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Basics of Supply Chain Management

Unit 1
UUnit
nit 11
SSupply
upply CChain
hain
M anagement BBasics
Management asics
Lesson 2
Forecasting Introduction
Basics of Supply Chain Management

Unit 1
Preface............................................................................................................3
Course Description................................................................................................................. 3
Lesson 2 – Forecasting Introduction ...............................................................4
Introduction and Objectives.................................................................................................. 4
Factors that Influence Demand............................................................................................. 4
Patterns of Demand................................................................................................................ 5
What to Forecast .................................................................................................................... 7
Forecasting Principles............................................................................................................ 7
Data Collection ....................................................................................................................... 8
Forecasting Techniques ......................................................................................................... 9
Moving Averages.................................................................................................................. 11
Exponential Smoothing ........................................................................................................ 11
Seasonality............................................................................................................................. 12
Forecast Accuracy ................................................................................................................ 14
Gathering Forecast Information......................................................................................... 17
Summary ............................................................................................................................... 18
Further Reading ................................................................................................................... 18
Review ................................................................................................................................... 19
What’s Next? ........................................................................................................................ 21
Appendix.......................................................................................................22
Answers to Review Questions .............................................................................................. 23
Glossary ........................................................................................................25

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Unit 1
Preface
Course Description
This document contains the second lesson in the Basics of Supply Chain Management unit,
which is one of five units designed to prepare students to take the APICS CPIM examination.
The Basics of Supply Chain Management unit provides the foundation upon which the other four
units build. It is necessary to complete this unit, or gain equivalent knowledge, before
progressing to the other units. The five units, which together cover the CPIM syllabus, are:
Basics of Supply Chain Management
Master Planning of Resources
Detailed Scheduling and Planning
Execution and Control of Operations
Strategic Management of Resources
Please refer to the preface of Lesson 1 for further details about the support available to you
during this course of study.

This publication has been prepared by E-SCP under the guidance of Yvonne Delaney MBA,
CFPIM, CPIM. It has not been reviewed nor endorsed by APICS nor the APICS Curricula and
Certification Council for use as study material for the APICS CPIM certification examination.

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Lesson 2 – Forecasting Introduction
Introduction and Objectives
Before planning production, it is necessary to estimate what conditions will exist in the near
future. Most firms cannot wait until orders are received before they start planning production:
they must anticipate future demand. This lesson looks at the factors influencing demand and the
principles and techniques of forecasting demand.
On completion of this lesson you will be able to:
Identify factors that influence demand
Recognize basic demand patterns
Describe basic forecasting principles
Explain the principles of data collection
Compare and contrast basic forecasting techniques
Define seasonality and the seasonal index
Identify possible sources of and types of forecast error

Factors that Influence Demand


Many factors influence demand. Often, it is not possible to identify all of them, or the effects
they have. Some of the major demand influences include
Business and economic conditions
Competition
Market trends
Company plans for products, pricing and promotion.
Other factors that affect demand in some situations include government or health regulations,
climate conditions, seasonality, and population demographics. For example, a reasonably
wealthy country that is experiencing a ‘baby boom’ may have increased demand for nursery-
related and pre-school education products. In this case, the birth rate is a factor influencing
demand.

“Those who ignore the past are condemned to


repeat it.”

George Santayana
Example
ABC Beverages has recorded the demand history for its premium freshly squeezed orange juice
in the first quarter of 2003 (see Figure 1 below), which shows an abnormal spike in demand for
February.
Normal demand for the product remains steady at around 50000 litres per month. However,
actual demand ‘spikes’ in February. This is mainly due to the success of a 6 week promotional

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period starting in February during which the company ran a ‘Buy 2 get 3rd free’ campaign. This
is responsible for an increase of 30,000 litres in February and 15,000 in March.

Orange Juice Demand Data

100000

80000

60000 Special Promotion


Litres

Seasonal Variation
40000
Trend Factor
20000 Normal Demand
0
Jan Feb Mar
-20000
F03

Figure 1 Freshly Squeezed Orange Juice Demand Data


The chart above also shows the affects of seasonal variation on demand for orange juice which
has a negative effect in January and February, as demand usually drops in those two months. In
March, seasonal demand usually increases.

Sources of Demand
It’s important to identify and monitor all sources of demand. These vary from industry to
industry. It is easy to overlook lesser sources of demand when concentrating on the main
customer. Other sources of demand include:
Spare parts, for example, exhaust pipes in the car industry
Promotions : for example, ‘buy one get one free’ promotion for baby wipes
Intracompany demand: for example, a beverage concentrate manufacturing facility in
England is unable to meet demand for several months. A plant in the same group, based
in Mexico is able to produce what is required and ship over the product.

Patterns of Demand
The best way to identify patterns of demand is to plot demand in a graph against a time scale. It
will then be easy to visually identify demand shapes or consistent patterns of demand. Although
actual demand varies, there are several underlying demand factors that often have a measurable
effect on demand, depending on the type of product. These are:
Trends
Seasonality
Random Variation
Cycle

The chart below shows a historical demand pattern. It shows quite large variations in demand.
There are also clear patterns of demand.

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40
Seasonal
35 Variation
30
25
Trend
20
15
10
5
0
Nov

Nov

Nov
Jan

Jan

Jan
Jul

Jul

Jul
Mar

Mar

Mar
Sep

Sep

Sep
May

May

May
Trends
The red line on the chart shows the underlying trend which is gradually increasing from year to
year. This is a linear trend. There are other types, for example, exponential or geometric.

Seasonal Variation
The demand pattern shows a recurring pattern of demand fluctuation based on the time of year.
According to this data sales are always highest in mid-summer and at their lowest in January.
Seasonality is most often apparent on a yearly basis like this. However, it can also occur on a
weekly or daily basis. For example, demand in a restaurant will fluctuate depending on the time
of day and day of the week. Many restaurants have their greatest demand on Friday and Saturday
nights.
The reasons for seasonality are varied. The weather, holiday seasons, or special
events may all play a part. For example, demand for accommodation will increase
dramatically in a city that is hosting a festival or major sporting event.

Random Variation
Many other factors affect demand during specific periods. These occur randomly. The actual
demand may still remain quite close to the underlying patters of seasonal variation. In other
points the variation may be much larger. Usually, this pattern of variation can be measured and
to some extent predicted.

Cycle
Over several years or decades, economic cycles play a part in influencing demand. These cycles
are often a slow moving but complex pattern of growth and recession which economists try to
predict. Although these cycles affect demand, it is quite difficult to predict such cycles.

Stable and Dynamic Demand Patterns


When the general shape of the demand pattern for a particular product remains the same over
time, the pattern is said to be stable. If the shape of demand is changing, it is called a dynamic
demand patter. The more stable the demand, the easier it is to forecast.

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Dependent and Independent Demand
Dependent demand occurs when the demand for the product is derived from the demand for
another product. For example, the sale of ice-cream cones and wafers is dependent on the sale of
ice-cream. The sale of mobile phone chargers is dependent on the sale of certain types of mobile
phone. It is not usually necessary to forecast demand for dependent items as this can be
calculated from the forecast of the product they are dependent on.
Independent items are usually end items of finished goods. However, this category also includes
service parts and inter-company transfers where items are supplied to other plants in the same
company. All independent demand items must be forecast.

1. All of the following have a measurable effect on demand except:


A. Trends
B. Seasonality

Review Q C. Random variation


D. Gut feel

What to Forecast
At each level of business planning the forecast requirements differ because the information
needed to plan the business differs. For example, a detailed forecast of the amount of raw
material required daily for the next 3 months will be of little use when formulating a strategic
plan of where the business needs to go in the next 5 years. The following table links each level of
business planning with the most appropriate time frame and forecast.

Forecast Time Frame

Strategic Business Plan Market direction Between 2 and 10 years

Production Plan Product groups Between 1 and 3 years

Master Production Schedule End items and options Months

Forecasting Principles
There are four basic principles of forecasting which help to ensure more effective use of
forecasts. These four principles are explained in the following paragraphs.

Forecasts are usually wrong.


Errors are inevitable and are to be expected. Even a forecast that is correct on average may be
inaccurate over each period.

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Forecasts should include an estimate of error.
Accepting the first principle that forecasts are usually wrong, it’s important to find out by how
much the forecast is in error. Every forecast should include an estimate of error. This is often a
percentage of the forecast. The forecast may also be expressed as a range set between maximum
and minimum values. Statistical estimates of forecast error can be made by studying the
variability of demand about the average demand.

Forecasts are more accurate for product groups .


Even when a product group has very stable demand characteristics, the
demand for the individual items of the group can vary a lot and is often
random. For example, it is easier to estimate the average speed of all
participants in a 100m sprint than to predict the exact finishing time of each
runner. Fast running times will average out with slower times. Forecasts are
generally more accurate for large groups of items than for the individual items in a group.
In manufacturing, products are usually grouped in families according to the similarity of the
processes and equipment used to make them. For example, a sweet factory will have different
processes for boiled sweets and chocolates. Although there may be several varieties of boiled
sweets, they are all made using a similar process and are a logical product group.

The further into the future you forecast, the greater the inaccuracy of your forecast.
Forecasts are generally more accurate for nearer time periods. The further into the future we
look, the greater the uncertainty. Mainly this is due to the fact that we have more information
about the near future. A company will know what promotional events are running in the near
future. It will have a good understanding about the current economic climate and customer
sentiment and will be able to extrapolate a fairly accurate picture of the near future from the
current demand.

Data Collection
TRAP Data
As forecasts are usually based on judgements or calculations made from historical data it is
essential to ensure high data integrity. It’s important that the data collected for historical demand
follows the TRAP principles. The data must be Timely, Relevant, Accurate and appropriately
Positioned.
Information must be available in time to be useful in decision- making. For
imely example, a production line may fill in records on how much material was used in
production. But if they are slow to record wasted materials, the system assumes
the waste material is still available at the production point and therefore an
insufficient reorder quantity would be specified.
Information should be as concise and relevant as possible and, where possible, in a
elevant consistent format.
Most users of computer systems assume the data is accurate. Therefore it is
ccurate important to ensure that the data is accurately entered and stored to avoid
expensive mistakes as a result of inaccurate data.
If the data is not stored in an area that is easily accessible by those who require the
ositioned data it is unlikely to be timely and may be overlooked entirely.

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Data Integrity
There are numerous ways in which error can be introduced into company systems as a result of
delayed or inaccurate data entry. More recent developments in data storage and transmission,
such as bar coding and electronic data interchange (EDI) have helped improve data integrity.
Bill of Material Error: A substitution may occur on any given BOM. If the change is not
updated, the recorded amount of both the original component and the substituted component held
in inventory will be incorrect.
Work Order Error: When a Work Order (WO) is released, the Bill of Material (BOM) for that
work order is locked at the time of WO release. Subsequent changes to the BOM must also be
updated in the WO to maintain accurate records.
Time Delays: Delays in updating data may affect the ability to cycle count correctly. In
consequence, incorrect stock record adjustments may be performed. For example, a delay in
scrapping material, the system may suggest material is available that has already been consumed
in manufacturing.
Data Entry Error: These occur particularly with manual data entry. For example, entering
receipt of 1010 units instead of 1100 will introduce errors into the system that will impact
inventory accuracy and planning.

Data Collection Principles


There are three important guidelines to consider when collecting data for forecasts:
Record the data in the same format required by the forecast. If the purpose is to forecast
demand on production, data based on demand, not shipments will be required. Shipments show
how production responded to incoming orders but this is not a true indicator of demand as
production may have under or over produced. The forecast period should be the same as the
schedule period and the items in the forecast should be the same as those controlled by
manufacturing.
Record the circums tances related to the data. Record details of external events such as sales
promotions, weather conditions or public holidays if they have a noticeable effect on the
demand.
Record the demand separately for different customer groups. Each customer group will have
its own characteristics. For example, a busy city retailer may make several orders for a product
in one week while a smaller outlet may only require one order a fortnight.

Forecasting Techniques
There are many different ways to forecast. However, they fall into one of two categories:
Qualitative forecasting
Quantitative forecasting

Qualitative Forecasting
Qualitative forecasting relies on the experience and judgement of the people involved in the
forecasting process. Future estimates are based on subjective assessments, intuition, and
informed opinion, as, for example, in the Delphi method, which relies on the opinion of a panel
of experts. These techniques are used to forecast business trends and potential demand for new

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products. They may be used extensively in medium and long range forecasting but are less
appropriate for detailed production and inventory forecasting.
Qualitative forecasting is useful where there is no reliable historical trend to work from, such as
in very dynamic and changeable markets or when introducing a new product.

Quantitative Forecasting
In contrast, quantitative forecasting is based on mathematical formulae using historical data.
Quantitative techniques are strongly influenced by the historical demand trends and are therefore
most useful where extensive demand history is available and the demand is relatively stable.
Both intrinsic and extrinsic factors may be assessed when using quantitative forecasting. These
factors are described below.
Extrinsic Technique s
Extrinsic techniques, sometimes called causal techniques, are concerned
with external influencers of demand. Examples of such influencers would
include the weather, the disposable income of the target market, and
changes in the demographic profile of the target market. For example,
demand for a magazine aimed at professional women in their early
twenties will be more likely to increase in the near future if the number of
women graduating is increasing and if employment is also on the
increase.
Intrinsic Techniques
Intrinsic techniques are based on internal factors that are mostly
recorded and are usually readily available in the demand history.
Forecasting that is reliant on intrinsic factors assumes that what
happened in the past will happen in the future. There are many
methods of extrapolating past data into the near future. These are
all useful for forecasting, particularly in an environment where
there is little random fluctuation in demand.

Quantitative Forecasting Techniques


At its simplest, quantitative forecasting involves one or two assumptions or rules, for example:
Demand this month will be the same as last month. This is only useful in a few cases where
there is little ongoing change in demand.
Demand this month will be the same as the same month last year. This is useful if demand is
relatively stable year to year but exhibits seasonal variation.
The difficulty with forecasting based on either of these assumptions is the strong influence of
random demand. For example, during the aftermath of 9/11 a great deal of uncertainty and fear
led to a drop in air travel. Demand figures for November of that year would not have been an
accurate predictor of airline ticket sales in the following year. Methods that average out history
to discover underlying trends help to reduce the effects of random variation. Some methods that
do this include moving averages, exponential smoothing, and seasonality.

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Moving Averages
It is often effective simply to forecast based on average demand in the preceding period. For
example, a soft drinks company may forecast demand for April equal to the average demand for
January February and March. Moving averages emphasise the underlying trend and smooth out
the ‘noise’ of random demand fluctuation.
Jan Feb Mar Apr May Jun The graphic to the right shows an example of moving
averages. The average demand for January, February
22 25 27 25
and March was 25. This is entered as the estimated
demand for April.
25 27 29 27 The actual demand for April turns out to be 29, higher
than the projected demand. The forecast for May is set
27 29 28 28
as the average of the demand for February, March, and
April. Each month’s forecast is based on the average of
the three preceding months.
The mathematical formula for moving averages is quite simple:

(Sum of the demand figures)


Moving Average = -----------------------------------
(The number of demand figures)

For example:
(22 + 25 + 27)
Moving Average for April = ------------------ = 25
3

1. Demand figures for January to June has been given below. Enter a forecast
for July based on a moving average of the previous three months.

Jan Feb Mar Apr May Jun Jul


Review Q
34 41 46 44 49 51

Exponential Smoothing
Exponential smoothing makes the calculation of a moving average simpler and reduces the
amount of data needed. It can be used as a routine method of updating item forecasts and works
well for stable items, particularly those with no trend or seasonality. It is an acceptable method
for short range forecasting and can detect trends but will lag them. The technique involves using
an average figure and the previous month’s actual demand and applying a weight factor, or
smoothing constant to each figure before calculating the forecast demand.
The formula for exponential smoothing is:
New forecast = old forecast + weighting factor(actual demand – old demand)
The weighting factor is often called alpha and is represented by the symbol ?

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The following table calculates the new forecast for a series of periods using exponential
smoothing with a weighting factor of 0.2.

Period Old Forecast Actual Demand (AD) Weighting Factor: New Forecast
(OF) 0.2 (AD-OF)
1 4000 4400 80 4080
2 4080 3400 -136 3944
3 3944 2200 -348 3596
4 3596 5400 360 3956
5 3956 4200 48 4004
Table 1 Exponential Smoothing Example

2. Using the data from Table 1 above, calculate the new forecast for period 5,
assuming the weighting factor has changed to 0.4 before the end of period 4.

Period Old Forecast Actual Demand New Forecast


Review Q
5 3956 4200

Seasonality
Seasonal demand patterns are evident in many consumer products. In summer months, the sale
of sunglasses, suncream, cold drinks, and garden furniture tends to increase. During colder
months, the demand for oil and electricity increases as the need for heat and light increases.
Seasonality also refers to more frequently recurring demand patterns. Supermarket and restaurant
sales are often highest at weekends and coming up to certain holidays. Canteens and cafes
experience peak demand for during the early morning and midday for breakfast and lunch.

Seasonal Index
Forecasts are made for the average demand. If seasonality exists as a factor in demand, it can be
calculated using the seasonal index. This is necessary in order to cut out the effects of seasonal
variation so that you can compare sales in a high season with those in a low season.

Seasonal Demand

1800
1600
1400
1200
1000 Demand
800 Average
600
400
200
0
v
n

c
l
n

p
Ju
b

y
r

t
r

No
Ap

Oc
Ma

De
Ja

Ju
Ma

Se
Au
Fe

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The extent of seasonal variation in demand is indicated by the seasonal index, an estimate of the
amount by which demand during the season will fall outside average demand.

Throughout the year, demand for sunglasses might average around 1000 per
month. However, the average demand in the month of June may be much higher,
at 1650. Average demand for the month of October may fall to 475. The
following formula calculates the seasonal index:
Period average demand
Seasonal index = ----------------------------------------------
Average demand for all periods

Using this formula, the seasonal index for June and October are calculated as follows:

1650 475
Index for June = ----------- = 1.65 Index for October = ------------ = 0.475
1000 1000

The period in question can be any length from daily to quarterly depending on the type of
seasonal demand. The average demand for all periods is taken by totalling the demand for each
period and dividing by the number of periods. The average demand for all periods is also called
deseasonalized demand.

3. From the following demand data, calculate the seasonal index for each
period against the average demand over the 6 months .

Jan Feb Mar Apr May Jun Month


Review Q
600 720 850 1100 1360 1650 Demand
Seasonal Index

When the seasonal pattern is relatively stable, the seasonal index can be applied to an average
demand in order to calculate a seasonal forecast using the following formula:

Seasonal demand = (seasonal index) x (deseasonalized demand)

For example, given that the seasonal index for June is 1.65, if we have predicted total demand
for next year to be 13200, that’s an average demand of 1100 for each period. We can then
calculate seasonal demand for June of next year as follows:
June demand = ( 1.65 ) x ( 1100) = 1815

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4. Using the seasonal indices you calculated in the last exercise, determine
the seasonal demand for next year, given that the deseasonalized demand is
1100.

Review Q Jan Feb Mar Apr May Jun Month


Seasonal Demand

Forecast Accuracy
It is commonly accepted that the forecast will never be exactly right. Even if the overall average
demand for a product group is accurately predicted over the year, the breakdown of demand for
each product in the group may be quite far out and the actual demand each month may vary
significantly from the average demand.
This poses a problem when actual demand exceeds forecast demand as it may affect customer
service. Most companies hold safety stock to ensure against stockouts when demand is higher
than forecast.
The forecast can be wrong in two ways: either through random error or forecast bias.

Random Error
When a forecast had random errors the actual demand will vary above and below the average
demand for the year but the total variation from the average will be close to zero. Random
variation such as this can be measured using mean absolute deviation (MAD) which is covered
in a later lesson. Once the random variation is known it is possible to:
Judge the reasonableness of the error.
Make plans to accommodate for expected error.
Set appropriate safety stock levels.

Forecast Bias
When a forecast has a persistent tendency to err in a particular direction it is said to be biased. In
the chart below, the forecast shows a positive bias; it is nearly always higher than the actual
demand. This can be due either to bias on the part of the forecaster or bias built into the business
process. It is more likely that the bias is due to the forecaster if the error is in one direction for all
items. However, if the error is in one direction for a specific set of items over a period of time it
may be due to the business process.

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1600

1400

1200
Actual Demand
1000 Forecast Demand

800

600

400
Jan Feb Mar Apr May Jun

Fixing Forecast Bias


Often, subjective bias on the part of the forecaster is introduced in order to safeguard against
certain issues. For example, the forecast may be increased to match performance objectives
within the forecaster’s functional area. It may be adjusted to create a higher safety stock in
response to problems in production. Usually, the bias tends to increase inventories, which leads
to a high risk of inventory obsolescence and carries associated costs of storing, managing, and
insuring such inventory.
When subjective bias of this kind has been identified, the simplest remedy may
simply be to reduce all the forecast figures by a percentage. The exact
percentage may be determined by examining historical forecast accuracy.
In some cases, forecast bias may be built into the process for specific products.
For examp le, if the business process has ignored increased growth trends in a
particular product group, the forecast will tend to be consistently low for that
product group.
Correcting process bias can be complex and time-consuming. Each item must be examined to
identify the cause of the bias and the process must then be adjusted to correct this bias.

Tracking Forecast Accuracy


An accurate forecast of demand is important to ensure efficient
allocation of resources within an organization. Inaccuracies in the
demand forecast will cause problems at all levels of the organization
and may impact customer service. It is particularly important that
detailed short-term forecasts used for tactical and operational planning
are accurate as errors here will increase inventory and potentially lose
sales and customers.
One way to measure forecast accuracy is to examine its converse concept: forecast error. To
calculate the forecast error, examine the forecast and actual demand figures for each SKU and
calculate the amount by which the forecast figure was in error.
In the table below, the forecast error for each SKU and the total forecast error were calculated by
subtracting the forecast figure from the forecast figure and recording the absolute value.

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FrescaJuice Forecast Accuracy
Absolute
F03 Actual Forecast Ltrs Actual Ltrs Error
Jul-03 Jul-03 Jul-03

Orange Juice 2,000 1,920 80


Grapefruit
Juice 800 750 50
Breakfast
Juice 550 700 150

Lemon Juice 200 150 50


Cranberry
Juice 600 640 40

Apple Juice 900 1,300 400

Total 5,050 5,460 410

Table 2 Absolute Error

When you divide the absolute error figure by the actual demand and multiply by 100, you see the
forecast error as a percentage of the total demand. Table 3 below displays the absolute error as a
percentage of the actual demand for each SKU.

FrescaJuice Forecast Accuracy


Forecast Absolute
F03 Actual Ltrs Actual Ltrs Error % Error
Jul-03 Jul-03 Jul-03 Jul-03

Orange Juice 2,000 1,920 80 4


Grapefruit
Juice 800 750 50 7
Breakfast
Juice 550 700 150 21

Lemon Juice 200 150 50 33


Cranberry
Juice 600 640 40 6

Apple Juice 900 1,300 400 31

Total 5,050 5,460 410 8

Table 3 Forecast error as a percentage of actual demand

Absolute(Actual - Forecast)
% Forecast Error = 100 x
Actual Demand

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Gathering Forecast Information
The forecast, as an estimate of future demand can be determined in many ways: using historical
data and mathematical formulae, using subjective opinion and informal sources, or any
combination of these approaches.
The forecast may use data from inside the company such as past sales or orders received in each
period. This information can be projected into the future taking into account growth factors or
economic trends, to achieve a forecast estimate. Many companies gather externa l information to
assist in the forecasting process, such as market surveys and market research.
The three main areas of research are market intelligence, market changes, and market demand.
Such research involves consulting with the market to identify what it believes it wants. Methods
include street polls, supermarket stands to gauge reaction to a product and focus groups.

Market Intelligence
This approach involves comparing intelligence of the market, gathered wherever possible, with
the statistical forecast to identify if any changes must be made. This may be an individual or
cross- functional team responsibility. Knowing what people want to buy is essential to the
business of forecasting.

Market Changes
Market changes may be temporary, for example as the result of promotions by an organization or
its competitors, or more permanent, for example, changes in government regulations that impact
on product demand as in the UK where beef on the bone was banned as a result of BSE fears.

Market Demand
Market demand is the total volume that will be bought by a defined customer group, in a
specified location, during a particular period of time under specific environmental conditions and
marketing effort. A shift in market demand can often be detected by market surve ys and
research. A typical example is the clothing industry where basic demand changes with each
season.

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Summary
Lesson 2 covered the factors influencing demand and the principles and techniques of
forecasting demand.
You should be able to:
Identify factors that influence demand
Recognize basic demand patterns
Describe basic forecasting principles
Explain the principles of data collection
Compare and contrast basic forecasting techniques
Define seasonality and the seasonal index
Identify possible sources of and types of forecast error

Further Reading
Introduction to Materials Management, JR Tony Arnold, CFPIM,
CIRM and Stephen Chapman CFPIM

APICS Dictionary
10th edition, 2002

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Review
The following questions are designed to test your recall of the material covered in
lesson 2. The answers are available in the appendix of this workbook.

6. The following are major influences on a firm’s demand for product and services except:
A. Master Production Schedule
B. General business and economic trends
C. The firm’s promotional activities
D. Market trends

7. All of the following are fundamentals of forecasting except:


A. Forecasts are generally inaccurate
B. Forecasts for sub-assemblies are more accurate
C. Forecasts are more accurate in the near term
D. Forecasts should include an estimate of error

8. When a company has to rely on external indicators when forecasting, the forecasting
technique for calculating the data is called:
A. Qualitative forecasting
B. Extrinsic forecasting
C. Intrinsic forecasting
D. Causal forecasting

9. Which forecasting technique uses the following formula:


New forecast = old forecast + ? (old forecast – actual demand)?
A. Weighted moving average
B. Seasonal index
C. Exponential smoothing
D. Focus forecasting

10. In the month of June a product sells 300 units. The product in question has an annual
demand of 2400. What is the seasonal index for this product for June ?
A. 1.0
B. 1.5
C. 1.75
D. 2.0

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Basics of Supply Chain Management

Unit 1
11. Which is the best description of forecast bias?
A. A forecast has a persistent tendency to err in a particular direction
B. The standard deviation is consistently positive
C. The mean absolute deviation (MAD) = the forecast error
D. The sum of the errors is less than the MAD

12. Tracking forecast accuracy is useful for


A. Monitoring the quality of the forecast
B. Determining the variation in the production plan
C. Measuring whether the schedule is being met
D. Measuring the material plan

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Basics of Supply Chain Management

Unit 1
What’s Next?
Lesson 2 covered a variety of techniques and tools that can be used to improve forecasting. At
this point you have completed two of the 10 lessons in Unit 1.
You should review your work before progressing to the next lesson which is:
Supply Chain Management Basics – Lesson 3 Master Planning.

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Basics of Supply Chain Management

Unit 1
Appendix

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Basics of Supply Chain Management

Unit 1
Answers to Review Questions
Lesson 2 Review

1. D Gut Feel
A gut feeling is an internal hunch or judgment made about demand. It does not
have any effect on demand.
2. Moving Average for July

Jan Feb Mar Apr May Jun Jul


34 41 46 44 49 51 48

This was calculated by dividing the sum of demand for April, May and June by 3

3. New forecast for period 5, assuming the weighting factor has changed to 0.4
before the end of period 4.

Period Old Forecast Actual Demand New Forecast


5 3956 4200 4054

This was calculated by multiplying the difference between forecast and actual demand by the
weighting factor of 0.4 and adding this to the old forecast figure.

4. Seasonal index for each period against the average demand over the 6
months.

Jan Feb Mar Apr May Jun Month


600 720 850 1100 1360 1650 Demand
0.6 0.72 0.85 1.1 1.36 1.65 Seasonal Index

The seasonal index for each month is calculated by dividing the average demand for the month
by the average demand over the entire season.

5. Seasonal demand for next year based on deseasonalized demand of 1100.

Jan Feb Mar Apr May Jun Month


660 792 935 1210 1496 1815 Seasonal Demand
This is calculated by multiplying the deseasonalized demand by the seasonal index for each
month.

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Basics of Supply Chain Management

Unit 1
6. A
The Master Production Schedule (MPS) is driven by market demand (as set down in the forecast
and production plan). It does not influence market demand.
7. B
Forecasts are most accurate at the aggregate level and tend to be less accurate for sub-
assemblies. For this reason, it is important to forecast at the product group level rather than the
sub-assembly level.
8. B
Extrinsic forecasting relies on external factors. An extrinsic forecast is based on external factors
that will influence demand. For example, the number of new houses built will impact on the
demand for flooring. Extrinsic forecasts are useful for large aggregations such as total company
sales.
9. C
Exponential smoothing uses a smoothing constant or weighting factor, often called alpha (? ).
The alpha factor smoothes variation between latest actual demand and forecast demand.
10. C
To calculate the seasonal index, you divide the period average demand by the average demand
for all periods in the season. In this example, the average demand for all periods in the season is
200, so the seasonal index for June is 300 / 200 or 1.5.
11. A
Forecast bias is evident when actual demand varies consistently higher or lower than the
forecast. When bias occurs in the forecast the forecast is incorrect and must be adjusted.
12. A
A tracking signal is used to measure the quality of the forecast and determine whether to adjust
the forecast. There are many methods of tracking forecast accuracy, including forecast error as a
percentage of demand.

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Basics of Supply Chain Management

Unit 1
Glossary

Term Definition
bill of material A listing of all the subassemblies, intermediates, parts, and raw materials
(BOM) needed for a parent assembly, showing the required quantity of each. It is
used with the MPS to determine items that must be ordered. Also called
formula or recipe.

Delphi method A qualitative forecasting technique where the opinions of experts are
combined in a series of iterations. The results of each iteration are used to
develop the next, so that convergence of the experts' opinion is achieved.

dependent Demand that is directly related to or derived from the bill of material
demand structure for another item or end product. Dependent demand should be
calculated rather than forecast. Some items may have both dependent and
independent demand at the same time.

exponential A weighted moving average forecasting technique in which past records are
smoothing geometrically discounted according to their age with the heaviest weight
assigned to most recent data. A smoothing constant is applied to avoid using
excessive historical data.

extrinsic forecast A forecast based on a correlated leading indicator, for example, estimating
furniture sales based on house builds. Extrinsic forecasts are more useful for
large aggregations like total company sales.

independent Demand for an item that is unrelated to the demand for other items.
demand Examples include finished goods and service part requirements.

intrinsic forecast A forecast based on internal factors, such as an average of past sales.

lead time Lead time is the span of time required to perform a process.

master The anticipated build schedule for those items assigned to the master
production scheduler. The master scheduler maintains this schedule and it drives
schedule (MPS) material requirements planning. It specifies configurations, quantities and
dates for production.

moving average An arithmetic average of a certain number of the most recent records. As
each new record is added, the oldest record is dropped. The number of
periods used for the average reflects responsiveness versus stability.

random A fluctuation in data that is caused by random or uncertain events.


variation

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Basics of Supply Chain Management

Unit 1
seasonality A repetitive pattern of demand from year to year or month to month (or other
time period) showing much higher demand in some periods than in others.

trend General upward or downward movement of a variable over time, for


example in product demand.

work order an order to the machine shop for tool manufacture or equipment maintenance
or an authorization to start work on an activity or product.

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