FORECASTING DEMAND

Why Forecasting of Demand?

Forecasting is necessary for planning, scheduling and

controlling the production system in order to deliver
goods and services effectively and efficiently.
A demand forecast should be based on a time series of
past demand rather than sales. Sales would not truly
reflect demand unless demand was less than the
amount of a good or service available for sale.

Why Forecasting of Demand? (Contd)

The basis for all planning decisions

Examples:
Production: aggregate planning, scheduling, materials
planning and inventory control
Marketing: sales force allocation, promotions, new
production introduction
Finance: plant/equipment investment, budgetary planning
Personnel: workforce planning, hiring, layoffs

All of these decisions are interrelated

Field Of Application

Process Design
Capacity and facilities planning
Aggregate Planning
Scheduling
Inventory Management

Forecasting Methods

Qualitative Models: Subjective, based on intuition,

estimates and opinions
Time Series: Based on the assumption that history can
be used to predict the model.
Causal Models: Attempts to understand the environment
underlying and surrounding the item being forecast.

Qualitative Models
Delphi Method

Developed at RAND Corporation in the 1950s to

help capture the knowledge of diverse experts
while avoiding the disadvantages of traditional
group meetings

To forecast with Delphi the administrator should

recruit between five and twenty suitable experts
and poll them for their forecasts and reasons

The administrator then provides the experts with

anonymous summary statistics on the forecasts,
and experts reasons for their forecasts

The process is repeated until there is little change

in forecasts between rounds two or three rounds
are usually sufficient. The Delphi forecast is the
median or mode of the experts final forecasts.

Qualitative Models
Historical Analogy

The outcomes of similar situations from the past

(analogies) may help a marketer to forecast the outcome
of a new (target) situation.

The structured-analogies method uses a formal process to

overcome biased and inefficient use of information from
analogous situations.

To use the structured analogies method, an administrator

prepares a description of the target situation and selects
experts who have knowledge of analogous situations;
preferably direct experience.

The experts identify and describe analogous situations,

rate their similarity to the target situation, and match the
outcomes of their analogies with potential outcomes in
the target situation

The administrator then derives forecasts from the

information the experts provided on their most similar
analogies.

Qualitative Models
Nominal Group Technique
This technique was developed by Andrew Van de Ven a
Wharton professor. It is a structured problem solving and
decision making method.
The steps involved are:
a. Generation of ideas
b. Round robin collection of ideas
c. Discussion
d. Preliminary voting
e. Final voting

Time Series -Simple Moving Average (SMA)

A SMA forecast uses a number of recent actual data

values to generate a forecast. Moving averages are useful
if we can assume that market demands will stay fairly
steady over time. A four-month moving average is found
simply summing the demand during the past 4 months
and dividing by 4.

Ft =

Dt-1 +Dt-2 ++Dt-n

n

Time Series - Weighted Moving Average(WMA)

When the forecaster wants to use a moving average but

does not want all the n periods equally weighted owing to
some trend or seasonality in demand.
n

Ft = Ct A t
t =1

Time Series - Exponential Smoothing

The data storage requirements are minimal (only the most
recent actual values are being stored), even though the
forecast is based on many of the values in the series.
Furthermore, the weights given to previous values are not
equal; instead, they decrease with the age of the data.
First Order Exponential Smoothing

Ft =D t-1+ 1- F t-1

Second Order Exponential Smoothing

A t =D t+ 1- A t-1+T t-1

Tt = A t -A t-1 + 1- Tt-1
Ft +1 = A t + Tt

Causal Models Regression Analysis

The simplest and most widely used form of regression

involves a linear relationship between variables.
The least squares line has equation Y = a + bx
where Y: Predicted (dependent variable)
a: Y intercept
b: Slope of the line
x: Value of independent variable

Selecting A Forecasting Method

Time Span: The time period for which the forecast is needed.
Short Range SMA, WMA, ES
Medium Range Regression Analysis
Long Term Delphi Technique
Data Availability: Amount and Nature of Data
Expensive data Delphi, Nominal Group Method
Historical data Time Series, MA, ES
Relational data Causal Models

Cost and Accuracy:

Low Costs Historical Analogy, Executive committee consensus
Expensive Complicated Statistical Techniques

Total Cost
Optimal Region

Causal Models
Increasing Cost

Demand Based Models

Simple Stati. Demand based

Models
Op. Costs due to
inaccurate forecasts

Implementation &
Maintenance cost
Declining Accuracy

Intuitive
Approach

Measures of Forecasting Accuracy

MAD
MSE
MFE
MAPE

Mean Absolute Deviation (MAD)

Measures the dispersion of observed values around

expected values
It is the mean of errors made by the forecast over a
period of time without considering the direction of error.
[Does not give any idea whether the estimate is an
overestimate or underestimate]
MAD = (1/n) | At Ft |
where At: Actual demand in the period t
Ft: Forecasted demand for the period t
N: Number of periods considered
| At Ft |: Indicates absolute value of deviation

Mean Square Error (MSE)

The mean of the squares of deviations of forecast

values from actual result is calculated.

MSE = (1/n) (At Ft)2

Mean Forecast Error (MFE)

To negate the impact of fluctuations caused by
independent variables in actual demand and to
smooth the effect of such functions

MFE = (1/n) (At Ft)

Mean Absolute Percentage Error (MAPE)

To find out the relative errors

MAPE = (100/n) (| At Ft |/ At)

Monitoring and Controlling Forecasts

1.
2.
3.

To reduce the cost of forecast errors

Forecasts should be reviewed and revised periodically
Methods to monitor:
Tracking Signal (TS)
Assess the accuracy with which forecasting methods are
able to predict demand.
Checks whether forecasting model is overestimating or
underestimating the forecasted value.
TS = ((Actual Demand Forecast demand)/MAD) = RSFE/MAD
RSFE refers to cumulative forecast error. Running
Sum
of Forecast Errors
Comparisons of actual data with the forecasted values