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Demand Forecasting

Chapter 5 Logistics Management - Satish C. Ailawadi & Rakesh Singh Chapter 7 Logistical Management - Donald J Bowersox & David J. Closs Chapter 5 Elements of Logistics & Supply Chain Mgmt. - Vijay Kumar Bhatia Chapter 7 Business Statistics - Neena Joshi, Gomathi Venkat, S R Rege

Outline
Definition Scope of Demand Forecasting * Purpose / Objectives of Demand Forecasting Nature of Demand * Forecast Components Approaches to Forecasting

Qualitative and Quantitative Forecasting Techniques & their Applicability Time Series Analysis [with numerical examples] * To be done from slides only

Demand Forecasting
Definition Demand forecasting is predicting the future demand of the product or services of an organization AKA Demand Estimation To forecast is to estimate or calculate in advance

Corporate decisions often depend on managerial forecasts, yet there is never a guarantee of the reliability or accuracy of the forecast

... Demand Forecasting


... Definition

If managers have a fair idea of the future demand of their product & services, they can improve the quality of decision with regards to production, procurement and promotion Consequently managers can meet client demands more efficiently, minimize funds tied up in inventories, save interest costs, avoid stock out situations and improve profits

... Demand Forecasting


... Definition Forecasts Drive logistics system planning & coordination Help in prediction of quantity of products that will be produced, shipped or sold A typical logistics forecast is a prediction of weekly / monthly shipments from a distribution center for an individual item

Determining the Scope of Demand Forecasting

Before taking up an estimation or forecast, certain factors have to be taken into consideration Savage & Small have identified six factors involved in demand forecast which need to be taken care of while determining the scope of the demand forecast Period of forecasting Levels of forecasting General Purpose or Specific Purpose Forecasts Forecasts of Established or New Products Type of commodity for which Forecast is to be done Miscellaneous Factors to be Included or Not

Determining the Scope of Demand Forecasting

Period of forecasting As a first step, the forecaster has to decide about the length of the period for the forecast Time periods are usually divided into The short-term The medium-term The long-term The short-term Is generally for periods upto 3 months Forecaster looks for the factors which result in fluctuations in demand patterns in the market Factors include weather conditions, tastes, fashions etc The demand for machine time, equipment, raw materials, power, transport, finance, labour etc influence the decisions of the firm in short-run forecasts

... Determining the Scope of Demand Forecasting

The medium-term Generally covers a period between 3 months & 1 year Experience & sound judgment are more important than statistical information Main feature of is the direction of trend which has important implications for factors such as employees' recruitment, training etc Can assist in decisions about timing of an activity such as advertising, expenditure etc The long-term Refers to a period of generally 3 or 5 or 10 years Provides information for strategic decisions Concerned with extending or reducing the limits of resources Takes into consideration influence on consumer's demand of factors like socio-economic changes, fiscal & monetary policy Validity of trend must be ascertained Is the basis of decisions of the size of output, expansion of capacity, modernization etc

... Determining the Scope of Demand Forecasting


Levels of forecasting Demand forecasting can be undertaken at any one of the following levels Macro-economic Forecasting Concerned with business conditions over the entire economy Business conditions measured with the help of appropriate indicators like those relating to national income, industrial production, wholesale prices etc. Indicators are provided by government & private agencies & can be treated as basic assumptions on which to base the demand estimates

... Determining the Scope of Demand Forecasting


... Levels of Forecasting Industry (market) Demand Forecasting Such forecasts can give indication to a firm regarding the direction in which the whole industry will be moving

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e.g. Ambuja Cement would like to know the way cement industry is likely to behave, so as to plan their future Data relating to a trend in a particular industry is provided by trade associations to their members Helps firms' estimate their outputs, sale, capacity, expansion etc Firm Demand Forecasting Several big firms would like to perform demand forecasting of their own products independent of the other players in the industry Such forecasts assess the position of the firm in relation to its competitors

... Determining the Scope of Demand Forecasting


... Levels of forecasting Product-line Demand Forecasting Helps firm to decide which of their products have priority in allocation of the firm's limited resources e.g. Firms such as HUL & P&G which have a large number of product lines, have to decide which product line gets priority International Level Forecasting

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MNCs need to forecast for the different countries where they have a presence General Purpose or Specific Purpose Forecasts Though a general estimate is useful for a firm, it will be even more useful to have a general estimate broken down into specific estimates with respect to areas of sale, domestic sale & export markets

... Determining the Scope of Demand Forecasting

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Forecasts of Established or New Products Methods of estimation differ for established or new products For established products, past sale trends & competitive conditions are know whereas for new products no such data is available Type of commodity for which Forecast is to be done Economists broadly classify goods into capital goods, consumer durables & non-durable goods For each category, the demand pattern would be different Hence for each category separate demand estimation is required Miscellaneous Factors to be Included or Not The forecaster has to decide how much the sociological & psychological factors are to considered in the demand forecasting exercise To be more effective, factors such as product features, product markets, nature of competition, impact of uncertainty & risk, change is population composition, income distribution etc need to be considered

Purpose / Objectives of Demand Forecasting

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Forecasting is to done for the short-term as well as long-term Purpose for the two differs Purpose for short-term forecasts Short-term forecasts cover a period of 3 months, 6 months or 1 year, chosen period depends on nature of business Short-term forecasts are undertaken for the following purposes
1. Appropriate production scheduling so as to avoid the problem of over-production & the problem of short supply 2. Helping the firm in reducing costs of purchasing raw materials & controlling inventory by determining its future resource requirements 3. Determining appropriate price policy to maintain consistent sales 4. Setting sales targets & establishing controls & incentives with changing pattern of demand & extent of competition among firms 5. Evolving suitable advertising & promotion programmes 6. Forecasting short term finance requirements

... Purpose / Objectives of Demand Forecasting

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Long-term forecasts cover a period of 3, 5 or 10 years depending upon the nature of the industry & nature of product Concept of demand forecasting is more relevant to the long-term forecasts than short-term forecasts, because it is easier to predict the immediate future than to predict the long-term future The maybe far more fluctuations in the long-run future Long-term forecasts are undertaken for the following purposes 1. Planning of a new unit or expansion of an existing unit requires an analysis of the long term demand potential, a multi-product firm must ascertain not only the total demand, but also the demand for different items separately 2. Planning long-term financial requirements as planning for a large quantum of funds requires considerable advance notice, long-term sales forecasts are essential to assess long-term financial requirements 3. Planning man-power requirements trained & skilled labour & business executives may be required in the long-run due to expansion or setting-up of a new manufacturing plant 4. Planning a suitable strategy to produce goods & services as per changing needs of customer tastes & preferences

Nature of Demand
Demand can be classified as Dependent demand Independent demand Dependent Demand Herein demand of dependent item can be derived directly from the forecast of the base item Can be further classified into Vertical Dependent Demand Horizontal Dependent Demand

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... Nature of Demand


Vertical Dependent Demand Is characterized by sequence of purchasing & manufacturing e.g. component parts such as tyres that are assembled to form finished goods such as automobiles Hence requirement of tyres depend on the automobile assembly schedule May extend through several channels such as raw material suppliers, component suppliers etc

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... Nature of Demand


Horizontal Dependent Demand Item demanded is not required to complete the manufacturing process but is required to complete the marketing / sales process e.g. user's manual shipped along with the product e.g. for a promotion that demands free tooth brush with purchase of toothpaste

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Demand of the base item is determined using forecasts, requirements of dependent components can calculated directly and no separate forecasting is done

... Nature of Demand


Independent Demand Those demands that are not related to the demand of another item e.g. the demand for refrigerators is probably not related to the demand of milk Hence, independent demand items must be forecasted individually

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Forecast Components
While the forecasted quantity is generally a single figure, the value is made up of six components Base demand Cyclic factors Promotions Irregular quantities Trends Seasonal factors

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... Forecast Components


Mathematically forecast can be expressed as Ft = (Bt X St X T X Ct X Pt) + I where Ft = forecast quantity for period t Bt = base level demand for period t St = seasonality factor for period t T = trend component: increase or decrease per time period Ct = cyclic factor for period t Pt = promotional factor for period t I = irregular or random quantity All forecasts may not include all the components

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... Forecast Components


Base Demand The quantity left after the remaining components have been removed Is based on the average over an extended period of time Is the appropriate forecast for products that have no seasonality, trend, cyclic or promotional components e.g. base demand would be an appropriate forecast for products such as bread, biscuits and milk

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... Forecast Components


Seasonal Component

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Is a generally recurring upward & downward movement in demand pattern, usually on an annual basis Changes in demand are caused by factors such as climatic changes, festivals, business hours etc during some specific time intervals of the year e.g. demand for air conditioners increase during summer season & reduces during the rainy & winter seasons In the above example, seasonality would be at consumer retail level; the seasonality at wholesale level precedes customer demand by approximately one quarter e.g. Vehicular traffic fluctuates everyday, increases during peak hours, reducing during other times of the day

... Forecast Components


Trend Component

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Exhibits long range general movement in periodic sales over an extended period of time Can be positive or negative or neutral in direction Positive trend implies increasing sales across time Negative trend implies decreasing sales across time Neutral sales trend implies sales of same quantities across time Increases / decreases in trend are dependent on changes in overall population or consumption pattern Direction of trend may change several times over the entire product life cycle e.g. a reduction in birth rate implies that a reduction in demand for diapers will follow

... Forecast Components


Cyclic Component AKA business cycles

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Exhibit swings in demand pattern lasting more than a year May be either upward or downward e.g. business cycle in which economies traditionally swing from boom / expansion to recession every 3 to 5 years The demand of housing and general spending levels of consumers are typically tied to these business cycles

... Forecast Components


Promotional Component

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Are demand swings initiated by a firm's promotional activities such as advertising, sales and schemes such as BOGOF Sales increase as customers take advantage of promotional offers These lead to liquidation of inventories Promotions can be either offerings to consumers or offerings to wholesalers / retailers Promotions, if offered regularly & at the same time every year will resemble a seasonal component Timing & magnitude to a large extent is under firm's control

... Forecast Components


Irregular Component

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Include random or unpredictable quantities that do not fit within the other categories Because of its random nature, it is impossible to predict Objective is to minimize the magnitude of random component by tracking & predicting the other components

Approaches to Forecasting
Approaches to sales forecasting usually involve forecasting down from the top level of demand or forecasting up from the lower levels of demand The two approaches to sales forecasting Top-down Forecasting Approach Bottom-up Forecasting Approach Approaches can be used independently or in combination

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The combination used must trade off the complication of data collection & tracking of bottomup approach with the data manipulation ease of topdown approach

... Approaches to Forecasting


Top-down Forecasting Approach

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... Approaches to Forecasting


... Top-down Forecasting Approach Is a centralized approach

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Involves predicting total demand at the top or global level of a product group or family Entire demand is then broken down by product class into central distribution center to branch or regional distribution center down to individual stock keeping unit [SKU] Approach should be used for short-term planning and shipping forecasts to distribution centers When available, point-of-sale data can increase forecast accuracy and improve performance of short-term issues, such as inventory and transportation

... Approaches to Forecasting


Bottom-up Forecasting Approach Is a decentralized approach

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Each distribution center demand forecast is developed independently Market is divided into segments, and then each segment demand is calculated Typically, analysts use sales force data, industry surveys, and intention-to-buy surveys to collect data Data across segments are aggregated to arrive at a total sales forecast Approach may not be simple to use because of complications with the accuracy of the data submitted

Qualitative & Quantitative Forecasting Techniques & Their Applicability

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... Qualitative & Quantitative Forecasting Techniques & Their Applicability


Forecasting techniques can be divided into two categories Qualitative Forecasting Techniques Quantitative Forecasting Techniques Qualitative Forecasting Techniques No formal mathematical model used Based on expertise, subjective in nature Ideal for situations where no historical data is available Typically concern long-term forecasting Are time-consuming Include the following methods The Delphi Technique Sales Force Opinions Jury of Executive Opinion Market Research

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... Qualitative & Quantitative Forecasting Techniques & Their Applicability

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Qualitative Forecasting Techniques The Delphi Technique An attempt is made to develop forecasts through "group consensus" Involves a panel of experts, physically separated from and unknown to each other Each expert is asked to to respond to an initial series of questionnaires Then, a second questionnaire is prepared incorporating information and opinions of the whole group Each expert is asked to reconsider and to revise his or her initial response to the questions Process is continued until some degree of consensus among experts is reached The objective of the Delphi technique is not to produce a single answer at the end Instead, it attempts to produce a relatively narrow spread of opinions

... Qualitative & Quantitative Forecasting Techniques & Their Applicability


... Qualitative Forecasting Techniques Sales Force Opinions The sales staff is often a good source of information regarding future demand The sales manager may ask for input from each salesperson and aggregate their responses into a sales force composite forecast

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Caution should be exercised when using this technique as the members of the sales force may not be able to distinguish between what customers say and what they actually do Also, if the forecasts will be used to establish sales quotas, the sales force may be tempted to provide lower estimates

... Qualitative & Quantitative Forecasting Techniques & Their Applicability


... Qualitative Forecasting Techniques Jury of Executive Opinion

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AKA Executive Opinion Sometimes upper-levels managers from different functional areas such as marketing, finance, production etc are brought together to develop forecasts based on their knowledge of their areas of responsibility Particularly suitable for new products which do not have any past history of sales There is a risk that the opinion of any one individual may overshadow the opinion of other experts The responsibility of forecast arrived is spread over the entire group, rather than any individual

... Qualitative & Quantitative Forecasting Techniques & Their Applicability


... Qualitative Forecasting Techniques Market Research Consumer surveys are used to establish potential demand

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Usually involves constructing a questionnaire that solicits personal, demographic, economic, and marketing information Market researchers generally collect such information in person at retail outlets and malls, where the consumer can experience, taste, feel, smell, and see a particular product The researcher must be careful that the sample of people surveyed is representative of the desired consumer target

... Qualitative & Quantitative Forecasting Techniques & Their Applicability


Quantitative Forecasting Techniques Are based on an analysis of historical data Objective in nature Include the following methods Casual Methods Time Series Forecasting Methods Moving Averages Exponential Smoothing Time Series Decomposition Trend projection Nave Approach

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... Qualitative & Quantitative Forecasting Techniques & Their Applicability


... Quantitative Forecasting Techniques Casual Methods Use mathematical techniques such as regression Relates a dependent variable to an independent variable in the form of a linear equation Also uses econometric models, input-output models, life-cycle analysis, computer simulation models & neural networks Most of these approaches are difficult to implement In practice, only single or multiple regression is used for logistics planning

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... Qualitative & Quantitative Forecasting Techniques & Their Applicability


... Quantitative Forecasting Techniques
Time Series Forecasting Methods

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A time series is a set of evenly spaced numerical data Is obtained by observing responses at regular time periods The forecast is based only on past values Assumes that factors that influence the past sales of a firm's product, will continue in the present and the future sales

... Qualitative & Quantitative Forecasting Techniques & Their Applicability


... Quantitative Forecasting Techniques
... Time Series Forecasting Methods Moving Averages

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Is a series of arithmetic means Is used if little or no trend is present in the data Provides an overall impression of data over time Moving Average = Demand in previous n periods n where n is the number of periods in the moving average

... Qualitative & Quantitative Forecasting Techniques & Their Applicability

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... Qualitative & Quantitative Forecasting Techniques & Their Applicability

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... Qualitative & Quantitative Forecasting Techniques & Their Applicability

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... Qualitative & Quantitative Forecasting Techniques & Their Applicability

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... Qualitative & Quantitative Forecasting Techniques & Their Applicability


... Quantitative Forecasting Techniques
... Time Series Forecasting Methods Weighted Moving Averages

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Adjusts the moving average method to reflect fluctuations more closely by assigning weights to the most recent data, meaning, that the older data is usually less important The weights are based on intuition
Weighted Moving Average ={(weight for period n) X (Demand in period n)} n

where n is the number of periods in the moving average

... Qualitative & Quantitative Forecasting Techniques & Their Applicability

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... Qualitative & Quantitative Forecasting Techniques & Their Applicability

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... Qualitative & Quantitative Forecasting Techniques & Their Applicability

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... Qualitative & Quantitative Forecasting Techniques & Their Applicability

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... Qualitative & Quantitative Forecasting Techniques & Their Applicability


... Quantitative Forecasting Techniques
Time Series Forecasting Methods Exponential Smoothing

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Is an averaging method that reacts more strongly to recent changes in demand by assigning a smoothing constant to the most recent data A new forecast is based on forecast of previous period & the following relation exists between them New Forecast = Last period's forecast + (Last
period's actual demand - Last period's forecast)

where denotes a weight or smoothing constant

... Qualitative & Quantitative Forecasting Techniques & Their Applicability


... Quantitative Forecasting Techniques
...Time Series Forecasting Methods ... Exponential Smoothing

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Mathematically Ft = Ft-1 + ( At-1 - Ft-1 ) where Ft = New Forecast Ft-1 = Previous Forecast = Smoothing constant ( 0 < < 1) At-1 = Previous period's actual demand

... Qualitative & Quantitative Forecasting Techniques & Their Applicability

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... Qualitative & Quantitative Forecasting Techniques & Their Applicability

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... Qualitative & Quantitative Forecasting Techniques & Their Applicability


... Quantitative Forecasting Techniques
... Time Series Forecasting Methods Time Series Decomposition

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AKA Seasonal variations Involves the measurement of seasonal variation Adjusts the seasonality by multiplying the normal forecast by a seasonal factor

... Qualitative & Quantitative Forecasting Techniques & Their Applicability

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... Qualitative & Quantitative Forecasting Techniques & Their Applicability

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... Qualitative & Quantitative Forecasting Techniques & Their Applicability


... Quantitative Forecasting Techniques ... Time Series Forecasting Methods

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Trend Projection The time series data of the item under forecast are used to fit a trend line or curve either graphically or through statistical method of Least Squares The trend line is worked out by fitting a trend equation to time series data with the aid of an estimation method The trend equation could take either a linear or a non-linear form Method often yields a dependable forecast Advantage is that it does not require the formal knowledge of economic theory & markets, it only needs the time series data Limitation is that it assumes that the past is repeated in future An appropriate method for long-run forecasts, but inappropriate for short-run forecasts

... Qualitative & Quantitative Forecasting Techniques & Their Applicability


... Quantitative Forecasting Techniques ... Time Series Forecasting Methods Nave Approach Among the time-series models, the nave approach is the simplest method Simply uses the actual demand for the past period as the forecasted demand for the next period Assumes that demand in the next period is the same as demand in most recent period

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Also assumes that any trends, seasonality, or cycles are either reflected in the previous period's demand or do not exist e.g. If July sales were 50 units, then Augusts sales will also be 50 units

References

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Determining the Scope of Demand Forecasting http://books.google.com/books? id=dX987hKb7hYC&pg=PA56&dq=scope+of+demand+forecasting&hl=en&ei=0UcTTsimLca urAfWhoiIBA&sa=X&oi=book_result&ct=result&resnum=8&ved=0CEwQ6AEwBw#v=onepag e&q=scope%20of%20demand%20forecasting&f=false Purpose / Objective of Demand Forecasting http://books.google.com/books? id=dX987hKb7hYC&pg=PA56&dq=scope+of+demand+forecasting&hl=en&ei=0UcTTsimLca urAfWhoiIBA&sa=X&oi=book_result&ct=result&resnum=8&ved=0CEwQ6AEwBw#v=onepag e&q&f=false Approaches to Demand Forecasting http://smallbusiness.chron.com/various-sales-forecasting-techniques-4695.html http://www.newswise.com/articles/view/574260/?sc=c14 http://www.answers.com/topic/sales-forecast

Forecasting Techniques http://www.referenceforbusiness.com/management/Ex-Gov/Forecasting.html http://people.brunel.ac.uk/~mastjjb/jeb/or/forecast.html http://www.referenceforbusiness.com/encyclopedia/Fa-For/Forecasting.html http://www.uoguelph.ca/~dsparlin/forecast.htm#MULTIPLICATIVE%20SEASONAL %20METHOD