Inventory Management, Supply Contracts and Risk Pooling

Phil Kaminsky kaminsky@ieor.berkeley.edu

Issues
• Inventory Management • The Effect of Demand Uncertainty
– – – – (s,S) Policy Periodic Review Policy Supply Contracts Risk Pooling

• Centralized vs. Decentralized Systems • Practical Issues in Inventory Management

Sources: plants vendors ports

Field Regional Warehouses: Warehouses: stocking stocking points points

Customers, demand centers sinks

Supply

Inventory & warehousing costs Production/ Transportati Transportati purchase on on costs costs Inventory & costs warehousing costs

Inventory
• Where do we hold inventory?
– Suppliers and manufacturers – warehouses and distribution centers – retailers

• Types of Inventory
– WIP – raw materials – finished goods

• Why do we hold inventory?
– Economies of scale – Uncertainty in supply and demand – Lead Time, Capacity limitations

Goals: Reduce Cost, Improve Service
• By effectively managing inventory:
– Xerox eliminated $700 million inventory from its supply chain – Wal-Mart became the largest retail company utilizing efficient inventory management – GM has reduced parts inventory and transportation costs by 26% annually

Goals: Reduce Cost, Improve Service
• By not managing inventory successfully
– In 1994, “IBM continues to struggle with shortages in their ThinkPad line” (WSJ, Oct 7, 1994) – In 1993, “Liz Claiborne said its unexpected earning decline is the consequence of higher than anticipated excess inventory” (WSJ, July 15, 1993) – In 1993, “Dell Computers predicts a loss; Stock plunges. Dell acknowledged that the company was sharply off in its forecast of demand, resulting in inventory write downs” (WSJ, August 1993)

Understanding Inventory • The inventory policy is affected by: – Demand Characteristics – Lead Time – Number of Products – Objectives • Service level • Minimize costs – Cost Structure .

Cost Structure • Order costs – Fixed – Variable • Holding Costs – Insurance – Maintenance and Handling – Taxes – Opportunity Costs – Obsolescence .

no lead time – Holding cost of 25% of inventory value annually – Mugs cost $1.00.EOQ: A Simple Model* • Book Store Mug Sales – Demand is constant.00 • Question – How many.00. at 20 units a week – Fixed order cost of $12. when to order? . sell for $5.

EOQ: A View of Inventory* Note: • No Stockouts • Order when no inventory • Order Size determines policy Inventory Order Size Avg. Inven Time .

Inven) * (Holding Cost) • Ordering (Setup Cost): Number of Orders * Order Cost • Goal: Find the Order Quantity that Minimizes These Costs: .EOQ: Calculating Total Cost* • Purchase Cost Constant • Holding Cost: (Avg.

EOQ:Total Cost* 10 6 10 4 10 2 Cost 10 0 8 0 6 0 4 0 2 0 0 0 50 0 O e Q a tity rd r u n 10 00 10 50 Total Cost Holding Cost Order Cost .

EOQ: Optimal Order Quantity* • Optimal Quantity = (2*Demand*Setup Cost)/holding cost • So for our problem. the optimal quantity is 316 .

EOQ: Important Observations* • Tradeoff between set-up costs and holding costs when determining order quantity. In fact. we order so that these costs are equal per unit time • Total Cost is not particularly sensitive to the optimal order quantity Order Quantity 50% Cost Increase 80% 90% 100% 110% 120% 150% 200% 125% 103% 101% 100% 101% 102% 108% 125% .

The Effect of Demand Uncertainty • Most companies treat the world as if it were predictable: – Production and inventory planning are based on forecasts of demand made far in advance of the selling season – Companies are aware of demand uncertainty when they create a forecast. but they design their planning process as if the forecast truly represents reality • Recent technological advances have increased the level of demand uncertainty: – Short product life cycles – Increasing product variety .

Demand Forecast • The three principles of all forecasting techniques: – Forecasting is always wrong – The longer the forecast horizon the worst is the forecast – Aggregate forecasts are more accurate .

the marketing department has a probabilistic forecast – The forecast averages about 13. . but there is a chance that demand will be greater or less than this. high variety of competitors • SnowTime Sporting Goods – New designs are completed – One production opportunity – Based on past sales. knowledge of the industry. and economic conditions.SnowTime Sporting Goods • Fashion items have short life cycles.000.

Supply Chain Time Lines Jan 00 Design Jan 01 Production Sep 00 Feb 01 Sep 01 Jan 02 Retailing Production Feb 00 .

SnowTime Demand Scenarios Probability D mn Se a s e a d c n rio 3% 0 2% 5 2% 0 1% 5 1% 0 5 % 0 % 0 0 0 0 0 0 0 0 0 0 0 0 0 4 0 2 8 1 1 1 1 6 S le a s 1 8 0 0 0 0 0 .

000 Q is production quantity. D demand • Profit = Revenue .Fixed Cost + Salvage .Variable Cost .SnowTime Costs • • • • • Production cost per unit (C): $80 Selling price per unit (S): $125 Salvage value per unit (V): $20 Fixed production cost (F): $100.

000) . – Profit = 125(12.100.100.000) .000 jackets and demand ends up being 11.000 • Scenario Two: – Suppose you make 12.000 jackets and demand ends up being 13.000) .80(12.000 . – Profit = 125(11.000 jackets.000 = $440.80(12.000 + 20(1000) = $ 335.SnowTime Scenarios • Scenario One: – Suppose you make 12.000 jackets.000) .

SnowTime Best Solution • Find order quantity that maximizes weighted average profit. • Question: Will this quantity be less than. or greater than average demand? . equal to.

marginal profit – if extra jacket sold. or greater than average demand? • Average demand is 13. equal to.What to Make? • Question: Will this quantity be less than. profit is 125-80 = 45 – if not sold. cost is 80-20 = 60 • So we will make less than average .100 • Look at marginal cost Vs.

000 $100.SnowTime Expected Profit Expected Profit $400.000 $0 8000 12000 16000 20000 Order Quantity .000 $300.000 Profit $200.

000 $300.SnowTime Expected Profit Expected Profit $400.000 Profit $200.000 $100.000 $0 8000 12000 16000 20000 Order Quantity .

SnowTime: Important Observations • Tradeoff between ordering enough to meet demand and ordering too much • Several quantities have the same average profit • Average profit does not tell the whole story • Question: 9000 and 16000 units lead to about the same average profit. so which do we prefer? .

000 Profit $200.000 $0 8000 12000 16000 20000 Order Quantity .SnowTime Expected Profit Expected Profit $400.000 $100.000 $300.

Probability of Outcomes 100% 80% Probability 60% 40% 20% 0% -3 00 00 -1 0 00 00 0 10 00 00 30 00 00 50 00 00 Q=9000 Q=16000 Revenue .

risk increases. In other words.Key Insights from this Model • The optimal order quantity is not necessarily equal to average forecast demand • The optimal quantity depends on the relationship between marginal profit and marginal cost • As order quantity increases. the probability of large gains and of large losses increases . average profit first increases and then decreases • As production quantity increases.

D demand • Profit = Revenue .SnowTime Costs: Initial Inventory • • • • • Production cost per unit (C): $80 Selling price per unit (S): $125 Salvage value per unit (V): $20 Fixed production cost (F): $100.Fixed Cost + Salvage .000 Q is production quantity.Variable Cost .

000 $100.000 $300.SnowTime Expected Profit Expected Profit $400.000 $0 8000 12000 16000 20000 Order Quantity .000 Profit $200.

Initial Inventory • Suppose that one of the jacket designs is a model produced last year. no setup cost • Question: If there are 7000 units remaining. • Some inventory is left from last year • Assume the same demand pattern as before • If only old inventory is sold.000 remaining? . what should SnowTime do? What should they do if there are 10.

Initial Inventory and Profit 500000 400000 300000 200000 100000 0 00 00 00 00 0 0 0 00 14 00 50 50 65 80 95 50 15 0 Profit 11 P roduc tion Qua ntity 12 .

Initial Inventory and Profit 500000 400000 300000 200000 100000 0 00 00 00 00 0 0 0 00 14 00 50 50 65 80 95 50 15 0 Profit 11 P roduc tion Qua ntity 12 .

Initial Inventory and Profit 500000 400000 300000 200000 100000 0 00 00 00 00 0 0 0 00 14 00 50 50 65 80 95 50 15 0 Profit 11 P roduc tion Qua ntity 12 .

Initial Inventory and Profit 500000 400000 Profit 300000 200000 100000 0 5000 6000 7000 8000 9000 13000 14000 10000 11000 12000 15000 16000 P ro d u ctio n Qu an tity .

Supply Contracts Fixed Production Cost =$100.000 Variable Production Cost=$35 Wholesale Price =$80 Selling Price=$125 Salvage Value=$20 Manufacturer Manufacturer DC Retail DC Stores .

Demand Scenarios Demand Scenarios 30% 25% 20% 15% 10% 5% 0% Probability 80 00 10 00 0 12 00 0 14 00 0 16 00 0 18 00 0 Sales .

Distributor Expected Profit Expected Profit 500000 400000 300000 200000 100000 0 6000 8000 10000 12000 14000 16000 18000 20000 Order Quantity .

Distributor Expected Profit Expected Profit 500000 400000 300000 200000 100000 0 6000 8000 10000 12000 14000 16000 18000 20000 Order Quantity .

) • Distributor optimal order quantity is 12.000 –Is there anything that the distributor and manufacturer can do to increase the profit of both? .000 • Supply Chain Profit is $910.000 units • Distributor expected profit is $470.000 • Manufacturer profit is $440.Supply Contracts (cont.

000 Variable Production Cost=$35 Wholesale Price =$80 Selling Price=$125 Salvage Value=$20 Manufacturer Manufacturer DC Retail DC Stores .Supply Contracts Fixed Production Cost =$100.

000 100.000 200.000 0 60 00 70 00 80 00 90 00 10 00 0 11 00 0 12 00 0 13 00 0 14 00 0 15 00 0 16 00 0 17 00 0 18 00 0 Order Quantity .000 Retailer Profit 500.000 300.000 400.Retailer Profit (Buy Back=$55) 600.

000 0 60 00 70 00 80 00 90 00 10 00 0 11 00 0 12 00 0 13 00 0 14 00 0 15 00 0 16 00 0 17 00 0 18 00 0 $513.800 Order Quantity .000 400.000 100.000 Retailer Profit 500.000 200.Retailer Profit (Buy Back=$55) 600.000 300.

000 Manufacturer Profit 500.000 200.Manufacturer Profit (Buy Back=$55) 600.000 400.000 100.000 300.000 0 60 00 70 00 80 00 90 00 10 00 0 11 00 0 12 00 0 13 00 0 14 00 0 15 00 0 16 00 0 17 00 0 18 00 0 Production Quantity .

000 Manufacturer Profit 500.900 Production Quantity .000 0 60 00 70 00 80 00 90 00 10 00 0 11 00 0 12 00 0 13 00 0 14 00 0 15 00 0 16 00 0 17 00 0 18 00 0 $471.000 300.000 100.000 400.000 200.Manufacturer Profit (Buy Back=$55) 600.

Supply Contracts Fixed Production Cost =$100.000 Variable Production Cost=$35 Wholesale Price =$?? Selling Price=$125 Salvage Value=$20 Manufacturer Manufacturer DC Retail DC Stores .

000 100.Retailer Profit (Wholesale Price $70.000 400.000 300.000 Retailer Profit 500.000 0 60 00 70 00 80 00 90 00 10 00 0 11 00 0 12 00 0 13 00 0 14 00 0 15 00 0 16 00 0 17 00 0 18 00 0 Order Quantity . RS 15%) 600.000 200.

RS 15%) 600.000 0 60 00 70 00 80 00 90 00 10 00 0 11 00 0 12 00 0 13 00 0 14 00 0 15 00 0 16 00 0 17 00 0 18 00 0 $504.000 Retailer Profit 500.000 100.Retailer Profit (Wholesale Price $70.000 300.000 400.325 Order Quantity .000 200.

000 500.000 Manufacturer Profit 600.Manufacturer Profit (Wholesale Price $70.000 300.000 100.000 400.000 0 60 00 70 00 80 00 90 00 10 00 0 11 00 0 12 00 0 13 00 0 14 00 0 15 00 0 16 00 0 17 00 0 18 00 0 Production Quantity . RS 15%) 700.000 200.

375 Production Quantity .000 200.Manufacturer Profit (Wholesale Price $70.000 500.000 0 60 00 70 00 80 00 90 00 10 00 0 11 00 0 12 00 0 13 00 0 14 00 0 15 00 0 16 00 0 17 00 0 18 00 0 $481. RS 15%) 700.000 100.000 Manufacturer Profit 600.000 300.000 400.

Supply Contracts Strategy Sequential Optimization Buyback Revenue Sharing Retailer Manufacturer 470.700 985.325 481.700 440.375 Total 910.700 985.700 .000 513.900 504.800 471.

000 Variable Production Cost=$35 Wholesale Price =$80 Selling Price=$125 Salvage Value=$20 Manufacturer Manufacturer DC Retail DC Stores .Supply Contracts Fixed Production Cost =$100.

000 600.Supply Chain Profit 1.000 Supply Chain Profit 1.000 0 60 00 70 00 80 00 90 00 10 00 0 11 00 0 12 00 0 13 00 0 14 00 0 15 00 0 16 00 0 17 00 0 18 00 0 Production Quantity .000 400.000.000 800.200.000 200.

Supply Chain Profit 1.000 400.200.000 0 60 00 70 00 80 00 90 00 10 00 0 11 00 0 12 00 0 13 00 0 14 00 0 15 00 0 16 00 0 17 00 0 18 00 0 $1.500 Production Quantity .000 600.000 200.000 800.000.014.000 Supply Chain Profit 1.

000 513.900 504.014.800 471.700 985.700 1.375 Total 910.325 481.Supply Contracts Strategy Sequential Optimization Buyback Revenue Sharing Global Optimization Retailer Manufacturer 470.700 985.700 440.500 .

Supply Contracts: Key Insights • Effective supply contracts allow supply chain partners to replace sequential optimization by global optimization • Buy Back and Revenue Sharing contracts achieve this objective through risk sharing .

Contracts and Supply Chain Performance • Contracts for Product Availability and Supply Chain Profits – Buyback Contracts – Revenue-Sharing Contracts – Quantity Flexibility Contracts • Contracts to Coordinate Supply Chain Costs • Contracts to Increase Agent Effort • Contracts to Induce Performance Improvement .

however .Contracts for Product Availability and Supply Chain Profits • Many shortcomings in supply chain performance occur because the buyer and supplier are separate organizations and each tries to optimize its own profit • Total supply chain profits might therefore be lower than if the supply chain coordinated actions to have a common objective of maximizing total supply chain profits • Double marginalization results in suboptimal order quantity • An approach to dealing with this problem is to design a contract that encourages a buyer to purchase more and increase the level of product availability • The supplier must share in some of the buyer’s demand uncertainty.

Contracts for Product Availability and Supply Chain Profits: Buyback Contracts • Allows a retailer to return unsold inventory up to a specified amount at an agreed upon price • Increases the optimal order quantity for the retailer. which increases supply chain costs • Can also increase information distortion through the supply chain because the supply chain reacts to retail orders. such as music. resulting in higher product availability and higher profits for both the retailer and the supplier • Most effective for products with low variable cost. magazines. software. not actual customer demand . and newspapers • Downside is that buyback contract results in surplus inventory that must be disposed of. books.

just as in the case of buyback contracts .Contracts for Product Availability and Supply Chain Profits: Revenue Sharing Contracts • The buyer pays a minimal amount for each unit purchased from the supplier but shares a fraction of the revenue for each unit sold • Decreases the cost per unit charged to the retailer. which effectively decreases the cost of overstocking • Can result in supply chain information distortion. however.

Contracts for Product Availability and Supply Chain Profits: Quantity Flexibility Contracts • Allows the buyer to modify the order (within limits) as demand visibility increases closer to the point of sale • Better matching of supply and demand • Increased overall supply chain profits if the supplier has flexible capacity • Lower levels of information distortion than either buyback contracts or revenue sharing contracts .

which would result in lower total supply chain costs • Quantity discounts lead to information distortion because of order batching . The buyer’s EOQ does not take into account the supplier’s costs. • A quantity discount contract may encourage the buyer to purchase a larger quantity (which would be lower costs for the supplier).Contracts to Coordinate Supply Chain Costs • Differences in costs at the buyer and supplier can lead to decisions that increase total supply chain costs • Example: Replenishment order size placed by the buyer.

as well as those of other manufacturers • Examples of contracts to increase agent effort include twopart tariffs and threshold contracts • Threshold contracts increase information distortion.Contracts to Increase Agent Effort • There are many instances in a supply chain where an agent acts on the behalf of a principal and the agent’s actions affect the reward for the principal • Example: A car dealer who sells the cars of a manufacturer. however .

but where the effort for the improvement comes primarily from the supplier .Contracts to Induce Performance Improvement • A buyer may want performance improvement from a supplier who otherwise would have little incentive to do so • A shared savings contract provides the supplier with a fraction of the savings that result from the performance improvement • Particularly effective where the benefit from improvement accrues primarily to the buyer.

20% of surveyed customers reported that they could not rent the movie they wanted . retailer must rent the tape at least 22 times before earning profit • Retailers cannot justify purchasing enough to cover the peak demand – In 1998.Supply Contracts: Case Study • Example: Demand for a movie newly released video cassette typically starts high and decreases rapidly – Peak demand last about 10 weeks • Blockbuster purchases a copy from a studio for $65 and rent for $3 – Hence.

the breakeven point is 6 rental per copy • The impact of revenue sharing on Blockbuster was dramatic – Rentals increased by 75% in test markets – Market share increased from 25% to 31% (The 2nd largest retailer.Supply Contracts: Case Study • Starting in 1998 Blockbuster entered a revenue sharing agreement with the major studios – Studio charges $8 per copy – Blockbuster pays 30-45% of its rental income • Even if Blockbuster keeps only half of the rental income. Hollywood Entertainment Corp has 5% market share) .

we always produce to the same level • Thus. it is better to not start production • If we start. transportation.S) policy. If the inventory level is below s. or manufacturing .(s. we produce up to S. and S is the order-up-to level • The difference between the two levels is driven by the fixed costs associated with ordering. S) Policies • For some starting inventory levels. • s is the reorder point. we use an (s.

The distributor periodically places orders to replenish its inventory . there are multiple reorder opportunities • Consider a central distribution facility which orders from a manufacturer and delivers to retailers.A Multi-Period Inventory Model • Often.

Reminder: The Normal Distribution Standard Deviation = 5 Standard Deviation = 10 0 10 20 Average =40 30 30 50 60 .

The DC holds inventory to: • Satisfy demand during lead time • Protect against demand uncertainty • Balance fixed costs and holding costs .

• Normally distributed random demand • Fixed order cost plus a cost proportional to amount ordered. This is expressed as the the likelihood that the distributor will not stock out during lead time. how will this effect our policy? The Multi-Period Continuous Review Inventory Model . • Inventory cost is charged per item per unit time • If an order arrives and there is no inventory. • Intuitively. the order is lost • The distributor has a required service level.

S) Policy S Inventory Level Inventory Position Lead Time s 0 Time .A View of (s.

we order to raise the inventory position to level S. S) Policy: Whenever the inventory position drops below a certain level. s. • The reorder point is a function of: – The Lead Time – Average demand – Demand variability – Service level .S) Policy • (s.The (s.

the Inventory Position at any time is the actual inventory plus items already ordered. . but not yet delivered. 5%) • Also.Notation • • • • • • AVG = average daily demand STD = standard deviation of daily demand LT = replenishment lead time in days h = holding cost of one unit for one day K = fixed cost SL = service level (for example. 95%). This implies that the probability of stocking out is 100%-SL (for example.

Analysis • The reorder point (s) has two components: – To account for average demand during lead time: LT× AVG – To account for deviations from average (we call this safety stock) z × STD × √LT where z is chosen from statistical tables to ensure that the probability of stockouts during leadtime is 100%-SL. • Since there is a fixed cost. we order more than up to the reorder point: Q=√(2 × K × AVG)/h • The total order-up-to level is: S=Q+s .

1 Replenishment lead time is 2 weeks.6 STD = 32.6) weeks of supply at warehouse and in the pipeline .Example • The distributor has historically observed weekly demand of: AVG = 44.6 × 2 = 89.2 • Safety Stock is: 1. or about 3.3 • Reorder point is thus 175.9 = (175/44. and desired service level SL = 97% • Average demand during lead time is: 44.88 × 32.1 × √2 = 85.

Example. Cont.18x250/52) – Therefore. • Weekly inventory holding cost: 0. Q=679 • Order-up-to level thus equals: – Reorder Point + Q = 176+679 = 855 .87= (0.

Periodic Review • Suppose the distributor places orders every month • What policy should the distributor use? • What about the fixed cost? .

Base-Stock Policy r L Base-stock Level r L Inventory Position L Inventory Level 0 Time .

• The base-stock level includes two components: – Average demand during r+L days (the time until the next order arrives): (r+L)*AVG – Safety stock during that time: z*STD* √r+L .Periodic Review Policy • Each review echelon. inventory position is raised to the base-stock level.

Risk Pooling
• Consider these two systems:
Warehouse One Supplier Warehouse Two Market Two Market One Supplier Warehouse Market Two Market One

Risk Pooling
• For the same service level, which system will require more inventory? Why? • For the same total inventory level, which system will have better service? Why? • What are the factors that affect these answers?

Risk Pooling Example
• Compare the two systems:
– two products – maintain 97% service level – $60 order cost – $.27 weekly holding cost – $1.05 transportation cost per unit in decentralized system, $1.10 in centralized system – 1 week lead time

Market 2 Prod B. Market 2 1 33 46 0 2 2 45 35 2 4 3 37 41 3 0 4 38 40 0 0 5 55 26 0 3 6 30 48 1 1 7 18 18 3 0 8 58 55 0 0 .Risk Pooling Example Week Prod A. Market 1 Prod A. Market 1 Product B.

Risk Pooling Example Warehouse P Market 1 A .

375 1.27 2.34 12.Risk Pooling Example Warehouse Product AVG STD CV Market 1 Market 2 Market 1 Market 2 Cent. 91 88 14 15 132 20 36% 43% 1.9 20.58 1.81 118 304 6 39 . Cent A A B B A B 39.26 5 77. Dec. % Inven.3 38.9 .7 .0 .2 .31 s 65 62 S 197 193 29 29 Avg.36 1.6 13.125 1.21 4 1.25 1.

– Negatively correlated demand. Why? • What other kinds of risk pooling will we see? . • This works best for – High coefficient of variation.Risk Pooling: Important Observations • Centralizing inventory control reduces both safety stock and average inventory level for the same service level. which increases required safety stock.

To Centralize or not to Centralize • What is the effect on: – Safety stock? – Service level? – Overhead? – Lead time? – Transportation Costs? .

Centralized Systems* Supplier Warehouse Retailers • Centralized Decision .

. it is allocated so that the service level at each of the retailers will be equal.Centralized Distribution Systems* • Question: How much inventory should management keep at each location? • A good strategy: – The retailer raises inventory to level Sr each period – The supplier raises the sum of inventory in the retailer and supplier warehouses and in transit to Ss – If there is not enough inventory in the warehouse to meet all demands from retailers.

Inventory Management: Best Practice • Periodic inventory reviews • Tight management of usage rates. to suppliers • Quantitative approaches . or inventory ownership. lead times and safety stock • ABC approach • Reduced safety stock levels • Shift more inventory.

0 turns per year to over 13 per year over a five year period ending in year 2000.Changes In Inventory Turnover • Inventory turnover ratio = annual sales/avg. . inventory level • Inventory turns increased by 30% from 1995 to 1998 • Inventory turns increased by 27% from 1998 to 2000 • Overall the increase is from 8.

Inventory Turnover Ratio Indus .

Factors that Drive Reduction in Inventory • Top management emphasis on inventory reduction (19%) • Reduce the Number of SKUs in the warehouse (10%) • Improved forecasting (7%) • Use of sophisticated inventory management software (6%) • Coordination among supply chain members (6%) • Others .

6%) More attention to inventory management (6.2%) Reduced lead time (15%) Improved forecasting (10.1%) Others .6%) Reduction in SKU (5.7%) Application of SCM principals (9.Factors that Drive Inventory Turns Increase • • • • • • • Better software for inventory management (16.

Forecasting • Recall the three rules • Nevertheless. forecast is critical • General Overview: – Judgment methods – Market research methods – Time Series methods – Causal methods .

both • Delphi method – Each member surveyed – Opinions are compiled – Each member is given the opportunity to change his opinion . external.Judgment Methods • Assemble the opinion of experts • Sales-force composite combines salespeople’s estimates • Panels of experts – internal.

etc. – Responses tested. – Extrapolations to rest of market made. written surveys. .Market Research Methods • Particularly valuable for developing forecasts of newly introduced products • Market testing – Focus groups assembled. phone-surveys. • Market surveys – Data gathered from potential customers – Interviews.

– Exponential Smoothing – more recent points receive more weight – Methods for data with trends: • Regression analysis – fits line to data • Holt’s method – combines exponential smoothing concepts with the ability to follow a trend – Methods for data with seasonality • Seasonal decomposition methods (seasonal patterns removed) • Winter’s method: advanced approach based on exponential smoothing – Complex methods (not clear that these work better) .Time Series Methods • Past data is used to estimate future data • Examples include – Moving averages – average of some previous demand points.

Causal Methods • Forecasts are generated based on data other than the data being predicted • Examples include: – Inflation rates – GNP – Unemployment rates – Weather – Sales of other products .

judgment methods – Rapid growth: time series methods – Mature: time series. . causal methods (particularly for long-range planning) • It is typically effective to combine approaches.Selecting the Appropriate Approach: • What is the purpose of the forecast? – Gross or detailed estimates? • What are the dynamics of the system being forecast? – Is it sensitive to economic data? – Is it seasonal? Trending? • How important is the past in estimating the future? • Different approaches may be appropriate for different stages of the product lifecycle: – Testing and intro: market research methods.

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