Case Report: L.L. Bean 1. How does L.L.

Bean use past demand data and a specific item forecast to decide how many units of that item to stock? L.L. Bean uses three steps to calculate determine the number of units of a particular item it should stock, both for a new item or a never out item. The first step is to detect a frozen forecast for the item in the future period which from the forecasting department, and is based on the book forecast and past demand data. The forecast is then used together with the historical forecast errors, namely the A/F ratios. These consider an individual item s past season s forecast and actual demand. By calculating the A/F ratio, L.L. Bean estimates the range of inventory that the product will be in the upcoming season after converting the point forecast into a demand distribution. For instance, if there was a 50 percent chance that the forecast errors for last season were between .6 and 1.6, then the same distribution would occur in the future period. If in this case the frozen forecast (point forecast) would be 1000 units, then with probability of 50 percent the stock amount to order this item would be between 600 and 1600 units. The last step in forecasting demand is to find the service level based on a profit margin calculation. Thus L.L. Bean considers the contribution margin in case an item is bought versus the liquidation costs spent if the item is not demanded. They can then use this to calculate the critical ratio (fractile) (costs of understocking relative to the sum of costs of both understocking and overstocking), which describes the item s probability distribution of demand. The critical ratio calculation must be done so that L.L. Bean knows at what point it is optimal to hold the stock in order to balance overstocking and understocking costs. Finally, the critical ratio is combined with the corresponding forecast error, while the number of items to stock is the product of these two numbers and the frozen forecast. 2. What item costs and revenues are relevant to the decision of how many units of that item to stock? Essentially, three pieces of data that L.L. Bean needs in order to decide how many units of an item to stock. They first need to know what the cost is to buy an item. Furthermore, they need to know the selling price of the item. From these two pieces of data, they can then calculate the profit margin generated from each individual item (profit margin = selling price cost of item), which is also the costs of understocking. The third piece of data they need is the liquidation cost of an item to calculate the costs of overstocking. With these calculations, L.L. Bean can use the methods mentioned in Q 1 to decide about the final amount of items to stock. For this, L.L. Bean needs to compare the costs associated with understocking relative to the sum of understocking plus overstocking inventory. However, the costs of understocking should not only include short terms losses like the loss of the sale for that item at that time, like it says in the case, but also include loss of future business due to customer dissatisfaction, which is not considered in the case. L.L. Bean must also consider that if a particular item is not in stock, the entire purchase orders may be cancelled (p. 1). The costs of overstocking therefore should include the cost to hold that inventory and, furthermore, L.L. Bean also needs to consider that these might change if the salvage value of a product leftover depends on the number of units remaining at the end of the season. For instance, if L.L. Bean has a lot of product leftover, then the liquidation

value might be a lot less, because they will transfer the items to the next season. 3. What information should Scott Sklar have available to help him arrive at a demand forecast for a particular style of men s shirt that is a new catalog item? First of all he has to know the number of different items in stock. Then he and his colleagues have to come up with ranking of these items by popularity (here maybe a market research department could be helpful to determine the trend for color). He and his colleagues only use rules of thumb to assign the value in dollars to each of the items. Instead of using rules of thumb, he should use statistical methods such as average, moving average, exponential smoothing or linear regression. The suggestion is that he should get as much historical data as possible for items that are similar to the new men s shirt (this is why a market research department is needed in this company). 4. What should L.L. Bean do to improve its forecasting process? The main problem is that L.L Bean should improve and adjust the estimates of contribution margin (= price cost) and liquidating cost as described in Q 2. A further problem with L.L. Bean s forecasting process is that they base their future forecasts only on past forecasts. As people s demand and preferences change constantly (especially for clothes) it is not a really accurate approach. A possibility could be to form product clusters with data gained from the marketing research department and then establish a forecasting system for each of those. The case does not mention market research that should be able to help determine the potential demand for e.g., seasonal colors for each new item that can be factored into the forecast process. Furthermore, the forecasting process is a bottom up approach because L.L. Bean forecasts only at the lowest item level, which is the color and size. As Barbara Hamaluk mentions, there should be an intermediate forecast higher in the aggregate hierarchy, namely, at the demand center level, so that it can be reconciled with the book forecasts. This could be done through creating a second forecasting process at the Demand Center level. Finally, a solution based on strategic reasons could be to think about vertical integration of suppliers in order to avoid one-shot commitments and be able to complete more quick responses , because for a retailer firm it should be in general more profitable to work close with the suppliers in order to address the customers demand (compare ZARA). The light version of this approach is to establish close relationships with the suppliers so that they have an incentive to collaborate with L.L. Bean.