Demand forecasting

Eng. Laura Macchion

Ph.D.
University of Padova – Management Engineering
Laura.macchion@unipd.it

1
 Agenda
¤ What is forecasting?

¤ Principles of Forecasting

¤ Different approaches to forecasting

¤ Qualitative methods
¤ Quantitative methods

¤ Selecting the right approach to forecast

¤ Integration of demand forecasting and Supply Chain

Management

2
 What is forecasting?
¤ The independent demand is driven by the market: Demand is
usually uncertain

¤ You do not know exactly what/how may products will be

sold in the next period.
 What is forecasting?
¤Forecasting: tool for predicting future based on past
demand information
¤Observation of correlations between variables to make
forecasts.
Demand for product

Time
Jan Feb Mar Apr May Jun Jul Aug

Past sales
Predicted demand
4
 What is forecasting?
¤ The dependent demand is driven by the demand of another
product.
¤ “You do not know how many wheels you need, but it is always 5
times the number of cars”

x5

x2

x2
 What is forecasting?
¤Importance of demand forecasting
Time

Long term Medium term <12 months

èaggregate
èItems/raw
èbusiness forecasting
materials/compone
forecasting • company’s
nts forecasting
resources,
• operative
• investments’ purchasing,
production
programs production,
organization
human resources
6
 What is forecasting?

Forecast Forecast
horizon detail

7
 What is forecasting?

Supply Chain Planning

Sales

Material
Requirements
Distribution Planning
Requirements Aggregate
planning planning

Master
Production
Planning
Demand forecasting
 What is forecasting?
¤ Importance of demand forecasting
1. Supporting the production model
DESIGN PURCHASING PRODUCTION ASSEMBLY Difficulties in
forecasting
activities
MTS
DRIVEN BY
FORECAST ATO

MT0
DRIVEN BY
PTO
DEMAND
ETO
DP= Decoupling Point
9
 What is forecasting?
¤ Importance of demand forecasting
3. Eliminating the Supply Chain BULLWHIP EFFECT

ü The variability of demand is increasing in the upper-side of supply

chains
ü Small variations of final demand can create very big variations in the
supply chains

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 What is forecasting?
¤ Importance of demand forecasting
3. Eliminating the Supply Chain BULLWHIP EFFECT
ü Very big variations in terms of ORDERS and STOCKS

Supplier Producer Distributors Shops

Orders Orders Orders Sales

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Principles of Forecasting
General problems of forecast

ü Forecasts are usually wrong

ü Forecasts are more accurate for groups or families of items
ü Forecasts are more accurate for shorter time periods
¤ long horizon è large errors
ü Forecasts are more accurate for larger areas
¤ Europe vs. Veneto region / vs. specific city
ü Every forecast should include an error estimate
ü Use different approaches
ü Use any other known information:
¤ an advertising or promotion campaign has been launched;
¤ a new product (which replaces the old one) is now
available.
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 Principles of Forecasting
Critical elements for forecasting: OPTIONS AND TIMES

Phenomenon: sales are growing

TIME NEEDED
AVAILABLE OPTIONS (decisions)
to implement the options
Hours
Increase production (units / hour)
Recruiting
New line construction
New plant construction
Years

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 Principles of Forecasting
Forecasting based on intuition

SHORT TERM LONG TERM

How many children will be tomorrow How many children will attend the
at school? school in 5 years?

analysis of the presence of children in analysis of population statistics

the classroom today
Future school
Birth
population

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36
 Principles of Forecasting
But… forecasting based on intuition are subject to error

….

Immigration

Future school
Economic prosperity Birth
population

Developments in Availability and type of

residential building accommodation

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 Principles of Forecasting
Decide the structure of Forecast Models

1.Data availability
2.Time horizon for the forecast
Year Semester Quarter Month Week Day

3.Level of aggregation

Wor Countr Area/regio Client Point of sale

d y n
Business unit Brand Family of Article SKU
products

1.Required accuracy
2.Required Resources

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 Principles of Forecasting
¤Level of aggregations

Product Defining production

capacity

Variant Defining planning and

purchasing activities

Defining
Article GLASS PLASTIC TIN … scheduling/production
activities

Sku Defining distribution

activities
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 Principles of Forecasting
¤Forecast horizon

Long • > years

range • Strategic decisions

Medium • 1-2 years

• Tactical decisions: budgets
term and cost controls

• <1 year
Short • Operative decisions:
term marketing, production and
operations operative activities

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 Principles of Forecasting
¤Importance of considering the product life cycle

Volume

Age

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 Principles of Forecasting

¤Key issue
1. A forecast is good just if the information included in the
forecast (past data) is reliable
2. History is not a perfect predictor of the future

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 Different approaches to forecasting

1. Quantitative Method
Rely on subjective opinions from one or
more experts. 3. Mix of qualitative
and quantitative
methods
2. Quantitative Method
Rely on data and analytical techniques.

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 1. Qualitative methods

¤ Collection and evaluation of past experiences

¤ Consideration of views, insight and opinions

¤ Involvement of "experts"

q Market research
q Historical analogy
q Panel of expert
q Delphi Method
q Scenario planning

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1. Qualitative methods

q Market research: trying to identify customer habits;

deriving future demand by asking customer (or the person
closest to the customer) impression.
q Used for new product ideas.

q Historical analogy: identifying similar market conditions by

studying past situations.

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1. Qualitative methods

q Panel of expert: deriving future estimations from the

synergy of a panel of experts in the area.

q Delphi Method: relies on a panel of expert. The experts

answer questionnaires in two or more rounds.

q Scenario analysis: This analysis will identify different

scenarios in which the company could compete.
q used to make flexible long-term forecasting.

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 1. Qualitative methods

q Panel of expert:
• All participants should talk openly and freely

• Many people at work èmore suggestions

•Difficult to reach a full agreement

•People with more power in the company can impose their point
of view
•Errors of judgment: even the experts could be wrong!

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 1. Qualitative methods
qDelphi Method

STEP 1
The questionnaire will be sent by mail / e-mail to experts
Responses will be analyzed and synthesized

STEP 2
Responses will be sent back to experts
Reconsideration of original response thanks to other experts
observations

STEP 3
Repeat the described process until reaching a consensus among
experts
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 1. Qualitative methods
qDelphi Method

• Assign different weighs to different questionnaires based on

experts’ experience, reputation
• More formal method
• Reduction of interference among people

•Construction of the questionnaire

•a panel of experts could identify more ideas
•Selection of experts

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 2. Quantitative methods

¤ Time Series: models that predict future demand based on

past history trends

¤ Causal Relationship: models that use statistical techniques to

establish relationships between various items and demand
¤ Linear regression

¤ Simulation: models that can incorporate some randomness

and non-linear effects

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 2. Quantitative methods
qTime series analysis

¤ The idea is that the evolution in the past will continue into
the future.

¤ Analysis of past stages of a phenomenon in order to predict

future stages
¤ This method examines the TREND of a phenomenon
(increase/decrease)

¤ The times series analysis is limited to considering the historical

data and ignores the random variables
¤ Attention: identifying other variations (ex: season)

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 2. Quantitative methods
qtime series analysis

¤ What should we consider when looking at past demand

data?

Demand

Demand
Demand

Time Time
Time
Trends Seasonality Random variations

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 2. Quantitative methods
EXAMPLE: TIME SERIES ANALYSIS

OBJECTIVE: identify future sales of a company

ANALYSIS OF SALES OF PREVIOUS PERIODS:

• growth of product sales
Demand

time

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 2. Quantitative methods
EXAMPLE: TIME SERIES ANALYSIS

Growing linear trend

demand

time

TREND: linear increase in sales

Decreasing linear trend

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 2. Quantitative methods
EXAMPLE: TIME SERIES ANALYSIS

Growing NON linear trend

demand

Decreasing NON linear trend

time

TREND: linear increase in

sales
“S” curve NON linear trend

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 2. Quantitative methods
EXAMPLE: TIME SERIES ANALYSIS
demand PANETTONI

time

TREND: linear increase in

demand

sales

time

SEASONALITY: cyclical
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 2. Quantitative methods
OTHER EXAMPLES OF SEASONAL PRODUCTS

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demand
2. Quantitative methods

time
TREND: linear increase in sales

demand
time

SEASONALITY: cyclical

demand
- Some fluctuations remain after the time
elimination of trends and seasonality
- The cause can not be identified RANDOM VARIATIONS:
within the same cycle
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 lesson

¤
We are in a situation in which we have no data, so we have to use qualitative methods
based on the experience of the experts.
The second option is quantitative method, used if we have some data of the previous
sell, we are analyzing how the past data can be used to forecast the future sell.

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 2. Quantitative methods
§Moving average
Very simple, average of the past sails

• The moving average model uses the last periods to predict

demand in the next period.
• The moving average model assumption is that the most
accurate prediction of future demand is a linear combination
of past demand.
• There can be two types of moving average models:
• simple moving average
• weighted moving average

Possible Mistake:
• By analyzing past data, we can not cover increasing peaks among
the mount.
• Used when we are in a “ at” situation (no uctuation in demand)

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 2. Quantitative methods
§Simple Moving average Moving = we can consider 2 or 10 periods, for example

Number of period that we are considering

¤ n the forecasting horizon (how far back we look)
¤ Aj the sales of each period j.
j =t -n

åA
¤ F the demand forecast period
¤ t the current period. j
j = t -1
Forecasting future sales Ft =
¤ Explain the random variations n
¤ All the periods have the same weight

¤ Attention: use only the n periods

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 2. Quantitative methods
Wee Actual Demand
A = past sales
k sales forecast §4-period Simple Moving average
Actual sale =
perfect number of t A F
products that we
sold in past period 20 63,3 j =t -n
21
22
62,5
67,8
åA
j = t -1
j

23 66,0
Ft =
24 67,2 64,9
n
25 69,9 65,9
26 65,6 67,7 F35 = (A34 + A33 + A32 + A31 )/4
27 71,1 67,2
= (72,5 +66,7 +68,3 + 67,0)/4
28 68,8 68,5
= 68,6
29 68,4 68,9
We are in 34
30 70,3 68,5 We are forecasting 35, considering the previous 4 periods.

31 72,5 69,7 4 periods is a simpli cation. In the reality we have to consider more
periods maybe, it’s depends on the business of the company.
32 66,7 70,0 If we are realizing a new product we can’t consider 20 periods (far
from the innovation), instead we should use very few periods.
33 68,3 69,5
34 67,0 69,5 When we are going to consider a larger amount of period we could
get more precise forecasting (statistical), observing the uctuation
35 68,6 in each period.
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 2. Quantitative methods
§Simple Moving average
Demand forecast is very di erent from the actual sales.
• Sometimes A are over Forecast
PREVISIONI
• Sometimes A are under Forecast CON MEDIA MOBILE
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72

70
Domanda

68

66

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Tempo
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20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35

Actual sales
Domanda A
effettiva A Demand forecast
Domanda previstaF F
Peaks of the “Actual Size” (column of the previous slide)

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 2. Quantitative methods
§Simple Moving average
Stability versus responsiveness in moving averages
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71

70

69

68

67

66

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25 26 27 28 29 30 31 32 33 34 35

Actual sales 4-period Simple Moving average

3-period Simple Moving average 2-period Simple Moving average
5-period Simple Moving average
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 2. Quantitative methods
§ Weighted Moving average

¤ n the forecasting horizon (how far back we look)

¤ A the sales
¤ F the demand forecast period
¤ t the current period.
Assign a weight for the di erent period.
¤ w weight of each period. (More weight for the last periods, because we could have in more
similarities. Maybe because we are in the same season)

¤ Some of the data are more important: give more importance to what
happened recently, without losing the impact of the past.

Ft = wt-1 At-1 + … + wt-n At-n

wt-1 + … + wt-n = 1
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 2. Quantitative methods
§ Weighted Moving average

¤ The choose of weights:

Depending on
1. the importance of past data
2. The presence of seasonality (weights can also be zero).

Ft = wt-1 At-1 + … + wt-n At-n

wt-1 + … + wt-n = 1

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 2. Quantitative methods
§ Exponential smoothing It could mitigate the previous problem, it is not an average

¤ The prediction of the future depends mostly on

¤ the most recent observation
¤ the error for the latest forecast.

¤ α smoothing constant: Denotes the importance of the past period

¤ A the actual sales
¤ F the demand forecast period
We are forecasting future sales based on 2 factors:
1. Comparison of past sales that we collect (A)
¤ t the current period. 2. Comparing the real past sales to the forecasted sales for the
previous period.

Ft = aAt -1 + (1 - a ) Ft -1
This factor considers the This factor considers the
real SALES of the FORECAST of the
previous period previous period
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a = Weight to the last period, how could increase or decrease the demand based on the previous
period.

0<a<1

• a = 0 : Situation of very stable market

◦F = F(t-1)
• a=1
◦F = A(t-1)

Possibility be more precise respect to the Moving Average (MM), doing some test and trying to nd
the right smoothing constant. But you have to be familiar with the formular and you have to test the
di erent value of the smoothing constant.

MM is more simple to use, not time consuming

2. Quantitative methods
§ Exponential smoothing

The choose of weights:

¤ α expresses
¤ The weight assigned to the latest information
¤ how much forecast will react to differences between A and F.
¤ α low (close to 0): there is little reaction to differences.
¤ α high (close to 1): there is a lot of reaction to differences.

¤ Determines responsiveness to changes in demand forecasts

0<α<1
¤ α close to 0 è forecast is not sensitive to changes but stable.
¤ α close to 1 è reactive forecast

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 2. Quantitative methods
§ Exponential Smoothing

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 2. Quantitative methods
Wee Actual Demand
k sales forecast §Exponential smoothing
t A F
α= 0,2
20 63,3 60,00
21 62,5 60,66
22 67,8 60,03
23
24
66,0
67,2
61,58
62,83
Ft = aAt -1 + (1 - a ) Ft -1
25 69,9 63,70
26 65,6 64,94
27 71,1 65,07
28 68,8 66,28
29 68,4 66,78 F35 = 0,2*(A34 ) + (1- α )* F34
30 70,3 67,12
31 72,5 67,75
32 66,7 68,70
= 0,2* 67,0 + (1-0,2)*68,30
33 68,3 68,30 = 68,04
34 67,0 68,30
35 68,04

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 2. Quantitative methods
PREVISIONI CON MODELLI CAUSALI
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72

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Domanda

68

66

64 MM has some little peaks, instead the yellow

line is not replying the peaks (but MM has a
lot of problems).
62 In this case the best solution is the one with a
= 0,6 (it’s the closer to the actual past sales) Tempo
L
60
20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35

Domanda effettiva
Actual sales A A α = 0,2 0,4 0,6 MM

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 2. Quantitative methods
§ Casual relationship: linear regression Statistical method, More complex

¤ Used to understand complicated relations among variables

Slope= b
Y= a + b*X

Y intercept = a dependent variable independent variable

Forecasts comparing to di erent factors.

¤ is based on
1. Fitting a straight line to data

2. Explaining the change in the variable y through changes

in other variables x.

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 2. Quantitative methods
§ Casual relationship
Least Squares Method of Linear Regression

¤ is based on minimizing the distance between the regression

line and points

ε ε
ε
Ice cream sales

y is the observed value

εi = yi - Yi Y is the predicted value
Temperature
 Selecting the right approach to forecast
¤ Goal: minimizing the sum of errors of forecasts

Step 0: Step 2:
Analysis of past data Definition of forecasting
(trends, seasonality) techniques

Iteration
Step 4:
Simulation of forecasting

Step 3:
Identification of
forecasting parameters Step 5:
Analysis of errors
(weight, smoothing
constant)

Step 6:
Final demand forecast
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 Selecting the right approach to forecast
Example

• calculate demand forecasts for the period 10, 11 and 12.

Use the method of moving average (3 periods) and
Exponential Smoothing (smoothing coefficient = 0.1)

Forecasted demanf F
week Actual demand A
SMA 3 ES α =0,1
6 11
7 10
8 15
9 12 3
10 16
11 18
12 15

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 Selecting the right approach to forecast
Example

week Actual demand A Forecasted demand F

SMA 3 ES α =0,1
6 11
7 10
8 15
9 12 3
10 16 12,33
11 18 14,33
12 15 15,33

Simple moving average

n=3 F10= (A9 +A8 + A7 )/3 = (12+15+10)/3 = 12,33
j =t -n
F11= (A10 +A9 + A8 )/3 = (16+12+15)/3 = 14,33
åA j

Ft =
j = t -1
F12= (A11 +A10 + A9 )/3 = (18+16+12)/3 = 15,33
n
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 Selecting the right approach to forecast
Example

week Actual demand A Forecasted demand F

SMA 3 ES α =0,1
6 11
7 10
8 15
9 12 3
10 16 12,33 3,90
11 18 14,33 5,11
12 15 15,33 6,40

EXPONENTIAL SMOOTHING F10 = 0,1*(A9)+(1- α)*F9= 0,1*12+(1-0,1)*3 = 3,9

α =0,1
F11= 0,1*(A10)+(1- α)*F10= 0,1*16+(1-0,1)*3,9 = 5,11
Ft = aAt -1 + (1 - a )Ft -1
F12 = 0,1*(A11)+(1- α)*F11= 0,1*18+(1-0,1)*5,11 = 6,4
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 Selecting the right approach to forecast
Example

Actual demand Forecasted demand F Errors

week
A
SMA 3 ES α =0,1 SMA 3 ES α =0,1
6 11
7 10
8 15
9 12 3
10 16 12,33 3,90 3.67 12.10
11 18 14,33 5,11 3.67 12.89
12 15 15,33 6,40 0.33 8.60
7.67 33.59

Errors= |A- F| ∑ errors

With a = 0,1; a=0,2;…;regression;MSA

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 Selecting the right approach to forecast
Example

wee Forecasted Errors MFE MAD TS

k Actual demand F
demand
A SMA ES α SMA ES α SMA ES α SMA ES α SMA ES α
3 =0,1 3 =0,1 3 =0,1 3 =0,1 3 =0,1

6 11
7 10
8 15
9 12 3
10 16 12,33 3,90 3.67 12.10 3,67 12,1 3,67 12,1
11 18 14,33 5,11 3.67 12.89 3,67 12,89 3,67 12,89
12 15 15,33 6,40 0.33 8.60 -0,33 8,93 0,33 8,6
7.67 33.59 2,34 11,31 2,56 11,20 2,74 3,03

Use IN THIS CASE SMA 3

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