School of Management and Economics

Demand Forecasting
- A study at Alfa Laval in Lund

Bachelor Thesis, FE 3583, 15hp

Spring 2008

Authors: Hana Klimsova, 780329

Stacey Lobban, 740819

Tutor: Peter Berling

Examinator: Petra Andersson
SUMMARY

Växjö 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 Laval’s 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 company’s problem.

Conclusion: The company’s 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

2
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 Malmö 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 Jönsson,
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.

Växjö, May 2008

Hana Klimsova Stacey Lobban

3
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

4
2.7 Summary of Methodology .............................................................................................. 24

3. Theory ................................................................................................................................ 25

3.1 Demand forecasting - Subjective and Objective........................................................... 25

3.1.1 Subjective forecasting approach ................................................................................ 25
3.1.2 Objective forecasting approach ................................................................................. 26
3.1.3 Summary of subjective and objective approaches...................................................... 27

3.2 Time series analysis......................................................................................................... 28

3.3 Definition of Time Series Behaviours ............................................................................ 28

3.4 Models for Time Series Forecasting .............................................................................. 30

3.4.1 Moving average.......................................................................................................... 31
3.4.2 Exponential smoothing............................................................................................... 32
3.4.3 Autocorrelation .......................................................................................................... 36

3.5 Evaluating forecasting accuracy .................................................................................... 36

3.6 Theoretical framework ................................................................................................... 39

4. Empirical............................................................................................................................ 40

4.1 Reintroduction of Alfa Laval ......................................................................................... 40

4.2 Interviewees ..................................................................................................................... 41

4.3 Ordering Raw Material at Alfa Laval........................................................................... 41

4.3.1 How an order is placed .............................................................................................. 41
4.3.2 How forecasting of raw material demand is done ..................................................... 42
4.3.3 What the forecast sent to suppliers is based on ......................................................... 42
4.3.4 Forecasting accuracy calculations ............................................................................ 42
4.3.5 Six Sigma .................................................................................................................... 43
4.3.6 Results of poor forecasting at Alfa Laval................................................................... 43

4.4 Current forecasting models ............................................................................................ 44

4.4.1 Summary of the forecasting methods used by Alfa Laval........................................... 46

4.5 Items to be analyzed ........................................................................................................ 46

4.6 Gathering of data ............................................................................................................ 47

5. Analysis .............................................................................................................................. 49

5.1 Foundation of analysis .................................................................................................... 49

5.2 Raw material analyzed.................................................................................................... 50

5.3 The analytical process..................................................................................................... 51

5
5.4 Summary and discussion of analysis ............................................................................. 60

6. Conclusion.......................................................................................................................... 63

6.1 Results .............................................................................................................................. 63

6.2 Reflections ........................................................................................................................ 64

6.3 Client Validity.................................................................................................................. 65

6.4 Future work ..................................................................................................................... 65

REFERENCES ...................................................................................................................... 66

APPENDIX 1 - Interview questions

APPENDIX 2 - Historical data (one item)

APPENDIX 3 and 4 - Raw material analysis (one item)

APPENDIX 5 - Analysis of evaluating method

6
1. Introduction

T he introduction chapter is intended to provide an overview of the subject, motivation,

and process of this thesis. It opens with a background of forecasting, giving the reader
insight to the important role of forecasting for demand. Thereafter is a presentation of
the company. Subsequently, this chapter leads to a discussion of the problem, followed
by problem questions, delimitations of the research, and key definitions.

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 company’s operations and production management’s 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
Nahmias, S. (2005:53)
2
Zotteri, K. (2007:85)

7
 3
may be present” and will prove advantageous to making predictions of outcomes. 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 company’s 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)
4
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)

8
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.

1.2 Alfa Laval - company presentation

Gustaf de Laval founded Alfa Laval in 1883. Its success was based on his invention of the
continuous separators. Over the years, heat transfer and fluid handling has been added to the
expertise in separation. Alfa Laval’s equipment, systems and services are used by customers
to optimize the performance of their processes. For example, heat transfer and fluid handling
solutions help customers’ heat, cool, separate and transport products such as food and
beverages, chemicals and petrochemicals, pharmaceuticals, starch, sugar and ethanol. Alfa
Laval sells its products to more than 20,000 customers including BASF, Bayer, BP, Heineken
10
and Tetra Laval. 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 Laval’s 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
http://www.alfalaval.com, 2008-04-06
11
Alfa Laval Annual Report 2006

9
heat exchangers. These are quality controlled and prepared for delivery to an end customer.
In the below value added chain, this study’s focus will be on unit highlighted in red.

Suppliers

Component Unit - CU

OM - CP (Component Unit Plates) OM - CF (Component Unit Frames)

Supply Unit - SU

OM - SE (Supply Equipment) OM - SP (Supply Process Technology)

End customer

Figure 1.1: Alfa Laval’s Value Added Chain.

10
1.3 Problem discussion
As mentioned earlier, this study will focus on business unit OM-CP (Operation
Manufacturing-Component Unit Plates). The OM-CP unit is experiencing problems with how
to handle trends and seasonal variations in forecasting outputs. There are other problems as
well. The final forecasts generated by the ERP system have to be subjectively adjusted to
meet actual demand. This is time consuming and the human factor involved in this task can
become a source of mistakes.

Today the OM-CP business unit uses mainly two types of forecasting methods to forecast
demand of raw material to be purchased for the different families of plate heat exchangers.
The forecasting methods were developed internally and resemble variations of moving
average methods. One method weights the previous 12-month demand to forecast demand for
one year ahead. The weight factor attaches different importance to each month. There is an
established rule that the biggest weight is put on the three preceding months. The further back
in the history (always 12 months), the lower the weight factor is. It is assumed that the
forecast for the next three months will be more accurate if it is based on demand development
during the preceding three moths. Generally, using this method, the demand forecast for one
year ahead is very similar to the actual demand in the past twelve months. The other method
distributes the weight evenly on all twelve past periods.

However, the automatic calculation of both demand forecasts has to be manually adjusted in
order to take into consideration the value of known orders of the next months. In addition,
the current weight factor methods seem not to account for trends and seasonal variations in
demand. The monthly forecasting accuracy evaluation reports show negative trend caused by
using these methods. In other words, forecasting errors are simply too high.12

Alfa Laval’s current forecasting situation results in many questions: Is the manner of
capturing historical demand sufficient to forecast future demand? Are there better forecasting
methods to take trends and seasonal variations into account? Which methods work well and
which do not in which situation? Which of the forecasting methods provides better results
than the current method?

12
Interview with Martin Jönsson, 2008-04-04

11
By evaluating the present situation and answering these and other questions, we hope to
suggest more appropriate forecasting methods for Alfa Laval.

1.4 Problem questions

• How does Alfa Laval currently forecast for demand?
• 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 Laval’s 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
1.7 Time plan
March April May
Chapter Title Week
11 12 13 14 15 16 17 18 19 20 21 22
1 Introduction

2 Research
Methodology
3 Theory

4 Empirical
Findings

5 Analysis

6 Conclusions and
Recommendations
Data Collection

PM 0 1 2 3

Tutoring

1.8 Definition of Concepts

Coil: a roll of raw material (metal, titanium, etc) to be cut and pressed into plates
Sheet: raw material in form of flat metal plates
Plate heat exchanger: The basic plate heat exchanger consists of a series of thin, corrugated
plates that are gasketed, welded together (or any combination of these) or brazed together
depending on application. The plates are then compressed together in a rigid frame to create
an arrangement of parallel flow channels. One fluid travels in the odd numbered channels, the
other in the even.

13
1.9 Disposition
The thesis will be organized as follows (see Figure 1.2):

Chapter 2 The Methodology chapter describes the scientific research approach chosen
for this study. Furthermore it presents methods used for data collection and
empirical findings. The chapter concludes by summarizing the chosen method
and discussing the validity and reliability of the study.

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 The Conclusion and recommendation chapter presents a review of the study
and proposes forecasting recommendations to Alfa Laval. The proposals are
based on theory, our data observations, and interviews with people involved in
the OM-CP business unit. Recommendations for future studies give feasible
ideas for studies of demand forecasting in this or another closely related
subject area.

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

Figure 1.2: Disposition of Study

15
2. Methodology

I 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.
Thereafter we present scientific credibility of the thesis. At the end is a summary of
methodological choices.

2.1 Scientific perspective - Positivism vs. Interpretivism

Interpretivism is an alternative to positivism in that it requires the researcher to take into
consideration the subjective meaning of social action. Positivism dictates that knowledge
comes from strict scientific methods.13 “Practical action research seeks to improve practice
through the application of the personal wisdom of the participants”14. Action research gains
new understanding of a practice and tends to have a lasting influence on the changes that
result. The implemented changes are naturally connected to the individuals involved in the
change process because the result provides a solution to their immediate problem. Practical
action research encourages professional development by emphasizing personal judgment on
decisions to act for the good of the client.15

2.1.1 Our perspective - Interpretivism

We chose the interpretivist perspective because it is consistent with our research question of
solving a practical demand-forecasting problem at Alfa Laval. Although theory plays a strong
role in providing a solution, the result also cannot take place without input from the
practitioners. This requires us, the researchers, to closely collaborate with the practitioners to
fully understand the meanings of their input and the empirical data gathered. “The action
research process thus creates a langue shared between practitioners and researchers that
identifies the meaning throughout the inquiry process.”16

13
Bryman, A (2007: 19)
14
Grundy, S. (1982:357)
15
http://www.scu.edu.au/schools/gcm/ar/arr/arow/rmasters.html (2008-04-15)
16
Greenwood, D. (1998:80)

16
2.2 Scientific approach – Deductive vs. Inductive
By using an inductive research approach, data is collected to build theory; not test it.
Inductive research also involves an iterative process, which requires the researcher to move
back and forth between theory and data.17 Deductive research seeks to apply theory to
observations or findings.18 A deductive process is usually linear meaning that one step
follows the other in a logical sequence. However, there are some situations where this does
not happen. Sometimes a researcher’s view of theory changes as a result of analyzing the
collected data. For example, data may not fit the initial hypothesis or the relevancy of the
data for a theory may become clear only after the data was collected.19

2.2.1 Our scientific approach - Deductive

Our scientific approach is deductive in that we are analyzing forecasting models that are
based on proven theory. We have in mind forecasting theories that can be better suited to the
current problem, but until all data has been assembled and we have tested the forecasting
theory, we do not know if we ought to test other forecasting theories. We will propose more
appropriate forecasting models to solve the current problem. We will not create any new
theories.

2.3 Research strategy – Quantitative vs. Qualitative

Qualitative research places emphasis on words in the gathering and analysis of data rather
than quantification. In quantitative research, the emphasis is on quantification of 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
Bryman, A & Bell, E. (2007:581)
18
Bryman, A & Bell, E. (2007:14)
19
Bryman, A & Bell, E. (2007:13)
20
Bryman, A & Bell, E. (2007:427)
21
Greenwood, D. (1998:77)

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.

2.3.1 Our research strategy - Quantitative

Our research is mostly quantitative in terms of data collection and the analysis to be
conducted. We are collecting and analyzing historical data of demand and using known
theoretical formulas to find better solutions to the action research problem. However, this
study also employs qualitative information gathering insofar as we are participating in our
observations by gathering some of the necessary data ourselves; requiring that we receive
training and learn how to locate and sort needed information from the company’s ERP
system. Other information we obtained from the company’s intranet or website in addition to
mostly unstructured interviews with three employees in the OM-CP business unit.

2.4 Research method - Action Research

A research method concerns choosing a technique to be used for data collection.25 As a
research method, action research requires communication and collaboration between insiders
(responders) and outsiders (the researcher) to diagnose a research problem and develop a
solution. The diagnosis evolves through the close interaction of both parties. The researcher
brings knowledge of theories and the responders bring their own personal experiences.26
Action Research, in social science, is a method that emphasizes combining science and
practice27 and can further be defined as having the following characteristics:28

22
Bryman, A. & Bell, E. (2007:429)
23
http://www.web.net/~robrien/papers/arfinal.html#_Toc26184652 (2008-04-15)
24
Bryman, A. & Bell, E. (2007:429)
25
Bryman, A. & Bell, E. (2007:40)
26
Bryman, A. & Bell, E. (2007:428)
27
Argyris, C., et al. (1985, preface x)
28
Greenwood, D., et al. (1998: 75-76)

18
 Action Research (AR) – Core Characteristics
• AR is context bound and addresses real-life problems.
• AR is inquiry where participants and researchers co-generate knowledge through
collaborative communicative processes in which all participants’ contributions are
taken seriously.
• 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.
• The credibility-validity of AR knowledge is measured according to whether
actions that arise from it solve problems (workability) and increase participants’
control over their own situation.

Figure 2.1: Action Research - Core Characteristics Source: Greenwood, D.(1998:75)

There is a special kind of question that action researchers ask in order to identify the
particular research design, to name a couple: 29

• How can I improve my personal practice?

• How can I improve my understanding of this?

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 real-
life 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)
30
Mc Niff, J. (1996:7)
31
Greenwood, D., et al. (1998:19)
32
Greenwood, D., et al. (1998:54)

19
Action research can be considered as a process that contains five phases: diagnosing, action
planning, action taking, evaluating, and specifying learning.33

Figure 2.2: Cyclical Process of Action Research Source: Susman,G., (1981:146)

2.4.1 Our motivation of research method

The motivation for using Action research as a research method is because our subject
company, Alfa Laval, has diagnosed a practical problem they are experience and we have the
task of solving it. Our work is characterized by finding a better solution for the current
situation.

33
Susman, G. (1981:146)

20
2.5 Data Collection- Theoretical and Empirical
Doing research requires the collection of different data sorts; theoretical and empirical. The
empirical evidence, similar to what was mentioned under qualitative analysis, can come from
documents, archival records, interviews, direct observations, participant-observation, etc.34
Data may fall into the category of primary or secondary data collection. Primary data is
collected from research, surveys, content analysis, etc. conducted by the researcher for his/her
own purposes. Secondary data, is this case, is data already collected by the studied
organization for its own purposes. Some benefits to secondary data is that it reduces
collection time and cost, and leaves more time for data analysis.35 Some limitations include
lack of familiarity with the data, complexity of the data, no control over data quality and
absence of key variables.36

2.5.1 Our data collection method

Our data collection method is composed mostly of secondary data. Here, secondary data
applies to previous demand forecasts and historical demand data taken from the subject
company’s ERP system. It is raw data and classified in a way that meets the needs of the
company. Therefore, information from different places in the ERP system have to be
gathered and sorted by us as much as possible before it can suit the objective of the study and
be used in our analysis. Due to confidentiality concerns, some information pertaining to the
demand forecasting and historical demand data will not appear in this paper.

Theoretical data collection consists of information found in previous papers, books, articles,
and also on the Internet. Vaxjo University library is the primary source for these media.
Besides books, we have used the ELIN, and E-brary to locate articles. Our data collection
will focus on books or peer-to-peer articles concerning purchasing, and application of various
forecasting theories.

34
Yin, R. (2003:86)
35
Bryman, A.. (2007: 328-333)
36
Bryman, A.. (2007: 334-336)

21
2.6 Scientific Credibility
The aim of all research is to create new knowledge. The social intent of research is to
improve a particular situation. Features of traditional research are replicability and
generalizability. If the method and its finding can be generalized to all situations, then the
research is proven to have external validity. Research of high quality is characterized by
meeting replicability meaning that it enables other people to do the same thing with the same
results. However, the criteria for high quality research are not appropriate for action research.
The replication or generalisation is not possible, nor desirable. The aim is to understand
rather than to predict. Action researchers do research with other people to understand and
contribute to improvement of their social practices.37 Researchers share people’s knowledge
collaboratively. This results in the construction of collective knowledge. Action research is
not build of replicability and generalisability but of knowledge constituted of case studies.
The stories of all people involved in a particular research are accumulated and demonstrate a
culture of collective knowledge.38

Greenwood describes credibility in action research as “the arguments and the processes
necessary for having someone trust research results”. First there is knowledge that has
internal credibility to the group generating it. This is vitally important to action research
because of the collaborative nature of the research. Second, there is external credibility –
knowledge capable of convincing someone outside the project that the results are
believable.39

As seen in Figure 2.2, action research operates in cycles. The pattern of each cycle is the
identification of an issue, imagination of solution, implementation of solution, gathering of
evidence, evaluation of solution resulting into the modification of practice. It is
recommended to make intermediate progress reports throughout each cycle. These reports
represent formative evaluations to check that one is in line with answering the research
question. 40

37
Mc Niff, J. (1996:106)
38
ibid (1996: 107)
39
Greenwood, D., et al. (1998:80-81)
40
Mc Niff, J. (1996:108)

22
Some forms of validation:41
Self - validation: Researcher should be able to show to his own satisfaction that he has been
done the things he set out to do.
Up-liner validation: To show to managers and authorities that an intervention has been done
to improve the practice and the way of working could be adopted.
Client validation: The intervention should contribute to improvement of quality of “client’s
life”.
Academic validation: This validation is done by the academic community in terms of
whether it agrees that the researcher has contributed to a new knowledge.

2.6.1 Our choice of scientific credibility

This paper will use the form of client validation. Our recommendation should improve the
current forecasting situation at the OM-CP business unit. To guarantee internal credibility,
we will present to Alfa Laval a description of their current forecasting situation. On a regular
basis, we will provide updates about our partial findings and progress and solicit feedback on
our interpretation. All empirical findings and analyses will be documented and made
available to the client in order to increase the credibility of our research. Collaboration
between the company and us is critical to ensure our full understanding of the client’s current
situation and demands. We believe that all these steps will lead to final knowledge that
convinces observers outside the project that the study’s results are believable and useful in
contributing to new knowledge.

41
Mc Niff, J. (1996:108)

23
2.7 Summary of Methodology

Methodology in General Methodology in this Thesis

Scientific Perspective Interpretative

Scientific Approach Deductive
Research Strategy Quantitative
Research Method Action Research
Theoretical Data Collection Articles, books, ELIN, Internet
Empirical Data Collection Unstructured interviews, secondary data,
brochures
Scientific Credibility Client validity

Figure 2.3: Summary of methodology

24
3. Theory

T he theory chapter aims to present different methods for forecasting demand. We

discuss two types of demand forecasting: subjective and objective. Next we identify
behaviors that impact time series analyses. It is followed by several well-known
methods to evaluate forecasting error. Subsequently, a theoretical framework is provided to
summarize the connection between the theories.

3.1 Demand forecasting - Subjective and Objective

“When the result of an action is of consequence, but cannot be known in advance with
precision, forecasting may reduce decision risk by supplying additional information about the
possible outcome.”42 There are two main approaches to forecasting, subjective or objective,
and sometimes a company may opt to use a combination of both approaches to predict
demand. It should be noted here that some authors use the terms objective and subjective43
while others use the terms quantitative and qualitative44, and still others use the terms
judgemental and statistical.45 For the sake of consistency, we use the terms subjective and
objective in this study. A discussion of both approaches follows.

3.1.1 Subjective forecasting approach

Subjective forecasting is based on human judgement. There are various types of subjective
techniques:46

• 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
Kalekar, P., (2004:1)
43
Nahmias, S. (2005:51)
44
Martin, J. (2008:222)
45
Armstrong, J. (2001:22)
46
Nahmias, S. (2005:55-56)

25
 • Customer surveys – These surveys or questionnaires, if properly conducted, can
indicate future trends and oscillating preference patterns.

• 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 organization’s sales force, or bringing people together who have knowledge of
a particular customer segment.47

3.1.2 Objective forecasting approach

Objective forecasting is derived from analyzing data from past history and generally falls
under two categories of analysis – time series analysis and regression models (causal).

• 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)
48
Nahmias, S. (2005:51)
49
Martin, J. (2008:222)
50
Nahmias, S. (2005:51)

26
 based on various factors such fiscal policies, agricultural performance, etc
(independent variables).

In this study we will focus on the objective forecasting approach using times series analysis.
This analysis model is further discussed under section 3.2 Time series analysis.

3.1.3 Summary of subjective and objective approaches

In summary one can say that each approach has unique advantages (see Figure 3.1). For
instance, subjective approach is good when used to estimate a new product or service
demand. It also provides an opportunity for the company to develop relationships with clients
through closer communication. The objective approach is good when used to estimate
demand of existing products; however one need several years of demand patterns and it may
encounter accuracy concerns. In addition, it is difficult to use when considering unusual
events that impact customer demand, i.e. a recession.51

Description Subjective Approach Objective Approach

Applicability Used when situation is
vague and little data exist
(e.g., new products and
technologies)
Considerations Involves intuition and
experience
Techniques Jury of executive opinion
Sales force composite
Delphi method
Consumer market survey
Figure 3.1: Summary of qualitative and quantitative forecasting approaches
Used when situation is stable
and historical data exist (e.g.
existing products, current
technology)
Involves mathematical
techniques
Time series models
Causal models
Source: SME Toolkit.org52

51
Martin, J. (2008:224)
52
http://www.smetoolkit.org/smetoolkit/en/content/en/416/Demand-Forecasting (2008-04-29)

27
3.2 Time series analysis
As mentioned under 3.1.2 Objective forecasting approach, time series analysis and
regression models are used to analyze past series of data. However, time series forecasting
has the largest number of applications of any approach to forecasting encompassing
production planning, budgeting, inventory management, distribution, sales and marketing,
which all depend on accurate forecasts.53 Time series analysis better suits this study due to
predicting demand for coming periods based on demand for same units in past periods.

Time series methods of analysis “assume that a time series is a combination of a pattern and
some random behaviour.”54 The goal is to separate the pattern from the white noise by
understanding the pattern’s trend, its long-term increase or decrease, and its seasonality.
Because it requires no other information than the past observations of the phenomena being
analyzed, time series methods are often referred to as naïve methods.55 When demand is
stable and few changes are expected to adjust the timing and volume of demand, the time
series analysis may be the most accurate input into demand planning.56 This type of
forecasting is also a necessity for companies that produce hundreds or more of items.

3.3 Definition of Time Series Behaviours

It is useful when conducting time series forecasting to understand the causes of demand
variations.57 These demand variations can be broken out into components (otherwise called
patterns or behaviours). Some of these components are trend, seasonality, cycles and
randomness. They are defined as:58

• Trend – Refers to a tendency to show a stable pattern of growth or decline.

• 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)
54
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)

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
3.4 Models for Time Series Forecasting
Below is a summary of major time series models and their applications. It should be noted
that much more involved models exist; however, the main ones are presented below.

Trend plot Plots time series data versus time without

creating mathematical model

Time series decomposition
Breaks a time series into its level, trend,
seasonal, and irregular components. It
models both trend and seasonal patterns
using constants calculated from the
decomposition.

Moving average models A time series model created by taking the

average of observations from the time
series to smooth out seasonal or other data
patterns.

Simple exponential smoothing Models a level (stationary) time series, i.e.,

no trend or seasonality, using one
smoothing parameter.

Double exponential smoothing (Holt’s Models a level (stationary) time series with
method) a trend but no seasonality using two
smoothing parameters.

Triple exponential smoothing (Winter’s Models a level (stationary) time series with
method) a trend and seasonality using three
smoothing parameters.

Autoregressive integrated moving Statistically based time series models that

model level, trend, and seasonal
average (ARIMA) models
components of a time series.

Figure 3.2: Major Time Series Models Source: Martin,J. (2008:240)

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
3.4.1 Moving average
Moving average is the simplest forecasting method. The moving average of demand N is
calculated as the average of the most recent N data observations.59 It is good at matching the
average level of the time series period by period and it will follow the up- and downward
movement of a time series.60

A common disadvantage of this method is that one must recalculate the average of the last N
observations each time a new demand observation becomes available.61 The N parameter
(representing the number of periods) in moving averages is similar to the smoothing
parameter of α used in exponential smoothing (discussed below in 3.4.2 - Simple exponential
smoothing). A small N puts more weight on recent observations, whereas a bigger N puts
greater weight on past observations.

Ft is the forecast made for period t in period t-1 and it is given by:
t-1

Ft = (1/N)* Σ Di = (1/N)*(Dt-1 + Dt-2 + …+ Dt-N)

i = t -N

The formula represents a one-step-ahead forecast.

Dt = observed values of demand during periods of time t
(Dt, t ≥ 1)
N = number of all past observations
di = value of all past demand observations
Source: Nahmias, S. (2005:64)

59
Nahmias, S. (2005:63)
60
Martin, J. (2008:245)
61
Nahmias, S. (2005:64)

31
Weighted moving average
A weighted moving average 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
62
less important. 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 = (α*(Dt-1+ …+ Dt-3) + β*(Dt-4+…+ Dt-6) + γ*(Dt-7 +...+ Dt-12))/12

3.4.2 Exponential smoothing

Exponential smoothing is another well-used forecasting method for stationary time series.
“The current forecast is the weighted average of the last forecast and the current value of
demand.”64 It is a good technique for continually revising a forecast when taking into
consideration more recent experiences. In other words, recent observations are given more
weight in a forecasting than older observations.

Simple exponential smoothing

Simple exponential smoothing constructs the forecast as a combination of previous demand
weighted by a smoothing parameter α. The larger the α, the more heavily recent demand will
be weighted in a forecast. This is good for short-range forecasting; usually a month into the
future.65 The smaller the α, the more heavily past demand will be weighted and forecasts are
more stable. Therefore, having a value of α between 0.1 and 0.2 generally represents a stable
forecast and is recommended for production planning purposes.66

A drawback to simple exponential smoothing is that it is not designed to forecast time series
exhibiting trend or seasonal behaviours.

62
http://www.smetoolkit.org/smetoolkit/en/content/en/416/Demand-Forecasting, 2008-04-29
63
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)

32
Formula: Ft = α*Dt-1 + (1-α)*Ft-1
That is:
New forecast = α(Current observation of demand) + (1 - α)(Last forecast)

Smoothing 0< α ≤ 1
constant:
Source: Nahmias, S. (2005:66)

Double exponential smoothing (Holt’s method)

Double exponential smoothing, Holt’s method, is designed to track time series with linear
trend. In other words, it is best used when data shows a pattern of trend. It works like simple
exponential smoothing except that two components, level of the time series (expressed as the
intercept) and trend (expressed as the slope), must be updated each period. Below is a figure
demonstrating an intercept and slope. The green line represents demand, red represents
forecast. An example of the slope and intercept are shown at the tail end of the forecast.

Sales

Intercept

Slope

Figure 3.3: Intercept and Slope Extracted from Lawrence, S. (2008:23)

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+η = St + ηGt

η-step-ahead forecast
made in period t

Intercept:
St = α*Dt + (1-α)*(St-1 + Gt-1)
Slope:
Gt = β*(St-St-1) + (1-β)Gt-1
Smoothing constants: 0< α ≤ 1
0< β <= 1
β≤α
Source: Nahmias, S. (2005:76)
St = the value of the intercept at time t
Gt = the value of the slope at time t

Note: When the smoothing constant is close to 1.0, more weight is given to recent

observations (quick dampening). When it is close to 0.0, relatively less weight is given to

recent observations (slow dampening). 68

Triple exponential smoothing (Winter’s method)

Winter’s method is built on the previous Holt method and is designed to handle time series
base, trend, and seasonal behaviours by using three smoothing parameters: α to smooth base,
β to smooth trend, and γ to smooth seasonality.69 This method provides an advantage in that
it is easy to update as new data is received.70

The following model is assumed:

Dt = (μ + Gt)*Ct + εt

67
Nahmias, S. (2005:77)
68
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)

34
There μ 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 εt.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 Holt’s 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: Ft, t+η = (St + ηGt)*Ct+η-N

St = α*(Dt/Ct-N)+(1-α)*(St-1 + Gt-1)

Gt = β*(St-St-1) + (1-β)Gt-1

ct = γ*(Dt/St) + (1-γ)*Ct-N
Smoothing constant: 0< α < 1
0< β < 1
0<γ<1
Source: Nahmias, S. (2005:84)

Ft = the forecast made in period t for any future period t + η, it assumes t≤N
St = smoothes the base forecast; the current level of deseasonalized serie
Gt = smoothes the trend forecast
ct = smoothes the seasonal forecast

71
Nahmias, S. (2005:83)
72
ibid (2005:86)
73
ibid (2005:88)

35
3.4.3 Autocorrelation
Before using Winter’s 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

Rn =COR(Dt, Dt-n) = COV(Dt, Dt-n)/(STD(Dt)*STD(Dt-n))

COV = covariance of Dt and Dt-n

STD = standard deviation of Dt and Dt-n

Source: Hoff, J. (1983:280)

3.5 Evaluating forecasting accuracy

One should take precautions to conduct unbiased forecasts and one way to test this is through
measurements of forecasting error.

Forecasting error in period t, et is the difference between the forecast value for that period
and the actual demand for that period. The formula for obtaining the forecast error for one-
step-ahead forecast is following:
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

MAD = (1/n) ∑ |ei|

i=1

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

MSE = (1/n) ∑ ei2

i=1

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

MAPE = [(1/n) ∑ |ei / Di|] x 100

i=1

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, Σei. 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)
78
Hoff, J.C. (1983:262)
79
ibid (1983:272)
80
Andersson, G. (1994:206)
81
Hoff, J.C. (1983:263)

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
3.6 Theoretical framework
To facilitate a clear understanding for our readers, we present the following model to
visualize the connection between different parts of the forecasting theoretical framework. The
highlighted areas directly affect our action research study.

Demand forecasting

Subjective Objective
(Human judgment) (Mathematical)

Time series methods

Regression (Causal)
Characterized by patterns:
Characterized by
-Trend
dependent variables
-Seasonal
and independent
-Cycles
variables
-Randomness

Time Series Models of Analysis

Evaluating forecast
-Simple Moving Average
-Weighted Moving Average accuracy
-Simple Exponential Smoothing -MAD
-Double Exponential Smoothing (Holt’s method) -MAPE
-Triple Exponential Smoothing (Winter’s method) -MSE

Figure 3.3: Theoretical framework

39
4. Empirical

T 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.

4.1 Reintroduction of Alfa Laval

Alfa Laval employs 10,000 people worldwide. The company provides various products and
solutions for centrifugal separation, filtration, fluid handling, and heat transfer. The facility in
Lund, Sweden employs 1,100 people and is responsible for the production of plate heat
exchangers, which fall under the category of heat transfer. Purchasing and storage of raw
material, and production take mostly place at the facilities in Lund. The facility at this
location is responsible for the production and storage of plate heat exchangers. Several
components such as stainless plates (i.e.: steel, titanium etc), frames and gaskets go into the
production of these plate heat exchangers.

The OM–CP business unit is responsible for ordering and receiving these materials to meet
customer demand. This study will focus only on the raw material demand of stainless steel
plates (a variety of metals - stainless steel, titanium, etc.) in form of coils or sheets to be later
transformed into plates used for heat exchanger products. OM-CP’s manufactures the plate
heat exchangers per orders from the internal customer, the SU (Supply Unit), located at the
same location in Lund. The SU then produces the plate heat exchangers per client
specifications and is responsible for quality control and subsequent delivery to the end
customers. The customers represent companies in various sectors such as hospitals, brewery,
food industry, oil and gas industry, marine etc.

40
4.2 Interviewees
We received assistance from Tobias Augustsson, Martin Jönsson, and Lars Hedberg of the
OM-CP unit throughout this study.

4.3 Ordering Raw Material at Alfa Laval

Alfa Laval has a plethora of product offerings, so for the purpose of this case we will only
focus on the purchase of stainless steel coil that fall into the A or B category (using A-B-C
classification). This means that for all stocked items, A items represent 80% of the volume
value, and B items represents 15% of the volume value. In other words, these items of higher
value will give more frequent procurement and therefore need more attention in inventory
management.

4.3.1 How an order is placed

The OM-CP unit receives internal orders from SU per customer specifications. An order
handler keys the order into Jeeves, the ERP system. Next, a purchaser reviews the order in
Jeeves. Purchasers are assigned responsibility for different plate types. At OM-CP two
purchasers are assigned to stainless steel products and they also handle product forecasting.
Upon review, if the required raw material component is below the necessary stock level, then
the purchaser must place an order to one of the stainless steel suppliers (currently five or six
available). The order quantity is communicated to suppliers in terms of kilograms. In Jeeves
it is recorded as quantity in kilograms and also converted into quantity of pieces for internal
communication purposes. Below is a diagram overview of the order process.

Figure 4.1: Current order and forecasting process

41
4.3.2 How forecasting of raw material demand is done
Forecasting for all Alfa Laval suppliers is conducted once a month. The forecasting is based
on data found in Jeeves and recorded as items “delivered from stock”. However, “delivered
from stock” is not necessarily a true representation of the demand since situations arise where
orders gets placed, but not fulfilled due to lack of stock. The SU places orders to stock,
however the measure of demand is calculated based on what has actually been delivered from
stock. For example, if SU places an order for a plate product but this product is not in stock,
then demand is recorded as zero (0) because for the purpose of forecasting, Alfa Laval
considers demand based on what is delivered from stock.

4.3.3 What the forecast sent to suppliers is based on

A one year forecast is automatically generated in Jeeves using different forecasting methods.
The value is then divided by fifty (50 weeks/year) in order to get an average forecast for one
week. This value will later be used to calculate two and three month forecasts. In order to get
forecast for the three following months (two and then one), the one week forecast is
multiplied by the number of weeks of the two nearest months and in the same manner also by
the number of weeks in the third month. Purchasers have to manually adjust (subjective
forecast) this statistical forecasting every month to take into consideration known information
such as current orders. However, the purchasers do not record their subjective forecast
adjustments in the system. The adjustments are only recorded in excel spreadsheets, not in
Jeeves. Therefore, it is not possible for the database to capture a real history of how much the
demand was adjusted up or down. These manipulated (subjective) forecasts are sent to a
supplier containing raw material demand one-month, three-months and 12-months ahead.
Updating of forecasts for suppliers is done on a monthly basis.

4.3.4 Forecasting accuracy calculations

Forecasting accuracy (testing the level of forecasting error) is also updated once a month. The
accuracy result measurement is currently about 50% correct so there is a lot of room for
improvement. However, the accuracy of measurement is based only on data registered in
Jeeves, which does not take into consideration manual adjustments of forecasts.

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 Laval’s accuracy evaluation method.

Alfa Laval’s 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

4.3.5 Six Sigma

Forecasting error is measured in the DPMO-measurement system (defects per million units)
within the Six Sigma program. This quality control also contains an assessment of how large
a forecasting error has been made (the forecasting errors exceeding the limit of ± 30 % are
registered in Six Sigma). Unfortunately, current forecasting does not show any improvement
what so ever. Incorrect forecastings are at 50%.

4.3.6 Results of poor forecasting at Alfa Laval

If a forecast is too high and the supplier produces the volume, then most likely Alfa Laval has
to follow through with the purchase even if that quantity is not required at present. However,
there is a certain margin built into the forecasting in terms of + and - quantity. The margin is
negotiated with each supplier. There is no universal margin across all suppliers. Under
forecasting can lead to shortages in stock, which halts production because of lack of material.
However, this is a very rare occurrence.

43
4.4 Current forecasting models
Alfa Laval has a selection of four different forecasting models. Two of them are named after
facilities located in Lund. In other words, the products manufactured at the facility located at
Öresundsväg were forecasted using a method named “Ö-väg method”. In the same manner,
products manufactured at a facility in Gunnesbo used “Gunnesbo method”. This manner of
using a model based on where the production takes place is no longer in use. However, these
forecast models have been grand-fathered into the system, meaning that current employees
don’t really know when or how they came into being, only that the methods seems to be
appropriate for current demand forecasting needs.

The four forecasting models are:

1. Öresundsväg (ö-väg) – resembles weighted moving average in which the most weight is
placed on the last three months.

Forecast in period t:

Ft = (α*(Dt-1+ …+ Dt-3) + β*(Dt-4+…+ Dt-6) + γ*(Dt-7 +...+ Dt-12))/12

Dt = Demand (Delivered from Stock) in period t

Weighted factors: α=2

β=1
γ = 0,5

2. Gunnesbo (G-BO) – weighted moving average – in the same manner as “Öresundsväg

method” the most weight is placed on the last three months. We have found no evidence of
this method being used.
Forecast in period t:

Ft = (α*(Dt-1+ …+ Dt-3) + β*(Dt-4+…+ Dt-6) + γ*(Dt-7 +...+ Dt-9) +

+ δ*(Dt-10 +...+ Dt-12))/12

Weighted factors: α = 1,25

β = 1,10
γ = 0,9
δ = 0,75

44
3. RAK – straight moving average – the weight is distributed evenly on all the twelve past
periods.
Forecast in period t:

Ft = (α*(Dt-1+ … + Dt-12))/12

Weighted factor: α=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 = α*(Dt-1+ (1- α)*Ft-1

Smoothing constant: α = 0,1

However, this method, though available in Jeeves is not used.

Note: Theory dictates that the smoothing constant values should be >0 and <1 and that the
average of weighted factors should be 1.

45
4.4.1 Summary of the forecasting methods used by Alfa Laval
Note: -01 represents the most recent past month; -12 represents 12 months ago. Each column
to the right of Period represents a weight assigned to that period. Exponential smoothing is
not listed as we saw no evidence of its use. (see Figure 4.2)

Period Gunnesbo (G-BO) RAK Öresundsväg (ö-väg)

Weighted factors Weighted factors Weighted factors
-12 0,75 1 0,5
-11 0,75 1 0,5
-10 0,75 1 0,5
-09 0,90 1 0,5
-08 0,90 1 0,5
-07 0,90 1 0,5
-06 1,10 1 1,0
-05 1,10 1 1,0
-04 1,10 1 1,0
-03 1,25 1 2,0
-02 1,25 1 2,0
-01 1,25 1 2,0
Figure 4.2: Summary of the forecasting methods used by Alfa Laval

4.5 Items to be analyzed

Below is a summary of selected raw materials and the corresponding forecasting method used
at Alfa Laval. Alfa Laval suggested these items for the purpose of conducting the analysis.
As mentioned earlier, these items were selected based on high order quantity and value. Data
was obtained from the ERP system, Jeeves. To respect Alfa Laval´s confidentiality
agreement, original item names and numbers will not be presented in this study. Instead, they
are replaced by numbers of convenience.

46
Raw Material Current Forecasting Raw Material Current Forecasting
Item Number Method Item Number Method
3 Rak 1577 Ö-väg
105 Ö-väg 1681 Rak
208 Ö-väg 1784 Ö-väg
310 Ö-väg 1806 Rak
413 Ö-väg 1827 Rak
487 Rak 1906 Ö-väg
590 Ö-väg 2009 Rak
693 Rak 2103 Rak
796 Ö-väg 2207 Rak
899 Ö-väg 2229 Rak
973 Ö-väg 2332 Ö-väg
1014 Ö-väg 2410 Ö-väg
1117 Ö-väg 2513 Rak
1220 Rak 2591 Ö-väg
1266 Rak 2713 Rak
1369 Ö-väg 2816 Rak
1473 Rak 2846 Rak

Rak: Straight Moving Average Ö-väg: Weighted Moving Average

Figure 4.3: Current forecasting methods for selected raw material items

4.6 Gathering of data

There are 34 raw material items to be analyzed in this study. Approximately half are
currently being forecasted using the “Öresundsväg” forecast; the others use “Rak method”.
The data for this study is a compilation of secondary data (i.e. data we extracted from Jeeves
and transferred to Excel sheets) and primary data – information gathered from unstructured
interviews, which influence our approach on how to analyze the data. We received training to
use Jeeves to extract past demand history for the 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”
• Historical data is chronologically sorted (ie: 2001 - 2008)
• 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

I 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.

5.1 Foundation of analysis

Our analysis was based on time series methods because the objects of our study have
historical observations of repeatable demand that span several years. As mentioned in the
theory chapter, time series analysis is a necessity for companies that produce hundreds or
more of items. Both criteria are suitable for the raw material analyzed in this study.

At Alfa Laval, demand is measured as delivered from stock. This poses a challenge when
evaluating demand this way because we can only conduct an evaluation based on what has
been shipped from stock causing a blind spot that makes it difficult to perform a proper
analysis of periods where no demand was recorded as shipped from stock. In other words, it
means that technically the actual demand is not captured. This caused some difficulty in the
analysis and forced us to consider using different methods of analysis better suited for the
perception of “0”demand. It also prevented us from being able to evaluate some of the other
selected coils as many periods showed a zero value, when in actuality there is a demand, but
it was not captured in the system because nothing was delivered from stock. If the correct
amount demanded is not available, then “0” product is delivered from stock. In addition, our
evaluation of such coils was hampered in that the periods of “0” value sometimes spanned a
significant number of periods, thereby reducing the number of historical periods available for
evaluation making time series method of analysis inappropriate for some coils.

49
5.2 Raw material analyzed
We had a selection of 34 coils (raw material items, in the following) to evaluate. Based on the
time required to fully analyze each coil, the behaviour exhibited by some coils during our
analysis, and the “0” value problem, our study refocused on the analysis of 12 of the raw
material items (see Figur 5.1).Nine of them have all past demand values available and three
contain “0” values in the original data. The remaining items contain too little historical data
or too many zero demand values and therefore they are not appropriate for analyzing with
time series forecasting methods.

The following 12 raw material items were analyzed:

Raw Material Item Current Forecasting

Number Method

3 Rak
105 Ö-väg
208 Ö-väg

310 Ö-väg

487 Rak

590 Ö-väg

693 Rak

796 Ö-väg

1117 Ö-väg

1266 Rak

2410 Ö-väg

2513 Rak

Figure 5.1: Raw material item numbers and current forecasting methods

50
5.3 The analytical process
Following is the step-by-step process we took to analyze the raw material items. A snapshot
of the physical analysis accompanies a written description. Appendix 3 contains complete
analysis of one raw material item. (See the note in the beginning of this chapter.)

Step 1
Demand data was gathered and sorted in chronological order from Jeeves database. Demand
is based on delivery from stock (see Figure 5.2 and also Appendix 2 for complete list of
historical demand data for one item).

Figure 5.2: Historical demand data - snapshot

Step 2
Where demand is positive in most periods and there were some “0”periods, these periods
were corrected to an average of the before and after period, or as a multiple-period average.
The reason for correcting “0”periods 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.

Figure 5.3: Historical demand with corrected values

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 Holt’s method ought to be used. (see Figure 5.4)

Delivery from Stock (Item Nr.3)

60000

50000

40000

Delivery from stock

Pcs

30000
Linjär (Delivery from stock)

20000

10000

0
1 5 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,
Ö-väg, and Triple exponential smoothing (see enclosed CD). Recall that Rak and Ö-väg 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 (α, β, and γ) 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
Figure 5.5: Snapshot of moving average analysis

Before triple exponential smoothing (Winter’s method) is applied, we use an autocorrelation

test of the data looking for evidence of seasonality. With autocorrelation we test if a
relationship between the data exists. By removing the trend from data we can see if there is
some other pattern left such as seasonality or just pure randomness (See Appendix 3). If
seasonality exists, the correlation should not be 0. Then Winter’s method can be
recommended.

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, Ö-väg 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
doesn´t 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
Evaluating Alfa Laval´s forecasting methods (Ö-väg and Rak)

We used three alternatives to evaluate Alfa Laval´s forecasting methods:

1. Alfa Laval’s internal error evaluation method for forecast accuracy:

Each month is the forecast value for the next 12 months divided by 4 in order to get a
3 months forecast. This value is then compared to delivery from stock values (real
demand) during the past 3 months. Next, the error is expressed as a percentage of the
forecast.

*Note: It seams this evaluation method is probably incorrect. In Appendix 5 we

provide a detailed mathematical analysis of the methods in order to demonstrate the
incorrectness of this method. This is the reason why we compute the forecast
accuracy using another method (explained below) based on the theory as presented in
the Theory Chapter 3.5.

2. Theory based error evaluation (1 month):

In the second alternative, we divide the one-year ahead forecast by 12 in order to get
forecast in period t. Next the forecast is compared to the real demand in period t.

3. Theory based error evaluation (3 months):

The last alternative is the same as the previous but calculated on a three month basis.

*When Alfa Laval evaluates the forecasting accuracy, the forecast error is divided by the
value of the forecast - not by the demand value as the common practice dictates. (See
Appendix 3 - MAPE (/D) and MAPE (/F)). The result of using this method is demonstrated in
Figure 5.7. The figure is explained below.

Item_no Fct_usage_one_yr_ah_DIV_4 sum_three_month compare diff Late

XXX 4327,5 680 0,842865 3647,5 1

Figure 5.7:Forecast accuracy, 01/ 2007 Extracted from Alfa Laval´s database

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:

et = ((680 - 4327,5)/ 4327,5)*100 = - 84%

It means the error compared to the forecast is - 84%. But in fact, the true error is actually
much higher using the common practice of error evaluation as presented in the Theory
Chapter 3.5. The forecast error should be divided by the demand not by the forecast, in order
to estimate how high the error is compared to the real demand, as shown here:

et = ((680 - 4327,5)/ 680)*100 = - 536%

Both alternatives are presented in our analysis. This example goes to prove that Alfa Laval´s
method for evaluating error results in very low forecasting errors compare to errors obtained
using the common practice of evaluating errors (see also Appendix 4).

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.

Item Nr. 3 (2exp)

60000

50000

40000

Delivery from Stock

Pcs

30000 Forecast
Linjär (Delivery from Stock)

20000

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.

Figure 5.9: Analysis of raw material items

59
5.4 Summary and discussion of analysis

Based on our analysis, below is summary chart of lowest forecast error results for the 12 raw
material items.
Forecasting methods
Item Forecast Accuracy Parameters Moving Double exp Triple exp Rak Ö-väg
Nr. Evaluating Average smoothing smoothing method method
3 MSEn 14 per Mav 77172831 228272046 99077664
MADn 12 per Mav 6554 12503 7992
MAPEn % 5 per Mav 32 19 12
α = 0,9 ,β = 0,1 ,γ =
105 MSE 0,9 95752687 235368856 1,12E+08
MAD 7517 11858 8121
MAPE % 33 16 11
208 MSE α = 0,9 ,β =0,1 ,γ = 0,1 39360646 66815561 31394540
MAD 4214 6266 4319
MAPE % 36 15 10
α = 0,9 ,β = 0,2 ,γ =
310 MSE 0,7 24968106 36908608 15783089
MAD 3237 4382 2860
MAPE % 39 17 11
487 MSE α = 0,9 ,β = 0,1 ,γ =0,7 34870514 78422544 35771303
MAD 4670 7278 4968
MAPE % 39 19 13
590 MSEn 5per Mav 6504583 14385157 6199812
MADn 12per Mav 1726 2275 1544
MAPEn % 5per Mav 39 16 11
α = 0,9 ,β = 0,1 ,γ =
693 MSE 0,9 19947452 40283391 17921812
MAD 3297 5378 3597
MAPE % 40 21 15
α = 0,8 ,β = 0,2 ,γ =
796 MSE 0,1 6031122 31332630 13594254
MAD 1853 4556 2984
MAPE % 29 22 14
1117 MSE α = 0,2 ,β = 0,1 9202567 21329880 8977227
MAD 2182 3515 2339
MAPE % 90 28 19
MAPE % (3 months)/D 37
α = 0,7 ,β = 0,1 ,γ =
1266 MSE 0,1 4843015 13756486 5726137
MAD 1442 3012 1936
MAPE % 71 41 28
α = 0,9 ,β = 0,1 ,γ =
2410 MSE 0,9 1522779 3588770 1615093
MAD 844 1451 983
MAPE % 57 30 21
2513 MSEn 5per Mav 330198 940763 395257
MADn 5per Mav 418 655 434
MAPEn % 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 Laval´s methods (Rak and Ö-väg). 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 (Holt’s 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 doesn’t 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 Laval’s 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 don’t 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 don’t 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 (α, β, γ), which can be manipulated in order to get the lowest forecast error. The
combination of high value of α and law value of β provides the best result. This probably
makes the method more flexible to provide better results than the other methods.

62
6. Conclusion

T 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 Ö-väg - 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 Laval’s 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
weren’t 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 Laval’s 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
6.3 Client Validity
The functions programmed in the Excel spreadsheets, as mentioned earlier, were designed to
make it simple to use and all the user needs to do is to paste in necessary data. It is a usable
tool for Alfa Laval for future forecasting and allows them to test different models for
suitability depending on the raw material demand they wish to forecast. The Excel
spreadsheet functions can also be used to forecast other products in Alfa Laval or in other
external organizations that wish to forecast and evaluate error accuracy for products that can
use time series related forecasting methods for historical demand data.

6.4 Future work

In our analysis of the raw materials, we adjusted each smoothing constant to come up with
the best error accuracy for a particular item. For future studies, it could be a good idea to use
the same smoothing constants across all products to see if these can be standardized.

65
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Fenstermacher, K. & Zeng, D., “Know Your Supply Chain”, Eller College of Business and
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Other:
www.alfalaval.com
http://www.web.net/~robrien/papers/arfinal.html#_Toc26184652 2008-04-15
http://www.scu.edu.au/schools/gcm/ar/arr/arow/rmasters.html 2008-04-15
http://www.smetoolkit.org/smetoolkit/en/content/en/416/Demand-Forecasting2008-04-29
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ntialSmoothingModel.html, 2008-05-23
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Figures:
Figure 1.1: Alfa Laval’s 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
Figure 3.2: Major Time Series Models
Figure 3.3: Intercept and Slope
Figure 3.4: Theoretical framework
Figure 4.1: Current order and forecasting process
Figure 4.2: Summary of the forecasting methods used by Alfa Laval
Figure 4.3: Current forecasting methods for selected raw material items
Figure 5.1: Raw material item numbers and current forecasting methods
Figure 5.2: Historical demand data - snapshot
Figure 5.3: Historical demand with corrected values
Figure 5.4: Delivery from stock (raw material item nr. 3) with increasing linear trend
Figure 5.5: Snapshot of moving average analysis
Figure 5.6: Snapshot of double exponential smoothing analysis
Figure 5.7:Forecast accuracy, 01/ 2007
Figure 5.8: Graph showing forecast and demand in upward trend. Forecast made by double
exponential smoothing (2exp)
Figure 5.9: Analysis of raw material items
Figure 5.10: Summary of the raw material items and the best forecasting methods

List of Abbreviations

CU Component Unit
SU Supply Unit
OM-CP Operation Manufacturing - Component Unit Plates
MAPE Mean Absolute Percentage Error
MAD Mean Absolute Deviation
MSE Mean Squared Error

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APPENDIX 1 - Interview questions

GENERAL QUESTIONS ABOUT THE ORDERING AND FORECASTING

PROCESS

Questions from interview with Martin Jönsson and Tobias Augustsson

These questions were used throughout the study during unstructured interviews.

1. Please describe the ordering process for raw materials.

2. Who is responsible for placing orders?
3. How many suppliers are available?
4. What are the current forecasting models? How are they weighted?
5. Upon what basis and when were the current forecasting models created?
6. How is demand measured? Using what metrics?
7. What ERP system do you use?
8. Based on what facts are prognoses created in Jeeves adjusted?
9. Are adjustments documented?
10. What do suppliers think of the prognoses?
11. Which products are to be analyzed and why?
12. What are the results of poor forecasting at Alfa Laval?

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APPENDIX 2 - Historical data (one item)

APPENDIX 3 and 4 - Raw material analysis (one item)

This report contains historical data and raw material analysis for one item only.

The complete results can be found on the enclosed CD

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APPENDIX 5 - Analysis of evaluating method
Analysis of Alfa Laval’s accuracy evaluation method

Formula for estimating the forecast error as a percentage (%):

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
b 5
6
7
8
9
10
a D3m 11 e/F3m = (D3m-F3m)/F3m
12
13 Forecast F3m
14 (2a+b)/4
15

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