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1
Agenda
• Forecasting,
• Factors influencing Demand
• Basic Demand Patterns
• Basic Principles of Forecasting
• Principles of Data Collection
• Basic Forecasting Techniques, Seasonality
• Sources & Types of Forecasting Errors
Forecasting can be conducted at
various levels
Required for Examples
• Product life cycle • Product line transitions
• Long-term capacity • Annual volume out
planning 3-5 years
• Capital asset/equipment/ • Buy/build/lease
Strategic human resource decisions
management
3
Role of Forecasting in Supply Chain,
• Basis for Strategic & Planning Decisions in SCM
• Decisions needing Forecast as Base
• Production
- Scheduling
-Inventory Control
-- Aggregate Planning
- Purchasing
• Marketing
-Allocation of Sales-Force
-- Promotion Activities
-- New Product Launching
• Finance
-Plant & Equipment Investment
-- Budgetary Planning
• HR
-Workforce Planning
-- Recruitment
3
- Lay-Offs
Forecasting Impact Directly impacted by
demand management
Demand management
Sales
history/ Forecasting Demand planning Sales and operations
orders planning
Production management
Aggregate planning
Distribution management
Master production
Inventory management scheduling (MPS)
BOM
Materials requirement inventory
planning (MRP) routing
Capacity requirements
Distribution/transport planning (CRP)
network
Production
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Higher forecast accuracy improves
service levels at lower inventory
Percent
Monthly average forecast error Reducing forecast error
100 Excellent Far Poor will permit
20% 40% 50%
1 Reduced inventory to a given
99 1
3 service level
2
2 Increased service level for a
98 given inventory level
3 Both reduced inventory and
97 improved service level
96
95
0
94
2 4 6 8 10 12
Required average inventory
Weeks
Forecasting error must be measured at different
levels
Forecasting error
Percent Forecasting tips
Mean forecasting error • Measure forecasting error as the
mean absolute percent error
60
Model Calculation/description
Simple • Last year plus percent • Last year‟s same period demand* increased by a flat
percentage
* Demand can be sales, shipments, orders depending on what works best and data available
8
Regression-based forecasting on high-promotion
items Fiscal year 1
Fiscal year 2
Fiscal year 3
National cases shipped/week – ketchup example
90,000
Off-invoice
80,000 promotions
20,000
10,000
9
Forecasting implementation requires three success
factors
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Characteristics of demand
Sources of demand
- Customers
- Spare parts
- Promotions
- Intra-company
- Test samples
- Others…
All the sources of demand must be
identified.
Characteristics of demand
Factors influencing demand
- General business and economic conditions
- Competitive factors
- Market trends
- Firm‟s own plans
- Government regulations
- Technology changes
- Others…
Characteristics of demand
Components of demand
- Trend 40
- Seasonality 35
30
- Random variation 25
20
- Cyclical variation 15
10
5
0
2002 2003 2004 2005
Q1 Q2 Q3 Q4
6
Characteristics of Demand
Trend
Seasonal Demand
Time 7
Characteristics of Demand
Dynamic
Stable
Average Demand
Time 8
Characteristics of demand
Demand Patterns
- Stable versus Dynamic
> Stable demand has certain general pattern over time
> Dynamic demand tends to be erratic
10
Characteristics of demand
Why Forecast?
• Before making plans, an estimate must be made of what
conditions will exist over some future period
• Most firms cannot wait until orders are actually received
before they start to plan what to produce
• Manufacturers must anticipate future demand and plan
to provide the capacity and resources to meet the
demand
• Firms that make standard products need to have salable
goods immediately available / with shorter delivery time
• Firms that MTO, must have labor and equipment to meet
demand
11
Working without Forecast
DemandForecasting Model 12
Principles of Forecasting and Data
Collection
Forecasts..
- Are rarely 100% accurate over time
- Should include an estimate of error
- Are more accurate for product lines and families
- Are more accurate for nearer periods of time
14
Qualitative Techniques
• Are based on intuition and informed opinion
• Tend to be subjective
• Are used for business planning and
forecasting for new products
• Are used for medium-term to long-term
forecasting
15
Quantitative Techniques
• Based on historical data usually available in
the company
• Assume future will repeat past
16
Extrinsic Techniques
• Based on external indicators
• Useful in forecasting total company demand
or demand for families of products
17
Forecasting Techniques
Moving Average: (Quantitative, Intrinsic)
3-period moving average
Period Demand Simple Weighted
1 265
2 240
3 295
4 265 267 281
5 310 267 269
6 285 290 300
7 304 287 288
8 312 300 301
9 328 300 308
10 299 315 322
11 313 306
Period Weightage
-3 0.1
-2 0.2
-1 0.7
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Forecasting Techniques
Moving Average: (Quantitative, Intrinsic)
• Lags the actual sales. More the number of
previous periods included, more is the lag
• Can be used to filter out random variation
• If a trend exists, it is hard to detect
• Calculations become cumbersome when
dealing with many time periods. More data
storage required
19
Problem 1
• Over the past three months, the demand for a
product has been 255,219 & 231.Calculate the
three month moving average forecast for month
4
• If the actual demand in month 4 is 228,calculate
the forecast for month 5
Answer
Moving Average Demand for 3 months= (255+219+231)/3
= 705/3
= 235
Moving Average for fourth month= (219+231+228)/3
=678/3
=226
Forecast for month 5 is 226
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Forecasting Techniques
Exponential Smoothing : (Quantitative, Intrinsic)
Period Demand Forecast (FT+1) = FT + alpha (DT - FT)
( FT )
alpha
(T) ( DT ) 0.1 0.5 0.9
Answer
In Exponential smoothing, forecast is calculated by formula
(FT+1) = FT + alpha (DT - FT)
= 122 + 0.15( 135-122)
= 122 + 1.95
= 123.95 say 124
23
Seasonality
Key concepts:
- Seasonality is variation in demand based on
the season.
- Seasonality may be annual, monthly, or even
daily!
- „Seasonal Index‟ is a measure of seasonal
variation. Period average sales
- Seasonal Index =
Average sales for all periods
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Seasonality
Forecasting with Seasonality:
- Historical data is influenced by seasonality;
hence can‟t be used „as-it-is‟ for forecasting
- Following steps are necessary:
# Deseasonalize historical data
# Forecast deseasonalized demand
(Baseline Forecast)
# Calculate the seasonal forecast by
applying the Seasonal Index to the
base forecast.
26
Problem 4
Month Average Demand Seasonal Index Forecast
January 30
February 50
March 85
April 110
May 125
June 245
July 255
August 135
September 110
October 90
November 60
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December 30
Month Monthly Seasonal Index New Av. Forecast
Demand Demand
January 30 0.27 166.67 45.28
February 50 0.45 166.67 75.47
March 85 0.77 166.67 128.30
April 110 1.00 166.67 166.04
May 125 1.13 166.67 188.68
June 245 2.22 166.67 369.81
July 255 2.31 166.67 384.90
August 135 1.22 166.67 203.77
September 110 1.00 166.67 166.04
October 90 0.82 166.67 135.85
November 60 0.54 166.67 90.57
December 30 0.27 166.67 45.28
Total 1325 2000.00
Average Sales for Month= 110.42
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Tracking the Forecast
Limitations of forecasts:
- For several reasons, forecasts tend to go wrong.
- We need methods to know how good the
forecasting method is.
- „Tracking‟ is the process of comparing actual
demand with the forecast
- Forecast Error is the difference between actual
demand and forecast demand
- Error can occur in two ways:
# Bias
# Random Variation
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Bias
Bias exist when the cumulative Actual Demand
varies from Cumulative Forecast
Month Forecast Actual
Monthly Cumulative Monthly Cumulative
1 100 100 110 110
2 100 200 125 235
3 100 300 120 355
4 100 400 125 480
5 100 500 130 610
6 100 600 110 720
Total 600 720
30
Bias
FORECAST
ACTUAL DEMAND
MONTHS 31
Random Variation
In a period actual demand will vary against
average demand based on Demand pattern
Month Forecast Actual Variation
(Error)
1 100 105 5
2 100 94 -6
3 100 98 -2
4 100 104 4
5 100 103 3
6 100 96 -4
Total 600 600 0 32
Random Variation
FORECAST
100
98 96
94
ACTUAL
MONTHS 33
Tracking the Forecast
Bias:
- Bias is a systematic error in which the actual
demand is consistently above or below the
forecast demand
- When bias is noticed, forecasting method
should be changed to improve the forecast
accuracy
- For a unbiased forecasting method, the
Cumulative Sum of Errors (CSE) will be zero
34
Tracking the Forecast
Bias: (Illustration)
Period Forecast (F) Actual Sales Error
Interpretation:
1 1000 1200 200
The bias (Average CSE) indicates
2 1000 1000 0
that the there is an underforecast /
3 1000 800 -200 positive bias of 20 per period.
4 1000 900 -100
9 1000 1000 0
Cumulative Sum
10 1000 900 -100 of Errors (CSE)
Total 10000 10200 200
35
Forecast Error Measurement
• Mean Absolute Deviation
• Normal Distribution
36
Mean Absolute Deviation
• Forecast Error must be measured before it is
used for planning or to revise the forecast
• Mean Absolute Deviation ( MAD) commonly
used for Error Measurement
• Mean implies Average
• Absolute means without reference to plus or
minus
• Deviation refers to the Error
• MAD= Sum of Absolute Deviations
Number of Observations
in Earlier case,
MAD = 5+6+2+4+3+4 = 24 = 4
6 6 37
Normal Distribution
38
Use of MAD
• Tracking Signal
- to monitor Quality of Forecast
• Tracking Signal= Algebraic Sum of Forecast Errors
MAD
• Past Six Month Consumption is - 105,110,103,105,107,
and 115 ,where Forecast is 100 per month.
• If MAD is 5
• Tracking Signal =(5+10+3+5+7+15)/5
= 45/5
=9
• Contingency Planning
- Manufacturing Department can devise contingency
plan for Capacity Utilization based on information
regarding MAD of Forecast
• Safety Stocks
- Demand Variation is to be guarded by Safety Stocks 39
with Inventory Investment Decisions
Tracking the Forecast
Mean Absolute Deviation (MAD):
- MAD is a measure of random variation.
- It measures the total error irrespective of the
direction
- For a normally distributed random variation,
Standard Deviation (Sigma) = 1.25*MAD
- MAD can be used to determine:
# Tracking Signal
# Safety Stock
40
Tracking the Forecast
Tracking Signal:
- It is difficult to determine whether the variation
is due to bias or random variation.
- If the variation is due to random variation, the
error will correct itself.
- If the variation is due to bias, the forecasting
method needs to be corrected.
- A tracking signal can be used to monitor the
quality of the forecast.
42
Tracking the Forecast
Tracking Signal: (Illustration)
Period Forecast Sales Abs. Deviation CSE
CSE
T W T W T W Tracking Signal =
5 1000 1400 1400 400 400 300 700 Tracking Signal (T) = 160
6 1000 1200 1200 200 200 500 900 = 1.25
7 1000 1100 1100 100 100 600 1000
1200
8 1000 700 1300 300 300 300 1300
A tracking signal between +/- 4 means that the forecast is matching the
actual data received.
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Tracking the Forecast
More about forecasts…..
- Forecasts forecast average demand
- Forecasts ignore random variations
- Forecasting methods need to be continuously tracked
and improved
- Multiple forecasts should be avoided in a supply
chain
- If forecasting does not happen at right place,
someone else is forced to do it
- Certain operations are most affected by the forecast
errors; postpone them as much as possible
- The main aim of all the forecasting methods is to beat
the naïve forecast
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Thank You
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