Basics of Supply Chain Management

Session 2
Demand Management
 Basics of Supply Chain
Management
1. 2. 3. 4. 5.

Capacity
Introduction to Material Management
Demand Master
Supply Chain Requirements and Production
Management Planning
Management Planning Activity
Control

Theory of
Aggregate Purchasing Lean/JIT and
Item Inventory Constraints
Inventory and Physical Quality
Management and Review
Management Distribution Systems
Activity

6. 7. 8. 9. 10.
 Learning Objectives
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 (cont.)
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
Session 1

Demand Management Processes

Demand Management Processes
Marketing
Strategy &
Product
Management
Marketing
Management
These topics
are covered
in the CSCP
Customer Program
Demand Relationship
Planning Management
(CRM)
Customer
Forecasting &
Interaction &
Other
Order
Demands (e.g.
Management
Internal)
 Marketing Mix: The Four Ps
The four P’s 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.

• Product
The design, features, cost, service, etc.., of the product need to be aligned
with the market segment requirements and the pricing strategy.

• Price
Key decision is whether to compete with a commodity product or provide
value that will bring premium pricing.

• Promotion
Must decide what sales promotion and advertising approach is right for the
product marketing strategy.

• Place
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 qualifiers—Competitive characteristics that a

firm’s products and services must exhibit in order
for the firm to be a viable competitor in the
marketplace

• Order winners—Competitive characteristics that

cause customers to prefer a firm’s products and
services over those of its competitors
Customer Relationship Management
Help customers achieve better business results through:

• Design assistance: helping in the design of new

products or improvement of existing ones

• Customer needs: assessing the customer’s

business and creating (expanding) product
offerings

• Information and communications: collecting and

analyzing customer data to support marketing,
sales, and customer service
 Order Management
CRM plays a major role in operations efficiency and
customer service through:

Fast and accurate order entry and tracking

Real-time, on-line order confirmation using Available-to-Promise functionality is best.

Meet promised delivery dates and quantities

Measure and improve “Delivery Reliability”

Handle customer inquiries and service

complaints, returns, and repair
Firm should be easy to do business with.

Accurate and timely shipping documentation,

invoicing, and recording of sales history
“Perfect Order Fulfillment” is the goal.
Demand Planning
Recognition of customer requirements through
– Forecasts
– Management of orders from
• Internal customers
• External customers Sample Demand Plan - APO

External Customer
Forecast
Distribution Replenishment
Internal Customer
Session 2

Characteristics of Demand
 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
Estimate of future demand based on quantitative or qualitative methods or a combination of the two.

• Customer orders
Orders from external customers, represents “actual” demand not estimated demand.

• Replenishment orders from DCs

Based on both forecast placed at the DC level and customer orders placed at the DC.

• Interplant transfers
Orders from other divisions or affiliates within the firm.

• Other
Sample Orders, Orders for research & testing, replacement of damaged goods, etc..
 Demand Patterns: Trend
Trends can be
“linear” or
“exponential”

Increasing
Decreasing
Level
Demand

Quarters
Demand Patterns: Seasonal Demand
Third Quarter is always high

In this
case,
Seasonal
&
Trending
Upward
Demand

First quarter is always low

Quarters
 Cyclical Pattern
The general economy goes through periods of expansion or growth followed by
contraction or recession.

Growth or Recession or
Expansion Contraction

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.
Dynamic
Stable vs. Stable
Dynamic
Demand

Average demand
Session 2

Forecasting
 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)

Sales volume ($); new

Business Planning market and supply 2 to 10 years
chain initiatives

Sales and Operations Physical units of

production at the 1 to 3 years
Planning product family level

Physical units of
Master Scheduling production at the end 3 to 18 months
item level
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
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 1500 1500 1500 1500 1500 1500 1500 1500 1500 1500 1500 1500
(Produce)

PAB 1000 2000 -3000 -2000 -1500 -1000 -0- 1000 -4000 -3000 -2000 -1000

Customer A’s annual demand: 12,000

Customer B’s annual demand: 6,000
Total: 18,000
Average over 12 months: 1,500 per month
Session 2

Forecasting Techniques
 Forecasting Techniques

Forecasting
Techniques

Qualitative Quantitative

Judgment
Includes inputs from Sales &
Marketing
Intrinsic
(Time Series)
• Based on historical sales
• Assumes the past demand
pattern will continue
Mathematics
Extrinsic
(Causal)
• Using housing start forecasts to predict
demand for construction chemicals
• Using weather forecasts to predict demand
for agricultural chemicals
 Qualitative Techniques

• Are based on intuition and informed opinion

Use such tools as surveys, expert opinions, marketing estimates of changes, etc…

• Tend to be subjective
Contain more “bias” (tendency to over or under forecast) than quantitative methods.

• Are used for business planning and forecasting for

new products
Factor in qualitative information about the economy, competitors, trends, etc.. .

• Are used for medium-term to long-term forecasting

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

For example, decrease prices to increase sales; higher unemployment leads to lower consumer spending.

• Rely on external indicators

For example, Consumer Price Index, Housing Starts, Auto Build Rates, Unemployment Rates, Interest
Rates, Stock Prices, etc….

• Useful in forecasting total company demand or

demand for families of products
Adjustments based on these type inputs is usually not applied at the article level.

• Two types of leading indicators

– Economic
e.g. Housing Starts, Defense Contracts, Consumer Spending, etc…

– Demographic
e.g. Birth rates, ethnic mix, etc….
 Quantitative Techniques: Intrinsic
• Based on several assumptions

– The past helps you understand the future

Future buying will be similar to past buying.

– Time series are available

Accurate demand data exist in the firm’s software system.

– The past pattern of demand predicts the future pattern of

demand No major change expected in demand components (e.g. trend, seasonality, etc..)
• Examples

– Moving Averages
Best used with horizontal demand patterns with only random variation. No good with trends or seasonality.

– Exponential Smoothing
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
We will discuss why in the examples that follow.

• 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
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 Nov Dec Jan
Mo.1 Mo.2 Mo.3

92 83 66 74 75 84 84 81 75 63 91 84 ?

95

90

85

What forecast would you choose

80 Avg.
for January and Why? 79
75

70

65

60
1 2 3 4 5 6 7 8 9 10 11 12
 Moving Average Forecast Logic
Moving average forecast = average demand of past periods

Moving average forecast for month 4

Σ demand for months 1 - 3 288
= = = 96 units
number of months 3

Month Demand Three-month total Forecast

1 102
2 91
3 95 288
4 96

Key:  = sum
Month 4 forecast
 Class Problem 2.1

Three-month
Month Demand Forecast
total
1 102

2 91

3 95

4 105

5 94

6 101

7
Class Problem 2.1 Solution

Three-month
Month Demand Forecast
total
1 102

2 91

3 95 288

4 105 291 96

5 94 294 97

6 101 300 98

7 100
 Class Problem 2.1 Solution (cont.)
106
Actual
104
Forecast

Month Three- Forecast 102

month 100
total

Demand
98
3 288
96
4 291 96
94
5 294 97
92
6 300 98
90
7 100 0 2 4 6 8
Period
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 110

• The farther back the moving average

105
forecast reaches for data, the greater
the lag 100

• The three-month moving average 95

Actual Sales
3-Mth MovAvg
forecast may have overreacted if the 6-Mth MovAvg

demand surge had abated 90

• The moving average forecast works 85

best when demand is stable with

random variation; it will “filter out” 80
1 2 3 4 5 6 7 8

random variation
 Exponential Smoothing Logic

• Take the old forecast and the actual demand for

the latest (most current) period
• Assign a weighting factor or smoothing constant
(α, alpha) to the latest period demand vs. the old
forecast
• Calculate the weighted average of the old
forecast and the latest demand

New forecast = (α) (latest demand) + (1 – α) ( old forecast)

Note: Higher alpha values place more weight on recent demand data.
 Smoothing Constant (α, Alpha)

New forecast = (α) (latest demand) + (1 – α) (previous forecast)

• Low smoothing constant gives more weight to the

old forecast: e.g.,
– α = .2 for latest demand (e.g. period X)
– 1 – α = .8 for old forecast (also period X)
• Appropriate if demand is stable, not rising or falling
• Run simulations with different α values to see
which one best fits the historical demand pattern
 Class Problem 2.2

New forecast = (α) (latest demand) + (1 – α) (previous forecast)

A. Prepare an exponential smoothing forecast for June.

May data: actual demand = 220; forecast = 200.

Calculate the forecast for June using a smoothing constant

(α) 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 (α) of .20
Class Problem 2.2 Solution

New forecast = (α) (latest demand) + (1 – α) (previous forecast)

May Actual Demand = 220 Units May’s Forecast = 200 Units

A. Prepare an exponential smoothing forecast for June.

= (.2) 220 + (.8) 200 =
= 44 + 160 = 204 June Forecast

Actual June Demand = 240

B. Prepare an exponential smoothing forecast for July.
= (.2) 240 + (.8) 204 =
= 48 + 163 = 211
 Seasonal Demand

Average demand
for all periods
Demand (units)

Seasonal demand

Time (quarters)
 Seasonal Forecast Process

Develop a seasonal forecast for each

period of the year being forecast
3

Develop a deseasonalized demand forecast

spanning all periods
2

Calculate a seasonal index of demand for

each period to establish seasonality
1
Seasonal Demand Indexes (Step 1)

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
Average demand for all quarters = 400 = 100 units Demand/Average Demand
4 for All Periods

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
 Deseasonalized Forecast (Step 2)

• 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
De-seasonalized demand Annual forecast
=
(average demand/period) No. of periods

420
= = 105 units
4
 Seasonal Forecast (Step 3)
Calculation

= (seasonal index) 
Expected quarter demand (deseasonalized forecast
demand)
Expected first quarter demand = 1.28 X 105 = 134 units
Expected second quarter =
1.02 X 105 = 107 units
demand
Expected third quarter demand = .75 X 105 = 79 units
Expected fourth quarter =
.95 X 105 = 100 units
demand
Total forecast demand = 420 units

Alternate Method: (1.28/4.00) x 420 = 134

Session 2

Tracking the Forecast

 Tracking the Forecast
never

• Forecasts are rarely 100% correct over time.

Random Variations alone ensures some error will occur.

• Why track the forecast?

– To understand why demand differs from the forecast

And take actions to eliminate error.

– To plan around error in the future

Develop safety stock targets, make contingency plans in case of demand peaks, etc..

– To improve forecasting methods

Identifying errors and investigating to find root causes will result in improved forecasting
methods.
 Bias vs. Random Variation
Bias Random Variation
Cumulative demand may not be the Demand will vary plus and minus
same as forecast 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
600 690 +90 600 600 0
Total

Bias exists since cumulative There is no bias since

variation is not zero. cumulative variation is zero.
 Forecast Error Data

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
40 20 30 10 40 0 30 10 30 20 10 20 260
deviation
 Mean Absolute Deviation (MAD)
Use “Absolute” error as
Key:  = Sum; I I = Absolute Value both over and under
forecasting are problems.

 | |A
| - F|
MAD = n
n

Σ Absolute errors 260

MAD = = = 22 units
No. of periods 12


A-F
[%]
A
MAPE =
n
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
So the forecasting method can be changed to match the new demand pattern.

• Identify and adjust for forecast error that results from

random events
For example, use averaging techniques to smooth out random variations in demand.

• Adjust the period forecast so that it is close to the true

forecast average demand to minimize bias
For example, remove data outliers that vary significantly from average demand.

• 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.
 Supply Chain Management Implications

Deal with demand uncertainty through process improvements

• Decrease reliance on long-term forecasts and

increase ability to react quickly to demand
Improved manufacturing flexibility and reduced lead times make it possible to react more quickly to
changes in demand.

• Collaborate with customers and suppliers,

especially in sharing demand information

• Increase manufacturing flexibility internally and

operations integration externally with customers
and suppliers
For example, sharing production schedules with suppliers instead of the supplier having to forecast demand.
Basics of Supply Chain Management
Session 2