if trend or seasonality is
suspected.
The importance of a customer, the
value of a product (high or low), and
product variance must be evaluated

together. For example, if the firms

most important customer wants a low
volume-high variance product on a
make-to-stock basis, the customer
rank may outweigh the risk and costs.
If CV analysis results are used to place
items on order point planning or maketo-order status, the firm must adjust their
raw materials planning accordingly.
In conclusion, the use of VolumeVariance Analysis to improve supply chain
performance will continue to grow as firms
look for new and different ways to gain a
sustainable competitive advantage.

(info@ibf.org)

BOOKS
Practical
Guide
to
Business
Forecasting edited by Chaman L.
Jain & Jack Malehorn. Flushing, New
York: Graceway Publishing Company.
2005. pp. 510. $59.95
Regression Analysis, Modeling and
Forecasting by George C. Wang &
Chaman L. Jain, Flushing, New York:
Graceway Publishing Company. 2003.
pp. 299. $58.95.
Benchmarking Forecasting Prac
tices by Chaman L. Jain & Jack
Malehorn. Flushing, New York:
Graceway Publishing Company. 2006.
pp. 116. $68.95.
Sales & Operations Planning: The
How to Handbook by Thomas F.
Wallace. 2004. pp. 176. $44.95.
Demand-DrivenForecasting:A Struc
tural Approach to Forecasting by
Charles W. Chase, Jr. 2009. pp. 270.
$60.00
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