CTL.

SC1x -Supply Chain & Logistics Fundamentals

Introduction to
Demand Planning
& Forecasting

MIT Center for

Transportation & Logistics
Demand Process – Three Key Questions
Demand Planning
n  Product & Packaging
What should we do to shape and n  Promotions
create demand for our product? n  Pricing
n  Place

Demand Forecasting
What should we expect demand to n  Strategic, Tactical, Operational
be given the demand plan in place? n  Considers internal & external factors
n  Baseline, unbiased, & unconstrained

Demand Management
n  Balances demand & supply
How do we prepare for and act n  Sales & Operations Planning (S&OP)
on demand when it materializes? n  Bridges both sides of a firm

Material adapted from Lapide, L. (2006) Course Notes, ESD.260 Logistics Systems.

CTL.SC1x - Supply Chain and Logistics Fundamentals Lesson: Demand Forecasting Basics 2
 Forecasting Levels
Level Horizon Purposes
•  Business Planning
Strategic Year/Years •  Capacity Planning
•  Investment Strategies

•  Brand Plans
Quarterly •  Budgeting
•  Sales Planning
Tactical •  Manpower Planning

•  Short-term Capacity Planning

Months/Weeks •  Master Planning
•  Inventory Planning

Operational Days/Hours
•  Transportation Planning
•  Production Planning
•  Inventory Deployment
Material adapted from Lapide, L. (2006) Course Notes, ESD.260 Logistics Systems.

CTL.SC1x - Supply Chain and Logistics Fundamentals Lesson: Demand Forecasting Basics 3
 Agenda

•  Forecasting Truisms
•  Subjective vs. Objective Approaches
•  Forecast Quality
•  Forecasting Metrics

CTL.SC1x - Supply Chain and Logistics Fundamentals Lesson: Demand Forecasting Basics
 Forecasting Truisms 1:
Forecasts are always wrong

CTL.SC1x - Supply Chain and Logistics Fundamentals Lesson: Demand Forecasting Basics 5
 1. Forecasts are always wrong
Why?
n  Demand is essentially a continuous variable
n  Every estimate has an “error band”
n  Forecasts are highly disaggregated
w  Typically SKU-Location-Time forecasts
n  Things happen . . .
OK, so what can we do?
n  Don’t fixate on the point value
n  Use range forecasts
n  Capture error of forecasts
n  Use buffer capacity or stock

CTL.SC1x - Supply Chain and Logistics Fundamentals Lesson: Demand Forecasting Basics 6
 Forecasting Truisms 2:
Aggregated forecasts
are more accurate
CTL.SC1x - Supply Chain and Logistics Fundamentals Lesson: Demand Forecasting Basics 7
2. Aggregated forecasts are more accurate
•  Aggregation by SKU, Time, Location, etc.
•  Coefficient of Variation (CV)
n  Definition: Standard Deviation / Mean = σ/µ
n  Provides a relative measure of volatility or uncertainty
n  CV is non-negative and higher CV indicates higher volatility

Red: µ=100, σ=45, CV=0.45 Blue: µ=100, σ=1, CV=0.01

200
180
160
140
Daily Demand

120
100
80
60
40
20
-
2/26/11 3/28/11 4/27/11 5/27/11 6/26/11 7/26/11 8/25/11

CTL.SC1x - Supply Chain and Logistics Fundamentals Lesson: Demand Forecasting Basics 8
 Aggregating by SKU
•  Coffee Cups and Lids @ the Sandwich Shop
n  Large ~N(80, 30) CV = 0.38
n  Medium ~N(450, 210) CV = 0.47
n  Small ~N(250, 110) CV = 0.44

800

700

600

500
Small
400 Medium

300 Large

200

100

-
8/14/13 9/13/13 10/13/13 11/12/13 12/12/13 1/11/14 2/10/14 3/12/14 4/11/14 5/11/14 6/10/14

CTL.SC1x - Supply Chain and Logistics Fundamentals Lesson: Demand Forecasting Basics 9
 Aggregating by SKU
•  What if I design cups with a common lid?
Large ~N(80, 30) CV=0.38
•  Common Lid ~N(780, 239) CV = 0.31 Med. ~N(450, 210) CV=0.47
Small ~N(250, 110) CV=0.44
n  µ = (80 + 450 + 250) = 780 units/day
Lids ~N(780, 239) CV=0.31
n  σ = sqrt(302 + 2102 + 1102) = 239 units/day
1,600
1,400
1,200
1,000
800
600
400
200
-
8/14/13 9/13/13 10/13/13 11/12/13 12/12/13 1/11/14 2/10/14 3/12/14 4/11/14 5/11/14 6/10/14

Example of Modularity or Parts Commonality

•  Reduces the relative variability
•  Increases forecasting accuracy
•  Lowers safety stock requirements

CTL.SC1x - Supply Chain and Logistics Fundamentals Lesson: Demand Forecasting Basics 10
 •  Forecasts with longer time
Aggregating by Time buckets have better
forecast accuracy.
1,600 Daily Demand for Lids ~N(780, 239) CV=0.31 •  The time bucket used
1,200 should match the situation.
800

400

-
8/14/13 9/13/13 10/13/13 11/12/13 12/12/13 1/11/14 2/10/14 3/12/14 4/11/14 5/11/14 6/10/14

8,000
Weekly Demand for Lids ~N(5458, 632) CV=0.12
6,000

4,000

2,000

-
1 5 9 13 17 21 25 29 33 37 41 45 49

30,000 Monthly Demand for Lids ~N(21840, 1264) CV=0.06

25,000
20,000
15,000
10,000
5,000
-
1 2 3 4 5 6 7 8 9 10 11 12
CTL.SC1x - Supply Chain and Logistics Fundamentals Lesson: Demand Forecasting Basics 11
 CV reduces as we
Aggregating by Locations aggregate over SKUs,
time, or locations.
•  Suppose we have three sandwich shops
n  Weekly lid demand at each ~N(5458, 632) CV=0.12

~N(5458, 632) ~N(5458, 632) ~N(5458, 632)

~N(16374, 1095)

•  What if demand is pooled at a common Distribution Center?

n  Weekly lid demand at DC ~N(16374, 1095) CV=0.07

σ σ n σ CVind
CVind = CVagg = = =
µ µn µ n n
CTL.SC1x - Supply Chain and Logistics Fundamentals Lesson: Demand Forecasting Basics 12
 Forecasting Truisms 3:
Shorter horizon forecasts
are more accurate
CTL.SC1x - Supply Chain and Logistics Fundamentals Lesson: Demand Forecasting Basics 13
 3. Shorter horizon forecasts are
more accurate

21 22 23 24 1 2 3 4 5 6 7 8 9 10 11 12

CTL.SC1x - Supply Chain and Logistics Fundamentals Lesson: Demand Forecasting Basics 14
 3. Shorter horizon forecasts are
more accurate
•  Postponed final customization to
closer time of consumption
•  Risk pooling of component (e.g.,
ham) increases forecast accuracy.

21 22 23 24 1 2 3 4 5 6 7 8 9 10 11 12

CTL.SC1x - Supply Chain and Logistics Fundamentals Lesson: Demand Forecasting Basics 15
 Forecasting Truisms

•  Forecasts are always wrong

Use ranges & track forecast error
è
•  Aggregated forecasts are more accurate
è Risk pooling reduces CV
•  Shorter time horizon forecasts are more
accurate
è Postpone customization until as
late as possible

CTL.SC1x - Supply Chain and Logistics Fundamentals Lesson: Demand Forecasting Basics 16
 Subjective & Objective Approaches

CTL.SC1x - Supply Chain and Logistics Fundamentals Lesson: Demand Forecasting Basics 17
 Fundamental Forecasting Approaches
Subjective Objective
Judgmental Causal / Relational
n  Sales force surveys n  Econometric Models
n  Jury of experts n  Leading Indicators
n  Delphi techniques n  Input-Output Models

Experimental Time Series

n  Customer surveys n  “Black Box” Approach
n  Focus group sessions n  Past predicts the future
n  Test marketing n  Identify patterns

Often times, you will need to use a combination of approaches

CTL.SC1x - Supply Chain and Logistics Fundamentals Lesson: Demand Forecasting Basics
 Forecasting Quality

CTL.SC1x - Supply Chain and Logistics Fundamentals Lesson: Demand Forecasting Basics 19
 Cost of Forecasting vs Inaccuracy
ß Overly Naïve Models à ß Good Region à ß Excessive Causal Models à

Total Cost
Cost

Cost of Errors Cost of Forecasting

In Forecast

Forecast Accuracy
CTL.SC1x - Supply Chain and Logistics Fundamentals Lesson: Demand Forecasting Basics
How do we determine if a forecast is good?
•  What metrics should we use?
•  Example - Which is a better forecast?
n  Squares & triangles are different forecasts
n  Circles are actual values

1100

1000

900

time

CTL.SC1x - Supply Chain and Logistics Fundamentals Lesson: Demand Forecasting Basics
 Accuracy versus Bias
n  Accuracy - Closeness to actual observations
n  Bias - Persistent tendency to over or under predict

Accurate

Not Accurate

Biased Not Biased

CTL.SC1x - Supply Chain and Logistics Fundamentals Lesson: Demand Forecasting Basics
 Forecasting Metrics

CTL.SC1x - Supply Chain and Logistics Fundamentals Lesson: Demand Forecasting Basics 23
 Forecasting Metrics et = At – Ft

Mean Deviation n Mean Absolute n
(MD)
∑e t
Deviation (MAD) ∑e
t =1
t

MD = t =1 MAD =
n n
Mean Squared n
Root Mean
Error (MSE) 2 Squared n

∑e t Error (RMSE) e
∑t 2

t =1
MSE = t =1 RMSE =
n n

n
Mean Percent et Mean Absolute n et
Error (MPE) ∑A Percent Error (MAPE) ∑A
t=1
MPE = t=1 t MAPE = t

n n
Notation:
At = Actual value for obs. t et = Error for observation t
Ft = Forecasted value for obs. t n = Number of observations
CTL.SC1x - Supply Chain and Logistics Fundamentals Lesson: Demand Forecasting Basics
 Example: Forecasting Bagels
•  For the bagel forecast and actual values
shown below, find the:
n  Mean Absolute Deviation (MAD) n

n  Root Mean Square of Error (RMSE) ∑e

t =1
t
n  Mean Absolute Percent Error (MAPE) MAD =
n
Forecast Actual n
2
Monday e
∑t
50 43 t =1
Tuesday RMSE =
50 42 n
Wednesday 50 66
Thursday 50 38 n et
Friday 75 86 ∑A
t=1
MAPE = t
n
CTL.SC1x - Supply Chain and Logistics Fundamentals Lesson: Demand Forecasting Basics 25
 Example: Forecasting Bagels
•  Solution: 90

1.  Graph it. Forecast Actual

80
2.  Extend data table:
w  Error: et=At-Ft

Daily Bagel Demand

70

w  Abs[error] = |et|

60
w  Sqr[error] = e2
w  AbsPct[error] = |et/At| 50

3.  Sum and find means

40

Ft At et |et| e2 |et/At|
30
Monday 50 43 -7 7 49 16.3% Monday Tuesday Wednesday Thursday Friday

Tuesday 50 42 -8 8 64 19.0%
Wednesday 50 66 16 16 256 24.2%
MAD = 54/5 = 10.8
Thursday 50 38 -12 12 144 31.6% RMSE = sqrt(126.8) = 11.3
Friday 75 86 11 11 121 12.8% MAPE = 104%/5 = 21%
Sum 0 54 634 104%
Mean 0 10.8 126.8 21%
CTL.SC1x - Supply Chain and Logistics Fundamentals Lesson: Demand Forecasting Basics 26
 Key Points from Lesson

CTL.SC1x - Supply Chain and Logistics Fundamentals Lesson: Demand Forecasting Basics 27
 Key Points
•  Forecasting is a means not an end
•  Forecasting Truisms
n  Forecasts are always wrong
n  Aggregated forecasts are more accurate
n  Shorter horizon forecasts are more accurate
•  Subjective & Objective Approaches
n  Judgmental & experimental
n  Causal & time series
•  Forecasting metrics
n  Capture both bias & accuracy
n  MAD, RMSE, MAPE
CTL.SC1x - Supply Chain and Logistics Fundamentals Lesson: Demand Forecasting Basics
 CTL.SC1x -Supply Chain & Logistics Fundamentals

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