Top-down or bottom-up forecasting?

Abstract

The operations literature continues on inconclusive as to the most appropriate sales forecasting approach (Top-Down or Bottom-up) for the determination of safety inventory levels. This paper presents the analytical results for the variance of the sales forecasting errors during the lead-time in both approaches. The forecasting method used was the Simple Exponential Smoothing and the results led to the identification of two supplementary impacts upon the forecasting error variance, and consequently, upon safety inventory levels: the Portfolio Effect and the Anchoring Effect. The first depends upon the correlation coefficient of demand between two individual items and the latter, depends upon the smoothing constant and upon the participation of the individual item in total sales. It is also analysed under which conditions these variables would favour one forecasting approach instead of the other.