Forecasting

Forecasting
All supply chain decisions based on estimates of
future demands
Historical demand information can be used to
forecast future demands
For push/pull philosophy of supply chain
Push processes are performed in anticipation of demand
Pull processes performed in response to the customer
demand
Dell orders components for computers in anticipation of
customer demand, while
Assembly is performed in response to a customer
demand

Forecasting
When individual stages in the supply chain make
their independent forecast of demand, there is always
a mismatch between the supply and demand
Collaborative forecast for the entire chain partners
tends to be much more accurate
Decisions for functions like Production, Marketing,
Finance, Personnel are best taken based on
collaborative forecast
Mature products with stable demand are usually
easiest to forecast
Staple products like food grains, sugar at superbazars

Forecasting
Forecasting and accompanying managerial decisions
are extremely difficult when either the supply of raw
materials or the demand for the finished product is
highly variable
Fashion garments, high tech products etc.

Good forecasting is important for products with short

life cycle, like fashion goods
Products with a long life cycle have less significant
effect from forecasting errors

Forecasting- Characteristics
Forecasts are always wrong and should include both
the expected value and a measure of the forecast
error
Long term forecasts are usually less accurate than
short term forecasts
The greater the degree of aggregation , the more
accurate is the forecast
Easier to forecast the GNP in a year of a country within 2%
accuracy than the annual revenue of a company

The greater up the supply chain a company is, the

greater the distortion of information they receive
Bullwhip effect

Bullwhip Effect
=

Tier 2
Suppliers

Tier 1
Suppliers

Producer

Distributor

Ordering

Amount of
inventory

Customers

Forecasting- Components
Companies need to first
Identify the factors that influence the future demand, and
then
Ascertain the relationship between these factors and future
demand

Some of the factors that need to be looked into

Past demand
Lead time of products
Planned advertising or marketing efforts
State of economy
Planned price discounts
Action competitors have taken

Demand Forecasting Basic Forecasting

Six step approach for effective forecasting
Understand the objective of forecasting
Integrate demand planning and forecasting throughout the
supply chain
Understand and identify customer segments
Identify the major factors that influence the demand forecast
Determine the appropriate forecasting technique
Establish performance and error measures for the forecast

Demand Forecasting - Basic Forecasting

Six step approach for effective forecasting
Understand the objective of forecasting Objective is to
support decisions that are based on the forecast so first
step is to identify these decisions. Eg how much to make
a particular product., how much inventory to keep etc. All
affected parties in the SC must be aware of the link
between decisions & forecasts. For eg If BigBazar plans a
promotion campaign in which all detergents will be sold on
20% discount in May, then this information should be
shared with all participants in the SC which include
manufacturer, transporter and others involved in filling
demand. All parties should come up with a common
forecast for promotion and a shared plan of action based on
the forecast. Failure to make these decisions jointly may
result in either too much or too little product in various
stages of the SC.

Demand Forecasting - Basic Forecasting

Six step approach for effective forecasting
Integrate Demand Planning & Forecast throughout the SC
A company should link its forecast to all planning activities
throughout the SC. These include capacity planning,
production planning, promotion planning and purchasing
among others. This link should exist at both the information
system and the HR management level. As a variety of
functions are affected by the outcomes of the planning
process, it is important that all of them are integrated into
the forecasting process. In a common but wrong scenario,
a retailer develops forecast based on promotional activities,
whereas a manufacturer, unaware of these promotions,
develops a different forecast for their production planning.
As a result, the manufacturer may not have enough product
for retailer, ultimately leading to poor customer service.

Demand Forecasting - Basic Forecasting

Six step approach for effective forecasting

Understand and Identify Customer segments here a firm must identify
the customer segments the SC serves. Customers may be grouped by
similarities in service requirements, demand volumes, order frequency,
demand volatility, seasonality and so forth. In general, companies may
use different forecasting methods for different segments.
Identify Major Factors that Influence the Demand forecast
As a next step, a firm must identify major factors that influence demand
forecast. A proper analysis of these factors is central to developing an
appropriate forecasting technique. The main factors influencing
forecasts are demand supply and product related phenomena.
On demand side, a company must ascertain whether demand is growing,
declining or has seasonal patterns. Estimate must be made on demand
not on sales data. Eg A supermarket may have promoted a certain
brand of shampoos while demand for other comparable shampoos was
low.
On supply side, a company must consider the available supply sources to
decide on the accuracy of the forecast desired. This is more important
when only a single supplier with long lead time is available so an
accurate forecast will be more valuable.

Demand Forecasting - Basic Forecasting

Six step approach for effective forecasting
Determine the appropriate Forecasting technique.
In
selecting an appropriate forecasting technique, a company
should first understand the dimensions that will be relevant
to the forecast. These dimensions include geographical
area, product groups and customer groups. The company
should understand the differences in demand along each
dimension.
Establish Performance and Error measurement for forecast
Companies should establish clear performance measures
to evaluate the accuracy and timeliness of the forecast.
These measures should correlate with the objectives of the
business decisions based on the forecasts.

Forecasting- Methods
Qualitative Method
Qualitative forecasting methods are primarily subjective and
rely on human judgment
Most appropriate when there is little historical data
available or when experts have market intelligence that
is critical in making forecast
Used to forecast future demand for long term in a new
industry

Time Series
Use historical demand to forecast
Method appropriate when the demand pattern does not
vary significantly from one year to the next

Forecasting- Methods
Causal
Method assumes that the demand forecast is highly
correlated with certain factors in the environment
State of economy, interest rates etc.
Used to determine the impact of price promotions on demand

Simulation
Methods imitate the consumer choices that give rise to
demand to arrive at a forecast
Simulation is used to combine time series and causal
methods to find answers to
Impact of price promotion, competitors stores coming up
in the vicinity etc.
Forecast demand for higher fare seats when there
are no seats available at economy class fare
Modeling makes use of computers

Time Series Forecasting Methods

A time series is a time-ordered sequence of
observations taken at regular intervals over a period
of time
Data may be measurement of demand, earnings, profits,
outputs etc.

Analysis of time series data requires identification of

the underlying behaviour of the series
Done by plotting the data with time and examining for some
pattern
Trend, Seasonal variations, Cycles, and Random or
Irregular variations ( errors)

Time Series Forecasting Methods

Trend
Refers to gradual, long term, upward or downward
movement in the data over time
Changes in income, population etc.

Seasonality
Refers to short term fairly regular variations related to factors
such as weather, holidays, vacations etc.
Variations can be daily, weekly or monthly

Cycles
Wave like variations of more than one years duration or
which occur every year
Business cycle related to economic, political or
agricultural conditions

Random variations
Residual variations which are blips in the data caused by
chance and unusual situations

Production Demand (Units)

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Li

Seasonal Trend

Constant Trend

Time

Demand Patterns

Quantitative Methods
Pattern continuous when it is constant and does not
consistently increase or decrease
Sales of a product in the mature stage of its life cycle
may show this
Linear pattern emerges when demand increases or
decreases from one period to the next
Sales of product in the growth stage of the product life
cycle shows increasing while in the decline stage show
decreasing trend
Cyclical pattern pertains to influence of seasonal factors
Demand of woolen wears will be high in winter and low
during summer

Time Series Forecasting Methods

Forecasts in time series methods based on averages
smoothened through averaging
Three techniques used for Averaging
Naive Forecasts
Simplest method
Assumption of demand for the next period based on the
actual demand in the most recent period
Moving Average method
Simple moving average
Weighted moving average

Time Series Forecasting Methods

Simple Moving Average (SMA)
Forecasts for the next month is the arithmetic average of the
actual sales for a specific number of recent past time
periods
SMA =Sum of demands for all periods/Chosen number of
periods
SMA = in=1/n =(D1+D2+D3Dn)/n,

where , n=the chosen number of periods,

i= 1 is the oldest period in the n-period average
i= n is the most recent period
D1= the demand in the i th period

Time Series Forecasting Methods

Weighted Moving Average (WMA)
A weighted average of past sales is the forecast for the next
time period
A WMA allows for varying, not equal weightage of old
demands
WMA= in=1 Ci Di ,
where Di is the demand during time period i, Ci is the
weight given to that demand and n is the chosen
number of periods
Also 0 Ci 1 , and in=1 Ci =1

Time Series Forecasting Methods

Exponential Smoothing Models
Forecasted sales for the last period modified by information
about the forecast error of the last periods
Modification of the last years forecasts are the forecast for
the next time periods
Weight assigned to a previous periods demand
decreases exponentially as that data gets older
Recent demand data receive a higher weight than does
the older demand data
Normally only three items of data are required
This periods forecast, the actual demand for this period
and which is referred to as smoothening constant and
having a value between 0 and 1

Time Series Forecasting Methods

Formula used is
Next periods forecast = This period's forecast + ( this
periods actual demand this periods forecast)
Or
Ft =Ft-1 + ( At-1 Ft-1)
Where Ft = Forecast for this period (t)

Ft-1 = Forecast for the previous period (t-1)

At-1 = Actual demand for the previous period ( t-1)

= Smoothening constant
Smoothening constant selection is a matter of judgment
Commonly used values range between 0.05 0.5

Common Time Series Models

Regression Analysis
A forecasting technique that establishes a relationship
between variables- one dependent and others independent
Only one independent variable in simple regression
Population, advertising expenses affecting sales
More than one independent variable in multiple regression
Population, income and sales force affecting sales
It involves fitting a straight line equation ( in simple linear
regression analysis) to explain sales fluctuations in terms of
related and presumable causal variables
Three major steps in regression analysis
Identifying variables which are causally related to the firms
sales
Determine / estimate the values of these variables related
to sales
Derive the sales forecast from these estimates

Common Time Series Models

A linear regression assumes the relationship between
dependent and independent variables a straight line
( known a simple linear regression analysis)
A curvilinear relationship is a non-linear regression
producing a curve

Forecasting- Adaptive Method

Adaptive method uses more sophisticated approach
compared to static methods
Popular models used in this method
Holts Model
This is a Trend corrected Exponential smoothened model
Appropriate when demand is assumed to have a level and a
trend but no seasonality
Systematic component of demand = Level + Trend
In period t, given estimate of level Lt and trend Tt, the
forecast for future periods is expressed as
Ft+1 = Lt + Tt and Ft+n = Lt+ nTt

Forecasting- Adaptive Method

After observing for Period t, the estimate for level and trend
is corrected as
Lt+1 = Dt+1 + (1- )(Lt + Tt)
Tt+1 = (Lt+1 Lt) + (1- )Tt ,
Where is a smoothening constant for the level, and is
a smoothening constant for trend and varies from 0 to 1
like

Winters Model
Trend and Seasonality Corrected Exponential Smoothened
model
Method appropriate when the demand is assumed to have a
level, trend and a seasonal factor

Forecasting- Adaptive Method

Systematic component of the demand
= ( Level + trend) x seasonal factor
Assume periodicity of demand to be p, initial estimates of level
L0, trend T0 and seasonal factors ( S1.Sn)
In period t, the forecast for future periods is given by
Ft+1 = (Lt + Tt)* St+1, and Ft+l = (Lt + lTt)*St+l
On observing the demand for period t+1, the estimates for
level, trend and seasonal factors are revised as
Lt+1 = (Dt+1 /St+1) + (1- )(Lt-Tt)
Tt+1 = (Lt+1 Lt) + (1- )*Tt
St+p+1 = (Dt+1 / Lt+1) + (1- )*St+1,
Where is a smoothening constant for seasonal factor
varying from 0 -1

Measure of Forecasting Errors

Managers perform a thorough error analysis on a
forecast to
Determine whether the current forecasting method is
accurately predicting the systematic components of demand
A method consistently giving positive error can indicate
over prediction by the method and manager can make
necessary corrections
Estimate forecast error as any contingency plan must
account for such an error
Contracting with an outsource agency , even though
more expensive, to supply shortfalls in the order on
urgent basis

Measure of Forecasting Errors

Forecasting Error is simply the difference between the
forecast and actual demand for a given period
et = Ft At , where et = forecast error for the period t,
At =
actual demand for period t, and Ft = the forecast for the period t

Mean Error (ME) = 1/n nt=1 et

Cumulative Sum or Error (CFE) = nt=1 et
CFE is useful in measuring the bias in a forecast

Mean Absolute Deviation (MAD) = 1/n nt=1 | et |

MAD is merely the average error for each forecast.
Popular because it is easy to understand

Mean Squared Error (MSE) = 1/n nt=1 et2

Used as an estimate of the variance of the random error e t
which is 2

Measure of Forecasting Errors

Mean Absolute Percentage Error (MAPE)
=1/n t=1 ( |et| / At) X100
MAPE is useful for putting forecast performance in the
proper perspective
Forecast error of 100 when the actual demand is 200
units results in larger percentage error than the error
occurring when the demand was 1000 units

Qualitative or Judgemental
Methods
Not based on quantitative numbers exclusively
Based on judgment about the causal factors that underline
the sales of particular products or services, and
On opinions about the relative likelihood of these causal
factors being present in the future
Useful when historical data are not available

Qualitative or Judgemental
Methods
Executive Committee Consensus
A committee of executives from different departments
constituted and entrusted with the responsibility of
developing a forecast
Uses inputs from all parts of organisation and analysts
analyse data as required
Such forecasts tend to be compromised ones, not reflecting
the extremes that might be present
Most commonly used method of forecast

Qualitative or Judgemental
Methods
The Delphi Method
Method seeks to remove the undesirable consequences of
group thinking existing in committees
Committee consists of experts from within and outside the
organisation
Expert in one aspect of the problem and no one
conversant with all aspects of the issue
Each expert makes independent predictions in the form of
brief statements
Coordinator edits and clarifies these statements
Coordinator provides a series of questions in writing to the
experts that includes feedback supplied by other experts
Above repeated several times till consensus reached

Qualitative or Judgemental
Methods
Survey of Salesforce/ Field Expectation Method
Individual members of the salesforce required to submit
sales forecasts of their respective regions
These combined to form total estimate of sales
Estimates transformed into sales forecasts to ensure
realistic estimates
A popular method for companies having good
communication system and salesforce directly selling to
customers

Qualitative or Judgemental
Methods
Survey of Customers/Users Expectation Method
Estimates of future sales obtained directly from customers
through survey
Sales forecast determined by combining individual
customers responses
Method useful where customers are limited in number

Qualitative or Judgemental
Methods
Historical Analogy
Estimates of future sales of product tied to knowledge of a
similar products sales
Knowledge of one products sales during various stages of
its product life cycle applied to estimates of sale for a similar
product
Method useful for a new product

Qualitative or Judgemental
Methods
Market Surveys
Questionnaires, telephone talks or field interviews form the
basis for predicting market demand for products
Normally preferred for new products or existing products in
new markets

Demand Forecasting
Forecasting is a key driver of virtually every design
and planning decision made in both an enterprise
and a supply chain
Collaborative forecasting taking all partners in the
supply chain give benefits an order of magnitude
higher than the cost
Value of data depends upon where one is in the
supply chain
Demand is not the same as sales
True demand can be obtained by making adjustments for
the unmet demands due to stock outs, competitors actions,
pricing, promotions etc.