Quantitative Methods in

Production and Logistics

DEMAND FORECASTING
DEMAND
 Demand is a need for a particular product or
component.
 The demand could come from any number of sources.
 Core components of demand includes:
 Trend
 Seasonality
 Random variation.
 Cycle.

2
 Trend:
 General upward or downward movement of a variable over
time.

 Seasonality:
 A repetitive pattern of demand from year to year (or other
repeating time intervals.)
 Demand may fluctuate depending on time of year.
 Example; holidays weather, or other seasonal events.

3
Random variation:
A fluctuation in data that is caused by uncertain or
random occurrences.
Many factors affect demand during specific time
periods and occur on a random basis.
Cycle:
Over time, increases and decreases in the economy
influence demand.

4
DEMAND PLANNING
The process of planning all demand for
products and services to support the market
place. The process involves updating the
supporting plans and assumptions and reaching
consensus on an updated demand plan.

5
Importance
If production outstrips demand, you suffer
financial losses and perhaps go bankrupt.
If order exceeds supply, your frustrated
customers may go to your competitors.

6
Sources of demand variability
 Competition.
 Seasonality
 Life cycle trends
 External factors.
 Promotions.
 Disasters

7
FORECASTING
 Forecasting demand is a necessary part of
business planning.
 Forecasts are subject to uncertainty, and this
uncertainty is one potential contributor to the
bullwhip effect.

8
Principles of Forecasting
1. Forecasts are (almost) always wrong.
2. Forecast should include an estimate of error.
3. Forecasts are more accurate for groups than
for single items.
4. Near term forecasts are more accurate than
long term forecasts.

9
Forecasting (continued)
 Independent Demand
 Dependant Demand.

10
Qualitative Approaches to Forecasting Demand

1. Personal Insight.
2. Sales force consensus estimate.
3. Management estimate
4. Market research.
5. Delphi Method.

11
Quantitative Approaches to Forecasting Demand

1. Naive approach.
2. Moving average
3. Weighted moving averages
4. Exponential smoothing.

12
1. Naive Approach

 This forecast method assumes that demand in

the next time period will be the same as
demand in the last time period.
 For e.g retailer sells 500 pair of shoes in
February, naïve forecast for the March would
be 500 pair of shoes.
 This forecast can be considered baseline for
use in evaluating more sophisticated
approaches.
 Forecast for Feb = AD of Jan
13
Simple Moving Average
 It is more sophisticated than naïve approach.
 Averages actual demand data for a specified number
of previous time periods.
 It is moving average because it is recalculated for
each new period.
 Moving average is used when demand is fairly
constant from period to period.
 For e.g moving average for 3 month is calculated as
(M1 + M2 + M3) / 3

14
Simple Moving Average - Example
Week Demand 3 Month Moving Average
1 350
348 + 366 + 381
2 397 Forecast8 =
3
3 375
Forecast8 = 365
4 342
5 Month Moving Average
5 381

6 366 348 + 366 + 381 + 342 + 375

Forecast8 =
5
7 348
Forecast8 = 362.4
15
Weighted Moving Average
 More sophisticated than simple moving
average.
 It emphasize on recent periods and less on
earlier periods.
 Any combination of weights that sums to 1.00
may be used
 Any number of periods may be used

16
Weighted Moving Average - Example
Week Demand Using the data from the previous
1 350 example, calculate a 4 week weighted
2 397 moving averag.
Jan = 0.1 Feb = 0.3, M= 0.25 Ap = 0.35
3 375

4 342 Fmay = (0.10) 350 + 0.3* 397 + 0.25 * 375 +

0.35 * 342
5 381
4 Period Weighted Moving Average
6 366
Forecast8 = [(1)(342)+ (2)(381)+ (3)(366)+ (4)(348)]/ 10
7 348

Forecast8 = 359.4
17
Exponential Smoothing
 It is a more sophisticated version of the weighted
moving average.
 It requires three basic terms:
 The last period’s forecast.
 The last period’s actual demand.
 Smoothing constant (forecast error margin), represented
by Greek letter alpha (α).
 Formula:
 New forecast = Last period’s forecast + α (Last period’s
demand – Last period’s forecast’s)
 α (Last period’s demand) + (1 – α) Last period’s
forecast
 Ffeb = Fjan + α (ADjan – Fjan) 18
 Exponential Smoothing - Example
Actual Forecasted Using the given data, calculate
Period
Demand Demand demand in week 12 using an
7 48 52.69 exponential smoothing forecast
8 45 51.15
with an alpha = 0.328

9 47 49.13 Forecast12 = (0.328)(40) + (1- 0.328)(47.31)

10 45 48.43
Forecast12 = 44.91
11 40 47.31

st period’s forecast + α (Last α (Last period’s demand) + (1 – α)

riod’s demand – Last period’s Last period’s forecast
ecast’s) 19
 SEASONAL INDEX

Deseasonalized Avg
Monthly Seasonal
Sales (Demand) Seasonal Avg Demand Demand Index
Month 2005 2004 2003 2003-2005
Jan 32 27 34 31 14 2.214
Feb 26 31 33 30 14 2.143
Mar 12 11 10 11 14 0.786
Apr 5 4 3 4 14 0.286
May 4 2 0 2 14 0.143
Jun 3 1 2 2 14 0.143
Jul 2 1 0 1 14 0.071
Aug 5 3 4 4 14 0.286
Sep 10 11 9 10 14 0.714
Oct 15 13 14 14 14 1.000
Nov 25 29 27 27 14 1.929
Dec 32 30 34 32 14 2.286
Total Average Annual Demand 168
20
Average Monthly Demand 14
Mean Absolute Deviation (MAD)
 MAD is the average of the absolute deviation between actual
and forecasted values
 The forecast with the smallest MAD best fits the data

MAD =
 Actual Demand - Forecasted Demand
Number of Periods

21
MAD - Example
Actual Forecasted Absolute
Period Error
Demand Demand Error

7 48 52.69 -4.69 4.69

8 45 48.97 -3.97 3.97
9 47 45.82 1.18 1.18
10 45 46.76 -1.76 1.76
11 40 45.36 -5.36 5.36
Total 16.96

16.96
MAD = = 3.39
5
22
Mean Squared Error (MSE)
 MSE is the average of all of the squared errors.
 It magnifies the error by each of the error.
 The forecast with the smallest MSE best fits the data

 Actual Demand - ForecastedDemand  2

MSE =
Number of Periods

23
Mean Squared Error - Example
Actual Forecasted Squared
Period Error
Demand Demand Error

7 48 52.69 -4.69 22
8 45 51.15 -6.15 37.82
9 47 49.13 -2.13 4.54
10 45 48.43 -3.43 11.76
11 40 47.31 -7.31 53.44
Total 129.56

129.56
MSE = = 25.91
5
24
Mean Absolute Deviation (MAD)
 MAD is the average of the absolute deviation between actual
and forecasted values
 The forecast with the smallest MAD best fits the data

MAD =
 Actual Demand - Forecasted Demand
Number of Periods

25
 Seasonal Variations In Data
Steps in the process:
1. Find average historical demand for each season
2. Compute the average demand over all seasons
3. Compute a seasonal index for each season
4. Estimate next year’s total demand
5. Divide this estimate of total demand by the
number of seasons, then multiply it by the
seasonal index for that season
 Seasonal Index Example
Demand Average Average Seasonal
Month 2005 2006 2007 2005-2007 Monthly Index
Jan 80 85 105 90 94
Feb 70 85 85 80 94
Mar 80 93 82 85 94
Apr 90 95 115 100 94
May 113 125 131 123 94
Jun 110 115 120 115 94
Jul 100 102 113 105 94
Aug 88 102 110 100 94
Sept 85 90 95 90 94
Oct 77 78 85 80 94
Nov 75 72 83 80 94
Dec 82 78 80 80 94
 Seasonal Index Example
Demand Average Average Seasonal
Month 2005 2006 2007 2005-2007 Monthly Index
Jan 80 85 105 90 94 0.957
Feb 70 85 85 80 94
Mar 80 93 average
82 85 monthly demand
2005-2007 94
Seasonal90index95= 115
Apr 100 94
average monthly demand
May 113 125 131 123 94
= 90/94 = .957
Jun 110 115 120 115 94
Jul 100 102 113 105 94
Aug 88 102 110 100 94
Sept 85 90 95 90 94
Oct 77 78 85 80 94
Nov 75 72 83 80 94
Dec 82 78 80 80 94
 Seasonal Index Example
Demand Average Average Seasonal
Month 2005 2006 2007 2005-2007 Monthly Index
Jan 80 85 105 90 94 0.957
Feb 70 85 85 80 94 0.851
Mar 80 93 82 85 94 0.904
Apr 90 95 115 100 94 1.064
May 113 125 131 123 94 1.309
Jun 110 115 120 115 94 1.223
Jul 100 102 113 105 94 1.117
Aug 88 102 110 100 94 1.064
Sept 85 90 95 90 94 0.957
Oct 77 78 85 80 94 0.851
Nov 75 72 83 80 94 0.851
Dec 82 78 80 80 94 0.851
 Seasonal Index Example
Demand Average Average Seasonal
Month 2005 2006 2007 2005-2007 Monthly Index
Jan 80 85 105 90 94 0.957
Feb 70 85 Forecast
85 for802008 94 0.851
Mar 80 93 82 85 94 0.904
Apr 90Expected
95 115annual demand
100 = 1,200
94 1.064
May 113 125 131 123 94 1.309
Jun 110 115 120 1,200 115 94 1.223
Jul Jan 113
100 102 x .957 = 96 94
105 1.117
12
Aug 88 102 110 100 94 1.064
1,200
Sept 85 90
Feb 95 x90.851 = 85 94 0.957
Oct 77 78 85 12 80 94 0.851
Nov 75 72 83 80 94 0.851
Dec 82 78 80 80 94 0.851
Seasonal Index Example
2008 Forecast
140 – 2007 Demand
130 – 2006 Demand
2005 Demand
120 –
Demand

110 –
100 –
90 –
80 –
70 –
| | | | | | | | | | | |
J F M A M J J A S O N D
Time
 San Diego Hospital
Trend Data

10,200 –

10,000 –

9,800 – 9745
Inpatient Days

9659 9702
9573 9616 9766
9,600 – 9530 9680 9724
9594 9637
9,400 – 9551

9,200 –

9,000 – | | | | | | | | | | | |
Jan Feb Mar Apr May June July Aug Sept Oct Nov Dec
67 68 69 70 71 72 73 74 75 76 77 78
Month
San Diego Hospital
Seasonal Indices

1.06 –
1.04 1.04
1.04 – 1.03
Index for Inpatient Days

1.02
1.02 – 1.01
1.00
1.00 – 0.99
0.98
0.98 – 0.99
0.96 – 0.97 0.97
0.96
0.94 –
0.92 – | | | | | | | | | | | |
Jan Feb Mar Apr May June July Aug Sept Oct Nov Dec
67 68 69 70 71 72 73 74 75 76 77 78
Month
 San Diego Hospital
Combined Trend and Seasonal Forecast

10,200 –
10068
10,000 – 9911 9949

9,800 – 9764
Inpatient Days

9724
9691
9,600 – 9572

9,400 – 9520 9542

9411
9265 9355
9,200 –

9,000 – | | | | | | | | | | | |
Jan Feb Mar Apr May June July Aug Sept Oct Nov Dec
67 68 69 70 71 72 73 74 75 76 77 78
Month