Basics of Supply Chain Management

Demand Management
Session 2

APICS Certified in Production and Inventory Management (CPIM)

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Basics of Supply Chain Management
1. 2. 3. 4. 5.

Capacity
Introduction to Material Management
Demand Master
Supply Chain Requirements and Production
Management Planning
Management Planning Activity
Control

Theory of
Aggregate Purchasing Lean/JIT and
Item Inventory Constraints
Inventory and Physical Quality
Management and Review
Management Distribution Systems
Activity

6. 7. 8. 9. 10.

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Learning Objectives

Demand Management Processes

– Describe the significance of marketing management and
customer relationship management
– Explain the role and objectives of demand planning (forecasting
and customer order management)
Characteristics of Demand
– Differentiate independent from dependent demand
– Identify at least five sources of independent demand
– Recognize at least four demand patterns

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Learning Objectives (cont.)

Basic Forecasting Concepts

– Describe three planning levels that are supported by demand
forecasts
– Explain four major principles of forecasting and three principles
of data collection and preparation
– Differentiate quantitative from qualitative forecasting techniques

Estimate Demand
– Calculate and explain the logic of an exponential smoothing
forecast
– Explain the logic behind the calculation of a seasonal forecast
– Calculate and explain the use of the mean absolute deviation

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 Demand Management
Session 2

Demand
Management
Processes

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Demand Management Processes

Marketing
Management

Customer
Demand Relationship
Planning Management
(CRM)

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Marketing Management and Mix
Marketing Marketing
Strategy Management

Product Positioning/
Differentiation, and Potential Order Order Qualifying
Qualifying and and Order
Market Segmentation Winning Products Winning Products
Decisions

Marketing Mix Decisions

Product
Price
Promotion
Place

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Customer Relationship Management
Help customers achieve better business results
through:

Design assistance: helping in the design of new products

or improvement of existing ones
Customer needs: assessing the customer’s business
and creating (expanding) product offerings
Information and communications: collecting and
analyzing customer data to support marketing, sales,
and customer service

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Order Management
CRM plays a major role in operations efficiency and
customer service through:

Fast and accurate order entry and tracking

Meet promised delivery dates and quantities

Handle customer inquiries and service

complaints, returns, and repair
Accurate and timely shipping documentation,
invoicing, and recording of sales history

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Demand Planning

Recognition of customer requirements through

– Forecasts
– Management of orders from
• Internal customers
• External customers

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 Demand Management
Session 2

Characteristics
of Demand

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Independent vs. Dependent Demand

Only independent demand needs to be forecasted

Dependent demand should never be forecasted; it
should be calculated

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Sources of Demand

Forecasts
Customer orders
Replenishment orders from DCs
Interplant transfers
Other

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Demand Patterns: Trend

Increasing
Decreasing
Level
Demand

Quarters

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Demand Patterns: Seasonal Demand
Demand

Quarters

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Demand Patterns: Random
5

4
Demand

Quarters

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Stable vs. Dynamic Demand

Stable demand retains same general shape over time

Dynamic demand tends to be erratic
Dynamic
Stable
Stable vs.
Dynamic
Demand

Average demand

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 Demand Management
Session 2

Forecasting

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Introduction

Purposes and uses of the forecast

Principles of forecasting
Principles of data collection and preparation

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How Forecasting Supports Planning

Planning Level Forecast Horizon (up to)

Sales volume ($); new

Business Planning market and supply 2 to 10 years
chain initiatives

Sales and Operations Physical units of

production at the 1 to 3 years
Planning product family level

Physical units of
Master Scheduling production at the end 3 to 18 months
item level

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Principles of Forecasting

Forecasts
– Are rarely 100% accurate over time
– Should include an estimate of error
– Are more accurate for product groups and families
– Are more accurate for nearer periods of time

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Data Collection and Preparation

Record data in terms needed for the forecast

Record circumstances relating to the data
Record demand separately for different customer
groups

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Data Collection and Preparation Example

Month 1 2 3 4 5 6 7 8 9 10 11 12

A 6000 6000

B 500 500 500 500 500 500 500 500 500 500 500 500

Average
1500 1500 1500 1500 1500 1500 1500 1500 1500 1500 1500 1500
Forecast

Customer A’s annual demand: 12,000

Customer B’s annual demand: 6,000
Total: 18,000
Average over 12 months: 1,500 per month

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 Demand Management
Session 2

Forecasting
Techniques

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Forecasting Techniques

Forecasting
Techniques

Qualitative Quantitative

Judgment Mathematics

Intrinsic Extrinsic
(Time Series) (Causal)

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Qualitative Techniques

Are based on intuition and informed opinion

Tend to be subjective
Are used for business planning and forecasting for new
products
Are used for medium-term to long-term forecasting

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Quantitative Techniques: Extrinsic

Based on correlation and causality

Rely on external indicators
Useful in forecasting total company demand or demand
for families of products
Two types of leading indicators
– Economic
– Demographic

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Quantitative Techniques: Intrinsic

Based on several assumptions

– The past helps you understand the future
– Time series are available
– The past pattern of demand predicts the future pattern of
demand

Examples
– Moving Averages
– Exponential Smoothing

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Moving Averages: Principles

Best used when demand is stable and there is little

trend or seasonality, and demand variations are
random
When past demand shows random variation…
– Do not second-guess what the effect of random variation
will be
– It is better to forecast based on average demand

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Moving Average Forecast Example

Assume it is the end of December;

forecast demand for the next month, January

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan
Mo.1 Mo.2 Mo.3

92 83 66 74 75 84 84 81 75 63 91 84 ?

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Moving Average Forecast Logic
Moving average forecast = average demand of past periods

Moving average forecast for month 4

Σ Demand for months 1 - 3 288
= = = 96 units
No. of months 3

Month Demand Three - Month Total Next-Month

Forecast
1 102
2 91
3 95 288 96

Key:  = Sum
MONTH 4 FORECAST

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Class Problem 2.1

Three-Month Next-Month
Month Demand
Total Forecast
1 102

2 91

3 95

4 105

5 94

6 101

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Class Problem 2.1 Solution

Three-Month Next-Month
Month Demand
Total Forecast
1 102

2 91

3 95 288 96

4 105 291 97

5 94 294 98

6 101 300 100

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Class Problem 2.1 Solution (cont.)

106
Actual
104
Forecast

Month 3-Month Next- 102

Total Month 100

Forecast

Demand
98
3 288 96
96
4 291 97
94
5 294 98
92
6 300 100
90
0 2 4 6 8
Period

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Three-Month Moving Average Forecast

Month Demand Three-Month Total Next-Month

Forecast
1 89 272 91
2 89 272 91
3 94 272 91
4 91 274 91
5 95 280 93
6 104 290 97
7 106 305 102
8 110 320 107

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Six-Month Moving Average Forecast

Month Demand Six-Month Total Next-Month

Forecast
1 89 545 91
2 89 544 91
3 94 549 92
4 91 546 91
5 95 552 92
6 104 562 94
7 106 579 97
8 110 600 100

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Moving Averages: Lessons Learned

The moving average forecast will lag the development of

a rising or falling trend
The farther back the moving average forecast reaches
for data, the greater the lag
The three-month moving average forecast may have
overreacted if the demand surge had abated
The moving average forecast works best when demand
is stable with random variation; it will ―filter out‖ random
variation

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Exponential Smoothing Logic

Take the old forecast and the actual demand for the
latest (most current) period
Assign a weighting factor or smoothing constant
(α, alpha) to the latest period demand vs. the old
forecast
Calculate the weighted average of the old forecast and
the latest demand

New forecast = (α) (latest demand) + (1 – α) ( old forecast)

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Smoothing Constant (α, Alpha)

New forecast = (α) (latest demand) + (1 – α) (previous forecast)

Low smoothing constant gives more weight to the old

forecast: e.g.,
– α = .2 for latest demand (e.g. period X)
– 1 – α = .8 for old forecast (also period X)

Appropriate if demand is stable, not rising or falling

Run simulations with different α values to see which one
best fits the historical demand pattern

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Class Problem 2.2

New forecast = (α) (latest demand) + (1 – α) (previous forecast)

A. Prepare an exponential smoothing forecast for June.

May data: actual demand = 220; forecast = 200.

Calculate the forecast for June using a smoothing constant (α) of .20

B. Prepare an exponential smoothing forecast for July.

June data: actual demand = 240

Calculate the forecast for July also using a smoothing constant (α) of .20

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Class Problem 2.2 Solution

New forecast = (α) (latest demand) + (1 – α) (previous forecast)

A. Prepare an exponential smoothing forecast for June.

= (.2) 220 + (.8) 200 =
= 44 + 160 = 204

B. Prepare an exponential smoothing forecast for July.

= (.2) 240 + (.8) 204 =
= 48 + 163 = 211

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Seasonal Demand

Average demand
for all periods
Demand (units)

Seasonal demand

Time (quarters)

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Seasonal Forecast Process

Develop a seasonal forecast for each

period of the year being forecast
3

Develop a deseasonalized demand forecast

spanning all periods
2

Calculate a seasonal index of demand for

each period to establish seasonality
1

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Seasonal Demand Indexes (Step 1)
Demand History
Year Quarter Total
1 2 3 4
1 122 108 81 90 401
2 130 100 73 96 399
3 132 98 71 99 400
Average 128 102 75 95 400

Average demand for all quarters = 400 = 100 units

4

Quarter Average Quarterly Demand/100 Seasonal Index

1 128/100 = 1.28
2 102/100 = 1.02
3 75/100 = 0.75
4 95/100 = 0.95
Total = 4.00

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Deseasonalized Forecast (Step 2)

Make the forecast for the next year

Deseasonalize the forecast — distribute it evenly across
the four quarters

Deseasonalized demand Annual forecast

=
(average demand/period) No. of periods

420
= = 105 units
4

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Seasonal Forecast (Step 3)
Calculation
Expected quarter demand
Expected first quarter demand
Expected second quarter
demand
Expected third quarter demand =
Expected fourth quarter
demand
Total forecast demand
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= (seasonal index) 
(deseasonalized forecast
demand)
= 1.28 X 105 = 134 units
=
1.02 X 105 = 107 units
.75 X 105 = 79 units
=
.95 X 105 = 100 units
= 420 units
 Demand Management
Session 2

Tracking the
Forecast

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Tracking the Forecast

Forecasts are rarely 100% correct over time.

Why track the forecast?
– To understand why demand differs from the forecast
– To plan around error in the future
– To improve forecasting methods

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Bias vs. Random Variation
Bias Random Variation
Cumulative demand may not be the Demand will vary plus and minus
same as forecast about the average
Month Forecast Actual Variation Forecast Actual Variation

1 100 90 -10 100 105 +5

2 100 125 +25 100 94 -6
3 100 120 +20 100 98 -2
4 100 125 +25 100 104 +4
5 100 120 +20 100 103 +3
6 100 110 +10 100 96 -4
Cumulative
600 690 +90 600 600 0
Total

Bias exists since cumulative There is no bias since

variation is not zero. cumulative variation is zero.
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Forecast Error Data

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Total

Forecast 500 500 500 500 500 500 500 500 500 500 500 500 -

Actual 460 520 530 490 460 500 530 490 530 480 490 520 -

Absolute
40 20 30 10 40 0 30 10 30 20 10 20 260
deviation

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Mean Absolute Deviation (MAD)

 | |A
| - F|
MAD = n
n

Σ Absolute errors 260

MAD = = = 22 units
No. of periods 12

Key:  = Sum; I I = Absolute Value

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MAD Analysis: Normal Distribution

1% 4% 15% 30% 30% 15% 4% 1%

-3 -2 -1 0 1 2 3 MAD

-66 -44 -22 22 44 66 Units

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Uses of Forecast Measurement

Identify changes and trends in demand

Identify and adjust for forecast error that results from
random events
Adjust the period forecast so that it is close to the true
forecast average demand to minimize bias
Making decisions on safety stock and service levels
based on the degree of random variation (forecast error)

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Supply Chain Management Implications

Deal with demand uncertainty through process improvements

Decrease reliance on long-term forecasts and increase

ability to react quickly to demand
Collaborate with customers and suppliers, especially in
sharing demand information
Increase manufacturing flexibility internally and
operations integration externally with customers and
suppliers

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 Demand Management
Session 2

Wrap-Up and
Homework

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Learning Objectives

Demand Management Processes

– Describe the significance of marketing management and
customer relationship management
– Explain the role and objectives of demand planning (forecasting
and customer order management)
Characteristics of Demand
– Differentiate independent from dependent demand
– Identify at least five sources of independent demand
– Recognize at least four demand patterns

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Learning Objectives (cont.)

Basic Forecasting Concepts

– Describe three planning levels that are supported by demand
forecasts
– Explain four major principles of forecasting and three principles
of data collection and preparation
– Differentiate quantitative from qualitative forecasting techniques

Estimate Demand
– Calculate and explain the logic of an exponential smoothing
forecast
– Explain the logic behind the calculation of a seasonal forecast
– Calculate and explain the use of the mean absolute deviation

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Vocabulary Check

Objective:
– Reinforce terminology used in this session
– Complete the activity in class, individually or in pairs, or as
homework

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Vocabulary Check
1 2 3
O R D E R Q U A L I F I E R S O
4
U R A N D O M
A D
5 6
I L M O V I N G A V E R A G E
N I R
7
D T W B
8
M E A N A B S O L U T E D E V I A T I O N
9
Q P T N A
10 11
U E I D E P E N D E N T S
A N V X E
12
N D E T D R
13 14
T R E N D R S E A S O N A L
I N I M
T T N A
15
A F O R E C A S T N
T I D
16
I I N T R I N S I C
V
17
E X P O N E N T I A L S M O O T H I N G

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Problem 2.4

Month Demand Next-Month Forecast

1 102
2 91
3 95
4 105
5 94
6 101
7 108
8 91
9 101
10 99

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Problem 2.4 (Solution)

Month Demand Next-Month Forecast

1 102
2 91
3 95 96
4 105 97
5 94 98
6 101 100
7 108 101
8 91 100
9 101 100
10 99 97

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