In the Japanese martial art of iaidō, apart from perfect technique, a very important element is to be vigilant and be able to act quickly. One of my favorite techniques is Ushirogiri. Our opponent is behind us. Until we turn around and analyze the situation, we will not be able to make an effective cut. It is similar with Outliers. We won’t be able to make accurate forecasts if we don’t turn back and catch Outliers in our sales history.
Outliers are unusual events that we face in everyday business practice. Unusual events are most often understood as:
In demand forecasting process these unusual events are called Outliers.
Failure to eliminate the impact of Outliers in sales history has its consequences. The main one is the lack of normal demand distribution and thus high values of standard deviations.
According to the classical theory of statistical safety stock management, its size depends on the standard deviation of demand and our business goal, usually determined by the measure of the required Service Level. The higher the standard deviation of the forecast and the higher the declarative Service Level, the higher the safety stock.
z – the number of standard deviations needed to reach the required Service Level
σ – standard deviation of demand during the Lead Time period
The solution to this problem is to replace the value of Outliers in sales history with “normal” values, i.e. those that sales would most likely take if there were no unusual events. Thanks to this, our distribution of demand should take the form of a normal distribution and protect us from building excessive safety stock levels.
Of course, unusual events will always appear, and if we do not want to deal with lost sales due to low inventory, we should be able to protect ourselves against them. We will try to address this topic in our next episode.
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Ushirogiri technique performed by Takashi Kuroki, the master of our iaidō school is available on https://www.youtube.com/watch?v=nmgZqhbU8i0