Edited CH 1 Demand Management and Forecasting

Chapter 1 Demand management and
Sales Forecasting
Outline:
1.Importance of Forecasting
2.Forecasting Horizons & Methods
3.Forecasting System
4. Forecasting Methods
5.Measurement of Error
6.Forecast Control System
7.Use of computer in forecasting systems
8.Choosing A Forecasting Method
1
Demand Management
The purpose of demand management is to coordinate and control all
sources of demand so that the productive system can be used
efficiently used and the product delivered on time. There are two
types of demands:
Dependent demand for a product or service is caused by the
demand for other product or service(e.g wheels of a Bajaj, if we
sell 1000 Bajajs, then 1000 front wheels and 2000 rear wheels are
needed).
how many Bajajs the firm might sell is independent demand
because its demand can not be derived directly from other
products.
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1.Importance of Forecasting
What is Forecasting?
charles F.Kettering said my concern is with the
future since I plan to spend the rest of my life
there.
 Forecasting deals with what we think will be.
 planning deals with what we think should be.
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Prediction is a process of estimating a future event based
on subjective considerations other than just past data.

If there is no past data exists to estimate the sales of
the new product, prediction, instead of forecasting, will
be needed.
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Importance of Forecasting…
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Importance of Forecasting…
In general, Importance of Forecasting:
To plan for the future by reducing uncertainty.
To anticipate and manage change.
 To increase communication and integration of
planning teams.
To anticipate inventory and capacity demands
and manage lead times.
To project costs of operations into budgeting
processes.
To improve competitiveness and productivity
through decreased costs and improved delivery
and responsiveness to customer needs.
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Common Characteristics of Forecasting
Forecasts are rarely perfect

Forecasts are more accurate for
aggregated data than for individual items
Forecast are more accurate for shorter
than longer time periods
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2.Forecasting Horizons & Methods
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Qualitative methods long
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 The future is a
function of the past.
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3.Forecasting System
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Forecasting System…
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Forecasting System…
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4 Forecasting Methods
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4.1 Qualitative Methods
It includes :
I. Grass Roots: deriving future demand by asking the person
closest to the customer. e.g sales person
II. Market Research: trying to identify customer habits, new
product ideas, likes & dislikes about existing products,
which competitive products are preferred & so on. The data
collection methods are surveys &interviews.
III. Panel Consensus: deriving future estimations from the
synergy of panel of experts in the area. But there is
intimidation in this case.
IV. Historical Analogy: identifying another similar market. In
trying to forecast for new product , an ideal situation would
be where an existing or generic product could be used as a
model. The analogies may be on complementary(e.g
toothpaste & toothbrush) or substitutable e.g tea &
coffee).
V. Delphi Method: similar to the panel consensus but with
concealed identity of individuals.
 Qualitative methods are more widely used than quantitative.
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Qualitative Methods…
Grass root
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4.2 Quantitative Methods
Quantitative Methods
 Rely on data and analytical techniques. It includes :
1.Time-Series Methods: it conducts a statistical
analysis of past data to develop forecasts for the
future. Assumes the future will follow same patterns as
the past.
Time series Methods includes:
 Moving Average
 Weighted Moving Average
 Exponential Smoothing
2.Causal Method:
 Explores cause-and-effect relationships
 Uses leading indicators to predict the future
 E.g. housing starts and appliance sales
Causal methods includes:
 Linear multiple regression methods.
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Quantitative Methods…
1.Time Series Forecasting
 Time series is a time-ordered sequence of
observation taken at regular time interval
 Obtained by observing response variable at
regular time periods
 Forecast based only on past values
 Assumes that factors influencing past and
present will continue influence in future
 But no attempt is made to identify the variables
that influence the series behind the time.
Note: Before selecting the method we should know
the pattern/variation of the data. E.g if the pattern
is trend, then we will select a trend method.
© 2006 Prentice Hall, Inc. 4 – 23

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25
Cyclical Component
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When we use methods?

If you think the most recent data are more
relevant to forecast, then simple moving
average or linear regression is appropriate; If
the data is more of seasonal, then method with
seasonal factor is appropriate.
27
Ans.(200+225+245)/3= 223.3 sets

N.B. Do not follow blindly the simple average
rather consider the maximum & minimum
variation/ outlier.
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estimate the demand for July.
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The limitation of WMA is having

subjectivity in selecting weights though it
is a objective or quantitative method.
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Exponential Smoothing
It is commonly practiced in inventory control.
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Decomposition of time series
Decomposition
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determine the f”
1) Seasonal factors
2) The trend equation
3) Forecast the demand for four quarters of the 4th Year.
4) Assume no trend& let the expected demand for the 4th
Year be 20,000 units, then using the given seasonal factors
forecast the demand for each quarter/season.
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Solution
1.Estimating Seasonal Factors
Step 1.Compute the sample mean of the entire data
set (should be at least several cycles of data)
Step 2.Average the observation for like/similar
seasons
Step 3.Divide step 2 to sample mean(this gives a
factor for each season)
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Quantitative Methods…Exhibit 3.18 seasonal factor & trend equation
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Solution 3.Forecast the demand for four quarters of the 4th Year.
We now reverse the procedure by multiplying the
quarterly data we derived by the seasonal factor for
that quarter.
4. discuss: Assume no trend& let the expected

demand for the 4th Year be 20,000 units, then
using the given seasonal factors forecast the
demand for each quarter/season.
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2. Causal Relationship Forecasting
Explores cause-and-effect relationships

between independent & dependent
variable
Uses leading indicators to predict the
future
E.g. housing starts and appliance sales
A common tool of causal modeling is
linear regression.
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Causal Relationship Forecasting…
 Identify dependent (y) and independent (x) variables

 Least square method is widely used to get the equation
of the line
 Solve for the slope of the line
 Solve for the y intercept
 Develop your equation for the linear regression line

 Y= a + bX
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Exhibit 13.21
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Correlations Among Variables
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Analysis of Forecast Error
Error is the difference between the forecast
value & what actually occurred.
Source of errors
Projecting past trends into future is a common
source of error.
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The two common measures of forecast accuracy
are the Mean Absolute Deviation(MAD) & Mean
Squared Error(MSE).
2
 ( Actual  forecast)
MSE =
n
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Measurement of Error…
EXAMPLE: Artel,a manufacturer of static random access memories,
has production plants in texas & california. The managers of these
plants are asked to forecast amount of production one week ahead
for their plants. Based on six weekly forecasts, the firm’s
management wishes to determine which manager is more successful
at predicting his plant’s amount of production.
FP1 is forecast
week FP O1 ІE1І FP2 O2 ІE2І
made by manager of
1
Plant 1 ,O1 is the amount
of production actually 1 92 88 4 96 91 5
Observed in plant 1 & E1 2 87 88 1 89 89 0
Is error. The same
3 95 97 2 92 90 2
Definitions apply to
Plant 2. 4 90 83 7 93 90 3
5 88 91 3 90 86 4
6 93 93 0 85 89 4
TOTAL 17 18
MAD1=17/6= 2.83, MAD2=18/6=3.00.Based on MAD the 1st
Manager is better.
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• MSE1= 79/6=13.17,MSE2=70/6=11.67.Based on MSE
THE 2nd Manager is better. The reason is
that MSE is more sensitive to one large
error(7) than is the MAD.
 Though the forecasting abilities of the
two managers are very similar, who is
the best manager is depends on which
method of evaluation management
chooses.
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6.Forecast Control System
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Forecast Control System…
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7.Use Of Computer In Forecasting Systems
Computer is used in analysis of forecasting systems to save time
&increase accuracy of forecasting.
In computer simulation several forecasting methods are
simulated(using programs such as excel), recorded(using database)
& the best method or combination of methods is/are used to make
better forecast. If the errors are out of the control limit,
computers help the analyst to identify root cause& to take the
corrective actions at inputs or at the process/analysis stage. so
based on the feedback of the system, a forecast can be modified &
controlled.
In addition, it helps to make what if analysis by making assumption
about internal &external variables. e.g what would happen to my
forecast if the Price increases by 10% ? What effect would a
national recession have on my forecast.
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Application of Machine Learning(ML) Algorithms in Demand/
Sales forecasting
 ML(is a branch of AI) is a set of methods that allow computers to learn from
data to make and improve predictions (E.G weekly sales, credit default).
 By introducing nonlinear analyses, ML techniques have been used to accurately

predict and forecast
demand, sales, and inventory, leading to optimization of supply chain performance.
 ML techniques usually do not heavily rely on the accuracy of historical data so
that ML techniques have been promoted as great alternatives for demand
forecasting.
 ML prediction reduces errors by on average 20-25% compared to classical
predictions
 ML deploys both quantitative and qualitative methods.
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8.Choosing A Forecasting Method
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Application of Forecasting
• Forecasts are vital to every business
organization and for every significant
management decision.
Sales Forecasting : Any company in selling
goods needs to forecast the demand for those
goods.
Forecasting Economic Trends : forecasting
economic trends on a regional, national, or even
international level.
Forecasting Staffing Needs:
Forecasting in education environment :
Ministry of Petroleum :
Department of Technology:
67

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Chapter 1 Demand management and

on subjective considerations other than just past data.

Forecasts are rarely perfect

© 2006 Prentice Hall, Inc. 4 – 23

When we use methods?

Ans.(200+225+245)/3= 223.3 sets

estimate the demand for July.

The limitation of WMA is having

It is commonly practiced in inventory control.

4. discuss: Assume no trend& let the expected

Explores cause-and-effect relationships

 Identify dependent (y) and independent (x) variables

 Solve for the y intercept

 Develop your equation for the linear regression line

 By introducing nonlinear analyses, ML techniques have been used to accurately

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