McGraw-Hill/Irwin

Copyright 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

Chapter 15
Demand Management and Forecasting

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OBJECTIVES Demand Management Qualitative Forecasting Methods Simple & Weighted Moving Average Forecasts Exponential Smoothing Simple Linear Regression Web-Based Forecasting

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Demand Management

Independent Demand: Finished Goods Dependent Demand: Raw Materials, Component parts, Sub-assemblies, etc.
C(2)

B(4)

D(2)

E(1)

D(3)

F(2)

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Independent Demand: What a firm can do to manage it?

Can take an active role to influence demand

Can take a passive role and simply respond to demand

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Types of Forecasts

Qualitative (Judgmental) Quantitative Time Series Analysis Causal Relationships Simulation

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Components of Demand

Average demand for a period of time Trend Seasonal element Cyclical elements Random variation Autocorrelation

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Finding Components of Demand

Seasonal variation

x x x x x

Linear
x x x

Sales

x x x

xx x x xx x x x x x x xxx x x x x x x x xx x

x x x x x x x

x x

Trend

Year

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Qualitative Methods

Executive Judgment

Grass Roots

Historical analogy

Qualitative Methods

Market Research

Delphi Method

Panel Consensus

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Delphi Method

l. Choose the experts to participate representing a variety of knowledgeable people in different areas 2. Through a questionnaire (or E-mail), obtain forecasts (and any premises or qualifications for the forecasts) from all participants 3. Summarize the results and redistribute them to the participants along with appropriate new questions 4. Summarize again, refining forecasts and conditions, and again develop new questions 5. Repeat Step 4 as necessary and distribute the final results to all participants

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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

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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

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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

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Calculating the moving averages gives us:

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

Demand 3-Week 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 them shows how the lines smooth out to reveal the overall upward trend in this example

1000 900 De m a n d 800 700 600 500 1 2 3 4 5 6 7 8 9 10 11 12 Week Demand 3-Week 6-Week

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

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Simple Moving Average Problem (2) Data

Week 1 2 3 4 5 6 7

Demand 820 775 680 655 620 600 575

Question: What is the 3 week moving average forecast for this data? Assume you only have 3 weeks and 5 weeks of actual demand data for the respective forecasts

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Simple Moving Average Problem (2) Solution

Week 1 2 3 4 5 6 7

Demand 820 775 680 655 620 600 575

3-Week
=758.33

5-Week

F4=(820+775+680)/3 F6=(820+775+680 +655+620)/5 =710.00

758.33 703.33 651.67 625.00

710.00 666.00

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Weighted Moving Average Formula

While the moving average formula implies an equal weight being placed on each value that is being averaged, the weighted moving average permits an unequal weighting on prior time periods The formula for the moving average is: Ft = w1A t-1 + w 2 A t-2 + w 3A t-3 +...+w n A t-n
n

wt = weight given to time period t 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 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 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 weights, what is the weighted moving average forecast 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

Week 1 2 3 4 5

Demand Forecast 820 775 680 655 672

F5 = (0.1)(755)+(0.2)(680)+(0.7)(655)= 672

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Exponential Smoothing Model

Ft = Ft-1 + E(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 E ! 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

Week 1 2 3 4 5 6 7 8 9 10

Demand 820 775 680 655 750 802 798 689 775

Question: Given the weekly demand data, what are the exponential smoothing forecasts for periods 2-10 using E=0.10 and E=0.60? Assume F1=D1

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Answer: The respective alphas columns denote the forecast values. Note 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 this example

900 D e m a n 800 700 600 500 1 2 3 4 5 6 7 8 9 10 Week Demand 0.1 0.6

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Exponential Smoothing Problem (2) Data

Week Demand Question: What are 1 820 the exponential smoothing forecasts 2 775 for periods 2-5 using 3 680 4 655 a =0.5? 5

Assume F1=D1

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Exponential Smoothing Problem (2) Solution

F1=820+(0.5)(820-820)=820

F3=820+(0.5)(775-820)=797.75

Week 1 2 3 4 5

Demand 820 775 680 655

0.5 820.00 820.00 797.50 738.75 696.88

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The MAD Statistic to Determine Forecasting Error

n

A
MAD =
t=1

- Ft

1 MAD } 0.8 standard deviation 1 standard deviation } 1.25 MAD

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 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
n

A
MAD =
t=1

- Ft

40 = = 10 4

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

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Tracking Signal Formula

The Tracking Signal or TS is a measure that indicates whether the forecast average is keeping pace with any genuine upward or downward changes in demand. Depending on the number of MADs selected, the TS can be used like a quality control chart indicating when the model is generating too much error in its forecasts. The TS formula is:

RSFE Running sum of forecast errors TS = = MAD Mean absolute deviation

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Simple Linear Regression Model

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

a
0 1 2 3 4 5 x (Time)

Yt = a + bx

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 regression model that can be used to predict sales in future 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 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 - n(x )

2 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: 180 175 170 165 160 155 150 145 140 135 1 2 3 Perio d 4 5

Sales

Sales Forecast

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Web-Based Forecasting: CPFR

Collaborative Planning, Forecasting, and Replenishment (CPFR) a Webbased 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 nTier 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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Question Bowl

Which of the following is a classification of a basic type of forecasting? a. Transportation method b. Simulation c. Linear programming d. All of the above e. None of the above
Answer: b. Simulation (There are four types including Qualitative, Time Series Analysis, Causal Relationships, and Simulation.)

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Question Bowl

Which of the following is an example of a Qualitative type of forecasting technique or model? a. Grass roots b. Market research c. Panel consensus d. All of the above e. None of the above
Answer: d. All of the above (Also includes Historical Analogy and Delphi Method.)

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Question Bowl

Which of the following is an example of a Time Series Analysis type of forecasting technique or model? a. Simulation b. Exponential smoothing c. Panel consensus d. All of the above e. None of the above
Answer: b. Exponential smoothing (Also includes Simple Moving Average, Weighted Moving Average, Regression Analysis, Box Jenkins, Shiskin Time Series, and Trend Projections.)

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Question Bowl

Which of the following is a reason why a firm should choose a particular forecasting model? a. Time horizon to forecast b. Data availability c. Accuracy required d. Size of forecasting budget e. All of the above
Answer: e. All of the above (Also should include availability of qualified personnel .)

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Question Bowl

Which of the following are ways to choose weights in a Weighted Moving Average forecasting model? a. Cost b. Experience c. Trial and error d. Only b and c above e. None of the above Answer: d. Only b and c above

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Question Bowl

Which of the following are reasons why the Exponential Smoothing model has been a well accepted forecasting methodology? a. It is accurate b. It is easy to use c. Computer storage requirements are small d. All of the above e. None of the above

Answer: d. All of the above

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Question Bowl

The value for alpha or must be between which of the following when used in an Exponential Smoothing model? a. 1 to 10 b. 1 to 2 c. 0 to 1 d. -1 to 1 e. Any number at all Answer: c. 0 to 1

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Question Bowl

Which of the following are sources of error in forecasts? a. Bias b. Random c. Employing the wrong trend line d. All of the above e. None of the above Answer: d. All of the above

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Question Bowl

Which of the following would be the best MAD values in an analysis of the accuracy of a forecasting model? a. 1000 b. 100 c. 10 d. 1 e. 0

Answer: e. 0

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Question Bowl

If a Least Squares model is: Y=25+5x, and x is equal to 10, what is the forecast value using this model? a. 100 b. 75 c. 50 d. 25 e. None of the above Answer: b. 75 (Y=25+5(10)=75)

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Question Bowl

Which of the following are examples of seasonal variation? a. Additive b. Least squares c. Standard error of the estimate d. Decomposition e. None of the above Answer: a. Additive (The other type is of seasonal variation is Multiplicative.)

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End of Chapter 15

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