Considerations for Effectively Forecasting a Product Hierarchy

Presented by Eric Stellwagen Vice President & Cofounder Business Forecast Systems, Inc. estellwagen@forecastpro.com

Business Forecast Systems, Inc. 68 Leonard Street Belmont, MA 02478 USA (617) 484-5050 www.forecastpro.com

Eric Stellwagen

Vice President, CEO & Cofounder of Business Forecast Systems, Inc. Coauthor of Forecast Pro product line. Over 25 years in forecasting. Currently serving on the board of directors of the International Institute of Forecasters and on the practitioner advisory board of Foresight: The International Journal of Applied Forecasting.

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What Well Cover

Introductions Basic Concepts Reconciliation Techniques Constructing the Hierarchy Examples Summary Q&A
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A Sample Hierarchy
Total Sales

Brand A

Brand B

Brand C

Group Levels

Retail

Commercial

Cans

Bottles

6-Pack

12-Pack

Item Level

Corporations typically deal with multiple levels of aggregation and require consistent forecasts at all levels.
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What Are the Forecasts Used For?

Item-level forecasts Drive production, purchasing and inventory control Short horizons are important Intermediate-level forecasts Drive marketing and revenue planning Medium horizons are important Upper-level forecasts Guide big picture decision making Medium to long horizons are important

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Should You Strive for One-Number Forecasts? Depends on the environment. The larger the company, the harder this is to achieve. Communication between the different functional groups is very important. This is a primary goal of an S&OP process.

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A Very Simple Hierarchy

Total Cans

6-Pack

12-Pack

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Common Reconciliation Techniques

Bottom-Up Create model-based forecasts at the lower level. Construct upper-level forecasts by summing nested lower-level forecasts. Top-Down First, create a model-based forecast at the top level by forecasting the aggregated history. Then, create model-based forecasts at the lower levels. Finally, apply proportionality factors to lower-level forecasts so that the forecasts sum to the top-level forecast. Proportional Allocation Disaggregate higher-level forecasts by applying proportionality factors. This method would be appropriate when proportions are constant and known.

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Reconciliation Techniques Example

Total Cans

6-Pack

12-Pack

Model-Based Bottom-Up 6-Pack 12-Pack Total Cans 70 30 120 70 30 100

Top-Down 84 36 120

Proportions (50-50) 60 60 120

In a hierarchy with 3 or more levels, combinations of top-down and bottom-up approaches can be applied (i.e., middle-out).
2010, Business Forecast Systems, Inc. www.forecastpro.com

Choosing a Reconciliation Approach

Group-level data is higher volume and often exhibits more structure than lower-level datathis argues for top-down. If two items exhibit distinctly different behaviors, then a single model is unlikely to perform wellthis argues for bottom-up. If relationships between levels are not changing in time, then forecasting based on history does not add valuethis argues for proportional allocation.

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Hierarchical Data
Total Sales

Brand A

Brand B

Brand C

Retail

Commercial

Cans

Bottles

Kegs

Full Kegs

6-Pack

12-Pack

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Choosing a Reconciliation Approach

Start by determining if proportional allocation should be used. Try to think like your consumers how do they view the items? At times, lack of structure at the lower levels may force you to use top-down approaches. Measuring empirical performance is always an option. Most multiple-level forecasts should combine top-down and bottom-up approaches.

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Setting up the Hierarchy

The units of measure need to be comparable. The hierarchy should be as simple as possible. Discontinued items may need to be included to ensure group totals are correct. The structure of the hierarchy should be selected for forecasting, NOT for reporting.

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Two Alternative Hierarchies

Total Business Residential Public

Main

Other

State 1

State 2

Etc.

State 1

State 2

Etc.

Total

State 1

State 2

Etc.

Business

Residential

Public

Main

Other

Basic

Addline

Other

Coin

Access

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Example

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Summary
Many organizations forecast hierarchical data and require forecasts that are consistent across levels. Defining the hierarchy to facilitate accurate forecasting is important. Selection of an appropriate reconciliation strategy is also important and directly impacts forecast accuracy.

2010, Business Forecast Systems, Inc.

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Business Forecasting Seminar

September 20-22, 2010 Boston, USA October 18-20, 2010 London, UK This three-day comprehensive course covers techniques, uses real-world examples and includes computer workshops using your data. Register at www.forecastpro.com
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Forecast Pro
Examples from todays Webinar used Forecast Pro. To learn more about Forecast Pro: Request a live WebEx demo for your team (submit your request as a question right now) Visit www.forecastpro.com Call us at 617-484-5050
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Questions?

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Thank you for attending!

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