Supply Chain Planning-Demand Planning PDF

SUPPLY CHAIN PLANNING: DEMAND
PLANNING
Introduction
Why is Demand Planning Important?
The goal of demand planning (DP) is to forecast what products customers will want, how
many of those products they will want, and when they will expect to have them.
The primary business issues addressed by demand planning include:
Consolidating multiple demand plans into a single plan usable by the entire
organization
Achieving more stable end-to-end planning and improved visibility of demand
Eliminating "seat of the pants" decision making
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Why is Demand Planning Important?
Demand planning is one component of the supply chain planning (SCP) process. SCP is
an integrated process that allows companies to plan and integrate the supply chain
functions of procurement, manufacturing, and fulfillment.
Demand, supply, production, and fulfillment planning operate as interdependent SCP

functions. The goal is to integrate these processes so that all the plans are synchronized
with one another. Plans generated during one process are used by one or more of the
other processes.
Specifically, the demand plan is the first step and a key input in the supply chain planning
process. The demand plan must be communicated to the supply and production planners
so that they can consider the impact on their capability to build and supply customer
requirements.
Objectives
After completing this module, you should be able to:
Describe the purpose, objectives, and benefits of demand planning
Describe the demand planning process and identify the stakeholders
Describe key concepts related to demand planning activities, including planning

horizons, product hierarchy, and forecast allocation techniques
Identify key inputs and understand other considerations that impact the demand
forecast
Define demand forecasting techniques
Describe the measurements and metrics for demand planning
Introduction to Demand Planning
Overview
Demand planning helps a company develop their best estimate of:
What customers will want

How much they will want
When they will want it
The answers to these questions serve as the foundation of the demand plan.
The goal of the demand planning process should be to create a single demand plan
across the organization. Often, organizational units within a company will have different
objectives and viewpoints, and consequently, develop separate demand plans. For
instance, Sales may have an item-by-item forecast by key customer, while Marketing
may have a separate plan that reflects the planned promotions for the year.
A good corporate demand plan is one that builds on the inputs from a variety of sources
to create a single consensus demand plan. This plan should reflect the corporate vision
that has been accepted and is being used by the entire organization.
Demand Planning Stakeholders
The forecasting process has many different stakeholders, often with competing
objectives; organizations must consider input from all of the stakeholders. The different
organizational units (Sales, Marketing, Finance, and Manufacturing) generate forecasts
and then work together with the demand planner during the Sales & Operations Planning
process to generate a one number consensus forecast that is used to drive business
operations as follows:
Sales Function
Responsible for ensuring that sales quotas and corporate sales objectives are met.
Typically, sales representatives generate time-phased forecasts for key customers or key
product groupings. Sometimes, they may also project the dollar volume of business they
expect to conduct with each customer. They then monitor the performance of actual sales
versus forecasted sales to determine their variance from forecast.
Marketing Function
Responsible for developing promotion plans and advertisement campaigns that maximize
product revenue streams. Marketing uses historical data and competitive information to
determine the influence of promotion plans and ad campaigns on customer demand.
Marketing is also responsible for forecasting the demand of new product introductions.
Because no history is available for the new products, they forecast the demand for such
products by using historical patterns of similar products.
Finance Function
Monitors forecasted sales to ensure that the organization will generate sufficient cash
flow to meet corporate financial obligations. Finance also uses demand projections for
budgeting purposes, and depends on forecast accuracy to effectively manage operating
expenses and determine whether capital investments are appropriate.
Manufacturing Function
Uses the demand plan to determine if enough resources are available to fulfill projected
demand. If they do not have the resources, the difference between the manufacturing
capability and forecasted demand must be resolved.
Demand Planner
The demand planner is part of the SCP organization, responsible for ensuring the
accuracy of the demand forecast and that the organization reaches a one number
consensus forecast.
Reaching Consensus
A single demand forecast is needed to effectively drive the operations and planning for a
company. The adjustments required to reach this consensus plan are identified during
the Sales and Operations Planning process (S&OP). The goal of the S&OP process is to
coordinate supply and demand to develop a single plan for the company. This plan will be
used to maximize customer fill rates at the minimum asset investment.
As we have seen, companies have several demand forecasts from different stakeholders
with competing objectives. S&OP can assist in balancing these different plans and
objectives. This is accomplished with a cross-functional team comprised of
representatives from Sales, Marketing, Finance, and Manufacturing, as well as planners
from the SCP function.
Although S&OP is a broad concept, we will limit our discussion to the role of demand
planning within S&OP that strives to reach consensus with a one number forecast.
Scenario: Reaching Consensus
Consider the following example of a company with two customers that manufactures just
one product that sells for $5/unit. In the table below, Sales and Finance have both
forecasted the sales of the product to each customer for the next three months.
Finance has forecasted total sales of $8,500 based on corporate cash flow requirements,
whereas the total dollar volume for Sales (who forecasted unit sales) is only $7,950
based on what they feel they can sell to their customers. This creates a difference of
$550 that must be resolved.
Scenario: Reaching Consensus - continued
During an S&OP meeting, the team decides that there are many possibilities for resolving
this issue, three of which are:
1. Finance revises its forecast to $7,950
2. Sales increases its forecast by focusing on customer acquisition
o Sales then needs to determine which customer(s) to target during what

month(s)
3. Marketing will run a promotion to stimulate customer demand during the third
month
The S&OP team agrees that all three solutions are viable. However, the third option
exceeds the revenue requirements from finance and should be more thoroughly
evaluated. Using historical sales data and statistical models, Marketing determines that
such promotions usually result in an increase (lift) of demand by 20 percent for each
customer. The sales forecast is then revised as follows:
Hence, the sales forecast matches the finance forecast (the $10 difference is within
tolerance limits), and the one number consensus demand forecast is reached.
Activities of a Demand Planner
Once a consensus demand forecast has been reached and communicated to the rest of
the organization, the demand planner must focus on a number of other crucial activities,
such as the ability to:
Manage by exception
Review ABC classification
Capture metrics to continuously improve forecast
Manage by Exception
Depending on the industry, the total number of SKUs a company plans for could range
from a few hundred to several thousand. From a workflow efficiency perspective,
therefore, companies strive to develop a systematic method of planning "high priority"
SKUs.
Demand planners commonly use exception-based management to organize a large

number of SKUs. Exceptions are generally defined as high volume SKUs that
consistently have high forecast error values. By labeling these SKUs as "high priority,"
demand planners are able to manage the SKUs with highest impact on the business
before the other lower priority titles.
First, a demand planner will establish how much the actual demand may differ from the
forecasted demand for each SKU. This is known as the acceptable deviation. If the
actual demand of the SKU is outside the established acceptable deviations, an exception
is generated for the demand planner to resolve. The demand planner will then resolve the
exception by one of the following three approaches:
1. Reallocating the demand to other SKUs (allocation is discussed later in this

module)
2. Revising the forecast for the SKU, in conjunction with the cross-functional S&OP
team, and aggregating the forecast up the product hierarchy (product hierarchies
are discussed later in this module)
3. Doing nothing because there are some exceptions that the demand planner will
choose to ignore and not attempt to resolve
Review ABC Classification
Another commonly used method of product analysis is known as ABC classification.

Using this analysis, companies identify a small percentage of items that account for a
large percentage of the dollar value of annual sales (Class A items). Studies have
repeatedly shown that in most companies, five to 20 percent of all items account for 55 to
65 percent of sales (Class A); 20 to 30 percent of all items account for 20 to 40 percent of
sales (Class B); and 50 to 75 percent of all items account for only five to 25 percent of
sales (Class C).
Beyond demand planning, ABC classification is used in conjunction with forecast

accuracy metrics and other supply planning parameters to set the safety stock levels for
each SKU. Since the safety stock is used for ensuring a certain service level to the
customers, it is important to ensure that the ABC classification is accurate and current.
Hence, the demand planner is responsible for periodically reviewing the classification of
items, and initiating a reclassification effort if needed.
Capture Metrics to Continuously Improve Forecast
Performance monitoring is a fundamental and necessary part of achieving high marks in

forecast accuracy. In many companies, forecast performance measures are not well
defined, which leads to a lack of motivation to improve forecasting. In other companies,
the greater challenge is to consistently measure, track, and report forecast accuracy
metrics by relevant product families.
Since many groups (Sales, Operations, Finance) are contributing to the final consensus
forecast, it is very important to capture the various adjustments made to a baseline
forecast as it develops over time. Monitoring these inputs as independent contributions
allows for more valuable insight into areas for process improvements, and sometimes to
incentive-based rewards for those groups committed to forecasting accuracy
improvements.
Topic Summary
Demand planning helps a company develop their best estimate of what product
customers will want, how much they will want, and when they will want it. Different
organizational units (Sales, Marketing, Finance, and Manufacturing) will have different
objectives and develop separate demand plans. A good corporate demand plan is one
that, during the sales and operations planning process, incorporates inputs from the
different sources to create a consensus demand plan. The demand planner then
manages the plan by reviewing exceptions, and captures metrics to help continuously
improve the forecast.
Key Concepts in Demand Planning
Overview
Some of the key questions companies seek to answer about the process of forecasting
customer demand include:
How often is the forecast updated?

In what time buckets is the demand forecastweek, month, quarter?
What is the right planning structure to support a corporate demand planning
process?
What is the appropriate level of detail to develop a forecast?
How do we aggregate or allocate the demand forecast throughout the planning
structure?
Key Concepts - Demand Planning Horizons
A company should update the demand forecast for its products based on the type of
demand forecast that is generated, such as:
Strategic Forecast - Used for strategic purposes, this forecast usually spans
several years. Most companies will update their long-term strategic forecast twice
a year or quarterly at most.
Tactical Forecast - Used to understand the demand for the company's products
in the near future, the tactical forecast is generally updated every month as part
of sales and operations planning. For products with long lead-times, the forecast
generated during this horizon is critical to ensure that these special products are
available for customers at the appropriate times.
Operational Forecast - Used to drive the business operations and to understand

immediate and near future demand for the company's products, the operational
forecast is usually updated every week to reflect current market conditions.
Companies who use advanced technology in an environment where speed-to-
decision is key can update the operational forecast more frequently (e.g., every
shift or every few hours).
Key Concepts - Forecast Bucket Granularity
Companies determine whether the demand forecast should predict the demand for each
day, week, month, or quarter. This is referred to as forecast bucket granularity. Buckets
are differentiated as follows:
Quarterly Buckets - Equates to four buckets per year of data. The forecast
number is a quarterly sales figure. Generally this is most useful for forecasting
long-term demand.
Monthly Buckets - Equates to 12 buckets, one for each month of the year.
Monthly buckets are used for forecasting demand on a monthly basis, and the
forecast is generally used for providing visibility into the upcoming near future
demand.
Weekly Buckets - Equates to 52 buckets, one for each week of the year. Weekly
buckets are used for providing visibility into the near-term and the immediate
future demand.
Most companies forecast demand for one year at a time, using smaller buckets for the
near-term quarter, and larger buckets to represent demand that is three or four quarters
in the future. This ensures that they have explicit visibility into immediate future demand,
and aggregated information regarding longer-term demand.
A soda can producer, for example, will forecast the next quarter's demand in 12 weekly
buckets, the following quarter's demand in three monthly buckets, and all future demand
in quarterly buckets.
If a company is forecasting for strategic reasons, they may only use quarterly buckets.
Key Concepts - Planning Structure
As a demand planner moves through the various planning horizons over time, and closer
to the expected customer delivery date, they are challenged to provide more accurate
forecasts at lower levels of detail. In addition, many companies view their data in a variety
of different ways; this capability is also referred to as a multi-dimensional view of data.
Companies organize their data in such a way to have maximum flexibility to view the data
in different dimensions, e.g., total sales by product family, or total sales by sales regions.
They may also use this structure to have the flexibility to aggregate or allocate forecasts
in different ways. To accomplish this, companies utilize product and geographical
hierarchies.
Product Hierarchy
A manufacturer of women's clothing in the apparel industry may define their product
hierarchy in the following way:
Product Family - Trousers
Product Category - Jeans, Casual, Business
Color - Blue, Gray
SKU - Trouser/Jeans/Blue
A product hierarchy can be several layers deep, and it will usually vary from company to
company and from product to product. The lowest layer of a product hierarchy is usually
a SKU. Thus, a blue business trouser would be considered a SKU.
Geographical Hierarchy
Companies also commonly develop a geographical hierarchy, typically used to segment

their customer base. A sample geographical hierarchy might be:
Company - Clothing Manufacturer
Region - Southern, Midwest, West
Location - Dallas, Atlanta, San Francisco
Customer - Store 1, Store 2
The figure depicts a graphic representation of a geographic hierarchy.
Key Concepts - Methods of Forecast Allocation
Since manually entering a forecast for each SKU is cumbersome, companies strive to
find the optimal level of detail at which to generate forecast. If using statistical forecasting
techniques, forecast generation at higher levels of detail reduces model error. Once
aggregate forecasts are generated, demand planners use the product and geography
hierarchies, along with "allocation strategy," to create forecasts at lower levels of detail.
A simplified version of the women's trousers example follows:
Product Family - Trousers
Product Category - Casual, Business
Color - Blue, Black
A company could forecast the sales at any of the levels above and would need to allocate
or aggregate the forecast (depending on the level at which they forecast sales). There
are essentially three methods of allocation and aggregation:
The process of forecasting at a lower level and then aggregating the forecast to a higher
level is known as bottom-up. For the trouser example, a blue casual trouser would be one
SKU.
The company could choose to forecast at the SKU level. In that case, they may need to
aggregate their sales into the different categories and/or family because the product
category manager may be more interested in managing the forecast of each product
category. The product manager, on the other hand, may be more interested in managing
the total sales of all trousers.
The company could choose to forecast at the product category level, i.e., for each week,
they forecast both the number of business trousers and casual trousers they can sell.
For manufacturing purposes, they then have to allocate the forecast to each color. Most
companies use percentages to allocate forecast. For example, the company may have
determined (from historical data) that of the business trousers they sell, 60 percent are
black and 40 percent are blue; of the casual trousers, 60 percent are blue and 40 percent
black.
Similarly, the forecast must be aggregated up to the product family level.
This is known as middle-out.
Middle-Out Forecast
The shaded forecast represents the product category level. The forecast is then allocated
to each SKU, and aggregated up to the product family level.
The company could also forecast its sales at the product family level, i.e., they forecast
the total number of trousers that will be sold during each week. They then use
percentages to allocate the forecast to each product category (e.g., 30 percent business
and 70 percent casual) and then allocate to each SKU. This is known as top-down
forecasting.
Top-Down Forecast
Note that while the two tables appear identical, in the Top-Down Forecast, weekly trouser
sales are the forecasted numbers, whereas in the Middle-Out Forecast, weekly sales of
business and casual trousers are the forecasted numbers.
Topic Summary
Several concepts are important during demand planning to ensure that the company
generates a good demand plan. These are:
Demand Planning Horizons - the frequency at which a company updates the

demand plan for its products
Forecast Bucket Granularity - whether the demand forecast predicts demand

for each day, week, month, or quarter
Level of Forecast - the level at which product and geographical hierarchy

forecasts are generated
Inputs, Techniques and Considerations
Overview
Organizations must consider a number of factors to arrive at an accurate demand plan.

The figure shown illustrates the key inputs and outputs for demand planning.
It is also important for companies to consider appropriate demand forecasting

techniques. Common quantitative approaches include exponential smoothing and
moving averages.
Key Inputs - Historical Sales Data
Companies usually base a customer demand forecast on sales history, using one or
more of the following sources:
Shipments
Many companies do not have access to actual customer sales data, but they do
accurately capture customer shipments. Since it is the most prevalent data available, it is
often used as a starting point for companies to begin forecasting. Companies then use
historical shipment data to forecast future demand (shipments).
Orders
A more accurate representation of actual demand is actual customer orders. Historical
customer order data can be used to forecast future customer orders. This is prevalent in
the consumer product goods (CPG) industry, e.g., a yogurt manufacturer would use
historical order data from customers, such as grocery stores, to forecast future yogurt
demand.
Point-of-Sales Data (POS)

POS data is the most accurate form of actual demand since it is captured at the time a
customer sale is made. This was made popular by diaper manufacturers, who
collaborated with their customers to capture actual diaper sales at the points of sales,
and then used that to forecast future demand.
Generally, a company needs about two years of sales history to capture any trends and
seasonal variations. More data is even better. If sufficient data is not available for
statistical forecasting, a company should immediately start to capture data so that they
can use statistical forecasting in the future.
Key Inputs - Promotions
Promotions are used to increase product sales, but companies must ensure that enough
product is available during the promotion period to avoid losing sales and customers.
Marketing is responsible for determining the timing and the type of promotions run for
products.
Suppose that, due to some advertising promotions in July, a company's demand for a
product increases during August. This is important information for demand planning to
model for several reasons. For instance, if the company does not run a promotion during
July next year, the demand for its products during next August will be lower than the
August demand this year. Alternatively, if the company decides to run the promotion at a
different time of the year, they can use this information to better estimate the anticipated
increase in demand.
Marketing uses many types of promotions, such as:
In-store Coupons
Coupons for items are provided in the aisles where the product is sold. This type of
promotion is very common for food items and other commonly consumed items (e.g.,
toothpaste, soaps, cereal, etc.) found at grocery stores and large drug store chains.
While promotional timing is determined by Marketing, the impact may be based on
historical analysis or the managerial judgment of demand planners.
Buy-One-Get-One-Free
Most commonly used for grocery and other food items, the timing of these events is also
determined by Marketing, but the impact on sales can be based on historical analysis or
managerial judgment.
Mail-in Rebates
Mail-in rebates are a commonly used promotion for several types of items, such as
computer disks, CD ROM disks, televisions, cell phones, tax software, etc. Mail-in
rebates usually require the consumers to purchase a product during a specific time
period. Once again, it is important for demand planners to model the effect of mail-in
rebates on product sales.
Free Standing Inserts (FSI)

Popular in the Consumer Packaged Goods (CPG) industry, a company will offer a free
tenth item in a 9-piece box of cooking utensils, for example. This is referred to as an FSI.
Once again, such promotions are usually run for very specific and short time periods, and
the impact on sales is taken into account in the forecasting models.
Model Close Out

As the life cycle for a model comes to an end, companies may offer incentives for their
distributors to push product to customers.
Quantity Discounts
Often companies will offer their distributors quantity discounts if they purchase product in
large quantities. This type of promotion generally generates a significant amount of
demand activity during the promotion period. If not accounted for during demand
planning, it may lead to a serious efficiency in the supply.
Key Inputs - Causal Factors
Sales of certain products are influenced by some external factors. For example, the sales
for beer will increase during a period when the weather prediction is for unseasonably
higher temperatures. If a company can model the effect of temperatures on the sales for
beer, the results from their forecasting model will be more accurate. Other causal factors
include sporting events such as the World Cup Soccer Tournament.
For many items, sales increase or decrease during specific times of the year. For
example, ice cream sales will usually soar during hot summer months, candy sales will
increase around holidays, and snow blower sales will increase during cold winter months.
On the other hand, ice cream sales are likely to dip during those same cold winter
months.
There are a number of statistical techniques used for forecasting the sales for products
with seasonal variations. Demand planners need to ensure that if seasonal effects are
suspected for a particular product, they include sufficient data to capture past seasonal
effects. This usually translates to at least two years of data.
Additional Considerations
There are additional inputs that the demand planner may take into account while
developing a demand plan. We classify these as additional considerations:
New Product Introductions

Substitute Products
Complementary Products
Collaborative Inputs
Lag Analysis
Additional Considerations - New Product Introductions
Statistical forecasts are usually based on historical data. In the case of new product
introductions, where there is no sales history, companies often analyze items similar to
the new product, and use their demand patterns as a gauge for the demand pattern of
the new productreferred to as like-item analysis. Marketing usually provides inputs to
demand planners who compare product characteristics, features, functions, price, etc.
Demand planners then use historical data and forecasting models for "like-items" to
develop forecasting models for the new product introductions.
As new products are introduced, some products are phased out. The complete cycle of a
product (from introduction to phase-out) is known as the product life cycle. During
demand planning, planners must also consider product phase-out, which leads to the
idea of product life cycle planning. The demand for products at the end of their cycles
may decrease rapidly, and planners must use like-item analysis to determine how quickly
the demand deteriorates.
Additional Considerations - Substitute Products
Companies offer substitute products, as alternatives to buyers, that satisfy a common set
of basic needs (as the original product), but that differ slightly in their specific
characteristics. For example, a manufacturer may offer four models of a dishwasher,
each of which has slightly different features and is offered at a slightly different price.
While modeling the behavior for substitute products is a challenging assignment, it will
enhance the accuracy of a company's modeling results.
Similar to forecasting demand for new product introductions, planners must analyze items
similar to the substitute product to forecast demand. However, the difficulty here is the
fact that substitute products are usually very similar to each other, and the demand for
one product affects the demand for another product. Thus, a demand planner may have
to analyze the demand patterns to understand the correlation in the demand patterns for
one or more substitute products. As in the case above, like-item analysis is conducted by
comparing product characteristics such as features, functions, and price. Marketing
usually provides such inputs to demand planners who then use historical data and
forecasting models for like-items to develop forecasting models for substitute products.
Additional Considerations - Complementary Products
Two products are said to be complementary when the purchase of one product increases
the likelihood that the second will be purchased. An increase in the sales of cell phones,
for instance, impacts the sales of earphones and travel chargers used with the cell
phones. Earphones and travel chargers would thus be considered complementary to cell
phones. A forecasting model can be enhanced significantly if, in the forecasting model for
earphones and travel chargers, a company could model the effect of cell phone sales.
Additional Considerations - Collaborative Inputs
Some leading companies use collaborative input from their trading partners to further
enrich their demand planning models. Collaboration involves the strategic and tactical
sharing of information between trading partners for the purpose of developing a joint plan
of action, and then working together to execute that plan. The objective of collaboration is
to eliminate inefficiencies with trading partners by sharing information and integrating
processes. For demand collaboration to be effective, vendor and customers jointly
develop a business plan. They collaborate on demand forecast, promotions, and order
forecast, and generate purchase orders (customer) and sales orders (vendor). Before
developing the demand forecast for a business, partners share information such as:
What their customers, e.g., retailers, think they can sell to consumers
What color(s) of sweaters are popular at a particular mall, and which ones are
still sitting on the shelf
Additional Considerations - Lag Analysis
Marketing promotions and advertisement campaigns impact sales, but not immediately.
Usually, there is a lag between the time an ad campaign runs and the time companies
see an actual increase in sales. To accurately model this, planners must determine how
many time periods in the past have a significant influence on the present, as well as what
the weight of each past period is relative to the other periods. For example, planners will
decide whether or not advertising levels from more than three months ago will be used to
determine present sales; their effects may no longer be important given more recent
advertising levels and impacts.
Overview of Forecasting Techniques
There are many different forecasting methods and techniques frequently used by
companies. We will discuss two common methods companies use:
Qualitative Methods - The process of forecasting demand based on "market

feel." Planners have historically forecasted demand using their judgment and
factors such as:
o Promotions - Planners may know from experience that a marketing

promotion usually increases the demand for their product by about 15
percent, and they model the effect of promotional activity based on this
information.
o Causal Factors - Planners may also use their judgment to determine the
impact of other causal factors, e.g., the impact that temperatures have
on the sales of beer during a hot summer holiday weekend.
o Manual Forecasts - Some companies may simply use their sales

organization's estimates to develop a forecast.
Quantitative Methods - The process of using statistical methods to forecast

customer demand. While there are many different statistical forecasting
techniques, we limit our discussion to the two simplest ones:
o Exponential smoothing
o Moving averages
Companies also use variations of these quantitative methods to forecast the effect of
seasonality.
Quantitative Forecasting Techniques - Exponential Smoothing
The most basic form of exponential smoothing is simple exponential smoothing. This is
useful when companies don't expect significant seasonal variations, trends, or other
cyclical variations. This technique simplifies forecasting calculations and has small data
storage requirements.
The simple exponential smoothing procedure creates a forecast based on a weighted

calculation, combining the most recent period's actual demand and forecast numbers,
using the formula:
Forecast (t+1) = *Actual (t) + (1- )*Forecast (t)
The smoothing factor (a) is a number between 0 and 1 that changes the weight on the
last period demand versus the last period forecast (higher a will give more weight to
recent actual demand rather than the forecast). The smoothing factor is chosen by the
planner, and can be revised as market conditions change. If the planner feels that recent
actual demand trend will continue, a should be closer to 1. If the actual demand has
significant variations in recent periods, the smoothing factor will most likely be reduced to
dampen the variation.
For example, assume that the sales data for soda cans for certain periods is given as
shown. The forecast for period 3 is then given by:
Forecast (3) = *Actual (2) + (1- )*Forecast (2)
In this example, we use a value of a equal to 0.20. Thus,
Forecast (3) = .2*4910 + .8*4890 = 4894
Using this method, we can forecast the sales for each time period.
The graph shows the relative accuracy of the forecasting model compared to actual
sales.
Quantitative Forecasting Techniques Moving Average
The moving average method calculates the next period's forecast based on a simple
average of some previous periods. Suppose that a company has sales of 200, 250, and
300 for the first three months (Jan, Feb, and March) of the year. The sales for April would
thus be computed as (200+250+300)/3, which is 250.
There are no rules about the number of periods used in computing this average. The
planner usually determines this by trying different numbers and determining the one that
best fits the data.
As an example, let's consider the sales data for the soda cans again. In the attached
table, we compute the forecasted sales for each period based on averaging three and
four periods respectively. The forecasted values for the two different averaging periods
are similar, but it appears that the three-period moving average is a slightly better
estimate of the actual sales than the four-period moving average.
Topic Summary
A forecast for customer demand is usually based on sales history, which could consist of
shipment history, order history, or point-of-sales information. The effect of several other
factors can enhance the forecast, including:
Promotion Plans - Marketing is usually responsible for determining the timing

and the type of promotions.
Causal Factors - External factors, such as seasonality, that affect the forecast of
a product.
New Product Introductions - The forecast for new products is based on a like-
item analysis. New products may also impact the sales forecast of older
products.
Substitute Products - Available alternatives to the product that is forecasted.
Complementary Products - Represent products where the purchase of one

product increases the likelihood that a second will be purchased.
Collaborative Inputs - Using input from trading partners.
Lag Analysis - Considering the effect of a lag between the times at which an ad
campaign is run and actual increase in sales.
There are two common methods that companies use to forecast demand:
Qualitative Methods - Based on "market feel."
Quantitative Methods - Based on statistical models. There are many such

modelsthe two most common ones are:
o Exponential smoothing
o Moving averages
Demand Planning Process
The Demand Planning Process
The demand planning process allows a company to create a single demand plan across
the organization. Often, organizational units within a company will have different
objectives and viewpoints, and consequently develop separate demand plans. The
demand planning process results in a single plan that is visible and usable by the entire
organization, and can assist in balancing these different plans and objectives. Press the
arrow below for more information.
A Demand Planning Case Study
Consider a company that has three customers, C1, C2, and C3. They manufacture two
products, products A and B, which both belong to a single class, Class 1. The company
typically forecasts demand for their products at the class level and then disaggregates
the forecast to product A and product B using percentages. The revenue from each unit
of product A is $2, and the revenue from each unit of product B is also $2.
In addition, the company has just introduced a new Class 2 product, product C, for which
they also need to forecast demand. The revenue from each unit of product C is $12.
Planners generally forecast demand quarterly, forecasting for the next three months in
monthly buckets.
Case Study - Create Baseline Forecast
Using historical orders for the next three months for each of the three customers, the
demand planner generates a statistical forecast for Class 1.
The forecast is then disaggregated for each of the products with 60 percent of the
forecast allocated to Product A, and 40 percent to Product B.
Using like-item analysis (and modeling the demand for the new product based on the
demand pattern for a similar product), the demand planner forecasts the demand for
product C for the next three months for each of the three customers.
Case Study - Create Functional Forecasts
Next, each of the functional areas will create their own forecasts that can be compared to
the Baseline Forecast created by the demand planner. See below to view the Sales &
Marketing, Financial, and Manufacturing Forecasts.
SALES & MARKETING FORECASTS

Sales and Marketing, and Finance also generate their own forecasts. Based on
discussions with customers and customers historical buying patterns, Sales and
Marketing work together to generate a forecast for each customer.
FINANCIAL FORECASTS
Finance generates a dollar forecast that reflects the financial targets for the company.
MANUFACTURING CAPABILITY FORECAST
At the same time, Manufacturing projects what they can produce during each of the
months, referred to as Manufacturing Capabilities.
Case Study - Reaching Consensus - Identify Discrepancies
A company's demand planner is puzzled by the fact that the statistical forecast (baseline)
during the third month is so much lower than the forecast by Sales and Marketing. She
decides to consult Sales and Marketing to resolve the discrepancy.
Solution
Upon consulting with Sales and Marketing, she learns that the reason for the high
forecast during the third month is that Sales and Marketing intends to run a promotion
that will impact sales during that month. She requests the promotional plan details from
Sales and Marketing to prepare a new baseline forecast.
Case Study - Reaching Consensus - New Baseline Forecast
After obtaining the promotional plan details from Sales and Marketing, the demand
planner uses historical data from a similar promotion and creates a demand-planning
model (i.e., Promotional Forecast) that models the anticipated lift in sales.
The Promotional Forecast replaces the original Baseline Forecast as the new Baseline
Forecast.
Case Study - Reaching Consensus - Adjusted Forecast
While further analyzing the new Baseline Forecast, the demand planner wonders why the
forecast for C2 is always higher than the corresponding forecast by Sales and Marketing.
She decides to adjust the baseline to reflect the numbers that Sales & Marketing is
forecasting. This creates a new demand plan, referred to as the Adjusted Forecast.
Adjusted Forecast
Based on changes made to the Baseline Forecast to adjust the forecast for C2, as noted
in the previous paragraph, the revised Baseline Forecast is revised again to become the
Adjusted Forecast.
Case Study - Reaching Consensus - Confirm Manufacturing Capabilities
The demand planner is now satisfied with the forecast. However, one issue still remains
to be resolved. Although the demand forecasts by the demand planner, Sales and
Marketing, and Finance are very close, Manufacturing is unable to meet the requirements
for Class 1 products. The forecast is for 60,000 units, but Manufacturing can only build
18,000 units per month for a total of 54,000 units.
Noticing this discrepancy, Manufacturing discussed this with Procurement and together
they have identified a vendor who is willing to supply 2,000 units/month of Class 1
products for three months at a cost of $1.60 per unit. While Manufacturing can
manufacture the Class 1 products at a cost of $1.50 per unit, Finance finds this
arrangement acceptable. The company agrees to outsource 6,000 units of Class 1
products to the vendor in spite of the lower margins this will generate. This is reflected in
the Final Demand Plan.
Case Study - Publish Demand Plan
Demand planners communicate the final demand plan to the executive team, bringing to
their attention the outsourcing decision and reduced margins. The executive team agrees
with the final demand plan and then publishes and distributes it to the rest of the
organization.
Case Study - Review Forecast - Manage Exceptions
During the month, actual sales data starts coming in, and the demand planner notices
that sales for Product C are much higher than expected, and those for the Class 1
products (Products A and B) are much lower than expected.
The demand planner discusses this trend with Sales and Marketing, who informs her that
Ultra Corp., a competitor for Class 1 products, has announced the release of a newer set
of Class 1 products with enhanced features and functionality. As a result, many
customers are waiting for the new product to hit the market.
Case Study - Review Forecast - Manage Exceptions
Since Ultra expects to capture a significant portion of the market for the Class 1 product,
they are delaying the launch of their product that competed with Product C in addition to
releasing the enhanced product that will compete with Class 1 products. Hence the sales
for Product C have increased whereas the sales for A and B have decreased.
Using this market intelligence, the demand planner updates her demand-planning model
and creates a revised forecast for Months 2 and 3, referred to as the Market Intelligent
Forecast.
Note: The numbers for M1 are the actual orders, and the numbers for M2 & M3 are the
revised forecast.
Case Study - Finalize Revised Plan
The Market Intelligent Forecast is acceptable to everyone except for Manufacturing, who
cannot meet the combined requirements for Products A, B, and C. The demand planner
points out that the contract with the vendor for Products A and B is still in effect, which
means that Manufacturing does not have to manufacture all the requirements for
Products A and B. Manufacturing analyzes their final requirements and agrees to the
plan.
The executive team approves the Final Revised Plan, and publishes and circulates it to
the rest of the organization.
Metrics Demand Planning
Overview
Companies monitor the "health" of their supply planning processes using a variety of
metrics, including:
Metrics to ensure process is being followed

Metrics used to measure supply chain effectiveness
An organization that implements an effective demand planning process will obtain a

consolidated view of customer demand that, together with effective procurement,
manufacturing, and fulfillment functions, increases shareholder value.
Demand Planning Process Control
The goal of planning is to trust and use the process-generated plans, and to minimize the
number of manual changes to those plans. This ensures that an organization can
maximize the value of their investment in supply chain initiatives.
Companies use the number of manual overrides as a crucial metric to monitor whether
they have sufficient control of the planning processes. This metric measures the number
of occurrences in which plans have been manually revised, and identifies the level of
intervention in the planning process.
A high level of intervention may indicate that there are process, organizational, or training
issues that need to be resolved.
Demand Planning Effectiveness Oriented Metrics
Companies engage in demand planning to improve their supply chain effectiveness. To

that end, forecasting accuracy is frequently used to measure demand planning
effectiveness.
Forecast accuracy, and conversely, forecast error, are key drivers of product
availability, customer service, cost, and inventory levels. In measuring forecast error,
companies must also look for what is called forecast bias. Bias is the tendency for a
forecast to be consistently "off" in the same direction. When present, forecast bias
indicates there is a problem with one or more data inputs, or the process itself. Bias is
often injected when an organization attempts to manipulate a forecast to match a
functional goal, such as a sales objective or a manufacturing volume commitment. A high
bias will drive increased inventories in proportion to lead-times, while a low bias will hurt
product availability, and ultimately, revenues.
While there are many ways to measure the accuracy of the demand planning process,
we will discuss the following metrics:
Mean Absolute Percent Error (MAPE) and Weighted Mean Absolute Percent
Error (WMAPE)
Percent Hit or Miss
Mean Squared Error (MSE)
Metric for Forecast Accuracy - MAPE/WMAPE
The most common and effective measure of forecast accuracy is mean absolute
percent error (MAPE). MAPE has the advantage of being relatively easily to understand
and correlate with business results. The formula for MAPE is generally applicable across
groups of items, e.g., to evaluate forecast accuracy for the most recent period. It is
important to note, however, that all errors are weighted equally. This means that a large
error on a low-value item can skew the overall measure.
For the above reason, some companies prefer to use a weighted mean absolute
percent error (WMAPE). Typically, item cost or revenue is used as the "weight." With
the formula for WMAPE, those items driving the largest weighted volume have the
greatest impact on the error measurement. WMAPE has the added benefit of being
highly correlated with safety stock inventory requirements, making it easy to relate
performance on this measure to business performance.
Metric for Forecast Accuracy - Percent Hit or Miss
The purpose of percent hit or miss is to measure the accuracy of forecast generated
during supply chain planning prior to any manual intervention. This KPI measures the
percentage of hits against the total number of SKUs for each SKU class. This is
accomplished by:
Assessing forecast error against a specified allowable tolerance.
Measuring the accuracy of the SCP forecast against actual demand by SKU, and
aggregating the demand for all SKUs within a class.
Classifying each SKU using ABC Classification to determine the SKU class.
Each SKU class has an assigned allowable tolerance for the forecast error.
Forecasts within the tolerance are recorded as a hit.
Metric for Forecast Accuracy - MSE
Mean Squared Error (MSE) is a measure that summarizes the variability of the forecast
errors. Forecast error is the difference between the actual value and the forecasted
value.
MSE is also important to capture because it is used by supply planning for safety stock
calculations. MSE is calculated based on actual values and forecasted values.
Demand Planning Influences on Shareholder Value
Forecast accuracy, or conversely, forecast error, are key drivers of product availability,
customer service, cost, and inventory levels. When a company is able to forecast
demand accurately, they are able to set lower inventory safety stock levels while
maintaining the same customer service level. This eventually leads to an increased
number of inventory turns as well as reduced work in process inventory, finished goods
inventory, and inventory-carrying costs.
A more accurate demand forecast also leads to increased product availability for
customers. This increases customer service levels, and results in lower costs for fulfilling
customer orders because fewer customer orders will need to be expedited. Furthermore,
less expediting also leads to reduced manufacturing and distribution overtime, as well as
reduced FTEs in the supply chain management function.
It is important for companies to identify expected benefits, set a baseline, and then
measure the benefits relative to that baseline and to industry standards. This will
demonstrate the value of the demand planning initiatives and activities, and provide
justification for further improvements in demand planning or other supply chain planning
areas if industry standards are not being achieved.
Topic Summary
Performance monitoring is fundamental to achieving a highly effective demand planning

process. The best companies define a set of measurements to measure forecast
effectiveness and use these measures to help them improve their forecasting models.
There are many ways to measure the performance of the demand planning process,
such as:
Mean Absolute Percent Error (MAPE), and Weighted Mean Absolute Percent
Error (WMAPE)
Percent Hit or Miss
Mean Squared Error (MSE)
Number of manual changes
A more accurate demand forecast leads to lower safety stock levels and increased
product availability for customers. This increases customer service levels, and results in
lower costs for fulfilling customer orders because fewer customer orders will need to be
expedited. These benefits ultimately translate into increased shareholder value.
CONCLUSION
Course Summary
Demand planning helps a company develop their best estimate of what product
customers will want, how much they will want, and when they will want it. A good
corporate demand plan is one that, during the S&OP process, incorporates inputs from
the different sources to create a consensus demand plan. The demand planner then
manages the plan by reviewing exceptions, and captures metrics to help continuously
improve the forecast.
Several concepts are important during demand planning to ensure that the company
generates a good demand plan, including demand planning horizons, forecast bucket
granularity, and the level of forecast. A forecast for customer demand is usually based on
sales history. Other factors, such as causal factors and lag analysis, can enhance the
forecast.
Performance monitoring is also fundamental to achieving a highly effective demand

planning process. The best companies use measures, such as MAPE and percent hit or
miss, to measure forecast effectiveness and then use this information to improve their
forecasting models.
A more accurate demand forecast leads to lower safety stock levels and increased
product availability for customers. This increases customer service levels and results in
lower costs to fulfill customer. These benefits ultimately translate into increased
shareholder value.

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SUPPLY CHAIN PLANNING: DEMAND

The primary business issues addressed by demand planning include:

Demand, supply, production, and fulfillment planning operate as interdependent SCP

After completing this module, you should be able to:

Describe the purpose, objectives, and benefits of demand planning

Describe the demand planning process and identify the stakeholders

Describe key concepts related to demand planning activities, including planning

Define demand forecasting techniques

Describe the measurements and metrics for demand planning

Demand planning helps a company develop their best estimate of:

What customers will want

1. Finance revises its forecast to $7,950

2. Sales increases its forecast by focusing on customer acquisition

o Sales then needs to determine which customer(s) to target during what

Demand planners commonly use exception-based management to organize a large

1. Reallocating the demand to other SKUs (allocation is discussed later in this

Another commonly used method of product analysis is known as ABC classification.

Beyond demand planning, ABC classification is used in conjunction with forecast

Performance monitoring is a fundamental and necessary part of achieving high marks in

How often is the forecast updated?

Operational Forecast - Used to drive the business operations and to understand

Product Family - Trousers

Product Category - Jeans, Casual, Business

Color - Blue, Gray

Companies also commonly develop a geographical hierarchy, typically used to segment

Company - Clothing Manufacturer

Region - Southern, Midwest, West

Location - Dallas, Atlanta, San Francisco

Customer - Store 1, Store 2

The figure depicts a graphic representation of a geographic hierarchy.

A simplified version of the women's trousers example follows:

Product Family - Trousers

Product Category - Casual, Business

Color - Blue, Black

Similarly, the forecast must be aggregated up to the product family level.

This is known as middle-out.

Demand Planning Horizons - the frequency at which a company updates the

Forecast Bucket Granularity - whether the demand forecast predicts demand

Level of Forecast - the level at which product and geographical hierarchy

Organizations must consider a number of factors to arrive at an accurate demand plan.

It is also important for companies to consider appropriate demand forecasting

Point-of-Sales Data (POS)

Marketing uses many types of promotions, such as:

Free Standing Inserts (FSI)

Model Close Out

New Product Introductions

Qualitative Methods - The process of forecasting demand based on "market

o Promotions - Planners may know from experience that a marketing

o Manual Forecasts - Some companies may simply use their sales

Quantitative Methods - The process of using statistical methods to forecast

The simple exponential smoothing procedure creates a forecast based on a weighted

Forecast (t+1) = *Actual (t) + (1- )*Forecast (t)

Forecast (3) = *Actual (2) + (1- )*Forecast (2)

In this example, we use a value of a equal to 0.20. Thus,

Forecast (3) = .2*4910 + .8*4890 = 4894

Promotion Plans - Marketing is usually responsible for determining the timing

Substitute Products - Available alternatives to the product that is forecasted.

Complementary Products - Represent products where the purchase of one

Collaborative Inputs - Using input from trading partners.

Qualitative Methods - Based on "market feel."

Quantitative Methods - Based on statistical models. There are many such

SALES & MARKETING FORECASTS

Metrics to ensure process is being followed

Forecast (t+1) = Actual (t) + (1- )Forecast (t)

Forecast (3) = Actual (2) + (1- )Forecast (2)

Forecast (3) = .24910 + .84890 = 4894