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Demand forecasting

What is a demand forecast?

A demand forecast is the prediction of what will happen to your company's existing product sales. It would be best to determine the demand forecast using a multifunctional approach. The inputs from sales and marketing, finance, and production should be considered. The final demand forecast is the consensus of all participating managers. You may also want to put up a Sales and Operations Planning group composed of representatives from the different departments that will be tasked to prepare the demand forecast.

Demand Management
Independent Demand: Finished Goods
A

B(4)

C(2)

Dependent Demand: Raw Materials, Component parts, Sub-assemblies, etc.

D(2)

E(1)

D(3)

F(2)

Types of Forecasts
Qualitative (Judgmental) Quantitative Time Series Analysis Causal Relationships Simulation

Qualitative Methods

Executive Judgment

Grass Roots

Historical analogy

Qualitative Methods

Market Research

Delphi Method

Panel Consensus

Time Series Analysis

Time series forecasting models try to predict the future based on past data You can pick models based on: 1. Time horizon to forecast 2. Data availability 3. Accuracy required 4. Size of forecasting budget 5. Availability of qualified personnel

Simple Moving Average Formula

The simple moving average model assumes an average is a good estimator of future behavior The formula for the simple moving average is:

A t-1 + A t-2 + A t-3 +...+A t- n Ft = n

Ft = Forecast for the coming period N = Number of periods to be averaged A t-1 = Actual occurrence in the past period for up to n periods

Simple Moving Average Problem (1)

Week 1 2 3 4 5 6 7 8 9 10 11 12

Demand 650 678 720 785 859 920 850 758 892 920 789 844

A t-1 + A t-2 + A t-3 +...+A t- n Ft = n

Question: What are the 3week and 6-week moving average forecasts for demand? Assume you only have 3 weeks and 6 weeks of actual demand data for the respective forecasts

Calculating the moving averages gives us:

W eek 1 2 3 4 5 6 7 8 9 10 11 12

Demand 3-W eek 6-Week 650 F4=(650+678+720)/3 678 =682.67 720 F7=(650+678+720 +785+859+920)/6 785 682.67 859 727.67 =768.67 920 788.00 850 854.67 768.67 758 876.33 802.00 892 842.67 815.33 920 833.33 844.00 789 856.67 866.50 844 867.00 854.83
The McGraw-Hill Companies, Inc., 2004

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Plotting the moving averages and comparing Plotting the moving averages and comparing them shows how the lines smooth out to reveal them shows how the lines smooth out to reveal the overall upward trend in this example the overall upward trend in this example

10 00 9 00 Demand 8 00 7 00 6 00 5 00 1 2 3 4 5 6 7 8 9 10 11 1 2 We e k Dema nd 3 -W e ek 6 -W e ek

Note how the Note how the 3-Week is 3-Week is smoother than smoother than the Demand, the Demand, and 6-Week is and 6-Week is even smoother even smoother

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Weighted Moving Average Formula

While the moving average formula implies an equal While the moving average formula implies an equal weight being placed on each value that is being averaged, weight being placed on each value that is being averaged, the weighted moving average permits an unequal the weighted moving average permits an unequal weighting on prior time periods weighting on prior time periods The formula for the moving average is: The formula for the moving average is:

Ft = w 1A t-1 + w 2 A t-2 + w 3A t-3 +. ..+w n A t-n

wt = weight given to time period t wt = weight given to time period t occurrence (weights must add to one) occurrence (weights must add to one)

w
i=1

=1

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Weighted Moving Average Problem (1) Data

Question: Given the weekly demand and weights, what is Question: Given the weekly demand and weights, what is the forecast for the 4th period or Week 4? the forecast for the 4th period or Week 4?
Week 1 2 3 4 Demand 650 678 720

Weights: t-1 .5 t-2 .3 t-3 .2

Note that the weights place more emphasis on the Note that the weights place more emphasis on the most recent data, that is time period t-1 most recent data, that is time period t-1

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Weighted Moving Average Problem (1) Solution

Week 1 2 3 4

Demand Forecast 650 678 720 693.4

F4 = 0.5(720)+0.3(678)+0.2(650)=693.4

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Weighted Moving Average Problem (2) Data

Question: Given the weekly demand information and Question: Given the weekly demand information and weights, what is the weighted moving average forecast weights, what is the weighted moving average forecast of the 5th period or week? of the 5th period or week?
Week 1 2 3 4 Demand 820 775 680 655

Weights: t-1 .7 t-2 .2 t-3 .1

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Weighted Moving Average Problem (2) Solution

W eek 1 2 3 4 5 Demand Forecast 820 775 680 655 672

F5 = (0.1)(775)+(0.2)(680)+(0.7)(655)= 672

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Exponential Smoothing Model

Ftt = Ft-1 + (At-1 - Ft-1 ) F = Ft-1 + (At-1 - Ft-1 )

Where : Ft = Forcast value for the coming t time period Ft - 1 = Forecast value in 1 past time period At - 1 = Actual occurance in the past t time period

= Alpha smoothing constant

Premise: The most recent observations might have the highest predictive value Therefore, we should give more weight to the more recent time periods when forecasting

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Exponential Smoothing Problem (1) Data Question: Given the weekly demand data, what are the exponential smoothing forecasts for periods 2-10 using =0.10 and =0.60? Assume F =D 1 1

Week 1 2 3 4 5 6 7 8 9 10

Demand 820 775 680 655 750 802 798 689 775

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Answer: The respective alphas columns denote the forecast values. Note Answer: The respective alphas columns denote the forecast values. Note that you can only forecast one time period into the future. that you can only forecast one time period into the future.

Week 1 2 3 4 5 6 7 8 9 10

Demand 820 775 680 655 750 802 798 689 775

0.1 820.00 820.00 815.50 801.95 787.26 783.53 785.38 786.64 776.88 776.69

0.6 820.00 820.00 793.00 725.20 683.08 723.23 770.49 787.00 728.20 756.28

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Exponential Smoothing Problem (1) Plotting

Note how that the smaller alpha results in a smoother line in Note how that the smaller alpha results in a smoother line in this example this example
900 800 Demand 700 600 500 1 2 3 4 5 6 7 8 9 10 Demand 0 .1 0 .6

Week

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The MAD Statistic to Determine Forecasting Error

MAD =

A
t=1

- Ft

1 M AD 0.8 standrd deviat a ion 1 standard deviation 1.25 M AD

The ideal MAD is zero which would mean there is no forecasting error The larger the MAD, the less the accurate the resulting model

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MAD Problem Data Question: What is the MAD value given Question: What is the MAD value given the forecast values in the table below? the forecast values in the table below?
Month
1 2 3 4 5

Sales Forecast 220 n/a 250 255 210 205 300 320 325 315

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MAD Problem Solution

Month 1 2 3 4 5 Sales 220 250 210 300 325 Forecast Abs Error n/a 255 5 205 5 320 20 315 10

40

MAD =

A
t=1

- Ft

40 = = 10 4

Note that by itself, the MAD Note that by itself, the MAD only lets us know the mean only lets us know the mean error in a set of forecasts error in a set of forecasts

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Simple Linear Regression Model

The simple linear regression The simple linear regression model seeks to fit a line model seeks to fit a line through various data over through various data over time time
Y

a
0 1 2 3 4 5 x (Time)

Yt = a + bx

Is the linear regression model Is the linear regression model

Yt is the regressed forecast value or dependent variable in the model, a is the intercept value of the the regression line, and b is similar to the slope of the regression line. However, since it is calculated with the variability of the data in mind, its formulation is not as straight forward as our usual notion of slope.

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Simple Linear Regression Formulas for Calculating a and b

a = y - bx
xy - n(y)(x) x - n(x )
2 2

b=

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Simple Linear Regression Problem Data

Question: Given the data below, what is the simple linear Question: Given the data below, what is the simple linear regression model that can be used to predict sales in future regression model that can be used to predict sales in future weeks? weeks?

Week 1 2 3 4 5

Sales 150 157 162 166 177

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Answer: First, using the linear regression formulas, we Answer: First, using the linear regression formulas, we can compute a and b can compute a and b

Week Week*Week Sales Week*Sales 1 1 150 150 2 4 157 314 3 9 162 486 4 16 166 664 5 25 177 885 3 55 162.4 2499 Average Sum Average Sum xy - n( y)(x) = 2499 - 5(162.4)(3) = 63 = 6.3 b= 55 5(9 ) 10 x 2 - n(x )2
a = y - bx = 162.4 - (6.3)(3) = 143.5

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The resulting regression model is:

Yt = 143.5 + 6.3x

Now if we plot the regression generated forecasts against the actual sales we obtain the following chart: 180 175 170 165 Sales 160 155 Forecast 150 145 140 135 1 2 3 4 5 Period

Sales

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Web-Based Forecasting: CPFR

Collaborative Planning, Forecasting, and Replenishment (CPFR) a Web-based tool used to coordinate demand forecasting, production and purchase planning, and inventory replenishment between supply chain trading partners. Used to integrate the multi-tier or n-Tier supply chain, including manufacturers, distributors and retailers. CPFRs objective is to exchange selected internal information to provide for a reliable, longer term future views of demand in the supply chain. CPFR uses a cyclic and iterative approach to derive consensus forecasts.

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Web-Based Forecasting: Steps in CPFR

1. Creation of a front-end partnership agreement 2. Joint business planning 3. Development of demand forecasts 4. Sharing forecasts 5. Inventory replenishment

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Thank you