DEMAND FORECASTING

Forecasting: is the process of estimating

future demand in terms of quantity, timing,
quality, and location for desired products
and services

Forecasting: is the art and science of

predicting future events

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 IMPLICATION OF FORECAST

• Correct forecast leads to huge amount of

profit
• Whereas incorrect forecast leads to huge
losses

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 WHY DO DEMAND FORECAST?

• A key element of business decision making

• Strongly influences an organization’s

strategy regarding its future direction,
priorities and activities

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 NEED FOR FORECASTING
• LEAD TIME: lead time requires that
decisions be made in advance of uncertain
events
• Forecasting is important for all strategic
and planning decisions in supply chain
• Forecast of product demand, materials,
labor, financing are important inputs for
scheduling, resource acquisition, and
determining resource requirement
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 FORECASTING: A DECISION MAKING
PROCESS
• The essential problem of management is to
transform a company’s strategic objectives into
decisions and actions. Forecasting plays a very
important role for a company to identify it is
strategic future direction

• The constantly increasing volatility of business

dynamics emphasizes the critical importance of
forecasting in decision making

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FORECASTING HORIZONS

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THE FORECASTING SYSTEM

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 THE FORECASTING SYSTEM
• The Inputs are basically data, either:
- Internal data (Historical, Subjective, or Survey)
- Environmental data (Economic, Sociopolitical or
Technological)

• The Outputs are:

- Estimate of expected demand, and
- Forecast error

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 THE FORECASTING SYSTEM
• The Decisions to make include:
- Selection of data type, and
- Selection of forecast method

• The Constraints are:

- Data availability/type
- Time for forecast
- Expertise available
- Funds available for the exercise
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 FORECASTING METHODS

• The are two main categories of forecasting

methods; qualitative and quantitative
• Qualitative methods: are subjective in nature and
they rely on human judgment and opinion

• Quantitative methods: are objective in nature and

use mathematical models or simulations based on
historical demand or relationships between variables

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 FORECASTING METHODS

Qualitative methods:

•Analogies, historical comparison

• Survey techniques, and

•Delphi method
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 FORECASTING METHODS

Quantitative methods:

•Time series Methods (Average, moving

average, and exponential smoothing)

•Causal methods (Linear regression and

multiple regression)

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 FORECASTING METHODS
Qualitative or Subjective methods:
•Rely primarily on the experience and opinions of
people inside or outside the organization
•Employed when there is little time or when there
is no past relevant data
•For example when introducing new product. It
represents and activity with limited or non-existent
historical data
•One of the major applications is in long range
strategic planning

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 FORECASTING METHODS
Subjective-Estimates Survey:
•Forecast draws from the experience,
knowledge and ‘sixth sense’ of their own
people
•Individual salesmen are asked to submit
estimates of anticipated demand
•These estimates are pooled at the regional
level and adjusted to account for regional
economic, demographics and other factors
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 FORECASTING METHODS
Subjective-Estimates Survey Cont…:
•The revised regional estimates are combined at
headquarters with further adjustments related to
the economy, international trade, competitors, and
other developments

•Such an exercise can produce a forecast rather

quickly, at low cost, and without any need of
special expertise

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FORECASTING METHODS

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 FORECASTING METHODS
The Delphi Method:

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 FORECASTING METHODS

The Delphi Method:

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 FORECASTING METHODS
The Delphi Method Cont…:
•The cost of this method is medium to high

•It was originally applied to technological

forecasting, used for a variety of long-term
prediction such as development of new products,
acquiring new capacity, penetrating new markets
and making other strategic decisions for which
historical data is insufficient

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 FORECASTING METHODS

Quantitative methods:

•Time series Methods (Average, moving

average, and exponential smoothing)

•Causal methods (Linear regression and

multiple regression)

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 FORECASTING METHODS

Quantitative methods:

•This method is applied where we have

some product that is not new product.

•And previous data is available.

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 FORECASTING METHODS

Quantitative methods:

•However the data from previous years may

vary in different pattern

•These patterns are called Business Time

Series i.e. the variation of demand with time

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 FORECASTING METHODS

Business Time Series

•Business Time Series can show:
•Increasing trend
•Decreasing trend
•Seasonal variation
•Cyclic variation
•Erratic/random variation

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 FORECASTING METHODS

Business Time Series

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 FORECASTING METHODS

Business Time Series

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 FORECASTING METHODS

Business Time Series

•It helps us to see the trend component. On x-axis
we have time, and on y-axis we have the demand
data
•In the first case, there is a continuously
increasing trend in the demand over the last few
years
•Similarly, contrary to that in the second case
there is decreasing trend

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 FORECASTING METHODS
Business Time Series
•So the demand is decreasing over the last 5 to 10
years
•Thirdly there are seasonal variations
•Then there is a business cycle variation; in which
there is an increasing demand and then it
decreases. This is a business cycle that may be
correlated with the economic boom or the
economic depression. The cycle may continue for 5
to 10 years time

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 FORECASTING METHODS
Business Time Series
•For 5 years we may have economic boom. So,
the demand will be high, but may be after 5 years
there can be depression. So, the demand comes
down

•Basically the variation of the demand in the

previous years helps us to make a decision of what
will be the forecast for the next year

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 FORECASTING METHODS
Business Time Series
•The first graph for example the demand is
continuously increasing. So, we can expect that
the demand will be higher in the next year. So, for
last 5 years if we have an increasing trend we can
expect that the next year or 6th or even 7th year
forecast must be higher than the demand of the
fifth year. So we focus on the last 5 years data and
trying to forecast for the 6th and 7th year

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 FORECASTING METHODS
Business Time Series
•Similarly, if there is a seasonal variation we can
take into account the seasonal variation, and
include it in our time series model, and make a
forecast on season to season basis

•Usually it is done on quarter to quarter basis. So,

the whole year is divide into 4 quarter. And the
forecast is made on quarterly basis.

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 FORECASTING METHODS
Business Time Series
•Similarly there can be random or erratic behavior
of the data. Whenever there is random or erratic
behavior of the data, we can use a simple average
method for making a forecast

•We can average out the readings and use that

averaged value as the forecast

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 FORECASTING METHODS
Business Time Series
•Plotting the Business Time Series helps you to
see the variation in the data and thus select the
right method for forecasting. For example if there
is no trend we use the simple average method.
The average becomes the forecast for next period

•Looking at the data we can take a decision on

what method to use

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 FORECASTING METHODS

Quantitative methods:
•Time series Methods (Simple Average, moving
average, and exponential smoothing)
•Causal methods (Linear regression and multiple
regression)

•The quantitative methods are more objective and

formal and systematically reduce forecasting errors

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 FORECASTING METHODS

Quantitative methods:
•We usually use time series models or casual
methods of forecasting

•For example, in regression we can develop a

curve fitting equation and make use of that
equation for making a forecast

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 SIMPLE AVERAGE METHOD
• Simple Average Method is used when there is
random/erratic business time series

Methodology:
• All past/previous observations are considered

• All the past observations are treated equally

• All observations are given a weight of 1/n

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 SIMPLE AVERAGE METHOD
• The Simple Average Method uses the formula

Where F = Forecast, D = Demand; Ft+1 = Forecast for time t+1, Dt =

Demand for time t
• Forecast for time t+1 is the average of all n previous
observations or actual Demands

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 SIMPLE AVERAGE METHOD
Example
•A XYZ television supplier found the demand of
200 sets in July, 225 sets in August, and 245 sets
in September. Find the demand forecast for the
month of October using simple moving average
Solution
•For the simple average method we add the 3 and
divide it by 3

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 MOVING AVERAGE METHOD

• This method is divided into two: (1) Simple

Moving Average and (2) Weighted Moving
Average
Methodology for moving averages:
• Not all past/previous observations are
considered

• Only n past most recent observations are

considered

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 SIMPLE MOVING AVERAGE METHOD
Methodology for simple moving averages:
•Only n most recent observations are retained

•All the n past observations are treated equally and given

weights of 1/n

•Observations older n are not considered

•There is problem when 1000s of items are being forecast

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SIMPLE MOVING AVERAGE METHOD

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 SIMPLE MOVING AVERAGE METHOD
Simple moving average can be:
•2,3,4,5,6-point moving averages etc. Depending on the
value of n you are considering

•For 3-point/3-period moving average we consider the

last 3 observation while 4-period moving average we
consider the last 4 observations only

•You choose what period to take based on your interest

and available data

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 SIMPLE MOVING AVERAGE METHOD
• The Simple Moving Average Method uses the formula

Where F = Forecast, D = Demand; Ft+1 = Forecast for time t+1, Dt =

Demand for time t
• Forecast for time t+1 is the average of n most recent
observations or actual Demands

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 SIMPLE MOVING AVERAGE METHOD
Example
•A XYZ refrigerator supplier has experienced the
following demand for refrigerator during the past
five months.

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 SIMPLE MOVING AVERAGE METHOD
Example
•Find out the demand forecast for the month of
July using five-period moving average and 3-
period moving average using simple moving
average method.
Solution
•From:

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SIMPLE MOVING AVERAGE METHOD

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 SIMPLE MOVING AVERAGE METHOD

• For the 5-period moving average considering all

5 months and giving equal weight to all 5
months. We get the forecast as 39 units
• Whereas as for 3 period moving average if we
seek giving n equal to 3, we get 48.33, that is
49 units
• So, we can see the difference between the two
forecasts. One forecast is giving 39 units while
another is giving 49

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 SIMPLE MOVING AVERAGE METHOD

• So, basically if we give more weightage to the

previous year’s data or previous month data it will
be more realistic, and it will give us a better
forecast as compared to giving equal weightage to
all the data that is available to us

• Why? Because the Business Time Series trend if

you see is not random, there is an increasing trend
in the data. Implying that we can’t use simple
average method

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 SIMPLE MOVING AVERAGE METHOD

• The difference between simple average and the

moving average is that for the moving average
the data points considered keep moving forward
and older data points keep on being ignored
• For example, suppose now we want to forecast
for the month of August, we will make use of
the data points of July, June and May. If we
want to make a forecast for September, we will
use the actual demand data for August, July and
June

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 SIMPLE MOVING AVERAGE METHOD

• So the average will keep on moving, because we

are giving more weightage to the most recent 3
years, or so data only

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 WEIGHTED MOVING AVERAGE METHOD

Methodology for simple moving averages:

•Only n most recent observations are retained

•Observations older n are not considered

•The n past observations are NOT treated equally but are

given different weights

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 WEIGHTED MOVING AVERAGE METHOD

• The Weighted Moving Average Method uses the

formula

Where F = Forecast, WMA = Weighted Moving Average, D =

Demand; Ft+1 = Forecast for time t+1, Di = Demand for time i,
Ci = weight of period i

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 WEIGHTED MOVING AVERAGE METHOD

Example
•The manager of a restaurant wants to make a
decision on inventory and overall cost. He wants to
forecast the demand for some of the items based
on a weighted moving average method. For the
past three months he experienced the demand for
pizzas as follows:

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 WEIGHTED MOVING AVERAGE METHOD

Example Cont…
•Find the demand for January by assuming
suitable weights to the demand data.
Solution
•Lets assume weights as follows; C1 = 0.2, C2 =
0.3, and C3 = 0.5

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 WEIGHTED MOVING AVERAGE METHOD

Solution Cont…

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 WEIGHTED MOVING AVERAGE METHOD

Example 2
•The past data on the load of a lathe machine is
shown below:

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 WEIGHTED MOVING AVERAGE METHOD

Example 2
•Compute a weighted three months moving
average for December, where the weights are 0.5
for the latest month, 0.3 and 0.2 for the other
months respectively.
Solution

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EXPONENTIAL SMOOTHING METHOD

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 EXPONENTIAL SMOOTHING METHOD

• In exponential smoothing we will include all the

past observations
• The data which is most recent is given the
maximum weight and the weights reduce
exponentially for older observations

• The most recent data point is given a value of alpha

and the previous years or data points will be given
lesser weight and that distribution will be
exponential distribution

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 EXPONENTIAL SMOOTHING METHOD

• The value alpha is called a smoothing coefficient

• If the smoothing coefficient value alpha is 0.7,

year before it will be alpha into 1 minus alpha,
because, it is varying exponentially. Then for
year before that year it will be alpha into 1
minus alpha to the power 2

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EXPONENTIAL SMOOTHING METHOD

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EXPONENTIAL SMOOTHING METHOD

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 EXPONENTIAL SMOOTHING METHOD

Example
•One of the two wheeler manufacturing company
experienced irregular but increasing demand for
their products. The demand was found to be 420
bikes for June and 440 bikes for July. Using simple
average method demand forecast for June is found
to be 320 bikes. Use exponential smoothing with
smoothing coefficient of 0.7 to find the demand
forecast for August

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 EXPONENTIAL SMOOTHING METHOD

Solution:

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 FORECAST ERROR AND ACCURACY
• Many times we are required to calculate the
forecast error, and

• Also the accuracy of our forecast. For this we

usually make use of a term called MAD which is
Mean Absolute Deviation

• MAD is sum of the absolute value of forecast

error for all the periods divided by the number of
periods
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FORECAST ERROR AND ACCURACY

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