Supply Chain Management

DEMAND FORECASTING
DEMAND and Core Components of Demand slide 3-6
DEMAND PLANNING 7
Importance of Demand 8
Sources of demand variability 9
Forecasting and Principle of Forecasting 10-13
DEMAND and Core Components of 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.

3
Core Components of Demand
Trend
componen
t
Seasonal peaks
Demand for product or service

Actual
deman
d

Average
demand
Rando over four
m years
| variatio| |
| n
1 2 3 Figure 4.1
4
Year
 Core Components of Demand
 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.

5
Core Components of Demand.. cont
 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.

6
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.

7
 Importance of Demand :
 If production outstrips demand, you
suffer financial losses and perhaps go
bankrupt.
 If order exceeds supply, your
frustrated customers may go to your
competitors.

8
Sources of demand variability
 Competition.
 Seasonality
 Life cycle trends
 External factors.
 Promotions.
 Disasters

9
 1- What is Forecasting?

??
• Process of
predicting a
future event
 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.
The art and science of making projections about what future
demand and conditions will be.
The basis for all strategic and planning decisions in a supply chain.
Examples are:
Production: capacity, scheduling, inventory, aggregate planning
Marketing: sales force allocation, promotions, new production
introduction
Finance: plant/equipment investment, budgetary planning
Personnel: workforce planning, hiring, layoffs
All of these decisions are interrelated
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.

12
 ELEMENTS OF A GOOD FORECAST

The forecast should be Timely

The forecast should be Accurate
The forecast should be Reliable
The forecast should be expressed in Meaningful units
The forecast should be In writing
The forecasting technique should be Simple to understand and use
The forecast should be Cost-effective
 2- The Strategic Importance of Forecasting

Why is forecasting important?

The Strategic Importance of
Forecasting is valuable to businesses
Forecasting
because it gives the ability to make
 Human Resources
informed business decisions and
 Capacity
develop data-driven strategies. Financial
 Supply Chain Management
and operational decisions are made based
on current market conditions and
What is forecasting in strategic
predictions on how the future looks
management?
What is the importance of forecasting in
Forecasting is a technique that uses
production?
historical data as inputs to make
Production Forecasting is an important input
informed estimates that are predictive
into the decision-making process and
in determining the direction of future
investment scenario evaluation, which are
trends. Businesses utilize forecasting to
crucial for an upstream organization. The
determine how to allocate their budgets
production forecast flows through the central
or plan for anticipated expenses for an
nervous system of an organization and helps to
upcoming period of time.
identify opportunities and decide on the best
way forward
3-The 7 STEPS IN THE FORECASTING PROCESS

1. Determine the purpose of the forecast

2. Select the items to be forecasted.
3. Establish a time horizon
4. Obtain, clean, and analyze appropriate data
5. Select a forecasting technique.
6. Make the forecast
7. Monitor the forecast
Forecasting (continued)
 Independent Demand
 Dependant Demand.

16
 4-Forecasting Approaches
Qualitative Qualitative
Used when situation is ‘stable’
Used when situation is vague
and historical data exist
and little data exist
Existing products
New products
Current technology
New technology
Involves mathematical
Involves intuition, experience
techniques
4-Forecasting Approaches
Forecasting Approaches

Overview of Qualitative
Methods Qualitative Quantitative

 Jury of Executive Opinions

Jury of
 Pool opinions of high-level experts, Time Series Associative
Executive
Models Models
Opinions
sometimes augment by statistical models
 Delphi method
Linear
Delphi method Naive approach
 Panel of experts, queried iteratively regression

 Sales force composite

Sales force Simple Moving
 Estimates from individual salespersons are composite averages
reviewed for reasonableness, then
aggregated Weighted
Consumer
Moving
 Consumer Market Survey Market Survey
Averages
 Ask the Customer
Exponential
smoothing
Forecasting - Quantitative -Time Series Forecasting

 Set of evenly spaced numerical data

 Obtained by observing response variable at
regular time periods
 Forecast based only on past values, no other
variables important
 Assumes that factors influencing past and
present will continue influence in future
Forecasting-Quantitative-Time Series-
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
20
Forecasting-Quantitative-Time Series-
2- 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

21
Simple Moving Average - Example
Week Demand 3 Month Moving Average
1 350

2 397 348  366  381

Forecast8 
3
3 375

4 342
Forecast8  365
5 381
5 Month Moving Average
6 366

7 348 348  366  381  342  375

Forecast8 
5
22
Forecasting-Quantitative-Time Series-
3- 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

23
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
Fmay = 0.10*350 + 0.3* 397 + 0.25 * 375 +
4 342 0.35 * 342 = 367.55
Other approach…..
5 381
4 Period Weighted Moving Average
6 366 Forecast8 [(1)(342) (2)(381) (3)(366) (4)(348)]/
10
7 348 Forecast8  359.4

24
Moving Average Method Weighted Moving Average

 MA is a series of arithmetic means

 Used if little or no trend
 Used often for smoothing
 Provides overall impression of
data over time

Moving average = ∑ demand in previous n periods

n
Forecasting-Quantitative-Time Series- 4- Exponential Smoothing
 It is a more sophisticated versionof 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 18
 Ffeb = Fjan + α (ADjan – Fjan)
 4-Exponential Smoothing - Example
Period
Actual Forecasted Using the given data, calculate
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)
(473. 1)
10 45 48.43

11 40 47.31 Forecast12  44.91

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

iod’s demand – Last period’s Last period’s forecast
ecast’s) 19
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 - ForecastedDemand

Number of Periods

29
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  5  3.39
30
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

MSE   Actual Demand -

Number of Periods
ForecastedDemand 2

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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  5  25.91
32
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 - ForecastedDemand

Number of Periods

33
 SEASONAL INDEX
Deseasonalized Avg
Monthly Seasonal
Sales (Demand) Seasonal Avg Demand Index
Demand
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
 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 2005 Average Average Seasonal
Month 2006 2007 2005-2007 Monthly Index
Jan 80 85 90 94 0.957
Feb 105
70 85 85 80 94
Mar 80 93 average
82 85 monthly demand
2005-2007 94
Seasonal90index95= 115 average monthly
Apr 100 demand94
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 2005 Average Average Seasonal
Month 2006 2007 2005-2007 Monthly Index
Jan 80 85 105 90 0.957
Feb 94 Forecast for 0.851
Mar 70 85 2008
85 80 0.904
Apr 94Expected annual demand = 1,200 1.064
May 80 93 82 85 1.309
94
Jun 1,200 1.223
Jul
90 Jan
95 115 x100
.957 = 96 1.117
94 12
Aug 1.064
113 125 131 1,200 123 94
Sept Feb 120 x .851 = 85 94 0.957
110 115 12 115
Oct 0.851
100 102 113 105 94
Nov 0.851
88 102 110 100
Dec 82
94 78 80 80 94 0.851
85 90 95 90
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

9702
9616 9659
9573 9724 9766
9,600 – 9530 9680
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
9949
10,000 – 9911
9764 9724
Inpatient Days

9,800 – 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