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Forecasting for operations
Why we should forecast with models
The importance of forecasting
Exponential smoothing in a nutshell
Case studies
1. Customer service: U.S. Navy distribution system
2. Inventory investment: Mfg. of snack foods
3. Inventory investment: Auto parts distributor
4. Purchasing workload: Mfg. of water filtration systems
Recommendations: How to improve forecast
accuracy
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Paper folding forecast
A sheet of notebook paper is 1/100 of
an inch thick.
I fold the paper 40 times.
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Fold Inches Miles
Start 0.01
1 0.02
5 0.32
10 10.24
20 10,485.76 0.17
25 335,544.32 5.30
30 10,737,418.24 169.47
35 343,597,383.68 5,422.94
40 10,995,116,277.76 173,534.03
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The Importance of Forecasting
Forecasts determine:
Master schedules
Economic order quantities
Safety stocks
JIT requirements to both internal and external
suppliers
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The Importance of Forecasting (cont.)
Better forecast accuracy always cuts inventory
investment. Example:
Forecast accuracy is measured by the standard
deviation of the forecast error
Safety stocks are usually set at 3 times the
standard deviation
If the standard deviation is cut by $1, safety stocks
are cut by $3
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Exponential smoothing methods
Forecasts are based on weighted moving
averages of
Level
Trend
Seasonality
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Origins of exponential smoothing
Simple exponential smoothing –
The thermostat model
Error = Actual data – forecast
New forecast = Old Forecast + (Weight x Error)
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Exponential smoothing at work
“A depth charge has a
magnificent laxative
effect on a submariner.”
Lt. Sheldon H. Kinney,
Commander,
USS Bronstein (DE 189)
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Forecast profiles from exponential smoothing
Additive Multiplicative
Nonseasonal Seasonality Seasonality
Constant
Level
Linear
Trend
Exponential
Trend
Damped
Trend
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Automatic Forecasting with the damped trend
In constant-level data, the forecasts emulate simple
exponential smoothing:
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30
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Automatic Forecasting with the damped trend
In data with consistent growth and little noise, the
forecasts usually follow a linear trend:
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50
45
40
35
30
25
20
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Automatic Forecasting with the damped trend
When the trend is erratic, the forecasts are damped:
50 Saturation level
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40
35
30
25
20
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Automatic Forecasting with the damped trend
The damping effect increases with noise in the data:
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Saturation level
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40
35
30
25
20
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Case 1: U.S. Navy distribution system
Scope
50,000 line items stocked at 11 supply centers
Decision Rules
Simple exponential smoothing
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U.S. Navy distribution system (cont.)
Problems
Customer pressure to reduce backorder delay
Solution
Automatic forecasting with the damped trend
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U.S. Navy distribution system (cont.)
Research design 1
Random sample (5,000 items) selected
Models tested
Random walk benchmark
Simple, linear-trend, and damped-trend smoothing
Error measure
Mean absolute percentage error (MAPE)
Results 1
Damped trend gave the best MAPE
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U.S. Navy distribution system (cont.)
Research design 2
The mean absolute percentage error was discarded
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U.S. Navy distribution system (cont.)
Research design 3
6-year simulation of inventory performance, using
actual daily demand and lead time data
Stock levels updated after each transaction
Results 3
Again, damped trend was the clear winner
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Average delay in filling backorders
U.S. Navy distribution system
50
Random walk
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Backorder days
Linear trend
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35 Simple smoothing
30 Damped trend
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370 380 390 400 410 420 430
Inventory investment (millions)
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Case 2: Snack-food manufacturer
Scope
82 snack foods
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11-Oz. corn chips
Monthly packaging inventory and usage
$2,500,000
Actual Inventory
from subjective
$2,000,000 forecasts
$1,500,000
$1,000,000
$500,000
$0
Month
Monthly Usage
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Snack-food manufacturer (cont.)
Solution
Automatic forecasting with the damped trend
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Damped-trend performance
11-oz. corn chips
$500,000
Outlier Actual
Forecast
$450,000
$400,000
$350,000
$300,000
$250,000
$200,000
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Investment analysis: 11-oz. corn chips
Forecast annual usage $4,138,770
Economic order quantity $318,367
Standard deviation of forecast errors $34,140
Nbr. shortages
per 1,000 Probability Safety Order Maximum
order cycles of shortage stock quantity investment
100.0000 0.1000 $43,758 $318,367 $362,125
50.0000 0.0500 $56,167 $318,367 $374,534
1.0000 0.0010 $105,510 $318,367 $423,877
0.0100 0.0000 $145,601 $318,367 $463,968
0.0001 0.0000 $177,496 $318,367 $495,863
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Safety stocks vs. shortages
11-oz. corn chips
$200,000
$180,000
Target
$160,000
$140,000
Safety stock
$120,000
$100,000
$80,000
$60,000
$40,000
$20,000
$0
0 10 20 30 40 50 60 70 80 90 100
$100,000
$50,000
$0
($150,000)
($200,000)
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11-Oz. corn chips
Target vs. actual packaging inventory
$2,500,000
Actual Inventory
from subjective
Actual Inventory
$2,000,000 forecasts
from subjective
forecasts
$1,500,000
$1,000,000
$500,000
$0
Target maximum
inventory based on
damped trend Month
Monthly Usage
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How to forecast regional demand
Forecast total units with the damped trend
Forecast regional percentages with simple
exponential smoothing
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Damped-trend performance
11-oz. corn chips
$500,000
Outlier Actual
Forecast
$450,000
$400,000
$350,000
$300,000
$250,000
$200,000
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Regional sales percentages: Corn chips
50%
East
40%
30% South
North
20%
West
10%
0%
Mar Jun Sep Dec Mar Jun Sep Dec
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Case 3: Auto parts distributor
Scope
24 distribution centers
350 company-owned stores, 1,600 affiliated stores
Millions of time series
Independent marketing, finance, and operations forecasts
Inventory system
Standard EOQ/safety stock
Operations forecasting system
Multiplicative seasonal adjustment for all time series
Simple exponential smoothing of seasonally-adjusted data
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Forecast profiles from exponential smoothing
Additive Multiplicative
Nonseasonal Seasonality Seasonality
Constant
Level
Linear
Trend
Exponential
Trend
Damped
Trend
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Seasonal adjustment procedures
Multiplicative
Range of seasonal fluctuation grows with the data
Additive
Range of seasonal fluctuation is constant
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Auto parts distributor (cont.)
Multiplicative seasonality is infeasible for data with
zeroes
Company solution for data with zeroes
Add a large constant to each month’s sales before
seasonal adjustment
Subtract the constant afterward
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Auto parts distributor (cont.)
Effects of company seasonal adjustment
procedure
Many non-seasonal time series were adjusted
Variance of seasonally-adjusted data was almost
always greater than original data
Inflated variance led to
Excess safety stocks
Purchases much larger than true requirements
Frequent subjective adjustments of forecasts
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Auto parts distributor
Example of inflated variance
80 Original data
60
50
40
30
20
10
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Auto parts distributor (cont.)
Proposals to Management
Test for seasonality before adjustment
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Auto parts distributor
Seasonal adjustment comparisons: no zeroes
80 Original data
Company seas. adjustment
70 Additive seas. adjustment
60
50
40
30
20
10
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Auto parts distributor
Seasonal adjustment comparisons: With zeroes
180
Original data
160 Company seas. adjustment
Additive seas. adjustment
140
120
100
80
60
40
20
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Auto parts distributor:
Estimated savings
Safety stock 95% confidence limits
Inventory reduction lower upper
Florida
Fast-movers 16% 14% 18%
Temperature control 22% 16% 28%
Minnesota
Fast-movers 18% 15% 20%
Temperature control 43% 33% 52%
Missouri
Fast-movers 17% 15% 19%
Temperature control 19% 11% 27%
California
Fast-movers 19% 16% 21%
Temperature control 20% 13% 27%
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Case 4: Water filtration systems company
Scope
Annual sales of $15 million
Inventory system
Reorder monthly to maintain 3 months of stock
Forecasting system
6-month moving average
No update to average if demand = 0
Numerous subjective adjustments
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Problems
Purchasing and receiving workload
70,000 orders per year
Forecasting
Total forecasts on the stock records = $28 million
Annual sales = $15 million
Frequent stockouts due to forecast errors
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Solutions
Develop a decision rule for what to stock
Forecast demand for all items with the
damped trend
Use the forecasts to do an ABC classification
Replace the monthly ordering policy with a
hybrid inventory control system:
Class A JIT
Class B EOQ/safety stock
Class C Annual buys
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What to stock?
Cost to stock
Average inventory balance x holding rate +
Number of stock orders x transportation cost
Cost to not stock
Number of customer orders x drop-ship transportation cost
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Water filtration company:
Inventory status
4,202 with
inadequate
6,336 active items demand to stock
27% 18%
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ABC classification based on
damped-trend forecasts
Class Sales forecast System Items Dollars
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The hybrid inventory control system
Inventory Production Lead-time
Control System
Class Schedule Behavior
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Annual purchasing workload
Total savings = 58,000 orders (76%)
40,000
Monthly ordering
ABC system
35,000
30,000
25,000
EOQ
20,000
EOQ
15,000
JIT Annual
10,000 buys
JIT
5,000
0
A B C
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Inventory investment
Total savings = $591,000 (15%)
Monthly ordering
3,000,000 ABC system
2,500,000 JIT
2,000,000
EOQ
1,500,000
EOQ
1,000,000 JIT Annual
buys
500,000
0
A B C
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Conclusions
Test all demand series for seasonality
For series that pass the test, compare additive
and multiplicative seasonal adjustment
Forecast at the highest possible level of
aggregation
For total units, forecast with the damped trend
model
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Conclusions (cont.)
Break down total forecasts with simple smoothing
applied to category percentages
Regions
Pack sizes
Colors
Benchmark the forecasts with a random walk
Get operations and marketing together and
produce one corporate forecast
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Conclusions (cont.)
Judge forecast accuracy in financial and
operational terms
Customer service measures
Backorder delay time
Percent of time in stock
Probability of stockout
Dollars backordered
Inventory investment on the balance sheet
Purchasing workload or production setups
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www.bauer.uh.edu/gardner
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