Chapter 3 - Demand Forecasting: # Het Begint Met Een Idee

CHAPTER 3 – DEMAND FORECASTING
Dung H. Nguyen
Faculty of International Economic Relations
University of Economics and Law
‹#› Het begint met een idee

CONTENTS
 Forecasting characteristics
 Forecasting methods
 Time-series forecasting models
 Forecasting errors
 Forecasting issues
2
Vrije Universiteit Amsterdam
FORECASTING CHARACTERISTICS
3
Source: foxbusiness.com Vrije Universiteit Amsterdam
 Forecast is always inaccurate  should include expected value and

measure of error
 Long-term forecasts are less accurate than short-term forecasts
Trumpet of Doom
Forecast Error Range over Time
Percentage
Forecast 0
Error
0 Time Until Forecast Event
4
 Aggregate forecasts are more accurate than disaggregate forecasts

 Law of Large Number: As volume increases, relative variability
decreases
 The farther up the supply chain, the greater the distortion of
information
5
FORECASTING METHODS
 Qualitative: primarily subjective; rely on judgment and opinion

 Time series: use historical demand only
 Causal: use the relationship between demand and some other
factor to develop forecast
 Simulation
o Imitate consumer choices that give rise to demand
o Can combine time series and causal methods
6
FORECASTING COMPONENTS
Observed demand (O) =

Systematic component (S) + Random component (R)
 Systematic component: expected value of demand
o Level: current deseasonalized demand
o Trend: growth or decline in demand
o Seasonality: predictable seasonal fluctuation
 Random component: The part of the forecast that deviates from the
systematic component
 Forecast error: difference between forecast and actual demand
7
MOVING AVERAGE MODEL
A t-1 + A t-2 + A t-3 +...+A t- n

Ft =
n
Ft = Forecast for the coming period

n = Number of periods to be averaged
A t-1 = Actual occurrence in the past period for up to “n”
periods
 Used when demand has no observable trend or seasonality
8
Week Demand 3-Week 6-Week

1 650 F4=(650+678+720)/3
2 678 =682.67
3 720 F7=(650+678+720
4 785 682.67 +785+859+920)/6
5 859 727.67 =768.67
6 920 788.00
7 850 854.67 768.67
8 758 876.33 802.00
9 892 842.67 815.33
10 920 833.33 844.00
11 789 856.67 866.50
12 844 867.00 854.83
9
950
900
850
800
Demand
Demand
750
3 Week
700
6 Week
650
600
550
500
1 2 3 4 5 6 7 8 9 10 11 12
Week
fewer n  more responsive  more accurate
10
EXPONENTIAL SMOOTHING MODEL
FFtt == FFt-1
t-1
+
+ (A
(A t-1
t-1
-
- F
F )
t-1)
t-1
Where :
Ft  Forecast value for the coming t time period
Ft - 1  Forecast value in 1 past time period
At - 1  Actual occurance in the past t time period
  Alpha smoothing constant
11
Week Demand Question: Given the weekly demand

1 820 data, what are the exponential
2 775 smoothing forecasts for periods 2-
3 680 10 using alpha = 0.10 and alpha =
0.60?
4 655
Assume F1=D1
5 750
6 802
7 798
8 689
9 775
10
12
Week Demand 0.1 0.6

1 820 820.00 820.00
2 775 820.00 820.00
3 680 815.50 793.00
4 655 801.95 725.20
5 750 787.26 683.08
6 802 783.53 723.23
7 798 785.38 770.49
8 689 786.64 787.00
9 775 776.88 728.20
10 776.69 756.28
13
850
800
750
Demand
Demand
700
0.1
650
0.6
600
550
500
1 2 3 4 5 6 7 8 9 10
Week
14
ADJUSTED EXPONENTIAL SMOOTHING FORECAST
15
ADJUSTED EXPONENTIAL SMOOTHING FORECAST
Assume that the forecast of Period 1 is 27 units and its trend is 0.

Alpha= 0.3; Beta= 0.6. The actual demand of Period 1 turned out to
be 30 units.
1. Calculate the forecast of Period 2.
2. The actual demand of Period 2 is 34 units. Calculate the forecast
of Period 3.
16
LINEAR REGRESSION
17
LINEAR REGRESSION
Month Demand
1 8
2 12
3 25
4 40
5 50
6 65
7 36
8 61
9 88
10 63
11 ?
12 ?
13 ?
18
TREND-CORRECTED EXPONENTIAL SMOOTHING (HOLT’S MODEL)
19
TREND-CORRECTED EXPONENTIAL SMOOTHING (HOLT’S MODEL)
Japan National Tourist Organization has reported a constant increase in

number of visitors to Japan during the last ten years. For example, the
number of visitors to Japan from other Asian countries during the period of
2002–2007 has been 3,417,774; 3,511,513; 4,208,095; 4,627,478;
5,247,125; and 6,130,262 annually. Forecast the number of visitors for 2008
using trend-corrected exponential smoothing with Alpha = 0.1, Beta = 0.2.
20
TIME SERIES WITH SEASONALITY (WITHOUT TREND)
1. Compute the average historical demand each season

2. Compute the average demand over all months
3. Compute a seasonal index for each season
4. Estimate next year’s total annual demand
5. Estimate demand for each month in the next year
21
Month Year 1 Year 2 Year 3

Jan 80 85 105
Feb 70 85 85
Mar 80 93 82
Apr 90 95 115
May 113 125 131 Year 4’s forecast: 1,200 units
Jun 110 115 120
Jul 100 102 113
Aug 88 102 110
Sep 85 90 95
Oct 77 78 85
Nov 75 82 83
Dec 82 78 80
22
140
120
100
80
60
40
20
0
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec
Year 1 Year 2 Year 3
23
TREND- AND SEASONALITY-CORRECTED EXPONENTIAL SMOOTHING (WINTER’S MODEL)
24
TREND- AND SEASONALITY-CORRECTED EXPONENTIAL SMOOTHING (WINTER’S MODEL)
1. De-seasonalize demand
2. Run linear regression to estimate level and trend
3. Estimate seasonal factors
4. Calculate the forecast for any period
25
FORECAST ERRORS
Mean Squared Error
t
e 2
Forecast Error MSE  t 1

n
e t = A t  Ft
Mean Absolute Deviation (MAD)
Where : n
et  Forecast error for period t |e | t
At  Actual demand for period t MAD  t 1

n
Ft  Forecast for period t
Mean Absolute Percentage Error (MAPE)
100 n et
MAPE  
n t 1 At
26
SELECTING THE SMOOTHING CONSTANT
Period Demand Simple exponential smoothing forecast:

1 180  Alpha = 0.1
2 168  Alpha = 0.5
3 159  Which alpha is preferred?
4 175 Hints: MSE and MAD
5 190
6 205
7 180
8 182
27
TRACKING SIGNAL
e t
TS  t 1
MAD
If TS [6, 6]  There is bias in the forecast
28
TRACKING SIGNAL
3.0
2.5
Period Demand Forecast 2.0
1 90 100 1.5
2 95 100 1.0
0.5
3 115 100
0.0
4 100 110 -0.5
0 1 2 3 4 5 6 7
5 125 110 -1.0

6 140 110 -1.5
-2.0
-2.5
29
FORECAST REMARKS
 No single technique works best in every situation

 Should use more than one forecasting method
 Factors to consider: cost, accuracy, the data availability & software,
time needed to gather & analyze data
 The higher the accuracy, the higher the cost
30
FORECASTING PROCESS
 Determine purpose of forecast

 Establish a time horizon
 Select a forecasting technique
 Obtain, clean, and analyze data
 Make a forecast
 Monitor the forecast
31
CHAPTER 3 – DEMAND FORECASTING
THANK YOU!
‹#› Het begint met een idee

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CHAPTER 3 – DEMAND FORECASTING

‹#› Het begint met een idee

 Forecast is always inaccurate  should include expected value and

0 Time Until Forecast Event

 Aggregate forecasts are more accurate than disaggregate forecasts

 Qualitative: primarily subjective; rely on judgment and opinion

Observed demand (O) =

A t-1 + A t-2 + A t-3 +...+A t- n

Ft = Forecast for the coming period

 Used when demand has no observable trend or seasonality

Week Demand 3-Week 6-Week

fewer n  more responsive  more accurate

Week Demand Question: Given the weekly demand

Week Demand 0.1 0.6

Assume that the forecast of Period 1 is 27 units and its trend is 0.

Japan National Tourist Organization has reported a constant increase in

1. Compute the average historical demand each season

Month Year 1 Year 2 Year 3

Year 1 Year 2 Year 3

Mean Squared Error

Forecast Error MSE  t 1

et  Forecast error for period t |e | t

At  Actual demand for period t MAD  t 1

Period Demand Simple exponential smoothing forecast:

If TS [6, 6]  There is bias in the forecast

5 125 110 -1.0

 No single technique works best in every situation

 Determine purpose of forecast

‹#› Het begint met een idee

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