Consumer Demand and the

Future of the Supply Chain

by Andrew Wilson
Vice President of Product Management

April 2002
 Executive Summary

Manufacturers and Retailers alike are assessing and utilising ever more sophisticated
techniques to understanding how consumer demand should be anticipated, planned for
and influenced. The design and operation of their supply chains, and the use of timely,
accurate consumer demand information to drive these supply chains is at the top of most
company's agendas. This paper considers the techniques such companies are using to
arrive at an improved understanding of consumer demand and addresses some of the
most important issues companies should consider when selecting and applying automated

Consumer Demand and the Future of the Supply Chain

techniques to assist in both predicting and influencing this demand.

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 The Competitive Power of Prediction

Decades of research and experience in the disciplines of econometrics, investment decision-making and natural
sciences have transformed the ability of companies to predict and create consumer demand. These approaches
have found their way into commercial software applications used in Demand and Supply Chain Planning - and
are now becoming a major competitive weapon for enterprises across all sectors of industry.

Companies have long understood how significant inventory reductions, coupled with high and profitable
consumer availability, provides competitive edge. They also recognise that using Point of Sale and SKU level
data for forecasting provides a more timely and accurate picture of consumer demand for their supply chain
and is a significant contributor to improving forecast accuracy and making appropriate and profitable inventory
decisions.

Understanding demand at the consumer level is a major enabler for companies under pressure to deliver the
inventory, availability and profitability improvements demanded of them.

Predictions by Industry Analysts in the mid 1990s on Demand Planning trends have proved to be highly

Consumer Demand and the Future of the Supply Chain

accurate. They included:

The availability of commercial software applications, which can accurately forecast all major
types of demand.

The use of forecasting approaches that automatically determine the best mathematical
models to be used in predicting demand.

The adoption of causal forecasting by leading edge enterprises.

While many companies have purchased software tools which promise the above, many have still to realise the
full benefit from their investment. Software should not be a constraint for companies to arrive at highly
accurate predictions of consumer demand: however, many companies are still in the early stages of achieving
those levels of accuracy.

The main reasons for this are:

The forecasting approach of the software application.

The complexity of the real world.

The use and deployment of the software application in the organisation.

It is important to understand the constraints companies are facing and what steps they can take to remove
them.

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 The Future of Forecasting: Next Steps

Which forecasting approach should I adopt?

In most statistical approaches there is a trade-off between the complexity of the model used and the accuracy
with which it predicts.

Using Bayesian logic is widely recognised as the most appropriate forecasting approach, as it selects the
combination of available models to achieve the best trade off between complexity and accuracy. Through 'out-
of-sample' testing, this approach usually divides the available data (eg: Customer POS information) into two
groups. The model is then built using the first group and validated using the second. The errors of the two
groups are compared to ensure that the model is equally accurate in both cases.

The Bayesian approach therefore has many advantages over less sophisticated forecasting approaches. Most
importantly, it:

Utilises all available statistical techniques so that seasonality, trends, outliers, intermittent

Consumer Demand and the Future of the Supply Chain

demand, step changes and other patterns inherent in the data can be checked for and
modeled.

Simultaneously checks the significance of other variables which may have influenced the
demand - often described as causal factors.

Utilises an 'out-of-sample' approach to trade off model complexity versus accuracy and
minimise overfitting.

Improves the overall run time of the forecast.

History
Bayesian Analytical Modeling Overview
Bayesian Estimator

Casual Factors Bayesian

Combined
Model

Final
Forecast
Estimator's
Models

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A multi-dimensional framework is essential
A company selecting a Demand Planning application for its supply chain environment using the Bayesian
approach is already a step closer to significantly improving its ability to predict demand with greater accuracy.
However, there are other considerations, relating to how the Bayesian logic is deployed within the software.
Perhaps most important of these is the framework within which it is deployed - which should be multi-
dimensional.

This becomes critical as companies move towards forecasting at the SKU level using POS data. Speed of
processing and flexibility in forecasting are key considerations here.

Users throughout the enterprise - and, increasingly, beyond it - must be able to 'slice and dice' the forecast if
they are to plan effectively.

'Making it real': modeling the extended enterprise is a critical step

The onus is as much on the company that is purchasing the application as it is on the software vendor to get

Consumer Demand and the Future of the Supply Chain

this right. Modeling the enterprise and its trading partners - the extended supply chain - is a critical step in the
deployment of the software application. Consideration must be given to the obvious such as the Product and
Location hierarchies, to sales and distribution channels, but also to key features of these structures.

Attributes of the Product such as colour, dimension, ABC rank and lifecycle phase can be important ways in
which to segment and analyse demand patterns. Location attributes such as throughput volumes may be a way
of segmenting the distribution network. Critically, these analyses reflect the real way in which a company is
organised and does business. Many of these cut across existing or planned organisational structures such as
Brand or Market - but can be vital in understanding and accurately predicting demand patterns, which may
otherwise be hidden.

e
Tim
Organisation
DC, Plants, Channel

Products
Product, Product Group, Product Family
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5
Cause and effect: the power to transform a Supply Chain environment
In broadest terms, seasonality, the day of the week or the month can all be considered as causal factors - and
all can have a major effect on demand and supply chains. For example, demand for ice cream is highly
seasonal; demand for a given newspaper will vary depending on the day of the week.

The real situation is however far more complex. Many other interrelated factors influence consumer demand -
from macro-economic influencers such as lending rates, to the weather on a particular day, to the price of an
item, to whether an item is being advertised or promoted. These factors will also vary by location, and the
effect of each will vary from product to product. In addition, their impact, whether externally (eg: weather) or
internally produced (eg: price) will usually be overlaid and will interact. Understanding the relative contribution
of each factor to accurately predict demand individually, collectively and in combination is critical but complex -
and has the power to transform a supply chain environment.

Sophisticated Demand Planning applications are vital to achieving this.

Demand History
Demand Planning Process
Data Final
Forecasts
Demand Planner

Consumer Demand and the Future of the Supply Chain

Demand Casual
Data

Statistical Forecast
Forecasts Overrides

Companies using the Bayesian approach in their Demand Planning can simultaneously introduce any and all
variables in their forecasting process, to arrive at the greatest understanding of the factors influencing demand
- and thereby achieve the most accurate prediction of that demand. They can then use that knowledge to
empower their supply chain, for cost reduction and competitive edge.

Mapping of the causal factors onto the real world model created in the Demand Planning application and
associating them with the correct Product / Location / Channel combinations is clearly crucial. It is important to
evaluate demand-planning processes throughout the organisation, from Finance through Marketing to
Operations, and to identify how causal factors can be used to improve the accuracy of those planning
processes. A corporate advertising campaign may be as important in influencing demand as consumer lending
rates or rainfall. These may not be significant at an individual SKU level, where a promotional event or price
change may be the primary factor impacting demand - but can be highly significant at the brand or market
level.

What is also important is to assess the impact of repeating an historic event in the future. For example - if the
price of an item was dropped by 20% a year ago, what would be the impact of repeating this 6 months from
now - and is that the right time to do it, or should it be 4 months (or 8 months) out? Should it be 25% or would
a 15% reduction be sufficient? Is there any other significant event planned at the same time, which may
reinforce or cancel out the effect on demand of a price reduction? Perhaps another event close by means that a
price reduction is unnecessary, and that funds can therefore be deployed more effectively elsewhere or at
another time.
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6
How should I plan to organise and implement?
Identifying, organising, testing, deploying and maintaining causal factors may seem daunting: but the real
world is complex. A greater understanding of that complexity will improve the accuracy with which demand
can be predicted - and drive top and bottom line benefits accordingly. This does not mean that all the
complexity needs to be understood and modeled at once. What is important is having a structured plan to
improve the sophistication of the model.

Start with the quick wins first - decide which area is likely to give you the greatest return.

It may be improving the market level planning and the setting of corporate targets. It may be the management
of trade promotions and promotional calendars to make more effective use of trade funds and improve the
synchronisation of demand and availability. These decisions will vary from company to company. What is
important is to start, and to continue once you have started. Get the buy-in of all functions involved in the
process, review the factors that are already used in your company - and try them early on.

Consumer Demand and the Future of the Supply Chain

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7
 Practical Examples from Leading Companies

Examples from three very different industries serve to illustrate the ways in which Causal Factors are used in all
aspects of Demand Planning - from predicting market level demand for agricultural equipment costing $250K
to predicting demand at the news stand for a daily paper.

The first example is taken from the world of discrete manufacturing - in this case complex, highly expensive
agricultural equipment. The Demand Planning requirements of this company centred on the prediction of
market trends and their competitive positioning. Forecasting the overall shifts in market demand and the
demand for products within those markets was the first step in developing the organisation's demand plan.

The company had highly qualified and experienced staff in its global marketing function, specifically focused on
market trend analysis. Prior to the introduction of the Demand Planning application they had already identified
the importance of causal factors in their market analysis, and were using several which they considered to be
leading indicators of demand. These included temperature and rainfall forecasts, influencing harvest yields; and
forecasted changes in the Green Pound rate - influencing the buyer's sense of economic well-being. In the early

Consumer Demand and the Future of the Supply Chain

stages of implementing their Demand Planning solution these factors were built into the model and tested for
their predictive impact. Although they were found to be loosely correlated with demand, the modeling
suggested they were not primary influencing factors.

They searched for other factors, which would more closely affect demand. This project coincided with the
height of the livestock disease crisis in Europe and it was suggested that this could be a significant factor in the
prediction of demand.

What was needed was an indicator already being forecasted elsewhere and which could be tested for its ability
to accurately predict demand. It was suggested that Livestock Future prices, readily available from other
agencies, should be tested. When tested on the UK market the correlation was very high - far more so than any
of the other factors previously used by the company.

This example also illustrates the importance of periodically reviewing the causal factors built into the process.
As consumer confidence in meat improved and livestock prices recovered and stabilised, the predictive ability
of this causal would be expected to wane and other factors would need to be checked.

The second example is taken from the world of publishing, specifically a leading national newspaper. The Print
Media industry is widely recognised as having one of the most fast-moving supply chain environments. The
publisher needed to understand and organise the highly complex combinations of factors, which influence
demand on any given day. These included seasonality and real world events, neither of which is under the
control of the publisher but which are significant factors affecting demand.

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There are however many additional factors which are under the control of the publisher. To maximise their
return on promotional investment, the impact of each of these must also be understood. Usually several factors
influence demand on any given day, and the impact of these factors individually and collectively must also be
understood. Price reductions must be assessed for their impact on demand. Complex promotional events are
run regularly, such as free papers with a coupon for a mobile phone, or money-off voucher for a vacation.
Predicting the impact of the promotion becomes even more complex as two demands must now be forecasted
- the mobile phone and how often the voucher for a vacation is used to obtain a copy of the newspaper.

This media group is expecting significant benefits from their ability to forecast demand more accurately,
recognising the crucial role of selecting and predicting the impact of causal factors. Anticipated benefits include
a $1m improvement in profitability, a 25% reduction in returns and an increase in circulation of up to 35%.

A further CPG industry example illustrates how a leading global manufacturer is using causal factors to
significantly improve the accuracy with which they predict demand for their Food and Household cleaning
Products. Promotional calendars for price reductions and consumer coupons have been introduced into their
Demand Planning application, to good effect. The model encompasses 10 promotional and advertising
strategies including In Store coupons, In Store Advertising and Instantly Redeemable coupons. Therefore the
forecasting model now has to take into account significant lags, which may occur between a promotion and its
impact. In addition, it now needs to differentiate the lagged effect from the other promotions running at the
time. These and other promotions are being modeled across a wide range of brands and SKUs - in up to
20,000 store locations.

Consumer Demand and the Future of the Supply Chain

These examples serve to illustrate the diversity and complexity of consumer behaviour and the wider
environment in which the consumer exists. Manufacturers and Retailers are trying to understand and influence
consumer behaviour in a repeatable and predictable manner. Improved understanding ensures that the right
investment decisions are made in Promotions, Advertising, Inventory, Production, Transportation and a myriad
of other costs incurred in getting the product to the consumer and enticing them to purchase it. Central to this
understanding is how each potential influence contributes to the consumer's decision to buy, and how to
successfully and accurately account for this when deciding which products to make, how many to make, where
to store and ship them and how, where and when to promote them.

In simple terms, how to bridge the gap between Marketing and Operations using the most accurate
understanding of demand?

This paper concludes with some recommendations about how companies can start to improve things either
through the selection of software to assist in automating these processes, through getting more from software
already purchased and by asking some simple questions about how they organise their demand management
processes.

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 Conclusions and Recommendations

Companies should review how they have organised their internal demand planning activities, and then how
they are involving their trading partners in the demand planning process. In particular they should focus on the
following:

Are all of the functions which influence demand - Marketing, Finance, and Operations -
involved in the process?

Are all of the potential causal factors at the company's disposal - market trends, new product
introductions, competitive influences, company revenue, profitability and volume targets,
pricing strategies, promotional and advertising activity etc - being considered?

Is real demand (or at least real sales) history being used, or are forecasts based on order or
shipment history?

Does the Demand Planning application provide feedback on the degree to which a causal

Consumer Demand and the Future of the Supply Chain

factor explains demand? Without this the user is driving blind.

Does the Demand Planning application cater for the modeling of several coincident causal
factors, and can it distinguish between the overall impact and the contribution each causal
makes both individually and in conjunction with others?

Are causal factors being reviewed on a regular basis to determine whether their impact is
increasing or decreasing? Automatic modeling will take this into account but it may also be
time to look for other causals.

Do not be put off by complexity. Carefully plan the model of your world - your organisation, products, markets
and trading partners - and use your demand planning application to identify the most important factors
influencing demand.

However, do not try to model everything at once. A structured and iterative approach to complexity will still
deliver significant and increasing returns.

Make good use of your chosen software vendor. They should have experience in your industry and across a
wide range of other markets. They should know which causals to look at first and where to look for them.

Finally, challenge any accepted wisdom in your company that the factors you have been using for years are the
only ones that count.

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About the author
Andrew Wilson is Demantra's Vice President of Product Management. He has over 20 years experience in
Operational Logistics and Supply Chain management and also in Software selection, design and
implementation. His experience has been gained working in and with companies in the High Technology,
Telecommunications, Automotive, CPG and After Market sectors.

About Demantra
Demantra is the leading provider of consumer demand-driven supply chain solutions. Unlike product-focused
supply chain solutions, Demantra's captures consumer demand intelligence to drive supply chain performance.
Over 100 Fortune 1000 companies, including Unilever*, Coca Cola FEMSA* and Hunter Douglas, use Demantra
to generate highly accurate demand forecasts and make enterprise-wide, single number planning a reality.
Documented results include forecast error reductions of as much as 40%, driving finished goods inventory
reductions of up to 60%, plus proven ROI of 100% to 500% in the first full year of operation. For more

Consumer Demand and the Future of the Supply Chain

information, see http://www.demantra.com or contact pr@demantra.com.

2002 Demantra Inc. All rights reserved

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*in partnership with J.D. Edwards