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Agenda

• Forecasting, • Factors influencing Demand • Basic Demand Patterns • Basic Principles of Forecasting • Principles of Data Collection • Basic Forecasting Techniques, Seasonality • Sources & Types of Forecasting Errors

**Forecasting can be conducted at various levels
**

Strategic Required for • Product life cycle • Long-term capacity planning • Capital asset/equipment/ human resource management Examples • Product line transitions • Annual volume out 3-5 years • Buy/build/lease decisions

Financial

• Budgeting • Financial reporting • Working capital management • Production scheduling • Purchasing • Resource planning • Customer service management (product allocations)

• Total annual/monthly volume • Projected product mix

Operational

• Weekly/monthly SKUlevel demand • Order size and frequency

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**Role of Forecasting in Supply Chain,
**

• Basis for Strategic & Planning Decisions in SCM • Decisions needing Forecast as Base • Production

- Scheduling -Inventory Control -- Aggregate Planning - Purchasing

• Marketing

-Allocation of Sales-Force -- Promotion Activities -- New Product Launching

• Finance

-Plant & Equipment Investment -- Budgetary Planning

• HR

-Workforce Planning -- Recruitment - Lay-Offs

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Forecasting Impact

Demand management

Sales history/ orders Forecasting Demand planning Sales and operations planning

Directly impacted by demand management

Production management Aggregate planning

Distribution management Inventory management Master production scheduling (MPS) BOM inventory routing

Materials requirement planning (MRP)

Distribution/transport network Shop floor scheduling and control

Capacity requirements planning (CRP)

Purchasing

Production

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Higher forecast accuracy improves service levels at lower inventory Percent 100 99 98 97 96 95 0 94 Monthly average forecast error Excellent Far Poor 20% 40% 50% 3 1 2 Reducing forecast error will permit 1 Reduced inventory to a given service level 2 Increased service level for a given inventory level 3 Both reduced inventory and improved service level 2 4 6 Required average inventory Weeks 8 10 12 .

Forecasting error must be measured at different levels Forecasting error Percent Mean forecasting error Forecasting tips • Measure forecasting error as the mean absolute percent error (Forecast – actual sales) Forecast 60 50 40 30 20 10 0 -12 -10 -8 -6 -4 SKU/DC (12 oz. bottle) Brand level (ketchup) • Error of forecasting can be measured at various levels: product family. ketchup bottle in Dallas warehouse)* SKU level (12 oz. however. best practitioners are doing weekly forecasts Product family level (all condiments) -2 Manufacturing lead time -0 • Measure bias as the mean percent error** (Forecast – actual sales) Forecast * Required level of detail for planning 7 ** A consistently positive or negative bias indicates a tendency to over. brand. SKU.or under-forecast which may be easily remedied . SKU/DC and will improve at higher levels of consolidation • Frequency of measurement is usually monthly.

price promotional activity) to best fit historical demand patterns • Time series • Real-time regression using POS data • Uses Fourier transforms to best fit historical demand patterns Complex • Modifies above models with changes in customer takeaway based on Nielsen. shipments.. IRI data * Demand can be sales.Range of algorithms can be used COMMON FORECAST ALGORITHMS Model Simple Calculation/description • Last year plus percent • Last 3 months • Experiential smoothing • Seasonality with trend • Last year‟s same period demand* increased by a flat percentage • Last 3-month moving average of demand • Last 12-month moving average with most recent 2-3 months more heavily weighted • Experiential smoothing with a seasonality factor that weights periods differently based on relative historical demand throughout the year • Regression • Incorporates variables other than historical demand (e. orders depending on what works best and data available 8 .g.

Regression-based forecasting on high-promotion items National cases shipped/week – ketchup example 90.000 80.000 40.000 50.000 20.000 0 1 Fiscal week 10 20 30 40 5052 Actual peak shipment week is last week of fiscal month Post-promotion period Off-invoice promotions Key business drivers • Off-invoice promotions – Before a summer holiday – Without holiday • Promotion month end week • Postpromotion period Fiscal year 1 Fiscal year 2 Fiscal year 3 Higher peaks prior to Memorial Day and Labor Day 9 .000 70.000 30.000 60.000 10.

need to balance trade-off • Rigorous measurement and tracking 10 .Forecasting implementation requires three success factors Tools and methodologies • “Single-point” forecast to manage (i. supported by market events • Explicit reconciliation steps Accountability • Accountability for both forecast error and inventory.e. consistency across functioning) • Skills to balance art and science of forecasting Process • Driven by analytics..

Characteristics of demand Sources of demand .Promotions .Spare parts .Customers .Test samples .Intra-company .Others… All the sources of demand must be identified. .

Others… .Firm‟s own plans .Characteristics of demand Factors influencing demand .Competitive factors .Technology changes .General business and economic conditions .Market trends .Government regulations .

Trend .Characteristics of demand Components of demand .Seasonality .Cyclical variation 40 35 30 25 20 15 10 5 0 2002 2003 Q1 Q2 2004 Q3 Q4 2005 6 .Random variation .

Characteristics of Demand Trend Seasonal Demand Time 7 .

Characteristics of Demand Dynamic Stable Average Demand Time 8 .

Dependent demand can be calculated.Stable versus Dynamic > Stable demand has certain general pattern over time > Dynamic demand tends to be erratic .Independent versus Dependent > Demand for an item unrelated to demand for other items. This is independent demand. > Demand that is directly related to derived from the bill of material structure of other items or end items.Characteristics of demand Demand Patterns . This is dependent demand. 9 . Only Independent demand needs to be forecasted.

Characteristics of demand Level of planning and forecast contents Forecast Business plan Market direction Time Frame 2 to 10 years Sales and operations Product lines and 1 to 2 years families End item and option Months Master production schedule 10 .

Characteristics of demand Why Forecast? • Before making plans. an estimate must be made of what conditions will exist over some future period • Most firms cannot wait until orders are actually received before they start to plan what to produce • Manufacturers must anticipate future demand and plan to provide the capacity and resources to meet the demand • Firms that make standard products need to have salable goods immediately available / with shorter delivery time • Firms that MTO. must have labor and equipment to meet demand 11 .

Working without Forecast DemandForecasting Model 12 .

.Record data in terms needed for the forecast . .Are more accurate for product lines and families . .Principles of Forecasting and Data Collection Forecasts.Should include an estimate of error .Are rarely 100% accurate over time .Record demand separately for different customer groups 13 .Record circumstances relating to the data ..Are more accurate for nearer periods of time While collecting data.

Forecasting Techniques Classification: .Short-range Techniques .Long-range Techniques 14 .Qualitative Techniques .Intrinsic Techniques .Extrinsic Techniques .Quantitative Techniques .

Qualitative Techniques • Are based on intuition and informed opinion • Tend to be subjective • Are used for business planning and forecasting for new products • Are used for medium-term to long-term forecasting 15 .

Quantitative Techniques • Based on historical data usually available in the company • Assume future will repeat past 16 .

Extrinsic Techniques • Based on external indicators • Useful in forecasting total company demand or demand for families of products 17 .

Forecasting Techniques Moving Average: (Quantitative.2 0. Intrinsic) 3-period moving average Period 1 2 3 4 5 6 7 8 9 10 11 Period -3 -2 -1 Weightage 0.7 Demand 265 240 295 265 310 285 304 312 328 299 267 267 290 287 300 300 315 313 281 269 300 288 301 308 322 306 Simple Weighted 18 .1 0.

it is hard to detect • Calculations become cumbersome when dealing with many time periods. Intrinsic) • Lags the actual sales. more is the lag • Can be used to filter out random variation • If a trend exists.Forecasting Techniques Moving Average: (Quantitative. More the number of previous periods included. More data storage required 19 .

Calculate the three month moving average forecast for month 4 • If the actual demand in month 4 is 228.Problem 1 • Over the past three months.219 & 231.calculate the forecast for month 5 Answer Moving Average Demand for 3 months= (255+219+231)/3 = 705/3 = 235 Moving Average for fourth month= (219+231+228)/3 =678/3 =226 Forecast for month 5 is 226 20 . the demand for a product has been 255.

Intrinsic) Period Demand Forecast ( FT ) alpha (T) ( DT ) DT 1 2 3 4 5 6 7 8 9 10 11 190 160 220 200 300 240 270 200 290 275 305 0.FT) .9 180 189 163 214 201 290 245 268 207 282 276 (FT+1) = FT + alpha (DT .9 alpha= 0.Forecasting Techniques Exponential Smoothing : (Quantitative.1 180 181 179 183 185 196 201 208 207 215 221 0.5 180 185 173 196 198 249 245 257 229 259 267 0.5 alpha= 0.1 alpha= 0.

but will lag them • Calculation and data requirements are manageable • Easy to „tune‟ 22 .Forecasting Techniques Exponential Smoothing: (Quantitative. Intrinsic) • A type of moving average • Routine method for updating item forecasts • Satisfactory for short range forecasting • Can detect trends.

with exponential smoothing techniques.15.95 = 123.FT) = 122 + 0.15( 135-122) = 122 + 1.Problem 3 If the forecast for February was 122 and actual demand was 135. forecast is calculated by formula (FT+1) = FT + alpha (DT .what would be forecast for March if smoothing constant is 0. Answer In Exponential smoothing.95 say 124 23 .

Seasonality may be annual.Seasonal Index = Average sales for all periods .„Seasonal Index‟ is a measure of seasonal variation.Seasonality is variation in demand based on the season. monthly. or even daily! .For forecasting purpose.Seasonality Key concepts: . . . de-seasonalized data is required. Period average sales .

666 0.33 33.33 403.327 0.6 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Total 10 13 33 45 53 57 33 20 19 18 46 48 395 12 13 38 54 56 56 27 18 22 18 50 53 417 11 11 29 47 55 55 34 19 20 15 55 47 398 Period average sales Seasonal Index = Average sales for all periods Average Sales for all months = 25 .33 49.992 1.33 17.33 19.00 12.33 Seasonal Index 0.367 0.565 0.605 0.33 48.626 1.Seasonality Illustration: Month Year1 Year2 Year3 Monthly Average 11.448 1.506 1.00 31.932 0.498 1.00 50.468 12 33.67 56.00 20.67 54.

Historical data is influenced by seasonality.Seasonality Forecasting with Seasonality: . 26 . hence can‟t be used „as-it-is‟ for forecasting .Following steps are necessary: # Deseasonalize historical data # Forecast deseasonalized demand (Baseline Forecast) # Calculate the seasonal forecast by applying the Seasonal Index to the base forecast.

Problem 4 Month January February March April May June July Average Demand 30 50 85 110 125 245 255 Seasonal Index Forecast August September October November December 135 110 90 60 30 27 .

Demand 166.81 384.00 28 .67 166.54 0.67 166.57 45.77 1.67 166.45 0.67 166.67 166.77 September October November December Total Average Sales for Month= 110 90 60 30 1325 110.42 1.67 166.67 166.27 166.90 203.67 166.85 90.04 135.13 2.00 0.22 New Av.30 166.67 166.47 128.22 2.28 75.31 1.00 1.27 0.28 2000.82 0.04 188.Month January February March April May June July August Monthly Demand 30 50 85 110 125 245 255 135 Seasonal Index 0.67 Forecast 45.67 166.67 166.68 369.

„Tracking‟ is the process of comparing actual demand with the forecast .Forecast Error is the difference between actual demand and forecast demand . forecasts tend to go wrong.We need methods to know how good the forecasting method is. .Error can occur in two ways: # Bias # Random Variation 29 . .For several reasons.Tracking the Forecast Limitations of forecasts: .

Bias Bias exist when the cumulative Actual Demand varies from Cumulative Forecast Month Forecast Actual Monthly 1 2 3 100 100 100 Cumulative 100 200 300 Monthly 110 125 120 Cumulative 110 235 355 4 5 6 Total 100 100 100 600 400 500 600 125 130 110 720 480 610 720 30 .

Bias FORECAST ACTUAL DEMAND MONTHS 31 .

Random Variation In a period actual demand will vary against average demand based on Demand pattern Month Forecast Actual Variation (Error) 5 -6 -2 4 3 -4 0 1 2 3 4 5 6 Total 100 100 100 100 100 100 600 105 94 98 104 103 96 600 32 .

Random Variation FORECAST 105 104 103 100 98 94 96 ACTUAL MONTHS 33 .

For a unbiased forecasting method.When bias is noticed.Bias is a systematic error in which the actual demand is consistently above or below the forecast demand . the Cumulative Sum of Errors (CSE) will be zero 34 . forecasting method should be changed to improve the forecast accuracy .Tracking the Forecast Bias: .

Tracking the Forecast Bias: (Illustration) Period 1 2 3 4 5 6 7 8 9 10 Total Forecast (F) 1000 1000 1000 1000 1000 1000 1000 1000 1000 1000 10000 Actual Sales 1200 1000 800 900 1400 1200 1100 700 1000 900 10200 Error 200 0 -200 -100 400 200 100 -300 0 -100 200 Interpretation: The bias (Average CSE) indicates that the there is an underforecast / positive bias of 20 per period. Cumulative Sum of Errors (CSE) 35 .

Forecast Error Measurement • Mean Absolute Deviation • Normal Distribution 36 .

Mean Absolute Deviation • Forecast Error must be measured before it is used for planning or to revise the forecast • Mean Absolute Deviation ( MAD) commonly used for Error Measurement • Mean implies Average • Absolute means without reference to plus or minus • Deviation refers to the Error • MAD= Sum of Absolute Deviations Number of Observations in Earlier case. MAD = 5+6+2+4+3+4 = 24 = 4 6 6 37 .

1 MAD of the Average about 60% of the time +/.2 MAD of the Average about 90% of the time +/.3 MAD of the Average about 98% of the time 38 .Normal Distribution 1% -3 4% 15% 30% 30% 15% 4% -2 -1 0 1 2 3 1% +/.

110. and 115 .105.Manufacturing Department can devise contingency plan for Capacity Utilization based on information regarding MAD of Forecast • Safety Stocks .Use of MAD • Tracking Signal . • If MAD is 5 • Tracking Signal =(5+10+3+5+7+15)/5 = 45/5 =9 • Contingency Planning .105.to monitor Quality of Forecast • Tracking Signal= Algebraic Sum of Forecast Errors MAD • Past Six Month Consumption is .107.Demand Variation is to be guarded by Safety Stocks 39 with Inventory Investment Decisions .where Forecast is 100 per month.103.

MAD can be used to determine: # Tracking Signal # Safety Stock 40 .It measures the total error irrespective of the direction .For a normally distributed random variation.Tracking the Forecast Mean Absolute Deviation (MAD): . . Standard Deviation (Sigma) = 1.MAD is a measure of random variation.25*MAD .

the error will correct itself.A tracking signal can be used to monitor the quality of the forecast.It is difficult to determine whether the variation is due to bias or random variation. . . 42 .If the variation is due to bias. the forecasting method needs to be corrected. .If the variation is due to random variation.Tracking the Forecast Tracking Signal: .

43 .4 means that the forecast is matching the actual data received.5 160 160 6 7 8 9 1000 1000 1000 1000 1200 1100 700 1000 1200 1100 1300 1000 200 100 300 0 200 100 300 0 500 600 300 300 900 1000 1300 1300 10 1000 900 900 MAD= 100 160 100 160 200 1200 A tracking signal between +/. Deviation T 200 0 200 100 400 W 200 0 200 100 400 T 200 200 0 -100 300 CSE W 200 200 400 300 700 CSE Tracking Signal = MAD 200 Tracking Signal (T) = = 1.25 1200 Tracking Signal (W) = = 7.Tracking the Forecast Tracking Signal: (Illustration) Period Forecast T 1 2 3 4 5 1000 1000 1000 1000 1000 1200 1000 800 900 1400 Sales W 1200 1000 1200 900 1400 Abs.

Forecasts ignore random variations .. someone else is forced to do it .Forecasts forecast average demand .Multiple forecasts should be avoided in a supply chain .Tracking the Forecast More about forecasts….The main aim of all the forecasting methods is to beat the naïve forecast 44 .Certain operations are most affected by the forecast errors. postpone them as much as possible .If forecasting does not happen at right place.Forecasting methods need to be continuously tracked and improved . .

Thank You 45 .

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