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Report

Omkar Khanvilkar | ME231 | April 11, 2016

Table of Contents
1. Introduction to Demand Forecasting ............................................................................................................. 2
2. Factors related to Demand Forecasting ......................................................................................................... 2
3. Demand Forecasting Techniques .................................................................................................................... 3
3.1 Qualitative Methods ................................................................................................................................ 4
3.2 Quantitative Methods ............................................................................................................................. 4
3.2.1 Time Series Forecasting Models ........................................................................................................... 4
3.2.2 Cause-and-Effect Models...................................................................................................................... 4
4. Forecast Accuracy ............................................................................................................................................. 5
Summary ............................................................................................................................................................... 6
References ............................................................................................................................................................. 7

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1. Introduction to Demand Forecasting


Demand forecasts form the basis of all supply chain planning. Consider the push/pull view of the
supply chain. All push processes in the supply chain are performed in anticipation of customer demand,
whereas all pull processes are performed in response to customer demand. For push processes, a manager
must plan the level of activity, be it production, transportation, or any other planned activity. For pull
processes, a manager must plan the level of available capacity and inventory but not the actual amount
to be executed. In both instances, the first step a manager must take is to forecast what customer demand
will be.
Forecasting is an important element of demand management. It provides an estimate of future
demand and the basis for planning and sound business decisions. Since all organizations deal with an
unknown future, some error between a forecast and actual demand is to be expected. Thus, the goal of a
good forecasting technique is to minimize the deviation between actual demand and the forecast.
Characteristics of Demand forecasting are:
o

Forecasts are always inaccurate and include both the expected value of the forecast and
a measure of forecast error.

Long term forecasts are usually less accurate than short-term forecasts.

Aggregate forecasts are usually far more accurate than disaggregate forecasts as they
tend to have a smaller standard deviation of error relative to the mean.

In general, the further up the supplier chain a company is (or further they are from the
consumer), the greater the distortion of information they receive.

2. Factors related to Demand Forecasting


A company must be knowledgeable about numerous factors that are related to the demand forecast,
including the following:
o

Past demand.

Lead time of product.

Planned advertising or marketing efforts.

State of economy.

Planned price discounts.

Actions taken by the competitors.

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3. Demand Forecasting Techniques

Figure 1 Demand Forecasting Techniques

Forecasting methods are classified according to the following four types:


1. Qualitative: Qualitative forecasting methods are primarily subjective and rely on human judgment.
They are most appropriate when little historical data are available or when experts have market
intelligence that may affect the forecast. Such methods may also be necessary to forecast demand several
years into the future in a new industry.
2. Time series: Time-series forecasting methods use historical demand to make a forecast. They are based
on the assumption that past demand history is a good indicator of future demand. These methods are
most appropriate when the basic demand pattern does not vary significantly from one year to the next.
These are the simplest methods to implement and can serve as a good starting point for a demand
forecast.
3. Causal: Causal forecasting methods assume that the demand forecast is highly correlated with certain
factors in the environment (the state of the economy, interest rates, etc.). Causal forecasting methods
find this correlation between demand and environmental factors and use estimates of what
environmental factors will be to forecast future demand. For example, product pricing is strongly
correlated with demand. Companies can thus use causal methods to determine the impact of price
promotions on demand.
4. Simulation: Simulation forecasting methods imitate the consumer choices that give rise to demand to
arrive at a forecast. Using simulation, a firm can combine time-series and causal methods to answer such
questions as: What will be the impact of a price promotion? What will be the impact of a competitor

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opening a store nearby? Airlines simulate customer buying behaviour to forecast demand for higher fare
seats when there are no seats available at the lower fares.

3.1 Qualitative Methods


Qualitative forecasting methods are based on intuition or judgmental evaluation and are
generally used when data are limited, unavailable, or not currently relevant. While this approach can be
very low cost, its effectiveness depends to a large extent on the skill and experience of the forecaster(s)
and the amount of relevant information available. The qualitative techniques are often used to develop
long-range projections when current data is no longer very useful, and for new product introductions
when current data does not exist. Four common qualitative forecasting models are as follows:
o
o
o
o

Jury of executive opinion


Delphi Method
Sales Force Composite
Consumer Survey

3.2 Quantitative Methods


Quantitative forecasting models use mathematical techniques that are based on historical data
and can include causal variables to forecast demand. Time series forecasting is based on the assumption
that the future is an extension of the past; thus, historical data can be used to predict future demand.
Cause-and-effect forecasting assumes that one or more factors (independent variables) are related to
demand and, therefore, can be used to predict future demand.
Since these forecasts rely solely on past demand data, all quantitative methods become less
accurate as the forecasts time horizon increases. Thus, for long-time horizon forecasts, it is generally
recommended to utilize a combination of both quantitative and qualitative techniques.

3.2.1 Time Series Forecasting Models


As discussed earlier, time series forecasts are dependent on the availability of historical data.
Forecasts are estimated by extrapolating the past data into the future. A survey13 of forecasting models
used shows that time series models are the most widely used (72 percent) and judgmental models are the
least used (11 percent). The study also finds that within the time series models, the ones most commonly
used are the simple models (averages and simple trend) and exponential smoothing. In general, demand
forecasts are used in planning for procurement, supply, replenishment and corporate revenue.

3.2.2 Cause-and-Effect Models


The cause-and-effect models have a cause (independent variable or variables) and an effect
(dependent variable). One of the more common models used is regression analysis. In demand
forecasting, the external variables that are related to demand are first identified. Once the relationship
between the external variable and demand is determined, it can be used as a forecasting tool.

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4. Forecast Accuracy
The ultimate goal of any forecasting endeavor is to have an accurate and unbiased forecast. The
costs associated with prediction error can be substantial and include the costs of lost sales, safety stock,
unsatisfied customers and loss of goodwill. Companies must strive to do a good job of tracking forecast
error and taking the necessary steps to improve their forecasting techniques. Typically, forecast error at
the disaggregated (stock keeping unit) level is higher than at the aggregated (company as a whole) level.
Forecast error is the difference between the actual quantity and the forecast. Forecast error can be
expressed as:

et = At Ft
where

et = forecast error for period t;


At = actual demand for period t;
Ft = forecast for period t.

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Summary
Forecasting is an integral part of demand management since it provides an estimate of future
demand and the basis for planning and making sound business decisions. A mismatch in supply and
demand could result in excessive inventories and stock outs and loss of profits and goodwill. Proper
demand forecasting enables better planning and utilization of resources for businesses to be competitive.
Both qualitative and quantitative methods are available to help companies forecast demand better. The
qualitative methods are based on judgment and intuition, whereas the quantitative methods use
mathematical techniques and historical data to predict future demand. The quantitative forecasting
methods can be divided into time series and cause-and-effect models. Since forecasts are seldom
completely accurate, management must monitor forecast errors and make the necessary improvements
to the forecasting process.

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References
Books:
1.

Supply Chain Management Strategy, Planning, and Operation, Sunil Chopra, 5th
Edition
2. Principles of Supply Chain Management, Wisner, Tan & Leong, 3rd Edition
3. The Essentials of Supply Chain Management, Hokey Min

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