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Demand Forecasting
- A study at Alfa Laval in Lund
SUMMARY
Vxj University, School of Management and Economics, FE3583, Spring 2008
Authors: Hana Klimsova and Stacey Lobban
Tutor: Peter Berling
Title: Demand Forecasting- A study at Alfa Laval in Lund
Background: Accurate forecasting is a real problem at many companies and that includes
Alfa Laval in Lund. Alfa Laval experiences problems forecasting for future raw material
demand. Management is aware that the forecasting methods used today can be improved or
replaced by others. A change could lead to better forecasting accuracy and lower errors which
means less inventory, shorter cycle times and better customer service at lower costs.
Purpose: The purpose of this study is to analyze Alfa Lavals current forecasting models for
demand of raw material used for pressed plates, and then determine if other models are better
suited for taking into consideration trends and seasonal variation.
Delimitations: Due to the large number of articles that go into the production of plate heat
exchangers, this study will only focus on forecasting of selected raw material (coils or sheets)
demand for pressed plates.
Method: This is an action research study using an interpretive scientific perspective, a
deductive approach, and a quantitative research strategy. The scientific credibility of the
study will hinge on providing a workable solution for the studied companys problem.
Conclusion: The companys current error evaluation method differs greatly from theory and
is probably wrong. Forecasting of raw material demand can be improved by using better
input data. Of the 12 items tested, triple exponential smoothing provided the lowest
forecasting error in 8 of the cases.
Future Work: In our demand forecasting analyses, we adjusted each smoothing constant to
come up with the best error accuracy for individual items. For future studies, one might use
the same smoothing constants across all products to see if these can be standardized so that
forecasting work can be done even more efficiently and effectively.
Keywords: Alfa Laval, demand forecasting, time series analysis, moving average,
exponential smoothing, autocorrelation, forecasting accuracy, plate heat exchangers
ACKNOWLEDGEMENTS
This Batchelor Thesis has been written during Spring 2008 and is a result of hard work and
dedication. It would not have been possible without support and constructive feedback from a
number of people.
First of all, we would like to take this opportunity to give thanks and show gratitude to our
tutor, Peter Berling, for his guidance and substantial feedback throughout the entire process.
Furthermore, we are grateful for the additional guidance of our examinator, Petra
Andersson, for her suggestions on how to structure our thesis. We would also like to express
our gratitude to Ivan Kruzela, associate professor at Malm University, for his conceptual
and moral support.
In addition, our appreciation goes to our opponents, who have given us constructive criticism
and support in finalizing our thesis. We also appreciate the feedback of our fellow seminar
members.
Finally, our gratitude goes to all the people who took time to help us perform our research,
including all interviewees at Alfa Laval OM-CP unit: Tobias Augustsson, Martin Jnsson,
and Lars Hedberg. They provided essential value in the development of our thesis by sharing
their knowledge and always made themselves available to answer countless questions and
provide feedback throughout various stages of the process.
Vxj, May 2008
Hana Klimsova
Stacey Lobban
TABLE OF CONTENTS
SUMMARY.............................................................................................................................. 2
ACKNOWLEDGEMENTS.................................................................................................... 3
TABLE OF CONTENTS........................................................................................................ 4
1. Introduction ......................................................................................................................... 7
1.1 Background........................................................................................................................ 7
1.2 Alfa Laval - company presentation.................................................................................. 9
1.3 Problem discussion .......................................................................................................... 11
1.4 Problem questions ........................................................................................................... 12
1.5 Purpose............................................................................................................................. 12
1.6 Delimitations .................................................................................................................... 12
1.7 Time plan ......................................................................................................................... 13
1.8 Definition of Concepts..................................................................................................... 13
1.9 Disposition........................................................................................................................ 14
2. Methodology ...................................................................................................................... 16
2.1 Scientific perspective - Positivism vs. Interpretivism .................................................. 16
2.1.1 Our perspective - Interpretivism ................................................................................ 16
2.2 Scientific approach Deductive vs. Inductive .............................................................. 17
2.2.1 Our scientific approach - Deductive .......................................................................... 17
2.3 Research strategy Quantitative vs. Qualitative ......................................................... 17
2.3.1 Our research strategy - Quantitative ......................................................................... 18
2.4 Research method - Action Research.............................................................................. 18
2.4.1 Our motivation of research method ........................................................................... 20
2.5 Data Collection- Theoretical and Empirical................................................................. 21
2.5.1 Our data collection method........................................................................................ 21
2.6 Scientific Credibility ....................................................................................................... 22
2.6.1 Our choice of scientific credibility ............................................................................. 23
1. Introduction
1.1 Background
Forecasting
Forecasting plays an integral role in our daily lives. We make decisions about what to wear
the next day or what to pack for a trip based on weather forecasts. We decide when to make
investments based on forecasts or listen to traffic reports to determine which route to take to
work in the morning. Of course, not everything can be accurately forecasted. Sometimes
forecasts are accurate; most often they are not. Similarly forecasting plays an important role
in business operations. All business planning is based on forecasts, sales of existing and new
products, requirements and availability of raw materials, capacity requirements to name a
few.1 Larger firms employ forecasting for different purposes and for different levels (in terms
of time, product and market) compared to smaller ones. The type of industry impacts the
forecasting methods as well. Manufacturing firms use more complex techniques than service
firms. Uncertainty and environmental turbulence are also issues to be considered, as there is a
correlation between environmental turbulences and judgmental adjustments of quantitative
forecasting techniques.2
A companys operations and production managements main focus is to forecast product
demand. Even though it is very likely that demand will be random in most circumstances,
forecasting methods are still of value. Although some portions of the demand process may
be unpredictable, other portions may be predictable. Trends, cycles, and seasonal variation
1
2
Nahmias, S. (2005:53)
Zotteri, K. (2007:85)
Such
forecasting outcomes are important information for the use of purchasing raw material. As
goods move from raw material processors through to manufacturers and further down the
supply chain to the end customer, extensive coordination is required among ordering, demand
forecasting and inventory decisions at every level.4
The importance of demand forecasting manifests itself in the purchasing function and can
have a strong influence a companys competitive advantage. Over-purchasing not only
negatively affects inventory and storage space, but also spending on unnecessary
procurement activities. On the other hand, under-purchasing can cause a shortage in raw
material, which could cause interruptions in the manufacturing process and lead to unfinished
or delayed products.5 Good demand forecasting helps to find the right balance.
Along with improving forecasting accuracy, there should be an overall strategy of demand
management. This would include making an increasingly larger proportion of product
demand firm while at the same time decreasing the percentage of products that have to be
forecasted.6 To predict future demand accurately is crucial for effective purchasing planning
since it leads to customer satisfaction and decreasing costs. Many companies invest in
expensive forecasting software that use statistical methods, however their forecasts are often
adjusted by using personal judgment and market knowledge to improve accuracy.7 Many
times business managers make the comment: If only we could do a better job of forecasting
demand. This statement is based on the fact that they too often experience unnecessarily
high errors in their forecasts. Accurate forecasting is a real problem at many companies.8
Improving forecast accuracy is the goal, but one must also take into consideration that there
are limits. The better forecast always includes some measure of the forecast error.9
Alfa Laval also experiences the same problem of forecasting for future demand. The
managers here are aware of the fact that the forecasting methods they use today can be
improved or replaced by others. A change could lead to better forecasting accuracy and lower
3
Nahmias, S. (2005:53)
Fenstermacher, K., & Zeng, D. (2000:4)
5
Kengpol, A., Kaoien, P., & Touminen, M., (2007:1605)
6
Martin, J. (2008:231)
7
Fildes, R. & Goodwin, P. (2007:42)
8
Lapide, L. (2007:16)
9
Nahmias, S. (2005:51)
4
errors which means less inventory, shorter cycle times and better customer service at lower
costs. These factors will play an important role in the company gaining competitive
advantages and flexibility.
10
Today the company has about 10,000 employees of whom many are
located in Sweden, India, Denmark, USA and France. Almost 50 per cent of total sales are
made in Europe, 30 per cent in Asia and 20 per cent in North and South America.11
Alfa Laval in Lund
Alfa Lavals facility in Lund specializes in the production of plate heat exchangers in
different sizes and types depending on the purpose of use. The company offers both
standardized plates and those made according to customer specifications. This facility is
comprised of mainly two divisions: CU (Component Unit) and SU (Supply Unit). Both
divisions are divided into two business units. This study will focus on one business unit,
OM - CP (Operation Manufacturing - Component Unit Plates). This unit is responsible for
ordering and receiving raw material (a variety of metals - stainless steel, titanium, etc.) in
form of coils or sheets to be cut and pressed into plates of different technical parameters and
characteristics.
After that they are welded or outfitted with gaskets to become finished plates. These plates
are delivered to the SU (Supply Unit), of which there are several worldwide locations, where
they are assembled; the plates are put together with frames to form the final product plate
10
11
http://www.alfalaval.com, 2008-04-06
Alfa Laval Annual Report 2006
heat exchangers. These are quality controlled and prepared for delivery to an end customer.
In the below value added chain, this studys focus will be on unit highlighted in red.
Suppliers
Component Unit - CU
Supply Unit - SU
OM - SE (Supply Equipment)
End customer
Figure 1.1: Alfa Lavals Value Added Chain.
10
12
11
By evaluating the present situation and answering these and other questions, we hope to
suggest more appropriate forecasting methods for Alfa Laval.
How can the demand forecasting for raw material purchases be improved and
which method/methods results in lower forecasting errors while taking into
consideration trends and seasonal variations?
1.5 Purpose
The purpose of this study is to analyze Alfa Lavals current forecasting models for demand of
raw material used for pressed plates, and then determine if other models are better suited for
taking into consideration trends and seasonal variation.
1.6 Delimitations
Due to the large number of articles that go into the production of plate heat exchangers, this
study will only focus on forecasting of raw material (coils or sheets) demand for pressed
plates (those classified by Alfa Laval as A or B products using the ABC classification
system).
12
Title
Introduction
Research
Methodology
Theory
3
4
Empirical
Findings
Analysis
Conclusions and
Recommendations
Data Collection
March
Week
11 12
PM
April
13
May
14
15
16
17
18
19
20
21
22
Tutoring
13
1.9 Disposition
The thesis will be organized as follows (see Figure 1.2):
Chapter 2
Chapter 3
The Theory chapter provides relevant theories applied to our study. We will
discuss different theories for forecasting of future demand using time series
analysis. At the end of the chapter we set up an analysis model based on
applicable theories.
Chapter 4
The Empirical Findings chapter describes the current order process and
demand forecasting for raw material. It also presents the current forecasting
techniques used by Alfa Laval and introduces the raw material selection for
this study.
Chapter 5
The Analysis chapter tests various forecasting methods using the historical
data provided in Appendix 2. From theory and empirical evidence, we propose
other forecasting methods for raw material demand taking into consideration
trends and seasonal variations.
Chapter 6
14
Introduction
Chapter 1
Methodology
Chapter 2
Theoretical Study
Chapter 3
Interviews
Empirical Findings
Chapter 4
Internal Data
Analysis of Data
Chapter 5
Conclusions,
Recommendations
Chapter 6
15
2. Methodology
n this chapter we describe the methodology choices for this study. Areas covered
include scientific perspective, scientific approach, and research strategy. Next the
action research method is described and the manner in which data was collected.
16
the
gathering and analysis of data. Another differentiation between qualitative and quantitative
research comes up from the relationship that qualitative researchers have with their research
subjects. The qualitative approach allows the subjects to play a greater role in designing the
research and influencing results of the process. This is a particular trait of action research.20
The practitioners (those working at the organization) have the local knowledge and every day
experience, and the researcher has the technical skills in research procedures and
comparative knowledge of the subject under investigation.21 Although action research is
17
17
likened to qualitative research, it can employ the gathering of both qualitative and
quantitative data.22 Data collection can include such things as analyzing documents,
participant observation recordings, unstructured and structured interviews, case studies23,
written description of meetings and interviews (can be given to participants to validate
information gathered), a collection of documents related to the situation, or a diary of
objective impressions24.
22
18
AR treats the diversity of experience and capacities within the local group as an
opportunity for the enrichment of the research-action process
The meanings constructed in the inquiry process lead to social action, or these
reflections on action lead to the construction of new meanings.
There is a special kind of question that action researchers ask in order to identify the
particular research design, to name a couple: 29
This is because action research is a type of practitioner research that works as a tool to help
improve professional activities in various types of workplaces.30 A quality criteria used to
judge how good the theory is will focus on its ability to provide a practical solution in reallife situation.31 Greenwood goes further to argue that it is far more likely than conventional
forms of social research to produce reliable and useful interpretations of social phenomena
because the research validity can be tested in action.32
29
Mc Niff, J. (1996:16)
Mc Niff, J. (1996:7)
31
Greenwood, D., et al. (1998:19)
32
Greenwood, D., et al. (1998:54)
30
19
Action research can be considered as a process that contains five phases: diagnosing, action
planning, action taking, evaluating, and specifying learning.33
33
Susman, G. (1981:146)
20
34
Yin, R. (2003:86)
Bryman, A.. (2007: 328-333)
36
Bryman, A.. (2007: 334-336)
35
21
37
Mc Niff, J. (1996:106)
ibid
(1996: 107)
39
Greenwood, D., et al. (1998:80-81)
40
Mc Niff, J. (1996:108)
38
22
41
Mc Niff, J. (1996:108)
23
Scientific Perspective
Interpretative
Scientific Approach
Deductive
Research Strategy
Quantitative
Research Method
Action Research
Scientific Credibility
Client validity
24
3. Theory
Sales force composites The sales force is in direct contact with customers so they
have an advantage of having a pulse on consumer preferences. Based on this
information members of the sales force can provide a sales estimate of products they
plan to sell in the forthcoming year.
42
25
Jury of executive opinion If there is no past history data (such as for a new product)
then expert opinions can be used as a source of information to derive a forecast. These
opinions are collected from individual sources in several ways. One is for the person
assembling the information to interview the managers directly, the second is to hold a
group meeting for the managers to come to a consensus.
Delphi method This is similar to the jury of executive opinion in that it is based on
expert opinions. It differs in that the managers are individually surveyed - no group
meeting - so that no personality can influence another in the group.
In short, subjective technique can encompass simply asking for managers opinions,
polling an organizations sales force, or bringing people together who have knowledge of
a particular customer segment.47
Time series analysis uses only the past history of the series to be forecasted.48 The
goal is to identify repeatable and predictable patterns in preferably several years of
past data. An example of time series forecasting is to predict sales for the next quarter
based on sales from this quarter.49
Regression models typically include the past history of other series. Therefore a
model can be constructed to predict one phenomenon based on the development of
other phenomenon.50 An example would be predicting inflation (dependent variable)
47
Martin, J. (2008:222)
Nahmias, S. (2005:51)
49
Martin, J. (2008:222)
50
Nahmias, S. (2005:51)
48
26
Subjective Approach
Objective Approach
Applicability
technologies)
technology)
Involves mathematical
experience
techniques
Causal models
Considerations
Techniques
Delphi method
Consumer market survey
Figure 3.1: Summary of qualitative and quantitative forecasting approaches
Source: SME Toolkit.org52
51
52
Martin, J. (2008:224)
http://www.smetoolkit.org/smetoolkit/en/content/en/416/Demand-Forecasting (2008-04-29)
27
Seasonality Pattern that repeats at fixed intervals, i.e. ice cream consumption
exhibits a seasonal pattern with increased demand during the summer.
53
Armstrong, J. (2001:209)
Kalekar, P., (2004:2)
55
Nahmias, S. (2005:57)
56
Crum, C., (2003:32)
57
Lapide, L., (1999:29)
58
Nahmias, S. (2005:58-59)
54
28
Cycles Variations similar to seasonality except the length and magnitude of the
cycle may vary. For example: a long-term economic business cycle that may be
present in addition to seasonal fluctuations.
Randomness - A series where data shows no recognizable pattern. One can generate
patterns purely at random that often appear to have structure.
29
Of these models, the following appear in the empiric and analysis of this study: Moving
average (and weighted moving average) models, Simple exponential smoothing, Double
exponential smoothing, and Triple exponential smoothing.
30
Ft = (1/N)*
i = t -N
59
Nahmias, S. (2005:63)
Martin, J. (2008:245)
61
Nahmias, S. (2005:64)
60
31
62
The weights lie between 0.0 and 1.0 for a total of 1.0. The higher the
weight, then the higher importance we place on more recent data; similarly, for lower
weights.63
Forecast in period t :
Ft = (*(Dt-1+ + Dt-3) + *(Dt-4++ Dt-6) + *(Dt-7 +...+ Dt-12))/12
62
http://www.smetoolkit.org/smetoolkit/en/content/en/416/Demand-Forecasting, 2008-04-29
http://shmula.com/308/forecasting-unweighted-and-weighted-moving-average-model, 2008-04-29
64
Nahmias, S. (2005:66)
65
Kalekar, P., (2004:3)
66
Nahmias, S. (2005:69)
63
32
Formula:
Ft = *Dt-1 + (1-)*Ft-1
That is:
New forecast = (Current observation of demand) + (1 - )(Last forecast)
Smoothing
0< 1
constant:
Source: Nahmias, S. (2005:66)
Intercept
Slope
A drawback using this analysis, similar to simple exponential smoothing, is how to first get
the method started. The best way to combat this is to establish a set of initial periods as a
33
starting point and use regression analysis to make estimates of the slope and intercept using
the starting point data.67 Also this method does not consider seasonal behaviours.
Formula:
Ft, t+ = St + Gt
-step-ahead forecast
made in period t
Intercept:
Slope:
Smoothing constants:
Dt = ( + Gt)*Ct + t
67
Nahmias, S. (2005:77)
http://openforecast.sourceforge.net/docs/net/sourceforge/openforecast/models/DoubleExponentialSmoothingM
odel.html, 2008-05-23
69
Martin, J. (2008:247)
70
Nahmias, S. (2005:83)
68
34
There is the base signal or intercept at time t = 0 excluding seasonality, Gt is the trend or
slope component, Ct is the multiplicative seasonal component i period t, and the error term is
expressed as t.71
To initiate the model, one must obtain a building block of estimates for the series, the slope
and the seasonal factors. It is suggested that one must have at least two seasons of data to
initiate the model; however, it is not the only way to start.72 Seasonal factors could be
determined by a moving average method, or by using the slope and intercept values as
proposed in Holts double exponential smoothing model.
A drawback to using this model is that the calculations become tedious since one has to test
many combinations of the three parameters. In addition, there is no assurance that the best
values of the smoothing parameters based on past data will be the best values to use in future
forecasts. The best assurance in this scenario is to choose smoothing parameters between 0.1
and 0.2.73
Formula:
Smoothing constant:
0< < 1
0< < 1
0<<1
Source: Nahmias, S. (2005:84)
71
Nahmias, S. (2005:83)
ibid
(2005:86)
73
ibid (2005:88)
72
35
3.4.3 Autocorrelation
Before using Winters method, it is recommend to first test for autocorrelation.
Autocorrelation is the correlation of a time series with its own past and future values.74 In
other words, the autocorrelation function helps test for the presence of patterns, seasonality.
For example, if low values in historical data tend to be followed by low values two periods
later, then the series exhibit a positive autocorrelation. A positive autocorrelation denotes
the presence of seasonality and therefore triple exponential smoothing method is
recommended. Under the right circumstances it may outperform simpler forecasting methods.
A negative autocorrelation would denote the lack of seasonality; therefore triple exponential
smoothing would not be recommended. At least 72 periods of observation are recommended
in order to get a reasonable estimate using the autocorrelation function. 75 An autocorrelation
is calculated as some value between -1 and +1. The value +1 indicates strong positive
autocorrelation; -1 indicates strong opposite (negative) autocorrelation; 0 means no
autocorrelation.76
et = Ft - Dt
74
http://64.233.183.104/search?q=cache:aYWnjh43K6oJ:www.ltrr.arizona.edu/~dmeko/notes_3.pdf ,
2008-05-23
75
Nahmias, S. (2005:91)
76
Hoff, J.C. (1983:55)
36
There are three often-used measurements of forecasting accuracy MAD, MSE, and MAPE.
Although MAD and MSE are most commonly used, MAD is usually preferred because it
does not require squaring. MAPE is a measurement not dependent on the magnitude of the
values of demand. 77
1. MAD (mean absolute deviation) measures average absolute deviation of forecast from
actuals. It is the average of all forecast errors divided by n periods. All errors are treated as a
positive value.78
n
2. MSE (mean squared error) measures variance of forecast error. It is the average of the sum
of the squared errors divided by n periods.79 This method puts more weight to large errors.80
n
3. MAPE (mean absolute percentage error) measures absolute error as a percentage of the
forecast. It is the average of all the ratios 100ei/Di, where Di is the value of demand and ei is
the forecast error at period i divided by n periods.81
n
As mentioned earlier, one should have an unbiased forecast. To that end, there are different
ways of tracking a forecast method. One of them is to graph the values of forecast error ei
over time. Forecast errors should fluctuate randomly above and below zero if the method is
unbiased. Another method is to sum all the forecast errors, ei. If the value of this moves too
far away from zero (either above or below), it indicates that the forecasting method is
77
Nahmias, S. (2005:60)
Hoff, J.C. (1983:262)
79
ibid
(1983:272)
80
Andersson, G. (1994:206)
81
Hoff, J.C. (1983:263)
78
37
biased.82 MAPE puts less weight to large forecast errors than MSE. It is useful to use for
comparing between different time series because the error is divided by corresponding
demand value.83
82
Nahmias, S. (2005:61)
83
Andersson, G. (1994:206)
38
Demand forecasting
Subjective
(Human judgment)
Objective
(Mathematical)
Regression (Causal)
Characterized by
dependent variables
and independent
variables
Evaluating forecast
accuracy
-MAD
-MAPE
-MSE
39
4. Empirical
his chapter contains the empirical data collected throughout the action research
study at Alfa Laval in Lund. The questions can be seen in Appendix 1. We begin with
a short reintroduction of the company; followed by information about the current ordering
process for raw materials, demand forecasting, and forecast and error evaluation models
currently used at Alfa Laval. Then we introduce the items to be analyzed and discuss how
data was gathered.
40
4.2 Interviewees
We received assistance from Tobias Augustsson, Martin Jnsson, and Lars Hedberg of the
OM-CP unit throughout this study.
41
42
Calculation: Each month is the forecast value for the next 12 months divided by 4 in order to
get a 3 month forecast. This value is then compared to real demand (delivery from stock)
during the past 3 months. Next, the error is expressed as a percentage of the forecast. There is
a limit for accepted forecast error. It should have an accuracy of 30 %. In Jeeves, the
values falling within the limit are classified as 0 and those exceeding the limit as 1. See
Appendix 5 for further explanation and analysis of Alfa Lavals accuracy evaluation method.
Alfa Lavals formula for estimating the forecast error as a percentage (%):
et =((D3m F3m)/F3m)*100
et = forecast error in period t
D3m = Demand (Delivery from Stock) - sum of the past three months
F3m = Forecast - usage one year ahead divided by four
43
=2
=1
= 0,5
Weighted factors:
= 1,25
= 1,10
= 0,9
= 0,75
44
3. RAK straight moving average the weight is distributed evenly on all the twelve past
periods.
Forecast in period t:
Ft = (*(Dt-1+ + Dt-12))/12
Weighted factor:
=1
4. Exponential smoothing the forecast in period t is the weighted average of the forecast in
period t-1 and the current value of demand in period t-1.
Ft = *(Dt-1+ (1- )*Ft-1
Smoothing constant:
= 0,1
45
RAK
resundsvg (-vg)
Weighted factors
Weighted factors
Weighted factors
-12
0,75
0,5
-11
0,75
0,5
-10
0,75
0,5
-09
0,90
0,5
-08
0,90
0,5
-07
0,90
0,5
-06
1,10
1,0
-05
1,10
1,0
-04
1,10
1,0
-03
1,25
2,0
-02
1,25
2,0
-01
1,25
2,0
Period
46
Raw Material
Current Forecasting
Raw Material
Current Forecasting
Item Number
Method
Item Number
Method
Rak
1577
-vg
105
-vg
1681
Rak
208
-vg
1784
-vg
310
-vg
1806
Rak
413
-vg
1827
Rak
487
Rak
1906
-vg
590
-vg
2009
Rak
693
Rak
2103
Rak
796
-vg
2207
Rak
899
-vg
2229
Rak
973
-vg
2332
-vg
1014
-vg
2410
-vg
1117
-vg
2513
Rak
1220
Rak
2591
-vg
1266
Rak
2713
Rak
1369
-vg
2816
Rak
1473
Rak
2846
Rak
Figure 4.3: Current forecasting methods for selected raw material items
47
The historical data we gathered and sorted are presented in Appendix 2 and have the
following characteristics:
Observations of only one phenomena demand of raw material items based on past
values of Delivered from Stock
The quantity of available past data varies (ie: varied numbers of observation)
Several zero (0) values are presented (ie: recorded as 0 delivered from stock)
After the historical data for demand of raw material was obtained and chronologically sorted,
it was of great importance to identify patterns (seasonality, trend) in data. This will be
discussed further in Chapter 5.
48
5. Analysis
n the analysis chapter we use various forecasting theories to analyze demand for raw
material items presented in the empirical chapter. We will seek to offer options of
theoretical model that can provide better forecasting accuracy in practical applications.
Note: Due to the huge amount of data produced during our study, the Appendix 2, 3 and 4 in
this report will present the analysis of one raw material item only to illustrate our approach.
The data and the complete analysis of all items are included on the CD.
49
Current Forecasting
Method
Rak
105
-vg
208
-vg
310
-vg
487
Rak
590
-vg
693
Rak
796
-vg
1117
-vg
1266
Rak
2410
-vg
2513
Rak
Figure 5.1: Raw material item numbers and current forecasting methods
50
Step 2
Where demand is positive in most periods and there were some 0periods, these periods
were corrected to an average of the before and after period, or as a multiple-period average.
The reason for correcting 0periods is because they would otherwise disrupt the formula for
51
computing the forecasting accuracy (MAPE). Another reason is that the time series methods
require more or less constant demand. As seen below, the new demand data to be used for
analysis appears under the column Data Correction. See enclosed CD for complete data for
all raw material items.
Step 3
After each raw material item was scrubbed and 0 periods corrected, a diagram was created
of the demand data to show if a trend or season in demand exists. If a trend exists, this is a
good indication that Holts method ought to be used. (see Figure 5.4)
Delivery from Stock (Item Nr.3)
60000
50000
Pcs
40000
Delivery from stock
30000
20000
10000
0
1
9 13 17 21 25 29 33 37 41 45 49 53 57 61 65 69 73 77 81 85 89 93 97
Months
Figure 5.4: Delivery from stock (raw material item nr. 3) with increasing linear trend
52
Step 4
We then programmed time series methods formulas and autocorrelation into an excel
spreadsheet. Each of the twelve raw material items is analyzed by each of the six methods:
Moving average, Simple exponential smoothing, Double exponential smoothing, Rak,
-vg, and Triple exponential smoothing (see enclosed CD). Recall that Rak and -vg are
methods currently being used at Alfa Laval.
All the six forecasting methods are programmed in excel to work automatically. However,
some adjustments have to be made in order for the methods to perform correctly for each
specific item. Such adjustments are:
The demand data must be pasted to the column Delivered from Stock. This applies
to each method. If required, the parameter and number of periods (n) have to be
adjusted.
To start the Single and Triple exponential smoothing methods, initial values are
required. To start the value, for single exponential smoothing, we take the average of
the ten first demand observations; and for triple exponential smoothing, we take the
demand average of two separate seasons (V1, V2).
After the initial data are selected, the different parameters such as smoothing
constants (, , and ) have to be tested in order to get the demand forecast with the
lowest error.
A snapshot of one of the analyzing methods, a moving average, of one raw material item is in
Figure 5.5.
53
54
Step 5
Evaluating forecast error
As mention above, depending on the method applied, we then had to adjust alpha, beta, and
gamma (smoothing constants) and use MAD, MAPE, and MSE to determine the lowest
forecast error of each method for each item. To evaluate the single, double exponential
smoothing, -vg and Rak methods we calculate the value of MAD, MSE and MAPE both
on one-month and three-month bases (see Figure 5.6). Since the moving average analysis
doesnt require a smoothing constant, we tested different n - step ahead moving averages in
order to determine which of them gives us the lowest error.
Figure 5.6: Snapshot of MAD, MSE and MAPE in double exponential smoothing analysis
55
XXX
4327,5
680
0,842865
diff
3647,5
Late
56
As previously mentioned in the Empirical Chapter 4.3.4, Alfa Laval evaluates the forecast
accuracy (%) using following formula:
et =((D3m F3m)/F3m)*100
et = forecast error in period t
D3m = Demand (Delivery from Stock) - sum of the past three months
F3m = Forecast - usage one year ahead divided by four
Using the values presented in Figure 5.7, we obtain the following result:
57
Step 6
For each analysis, we created a graph showing both demand and forecast in order to visually
asses how closely the forecast followed demand. (see Figure 5.8 and enclosed CD)
We also graph the forecast error over time in order to determine if the method is unbiased.
As we explained in the Theory Chapter 3.5, the method is unbiased when the forecast error
fluctuate randomly above and below zero.
50000
40000
Pcs
30000
10000
0
1 4
7 10 13 16 19 22 25 28 31 34 37 40 43 46 49 52 55 58 61 64 67 70 73 76 79 82 85 88 91 94 97
Months
Figure 5.8: Graph showing forecast and demand in upward trend. Forecast made by double
exponential smoothing (2exp)
58
Step 7
After a raw material item was analyzed using each method, we then created a summary chart
to evaluate error accuracy of all methods applied. See Appendix 4 - Raw Material Analysis
(Analysis table). In Figure 5.9 below, the orange highlighted value is our observation of the
lowest forecasting error. However, depending on other factors in a real life situation, another
of the evaluations of accuracy (MAD, MAPE, MSE) may be more appropriate to Alfa Laval.
Note: 3 months MAPE evaluation is provided for comparison since it is a measurement used
at Alfa Laval.
59
Forecast Accuracy
Nr.
Evaluating
105
Parameters
MSEn
MADn
14 per Mav
12 per Mav
MAPEn %
5 per Mav
= 0,9 , = 0,1 , =
0,9
MSE
MAD
Moving
Double exp
Triple exp
Rak
-vg
Average
smoothing
smoothing
method
method
77172831
6554
228272046 99077664
12503
7992
32
19
MAPE %
208
MSE
MAD
33
= 0,9 , =0,1 , = 0,1
39360646
4214
MAPE %
310
MSE
MAD
36
= 0,9 , = 0,2 , =
0,7
24968106
3237
MAPE %
487
MSE
MAD
39
= 0,9 , = 0,1 , =0,7
34870514
4670
MAPE %
590
693
39
MSEn
MADn
5per Mav
12per Mav
MAPEn %
5per Mav
= 0,9 , = 0,1 , =
0,9
MSE
MAD
MSE
MAD
MAPEn %
36908608 15783089
4382
2860
17
11
78422544 35771303
7278
4968
13
39
16
11
19947452
3297
40
= 0,8 , = 0,2 , =
0,1
6031122
1853
29
= 0,2 , = 0,1
40283391 17921812
5378
3597
21
15
31332630 13594254
4556
2984
22
14
21329880
3515
28
8977227
2339
19
4843015
1442
13756486
3012
5726137
1936
71
41
28
1522779
844
3588770
1451
1615093
983
9202567
2182
90
37
= 0,7 , = 0,1 , =
0,1
= 0,9 , = 0,1 , =
0,9
MAPE %
2513 MSEn
MADn
10
6199812
1544
MAPE %
2410 MSE
MAD
15
19
MAPE % (3 months)/D
1266 MSE
MAD
11
14385157
2275
MAPE %
1117 MSE
MAD
MAPE %
16
66815561 31394540
6266
4319
6504583
1726
MAPE %
796
12
30
21
5per Mav
5per Mav
330198
418
57
940763
655
395257
434
5per Mav
49
36
21
Figure 5.10: Summary of the raw material items and the best forecasting methods
60
According to the summary above, the forecasting methods providing the lowest errors are
Alfa Lavals methods (Rak and -vg). The reason for this result is that the evaluating
method of forecasting accuracy employed by Alfa Laval is not correct. (See Appendix 5).
Using the evaluating method, corresponding to the common practice, reveals the fact that
other time series analysis methods provide better results. (See Appendix 3 and 4)
According to the theory presented in Theory Chapter 3.4, one would expect that the best
forecasting method should be determined with the help of following rules of thumb:
1) The moving average and single exponential smoothing forecasting methods should be
used if the data exhibits no trend.
2) Double exponential smoothing (Holts method) accounts for a trend in the time series
data.
3) Triple exponential smoothing is an appropriate forecasting method if the data exhibits
seasonal pattern with or without trend.
However, the result of analyzing the 12 raw material items using time series forecasting
methods is in contrast to our expectations. In the summary above, five periods moving
average gives the lowest forecast error for items 3, 590 and 2513 despite the fact that all of
them exhibit slightly increasing trend. Moving average is supposed to lag behind the trend.
Items 1266 and 2410 exhibit very high forecast error compared to other items. The reason is
the character of the historical data. They have many zero values, which had to be adjusted
manually by averaging observations. This negatively impacts the performance of the
forecasting methods.
Item number 1117 exhibits a lot of varying demand over time. Using triple exponential
smoothing gives low error by 35% (MAPE). However, the relatively low error leads to
negative forecast values, which are not desirable. Trying different smoothing constants in
order to eliminate the negative values doesnt help the situation. We decided to manipulate
smoothing constants at double exponential smoothing instead. Using this method guarantees
the positive forecast values even if the forecast error is very high, 90% (MAPE).
61
Altogether we tested six forecasting methods, inclusive of Alfa Lavals methods, on 12 raw
material items. The triple exponential smoothing method provides the lowest forecasting
error in 8 out of 12 cases. This result contradicts theory, which states this method is
successful with data that has seasonal pattern, which is not our case. We carefully examined
the available historical data spotted by graphing in order to answer the following question:
Why dont these forecasting methods work according to theory? According to theory,
presented in Theory Chapter 3.2, the time series forecasting methods require more constant
demand over time. Our historical data, based on delivered from stock values, in most of the
cases dont comply with this requirement. The only method that seems to have the ability to
cope with our data is triple exponential smoothing. The method is based on three smoothing
constants (, , ), which can be manipulated in order to get the lowest forecast error. The
combination of high value of and law value of provides the best result. This probably
makes the method more flexible to provide better results than the other methods.
62
6. Conclusion
his chapter concludes our findings and answers our research questions. We address
the validity of our research and give recommendations to Alfa Laval. Then we provide
suggestions for continued research. Finally are our reflections concerning the writing of this
thesis, and then some observations on conducting the data analysis, client validity, and future
work.
6.1 Results
We begin this chapter with a reminder to the reader of the research questions posed at the
beginning of this thesis and the response.
1) How does Alfa Laval currently forecast for demand?
For the selected raw materials evaluated in this study, we have found evidence that Alfa
Laval currently uses two of four internally devised forecasting models. The two models are
internally referred to as Rak - which resembles Straight Moving Average; and -vg - which
resembles Weighted Moving Average. The disadvantage of using these models is that they
are not the best tools to consider trends or seasonality, which are exhibited in some of the raw
materials analyzed. This lack of adequate measurement contributes to the 50% accuracy Alfa
Laval is currently experiencing.
Additionally, it was observed that Alfa Lavals current error evaluation method differs
greatly from theory and is probably incorrect, since the formula is comparing the future data
with the past data. Furthermore, Alfa Laval divides the forecast error by the value of the
forecast - not by the value of demand as theory and common practice dictate.
Our recommendation is to compare the demand data at period t to the forecast data at the
same time period t. In order to get the most reliable result of the forecasting method, the
forecasting error should be related to the demand instead of to the forecast.
63
2) How can the demand forecasting for raw material purchases be improved and
which method/methods results in lower forecasting errors while taking into
consideration trends and seasonal variations?
The demand forecasting for raw material purchases can be improved by using other input
data than Delivery from Stock. Currently, all forecasting is based on the Delivery from stock
values. Doing so leads to some periods (months) with zero values in the input data. The zero
values signify there is no raw material delivered from stock. However, it does not mean there
werent any orders placed in that particular month.
The zero problem will be solved at most of the cases using placed orders as a source of
input data instead of Delivery from stock values. This will also lead to better knowledge
about the real demand.
As mentioned in the analysis, we tested four standard forecasting methods as well as two of
Alfa Lavals own methods on 12 raw material items. The triple exponential smoothing
method provides the lowest forecasting error in 8 out of 12 cases. However, this is based on
the Delivered from Stock data. If the analysis had been based on different input, other
methods could have been more appropriate, but in this situation, triple exponential smoothing
seemed to provide the greatest flexibility.
6.2 Reflections
A great amount of time was required to create Excel spreadsheet functions to be able to use
the forecasting methods. To make the analysis as simple a process as possible we tried to
express all formulas in a user friendly way before doing the analyses so that only historical
data and other parameters needed to be pasted in and adjusted as necessary. This was a
quality control effort to make sure that opportunities for human error were at a minimum.
Because Alfa Laval records historical data in Jeeves in a way that suits their own business
and administrative needs and not to aid forecasting, it was time consuming to make data
suitable for the purpose of this study (for example: current forecasting error per each raw
material studied). It required looking in different places of the ERP system, collecting the
information, and then sorting, recalculating and analyzing it.
64
65
REFERENCES
Literature:
Andersson, G. & Jorner U. & gren A., Regressions- och tidsserieanalys, Studentlitteratur,
1994
Bryman, A. & Bell, E.,Business Research Methods, Oxford University Press, 2007.
Greenwood, D. & Morten, L., Introduction to Action Research, Sage Publications, 1998.
Grundy, S. Three Modes of Action Research, Deakin University Press, Geelong, 1982.
Hoff John C. A Practical Guide to Box-Jenkins Forecasting, Wadsworth, 1983
Nahmias, S., Production and Operations Analysis, McGraw-Hill Irwin, 2005.
Yin, R., Case Study Research: Design and Methods, Sage Publications, 2003.
E-books:
Argyris,C., Putnam, R., Smith, D. Action Science Concepts, Methods, and Skills for
Research and Intervention, Jossey-Bass Inc., Publishers, 1985.
Armstrong, J., Principles of Forecasting. A Handbook for Researchers and Practitioners,
Kluwer Academic Publishers, 2001.
Crum, C., Demand Management Best Practices: Process, Principles, and Collaboration, J.
Ross Publishing, 2003.
McNiff Jean, You and Your Action Research Project, Routledge Falmer Publisher, 1996.
Articles:
Fawcett, S. & Fawcett, S., The firm as a value-added system: Integrating logistics,
operations and purchasing, 1995
Fenstermacher, K. & Zeng, D., Know Your Supply Chain, Eller College of Business and
Public Administration, University of Arizona
Fildes, R., Goodwin, P., Forecasting, Financial Management Caspian Publisher, 2007
Kalekar, P., Time Series Forecasting Using Holt-Winters Exponential Smoothing,
December 6, 2004
Kengpol, A., Kaoien, P., & Touminen, M., A Procurement Planning Improvement by Using
Linear Programming and Forecasting Models, PICMET, 2007
66
Figures:
Figure 1.1: Alfa Lavals Value Added Chain
Figure 1.2: Disposition of Study
Figure 2.1: Action Research - Core Characteristics
Figure 2.2: Cyclical Process of Action Research
Figure 2.3: Summary of methodology
Figure 3.1: Summary of qualitative and quantitative forecasting approaches
67
List of Abbreviations
CU
Component Unit
SU
Supply Unit
OM-CP
MAPE
MAD
MSE
68
69
This report contains historical data and raw material analysis for one item only.
The complete results can be found on the enclosed CD
70
et =((D3m F3m)/F3m)*100
et = forecast error at period t (three months)
D3m = Demand (Delivery from Stock) - sum of the past three months
F3m = Forecast - usage one year ahead divided by four
Forecast for the next three months is:
Ft3m = (2*(12+11+10) + 1*(9+8+7) + 0,5*(6+5+4+3+2+1)) / 4
Let us call (12+11+10) for a and 1*(9+8+7) + 0,5*(6+5+4+3+2+1) for b
Than we can write Ft3m as (2a+b) / 4
D3m is (12+11+10) = a
Formula for the forecast evaluation is: (D3m-Ft3m) / Ft3m
Substituting in the formula we obtain:
(a -(2a+b) / 4) / ((2a+b) / 4) = ((4a -2a - b) / 4) / ((2a +b) / 4) = (2a-b) / (2a+b)
It means that the evaluation method is probably incorrect; formula is comparing the
forecasted future data (next three months 13, 14 and 15) to the past data (months 10, 11 and
12). There is no indication of how accurate the prediction Ft3m is, it should be compared to
recorded real data in months 15, 14 and 13 which it forecasts.
1
2
3
4
5
6
7
8
9
10
D3m 11 e/F3m = (D3m-F3m)/F3m
12
13 Forecast F3m
14 (2a+b)/4
15
71
72