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DEMAND FORECASTING

FORECASTING
Forecast is an estimation of a future event achieved by systematically combining and casting forward in a pre-determined way, date about the past

Prediction is an estimation of future events achieved through subjective consideration, other than just past data. This subjective consideration need not occur in any predetermined way [Before start of a business, prediction or forecast of the Demand is made]

3 PLANNING HORIZONS
Long Term Planning Horizon > 2 Yrs Intermediate Range Planning Horizon 3 months to 2 years Short Term Planning Horizon < 3 months [How much material to keep]

LONG TERM PLANNING HORIZON


Eg: Car Manufacturing - Demand after 20 years Data Required is sector-wise (Macro-level) We talk that present market in car manufacturing is 500 crore, and it will be 2000 crore industry after 20 years Past Data is less relevant Experience of Experts is taken into consideration (Qualitative / Subjective models) Location of Plant, Product Design etc related decisions

INTERMEDIATE RANGE PLANNING HORIZON


Data Required is group-wise Demand of Product may be caused by some other thing like demand of Air-Conditioners depends upon number of houses built in the locality Causal model or regression analysis is used more than timeseries models (Quantitative model) Adding capacity, manpower, make or- buy (outsourcing), developing contractors / sub-contractors etc related decisions

SHORT TERM PLANNING HORIZON


Data Required is Unit-wise Data-based or quantitative based (Time series model) Inventory related, Production related, scheduling/sequencing related decisions More weightage to time-series model & less to qualitative models

Parameters
Lagging Parameters: Parameters which has already happened in past Leading Parameters: Parameters which are expected to take place in future eg: Research may lead to change in scenario, so plan according to the changes taking place

QUALITATIVE MODELS
1. Market Research Questioner Technique
Problem:
a) People are not serious while answering b) Questionnaire is going to all kind of respondents

1. Brain Storming Tools (Structured Discussion)


1. Take only ideas 2. Explain ideas, criticize it, etc

Problem:
a) Ideas not agreed to due to ego b) Discussion loses direction or is not based upon correct presumptions or facts

QUALITATIVE MODELS
3. Delphi Technique
Takes best of questionnaire and brain storming techniques Questionnaire is sent to limited number of respondents, who are experts in that area 1st Round of Questionnaire: Opinion is taken along with reasons 2nd Round of Questionnaire: Group view is given and then option is given to change your opinion

QUANTITATIVE TECHNIQUES
1. Extrapolative or Time Series Analysis 2. Causal or Explanatory Model or Regression Analysis

EXTRAPOLATIVE OR TIME SERIES ANALYSIS


Date is in the form of Periods

Period (t) 1 2 3 4 5 6

Demand (Dt) 10 8 12 11 9 15

Forecast (Ft)

Time Series Analysis 1st Model


Ft+1 = Dt ie Forecast for the next period is demand of the present period Problem: Dt may get high/low, then next demand get wrong

Time Series Analysis 2nd Model


(Moving Average Method)
Ft+1 = (Dt + Dt-1 + Dt-2)/3 ie Moving average of different periods is taken to forecast for the next period. 3 period moving average is most popular For 4th period, average of 1, 2, 3 period is taken For 5th period, average of 2, 3, 4 period is taken Criticism: Equal weightage is given to all the periods, whereas 3rd period is more relevant to the 4th period

(Moving Average Method) Cont


Period (t) 1 2 3 4 5 6 Demand (Dt) 10 8 12 11 9 15 Forecast (Ft+1 )

10 10.33 10.67

Time Series Analysis


(Weighted Moving Average Method) Ft+1 = w1 Dt + w2 Dt-1 + w3 Dt-2 where w1 > w2 > w3 ; and w 1 + w2 + w 3 = 1

Time Series Analysis 3rd Model


(Exponential Smoothing)
Exponential Smoothing method are used in applications that involves forecasting of large number of items Methods works best under following conditions:
Forecasting horizon is relatively short Little outside information is available about cause and effect relationship between demand of an item and independent factors that influence it Small effort in forecasting is required Updating of forecast as new data become available is easy Forecast is adjusted for randomness (fluctuations in demand are smoothed) and track trends and seasonality

Exponential Smoothing
Ft+1 = Ft + (Dt - Ft) = Dt + (1 - ) Ft where smoothing coefficient; and 0<<1 corrects the observed error (Dt - Ft) in period t or tries to adjusts the average demand (base), so as to remove the randomness in the demand Ft+1 = Dt + (1 - ) [ Dt-1 + (1 - ) Ft-1 ] = Dt + (1 - ) Dt-1 + (1 - )2 Ft-1

Forecast Errors
Forecast Error = Actual Demand for period t Forecast for period t et = Dt Ft Forecast Errors provide a measure of accuracy and basis for comparing the performance of alternate models

Forecast Errors Measures


Average Error (AE) = ( et ) / N; t = 1N Mean Absolute Deviation (MAD) = ( I et I ) / N; t = 1N Mean Squared Error (MSE) = ( et2 ) / N; t = 1N Mean Absolute Percentage Error (MAPE) = ( I et * 100 / Dt I) / N; t = 1N AE should be near zero for larger sample; otherwise the model exhibits bias. AE obscures variability because positive and negative errors cancel out. MAD gives sum of all errors without regard to algebraic sign, divided by number of observations MSE penalises larger errors MAPE gives the decision maker an idea of how much the forecast is off as a % of Demand

Forecast Errors Measures


Period Demand 1 2 3 4 5 20 30 10 40 30
AE = 1.4 ; MSE = 35.8;

Forecast 18 25 15 30 35

Error +2 +5 -5 +10 -5

(Error)2 4 25 25 100 25

%Error +10 +16.67 -50 +25 -16.67

MAD = 5.4; MAPE = 23.6%

4 Types of Pattern in any Phenomenon


1. 2. 3. 4. Horizontal Pattern Trend Pattern Seasonality Pattern Cyclic Pattern

Horizontal Pattern
Graph between Demand & Time Important from Operational Point of View

Demand

Time

Trend Pattern

Demand

Time

Seasonality Pattern
Seasonality can range from 1 day to 1 year
Season 1 Season 2

Demand

Time

1 Day Seasonality: Telephone calls, Newpaper 1 Month Seasonality: Grocery purchase in beginning of month

Cyclic Pattern
One cycle running into 5 / 20 / 50 yrs

Demand

Time

Important from Strategic point of view

Time Series Model (Trend Adjusted)


Exponential smoothing model used when demand is growing or falling in a linear trend Smoothing coefficient for the average Demand Smoothing coefficient for the trend Ft+1 Forecast of next period ie t + 1 At Exponentially smoothed average of the series in period t Tt Exponentially smoothed average of the trend in period t CTt Current estimates of the trend in period t

Time Series Model (Trend Adjusted)


Equations 1. Ft+1 = At + Tt 2. At = Dt + (1 )[At-1 + Tt-1] Exponentially smoothed average of the series in period t now reflect the old smoothed trend of the previous period t 1 (ie Tt-1) CTt = At At-1 Tt = CTt + (1 ) Tt-1 The trend has been smoothed using

3. 4.

Time Series Model (Trend Adjusted)


Eg: A newly opened restaurant want to forecast the number of customers per week. An average of 280 customers per week visited over the past 4 weeks. The trend over that period was 30 additional customers per week. This week demand was 270 customers, below the historical average but reasonably in line with the past performance. Use = 0.2 , = 0.3 to calculate the forecast for the next period.

Time Series Model (Trend Adjusted)


Trend with 30 additional customers per week. But this additional customers is not constant, therefore need to smooth this trend by using
At-1 = 280 cust / week

Demand

Tt-1 = 30 addl cust / week Dt = 270 cust (this week) = 0.2 = 0.3 Time

Time Series Model (Trend Adjusted)


2. 3. At-1 = 280 cust / week ; Dt = 270 cust (this week); Tt-1 = 30 addl cust / week = 0.2 ; = 0.3 Calculate equation 2, then 3, then 4 and then 1. At = Dt + (1 )[At-1 + Tt-1 ] = (0.2) (270) + (1 0.2)[280 + 30] = 302 CTt = At At-1 = 302 280

4.

Tt = CTt + (1 ) Tt-1 = (0.3)(22) + (1 0.3)(30) = 27.6

1.

Ft+1 = At + Tt = 302 + 27.6 = 329.6

Time Series Model (Trend Adjusted)


2. 3. If actual number of customers in this (ie week 6) period is 440, forecast for the next period ? At = 302 cust / week ; Tt = 27.6 addl cust / week Dt+1 = 440 cust (this week); = 0.2 ; = 0.3 Calculate equation 2, then 3, then 4 and then 1. At+1 = Dt+1 + (1 )[At + Tt] = (0.2) (440) + (1 0.2)[302 + 27.6] = 351.68 CTt+1 = At+1 At = 351.68 302 = 49.68

4.

Tt+1 = CTt+1 + (1 ) Tt = (0.3)(49.68) + (1 0.3)(27.6) = 34.22

1.

Ft+2 = At+1 + Tt+1 = 351.68 + 34.22 = 385.9

Time Series Model (Seasonality factors)


Eg: The demand date of a dry cleaning shop for the year 2007-10 is given below:
Qtr 1 2 3 4 Total 2007 45 335 520 100 1000 2008 70 370 590 170 1200 2009 100 585 830 285 1800 2010 100 705 1160 215 2200

Forecast customer demand for each quarter of 2011, based on managers estimate of 2600 customers in 2011.

Time Series Model (Seasonality factors)


Average Demand in 2007 (D2007 ) = (D1,2007 + D2,2007 + D3,2007 + D4,2007 ) / 4 Frequency in ith quarter of 2007 (f) = Di,2007 / D2007 Or f = Di,2007 / D; where D Total demand of the year Let us take f = Di / D; and find the forecast for 2011

Qtr D 1 2 3 4

2007 f .045 .325 .52 .1 D 45 335 520 100

2008 f .058 .308 .492 .142 D 70 370 590 170 1200

2009 f .056 .325 .461 .158 D 100 585 830 285 1800

2010 f .045 .33 .527 .098 f 100 705 1160 215 2200

2011 D 132.6 837.2 1300 325 2600 .051 .322 .5 .125

Total 1000

Frequency for each quarter of 2011 would be average frequency of frequencies of previous 4 years in each quarter ie f1 = (0.045 + 0.058 + 0.056 + 0.045) / 4 = 0.051. And Demand Di = fi * Total Demand (2600)