Supply Chain Planning:

1) Forecasting demand : Introduction

a) Supply chain planning is the foundation of all other supply chain tasks. Sourcing,
operations and logistics depend on the accurate prediction of demand. Precision
planning is essential to match supply with demand. Without planning, all other links in
the supply chain will be broken in any marketplace.
b) Demand Forecasting refers to the process of predicting the future demand for the firm’s
product under both controllable and non-controllable factors.
c) There are several types of forecasting approaches, what we're going to use here is time
series and time series relies on historical data. We have demand recorded over time
from past until the future and we're sitting here at point t, and this demand data is
going to be recorded in equal size intervals of time (like a day, week, month etc.). We
are going to forecast in those same intervals into the future.
d) Our goal is to build forecasting model based on past demand, which we denote as d
typically and we are going to forecast into the future and we denote that as F.
e) Once future data comes in, we are going to continuously refine our forecasting
approach and hopefully have a forecasting method that minimizes the error and gets us
the best prediction possible.
f) Time series are made up of several different patterns and noise. The different types of
patterns that we typically see in time series are –
i) A base level of demand gives us a starting value, any trend that might persist. So,
either demand goes up over time or it goes down over time.
ii) Seasonality – A pattern that repeats every month, every quarter or every year.
iii) Longer range cycles – Everything that's longer than a year, we call a cycle. It works
like seasonality.
iv) Noise - Noise is random. It follows no rhyme or reason, but it's always there.
g) A good forecast will try to resolve all of the pattern without trying to forecast noise. We
cannot forecast randomness, so the best forecast does not even try.
h) The best forecast is not always the most complicated one. While complicated methods
are usually more sensitive (i.e. better at picking up patterns), they can also be more
likely to pick up noise. In fact, if you can have an equally good forecast that is simpler,
it's a better one to use.

2) Methods to forecast demand

a) Naïve Forecast –
i) Naïve forecast is a very simple and easy to use forecasting method. It's naive
because all we're doing is, we're saying what we sold yesterday, that's how much
we're going to sell today.
 ii) The naive forecast works very well in certain situations. And it sometimes works
even better than other more complicated methods.
iii) Mathematically it is represented as F t=D t −1
iv) There are several adaptations of naïve method –
 Seasonal naive method – It takes into account seasonality. Let us say that our
interval of measuring time is a month and we find that rather than repeat every
month, demand repeats every year (i.e. demand of May 2020 is similar to that of
May 2019 instead of April 2020). This can be represented as F t=Dt −12
 Another version takes into account growth every time interval (T). This can be
represented as F t=Dt −1+ T
v) The naive forecast is very noisy because it doesn't filter out any noise whatsoever.
That makes it very nervous but also responsive to changes in demand. Nervous
means we have a very volatile forecast.
vi) That may not be in our best interest when we're trying to plan for a smooth
production. This is because our assumption that only the last period affects our
current demand is not very realistic.
vii) So, this method is generally used as a benchmark for more robust or complex
methods.
b) Cumulative Mean Forecast –
i) In this forecast, our prediction for current demand is equal to the average of all the
previous data.
ii) Here, our assumption is that all prior data is equally useful in our forecast. It may
work well in some situations and it averages out all the noise.
iii) The advantage of this method is that it is very stable and filters out noise. If we have
a situation where overall demand is dependent only on the level and noise and has
no other patterns, then this is a good forecast to use.
iv) The disadvantage is that it mostly does not recognize patterns and so it is also not
very realistic or robust.
t−1

v) It can be represented as
∑ Di
F t= i=1
t−1
c) Moving Average –
i) The moving average (MA) is a forecasting method where the average is taken over a
specific time period, like 10 days, 50 days, 20 weeks or any time period we choose.
This smooths out demand data by creating a constantly updated average price.
t−1

∑ Di
ii) It is represented as i=t− N+ 2
F t=
N
iii) Here, N is the number of periods you're going to average together, which we can
choose. For small values of N, the forecast is more sensitive but also picks up more
noise and therefore is quite uneven. A large N makes is more stable, but also less
 reactive (to recent changes or patterns). You have to try different values of N,
measure accuracy for each one of them, and then pick the best one.
iv) Moving average is a tremendously adaptable forecasting method. You can make it
very reactive or you can make it very stable. And that's why a lot of companies that
have reasonably stable demand use it.
d) Exponential Smoothing –
i) Exponential smoothing, similarly to the moving average, is a very versatile method.
By changing one value (alpha), you can make it more reactive or more stable.
ii) It is represented as
iii) Alpha goes from 0 to 1 and we have to vary it to get the most accurate model. If your
accuracy is improving, then you're going in the right direction. If your accuracy's
getting worse, you're going in the wrong direction.
iv) There are a number of extensions to the exponential smoothing formula. You can
take into account trended data, which means you have a consistent increase over
time or decrease over time. Or you can estimate demand that is seasonal.
v) Just Trend – Holt’s Model
Both Trend and seasonality – Winter-Holt’s Model

3) Forecast Accuracy Measures –

a) Calculating demand forecast accuracy is the process of determining the accuracy of
forecasts made regarding customer demand for a product.
b) Bias – A forecast bias occurs when there are consistent differences between actual
outcomes and previously generated forecasts of those quantities, i.e. forecasts may
have a general tendency to be too high or too low. A good forecast is not biased in
either direction.
c) Mean Error (ME) – It is the simplest form of a forecast accuracy measure. We subtract
the forecast from the demand and then we average up all of these time periods that we
have forecasted so far, and that gives us our mean error. It serves as a measure of bias.
It is defined as ME=
∑ ( D−F)
t

d) Mean Absolute Percentage Error (MAPE) - Forecast accuracy in the supply chain is
typically measured using this. Statistically MAPE is the average of percentage errors.
D−F
It is defined as
MAPE=∑
| D |
t

e) Mean Squared Error (MSE) – MSE is used because it gives more weightage to larger
errors because it squares them. This is because larger errors are to avoided at all costs
as they can disrupt our supply chain more and make planning more difficult.
 ( D−F )2
It is defined as MSE= ∑
t
f) When deciding on which forecast is most accurate, we should compare all the three
measures as each of them tell us something different.