Forecasting is supposed to enable proper capacity and production planning but customers don't like to commit. Boundaries and guidelines can mitigate risks and avoid surprises.
Competing requirements for suppliers and customers
Sales managers want to bring home the big numbers in new contracts. Customers want to make sure that their supply demands are being met when they require the material or goods.
This can be a dangerous mix.
No sales representative is challenging their clients too aggressively when it comes to their predication as to how much they anticipate to order. Customers are under pressure from their investors and management too and would not want to predict a bleak sales forecast for their end products.
In addition they would rather set their expectations high so the supplier will not create a bottleneck while they are not willing to share the risk of overly optimistic predications. Meaning: if the supplier sits on too much raw material and reserved production capacity, it should remain their problem.
In order to limit this risk, the supplier is in need to properly plan their capacity and raw materials without inflating the warehousing cost and other net working capital elements.
So, the forecasting process is squeezed between a supplier who wants to deliver the right amount at the right time but plan as long as possible ahead of time and the customer who wants security of supply without participating in potentially unabsorbed cost in case they would have to reduce their orders during times of weak sales on their end.
Making commercial risks understandable and risk mitigation agreeable
An effective process to make risks from both parties transparent and negotiate the right mix of risk sharing is the contracting sequence. For large contracts that involve big cost blocks for raw materials plus assets and human capital those risks can be as costly as failing to supply at the desired time.
Commercial managers who negotiate those contracts need a common understanding of the risks involved and the support to negotiate in favor of their company’s bottom line. In the best case they should be enabled to create a win-win situation by addressing both partner’s concerns and risks in a fair contract construction.
Let them talk it out
The establishment of contracting guidelines or business rules can set the boundaries that are needed to force the supplier and their customers into negotiating the right forecast terms.
When both parties can agree on forecasting periods, frequencies and communication as well as binding forecasts they would surely be able to work some goodwill rules into the contract that would give them some flexibility.
Providing contracting clause examples as a guideline
The following guideline can be given to commercial managers (sales, business development or whomever is supposed to negotiate the contracts with their customers):
A 18-24 month rolling forecast is desired to enable mid-term production-planning and get all critical suppliers aligned. The accuracy of this rolling forecast should be approximately 30%. It should not be an option for our customers to reserve capacity for free, followed by a reduction in demand in the following month. The forecast over the next 6-9 month, length is depending on the lead-time of the supply chain, must be transferred into a binding forecast or confirmed with purchase orders.
Whether the customer issues purchase orders or confirms the forecast over this time period as binding (this should be treated equal to an issued purchase orders) depends on the cooperation mode with the customer and is defined in the supply agreement or in the contract.
Risk / Potential
A reliable and regularly updated forecast facilitates production planning and raw materials ordering. It also allows for flexibility and contributes to the assurance of supply.
If however the forecast proves to be unreliable and the customer changes the binding forecast or an already issued purchase order on short notice the risk increases to create additional cost or losses if a downside occurs or supply cannot be fulfilled in case of an upside.
Guideline and boundaries
CUSTOMER shall provide SUPPLIER with a rolling 24-months forecast schedule of demand. The first 12 months of any forecast schedule shall be binding (“binding forecast schedule”). The remaining 12 months of the forecast schedule shall be non-binding and on a rolling basis.
Order increase on short notice:
Where the CUSTOMER orders a quantity of product/material in excess of the binding forecast schedule SUPPLIER shall use reasonable efforts to meet this additional order but is under no obligation to do so.
Order decrease on short notice:
Bill and Hold, i.e. “SUPPLIER will manufacture and CUSTOMER will pay the initially ordered quantity and SUPPLIER will store the manufactured surplus to the actual demand of product/material up to 12 month free of charge.
As a second negotiation position a fallback option is being offered that is only activated in case the customer won’t agree to the preferred option:
Customer provides a forecast for a shorter term. As a minimum purchase orders must be submitted taking into account the production lead time and the lead time for raw material ordering.
Order increase on short notice:
Additional quantities should not be guaranteed. If the customer needs to have more flexibility safety stocks at specific conditions could be offered.
Order decrease on short notice:
Bill and Hold, i.e. “SUPPLIER will manufacture and CUSTOMER will pay the initially ordered quantity and SUPPLIER will store the manufactured surplus to the actual demand of Product up to 12 month free of charge.
If the “Bill and Hold” option is not acceptable to the customer a further fall back option is that the customer does not pay the full quantity produced and the surplus to the actual demand of product/material is stored in the SUPPLIER warehouse with the obligation of the customer to pay the capital costs.
It might make sense to clarify the term “short notice” as well in the contract.
Safety stocks or any alteration to the preferred option could be safeguarded by double signatures of upper management.
If management sets up boundaries like this and provides guidance the commercial managers will feel protected and well equipped to establish a win-win situation with the customer that regulates the competing positions and offers fair risk sharing.