Forecasting & Demand

Management

Mohammed Zia Uddin

 OBJECTIVES

 Demand Management
 Qualitative Forecasting Methods
 Simple & Weighted Moving
Average Forecasts
 Exponential Smoothing
 Simple Linear Regression
 Web-Based Forecasting
Role of Forecasting in a Supply Chain
 The basis for all strategic and planning decisions
in a supply chain
 Used for both push and pull processes
 Examples:
– Production: scheduling, inventory, aggregate
planning
– Marketing: sales force allocation, promotions,
new production introduction
– Finance: plant/equipment investment,
budgetary planning
– Personnel: workforce planning, hiring, layoffs
 All of these decisions are interrelated
 Characteristics of Forecasts
 Forecasts are always wrong (rarely
correct). Should include expected value
and measure of error.
 Long-term forecasts are less accurate
than short-term forecasts (forecast
horizon is important)
 Aggregate forecasts are more accurate
than disaggregate forecasts
Basic Approach to Demand Forecasting

 Understand the objectives of forecasting

 Integrate demand planning and forecasting
 Identify major factors that influence the demand
forecast
 Understand and identify customer segments
 Determine the appropriate forecasting technique
 Establish performance and error measures for the
forecast
 Forecasting and Demand Planning
• Forecasting is the process of projecting the values of one or more
variables into the future.
• Poor forecasting can result in poor inventory and staffing decisions,
resulting in part shortages, inadequate customer service, and many
customer complaints.
• Many firms integrate forecasting with value chain and capacity
management systems to make better operational decisions.
• Accurate forecasts are needed throughout the value chain, and are used
by all functional areas of the organization, including accounting, finance,
marketing, operations, and distribution.
• One of the biggest problems with forecasting systems is that they are
driven by different departmental needs and incentive systems.
• Demand planning software systems integrate marketing, inventory,
sales, operations planning, and financial data.
 Demand Management
Independent Demand:
Finished Goods

A Dependent Demand:
Raw Materials,
Component parts,
B(4) C(2) Sub-assemblies, etc.

D(2) E(1) D(3) F(2)

 Independent Demand:
What a firm can do to manage it?

 Can take an active role to influence

demand

 Can take a passive role and simply

respond to demand
 Types of Forecasts
 Qualitative (Judgmental)

 Quantitative
– Time Series Analysis
– Causal Relationships
– Simulation
 Components of Demand

 Average demand for a period of

time
 Trend
 Seasonal element
 Cyclical elements
 Random variation
 Autocorrelation
 Finding Components of Demand
Seasonal variation

x Linear
x x
x x
x x Trend
x
Sales

x
x x x
x
x
xx
x xx x x
x
x
x x x x x x
x x x x x x
x x x
x xxxxx
x
x x

1 2 3 4
Year
 Qualitative Methods

Executive Judgment Grass Roots

Qualitative Market Research

Historical analogy
Methods

Delphi Method Panel Consensus

 Delphi Method
l. Choose the experts to participate representing a
variety of knowledgeable people in different areas
2. Through a questionnaire (or E-mail), obtain
forecasts (and any premises or qualifications for the
forecasts) from all participants
3. Summarize the results and redistribute them to the
participants along with appropriate new questions
4. Summarize again, refining forecasts and conditions,
and again develop new questions
5. Repeat Step 4 as necessary and distribute the final
results to all participants
 Time Series Analysis

 Time series forecasting models try to

predict the future based on past data
 You can pick models based on:
1. Time horizon to forecast
2. Data availability
3. Accuracy required
4. Size of forecasting budget
5. Availability of qualified personnel
 Simple Moving Average Formula
 The simple moving average model assumes an
average is a good estimator of future behavior
 The formula for the simple moving average is:

A t-1 + A t-2 + A t-3 +...+A t- n

Ft =
n
Ft = Forecast for the coming period
N = Number of periods to be averaged
A t-1 = Actual occurrence in the past period for
up to “n” periods
Simple Moving Average Problem (1)

A t-1 + A t-2 + A t-3 +...+A t- n

Week Demand Ft =
1 650 n
2 678
3 720 Question: What are the 3-
4 785 week and 6-week moving
5 859
average forecasts for
6
7
920
850
demand?
8 758 Assume you only have 3
9 892 weeks and 6 weeks of
10 920 actual demand data for
11 789
the respective forecasts
12 844
Calculating the moving averages gives us:

Week Demand 3-Week 6-Week

1 650 F4=(650+678+720)/3
2 678 =682.67

3 720 F7=(650+678+720
+785+859+920)/6
4 785 682.67
=768.67
5 859 727.67
6 920 788.00
7 850 854.67 768.67
8 758 876.33 802.00
9 892 842.67 815.33
10 920 833.33 844.00
11 789 856.67 866.50
12 844 867.00 854.83
©The McGraw-Hill Companies, Inc., 2004
Plotting the moving averages and comparing them shows how
the lines smooth out to reveal the overall upward trend in this
example

Note how the 3-

Week is
smoother than
the Demand,
and 6-Week is
even smoother
Simple Moving Average Problem (2) Data

Question: What is the

3 week moving
Week Demand average forecast for
1 820 this data?
2 775
Assume you only have
3 680
3 weeks and 5
4 655
5 620 weeks of actual
6 600 demand data for the
7 575 respective forecasts
Simple Moving Average Problem (2) Solution

Week Demand 3-Week 5-Week

1 820 F4=(820+775+680)/3
=758.33
2 775
F6=(820+775+680
3 680 +655+620)/5
=710.00
4 655 758.33
5 620 703.33
6 600 651.67 710.00
7 575 625.00 666.00
 Weighted Moving Average Formula

While the moving average formula implies an equal

weight being placed on each value that is being
averaged, the weighted moving average permits an
unequal weighting on prior time periods

The formula for the moving average is:

Ft = w 1 A t-1 + w 2 A t- 2 + w 3 A t-3 + ...+ w n A t- n

n
wt = weight given to time period “t”
occurrence (weights must add to one)
w
i=1
i =1
Weighted Moving Average Problem (1) Data
Question: Given the weekly demand and weights, what is the
forecast for the 4th period or Week 4?

Week Demand
Weights:
1 650
2 678 t-1 .5
3 720 t-2 .3
4 t-3 .2

Note that the weights place more emphasis on the most

recent data, that is time period “t-1”
Weighted Moving Average Problem (1) Solution

Week Demand Forecast

1 650
2 678
3 720
4 693.4

F4 = 0.5(720)+0.3(678)+0.2(650)=693.4
Weighted Moving Average Problem (2) Data

Question: Given the weekly demand information

and weights, what is the weighted moving
average forecast of the 5th period or week?

Week Demand Weights:

1 820 t-1 .7
2 775 t-2 .2
3 680
t-3 .1
4 655
Weighted Moving Average Problem (2) Solution

Week Demand Forecast

1 820
2 775
3 680
4 655
5 672

F5 = (0.1)(755)+(0.2)(680)+(0.7)(655)= 672
 Exponential Smoothing Model

Ft = Ft-1 + a(At-1 - Ft-1)

Where :
Ft  Forcast value for the coming t time period
Ft - 1  Forecast value in 1 past time period
At - 1  Actual occurance in the past t time period
a  Alpha smoothing constant
 Premise: The most recent observations might have
the highest predictive value
 Therefore, we should give more weight to the
more recent time periods when forecasting
Exponential Smoothing Problem (1) Data

Week Demand
1 820 Question: Given the weekly
2 775 demand data, what are
the exponential
3 680
smoothing forecasts for
4 655
periods 2-10 using a=0.10
5 750 and a=0.60?
6 802 Assume F1=D1
7 798
8 689
9 775
10
Answer: The respective alphas columns denote the forecast
values. Note that you can only forecast one time period into the
future.

Week Demand 0.1 0.6

1 820 820.00 820.00
2 775 820.00 820.00
3 680 815.50 820.00
4 655 801.95 817.30
5 750 787.26 808.09
6 802 783.53 795.59
7 798 785.38 788.35
8 689 786.64 786.57
9 775 776.88 786.61
10 776.69 780.77
Exponential Smoothing Problem (1) Plotting
Note how that the smaller alpha results in a smoother line in this
example
Exponential Smoothing Problem (2) Data

Question: What are the

Week Demand exponential smoothing
1 820 forecasts for periods 2-5
2 775 using a =0.5?
3 680
4 655 Assume F1=D1
5
 Exponential Smoothing Problem (2) Solution

F1=820+(0.5)(820-820)=820 F3=820+(0.5)(775-820)=797.75

Week Demand 0.5

1 820 820.00
2 775 820.00
3 680 797.50
4 655 738.75
5 696.88
 The MAD Statistic to Determine Forecasting
Error

1 MAD  0.8 standard deviation

n

A
t=1
t - Ft
1 standard deviation  1.25 MAD
MAD =
n

 The ideal MAD is zero which would

mean there is no forecasting error

 The larger the MAD, the less the

accurate the resulting model
 MAD Problem Data

Question: What is the MAD value given

the forecast values in the table below?

Month Sales Forecast

1 220 n/a
2 250 255
3 210 205
4 300 320
5 325 315
 MAD Problem Solution

Month Sales Forecast Abs Error

1 220 n/a
2 250 255 5
3 210 205 5
4 300 320 20
5 325 315 10

40
n
Note that by itself, the
A
t=1
t - Ft
40 MAD only lets us know
MAD = = = 10 the mean error in a set of
n 4 forecasts
 Simple Linear Regression Model
Y

The simple linear a

regression model seeks
to fit a line through
various data over time 0 1 2 3 4 5 x
(Time)

Yt = a + bx Is the linear regression model

Yt is the regressed forecast value or dependent

variable in the model, a is the intercept value of the
the regression line, and b is similar to the slope of the
regression line. However, since it is calculated with
the variability of the data in mind, its formulation is
not as straight forward as our usual notion of slope.
Simple Linear Regression Formulas
for Calculating “a” and “b”

a = y - bx

 xy - n(y)(x)
b= 2 2
 x - n(x )
 Simple Linear Regression Problem Data

Question: Given the data below, what is the simple linear

regression model that can be used to predict sales in future
weeks?

Week Sales
1 150
2 157
3 162
4 166
5 177
 38
Answer: First, using the linear regression formulas, we can
compute “a” and “b”

Week Week*Week Sales Week*Sales

1 1 150 150
2 4 157 314
3 9 162 486
4 16 166 664
5 25 177 885
3 55 162.4 2499
Average Sum Average Sum

b=
 xy - n( y)(x) 2499 - 5(162.4)(3) 63
=  = 6.3
 x - n(x )
2 2
55  5(9 ) 10

a = y - bx = 162.4 - (6.3)(3) = 143.5

 39

The resulting regression

model is: Yt = 143.5+6.3x
Now if we plot the regression generated forecasts
against the actual sales we obtain the following
chart: 180
175
170
165
160 Sales
Sales

155 Forecast
150
145
140
135
1 2 3 4 5
Period