The Impact Of Offshore Resources In ERP Projects

Introduction

There are several compelling benefits when considering the use of offshore resources in ERP systems integration projects – reduced costs, access to a growing and talented workforce, 24 x 7 work days, shorter project lifecycles, and more. Systems integrators boast about their increasing offshore workforce, and they have to to remain competitive. The India-based systems integrators identified above are also becoming increasingly active the ERP space. Critics of sending work offshore say that communication costs increase, project managers don’t have as much visibility into project progress and that language barriers can cause confusion with respect to project goals.

The fact of the matter is that off-shoring components of ERP systems integration projects is on the rise, and this trend is not likely to change as long as it allows systems integrators to remain competitive in the marketplace. The real question, however, is what type of impact these offshore resources have the quality of delivery, and, ultimately, client goal attainment.

This article compares client assessments of systems integrator performance when offshore resources are part of the delivery model with those projects where they are not.

Offshore Delivery Model

In 2004 and 2005 approximately 45% of North American ERP systems integration projects utilized offshore resources as a component of project delivery. In 2006, the use of offshore resources increased by nearly fifty percent, with nearly two-thirds of projects including an offshore component.

There are notable differences, however, in the types of projects that incorporate offshore resources as part of the delivery model. For example, large budget projects, those with budgets exceeding $50M in total budget (hardware, software, and services) are most likely to include an offshore component. The trend of utilizing offshore resources in large projects is increasing, but is not new. In 2004 three out of five large projects utilized offshore resources, though it increased to four out of five projects in 2006.

Perhaps the most interesting trend in the table below is that use of offshore delivery models has doubled in the smaller ERP systems integration projects. As pricing pressures increase, systems integrators are more likely to leverage offshore resources for smaller projects to help keep prices lower and margins intact. As the systems integrators’ methods of deriving value from their use of offshore resources improve over time, they extend their use to more and more projects.

In addition to segmenting the results by budget size, this research studies the different types of projects clients conduct; initial implementations, upgrades, geographic roll-outs, and optimizations.

Initial implementations are the least likely to include offshore components. Follow-on projects, like upgrades, roll-outs, and optimizations, are more likely to include an offshore component.

Three-quarters of geographic roll-outs in 2006 incorporated offshore delivery components. One of the benefits of going offshore is that resources can be centered in any location around the globe. Systems integrators with resources in multiple locations assign local resources to many locations more easily (and affordably).

Change in Delivery Priorities

Client goals and delivery priorities vary from project to project, depending on their business challenges, internal skill sets, and type of project. When comparing the delivery priorities of clients with projects that include offshore resources with those that do not, the research reveals some interesting differences.

Clients whose projects include offshore components place a stronger emphasis on a provider’s partner network and delivery model. This is fairly intuitive – when offshore resources are used the client is more focused on the quality of resources, how and when these resources will be leveraged, and how the provider intends to manage these resources.

When looking at client’s delivery priorities, staff quality ranks third overall among clients whose projects include offshore resources. That said, this research reveals a reduced level of importance when compared with projects that do not include offshore resources. The interpretation is that offshore resources can be viewed as a ‘black box’ that clients can’t see into. The work is assigned and delivered, and the scrutiny of the people doing the work is lessened because the resources are ‘invisible’.

What is interesting is the decreased focus on knowledge transfer. The effective transfer of knowledge from the systems integrator to the client is important for the client to be able to maintain and use the systems in the post go-live environment. The increased focus on post-implementation planning and industry focus (the application of industry best practices) suggest that a stronger emphasis on planning reduces the requirements for the specific transfer of knowledge to users and technical staff. In other cases, clients may be willing to trade off the advantages of effective knowledge transfer for reduced fees, and are willing to proceed at their own peril in this respect.

Impact of Offshore Resources on Project Delivery

A variety of metrics are used to measure systems integrator performance. Two of these metrics are the Overall Performance Score, which describes the delivery experience across the project lifecycle, and Overall Goal Attainment Index, which is a measure of the effectiveness of the integrator in meeting their client’s expectations for goal attainment.

The Overall Performance Score runs from a low score of one (1) to a high of ten (10). The Overall Goal Attainment Index runs from a score of one (1), meaning Falls Far Short of Expectations, to a high score of five (5), which means Far Exceeding Expectations; a score of three (3) means Meeting Expectations.

Comparing projects with and without offshore delivery components reveals that there is no difference in project delivery or client goal attainment when offshore resources are used. When asked specifically about the impact offshore resources had on their projects, five out of six indicate the offshore resources contributed positively to the engagement. Our interpretation of this finding is that systems integrators in general are effective at identifying which projects should and should not include offshore resources. Further, they are effective at identifying the specific tasks that can be off-shored without a negative impact on the project. This highlights the relative maturity that already exists in the market around the use of offshore resources to support ERP efforts.

While the overall numbers confirm that offshore resources can be effectively deployed without negatively impacting the quality of delivery or client goal attainment, digging deeper into the data reveals that offshore resources can be better leveraged for specific types of ERP projects.

The tables below segment SAP and Oracle projects by budget size. As a first level of comparison, projects with larger budgets see the greatest performance improvements while small budget projects generally do not realize overall performance increases from offshore resources. On average, medium-sized projects aren’t impacted in terms of project delivery but do see improvements for goal attainment.

Small projects have seen the greatest increase in the use of offshore resources, but this research reveals that projects of this size do not reap the benefits that larger budgets do. Clients with projects within this budget range should fully understand how a provider’s methods have been adapted to ensure that offshore resources will not be a detriment to the project.

Comparing Oracle and SAP projects reveals some interesting differences as well. SAP projects tend to see a greater benefit from utilizing offshore resources. This is especially true for the large budget projects. Oracle projects with budgets in the $5M – Better Performance At A Cost

Better performance comes at a cost, however, as the management required to coordinate multi-time zone projects can create additional headaches for project managers. This research studies fourteen different problems that are typical of ERP systems integration projects. Comparing projects with and without offshore components reveals that each of the fourteen problems is more likely to occur on projects where offshore components are utilized.

Four of the more common problems are related to the management or expertise of project resources: deficient management of resources, personnel not to expected levels of expertise, lack of agility, and deficient process and/or scope management. Knowing that these challenges exist, buyers need to weight these risks against the benefits of lower costs of using offshore resources. Further, clients should be sure to make contingency plans in case issues arise.

Problems related to effective measurement are more prevalent in projects that utilize offshore resources. While clients do place a stronger emphasis on planning components when utilizing an offshore delivery model, clients must define measurement programs in advance to ensure they will be able to capture the relevant metrics identified.

In summary, clients need to fully understand which phases of their projects will include offshore components. Clients should not be bashful in asking their integrator about the qualifications of the staff working on their projects, and the integrator should be able to communicate the process for transferring relevant information to technical teams and end users, where appropriate. Finally, clients should understand the change management processes and guidelines to ensure appropriate levels of flexibility, should it be necessary to make course corrections along the way.

Systems Integrator Performance

Among the leading ERP system integrators, Accenture and Deloitte have utilized offshore resources most frequently over the last few years, though BearingPoint and Capgemini have recently begun including offshore components in more of their projects recently. IBM also has extensive offshore resources capable of being deployed. The consulting divisions of Oracle and SAP tend to go offshore least frequently.

When evaluating any systems integrator’s offshore delivery model, clients should fully understand the volume of offshore resources available, at which phases of delivery they will be deployed, and what their respective skills are. Stakeholders involved in the project day-to-day should understand the channels of communication when offshore resources are being used, and how to escalate issues to the systems integrators leadership should issues arise.

Accenture and Deloitte clients report the most improvement in project delivery and goal attainment when offshore resources are included in the delivery model. According to these findings, these two integrators have a history of including offshore components in their projects more frequently than the other integrators, and perhaps this has helped them maximize the effectiveness of their offshore delivery methodologies.

The difference in performance when IBM and BearingPoint do and do not include offshore resources is negligible. The interpretation here is that both firms consistently manage projects and deliver value to clients regardless of the whether offshore resources are included or not.

Capgemini and CSC clients that leveraged offshore resources do not report improved performance and goal attainment. Capgemini’s performance improves for larger budget engagements, however.

The multinational pure-play systems integrators typically have separate lines of business for their SAP and Oracle practices, though their results are aggregated in this analysis.

Conclusions

Clients with ERP systems integration projects with projects above $5M are likely to realize improvements in project delivery and goal attainment by utilizing offshore resources. Clients should expect decreases in systems integrator agility and additional challenges in training technical staff and end users.

Clients with smaller ERP projects are less likely to see improvements in project delivery and goal attainment as a result of using offshore resources. Clients should expect to see offshore delivery models in RFP responses, as systems integrators are becoming more and more likely to include offshore components to stay competitive. Clients should fully understand at which phases of delivery integrators intend to send work offshore.

Not every ERP systems integrator has proven to consistently leverage offshore resources for the benefit of the engagement. While certain project tasks can (and perhaps should) be off-shored, clients should fully understand each integrators methodologies when off-shoring is included. Multiple references for similar projects should be interviewed specifically to understand the change management and knowledge transfer processes, as well as to gauge the quality of the personnel doing the work.

Poverty Alleviation: An Aim Of Islamic Economics

Poverty is treated as WMD (weapon of mass destruction) of modern world. Eradication of it bears very importance. The economic systems like capitalism and communism have presented number of instruments for the alleviation of the poverty from the world. But, these extreme ideologies failed to satisfy the need of the people. Private ownership of property, laissez-faire policy of capitalism and class war, dialectical materialism, state ownership of property of communism didn’t touch the real cause of poverty. This situation necessitates seeking the possibilities of Islamic economics in alleviating poverty. The aim of poverty alleviation can be attained, in an Islamic Economic system through reducing the inequality. It never means attaining equality but equity and justice in the income and wealth distribution. Islam eliminates the absolute inequality which arises from unequal distribution of income, but relative inequality emerges from equitable distribution of income and wealth.

First part of this article has given a small introduction to both conventional economics and Islamic economics. Then it provides a picture of poverty of current world and Islamic perspective of poverty. Then Islamic economics instruments to alleviate poverty such as zakat, sadaqa, qard hasan, ganima, khums, fay, jizya, mudaraba, musharaka, prohibition of interest, abolition of extravaganza, prohibition of speculation and hoarding have been mentioned in briefly. Influence of Islamic economic instruments on marginal propensity to consume, multiplier, price investment and production have been dealt with.

The books and articles I referred for this article are Dr. Dr.Sabahuddin Azmi’s Islamic Economics, S. M. Hasanuzzaman’s Economic function of an Islamic state (The early experience), Towards understanding the economic system of Islam written by Dr.P Ibrahim and Introduction to the economic system by Moulavi.M.V.Saleem.

Introduction

Nobody can undermine the importance of economics which is a social science that studies the production, distribution, trade and consumption of goods and services. This very importance of economics resulted in emergence of different economic systems in the world and all of those economic systems claim that they will fetch economic welfare. Those dominating and prominent economic system’s failure to accomplish economic justice, prosperity, the eradiation of the inequality and poverty make necessary an alternative economic system which can successfully make a starvation free and poverty free world.

Definition of Economics

Social scientists have developed various definitions of economics. Lionel Robinson’s scarcity definition of economics is most accepted amongst them. According to Robinson “economics is a science which studies human behavior as a relationship between ends and scarce means which have alternative uses” This definition is based on two points which are scarcity of resources and the never ending needs. But in reality former is a myth. The survey conducted by UNO shows that are enough resources for 20000 million people on earth we have only 6000 million people on earth residing now. Latter point ‘never ending needs’ is also incorrect as the desire and greed of the man is unlimited but the need is countable and controllable.

Definition of Islamic Economics

As a system of life Islam has not left any area of human life without guidance. Whether it is spiritual, individual, social, economical or political Islam gives clear cut guidelines. By considering the economic guidelines of Islamic sources, Islamic economists have developed plethora of definitions. Derivation of each definition of Islamic economics is based on guidance given in the basic sources of Islamic shariah which are Quran and hadith.

According to Yusuf Ibrahim, professor of Islamic economics, Qatar University “Islamic economics is a science studying the guidance of the human behavior towards the use of resources to satisfy the needs”. This definition is based upon the following facts.

1. The resources are enough for satisfying the needs.

2. But the resources should be protected from the waste, and improper use.

3. The human behavior towards the resources should be controlled by divine injunctions.

4. Only legal needs, needs that build life on the earth, should be satisfied.

5. Illegal needs (desires), which destroy life on earth, should not be satisfied; they are never ending and never satisfied.

Islamic economic system, a normative economic system, has been built upon certain fundamental Islamic philosophies. According to Quranic teachings real and absolute ownership of the wealth belongs to the creator of the same, Almighty God. Quran says “To Allah belongs to everything in the sky and on the earth” (2:284).Role of the man is considered as trustee who is to manage the trust, i.e. wealth according to the directives of the real owner; God. Quran clearly states “And spend of that where of hath made you trustees” (57:7). So man has been granted

conditioned and limited ownership.

Another Islamic philosophy is universal brotherhood and equality of men as their creator is one and parents are same. Hence distinction based on color, caste, creed, races do not suffer at any cost. This concept induces the people for cooperation and participation in their all efforts instead of cheating, exploiting and making fraud each other. Another aspect of Islamic philosophy is the faith in the Day of Judgment after death. In the life after death man is accountable for his deeds on earth. The implication of this faith is that economic choices one makes in world are to be judged according to the norms Allah has laid down.

These are the revolutionary points which differentiate Islamic economics from the liberal, capitalistic, imperialistic, mainstream, usurious economic system and communist, class war, state dictatorship economic system. Islam constructs a just world on the spirit of everlasting divine concepts.
Poverty

Evil of any economy is poverty. The presence of begging hands in an economy pulls that economy into decades back. Poverty midst plenty is the challenge faced in the modern world. Impact of the poverty cannot confine into starvation only, but poor people, apart from starvation, suffering limited income which leads to inaccessibility of good education it disables them for challenging careers which requires number of years long education. Absence of nutritious food results in more child morality among deprived sections. Since limited access for information and knowledge those are prevented from market and opportunities.

Every country and international organizations like World Trade Organization, World Bank and Asian Development Bank hard work to construct the countries and world on the foots of self sufficiency respectively. Mission of the World Bank is described as global poverty reduction and improvement of living standards. General Council of UN has declared October 17 as International day for the eradication of poverty. It shows how seriously they took poverty as a problem

But, it is wondering that out of 6.1 billion world population more than 1 billion are finding their livelihood in less than $1 per day and almost 3 billion on less than $2 per day. You might be provoked that 74% of total income of world is shared by the 20% of the elite class of the world. It is heartening you that there are countries whose national income is less $800 and morality of below five years age children is about 26%.It is worrying that 110 million primary school age children are out of school and 60 percent of them are girls.
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Poverty and Islamic Economics

Below Poverty Line (BPL) fixes in Islamic economics system on the basis of ownership of nisab, which limit makes one eligible for the payment of zakat Whosoever wealth on or over the nisab is responsible for the payment of zakat. Those wealth is below nisab are zakat recipients and they are treated as poor. Hence, in Islamic economics, the size of deprived come under BPL will be large. Starvation and inaccessibility of food, shelter, cloths and education could not suffer in an Islamic economy which aims human falah, i.e. human welfare. It does not support any economic instrument that leads to the deprivation of the man. Since poverty emerges in an economy as a result of various causes so wiping out of these causes is primarily important.

Limited income, unequal distribution of income and wealth, misdistribution of resources, regional disparities, unemployment, social injustice, and decreased investments …etc are some of the obstacles in the way of attainment of self-sufficiency and welfare. Islam considers the fulfillment of basic needs of every member of society is economic, moral as well as religious obligation of the ruler. List of the basic goods extends from traditional food, clothing and shelter to seasonal clothing, personal attendant to disabled person, and expenditure on marriage of poor and expenditure on entire family of poor, which are intensified by scholars from time to time and likely to extend the list time to time for the welfare of the citizen. Islamic economic system introduces a bunch of divinely guided instruments which bring to an end of poverty and build
poverty less world.

Islamic Economic Instruments to eliminate poverty

It is advised to Muslim citizens in an Islamic county, as the part of believe, to practice certain things in their life, some of them are compulsory nature and the rest are voluntary nature. The practice of these will have vast economic implications apart from the reward of God. Non Muslim citizens also have to make certain compulsory payments, which have economic impacts, as the part of their citizenship in the Islamic country. Compulsory duties and agreements of citizens are governed by the Islamic country and violation of any part would not suffer Islamic state. In addition to these functions there are other things the Islamic state has to carry out similar to any nation does for the welfare of citizens. Both positive and negative measures have recommended by Islam for wiping out the reason of poverty.

Positive Measures

There are numerous Islamic orders and injunction to perform certain things which have immense influence on economies justice, prosperity and growth. Important divine injunctions amongst them and their influence upon the economy are briefed below.

Zakat

Zakat is the yearly obligation of wealthy Muslims to poor and it is the share of have-nots in the property and wealth of the rich. Quran commends “establish worship and pay the poor his due (zakat) and obey the messenger”. Technically we can call it as spiritual tax. It is imposed on those forms of wealth which have the capacity to grow in value or otherwise produce further, is having the custody of whole year and have exceed a certain minimum value called ‘nisab’. Quran has stated the eight specific heads for the distribution of zakat.
Due to the divine spirit for the performance of zakat, chances for evasion are less. The imposition of zakat on idle wealth urges the owners for the productive and profitable employment of idle wealth which increases the wealth of economy and again the share of zakat.

Donations

Sadaqa is the one of the voluntary economic instrument. No limit and eligibility criteria for performing contributions to needy. It can be divert, apart from the eight heads mentioned for the distribution of zakat, to any needy. and it will strengthen what economic implications emerged by zakat.

Qard hasan

It is an arrangement of interest free loans for unproductive purposes or for the needy to meet the expenses like hospital expenses, home expenses and education expenses etc which are do not make any earnings. So it is not able to charge any material benefit, like profit share, from qurd hasan. These are provided as the part of kindness to human beings. In an Islamic economy individuals and institutions like Islamic banks will offer this type of loans expecting the reward of Allah. Availability of qard hasan reduces the financial burdens like interest, of deprived.

Profit and loss sharing

Islam formulates profit and loss sharing as the tool of trade contracts instesd of interest. The motivation behind it is the cooperation amongst the people. In profit sharing there are different types of financing such as mudaraba (profit and loss sharing) and musharaka (participation) …etc
Mudaraba is the agreement between both capital owner and entrepreneur to share the profit arises from the business and in case of loss capital owner’s capital reduces and entrepreneur’s time and effort loose. Musharaka is the agreement to share profit and loss where all contributors participate in management of business. Both mudaraba and musharaka help the people, who have inadequacy of capital, to engage in business, production and contribute their share into the welfare nation and earn for their own.

Ganima (war booty), Khums (one fifth) and Fay

Ganima is the property Muslims seize from the enemy. Four fifth of the ganima is divided among the fighting army and one fifth (khums) of the entire ganima move to state fund, which is earmarked for the special beneficiaries mentioned in Quran. Fay is the property receives from the enemy without actual fighting. This source of state revenue is generalized for the common good of the entire population and public welfare.

Kharaj (Land- Tax)

Land-Tax, a source of revenue of state, is the levy imposed on land produce. This is actually the rent for the use of value of agricultural land. The rate of kharaj and method of collection can be declared by state from time to time as there is no direction of Quran and tradition of prophet in this regard.

Jizya (Poll tax)

Jizya (poll-tax) imposed on the non-Muslim citizens of Islamic country for securing their wealth, property and lives from damage. It helps them to contribute their skill, talent, health, wealth and property for the prosperity of the country

Waqf (Endowment)

Waqf (endowment) is regular source of revenue which is earmarked and dedicated fund of Muslim for supporting charitable and welfare activities
State ownership on uncultivated land:
Any economic instrument that hinders productivity is harmful to economies prosperous. According to Islamic shariah, if a land is remained uncultivated three consecutive years lead to moving of ownership of that land from current owner to other who is ready for cultivate the land and produce. Prophet (pbuh) said “The original rights of ownership in land are God’s and the prophets and then yours afterwards. But he who revives any dead land acquires the right of ownership to it”. There is an another institution, iqta, boost the circulation and tax revenue of the state by transferring the uncultivated/dead land to someone in return for ushr or khraj.

Combined ownership of natural resources:

Individual ownership of natural resources like fire, water, pasture and salt are restricted by the Islamic shariah. People have combined ownership in these natural resources which should be accessible to anyone. This rule allow anyone to use the benefit derives from the natural goods and ensure that nobody is away from the natural goods which are easy to get to without any hard work.. List of natural goods, in addition to mentioned goods, can be extended into more goods in time to time. Prophet (pbuh) said “people are joint owners in water, pasture and fire”.
There are other sources of revenues like property of deceased with no legal heir, lost and found with no claimants and additional taxations.

Negative Measures

There are some prohibitions of God which has influence on the economies prosperity and welfare of every men of country.
Prohibition of interest
Interest, whatever form, has been contemned by Allah and His messenger. Quran says “Allah has permitted trade and hath prohibited riba” (interest). Islam doesn’t support interest but profit and loss sharing. Every financial transactions of Islamic economy should be free of Interest. But absence of interest in an Islamic economy doesn’t create any hindrance to prosperity but flourish the prosperity.

Prohibition of speculative instruments

Instruments which don’t have any advantage to real economy such as futures and option are not permitted in Islamic economy. Stock market instruments like day trading, marginal trading are prohibited, either. Absence of these instruments in the economy reduces speculation which is harm to the entire economy.
Implications

The implementation of shariah guidelines we discussed above in an economy lead to number of positive fruits which make the state free from every form of poverty.
Increased redistribution of income and wealth will result in, when the people perform the religious obligations like zakat, donation, waqf, inheritances, fithr zakat and kaffarath etc… It leads to flow of wealth and money from rich to poor. Thus the concentration and accumulation of wealth in a few hands come down. Poor and needy spend approximately eighty percent of their earnings to fulfill their basic needs. Economically Marginal Propensity to Consume (MPC) of the poor is larger than middle and high class. A large portion of whatever comes into handy of poor will flow to economy for consumption of basic goods; it lead to more demand for primary goods and then it result in the increased production of basic goods. It is difficult to restrict luxurious consumption and production completely by law and force. But the increased rate of redistribution of wealth and income increase the demand for basic goods and decrease the demand for luxurious goods. Automatically it reduces the utilization of resources for the production of luxuries. Consequently, natural resources use for the production of basic goods and for the benefit of public welfare
This increased redistribution of wealth to poor enables them to get the accessibility of good education and nutritious food. Increased knowledge and skills help the poor to get good jobs and earn. This raises the entire poor family and dependence to heights. In turn, increase of income more than a certain limit make them capable for performing zakat and other voluntary donations for the sake of the benefit of have-nots. Rise in the redistribution help to reduce the gap between haves and have-nots and bring economic justice to all citizens.

Increased MPC of poor as the redistribution of income results in more multiplier effect in economy that fuels more income to the overall income of economy that help the poor section of people to raise their per capita income and living standards.

According to Professor Keynes, investment depends on two variables which are current rare of interest and the marginal efficiency of capital or expected profit rate. Investment would take place only if the expected rate of profit exceeds of interest. Due to the absence of interest, in an Islamic economy, only the size of expected rate of profit of profit will be the determinant of investment.

Speculative motive of money and liquidity theory of money will have no place in an interest free economy which reduces investment. But the presence of only expected rate of profit will result in investments, even in low rate of expected rate of profit to increase their principle amount and to avoid the deterioration of principal through zakat. The increased investment raises the production, employment, wages and overall national income of economy. It flows wealth to poor and raises their economic status.

Fisher’s quantity theory which states that quantity of money affects the price and value of money. It means that increase in the supply of money will proportionately increase the price in economy but the output will not increase. But in the case of Islamic economy money should not be supplied without making increase in the output. The central bank and commercial banks of Islamic state increase the money supply through making investment contracts on the basis of profit and loss sharing. So every flow of money into economy results in output growth without making proportionate hike in price. It is helpful to the poor to get need things at reasonable price

The Beginning of Superior Inventory Management – Accurate Demand Planning and Forecasting

When retailers seek help with issues relating to inventory management, they are usually concerned about an increasing level of out-of-stocks, which are leading to lost sales and customer service complaints, or over-stocks, which are resulting in slow inventory turnover and a build up of dead inventory. In fact, out-of-stocks and over-stocks are actually the flip side of the same inventory management coin.

Any effective initiative to resolve these issues must address the core structural causes of these inventory management problems. Superior inventory management begins with timely, accurate, detailed demand forecasts.

It is critical to differentiate between demand planning and purchase planning. Demand planning is the sales plan from which inventory planning, purchase planning and replenishment parameters are built. It is impossible to plan inventory and purchasing activities or build replenishment parameters without a detailed forecast of what will be sold, how much will be sold, when it will be sold, the channels it will be sold through, and who the ultimate customers will be. And yet, all too frequently replenishment parameters are rolled over, existing purchasing patterns continue, and inventory is allowed to ebb and flow as if on auto- pilot. The result is out-of-stocks and over-stocks as demand changes.

Without highly reliable forecasts, retailers must attempt to strike a delicate balance between carrying too little or too much stock. Frequently, they feel compelled to protect themselves against out-of-stocks and backorders by stocking layers of additional inventory in reserve, unnecessarily tying up valuable resources that could be used in more productive ways to serve customers and grow the business.

Review Historical Sales Data

Accurate demand planning and forecasting begins with a thorough review of historical sales data. It is critical that sales not made from stock, special orders, large closeout sales and any other extraordinary sales be excluded from this historical data. Most demand planning and forecasting software packages will exclude these sales if the forecasting software is fully integrated with order management software, and those excluded orders have been properly tagged or exclusion parameters have been loaded into the system. It’s also critical that lost sales due to out-of-stocks are also factored in so that the history reflects actual demand rather than just sales.

It is important that the planning process drills down to the lowest possible level so that every category, sub- category, style or SKU is reviewed not just for potential opportunities and current sales trends, but also for the potential negative impacts of increased competition, emerging technology, changes in promotional patterns and new product introductions. For distributors and wholesalers this may mean planning at the individual SKU level. Planning can be further refined by breaking key categories and items down by customer type, key customer, and even key customer by shipping location. Important sales trends, both positive and negative can be identified, and important historical events, such as unusual local weather, can be taken into account.

Once the historical sales data has been reviewed and adjusted, the data will frequently be averaged or smoothed to eliminate any remaining fluctuations in the sales pattern. Smoothing, however, can often lead to problems if not done carefully. For instance, using a three week moving average to smooth weekly historical sales may lead to out-of-stocks or over-stocks if sales are typically heavy at the beginning or end of each month. Utilizing monthly historical data rather than weekly data may seem like a reasonable way to simplify the planning process, but may in fact have the unintended consequence of smoothing historical sales in a way that may conceal meaningful sales patterns.

Understand Selling Characteristics

It is imperative to clearly understand the selling characteristics of each category, sub-category, item or SKU. These characteristics will determine the appropriate methodology for developing a forecast, as well as the level of detail required in the forecast. The most obvious characteristic is the degree of seasonality. Items which exhibit little sales fluctuation from month to month throughout the year require a very different forecasting methodology than items which exhibit significant seasonal sales fluctuations.

For seasonal items, most forecasting methods will start with the prior year’s sales by week or month, apply some smoothing technique, and then apply a current trend factor to arrive at a current year forecast for the corresponding time frame. For non-seasonal items, sales by week or month for the most recent weeks or months will be used as a starting point, smoothed and adjusted for the trend factor to arrive at a current forecast. In fact, it is very easy to completely overlook non-seasonal items when forecasting. It may seem sufficient to merely update replenishment parameters. A thorough analysis of non-seasonal items is necessary, however, to identify sales trends which may affect future sales volume, as well as to build an overall sales forecast.

Another characteristic which must be clearly understood is the sales velocity of an item. Sales velocity is defined as the number of orders an item generates over a given period of time. Items with high sales velocities generate a substantial number of orders during a given period of time, which makes their sales volume during that period more predictable than items with low sales velocities, which may only generate orders sporadically.

It is important to note that sales velocity is not the same as sales volume. For example, an item that generates 50 orders of 2 units each over a given period of time will have the same sales volume as an item which generates 2 orders of 50 units each, but the velocity of each item will be dramatically different. Clearly, the sales history of the item which generates 50 orders will lead to a forecast that will be more meaningful in the development of future inventory plans, purchasing needs and replenishment parameters than the sales history of the item which generates only 2 orders.

Many distributors group their items by sales volume using an A-B-C-D system. A items are those items which generate the vast majority of their sales volume, while B, C and D items generate increasingly smaller fractions of their sales volume. As a result, frequently these distributors will forecast and replenish their A items using one methodology, their B items another, and so on. However, while the grouping of A items may be made up primarily of high velocity items, every item will not necessarily be an A item. Conversely, while the grouping of D items will most likely be made up entirely of low velocity items, it is likely that within the B and C groupings that there will be a mix of both low and high velocity items. Utilizing sales velocity rather than A-B-C-D groupings to determine the appropriate forecasting methodology will result in forecasts that will result in fewer out-of-stocks and over-stocks.

Low velocity items may include supplementary items, which may be necessary to complete a given customer order for high velocity items, such as specialty ceramic tile trims to go with standard field tile. Low velocity items may also include complementary or customer convenience items, which are stocked so customers can purchase all of their needs in “one stop”. For low velocity items which exhibit an irregular sales pattern the forecast may reflect smoothed historical sales data, but that forecast would be less meaningful for actual replenishment than the average customer order quantity. As a result, the replenishment parameters would likely be calculated based on maintaining enough quantity in stock to support a given number of orders at the typical or usual sales order quantity.

Bottom Up versus Top Down Planning

As SKU’s are rolled up into sub-categories, and then into categories, the resulting planned sales increase can be evaluated in the aggregate at the total company level. This “bottom up” planning must be done in units. Regardless of what the actual unit of measure is, the obvious purpose of developing any demand plan or forecast is to provide the information necessary to build replenishment parameters, plan purchasing activities and issue actual purchase orders to vendors.

As the demand plan is being developed, however, unit plans must also be “dollared out.” As management assesses the overall market environment and the strategic opportunities and risks for the company, they will likely establish a financial budget, critical for cash flow forecasting, from the “top down”, which will be stated in dollars. As managers develop and roll up their forecasts, they must be careful that their “bottom up” unit plan remains in line with the financial “top down” dollar plan, and be prepared to adjust the unit plans accordingly.

Frequently, “bottom up” unit plans will forecast a sales increase significantly greater than the company’s “top down” financial budget. The reason for this is that in the course of building a “bottom up” unit plan far more items or categories are likely to be planned up than planned down. The natural tendency is to plan sales increases, especially in organizations with multiple buyers who are evaluated on their ability to generate sales increases with their items, categories and departments. Clearly, every item, category or department is not going to generate an increase, and companies which discourage their buyers from forecasting sales decreases are building in potential inventory problems right from the very beginning of the process.

Forecasts Need To Be Continually Updated

While demand planning and forecasting are generally thought of as a process that takes place at the beginning of each year or selling season, superior inventory management requires that forecasts remain dynamic and be continually updated to reflect the most current market conditions and sales trends. It does little good for a company to have taken the time to carefully forecast demand for the upcoming season or year, only to open the door to out-of-stocks or over-stocks by failing to update those forecasts on a continual basis. Static forecasts which have not been updated will invariably lead to faulty purchasing decisions.

Updating forecasts may be as simple as carefully monitoring the sales trend and updating the forward periods accordingly. In other cases there may be leading indicators that can be utilized to continually adjust the forecast. For those items or categories where customer orders are booked well in advance of actual ship dates, advance bookings may be able to be used as a leading indicator. In order for this to be an accurate indicator, however, prior year orders must be cross referenced between the period in which the order was booked, and the planned and actual ship date. Without a fairly sophisticated order management system to track this information, and very careful assessments of individual factors which may be impacting the timing of the placement of orders this year versus last year, utilizing advanced bookings to make significant adjustments to the forecast may by itself lead to variances between planned and actual sales, resulting in out-of-stocks or over-stocks.

A far more accurate leading indicator of sorts is, in fact, the demand forecast of a company’s customers. In fact, the closer any forecast is to the ultimate point of sale the more accurate and timely it will be.

Vertical information sharing throughout the supply chain is at the cutting edge of efforts to improve forecasting accuracy. The Collaborative Planning, Forecasting and Replenishment Committee is made up of retailers, manufacturers, and solution providers dedicated to this effort. It was formed to create collaborative relationships between buyers and sellers through shared information and co-managed processes. The Committee states that by “integrating demand and supply side processes CPFR® will improve efficiencies, increase sales, reduce fixed assets and working capital, and reduce inventory for the entire supply chain while satisfying consumer needs.” This group has developed a set of guidelines for developing business processes that enable collaboration across a number of buyer/seller functions.

The potential of collaborative forecasting is to finally fully rationalize the supply chain so that unnecessary inventories can be completely eliminated rather than inevitably building up with the company in the chain with the least economic leverage. In a supply chain where information is not shared, but, in fact, is closely held, it is inevitable that inventory risk will be pushed back by the companies with the greatest leverage onto the companies with the least. But the mere presence of excess, unnecessary inventory anywhere within the supply chain inflates costs for every member of the chain, and ultimately weakens the chain.

Measure and Analyze Variances Between Forecast and Actual

Finally, once a forecast has been developed, it is critical to measure its accuracy. It’s important to recognize that a forecast is just that, a forecast. There will always be variances between forecasted and actual demand. By measuring and then analyzing those variances, the factors that contribute to variances can be identified and strategies can be developed to account for them, so that future forecasts are that much more accurate, and variances minimized.

Conclusion

The greatest challenge to finally achieving superior inventory management, and maximizing the return on inventory investment, lies in developing accurate forecasts. Much work has been done over the past ten to fifteen years to rationalize processes in the supply chain, and eliminate unnecessary inventory. This has led directly to truly astounding cost saving and productivity gains. But for all the gains that have been made on the supply side of the inventory equation, the greatest opportunity for additional gains today is on the demand side. Not only does superior inventory management begin with accurate demand planning and forecasting, but making the commitment to developing accurate forecasts, continually updating them, and measuring their accuracy against actual sales also offers independent retailers the greatest opportunities today to maximize their return on inventory investment.