Basics of Supply Chain Management

Session 2
Demand Management
Basics of Supply Chain
Management
Introduction to
Supply Chain
Management
Aggregate
Inventory
Management
Demand
Management
Item Inventory
Management
Capacity
Management
and Production
Activity
Control
Theory of
Constraints
and Review
Activity
Material
Requirements
Planning
Lean/JIT and
Quality
Systems
Master
Planning
Purchasing
and Physical
Distribution
1. 2. 3. 4. 5.
6. 7. 8. 9. 10.
Demand Management Processes
Describe the significance of marketing management and customer
relationship management
Explain the role and objectives of demand planning (forecasting and
customer order management)
Characteristics of Demand
Differentiate independent from dependent demand
Identify at least five sources of independent demand
Recognize at least four demand patterns


Learning Objectives
Basic Forecasting Concepts
Describe three planning levels that are supported by demand forecasts
Explain four major principles of forecasting and three principles of data
collection and preparation
Differentiate quantitative from qualitative forecasting techniques

Estimate Demand
Calculate and explain the logic of an exponential smoothing forecast
Explain the logic behind the calculation of a seasonal forecast
Calculate and explain the use of the mean absolute deviation
Learning Objectives (cont.)
Demand Management Processes
Session 1
Marketing
Management
Customer
Relationship
Management
(CRM)
Demand
Planning
Demand Management Processes
Forecasting &
Other
Demands (e.g.
Internal)
Marketing
Strategy &
Product
Management
Customer
Interaction &
Order
Management
These topics
are covered
in the CSCP
Program
Marketing Mix: The Four Ps
Product

Price

Promotion

Place
The four Ps are used to implement marketing strategy via product positioning, product differentiation, and
market segmentation. Each attribute should contribute to the creation of Order Qualifiers & Order Winners
consistent with strategy.
The design, features, cost, service, etc.., of the product need to be aligned
with the market segment requirements and the pricing strategy.
Key decision is whether to compete with a commodity product or provide
value that will bring premium pricing.
Must decide what sales promotion and advertising approach is right for the
product marketing strategy.
Such decisions as sales channels used, distribution inventory policy, and
network design are critical to providing the product where and when the
customer wants it.
Order Qualifiers and Winners
Order qualifiersCompetitive characteristics that a
firms products and services must exhibit in order
for the firm to be a viable competitor in the
marketplace

Order winnersCompetitive characteristics that
cause customers to prefer a firms products and
services over those of its competitors
Customer Relationship Management
Design assistance: helping in the design of new
products or improvement of existing ones
Customer needs: assessing the customers
business and creating (expanding) product
offerings
Information and communications: collecting and
analyzing customer data to support marketing,
sales, and customer service
Help customers achieve better business results through:
Order Management
CRM plays a major role in operations efficiency and
customer service through:
Fast and accurate order entry and tracking
Meet promised delivery dates and quantities
Handle customer inquiries and service
complaints, returns, and repair
Accurate and timely shipping documentation,
invoicing, and recording of sales history
Real-time, on-line order confirmation using Available-to-Promise functionality is best.
Measure and improve Delivery Reliability
Perfect Order Fulfillment is the goal.
Firm should be easy to do business with.
Demand Planning
Recognition of customer requirements through
Forecasts
Management of orders from
Internal customers
External customers
Internal Customer
External Customer
Forecast
Distribution Replenishment
Sample Demand Plan - APO
Characteristics of Demand
Session 2
Independent vs. Dependent Demand
Only independent demand needs to be forecasted
Dependent demand should never be forecasted; it
should be calculated
In this example,
only the
arrows would
be forecasted.
The components
would be
calculated using
MRP.
Sources of Demand
Forecasts
Customer orders
Replenishment orders from DCs
Interplant transfers
Other
Estimate of future demand based on quantitative or qualitative methods or a combination of the two.
Orders from external customers, represents actual demand not estimated demand.
Based on both forecast placed at the DC level and customer orders placed at the DC.
Orders from other divisions or affiliates within the firm.
Sample Orders, Orders for research & testing, replacement of damaged goods, etc..
Demand Patterns: Trend
Quarters
D
e
m
a
n
d

Increasing
Decreasing
Level
Trends can be
linear or
exponential
Demand Patterns: Seasonal Demand
D
e
m
a
n
d

Quarters
Third Quarter is always high
First quarter is always low
In this
case,
Seasonal
&
Trending
Upward
Cyclical Pattern
Growth or
Expansion
Recession or
Contraction
The general economy goes through periods of expansion or growth followed by
contraction or recession.
Cyclical Patterns occur across years where Seasonality occurs within a year.
Stable vs. Dynamic Demand
Stable demand retains same general shape
over time and average demand may yield a
usable forecast.
Dynamic demand tends to be erratic and more
difficult to forecast.
Stable vs.
Dynamic
Demand
Stable
Dynamic
Average demand
Forecasting
Session 2
Introduction
Purposes and uses of the forecast
Principles of forecasting
Principles of data collection and preparation

How Forecasting Supports Planning
Planning Level Forecast Horizon (up to)
Business Planning
Sales volume ($); new
market and supply
chain initiatives
2 to 10 years
Sales and Operations
Planning
Physical units of
production at the
product family level
1 to 3 years
Master Scheduling
Physical units of
production at the end
item level
3 to 18 months
The business should generate a one number forecast at the detailed level which can then be aggregated by
product group or total business forecast.
Principles of Forecasting
Forecasts
Are rarely 100% accurate over time

Should include an estimate of error

Are more accurate for product groups and
families

Are more accurate for nearer periods of
time

Data Collection and Preparation
Record data in terms needed for the
forecast
Record demand and in similar forecast periods as manufacturing.
Record circumstances relating to the data
Weather, price changes, competitors initiatives
Record demand separately for different
customer groups
Business, government, A versus B and C customers
Data Collection and Preparation Example
Customer As annual demand:
Customer Bs annual demand:
Total:
Average over 12 months:
12,000
6,000
18,000
1,500 per month
Month 1 2 3 4 5 6 7 8 9 10 11 12
A 6000 6000
B 500 500 500 500 500 500 500 500 500 500 500 500
Average
Forecast
(Produce)
1500 1500 1500 1500 1500 1500 1500 1500 1500 1500 1500 1500
PAB 1000 2000 -3000 -2000 -1500 -1000 -0- 1000 -4000 -3000 -2000 -1000
Forecasting Techniques
Session 2
Forecasting
Techniques
Qualitative Quantitative
Judgment Mathematics
Intrinsic
(Time Series)
Extrinsic
(Causal)
Forecasting Techniques
Using housing start forecasts to predict
demand for construction chemicals
Using weather forecasts to predict demand
for agricultural chemicals
Based on historical sales
Assumes the past demand
pattern will continue
Includes inputs from Sales &
Marketing
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
Use such tools as surveys, expert opinions, marketing estimates of changes, etc
Contain more bias (tendency to over or under forecast) than quantitative methods.
Factor in qualitative information about the economy, competitors, trends, etc.. .
Because quantitative forecasts are based on history and longer term changes must be input by
marketing and sales.
Quantitative Techniques: Extrinsic
Based on correlation and causality
Rely on external indicators
Useful in forecasting total company demand or
demand for families of products
Two types of leading indicators
Economic
Demographic
For example, Consumer Price Index, Housing Starts, Auto Build Rates, Unemployment Rates, Interest
Rates, Stock Prices, etc.
For example, decrease prices to increase sales; higher unemployment leads to lower consumer spending.
Adjustments based on these type inputs is usually not applied at the article level.
e.g. Housing Starts, Defense Contracts, Consumer Spending, etc
e.g. Birth rates, ethnic mix, etc.
Quantitative Techniques: Intrinsic
Based on several assumptions
The past helps you understand the future
Time series are available
The past pattern of demand predicts the future pattern of
demand
Examples
Moving Averages
Exponential Smoothing

Future buying will be similar to past buying.
Accurate demand data exist in the firms software system.
No major change expected in demand components (e.g. trend, seasonality, etc..)
Best used with horizontal demand patterns with only random variation. No good with trends or seasonality.
Provides the ability to place more weight on recent data points which in times of change may be more
representative of the demand pattern.
Moving Averages: Principles
Best used when demand is stable and there is
little trend or seasonality, and demand variations
are random


When past demand shows random variation
Do not second-guess what the effect of random
variation will be
It is better to forecast based on average demand
We will discuss why in the examples that follow.
Moving Average Forecast Example
Assume it is the end of December;
forecast demand for the next month, January
Jan Feb Mar Apr May Jun Jul Aug Sep Oct

Mo.1
Nov

Mo.2
Dec

Mo.3
Jan
92 83 66 74 75 84 84 81 75 63 91 84 ?
60
65
70
75
80
85
90
95
1 2 3 4 5 6 7 8 9 10 11 12
Avg.
What forecast would you choose
for January and Why? 79
Moving Average Forecast Logic
Month 4 forecast
demand for months 1 - 3
number of months
=
288
3
= = 96 units
Moving average forecast = average demand of past periods
Key: = sum
Moving average forecast for month 4

Month Demand Three-month total Forecast
1 102
2 91
3 95 288
4 96
Class Problem 2.1
Month Demand
Three-month
total
Forecast
1 102
2 91
3 95
4 105
5 94
6 101
7
Month Demand
Three-month
total
Forecast
1 102
2 91
3 95
4 105
5 94
6 101
7
Class Problem 2.1 Solution
288
96 291
97
294
98 300
100
Class Problem 2.1 Solution (cont.)
Month Three-
month
total
Forecast
3 288
4 291 96
5 294 97
6 300 98
7 100
90
92
94
96
98
100
102
104
106
0 2 4 6 8
D
e
m
a
n
d
Period
Actual
Forecast
Three-Month Moving-Average Forecast
Month Demand Three-month total Forecast
1 89
2 89
3 94 272
4 91 274 91
5 95 280 91
6 104 290 93
7 106 305 97
8 110 320 102
9 107
Six-Month Moving-Average Forecast
Month Demand Six-month total Forecast
1 89
2 89
3 94
4 91
5 95
6 104 562
7 106 579 94
8 110 600 97
9 100
Moving Averages: Lessons Learned
The moving average forecast will lag
the development of a rising or falling
trend
The farther back the moving average
forecast reaches for data, the greater
the lag
The three-month moving average
forecast may have overreacted if the
demand surge had abated
The moving average forecast works
best when demand is stable with
random variation; it will filter out
random variation
80
85
90
95
100
105
110
1 2 3 4 5 6 7 8
Actual Sales
3-Mth MovAvg
6-Mth MovAvg
Exponential Smoothing Logic
Take the old forecast and the actual demand for
the latest (most current) period
Assign a weighting factor or smoothing constant
(, alpha) to the latest period demand vs. the old
forecast
Calculate the weighted average of the old
forecast and the latest demand
New forecast = () (latest demand) + (1 ) ( old forecast)
Note: Higher alpha values place more weight on recent demand data.
Smoothing Constant (, Alpha)
Low smoothing constant gives more weight to the
old forecast: e.g.,
= .2 for latest demand (e.g. period X)
1 = .8 for old forecast (also period X)
Appropriate if demand is stable, not rising or falling
Run simulations with different values to see
which one best fits the historical demand pattern


New forecast = () (latest demand) + (1 ) (previous forecast)
Class Problem 2.2
A. Prepare an exponential smoothing forecast for June.
May data: actual demand = 220; forecast = 200.

Calculate the forecast for June using a smoothing constant
() of .20

B. Prepare an exponential smoothing forecast for July.
June data: actual demand = 240

Calculate the forecast for July also using a smoothing
constant () of .20
New forecast = () (latest demand) + (1 ) (previous forecast)
Class Problem 2.2 Solution
A. Prepare an exponential smoothing forecast for June.
= (.2) 220 + (.8) 200 =
= 44 + 160 = 204

B. Prepare an exponential smoothing forecast for July.
= (.2) 240 + (.8) 204 =
= 48 + 163 = 211
New forecast = () (latest demand) + (1 ) (previous forecast)
May Actual Demand = 220 Units Mays Forecast = 200 Units
Actual June Demand = 240
June Forecast
Average demand
for all periods
D
e
m
a
n
d

(
u
n
i
t
s
)

Time (quarters)
Seasonal demand
Seasonal Demand
Seasonal Forecast Process
1
2
3
Calculate a seasonal index of demand for
each period to establish seasonality
Develop a deseasonalized demand forecast
spanning all periods
Develop a seasonal forecast for each
period of the year being forecast
Quarter Average Quarterly Demand/100 Seasonal Index
1 128/100 = 1.28
2 102/100 = 1.02
3 75/100 = 0.75
4 95/100 = 0.95
Total = 4.00
Seasonal Demand Indexes (Step 1)
Average demand for all quarters = = 100 units
400
4
Demand History
Year Quarter Total
1 2 3 4
1
122 108 81 90 401
2
130 100 73 96 399
3
132 98 71 99 400
Average
128 102 75 95 400
Average Period
Demand/Average Demand
for All Periods
Make the forecast for the next year (The business
expects to sell 420 in Year 4)
De-seasonalize the forecast distribute it evenly
across the four quarters
Annual forecast
No. of periods
=
De-seasonalized demand
(average demand/period)
105 units
420
4
= =
Deseasonalized Forecast (Step 2)
Seasonal Forecast (Step 3)
Expected quarter demand
=
(seasonal index)
(deseasonalized forecast
demand)
Expected first quarter demand
=
1.28 X 105 = 134 units
Expected second quarter
demand
=
1.02 X 105 = 107 units
Expected third quarter demand
=
.75 X 105 = 79 units
Expected fourth quarter
demand
=
.95 X 105 = 100 units
Total forecast demand
=
420 units

Calculation
Alternate Method: (1.28/4.00) x 420 = 134
Tracking the Forecast
Session 2
Forecasts are rarely 100% correct over time.


Why track the forecast?
To understand why demand differs from the forecast
To plan around error in the future
To improve forecasting methods
never
Random Variations alone ensures some error will occur.
Develop safety stock targets, make contingency plans in case of demand peaks, etc..
Identifying errors and investigating to find root causes will result in improved forecasting
methods.
And take actions to eliminate error.
Tracking the Forecast
Bias vs. Random Variation
Bias Random Variation
Cumulative demand may not be the
same as forecast
Demand will vary plus and minus
about the average
Month Forecast Actual Variation Forecast Actual Variation
1
100 90 -10 100 105 +5
2
100 125 +25 100 94 -6
3
100 120 +20 100 98 -2
4
100 125 +25 100 104 +4
5
100 120 +20 100 103 +3
6
100 110 +10 100 96 -4
Cumulative
Total
600 690 +90 600 600 0
Bias exists since cumulative
variation is not zero.
There is no bias since
cumulative variation is zero.
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Total
Forecast 500 500 500 500 500 500 500 500 500 500 500 500 -
Actual 460 520 530 490 460 500 530 490 530 480 490 520 -
Absolute
deviation
40 20 30 10 40 0 30 10 30 20 10 20 260
Forecast Error Data
Absolute errors
No. of periods
=
MAD
260
12
= 22 units =
Key: = Sum; I I = Absolute Value
n
| |

MAD =
n
|A - F|
Use Absolute error as
both over and under
forecasting are problems.
MAPE =

A - F
A
[%]
n
MAPE =

A - F
A
[%]
n

A - F
A
[%]

A - F
A
A - F
A
[%]
n
Mean Absolute Deviation (MAD)
MAD Analysis: Normal Distribution
-3 -2 -1 0 1 2 3 MAD
-66 -44 -22 22 44 66 Units
If the data is normally distributed, 60% of the data points will fall within +or- 1 MAD or 22 Units. Ninety (90%) will
fall within +or- 2 MADs.
Uses of Forecast Measurement
Identify changes and trends in demand
Identify and adjust for forecast error that results from
random events
Adjust the period forecast so that it is close to the true
forecast average demand to minimize bias
Making decisions on safety stock and service levels based
on the degree of random variation (forecast error)
For example, calculate statistical safety stocks using the standard deviation of error.
For example, remove data outliers that vary significantly from average demand.
So the forecasting method can be changed to match the new demand pattern.
For example, use averaging techniques to smooth out random variations in demand.
Supply Chain Management Implications
Decrease reliance on long-term forecasts and
increase ability to react quickly to demand
Collaborate with customers and suppliers,
especially in sharing demand information
Increase manufacturing flexibility internally and
operations integration externally with customers
and suppliers
Deal with demand uncertainty through process improvements
Improved manufacturing flexibility and reduced lead times make it possible to react more quickly to
changes in demand.
For example, sharing production schedules with suppliers instead of the supplier having to forecast demand.
Basics of Supply Chain Management
Session 2