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Chapter 7: Demand Forecasting in a Supply Chain
Exercise Solutions:
Problem 7-1:
We utilize a static model with level, trend, and seasonality components to evaluate the
forecasts for year 6. Initially, we deseasonalize the demand and utilize regression in
estimating the trend and level components. We then estimate the seasonal factors for each
period and evaluate forecasts. Spreadsheet Exercise 7-1 provides the solution to this
problem.
The deseasonalized regression model is (see Cells T52 and T53 for values of
deseasonalized level at period 0 and trend at period 0):
_
D t = 5997.261 + 70.245 t
The seasonal indices for each of the 12 months are (see Cells T59-70):
Month S.I
JAN 0.427
FEB 0.475
MAR 0.463
APR 0.398
MAY 0.621
JUN 0.834
JUL 0.853
AUG 1.151
SEP 1.733
OCT 1.778
NOV 2.124
DEC 1.095
For example, the forecast for January of Year 6 is obtained by the following calculation
(Cell H81):
Problem 7-2:
Worksheet Exercise 7-2 compares the four-week moving average approach with the
exponential smoothing model (alpha = 0.1). In a four-week moving average model, the
weight assigned to the most recent data is 0.25 whereas in the case of the exponential
smoothing model the weight assigned is 0.1. The following graphs depict the results from
the two models.
130
125
120
115
Unit Demand
110
105
100
95
90
85
80
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16
Periods
115
110
105
100
95
90
85
80
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16
Periods
For this specific problem, it is evident that the moving average model is more responsive
than the exponential smoothing approach due the difference in weights allocation (0.25
and 0.1). The two methods have very similar errors (the errors for Moving Average are
shown in Cells G14:N26; the errors for Exponential Smoothing are shown in Cells
G40:N53). Using MAD as a measure for forecast accuracy, it can be concluded that the
moving average model (MAD = 9) is slightly more accurate than the exponential
smoothing model (MAD = 10) in evaluating forecasts.
Problem 7-3:
The simple exponential smoothing model only considers the level component and does
not include a trend component in the analysis. However, Holt’s model allows for the
incorporation of the trend component into the analysis. Worksheet Exercise 7-3 provides
the results of the two approaches.
The forecast and errors using simple exponential smoothing (alpha = 0.1) are as shown
below:
Given the obvious trend in the data, it is not surprising in the analysis that Holt’s model
(alpha = 0.1, beta = 0.1, MAD = 8) is a better approach than the simple exponential
smoothing model (alpha = 0.1, MAD = 21).
Worksheet Exercise 7-4 evaluates demand forecasts for the ABC Corporation using
moving average (see sheet MovingAverage), simple exponential smoothing (see sheet
ExponentialSmoothing), Holt’s model (see sheet Holt’sModel), and Winter’s model (see
sheet Winter’sModel). Note that solver is utilized for simple exponential smoothing,
Holt’s and Winter’s models in determining the optimal values for the smoothing
constants by minimizing the MAD subject to the constraint that the smoothing constant
values are < 1. The forecasts for Year 6 using the various methods are as in the Table
below:
Method MAD
Moving Average 3,590
Simple Exponential Smoothing 3,004
Holt’s Model 2,961
Winter’s Model 1,028
It is evident that Winter’s model is preferable in this case with the lowest MAD value,
that is, lowest forecast error. It is also important to note that Winter’s model allows for
the incorporation of level, trend, and seasonality, which are evident in the demand data
for this case.
Worksheet Exercise 7-5 compares the two exponential smoothing forecasts with an alpha
of 0.1 and alpha of 0.9.
α = 0.1
α = 0.9
While at first glance that the alpha of 0.9 is a better tracker of the forecast, a careful
review indicates that the alpha of 0.9 model is essentially using the last period demand to
predict next period demand. As a result, during unstable times (periods 4–10) it has large
errors. In contrast, the method with alpha of 0.1 is not so reactive to recent changes and
provides a more stable forecast where errors are never very large. This difference really
shows up in the forecasts from period 13 onwards. The method with alpha of 0.9 behaves
as though demand has permanently dropped in periods 11 and 12. In contrast, the method
with alpha of 0.1 behaves as though the drop in periods 11 and 12 is part of natural
variation. This where forecast becomes as much art as science. An experienced manager
will be in a position to decide which of the two methods is more reflective of the current
reality.
Worksheet Exercise 7-6 looks at the forecast for A&D Electronics and compares the
results of simple exponential smoothing model with the Holt’s model. In looking at the
results of these two models, it is evident that the Holt’s model is a better forecasting
model. A plot of sales over the 12 periods indicates a clear increasing trend, making
Holt’s model the appropriate choice.
Worksheet Exercise 7-7 reexamines the A&D Electronics data with the Holt’s model
being run with the original alpha at 0.05 and beta at 0.1 and a revised Holt’s with an
alpha and beta both of 0.5.
Observe that increasing the values of α and β results in a more volatile forecast that has
larger errors. The smoothing constants α = 0.05 and β = 0.1 are preferred because they
result in lower errors and a less volatile forecast.
Worksheet 7-8 compares the five-week moving average approach with the exponential
smoothing model (alpha = 0.1). The results are as shown below:
Given a lower MAD and MAPE, the exponential smoothing method seems to do a little
better.
Worksheet 7-9 contains the results of the analysis. The first step is to perform a
deseasonalized analysis to estimate the initial value of level (for period 0), trend (for
period 0), and seasonal factors (for periods 1–4). Our initial estimates (see worksheet
Values) are obtained to be:
L0 = 921.54; T0 =91.24; S1 = 0.50; S2 = 0.79; S3 = 1.21; S4 = 1.50.
Using these estimates, Winter’s model provides the following forecasts and errors (see
worksheet Values):
The values of α, β, and γ that minimize MAD and the associated forecasts are obtained on
worksheet Values (optimal MAD). The optimization limits all smoothing constants to be
between 0 and 0.9.
Observe that optimizing the smoothing constants lowers the MAD to 27 (compared to 31).
Observe that optimizing the smoothing constants lowers the MSE to 1161 (compared to
1466).
Worksheet 7-10 contains the results of the analysis. The first step is to perform a
deseasonalized analysis to estimate the initial value of level (for period 0), trend (for
period 0), and seasonal factors (for periods 1–4). Our initial estimates (see worksheet
Values) are obtained to be:
L0 = 1985.68; T0 = 541.43; S1 = 0.94; S2 = 0.45; S3 = 1.17; S4 = 1.46.
Using these estimates, Winter’s model provides the following forecasts and errors (see
worksheet Values):
The values of α, β, and γ that minimize MAD and the associated forecasts are obtained on
worksheet Values (optimal MAD). The optimization limits all smoothing constants to be
between 0 and 0.9.
Observe that optimizing the smoothing constants lowers the MAD to 515 (compared to
592).
Observe that optimizing the smoothing constants lowers the MSE to 500,481 (compared
to 706,550).
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