Week 4 Forcasting + Inventory Part 1

SESSION 5
Copyright 2014 - Fadi Kotob
Chapter 11
!
Forecasting and Demand Planning
Learning Objectives
CHAPTER 11
FORECASTING AND DEMAND PLANNING
Introduce forecasting and describe the importance of

forecasting to the value chain.
Describe the basic principles of forecasting
Explain how to apply time-series analysis in forecasting
Discuss the fundamental components of demand and

types of forecasting methods
Explain the qualitative and causal forecasting methods
Discuss forecast accuracy and how to determine the best

forecasting method to use
2013 OM4 Cengage Learning. All Rights Reserved.

May not be scanned, copied or duplicated, or
posted to a publicly accessible website, in whole or in part.
What Is Forecasting?
Forecasting is the process of projecting the values of one
or more variables into the future.
Types of forecasts:
Long-range forecasts in total sales dollars (top
management level)
Aggregate forecasts of sales volume (middle
management level)
Forecasts of individual units (operational level)
Adapted - Collier & Evans (2013). OM4, South-Western, Cengage Learning. ISBN-13: 978-1-133-37242-4
Why We Need to Forecast?
CHAPTER 11
To Plan:
Facilities
Production Schedules
Staffing Allocation
Capacity Planning
This forecasting is essential across the value chain as can be seen

on the next slide
Adapted - Boyer & Verma (2010). Operations and Supply Chain Management for the 21st Century, South-Western,
Cengage Learning. ISBN-13: 978-0-618-74933-1

Various Value Chain Forecasting
The goal of a business forecast is not to have a perfect forecast

but to have a reasonable forecast that supports planning
THIS BRINGS ME TO THE PRINCIPLES OF FORECASTING SHOWN NEXT
The Principles of Forecasting
CHAPTER 11
Forecasts are wrong

Forecasts get worse the farther they go into the future
Aggregated forecasts for product or service groups tend to
be more accurate
Forecasts are not a substitute for derived values
TO UNDERSTAND FORECASTING WELL, IT IS IMPORTANT TO FIRST

UNDERSTAND THE BASIC CONCEPTS OF FORECASTING WHICH INCLUDE:
1.
FORECAST PLANNING HORIZON
2.
DATA PATTERNS IN TIME SERIES
3.
FORECAST ERRORS AND ACCURACY

Forecast Planning Horizon
CHAPTER 11
Time Buckets: the unit of measure for the time period used in a forecast.
Planning Horizon: is the length of time on which a forecast is based.
This spans from short-range forecasts with a planning horizon of under 3

months to long-range forecasts of 1 to 10 years.
!
!
Adapted - Collier & Evans (2013). OM4, South-Western, Cengage Learning. ISBN-13: 978-1-133-37242-4!
Adapted - Boyer, Verma (2010). Operations and Supply Chain Management for the 21st Century, South-Western, Cengage Learning. ISBN-13:
978-0-618-74933-1

Data Patterns In Time Series

!
!
!
!
This could be achieved by making and measuring observations

at successive points in time or over successive periods of time.
This helps identify several demand patterns which are:

- Average
- Trend
- Seasonal
- Cyclical
- Random (or noise)
- Irregular (one time) variation
THESE PATTERNS WILL BE EXPLAINED NEXT
!!
978-0-618-74933-1
Data
Patterns
In
Time
Series
Continued
!
Average is a measure of the average demand for a specified time period.
A trend is the underlying pattern of growth or decline in a time series.
Seasonal are characterised by repeatable periods of ups and downs over short
periods of time.
Cyclical are regular patterns in a data series that take place over longer periods
of time.
Random variation (sometimes called noise) is the unexplained deviation of a

time series from a predictable pattern, such as a trend, seasonal, or cyclical
pattern.
Irregular variation is a one-time variation that is explainable

SOME OF THESE PATTERNS ARE OFTEN CONSIDERED WHEN
FORECASTING DEMAND
!!
978-0-618-74933-1
Forecast Errors And Accuracy
CHAPTER 11
What about errors?

It is important to recognise that all forecasts are wrong to some
extent.
The forecast error is the difference between the observed value of
the time series and the forecast, or At Ft
So how do we choose the best forecast?

BY EVALUATING THE FORECASTS CREATED USING DIFFERENT METHODS
SOME OF THESE FORECASTING METHODS WILL BE COVERED NEXT

Forecasting Methods
CHAPTER 11
Forecasting methods are divided into 2 main categories:
!
1. Quantitative or Statistical Forecasting
!
Time-series Analysis: a technique that utilises past demand data
! to predict future demand. It is based on the assumption that the
!future will be an extrapolation of the past.
!
!Regression Analysis: a technique for building a statistical model
that defines the relationship between a single dependent
!
variable and one or more independent variables, all of which are
!numerical
!
!!
!
2. Qualitative or Judgmental Forecasting: a method of forecasting

that is based on subjective factors, estimates and opinions
978-0-618-74933-1

Time-series Analysis
CHAPTER 11
Based on historical data

Assumes that past patterns will continue in the future
!
Goal:
Identifying demand patterns and developing a model to
predict these patterns in the future
!
The following forecasting techniques will be explained:
!
Nave forecast
Moving averages
Single exponential smoothing
Trend adjusted exponential smoothing
Seasonable patterns

Nave Forecast
CHAPTER 11
Nave Forecast:
Uses demand for the current period as the forecast for the next period
Simple and low cost to use
Works best when demand is stable and there is relatively little random
variation
The nave approach is the simplest of all the possible forecasting
methods and works particularly well when there is autocorrelation

Moving Average
CHAPTER 11
Moving Average:
Estimates the average of a demand series
Involves computing the average of n previous periods of demand and
then using this as the estimate for the next period of demand
The average is updated after every period to include the most recent
demand data
!!
!
978-0-618-74933-1

Single Exponential Smoothing
CHAPTER 11
Single Exponential Smoothing:

Calculates forecasts by giving more weight to recent demand or
forecast rather than to earlier demand or forecast
Requires less data than the weighted moving average
!!
!
978-0-618-74933-1

CHAPTER 11
Trend Adjusted Exponential Smoothing

Trend Adjusted Exponential Smoothing:
Includes a trend component in the forecast
Calculates both the average and trend of the series which together
provides the forecast

Seasonable Patterns
CHAPTER 11
Many organisations sell products or services that have a seasonal demand

Seasonal demand is characterised by regular repetition of increases or decreases
in demand as measured in time periods of less than a year (quarters, months,
weeks, days, or hours)
Example: Airline travel has substantially higher demand in the summer and
holidays

Multiplicative Seasonal Patterns Method

CHAPTER 11
Multiplicative Seasonal Method:

Calculates average demand for the year, the season and other times
Calculates a seasonal index for the season and other times
Multiply the seasonal index by the average demand for the year

Reducing Seasonality
CHAPTER 11
How to reduce seasonality?

- Advertising during slower-demand periods
- Discounting the product or service in periods of slower demand
to increase sales
!
Outcome - Consistent Planning

CHAPTER 11
Additional Forecasting Methods
Qualitative or judgmental forecasting

Causal Methods

CHAPTER 11
Qualitative Or Judgmental Forecasting Methods
Market Research:
- A systematic approach to measuring customer interest in a
service or product through data-gathering surveys
- Widely used for forecasting new products
- Has a high degree of uncertainty
- Must be interpreted with caution
!
Delphi Method:
- A forecasting method that uses a team of experts to develop a
consensus forecast
- Useful for long-range and technological forecasting
!
Grass Roots Forecasting:
- A forecasting method that gathers the opinions of those close to
the end consumer, such as salespeople, about customers
purchasing plans
- The direct contact with customers provides insight into future
buying intention

Causal Methods
CHAPTER 11
A method of Regression Analysis used when:

Historical data is available and there is a relationship
between the item to be forecasted and some other factor
Example: relationship between advertising expenditure,
and sales of a product
!
Causal methods employ mathematical techniques to relate
one or more independent variables to the variable being
forecast
!!
!
978-0-618-74933-1

!
Forecasting
In Practice
Managers use a variety of judgmental and quantitative

forecasting techniques.
They will examine a range of forecast types over a period

of time and choose the one with the least amount of
error.
Statistical methods alone cannot account for such factors

as sales promotions, competitive strategies, unusual
economic disturbances, new products, large one-time
orders, labor complications, etc.
Statistical forecasts are often adjusted to account for

qualitative factors.
SYSTEMS OFTEN AID IN MAKING AN APPROPRIATE FORECAST

!!
!
Adapted - Boyer, Verma (2010). Operations and Supply Chain Management for the 21st Century, South-Western, Cengage Learning.
ISBN-13: 978-0-618-74933-1
Thank You For Your Time
Chapter 12
!
Managing Inventories Part 1
Learning Objectives
- Define inventory and inventory management

- Explain the reasons for and reasons against having inventory
-
Define the different types of inventory and the roles they play in
supply chains
- Explain the considerations required to manage inventory

-
Explain the categories of inventory cost and the characteristics of
inventory
- Explain the role of inventory systems

- Explain the continuous and periodic order review systems
What do you think?

!
Can you cite any experiences in which the lack of

appropriate inventory at a retail store has caused
you to be dissatisfied?
Managing Inventory Support Success
CHAPTER 12
MANAGING INVENTORIES
Having a good inventory management process is essential for

organisations to meet their customers needs
!
This process is important for both manufacturing and service
(Intangible) environments
2013 OM4
Cengage Learning. All Rights Reserved.
What Is Inventory
CHAPTER 12
!
!
Inventory is any asset held for future use or sale to satisfy
customer demand or to support the production of services or goods.
Objectives:
Maintain sufficient inventory
Incur lowest possible cost
!!
Adapted - Krajewski, Malhotra & Ritzman (2013). Operations Management Processes And Supply Chains, Pearson Education Limited,
ISBN: 9780273766834
2013 OM4
What Is Inventory Management
CHAPTER 12
!
!
The planning, coordinating, and controlling the acquisition, storage,
handling, movement, distribution, and possible sale of raw
materials, component parts and subassemblies, supplies and tools,
replacement parts, and other assets that are needed to meet
customer wants and needs and deliver the competitive priorities of
the organisation.
!!
ISBN: 9780273766834
2013 OM4
Inventory - The Good & The Bad
CHAPTER 12
Reasons to Carry Inventory

Set-up and ordering costs
Customer service and variation in demand
Labor and equipment utilisation
Transportation cost
Costs of materials/quantity discounts
Reasons Not to Carry Inventory

Storage and Handling
Interest and opportunity cost
Property taxes and insurance premiums
Shrinkage and spoilage
Adapted - Boyer & Verma (2010). Operations and Supply Chain Management for the 21st Century, South-Western, Cengage Learning.
ISBN-13: 978-0-618-74933-1
ISBN: 9780273766834
2013 OM4
Inventory Types
CHAPTER 12
Inventory exists in 3 aggregate categories that are useful for accounting purposes:
!
Raw materials, component parts, subassemblies, and supplies are inputs to
manufacturing and service-delivery processes.
Work-in-process (WIP) inventory consists of partially finished products in various
stages of completion that are awaiting further processing.
Finished goods inventory is completed products ready for distribution or sale to
customers.
!!
ISBN: 9780273766834
2013 OM4
Inventory Types Supply Chain View
Many different types of inventory are maintained throughout the

value chain before, during and after production to support operations
and meet the demand of customers.
Inventory Types Continued
CHAPTER 12
When managing inventory, there is another perspective often used:

Cycle Inventory: a quantity of inventory that varies in proportion to
order quantity
Pipeline Inventory: inventory that is in the process of moving from one
location in the supply chain to another
Safety Stock Inventory: excess Inventory that a company holds to guard
against uncertainty in demand, lead time, and supply
Anticipation Inventory: inventory that is held for future use at a time
when demand will exceed available capacity
THESE INVENTORIES MUST BE MANAGED FOR SUCCESS

HOW TO MANAGE INVENTORIES IN A SUPPLY CHAIN TO ACHIEVE SUCCESS?
ISBN-13: 978-0-618-74933-1
ISBN: 9780273766834
2013 OM4
Managing Inventories In Supply Chains

!
Requires good technology, processes, and information technology (IT)

support to manage the purchasing, tracking and return.
Inventory management should:
Focus on cost, quality, delivery performance, and technical support

Seek new suppliers and products and evaluate their potential to the
company.
!
Nowadays, the concept of Environmentally Preferable Purchasing
(EPP), or green purchasing, is becoming more important
!
The affirmative selection and acquisition of products and services that
most effectively minimise negative environmental impacts over their
life cycle of manufacturing, transportation, use, and recycling or
disposal.
Why Technology, Processes & Support?

Important to manage risks
CHAPTER 12
How
To Manage Inventory - The Inventory Management Scale
!
Inventory managers deal with two fundamental decisions:
!
1.
When to order items from a supplier or when to initiate

production runs if the firm makes its own items
2.
How much to order or produce each time a supplier or production

order is placed
!
It is similar to balancing a scale and assessing the benefits of carrying
larger amounts of inventory against the drawbacks and the risks of not
carrying that inventory.
THIS PROCESS HELPS MANAGE INVENTORY COST
!
THE 4 CATEGORIES OF INVENTORY COST WILL BE COVERED NEXT
ISBN-13: 978-0-618-74933-1
ISBN: 9780273766834
2013 OM4
Categories Of Inventory Cost

The four categories of inventory costs are:
1. Ordering or setup costs
2. Inventory-holding costs
3. Shortage costs
4. Unit cost of the stock-keeping units (SKUs/
SKNs)
Categories Of Inventory Cost Continued

!
Ordering costs or setup costs are incurred as a result

of the work involved in placing purchase orders with
suppliers or configuring tools, equipment, and machines
within a factory to produce an item.
!
Inventory-holding costs or inventory-carrying

costs are the expenses associated with carrying
inventory.
Categories Of Inventory Cost Continued

!
Shortage costs or stockout costs are the costs

associated with a SKU(SKN) being unavailable when
needed to meet demand.
!
Unit cost is the price paid for purchased goods or the

internal cost of producing them.
Inventory
Characteristics
!
One of the first steps in analysing an inventory problem should be to

describe the essential characteristics of the inventory to manage.
!
The characteristics are divided in the following categories:

Number of items
Nature of demand
Number and duration of time periods
Lead time
Stockouts
!
!
THESE CHARACTERISTICS WILL BE COVERED NEXT
Number Of Items
!
Number of items: each item is identified by a unique

identifier, called a stock-keeping unit (SKU) or stockkeeping number (SKN).
A stock-keeping unit (SKU) is a single item or asset

stored at a particular location.
Nature
Of Demand
!
Nature of Demand:
Independent demand is demand for an SKU that is:

-
Unrelated to the demand for another
Goes directly to a customer
Influenced by market conditions
Dependent demand is demand for an SKU that is:

-
Related to the demand for other SKUs
Used to make another item or are considered to be component

parts
Demand can either be constant (deterministic) or uncertain (stochastic)

-
Static demand is stable demand.
Dynamic demand varies over time.
Number And Duration Of Time Periods

!
Number and Duration of Time Periods:

!
Single period
Multiple time periods
Lead Time
!
Lead Time:
-
The lead time is the time between placement of an

order and its receipt.
Stockouts
Stockouts:
A stockout is the inability to satisfy demand for an

item.
A stockout often leads to one of the following

outcomes:
-
A backorder occurs when a customer is willing to

wait for an item.
A lost sale occurs when the customer is unwilling to

wait and purchases the item elsewhere.
The Inventory Management System
CHAPTER 12
By considering the Inventory Characteristics and Inventory Costs, an Inventory System

provides the structure and operating policies for maintaining and controlling goods to be
stocked in inventory
!
The system is responsible for ordering, tracking, and receiving goods.
There are two essential policies:
1. How much or what quantity of an item to order?
2. When should an order for that item be placed?
ISBN-13: 978-0-618-74933-1
ISBN: 9780273766834
2013 OM4
Two Main Types of Systems
CHAPTER 12
Fixed Quantity System or Continuous Review System:

- Orders same quantity of items
- Has differing periods of time between orders
Fixed Period System or Periodic Review System:
- Orders different quantity of items
- has a fixed time between orders
2013 OM4
Fixed Quantity System Or The Continuous Review
In a fixed quantity system (FQS), the order quantity or

lot size is fixed; the same amount, Q, is ordered every time.
The fixed order (lot) size, Q, can be a box, pallet,

container, or truck load.
Q does not have to be economically determined, as we

will do for the EOQ model later.
Fixed Quantity System Or The Continuous Review Continued
The process of triggering an order is based on the

inventory position.
Inventory position (IP) is the on-hand quantity (OH)

plus any orders placed but which have not arrived
(scheduled receipts, or SR), minus any backorders (BO).
IP = OH + SR BO
CHAPTER 12
The Continuous Review Or Fixed Quantity System Example

Inventory Position:
= on-hand inventory + outstanding orders - backorders
!
Example:
The organisation currently have 20 Iphones (OH)
They ordered 40 new Iphones (SR)
Total number of Iphones: 20 + 40 = 60
Customers ordered 20 Iphones which are yet to be delivered (Backorders (BO) items promised to a customer but not yet delivered))
The inventory position is:
Total number of Iphones - Backorders
= 60 - 20 = 40 Iphones
2013 OM4
The Continuous Review Or Fixed Quantity System Continued

!
!
When inventory falls at or below a certain value, r, called

the reorder point, a new order is placed.
The reorder point is the value of the inventory
position that triggers a new order.
The quantity depends on the lead time.
CHAPTER 12
Setting the Reorder Point With Stable Demand
2013 OM4
Stability Ordering Impact
CHAPTER 12
To setup the appropriate reorder point, the following should be

considered:
- Demand is unstable
- Lead time is unstable
- Supply is unstable
- Data on the system is not accurate
2013 OM4
CHAPTER 12
Reorder Point when Considering Instability
2013 OM4
Final Notes - Your Tasks For This Week

!
Review the lecture slides and the notes you have taken
!
Read chapters 12 and 14
!
Attempt the Chapter 8 Calculations Home Exercises loaded on the tutorial 5 Moodle folder
!
Start working on assignment 2, part 2
!
Read the Assessment 2, Part 2, Briefing Document loaded on the Moodle site
Thank You For Your Time

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SESSION 5

Copyright 2014 - Fadi Kotob

Forecasting and Demand Planning

Copyright 2014 - Fadi Kotob

FORECASTING AND DEMAND PLANNING

Introduce forecasting and describe the importance of

Describe the basic principles of forecasting

Explain how to apply time-series analysis in forecasting

Discuss the fundamental components of demand and

Discuss forecast accuracy and how to determine the best

Copyright 2014 - Fadi Kotob

2013 OM4 Cengage Learning. All Rights Reserved.

Why We Need to Forecast?

FORECASTING AND DEMAND PLANNING

This forecasting is essential across the value chain as can be seen

2013 OM4 Cengage Learning. All Rights Reserved.

Various Value Chain Forecasting

The goal of a business forecast is not to have a perfect forecast

The Principles of Forecasting

FORECASTING AND DEMAND PLANNING

Forecasts are wrong

TO UNDERSTAND FORECASTING WELL, IT IS IMPORTANT TO FIRST

FORECAST PLANNING HORIZON

DATA PATTERNS IN TIME SERIES

FORECAST ERRORS AND ACCURACY

2013 OM4 Cengage Learning. All Rights Reserved.

Forecast Planning Horizon

FORECASTING AND DEMAND PLANNING

This spans from short-range forecasts with a planning horizon of under 3

Copyright 2013 - Fadi Kotob

2013 OM4 Cengage Learning. All Rights Reserved.

Data Patterns In Time Series

This could be achieved by making and measuring observations

This helps identify several demand patterns which are:

Average is a measure of the average demand for a specified time period.

A trend is the underlying pattern of growth or decline in a time series.

Random variation (sometimes called noise) is the unexplained deviation of a

Irregular variation is a one-time variation that is explainable

Forecast Errors And Accuracy

FORECASTING AND DEMAND PLANNING

What about errors?

So how do we choose the best forecast?

SOME OF THESE FORECASTING METHODS WILL BE COVERED NEXT

Copyright 2014 - Fadi Kotob

2013 OM4 Cengage Learning. All Rights Reserved.

FORECASTING AND DEMAND PLANNING

Forecasting methods are divided into 2 main categories:

2. Qualitative or Judgmental Forecasting: a method of forecasting

Copyright 2014 - Fadi Kotob

2013 OM4 Cengage Learning. All Rights Reserved.

FORECASTING AND DEMAND PLANNING

Based on historical data

2013 OM4 Cengage Learning. All Rights Reserved.

FORECASTING AND DEMAND PLANNING

2013 OM4 Cengage Learning. All Rights Reserved.

FORECASTING AND DEMAND PLANNING

Copyright 2014 - Fadi Kotob

2013 OM4 Cengage Learning. All Rights Reserved.

Single Exponential Smoothing

FORECASTING AND DEMAND PLANNING

Single Exponential Smoothing:

Copyright 2014 - Fadi Kotob

2013 OM4 Cengage Learning. All Rights Reserved.