USING AND DEVELOPING RANGE

FORECASTS FOR CAPACITY PLANNING—

ON SEMICONDUCTOR’S JOURNEY
By Ketan Khowala, Prabhu Valiveti, and Tim Williams

Short product life cycles coupled
with long lead-times for procuring
capacity necessitate a forecast ... er-
rors in product forecast often lead to
incorrect capacity investment deci-
sions ... describes a novel approach
that ON Semiconductor has devel-
oped to deal with such a problem.
contracts with upside protection, and
eroding selling prices are some of the
challenges that the ON Semiconductor
supply chain (and indeed, any semi-
conductor supply chain) faces in response
to the changing B2B customer landscape.
The ON product portfolio is dominated
by commodity products with multiple
customers and alternatives; market share is
gained by leveraging operational excellence
in the form of low-cost manufacturing and
superior customer service. In most cases,
VXSHULRU VHUYLFH LQYROYHV VLJQL¿FDQW ULVN
in inventory builds. New products in this
industry, for which no history exists, add
yet another component to risk. Products
in the computing and consumer segments
have life cycles of one to two quarters,
which is less than the typical product
development lead-time of one year. A
minor delay in product availability to
the market can result in a failed product

T
he semiconductor industry is
dominated by capacity bottlenecks.
To ensure low cost and superior
service to our increasingly demanding
customer base, it is essential to have a
timely access to capacity. But capacity
investment is very costly, easily running
into millions of dollars and requiring long
lead-times. To do it right, you must have
a reliable view of future market demand,
ZKLFK LV H[WUHPHO\ GLI¿FXOW IRU QHZ
products and new technologies because
they have no history to rely on.

A new product forecast comes from

a new product planner, which often is
not very good. Here we present range
forecasting, which is an approach that
combines consensus demand planning
(a part of S&OP process) with stochastic
principles to derive a map of potential
future outcomes. This approach not only
eliminates individual biases but it also
improves the quality of a forecast. In
this article, we describe how to develop
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capital expenditure planning.
BACKGROUND
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KETAN KHOWALA
Mr. Khowala, Senior Industrial Engineer
at ON Semiconductor, currently works on
capacity modeling and scenario analysis
for back-end manufacturing. He has led
several projects in the Global Supply
Chain Organization relating to forecast
optimization, product segmentation, and
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Sigma Black Belt practitioner. His M.S.
degree in Industrial Engineering is from
Arizona State University.
PRABHU VALIVETI
Mr. Valiveti is a Demand Manager at
ON Semiconductor. His role includes
continuous improvement and management
of strategic projects within the Global
Supply Chain Organization. Before
that, he worked at i2 Technologies as a
solution architect for 5 years. He has wide
H[SHULHQFHLQSURFHVVDQGGDWDPDQDJHPHQW
related to Capacity Planning and Scenario
Management. He holds a Ph.D. from
Cornell University in Ithaca, New York.

10 THE JOURNAL OF BUSINESS FORECASTING, SUMMER 2008

launch. To avoid that, the supply chain has
to build inventory based on a reasonably
accurate forecast.
Inventory is produced by applying
the capacity to raw materials. It is well
known in the semiconductor industry that
the supply chain is very much capacity
constrained, but building capacity requires
massive capital investment. Most mature
companies now have a formal capital
expenditure review and approval process
as part of their S&OP processes. Owing
to long cycle times (from raw material
elements in the capital expenditure process.
Capital investment decisions typically are
based on one-number forecasts of future
market demand. In principle, the forecast
of a new product represents a consensus
between sales and product marketing,
WKHUHE\UHÀHFWLQJWKHFXUUHQWXQGHUVWDQGLQJ
of the future dynamics of the market. The
analysis of new product forecasts reveals
WKDWWKH\JHQHUDOO\KDYHDVLJQL¿FDQWELDV
of over- or under-forecasting, resulting
in the twin evils mentioned earlier—
XQGHUXWLOL]DWLRQ RI FRVWO\ FDSDFLW\ DQG
unavailability of revenue earning capacity.
information is obtained when we view it
in terms of intervals rather than looking
at a single value; the probability of hitting
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most goals are interpreted in terms of
narrow bands with this approach. This
distribution of forecasts is called range
forecast.
SCENARIO EVALUATION
USING RANGE FORECAST
Figure 2 illustrates how a range forecast
could be used effectively to evaluate
WR ¿QLVKHG JRRG WUDQVIRUPDWLRQ LQ WKH
supply chain, and even longer capacity
procurement and/or deployment lead-
times, capacity requirements are forecasted
based on the demand forecast of four to
six quarters into the future. New product
IRUHFDVWVFRQWULEXWHVLJQL¿FDQWXQFHUWDLQW\
to the overall forecast with the result that
precious capital is often allocated to the
Furthermore, a new product forecast is
often a one-person forecast. To improve
forecasts and consequently decisions for
capital expenditure, we tried to create a
composite forecast through the systematic
involvement of sales and marketing. The
objective of this exercise was to obtain
a range of possibilities for the forecast
instead of just one number. Statistically,
capacity options for better investment
decisions, compared to the one-number
forecast, which is often biased—either
high or low. Here the dotted lines
represent higher and lower volumes of
future demand at a certain capacity level.
The various levels of capacity increment
options are presented along the planning
“wrong” capacity equipment. KRUL]RQ ;D[LV 7KH <D[LV UHSUHVHQWV
there is evidence to support that better the future demand. Let us assume that
This article describes a forecast im-
provement initiative, led by members
of our global supply chain operations
(GSCO) group, to provide a rigorous and
accurate basis for capital expenditure
(CAPEX) decisions. The study shows that
idle capacity is often caused by overly
optimistic forecasts. Further, wrong
CAPEX decisions often turn out to be a
double-edged sword, denying capacity to
needed products and, at the same time,
letting capacity sit idle. The lean six-sigma
IUDPHZRUN 'H¿QH 0HDVXUH $QDO\]H
Improve, and Control—DMAIC) was
adopted for this study. Here we present
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SURFHVV UHFRPPHQGDWLRQ LV WR IRUPDOL]H
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forecasting as part of best practices in
demand planning processes. Our experience
shows that a range forecast is the best
for deciding about capital expenditure,
particularly in the semiconductor industry.
PROBLEM DEFINITION AND
SOLUTION APPROACH
Figure 1 outlines the key process
THE JOURNAL OF BUSINESS FORECASTING, SUMMER 2008
TIM WILLIAMS
Mr. Williams is a Demand Forecasting
Manager at On Semiconductor. In
addition to this role, he is responsible for
Sales and Operations Planning for the
Global Supply Chain. Prior to that, he held
various management positions in several
areas including Capacity Planning and
Manufacturing Operations. He holds a
bachelor’s degree in Business Management
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&HUWLÀHG3URIHVVLRQDO)RUHFDVWHU
ZH DUH LQ WKH ¿UVW TXDUWHU 4 DQG D
decision has to be made about the capital
investment. In Scenario A, all that is
known is the point forecast, which is
overestimated. Looking at this forecast,
the decision would be to explore all the
options of external and internal capacity
as well as how much capacity needed to
be procured though capital investment. In
Scenario B where the point forecast has
been underestimated, the decision would
be neither to increase the capacity nor to
make any capital investment to generate
additional capacity.
These two scenarios lead us to the
extremes in the capital acquisition.
Scenario A will leave us with idle
capacity if the demand does not reach the
point forecast, whereas capacity will be
constrained in Scenario B if the demand
exceeds the point forecast. In scenario A,
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whereas revenue would be lost because
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However, we can mitigate the risk by
using range forecast instead of point
forecast. Consider Scenario C, where
a range forecast is used in the decision
process. The best strategy is to leverage
11
WKHLQWHUQDOFDSDFLW\¿UVWE\LQFUHDVLQJLW
as much as we can and postpone the capital
investment to the next quarter when more
FIGURE 1
and better demand data will be available. In SIPOC DEPICTION OF CAPITAL EXPENDITURE PROCESS
this way, capital investments will be made
on the data that are more reliable, thereby
mitigating the risk of unwise investment.
By repeating this exercise at periodic SUPPLIER INPUT PROCESS OUTPUT CUSTOMER
intervals, we will have the opportunity to
make corrections along the way.

A CASE STUDY - Sales & - Overrides to - Use the single - Decision of - Various
Marketing baseline point forecast capital Business Units
A select number of capacity groups Managers forecast to make the expenditure
were chosen from the pool of candidate capacity - Manufacturing
capacities for further investment - Sales & - Demand expenditure - Pay or Take Sites for new
Operations numbers from related decision capacity
for capacity expansion. In total, we new product
Planning decisions expansion
conducted the range forecasting exercise Manager development program
- Internal vs.
for six different capacities, and for some registry External
capacities, the exercise was repeated - Capacity decision - Finance for
during different times of a year (in different Planning - Capacity allocating
quarters) to trace the trend and shift in Analyst options and - Supplier funds
associated costs negotiation
demand. The range forecast generated
from the inputs gathered from sales and -Manufacturing - Supply
Units/Sites Management
PDUNHWLQJVHUYHGDVDFRQ¿GHQFHEDQGIRU
a capacity expansion decision. Capacity
expansion options are through internal
investments or purchases from external
sub-contractors which require longer term FIGURE 2
negotiations, and hence, a better forecast. CAPACITY OPTION EVALUATION AGAINST POINT AND
RANGE FORECASTS
An aggregate capacity group is broken
into a set of sub-capacity groups. The
attributes used to identify sub-capacity
ted
JURXSV ZHUH EDVHG RQ VSHFL¿F FXVWRPHU t i ma Scenario A
Es st
business segments and product lines. v er- reca
O Fo
Three data inputs were collected from of
le
c e nti ast
sales and marketing for each of these sub- r
Pe Fore
c
th
capacities. 90 ange
R of
Scenario C
(in million units)

n tile st
1. Lowest possible level of demand rc e ca
Demand

Pe Fore
forecast (L) th
10 ange ate
d
R s tim t
r-E ecas Scenario B
2. Highest possible level of demand de
Un For
forecast (H)
Optional Capacity Achieved through Capital Investment
External Capacity Increase Option
3. Median (expected) level of demand
Internal Capacity Increase Option
forecast (M)
Current Capacity
The sales and marketing managers
of various products provide their inputs Q1 Q2 Q3 Q4 Q5
DFURVV WKH SODQQLQJ KRUL]RQ JHQHUDOO\
for next eight quarters). These inputs Planning Horizon
are based on their knowledge about

12 THE JOURNAL OF BUSINESS FORECASTING, SUMMER 2008

the markets and the commitments that
they might have received from potential
customers. Most of these capacities were
for new technology for which historical
sales data were not available.
DEVELOPING RANGE
in Figure 2). The 90th percentile forecast
on the aggregate capacity group serves
as the upper bound of the range forecast.
On the other side, the use of all the most
pessimistic demand scenario resulted in
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10th percentile of the aggregate forecast
is in a better position to assess risks and
make right decisions.
Figure 3 shows the range forecast for
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at three different points in time. The
vertical axis shows the forecasted capacity
FORECASTS (Scenario B in Figure 2), which serves as ZHHNO\UXQUDWHDQGWKHKRUL]RQWDOD[LV
DORZHUERXQG6FHQDULRV$DQG%UHÀHFW UHÀHFWV WKH SODQQLQJ KRUL]RQ LQ TXDUWHUV
“perfect” correlation between the sub- The inputs were collected at three
A Monte Carlo simulation technique capacity groups and are unlikely to occur GLIIHUHQW WLPHV EHJLQQLQJ RI 4
was used to pool the risk and variation
in forecasts of various products along
with their capacity needs to determine the
range forecasts as well as their capacity
needs at an aggregate level. The decision
on capacity is made at an aggregated level
because aggregated capacity is fairly
ÀH[LEOHLQPHHWLQJWKHQHHGVRIGLIIHUHQW
products and technologies.
The forecast for an aggregate capacity
in practice. Representative optimistic
and pessimistic bounds on forecasts are
obtained by the 90th and the 10th percentile
of the aggregate forecast, and the 50th
percentile, as an estimate of the most
likely (or mean) forecast.
The results of the Monte Carlo simulation
are presented to the capital expenditure
board for evaluation and decisions on
capacity options. By providing all this
4 DQG 4 DQG WKH SURFHVV
was repeated to monitor the change in
the market trend and to make capacity
expansion decisions based on the range
forecast. The range forecast developed in
a period shows a gradual “widening” over
WKHKRUL]RQUHÀHFWLQJJUHDWHUXQFHUWDLQW\
LQWKHGHPDQGDQGDJUHDWHUFRQ¿GHQFHLQ
the near-term demand. The low and high
ranges also are used to provide independent
validation of the consensus forecast (used
(FtLQDVSHFL¿FWLPHSHULRGt (typically information about forecasts, the board in our standard S&OP process). Finally,
one calendar quarter), is as follows:

Ft = f1t + f2t + f3t + … + fnt FIGURE 3

RESULTS OF TYPICAL RANGE FORECASTING EXERCISES
Here fit is a random variable representing
the forecast for the need for ith sub-capacity
group in time period t. A Monte Carlo
simulation was conducted by sampling
from the n QRUPDO GLVWULEXWLRQV ¿W WR WKH
low, median, and high estimates for each
capacity group. The low and high demand
Weekly Run Rate (Million)

numbers were taken to be 10% and

 FRQ¿GHQFH LQWHUYDO HVWLPDWHV 7KH
sampling procedure was conducted over
multiple trials to get a stable distribution
for Ft, from which the 10%, 50%, and 90%
percentiles were extracted. This procedure
was repeated for all time periods (in the
KRUL]RQ RYHU ZKLFK UDQJH IRUHFDVWV ZHUH
developed) to yield the space of future
demand possibilities.

RESULTS
The results of the Monte Carlo
simulation are quite instructive. The use
of the most optimistic demand estimate on
all capacity sub-groups results in a forecast
WKDW LV VLJQL¿FDQWO\ KLJKHU WKDQ WKH th
percentile of the forecast on the aggregate Time Horizon
capacity group (analogous to Scenario A

THE JOURNAL OF BUSINESS FORECASTING, SUMMER 2008 13

investment required to support demand
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between the low and high ranges. The
three sets of graphs generated at three
different times periods provided a better
understanding of the market dynamics and
more visibility on the upcoming changes
in the demand. ‡-RXUQDO RI %XVLQHVV )RUHFDVWLQJ covers issues such as “How to Win the Support
Complimentary for active IBF Members, each of Top Management for Forecasting,” “How
PROCESS IMPROVEMENTS issue gives you a host of jargon-free articles to Select Forecasting Software/ Systems,” and
on how to obtain, recognize, and use good more. Plus, you will have access to electronic
AND BENEFITS forecasts written in an easy-to-understand copies of the latest journal. Moreover, you
style for business executives and managers. will also have access to our Action Templates,
Range forecasts developed at different Plus, it provides new, practical forecasting ready to use. Currently, they include: (1)
ideas to help you make vital decisions about How to calculate forecast error? (2) How to
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sales, capital outlays, credit, plant expansion, calculate how much money you will save by
around future market demand as well as ¿QDQFLDO SODQQLQJ EXGJHWLQJ LQYHQWRU\ UHGXFLQJVSHFL¿FDPRXQWRIHUURU"+RZWR
better decisions for capital expenditure control, production scheduling and marketing calculate safety stocks (forthcoming).
than a point forecast. Range forecasting strategies. A one-year subscription includes 4
should be embedded within the S&OP
process. The quarterly capital decision
process should be an iterative process
to continually monitor the need and
performance of capacity, as well as the
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of range forecasting are as follows:
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better quality of market dynamics
into forecasts.
2. It establishes time-phased strategy for
capacity expansion.
issues. Most of the articles are written for and
by practicing forecasters.
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$UWLFOHV NEW! Active Members will now
have FULL access to all Journal of Business
Forecasting articles since inception. With
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articles based on your set search criteria.
This way you will have access to research at
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articles representing a multitude of industries,
companies, and topics including demand
planning and supply chain management.
This access will give you a step ahead in
improving your forecasting performance.
There is no other body of knowledge which
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‡,Q+RXVH 7UDLQLQJ 6HPLQDUV 'LVFRXQWV
3. It provides a framework for evaluating
demand as well as internal and
external capacity options.
CONCLUSION
The range forecasting is a good approach
for determining appropriate capital
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is as extensive as this one and is geared
primarily towards forecasting practitioners.
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we can have depends on to what extent
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for it. It has great potential for generating
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to the model include consideration of
capacity and time period correlations and
net present value evaluation of options to
construct a make vs. buy risk model. „ (8 People Maximum)
(Ketan.Khowala@onsemi.com)
(Prabhu.Valiveti@onsemi.com)
(Tim.Williams@onsemi.com)
14
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