International Journal of Operations & Production Management

Forecasting demand from heterogeneous customers

Matteo Kalchschmidt Roberto Verganti Giulio Zotteri
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Matteo Kalchschmidt Roberto Verganti Giulio Zotteri, (2006),"Forecasting demand from heterogeneous
customers", International Journal of Operations & Production Management, Vol. 26 Iss 6 pp. 619 - 638
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Demand from
Forecasting demand from heterogeneous
heterogeneous customers customers
Matteo Kalchschmidt
Department of Management and Information Technology, 619
Università degli Studi di Bergamo, Dalmine (BG), Italy
Roberto Verganti
Department of Management, Economics and Industrial Engineering,
Politecnico di Milano, Milan, Italy, and
Giulio Zotteri
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Dipartimento di Sistemi di Produzione ed Economia Aziendale,

Politecnico di Torino, Torino, Italy

Abstract
Purpose – In many industrial contexts, firms are encountering increasingly uncertain demand.
Numerous factors are driving this phenomenon; however, a major change that is spreading among
different sectors is the ever-growing attention to customers. Companies have identified that customers
are critical not only because they directly influence the success of specific products or firms, but also
because they play a fundamental role in many internal processes. Although the role of customers in
business processes has been deeply analysed, the issue of demand forecasting and the role of
customers has not been fully explored. The present study aims to examine the impact of heterogeneity
of customer requests on demand forecasting approaches, based on three action research cases. Based
on the analysis of customer behaviour, an appropriate methodology for each case is designed based on
clustering customers according to their demand patterns.
Design/methodology/approach – Objectives are achieved by means of three action research case
studies, developed in cooperation with three different companies. The paper structures a general
methodology based on these three experiences to help managers in better dealing with uncertain demand.
Findings – By means of proper analysis of customers’ heterogeneity and by using simple statistical
techniques such as cluster analysis, forecasting performance can significantly improve. In these terms,
this work claims that focusing on customers’ heterogeneity is a relevant topic both for practitioners
and researchers.
Originality/value – The paper proposes some specific guidelines to forecast demand where
customers’ differences impact significantly on demand variability. In these terms, results are relevant
for practitioners. Moreover, the paper claims that this issue should be better analysed in future
researches and proposes some guidelines for future works.
Keywords Demand forecasting, Cluster analysis, Customers
Paper type Research paper

Introduction to the problem

Demand forecasting has always been a major issue in operations and production
management. Many decisional processes, such as inventory management, product International Journal of Operations &
development, production and supply chain planning, require forecasts. In recent times, Production Management
Vol. 26 No. 6, 2006
pp. 619-638
q Emerald Group Publishing Limited
The authors would like to thank the editor and the two anonymous referees for their valuable 0144-3577
contributions in improving this paper. DOI 10.1108/01443570610666975
 IJOPM however, demand has tended to become more variable and uncertain. Managing such
26,6 uncertain demand has posed significant problems for some industrial sectors. The
issue of demand variability and uncertainty has been deeply analysed in the operations
management literature. Significant contributions have been made in the area of
demand forecasting, in particular when demand shows a lumpy pattern. Lumpy
demand can be defined as variable, and therefore characterized by relevant
620 fluctuations (Wemmerlöv and Whybark, 1984; Wemmerlöv, 1986; Ho, 1995), sporadic,
because the demand series is characterized by many periods of very low or no demand
(Ward, 1978; Williams, 1982; Van Donselaar, 1989; Fildes and Beard, 1992; Dar-El and
Malmborg, 1991; Vereecke and Verstraeten, 1994), and nervous, reflecting the low
auto-correlation of the demand (Wemmerlöv and Whybark, 1984; Ho, 1995;
Bartezzaghi and Verganti, 1995). In fact, lumpy demand is not a new phenomenon;
the issue of variable demand is a long-standing problem in many sectors, for example,
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spare parts and fashion products (Fisher et al., 1994; Cachon and Fisher, 1997;
Brandolese and Cigolini, 1999). Lumpiness may emerge as a consequence of specific
market characteristics. Bartezzaghi et al. (1999) identify five elements that should be
considered: numerousness and heterogeneity of customers in the market, order
frequency, variety and correlation of customer requests.
Past work on lumpy-demand management can be clustered according to the source
of the information used. One approach has been to conduct forecasting based on
demand/sales data (Croston, 1972; Sweet, 1980; Johnston and Boylan, 1996; Syntetos
and Boylan, 2001). When applied to systems with lumpy demand, methods based on
this approach have been shown to give better forecasting performance (Willemain et al.
1994; Sani and Kingsman, 1997; Bartezzaghi et al., 1999) compared to traditional
smoothing techniques. From a different perspective, researchers have also developed
approaches based on information regarding the demand generation process. This idea
has been developed in the literature on information in business processes (Azoury,
1985; Lovejoy, 1990); here information is considered as a control variable, allowing
firms to manage (at least partially) the kind of information they require and its quality.
These techniques include the analysis of reliability (Yamashina, 1989), lost sales
estimation (Wecker, 1978; Bell, 1981; Agarwal and Smith, 1996), order overplanning
(Verganti, 1997; Bartezzaghi et al., 1999), multi-level supply control (De Kok, 1990;
Eppen and Schrage, 1981; Van der Heijden et al., 1997; Lee and Tang, 1997;
Van Donselaar et al., 2001) and early sales (Fisher et al., 1994; Kekre et al., 1990). These
methods have been shown to have significant benefits compared to traditional
techniques when demand tends to be multimodal (and in particular when demand is
lumpy). However, because these techniques manage demand according to prior
information collected on the demand generation process, they require the systematic
collection of data from multiple sources. This introduces the problem of managing the
trade-off between the amount of information collected and the forecast accuracy.
Several authors have provided evidence of a positive relationship between the amount
of early information collected and forecasting performance (Bartezzaghi et al., 1999),
thus leading to the problem of estimating the amount of organizational effort that
should be invested in information gathering such that the cost of information gathering
does not exceed the cost of forecast error.
In homogeneous markets, companies usually solve the problem of balancing the
trade-off between the costs of information gathering and forecast error by focusing
 their efforts on their most important customers, who, in many cases, are also the Demand from
primary source of demand variability. However, we argue that this approach may heterogeneous
be ineffective when specific market characteristics influence demand lumpiness, in
particular when customer heterogeneity is high. customers
In the present work, we address the management of demand from heterogeneous
customers by examining three case studies, from which we infer lessons of potential
wider applicability. 621
Problem setting
Customer heterogeneity is one of the elements that affect demand lumpiness;
however, its impact on information-based forecasting techniques can be complicated.
Bartezzaghi et al. (1999) noted that “heterogeneous requests occur when the potential
market consists of customers with considerably different sizes”. Here, we argue
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that although the customer size distribution will affect demand, other sources of
heterogeneity associated with customers are also important. In particular, demand
from a customer will be affected by the inner characteristics of the customer, for
example, its purchasing process, size, brand loyalty, utility and so on. Each customer is
expected to have a unique set of inner characteristics.
From another perspective, environmental factors may influence customer
behaviour, for example, socio-cultural elements, macroeconomic factors, weather
conditions and so on (Ailawadi et al., 1999); hence customers may differ according to
their reactions to exogenous variables.
Finally, a firm’s decisional factors may influence the characteristics of its customers,
for example, the service level provided, pricing conditions, promotional activities,
distributional politics and so on.
As customer heterogeneity increases, demand lumpiness also increases
(Bartezzaghi et al., 1999) and traditional techniques become less effective compared
to information-based techniques. However, the greater the heterogeneity, the greater
the amount of information that must be gathered to capture customer specificities.
Since, customers behave differently, partial information collection will likely capture
only some of the customers’ characteristics. In particular, the practice of collecting
information only from the most important customers may miss vital information on
customer behaviour. Further, even if information from single smaller customers may
have little effect on variability, the combined information from many smaller
customers may significantly impact overall demand variability. As a result, higher
heterogeneity makes information-based techniques less applicable, or at least more
expensive to apply due to the higher costs of information gathering.
The remainder of this paper is structured as follows. In the next section, we outline
our research objectives and the methodology used, and then present an empirical
analysis leading to the definition of a theoretical framework for the problem
considered. Finally, we present our conclusions and guidelines for future research.

Objectives and methodology

The main objective of the present work is to develop an effective approach to forecast
demand in contexts where demand multimodality is mainly due to customer
heterogeneity.
More specifically this work aims to:
 IJOPM .
Evaluate the impact of adopting forecasting approaches that consider customer
26,6 heterogeneity as a main source of uncertainty. Although previous authors (see
Introduction) have modelled the effect of customer heterogeneity on demand
lumpiness, none of the methods developed to date properly manage the effect on
demand of significant differences in customer behaviour. Thus, we aim to
develop an approach to cope with this issue.
622 .
Define specific guidelines that can help managers to better understand and
manage demand. In particular, we aim to define specific techniques that
managers can adopt to improve operational performance when demand is
heterogeneous.

The analysis presented here was inspired by our experiences in three research projects
developed in cooperation with three companies belonging to distinct industrial sectors.
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Specifically, we found that even though these companies were from different industrial
sectors, they faced analogous problems which could be handled similarly, at least in
terms of the general approach used.
The three cases considered are the spare parts division of a multinational white
goods producer, a major retailer, and a multinational fresh food producer. Table I
summarizes some of the key data of the three cases considered.
The three cases show different forecasting scenarios. First, the number of SKUs
(i.e. stock-keeping units) managed ranges from 65,000 in the spare parts case
(the considered sample was chosen among 23,000 fast and medium movers) to 36 in the
fresh food case. The number of periods for model testing was defined according to the
amount of information provided by the company in order to have a sufficient fitting
period. Finally, all of the companies considered deal with numerous customers.
To make cross-case comparison easier, all cases are described according to a
structure based on the action research cycle proposed by Coughlan and Coghlan (2002)
and shown in Figure 1.
First, we describe the context in which the companies operate, in terms of the
number of products and major problems faced. Then, we provide details on demand
variability, supply chain structure, and customer behaviour. Coughlan and Coghlan
(2002) consider three phases of data processing: data gathering, data feedback and data
analysis. To simplify the description of the cases, we condensed the three phases into a
single phase referred to as “data investigation”. After the data have been presented, the

No. of SKUs
No. of SKUs managed considered in the No. of periods for Time No. of direct
by the company analyses model testing bucket customers

Spare
parts
case 23,000 1,000 50 Day 430
Retail
Table I. case 400 5 24 Week 400
Information on the three Fresh
considered cases food case 36 5 6 Week 864
 Demand from
heterogeneous
customers

623

Figure 1.
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The action research cycle

used to described the cases

proposed solution is described. No new forecasting models were developed; thus, rather
than presenting the details here, we refer to the relevant works describing the adopted
models. In the end, performances are evaluated based on real demand data. To
properly evaluate the effects of the adopted approaches, we divided all data sets into a
fit sample and a testing sample, as summarized in Table I. To evaluate the impact of
the approach used in each case, we compared its performance with that obtained using
the technique adopted by the company. In this work, we use only existing
methodologies (mainly exponential smoothing or regression), but we apply them in a
new way that gives improved performance.
In the next section, the specific cases are described and the solutions applied are
detailed.

Spare parts case

Context and purpose
This case was developed in cooperation with a multinational white goods producer, in
particular its spare parts division. Spare parts are typically characterized by lumpy
demand (Yamashina, 1989). The company was mainly concerned with its fast and
medium moving SKUs. The company manages almost 65,000 SKUs, of which
approximately 42,000 are classified as slow movers (i.e. less than four orders per year)
and are responsible for 23 per cent of the inventory average value. The company was
having problems in managing spare parts inventories due to highly variable demand.
This, in conjunction with an inability to accurately forecast demand and with the
greater attention paid to the service level provided to customers, forced the company to
gradually increment its inventory level. Given the high inventory costs, the company
wanted to analyse whether applying a different forecasting approach would be
beneficial.

Data investigation
The company cooperated by providing daily demand data for 1,000 fast and medium
mover SKUs covering a period of 204 working days. Demand variability was high: the
analysis of the provided data showed an average coefficient of variation of daily
 IJOPM
26,6

624

Figure 2.
An example of an SKU
demand pattern
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demand of over three. Within the 204 days of data, many SKUs showed several days
with very low demand and a few days with huge demand. Figure 2 shows an example
daily demand pattern for a single SKU. The forecasting system adopted by the firm
was based on simple exponential smoothing, and the inventory policy was essentially
defined by means of an order-up-to inventory system. Both of these approaches are
unable to properly handle very unstable demand.

Action planning
The firm manages the spare parts service throughout Europe by means of a central
warehouse that directly distributes to end customers. However, due to the large
distances from the central warehouse to some European countries, regional
warehouses were also adopted. External wholesalers, similar to the regional
warehouses in terms of size, were also managed. Figure 3 shows the supply chain
configuration.
The supply chain consists of two channels: in one channel, the central warehouse
directly serves end customers; and in the other channel, a two-echelon chain is
managed, consisting of regional warehouses and wholesalers that purchase spare parts
from the central warehouse and then sell them back to end customers. More
specifically, for the 1,000 SKUs considered, the central warehouse served 402 end
customers directly, and 28 intermediate customers consisting of regional warehouses
and external wholesalers.
From the above information, demand variability can be easily understood. Demand
is made up of two main components:

Figure 3.
Supply chain structure for
the spare parts case
 (1) many different orders, each for a small number of SKUs, are received from the Demand from
direct customers each day; and heterogeneous
(2) on some days a small number of huge orders are received from regional customers
warehouses or external wholesalers.
Thus, the demand variability was mainly due to the complexity of the company’s
supply chain, which manages at the same level customers that differ greatly in terms of 625
size, decision making processes, relevant decisional variables and so on. Interestingly,
when demand from regional warehouses and external wholesalers was separated from
overall demand, two distinct patterns emerged: stable demand from direct customers
and lumpy demand from regional warehouses and wholesalers, as shown in Figure 4.
Table II compares the average coefficients of variation for the total demand, the
direct customers series, and the warehouses and wholesalers series. For the irregular
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series, we estimated variability using the modified coefficient of variation, evaluated as

the ratio between the standard deviation and average demand of the non-zero orders.
This guarantees that the variability of the irregular series is not biased by the high
number of days with no demand.

Implementation
As shown in Figure 4, the direct customers series and warehouses and wholesalers
series are characterized by very different kinds of variability: the direct customers
demand seems to vary randomly, whereas the remainder of the total demand shows a
lumpy pattern. To properly forecast demand, the two series were managed separately
using different forecasting methods: for the direct customers series, a simple
exponential smoothing was adopted, since the characteristics of this series make it well
suited to this kind of forecasting approach. For the warehouses and wholesalers series,
we used the approach of Syntetos and Boylan (2001), based on a modification of the

Figure 4.
Example of demand
separation

Total Direct customer Warehouse and wholesaler

demand demand demand Table II.
Average coefficients of
Average coefficient of variation of total demand,
variation 3.73 1.15 0.71 stable and irregular series
 IJOPM Croston (1972) method, which can be applied to sporadic and lumpy series. For the
26,6 details of these methods, please see Syntetos and Boylan (2001) and Croston (1972).

Evaluation
The considered company does not measure forecast accuracy; it only evaluates the
average service level and the overall stock. For this reason, results are provided in
626 terms of overall stock (i.e. number of parts), on the 1,000 SKUs analysed, for specific
service levels. Table III summarises the average inventory levels the company needs
compared to those required under the proposed solution in order to maintain either an
83 or 95 per cent service level[1]. The proposed solution shows significantly improved
performance, moving from 10,000 to 5,100 parts in inventory (, 50 per cent reduction)
for an 83 per cent service level, and from 14,750 to 8,800 (, 40 per cent reduction) for a
95 per cent service level. One may argue that this improvement is totally due to the
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application of the Syntetos and Boylan method, which is more consistent with the
inventory problem; however, application of this technique to the total demand series
did not significantly improve performance, indicating that the majority of the
improved performance was due to the separation of demand in the two groups.

Retail case
Context and purpose
The company considered is a major retailer operating in the northern part of Europe.
The company is encountering several problems in managing forecasts at the SKU level
due to a high variability of demand (see Figure 5, for example, demand pattern). The
major factor underlying the demand variability encountered by this company is its use
of promotions, with demand during promotional periods dramatically outweighing
demand during non-promotional periods. Proper forecasting of demand during
promotional periods is critical due to its high impact on performance, both in terms
of sales and inventory management, and because forecasting is a major source of
information for distribution planning.

Data investigation
In our study, we were able to analyse demand for a set of five products (ranging from
fast-moving sodas to slow-moving diapers) in a network of 38 stores for 117 weeks.
Demand data were split into a fit sample of 111 weeks and a test sample of six weeks;
this division was chosen because six weeks is the forecasting horizon used by the
retailer. Compared to the spare parts case considered above, the retailer case is
characterized by a simpler supply chain: each division located in a particular country
manages a central warehouse that distributes to the different stores by means of
distribution centres (Figure 6). From a logistics viewpoint, the central warehouse uses
distribution centres; however, decisions regarding stores fulfilment and data are

Table III. Firm’s method Proposed method

Inventory levels (number
of parts) of the solutions SL ¼ 83 per cent
considered for service Inventory level 10,000 5,100
levels equal to 83 and SL ¼ 95 per cent
95 per cent Inventory level 14,750 8,800
 Demand from
heterogeneous
customers

627

Figure 5.
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An example of an SKU
demand pattern

Figure 6.
Supply chain structure of
the retail case

managed at the central unit level. Thus, the distribution centres are irrelevant from a
planning standpoint. Planning decisions are aggregated at the central warehouse level
with the central division being provided with data regarding sales, number of
customers purchasing, number of customers entering a specific store and so on.
The forecasting system used by the company is based on the NPQ model (Kotler,
1991), which uses a logarithmic regression of different variables on total demand.
Variables considered were whether a promotional activity was taking place during a
particular week, the type of promotion, the environmental temperature, weather
conditions, price, etc. This forecasting approach was adopted by the company at the
supply chain level. This meant that the forecasting was conducted as a single
estimation including all stores considering the aggregate total demand.

Action planning
The problem faced by the company can be traced back to the level at which the forecasting
is conducted: since the company evaluates a single forecast for all the stores together, it is
not able to identify each store’s specific demand pattern. For example, when a promotion
takes places on a specific product, different stores may encounter different responses in
terms of demand due to factors such as store location, time period, type of promotion and
so on. By aggregating demand and applying a single model to all stores, the company loses
information on each store’s specific demand pattern, and increases the forecast error. Some
authors (Theil, 1954; Grunfeld and Griliches, 1960; Lapide, 1998) argue that an aggregate
 IJOPM approach works better because it is more efficient and more accurate in times of stable
26,6 demand, while others contend that a detailed approach is needed when there are
differences across time series (Orcutt et al., 1968; Zellner and Tobias, 2000; Weatherford
et al., 2001). However, forecasting at the single-store level may not be effective because
little information is available at that level; for example, a single store may arrange only a
few promotions per year and thus estimation errors may occur when the forecasting model
628 is applied (see Zotteri and Kalchschmidt, 2005, for detailed modelling of this problem). To
balance the trade-off between having a high error due to the sampling process or a high
error due to the estimation process, we adopted a cluster-based approach in which stores
are aggregated in clusters according to their weekly demand patterns.

Implementation
Clusters were built through the variable:
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PQij
PQ per centijt ¼ P t ij
PQt
t

which captures how the penetration rate PQijt (i.e. the average number of units of
product i sold per customer that entered store j during period t) fluctuates over time.
By clustering stores according to PQ per centijt , we grouped together those stores that
tend to buy similarly over the year. In other words, each cluster comprises stores
that react similarly to particular environmental factors. A forecast at the cluster level is
applied and the total forecast is obtained by aggregating the cluster forecasts.

Evaluation
The cluster-based approach was tested on five products and compared to the results
obtained by forecasting aggregate demand (aggregate approach) and by forecasting
each single store separately (disaggregated approach). Forecasts were compared by
means of the mean absolute percentage error (MAPE) evaluated on a weekly level. The
results obtained using these approaches are shown in Table IV.
The cluster approach performed significantly better than the aggregate and
disaggregated approaches (paired-sample t-tests on the mean differences among the
considered approaches all less than 5 per cent), indicating that when stores behave
differently a more specific estimation tends to pay off. The disaggregated approach,
which essentially considers each store individually, performs poorly due to the high
estimation error associated with this approach. These results thus indicate that
focusing on store differences may be beneficial provided demand variability is not too

SKU Aggregate (per cent) Disaggregated (per cent) Cluster (per cent)

a 8.14 21.08 11.42

Table IV. b 7.55 15.73 3.15
Comparison of accuracy c 11.54 8.90 8.06
among different d 11.13 13.66 10.41
aggregation levels e 13.88 21.71 15.16
(MAPE) Average 10.45 16.22 9.64
 high: clustering customer demand helps in balancing the trade-off between customer Demand from
specificity and demand variability. heterogeneous
Fresh food case
customers
Context and purpose
The case considered was developed in cooperation with a multinational fresh food
producer based in northern Italy. Demand management is particularly critical for this 629
company because the nature of its products means that inventories cannot be used
(fresh food has an average selling life of two to three weeks), so forecasting is
particularly important to properly manage planning and sales activities. Forecasting
demand for the products sold by the company is made particularly difficult by the fact
that all of the products sold by the company show several promotional activities that
strongly impact demand variability.
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Data investigation
The company provided demand data for five consolidated products over a period of
140 weeks. This data shows variable demand, with coefficients of variation ranging
from 12 to 85 per cent with an average value of 33 per cent (see Figure 7, for example,
demand pattern).
Unlike the retail case, promotions are managed at the single customer-single
product level; hence, during promotional periods, only a small number of customers
show a significant increment in demand. The supply chain faced by the company is
particularly complex because it uses many distribution channels: some customers are
managed directly, others by means of distributors, others through retailers, and others
through dealers. Figure 8 shows the supply chain structure.
This supply chain structure forces the company to manage several types of
customer at the same level, thus making demand at the product level very variable and
difficult to forecast.

Action planning
The analysis of demand shows that several customers are deeply affected by
promotional activities, and that this significantly influences total sales and demand

Figure 7.
An example of a SKU
demand pattern
 IJOPM variability. Some customers, given their importance in terms of sales, negotiate
26,6 dedicated promotions, while others participate in the promotional activities the
company arranges at the channel level. For this reason, customers that strongly affect
the company’s performance and demand variability are managed separately and
singularly, while the remaining customers are forecasted as a whole. However, this
leaves high variability in the demand series because numerous customers show
630 correlated demand, owing to promotional activities conducted at the channel level. The
situation is similar to that of the retail case; hence we applied a similar approach. In our
analysis, we identified three main groups of customers, according to their importance
and to their demand pattern and variability:
(1) Huge and variable customers. customers that significantly impact the total sales
and total demand variability. In cooperation with the company, we selected 30
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such customers according to their size and to the managerial policies applied
(i.e. customers that frequently participate in promotional activities). These
customers were responsible for more than 50 per cent of total sales and were
characterised by customer-specific promotions.
(2) Correlated customers. customers that singularly have little impact on the total
demand variability, but that tend to show similar demand patterns due to
promotions at the channel level. We identified more than 300 customers that
showed this specific pattern that were responsible for almost 30 per cent of total
sales.
(3) Small customers. customers that do not impact significantly on total demand
variability, mainly due to their limited size. More than 400 customers showed
this behaviour; these customers were responsible for less than 20 per cent of
total sales.

Implementation
Given the above considerations, the forecasting approach was differentiated for the
three groups of customers:
(1) Huge and variable customers. These customers tend to perform promotional
activities that are developed jointly with the supplier. Owing to their size, these
customers have personalized promotions both in terms of time period and
promotional means (e.g. discount, coupon, promotional package, etc.), and thus
show different reactions to similar promotional activities. Given the
heterogeneity of single-customer reactions, we implemented a smoothing

Figure 8.
Supply chain structure of
the fresh food case
 technique based on information regarding future promotional activities that Demand from
was applied at the single customer level. heterogeneous
(2) Small customers. Since, they do not impact significantly on total demand customers
variability, small customers’ demand can be easily forecasted by applying
simple exponential smoothing to their aggregated demand, as for the stable
customers in the spare parts case.
(3) Correlated customers. For this class of customers we applied a cluster-based
631
forecasting technique (similar to the approach applied in the retail case). In
particular, cluster analysis on weekly demand data has been applied to separate
customers in different groups in order to make homogeneous classes. By
applying hierarchical clustering, we determined that these customers could be
separated into three clusters. Given these classes, we applied a forecasting
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approach similar to that applied to the huge customers, except that here
information is collected only for the centre of the cluster (i.e. the most
representative customer of the cluster considered). The forecast for each cluster
centre was derived using a method similar to that used for the huge customers,
thus requiring specific data collection regarding promotional activities, and
then the total forecast was defined by means of linear regression of the centre
demand on the cluster demand.

Evaluation
This approach was tested on five of the 42 products the company manages, over a
2.5-year period (separated into a fitting period of two years and a testing period of 6
months). Table V summarises the results, expressed in terms of average MAPE,
obtained during the testing period.
The proposed method performs significantly better than the solution implemented
by the firm, which was simply based on exponential smoothing of total demand and
requires user modification during promotional periods. One may argue that the
superiority of the results obtained using the proposed method is due to the use of
information on the promotional activities of particular customers; however the
company adopted the same kind of information to modify its exponential smoothing
forecasts during promotions. We can, therefore, assume that the quantity of
information is similar in the two scenarios, but that it is better organised and utilised in
the proposed solution. We, therefore, argue that compared to the approach used by the
company, the proposed method provides a better estimation of the specific
contributions of the various customer groups to the total demand variability.

SKU Firm’s method (per cent) Proposed method (per cent)

a 19.0 9.8
b 11.3 9.1 Table V.
c 24.3 17.5 Forecast accuracy
d 17.9 13.4 (MAPE) between
e 15.4 12.9 company’s practice and
Average 17.6 11.2 proposed method
 IJOPM Theoretical framework
26,6 In the preceding sections, we have described the three cases considered and the
solutions adopted. Here, we present a summary of the results.
Our findings for all three of the cases considered in the present work confirmed the
hypothesis that focusing on the root causes of demand variability tends to pay off.
To gain this benefit, however, the trade-off between quantity of information used and
632 forecast accuracy must be properly managed. In the cases presented here, this issue
was managed using different approaches that can be traced back to a similar structure.
Table VI summarises some information on the proposed approaches.
One interesting feature of the present results is that in all cases the solutions
developed gave improved operational performance. In the spare parts and fresh food
cases, the improvements were quite impressive, while in the retail case they were more
modest. This variability in improvement may be due to the fact that customer
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heterogeneity is only one of the possible sources of demand variability, and its impact
on total demand variability may vary depending on the situation.
A second interesting aspect is that, in all cases, different customer groups were
defined. This was due not only to the specific characteristics of the market faced by
each company, but also to the complexity of the problem and the amount of
information available. In particular, in the fresh food case 34 different estimation
procedures were applied (30 for the promotional customers, 3 for the clustered
customers and 1 for the remaining ones). This approach was taken mainly due to the
significant impact of customer heterogeneity on demand patterns; each promotional
customer had a very different demand pattern, in particular during promotional
periods. In the case of clustered customers, estimation at the customer level would have
been more accurate, but it would have required collection of data for numerous
customers, making data gathering costly and potentially not worth the benefit. In the
retail case, there were fewer customer groups because despite some differences,
customers tended to have several elements in common. For example, whereas in the
fresh food case promotions were arranged specifically for each customer (at least for
some of them), in the retail case promotions were applied at the channel level, and
hence the main differences among customers in terms of demand arose from
differences in their reactions to promotional activities. This is similar to the fresh food
case, where customers frequently responded to promotions in similar ways, and hence
could be clustered based on their demand patterns. In the spare parts case, only two

No. of No. of Improvement of proposed

customer No. of forecasting estimation solution compared to actual
groups techniques applied procedures performance (per cent)

Spare parts 40 per cent

case 2 2 2 (for SL ¼ 95 per cent)a
Retail case 3 1 3 8 per centb
Fresh food
case 34 2 34 36 per centb
Table VI.
a b
Summary results for the Notes: Inventory level reduction in terms of average number of items; percentage improvement of
three considered cases forecasting accuracy measured by reduction of average MAPE
 groups of customers were considered due to the bimodal nature of demand and to the Demand from
fact that when huge and small customers were separated, the two demand series heterogeneous
obtained were much more easily managed.
Several factors underlie the differences among the cases: different forecasting customers
problems are considered and different elements influence demand variability, and, in
particular, heterogeneity shows up on diverse dimensions. In the spare parts case,
heterogeneity is mainly tied to customer size. In the retail case, customers differ 633
according to their reactions to environmental variables (e.g. promotions, weather
conditions and so on). In the fresh food case, heterogeneity is evident in both size and
reaction to promotional activities. This highlights the multidimensional nature
of heterogeneity, and the difficulties associated with identifying measures of
heterogeneity. Correlations among the demand patterns of customers can be helpful, as
shown in the fresh food and retail cases, where customer clustering was essentially
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based on evaluation of such correlations. Correlation-based analyses may be less useful

in other situations, however, as was found in the case of the spare parts company,
which had huge customers whose demand patterns were completely uncorrelated. Our
findings indicate that important hints regarding heterogeneity can be obtained by
analysing the supply chain: one root cause of customer heterogeneity can be traced
back to a complex supply chain that merges together customers with different
reordering processes (as in the spare parts case) or that purchase according to different
goals in specific periods (as in the fresh food case).
The empirical analyses conducted for the three cases considered here suggest the
following guidelines:
(1) Identify the root causes of demand uncertainty. First, to better understand
whether demand variability originates from customer heterogeneity or other
factors (e.g. systematic variability or seasonality), detailed analyses of both
demand patterns and supply chain structure must be conducted. Attention
should be paid to the supply chain structure because differences (and
similarities) among customers may be due to the specifics of the supply chain
the company deals with. The cases considered in the present study show that
various elements should be analysed to identify heterogeneity. The supply
chain may be one determinant of heterogeneity because the behaviour of a
customer may depend on the structure of the supply chain and the customer’s
position within that structure. For example, in the spare parts case, customers
differ mainly because they belong to different levels of the supply chain and
thus tend to have different purchasing policies. The market structure may be
relevant in terms of environmental variables affecting customer demand. In the
retail case, for example, customers differ according to their reaction to weather
conditions. In addition, the customer relationship with the company may
influence customer behaviour, since customers may react differently to policies
applied by companies. In the fresh food case, for example, customers differed
significantly according to the promotional activities they negotiated with the
company, leading to specific reactions in terms of demand pattern.
(2) Define homogeneous groups. A common element of the three cases considered is
that some kind of aggregation or disaggregation of data was applied. In the
spare parts case, customers belonging to different supply lines were grouped
together and managed separately, according to their size and purchasing
 IJOPM process; similarly, in the fresh food case, customers belonging to different
26,6 distribution channels that showed different behaviours were assigned to
distinct groups, and a distinct approach was developed for each group. Again,
in the retail case, customers showing similar demand patterns were clustered
together and separated from other groups.
To manage the effects of heterogeneity, appropriate groups of customers
634 must be defined according to the specific dimensions in which heterogeneities
arise. The filtering approach used in the spare parts case and the clustering
method used in the retail and fresh food cases were implemented for this
purpose.
These approaches consider that at the outset, one should define the proper
level of aggregation of the information used (in this case demand data). If the
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forecast is evaluated at the market level, we assume that the market is

homogeneous enough to let us model single customer demand by means of the
total market demand. On the contrary, if the forecast is evaluated at the single
customer level, we assume that customers are so heterogeneous that a specific
approach should be designed for each single customer. In some cases,
however, the approach taken will fall between these two extremes:
aggregating, disaggregating and clustering demand are essentially different
ways to find the best level at which demand should be forecasted. Attention
should be paid to the fact that, as shown for the retail and fresh food cases, the
aggregation level may not be defined according to any managerial or
structural dimension; rather, it may be defined with the sole purpose of
making the estimation process more accurate.
(3) Define the sampling procedure. After groups of customers have been defined, a
specific forecasting approach should be applied. In the cases considered here,
we used different forecasting approaches that fitted the specific problems and
the particular nature of the variability encountered. In the spare parts case, two
forecasting methodologies were used (one for huge customers and one for
smaller ones). Similarly, two distinct methodologies were used in the fresh food
case (one for the most important customers, and another for the clustered
customers and for the remaining uncorrelated customers). In the retail case,
although different groups of customers were defined, a single approach was
applied to all groups.

When defining the approach to be used, one should take into account the elements that
distinguish each group of customers from the other customer groups. In particular, if
differences are mainly due to different reactions to similar variables (as in the retail
case), then emphasis should be placed on the estimation of a single forecasting
technique. On the contrary, when customers differ because different variables are
relevant in determining their variability, multiple forecasting approaches should be
adopted (as in the spare parts case).
In the retail case, customers differed essentially according to their reaction to similar
external factors (i.e. promotional activities, weather conditions and so on). In the spare
parts case, by contrast, customers differed according to their internal structures. In
particular, they had different reordering policies, due to different cost structures and
demand; in other words, different variables seem to influence the reordering processes
 of customers. The fresh food case showed both of these elements: some customers were Demand from
influenced by promotional activities, while others were not. The promotional
customers also differed in their reactions to promotional activities, because their
heterogeneous
demand patterns during promotional periods mainly depended on their specific customers
inventory positions, logistic structures and so on.
For each group of customers, a separate forecasting approach should be applied,
either in the form of a different technique or a different estimation of a similar 635
technique.
The overall approach is shown in Figure 9.

Conclusions
In the present study, we considered the cases of three companies that were having
difficulties in forecasting demand due to heterogeneity in their customers leading to
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heterogeneity in the demand generation process.

In all of the cases considered, the key problem was defining the proper level of detail
at which to conduct the forecasting. Demand cannot be managed at the aggregate level
because heterogeneity and variability cannot be identified when demand is considered
as a whole. On the other hand, demand cannot be managed at the detailed level because
this solution is costly and the estimation process may be ineffective due to insufficient
data. The main problem is thus to properly define the appropriate level of detail at
which to manage demand. However, simply defining the appropriate level of detail is
not enough; to identify proper forecasting systems to manage demand, customers must
still be separated into homogeneous groups based on their behaviour. The key finding
of the present work is that focusing on heterogeneity can significantly improve
forecasting performance and the balance between accuracy and data collection.
Moreover, our results suggest that clustering the demand of customers according to
their heterogeneity may provide a good solution to the trade-off between forecasting
performance and forecasting cost.
Although in all three cases presented here we have arrived at some understanding
of the factors that influence the degree of heterogeneity, we are fully aware that there is
no explicit link in this work between structural elements (i.e. supply chain complexity,
industrial sector and so on) and the degree of heterogeneity. In particular, we lack a
formal measure of heterogeneity with which to compare the cases, since the elements in

Figure 9.
The overall methodology
 IJOPM which these differences arise are themselves different. Measures of heterogeneity have
26,6 been used in previous works to cope with this problem; for example, Bartezzaghi et al.
(1999) use measures of customer size heterogeneity to model lumpy demand. Here, we
argue that the problem is more general, and that heterogeneity may manifest in
different elements, making estimation of customer heterogeneity difficult because it
can occur in several dimensions (i.e. size, reaction to external variables and so on).
636 We believe that the results obtained for the three cases considered in the present
work have wider implications. Further studies of the proposed approach should be
undertaken to test the conditions under which it gives improved performance.

Note
1. The company evaluates the service level as the ratio of fulfilled orders to received orders.
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Corresponding author
Matteo Kalchschmidt can be contacted at: matteo.kalchschmidt@unibg.it

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