Section : Managing The Supply Chain

Chapter 13: Forecasting

Importance of Forecasting
Any management decision in any business
organization depends on forecasts for
the organizations products.
It is the basis of long-run planning,
budgetary planning and control.
-To plan new products, deciding about
advertisement strategy (Marketing)
-Process selection, capacity planning,
facility layout, production planning,
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inventory management (Production and
Operation)

Forecasts
A perfect forecast is usually
impossible.
There
are
many
random factors in any business
environment.
For that, it is very important to
establish the practice of continual
review of forecasts and to learn to
live with inaccurate forecasts.
A good strategy is to use two or
three methods and try to take a
2
common-sense view.

Demand Management
To coordinate and control all of the
sources of demand so that the productive
system can be used efficiently and the
product delivered on time.
There are two basic sources of demand:
Dependent demand and Independent
demand.
Dependent Demand- The demand for a
product or service caused by the demand
for other products.
Independent Demand- The demand for a
product or service does not depend 3on
any other product.

Demand Management: Active

and Passive Role To Influence
Demand
Active role - Apply pressure on sales
force, offer incentive to customer and
own employee, wage campaign to sell
products, cut price (to increase
demand); price increase, reduced
sales effort (to decrease demand)
Passive role - Accept what happens;
when running on full capacity, market
size is fixed and static, demand 4is
beyond control

Demand Management

Coordination is required to manage

demand.
Demands originate internally and
externally in the form new product
sales from marketing, repair parts
for previously sold products from
product service, restocking from the
factory warehouse, and supply items
for manufacturing.
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Types of Forecasting

Qualitative subjective and judgmental,

based on estimates and opinions.
Time Series Analysis data relating to
past demand can be used to predict
future demand; past data may include
trend,
seasonal,
and/or
cyclical
components.
Causal Forecasting assumes that
demand related to some underlying
factor in the environment.
Simulation allow the forecaster to run
through a range of assumptions about
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the condition of the forecast.

Components of Demand

Average demand for a product - The average

portion of the demand
Trend Increment or decrement of demand
with time
Seasonal element Increment or decrement of
demand in a particular season during a year
Cyclical element Increment or decrement of
demand
for
occurrences
like
political
elections,
war,
economic
condition,
sociological pressure, etc.
Autocorrelation - Denotes the persistence of
occurrence; the value expected at any point is
highly correlated with its own past values 7
Random Uncertain portion of the demand

Trend
Trend lines are the starting point and then
adjusted for seasonal, cyclical, and any other
expected event that may influence demand.
Linear trend Straight continuous relationship
S-curve Typical of product growth and
maturity cycle; changes in trend line are the
critical points
Asymptotic trend Highest demand growth at
the beginning but then tapers off; this can
happen when a firm enters an existing market
with the objective of saturating and capturing
a large share of the market
8
Exponential trend For products with explosive
growth; demand will continue to increase

Trend (Continued)
A widely used forecasting method plots
data and then searches for the standard
distribution that fits best.
The attractiveness of this method is that
because the mathematics for the curve are
known, solving for future time periods is
easy.
When data does not seem to fit any of the
standard type, effective forecast can be
9
obtained by plotting data.

Qualitative Techniques
Grass Roots

Builds the forecasts by adding

successively from the bottom
The person closest to the end user
knows its future needs best. In many
instances its a valid assumption.
Forecast at the bottom level are
summed and given to the next level.
This continues up to top level.
10

Market Research
Firms specializing in market research
conduct forecasting survey.
It is mostly for product research (new
product ideas, likes and dislikes about
existing product, preference about
competitive products, etc.)
Data collection methods are primarily
surveys and interviews.
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Panel Consensus
The idea that two heads are better than
one is extrapolated to the idea that a
panel of people from a variety of positions
can produce a more reliable forecast.
Forecasts are developed through open
meetings with free exchange of ideas from
all levels of management and individual.
A concern is that lower levels employees
might be intimidated by higher level
employees.
When forecasting are at a broader and
higher level (introducing a new product
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line, strategic product decisions), the
term executive judgment is used.

Historical Analogy

In developing forecast for a new

product, demand for existing products
or generic products can be used as
model.

For example, demand for DVD players

are somewhat related to demand for
DVDs.

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Delphi Method

Similar to panel consensus but the

identities
of
the
individuals
attending
the
study
are
concealed.
No intimidation by the higher level
of management.
Everybodys opinion has the same
weight.
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Step-by-Step Procedure

Choose the expert to participate. There

should be a variety of knowledgeable
person in different areas.
Through a questionnaire (or E-mail), obtain
forecasts from all participants.
Summarize the results and redistribute
them to the participants along with
appropriate new questions.
Summarize again, refining forecasts and
conditions,
and
again
develop
new
questions.
Repeat the previous step if necessary.
15
Distribute
the
final
results
to
all
participants.

Quantitative Techniques
Time Series Analysis
Time series forecasting models try to
predict the future based on past
data.
-Sales figures collected for the last
twelve weeks can be used to predict
the demand in the thirteenth week.
Forecasting can be done for shortterm (under three months), mediumterm (three months to two years),
and long-term (more than two
16
years).

Time Series Analysis (Continued)

Choosing
a
forecasting
model
depends on
Time horizon to forecast
Data availability
Accuracy required
Size of forecasting period
Availability of qualified personnel
Degree of flexibility (response time
to change in demand)
of the
organization
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Simple Moving Average

It is used when demand for a product is
neither growing or declining rapidly.
Forecast for the next period is the
average of the past n periods.
The longer the moving average period,
the greater the random elements are
smoothed.
-But, if there is a trend in the data, the
moving average has the adverse
characteristic of lagging the trend.
Data availability and storing is crucial
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in using moving average method.

Weighted Moving Average

A weighted moving average allows any
weights to be placed on each data,
providing, of course, that the sum of all
weights equals 1.
Ft= w1 At-1+ w2 At-2+ w3 At-3++ wn At-n
Choosing Weights:
-Experience and trial and error are the
simplest ways.
-Most recent past values might get the
highest weight.
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-If the data has seasonal influence, weights
should be established accordingly.

Exponential Smoothing Technique

Most recent occurrences are more indicative of
the future than those in the more distant past.
In exponential smoothing, each increment in the
past is decreased by (1-), where is the
smoothing constant.
Advantages:
-Exponential models are surprisingly accurate.
-Formulating an exponential model is relatively
easy.
-The user can understand how the model works.
-Little computation is required to use the model.
-Computer
storage
requirements
are
small
because of the limited use of historical data.
-Test for accuracy as to how well the model 20is
performing are easy to compute.

Exponential
(Continued)

Smoothing

Technique

Three pieces of data are needed: most recent

forecast, actual demand that occurred for that
forecast, and a smoothing constant ().
Ft = Ft-1 + (At-1 Ft-1)
determines the level of smoothing and the
speed of reaction to differences between
forecast and actual performance.
is determined both by the nature of the
product and by the management sense of
what constitutes a good response.
-For a standard item with relatively stable
demand, reaction rate will be small.
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-If the product is experiencing growth, the
reaction rate will be higher.

Choosing The Smoothing Constant

Single exponential smoothing has the
shortcoming of lagging changes in
demand.
The higher the values of , the more
closely the forecast follows the
actual.
To more closely track actual demand, a
trend factor may be added.
FITt = Ft +Tt
Ft = FITt-1 +(At-1- FITt-1)
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Tt = Tt-1 +(At-1- FITt-1)

Example
Exponential smoothed forecast for
the month of September was 100
units. Trend effect for September was
10 units. But, actual demand in
September turned out to be 115.
Calculate forecast including trend for
October. The values of and are
0.20 and 0.30 respectively.
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Adaptive Forecasting

Two or more predetermined values of The

amount of error between the forecast and
the actual demand is measured. If the error
is large, large value of (0.8) is used; if the
error is small, small value of (0.2) is used.

Compute values for A tracking

computes whether the forecast is keeping
pace with genuine upward or downward
changes in demand. The tracking is defined
as the exponentially smoothed actual error
divided by the exponentially smoothed
absolute error. It can range from 0 to 1.
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Forecast Errors
The difference the forecast value and
what actually occurred. If the error
is within confidence limit, this is
not really an error.
Demand for a product is generated
through the interaction of a number
of factors too complex to describe
accurately in a model. Therefore, all
forecasts certainly contain some
error.
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Sources of Errors
One source is projecting past trends into
future.
-In regression analysis, it is common to attach
a confidence band to the regression line to
reduce the unexplained error. The error may
not be defined correctly by the projected
confidence band. As confidence interval is
based on past data, it may not provide same
confidence for the future value.
-Error can be classified as bias or random.
-Bias error occurs when a consistent mistake
is made. Random errors cannot be explained
by the forecasting model.
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Measurement of Error
Mean absolute deviation
average absolute error.

(MAD)

The

(At Ft)

MAD =

Tracking signal (TS) A measurement that

indicates whether the forecast average is
keeping pace with any genuine upward or
downward changes in demand. It is the
number of MAD that the forecast value is
above or below the occurrence.
RSFE

TS =

MAD

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Measurement
(Continued)

of

Error

Acceptable limits for the tracking

signal depend on the size of the
demand
being
forecast
(highvolume
or
high-revenue
items
should be monitored frequently)
and the amount of personal time
available.
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Linear Regression Analysis

Regression can be defined as a functional
relationship
between
two
or
more
correlated variables. The relationship is
usually developed from observed data.
Linear regression refers to the special
class of regression where the relationship
between variables forms a straight line.
Y = a + bX
X= Independent variable, Y= Dependent
variable,
a= Y-axis intercept, b= Slope

29

Advantages and Disadvantages

-Linear regression is useful for longterm
forecasting
of
major
occurrences and aggregate planning.
It would be very useful to forecast
demands for product families.
- The major restriction is that past
data and future projections are
assumed to fall about a straight line.

30

Linear Regression Model

Y = a + bX
a = y - bxx
b=

xy nxx.y
x2-nxx2

31

Example
A firms sales for a product during the last
12 quarters of the past 3 years were as
follows:

Quarter

Sales

Quarter Sales Quarter

Sales

600

2400

3800

1550

3100

10

4500

1500

2600

11

4000

1500

2900

12

4900

The firm wants to forecast sales for each

quarter for the next year using linear
32
regression technique.

Example
Effect

Trend

and

Seasonal

A firms sales for a product during the last

8 quarters
pastSales
2 years were as
Quarter of
Salesthe
Quarter
follows:
I-2011
300
I-2012
520

II-2011

200

II-2012

420

III-2011

220

III-2012

400

IV-2011

530

IV-2012

700

The firm wants to forecast sales for each

33
quarter for the next year.