Heath and Jackson(1994)- MMFE

Pradipta Patra 12th April 2011

Introduction

Martingale Model of Forecast Evolution (MMFE)is a general probabilistic model for modeling the evolution of demand forecasts. In this paper MMFE has been used in a simulation study to analyze safety stock levels for a multi-product, multi-plant production distribution system.

Problem Description

1. Operating company is a national producer and distributor of consumer grocery goods. The study in this paper focussed on a product family consisting of ve product lines that dier primarily in package sizes. 2. The company has production plants in dierent regions of the country with a number of production lines of diering eciencies and capabilities. 3. The production plants feed a national distribution system with eight regional warehouses. Transhipment between warehouses is an option to x inventory imbalances. 4. Demand for the product family is seasonal with major selling season of 6 months and peak selling season of 3 months. 5. Due to sales promotion, one month exhibits signicantly higher demand than the adjacent months. Demand in month following the promotion month is negatively correlated with demand in promotion month. This is because major buyers buy items in large batches during the promotion month. 6. Demand is highly correlated along product lines and to a lesser extent across regions. 7. Forecasts are made by region, by month, by product line twelve months in advance. Forecast error is high, even on the eve of month of sale. 8. Production capacity is limited. Inventory is produced and stored three to four months ahead of major selling season. 9. Inventory is sold on a rst-in-rst-out(FIFO)basis. Product has a long shelflife. 10. Due to inventory created in advance during build up phase to major selling season, company must rent additional warehouse space at high cost. 11. Safety stock policy for the company for each region is dened as: region must have enough inventory to cover S months of forecast demand.

12. Performance attributes of the production-distribution system are cost and customer service. 13. Costs include production cost, transportation cost, inventory holding cost. Production cost is proportional to standard hours of production. Transportation cost is proportional to volume-miles. 14. Customer service is measured by weighted average of monthly ll rates across product lines and regions. 15. Objective is to nd an economical safety stock factor.

3
3.1

Model
Simulation Model

The forecasts for future demand are generated by a program called SIMFORECAST. The production and shipment decisions for the current period of simulation and planned production and shipment decisions for future period are generated by a linear programming model SIMLP. The production process was far too complex to build analytical models. So simulation model is used.

3.2

Martingale Model of Forecast Evolution

1. The predictions made in period s for demand of a product in period t is considered along with the change in prediction from period s 1 to s. If there are N products the change in prediction forms a N vector. Forecasting stops once actual demands are observed. There are two models that express the change in prediction: additive and multiplicative. 2. Additive Model: a. In additive model the change in prediction is simple dierence in prediction between period s 1 and period s. b. It is assumed that the amount of information available to make prediction grows as time increases. Predictions made are conditional expectations of the variables to be predicted given the available information. The successive predictions form a martingale. From these two assumptions it can be shown that expected change in prediction in a period is zero. It can also be shown that change in prediction in a period is uncorrelated with information available in previous period and uncorrelated

with change in predictions till previous period. c. It is assumed that the changes in prediction form stationary stochastic process. d. It is assumed that the changes in prediction are multivariate normal random vectors. e. From above assumptions b, c and d it can be concluded that the change in prediction vectors are independent, identically distributed, multivariate normal random vectors with mean zero. 3. Multiplicative Model: a. In multiplicative model the change in prediction is dierence in logarithm of prediction between period s 1 and period s. b. The change in prediction vectors are independent, identically distributed multivariate normal random vectors with mean of each coordinate equal to negative of one half of its variance. 4. Forecasts for the N products are not updated until time has advanced to within M periods of the period being forecast. 5. Thus we get a set of change in prediction vectors or curves. The idea is to generate new curves which have same variance-covariance structure as the data. So we estimate the variance-covariance structure (using the change in prediction vectors)and generate samples for use in the simulation. 6. Once we have characterized the change in prediction vectors by nding their mean and variance-covariance, they can be used for forecasting. 7. Since the change in prediction vectors are multivariate normals they can be generated by mean+ CZ where Z is a standard normal random vector and C is a matrix such that CC T is variance-covariance matrix. So using this we can simulate the multivariate normal or change in prediction vectors. 8. Variance-covariance matrix can be represented as U DU T where U is a real unitary matrix, U T = U and D is a diagonal matrix with non-negative entries that decrease down the diagonal. Therefore C = U D1/2 .

3.3

SIMLP

This is a linear programming formulation that takes care of shipment and production decisions. The linear program is modeled as follows.

1. The objective function minimizes sum of total costs. The following costs are considered. Total cost of producing and shipping to local warehouse for all products, production lines and time periods. Total overtime cost for all production lines. Total transhipment costs between possible transhipment destinations for all products and time periods. Total cost of holding excess inventory, cost of backorders and cost of shortfall below coverage target over all products, warehouses and time periods. 2. Capacity constraints, overtime limits, material balance equations, coverage constraints, backorder limits, non-negativity constraints are considered. 3. Shipments between particular pairs of warehouses can be disallowed. 4. Each production line consists of only one component. 5. Raw material availability as constraint is ignored. 6. Penalty for under utilization of a production line is not considered. 7. Coverage restrictions are stated in terms of months of supply. 8. Overtime is allowed on each production line in the current period only. No planned overtime for future periods. 9. Shortages in a period must be satised by planned production or shortages in next period. Shortages at the end of horizon is left unsatised.