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Chapter 15. Demand Management and Forecasting


Demand Management
Independent vs. dependent demand
Qualitative Techniques
Market research, focus groups, Delphi technique,
Quantitative Techniques
1. Time series based models
2. Associative (causal) Models
Accuracy and Control of Forecast (errors)
1. Measuring and comparing forecast errors using MAD,
MAPE, MSE, RMSE
2. Controlling Forecasting Process via Tracking Signal
2
A
B(4) C(2)
D(2) E(1) D(3) F(2)
Dependent Demand:
Raw Materials,
Component parts,
Sub-assemblies, etc.
Independent Demand:
Finished Goods
Demand Management
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Demand Management
Active role to influence demand.
Examples from seasonal goods or services
Campaigns, discounts, etc.
Incentives to sales personnel


Passive role, limited or no action taken.
Why?
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Qualitative Methods
Grass Roots
Market Research
Panel Consensus
Executive Judgment
Historical analogy
Delphi Method
Qualitative
Methods
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Delphi Method
1. 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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Quantitative forecasting methods
Time series models
Past predicts future
Uses time series data
Key variable: time (t)
Easier to apply
Less accurate
Examples:
Moving averages
Exponential smoothing
Causal models
Examines potential cause => effect
relationships
Requires cross sectional data
Key variables are usually denoted
as X
1
, X
2
, X
3
,
More difficult
Takes more time
But worth it since it provides
insight to the system (process)
under study
Examples:
Various regression models
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Quantitative techniques
Basic time series approaches
i. Moving averages, simple &weighted
ii. Exponential smoothing, simple & trend adjusted
iii. Linear regression (linear trend model)
iv. Techniques for seasonality and trend -
Decomposition of time series
Causal approach
i. Simple Linear Regression
ii. Multiple Linear Regression
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Finding Components of a Time Series
1 2 3 4
x
x
x
x
x
x
x x
x
x
x
x x x
x
x
x
x
x
x x
x
x
x
x x x
x
x
x
x
x
x
x
x
x
x
x
x
x
x
x
x
x
x
x
x
Year
S
a
l
e
s

Seasonal variation
Linear
Trend
15-8
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What to look for in a time series
Trend - long-term movement in data

Seasonality - short-term regular and repetitive variations in data

Cyclical variations long(er) term, occasionally caused by
unusual circumstances, (war, economic downturn, etc.)

Autocorrelation denotes persistence of occurrence (momentum
driven)

Random variations - caused by chance
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Moving Averages
Simple moving average (MA)
F
t
= 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


Weighted moving average (WMA)
permits an unequal weighting on
prior time periods


Excel time!
Problem 20.
n
A + ... + A + A + A
= F
n - t 3 - t 2 - t 1 - t
t
1 = w
A w + ... + A w + A w + A w = F
n
1 = i
i
n - t n 3 - t 3 2 - t 2 1 - t 1 t

where
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Exponential Smoothing Models
Simple exponential smoothing
model
Alpha is the smoothing constant

Whenever appropriate more weight
can be given to the more recent
data (time periods)

Double exponential smoothing
(Holts model)
Adds trend component, T and delta
(gamma) as the smoothing constant
for trend
Forecast Including Trend (FIT)
Excel time!
Problem 20, continued.

) F A ( F F
1 1 1
+ =
t t t t
o
1 0 where s so
) FIT F ( T T
1 1
+ =
t t t t
o
) FIT A ( FIT F
1 1 1
+ =
t t t t
o
t t t
T F FIT + =
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Measuring Accuracy, Forecast Errors
To compare different time series techniques or to select the
best set of initial values for the parameters, use a combination
of the the following four metrics:
Mean Absolute Deviation
Most popular but

Mean Absolut Percent Error
Should be used in tandem with MAD

Mean Square Error


Root Mean Square Error

n
F A
= MAD
1

=

n
i
i i

n
i
i
i i
n
1
A
F A
100
= MAPE
( )
n
F A
= MSE
1
2

=

n
i
i i
MSE RMSE=
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Tracking Signal
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.
TS is a monitoring system.
The TS formula is:


Deviation Absolute Mean
Errors Forecast of Sum Running
= TS
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Regression analysis
Identify factors (independent variables) that can be used to
predict the values for the forecast variable (e.g., sales).

Regression applied to causal data requires different kinds of
data

Regression applied to time series data is also know as
trend line analysis

We will use Excel (Tools/Data analysis) to obtain the
regression line and all relevant statistics.

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A simple regression example
The first example applies regression to time series data.
Whenever possible, plot and observe the data.
The scatter plot shows a linear relation between advertising and
sales. So the following regression model is suggested by the data,
which refers to the true relationship between the entire population of
advertising and sales values.



Other common formats are:
i
i
c | | + + =
1 1 0 i
X Y
t b a Y
X b a Y
+ =
+ =
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Decomposition of a Time Series
Demand has both trend and seasonal components.
View data via Excel.
1. Compute overall average
2. Compute average of the same seasons of each cycle (e.g., year)
3. Compute seasonal indexes (seasonal averages / overall avg.)
4. Deseasonalize data (actual values /seasonal indexes)
5. Apply regression to deseasonalized data
6. Compute (project) deseasonalized forecasts using the regression
equation
7. Reseasonalize the forecasts by multiplying them with the
seasonal indexes.
Excel time.
Problem 21.
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Multiple regression
Most regression problems involve more than one independent
variable.
If each independent variables varies in a linear manner with Y, the
estimated regression function in this case is:


Where b
0
is the intercept (also called constant)
The optimal values for the b
i
(slopes) can again be found using the
least squares method

k k
b b b b X X X Y
2 2 1 1 0
+ + + + =
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Steps in multiple regression analysis
1. Hypotheses for testing whether a general linear model is useful is
predicting Y:
1. H
o
:
1
=
2
=
3
= ... =
k
= 0 (means there is NOTHING useful)
2. H
A
: At least one of the parameters in H
o
is nonzero.
2. Test statistic: F-statistic = MSR / MSE
3. If the model is deemed adequate (passes the F-test; rejected H
0
)
then go to step 4 (otherwise, none of variables have any impact on Y )
4. Conduct t-tests (significance tests) on parameters (slopes).
5. Remove the most insignificant independent variable, re-run the
regression, and go to step 4.
6. Repeat steps 4 & 5 until all remaining independent variable
parameters (slopes) are significant, then go to step 7
7. If the intercept (
0
) is insignificant then remove it, run regression one
more time.
Excel time!
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What Forecasters Should Do
Determine what elements of historical data provide repeatable
patterns and utilize this to make extrapolations.
Make a list of the possible independent variables that may have
influenced the historical data and may influence future
outcomes.
Statistically correlate the independent variables to the outcome
history using regression analysis to validate their importance
and to calibrate their effects.
Make estimates of forecast error wherever possible using MAD
or standard deviation measures.
Make clear presentations of the results and assumptions and
listen to feedback.
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Forecasting
Always remember that you (managers) are decision makers and
sound decisions are based on good forecasts

Suggested problems:
2, 3, 4, 7, 11, 12, 14, 17, 20, 21, 27