Demand Forecasting

Sources:
• Operations management along the supply chain By Robert
S. Russell, Bernard W.Taylor-Wiley India
• Operations Management : Processes and Value Chains ,
Lee J. Krajewski, Larry P. Ritzman, Prentice Hall India
• Operations Management , Jay Heizer J, Barry Render, J.
Rajashekhar, Pearson

For Academic Purpose Only

 Forecasting
• Forecasting is Predicting the future
• Forecast of demand of product or services is basis of
important strategic and planning decisions

• Forecasts can never eliminate uncertainty in demand.

• Forecasting is uncertain more so in current business

environment

• Qualitative forecast methods

• Subjective based on judgment, past experience, opinions

• Quantitative forecast methods

• based on mathematical formulas & models

12-2
 Demand Forecasting & Supply Chain
Management
• Demand Forecasting critical to supply chain
management

• Demand Forecasts determine:

✓ Location, Capacity of plants
✓ Mode of transportation
✓ Location of warehouses & distribution centers
✓ in the supply chain
✓ Inventory levels (at various points in supply chain)
✓ Production quantity
✓ Purchasing quantity
✓ Others

12-3
The Effect of Inaccurate Forecasting

12-4
 Types of Forecasting Methods
• Depend on

• Time Frame

• Demand Behavior or Demand

Patterns

• Causes of Demand behavior

12-5
 Time Frame
• Indicates how far into the future is forecast
• Short- to mid-range forecast

• typically encompasses the immediate future

• Can be daily, weekly, monthly demand forecasts
• Forecasts up to approx. two years in the future
• Primarily used to determine: inventory levels,
production plans and scheduling employees etc

• Long-range forecast
• usually encompasses a period of time longer than
two years
• Primarily used for strategic planning to establish long
term goals
• E.g. planning new products, new facilities, new
technology etc
 Time Frame
• Differentiation between short/mid/long range forecasts
not distinct.

• Usage of these terms depends on the context.

• In many organisations, short-range may be period up to 3

months, mid-range may imply period from 3 months to 2
years or one and a half year.

• For some organisations, long-range forecast can be in

terms of months not years.

• It depends on how quickly the product market changes or

how susceptible the market is to technological changes.
 Demand Behavior
Demand may behave in predictable or random manner.

Major types of demand behavior are:

1. Trend
• a gradual, long-term up or down movement of demand e.g. demand
for mobiles

2. Random variations
• movements in demand that do not follow a pattern; have no
assignable cause; unpredictable

3. Irregular variations
• movements in demand that do not follow a pattern but can have a
assignable cause
• i.e. decrease in firms’ sales on account of promotional campaign by
a competitor; decrease in sales of electronics products due to a
natural calamity e.g. floods
12-8
 Demand Behavior
4. Cycle
• an up-and-down repetitive movement in demand
• Typically demand repeats itself over lengthy time span (more than a
year)
• e.g. demand for automobiles; housing tends to follow cycle in
economy; demand for winter sports equipment increases every four
years before & after winter Olympics

5. Seasonal pattern
• An up-and-down repetitive movement in demand occurring
periodically in short run
• Often weather related e.g. demand for winter cloths; automobiles
during festive season
• Seasonal variations can also occur on daily or weekly basis e.g.
weekend rush to shopping malls or movie theatres; restaurants near
office busier during lunch hours

Demand behavior frequently displays many of above mentioned

characteristics simultaneously
12-9
 Forms of Demand Behavior

Demand
Demand

Random
movement

Time Time
(a) Trend (b) Cycle

Demand
Demand

Time Time
(c) Seasonal pattern (d) Trend with seasonal pattern

12-10
 Forecasting Methods
• Three basic forecasting techniques are:

1. Qualitative
• use management judgment, expertise, and opinion to
predict future demand

2. Time series
• statistical techniques that use historical demand data to
predict future demand

3. Regression methods
• attempt to develop a mathematical relationship between
demand and factors that cause its behavior
12-11
 Qualitative Methods for Forecasting
• Top management and managers from functional areas like sales,
marketing, purchasing, and engineering are sources for internal
qualitative forecasts

• Also called “Jury Of Executive Opinion” involving Top

Management.

• Top Management- Most familiar with firm’s own capabilities and

resources as well as market of their products & trends.

• Engineering involved as they have understanding of technological

aspects of products that might have more demand in the future

• Technological forecasting important for accurate demand

forecasting - what technology shall be available in future & how it
can be exploited, what new products & services shall be
technologically feasible etc

• More often used for long term strategic planning

12-12
 Qualitative Methods for Forecasting
• Delphi method
• Systematic, interactive forecasting method to collect informed
judgements and opinions

• Employs a panel/group of experts , knowledgeable individuals

• Utilises structured communication using series of questionnaire

• The experts answer series of questionnaires in two or more

rounds

• Facilitator provides an anonymous summary of the experts’

forecasts from the previous round along with reasons given by the
expert

• Panel converges towards the best answer i.e. consensus forecast

about what will happen in future.

12-13
 Forecasting Process
1. Identify the 2. Collect historical 3. Plot data and identify
purpose of forecast data patterns

6. Check forecast 5. Develop/compute 4. Select a forecast

accuracy with one or forecast for period of model that seems
more measures historical data appropriate for data

7.
Is accuracy of No 8b. Select new
forecast forecast model or
acceptable? adjust parameters of
existing model
Yes
9. Adjust forecast based 10. Monitor results
8a. Forecast over
on additional qualitative and measure forecast
planning horizon
information and insight accuracy

Forecasting is NOT simply identifying and using a method to compute a

numerical estimate for what will be the demand in future. It is a continuous
process that requires constant monitoring and adjustment
Forecasting Methods

12-15
 Time Series
• Statistical techniques that make use of historical data accumulated in
past.
• Assume that:
✓ What has occurred in the past will continue to occur in the future
✓ Identifiable historical patterns or trends for demand over time repeats
themselves
✓ Historical data is typically past sales or order data.
• Popular for short range forecasting in both manufacturing and services
• Relate the forecast to only one factor – time, hence the name Time
Series
• Various methods are:
• Naïve Forecast Method
• Moving average Method
• Exponential smoothing Method
• Linear trend line Method 12-16
 Naive or intuitive forecast

• Naive or intuitive forecast

• Demand In Current Period Is Used As Next Period’s
Forecast
• Use only one period to predict demand
• E.g. if demand forecast is 100 units this week, next week’s
forecast is 100 units
• if actual demand is 90 units then following weeks demand
is 90
• Does not take into account historical demand behavior
• Very susceptible to random variations in demand

12-17
 Moving Average Method
• Simple moving average
• Uses average demand for a fixed sequence of periods

• Averaging smooth out or dampen the random increases and

decreases in forecasts compared to forecast that uses only one period

• Averaging Period is typically 3 month or 5 month depending on

how much the forecaster wishes to “smooth” the demand data.

• Longer the moving average period smoother the forecast

• Shorter period moving average more susceptible to random variations

in demand

• Used when :
✓ demand behavior is stable with no pronounced behavioral patterns
✓ short planning horizon

• Ignores demand patterns like trend, cyclical, seasonal

12-18
Simple Moving Average

n

i=1
Di
MAn =
n
where

n = number of periods in
the moving average
Di = demand in period i

12-19
 Moving Average Method
Caselet 1:
• The Heartland Produce Company sells and delivers food
produce to restaurants and catering services within a 100 mile
radius of its warehouse. The food supply business is
competitive and ability to deliver promptly is a important factor
in getting new customers and retaining old ones.

• The Manager of the company wants to be certain that enough

drivers and vehicles are available to deliver orders promptly
and they also have adequate inventory in stock.

• Thus the Manager wants to forecast the number of orders that

will occur during next month.

• Manager has compiled order data for last 10 months.

• Develop Demand Forecast for next month using 3 month

and 5 month moving average.
Moving Average Method - Illustration
Heartland Produce Company
Order Data
Month Orders
Jan 120
Feb 90
Mar 100
Apr 75
May 110
June 50
July 75
Aug 130
Sept 110
Oct 90 12-21
 Naïve Approach

Caselet 1

ORDERS
MONTH PER MONTH FORECAST
Jan 120 -
Feb 90 120
Mar 100 90
Apr 75 100
May 110 75
June 50 110
July 75 50
Aug 130 75
Sept 110 130
Oct 90 110
Nov - 90
12-22
 3-month Simple Moving Average

ORDERS MOVING
MONTH PER MONTH AVERAGE 3

Jan 120 – 
i=1
Di
Feb 90 – MA3 =
Mar 100 – 3
Apr 75 103.3
May 110 88.3 90 + 110 + 130
June 50 95.0
= 3
July 75 78.3
Aug 130 78.3
= 110 orders for Nov
Sept 110 85.0
Oct 90 105.0
Nov - 110.0

12-23
 5-month Simple Moving Average

ORDERS MOVING
MONTH PER MONTH AVERAGE 5

Jan 120 – 
i=1
Di
Feb 90 – MA5 =
Mar 100 – 5
Apr 75 –
May 110 – 90 + 110 + 130+75+50
= 5
June 50 99.0
July 75 85.0
Aug 130 82.0 = 91 orders for Nov
Sept 110 88.0
Oct 90 95.0
Nov - 91.0

12-24
 Smoothing Effects
150 –

125 – 5-month

100 –
Orders

75 –

50 – 3-month

Actual
25 –

0– | | | | | | | | | | |
Jan Feb Mar Apr May June July Aug Sept Oct Nov
Month

12-25
 Simple Moving Average
• In previous illustration, if the current month is Oct, then
forecast is needed only for Nov.

• But earlier forecasts of previous months are calculated to

compare forecast with actual demand and determine the
accuracy of forecasting method.
Shorter period moving range Longer period moving
average
smooth out fluctuations less smooth out fluctuations more
React faster to recent demand React slowly to recent demand
changes changes
More susceptible to random Less susceptible to random
variations in demand variations in demand

• Period of moving average based on trial and error. 12-26

 Weighted Moving Average

• Adjusts moving average method to more closely

reflect data fluctuations.
• Weights are assigned to past demand data
n
WMAn =  Wi Di
i=1
where
Wi = the weight for period i,
between 0 and 100
percent
 Wi = 1.00
More or heavy weight means stronger influence on forecast
Weighted Moving Average Example
MONTH WEIGHT DATA
August 17% 130
September 33% 110
October 50% 90
3
November Forecast WMA3 = 
i=1
Wi Di

= (0.50)(90) + (0.33)(110) + (0.17)(130)

= 103.4 orders

12-28
 Moving Average Method
• Weighted moving average

• More closely reflects the variations in data

Too heavy weights for most Forecasts overreact to random

recent periods fluctuations in demand in
recent periods
Too light weights for most Forecasts underreact to actual
recent periods changes in demand behavior in
recent periods

• Weights decided with trial and error

12-29
 Exponential Smoothing

• Averaging method
• Weights most recent data more strongly
• Forecasts reacts more to recent changes
• Useful when recent changes in data are
significant and not on account of random
fluctuations
• Widely used, accurate method, good track
record of success

12-30
 Exponential Smoothing Formula

Ft +1 =  Dt + (1 - )Ft
where:
Ft +1 = forecast for next period
Dt = actual demand for present period
Ft = previously determined forecast for
present period
= weighting factor, smoothing constant

 is between 0 to 1.
▪ However, commonly used values are between .01
to 0.5
▪ Determined by trial & error and subjective 12-31
judgment
 Effect of Smoothing Constant

0.0    1.0
If  = 0.20, then Ft +1 = 0.20 Dt + 0.80 Ft
Forecast reflects 20% of recent demand and 80 % of past demand

If  = 0, then Ft +1 = 0 Dt + 1 Ft = Ft
Forecast does not reflect recent data

If  = 1, then Ft +1 = 1 Dt + 0 Ft = Dt
Forecast based only on most recent data
 closer to 1, greater the sensitivity to changes in
most recent demand and smoothing will be less
Note: Past Demand is reflected in Ft as it is derived from past demand data
 Exponential Smoothing
• Caselet 2:

HiTek Computer Services repairs and services personal

computers at its store and it makes local service calls. The
company has seen a steady growth since it started. It purchases
genuine computer parts in volume at a discount from variety of
sources whenever they get a good deal.

Thus, they need a good forecast of demand for repairs so that

they will know how many computer component parts to purchase
and stock and how many technicians to hire.

The company has accumulated the demand data shown in next

table for repair and service calls for last 12 months. It wants to
determine exponential smoothing forecast for the next period
using smoothing constants of  = 0.3 & 0.5.
 Exponential Smoothing

• Caselet 2:

Period Month Demand

1 January’22 37
2 February 40
3 March 41
4 April 37
5 May 45
6 June 50
7 July 43
8 August 47
9 September 56
10 October 52
11 November 55
12 December’22 54
 Exponential Smoothing (α=0.30)
Caselet 2
PERIOD MONTH DEMAND F2 = D1 + (1 - )F1
1 Jan’22 37
= (0.30)(37) + (0.70)(37)
2 Feb 40
3 Mar 41 = 37
4 Apr 37
F3 = D2 + (1 - )F2
5 May 45
6 Jun 50 = (0.30)(40) + (0.70)(37)
7 Jul 43 = 37.9
8 Aug 47
9 Sep 56 F13 = D12 + (1 - )F12
10 Oct 52 = (0.30)(54) + (0.70)(50.84)
11 Nov 55
= 51.79
12 Dec’22 54

12-35
 Exponential Smoothing
FORECAST, Ft + 1
PERIOD MONTH DEMAND ( = 0.3) ( = 0.5)
1 Jan’22 37 – –
2 Feb 40 37.00 37.00
3 Mar 41 37.90 38.50
4 Apr 37 38.83 39.75
5 May 45 38.28 38.37
6 Jun 50 40.29 41.68
7 Jul 43 43.20 45.84
8 Aug 47 43.14 44.42
9 Sep 56 44.30 45.71
10 Oct 52 47.81 50.85
11 Nov 55 49.06 51.42
12 Dec’22 54 50.84 53.21
13 Jan’23 – 51.79 53.61

12-36
 Exponential Smoothing
70 –

60 – Actual  = 0.50

50 –

40 –
Orders

 = 0.30
30 –

20 –

10 –

0– | | | | | | | | | | | | |
1 2 3 4 5 6 7 8 9 10 11 12 13
Month

12-37
 Linear Trend Line
• It is a special case of a simple regression model or
ordinary least squares (OLS) or linear regression.

• Used when demand displays a trend over time

• Here Demand is the Dependent variable and Time is

the independent variable.

• Note - Linear regression establishes the linear

relationship between two variables based on a line
of best fit.

12-38
 Linear Trend Line
 xy - nxy
y = a + bx b =
 x2 - nx2
a = y-bx
where
a = intercept where
b = slope of the line n = number of periods
x = time period
x
y = forecast for x = = mean of the x values
demand for period x n
y
y = n = mean of the y values

Parameters calculated using least squares formulas

12-39
 Linear Trend Line
Caselet 2 continued
x(PERIOD) y(DEMAND) xy x2
1 37 37 1
2 40 80 4
3 41 123 9
4 37 148 16
5 45 225 25
6 50 300 36
7 43 301 49
8 47 376 64
9 56 504 81
10 52 520 100
11 55 605 121
12 54 648 144
78 557 3867 650

12-40
 Linear Trend Line

x = 78 = 6.5
12
y = 557 = 46.42
12
b = xy - nxy = 3867 - (12)(6.5)(46.42) =1.72
x2 - nx2 650 - 12(6.5)2

a = y - bx
= 46.42 - (1.72)(6.5) = 35.2
y = 35.2 + 1.72 x
X=13, y = 35.2 + 1.72 x 13 = 57.56

12-41
 Linear trend line y = 35.2 + 1.72x
Forecast for period 13 y = 35.2 + 1.72(13) = 57.56 units

70 –

60 –
Actual

50 –
Demand

40 –
Linear trend line
30 –

20 –

10 – | | | | | | | | | | | | |
1 2 3 4 5 6 7 8 9 10 11 12 13
Period

12-42
 Forecast Accuracy
• Forecast error
• difference between forecast and actual demand

• Should be as small as possible

• If forecast error is more, it means:

✓ Either forecasting method is wrong
✓ Or demand behavior has changed

• Measures of forecasting error

1. MAD: mean absolute deviation
2. MAPD: mean absolute percent deviation
3. Cumulative error
4. Average error or bias
12-43
Mean Absolute Deviation (MAD)

 Dt - Ft 
MAD = n
where
t = period number
Dt = demand in period t
Ft = forecast for period t
n = total number of periods
  = absolute value

Average , Absolute difference between forecast and

demand; Smaller MAD is desirable; Value of MAD is
dependent on the values of the given data and
interpreted accordingly 12-44
 MAD Example
For Caselet 2
PERIOD DEMAND, Dt Ft ( =0.3) (Dt - Ft) |Dt - Ft|
1 37 37.00 – –
2 40 37.00 3.00 3.00
3 41 37.90 3.10 3.10
4 37 38.83 -1.83 1.83
5 45 38.28 6.72 6.72
6 50 40.29 9.69 9.69
7 43 43.20 -0.20 0.20
8 47 43.14 3.86 3.86
9 56 44.30 11.70 11.70
10 52 47.81 4.19 4.19
11 55 49.06 5.94 5.94
12 54 50.84 3.15 3.15
557 49.31 53.39

12-45
 MAD Calculation

 Dt - Ft 
MAD = n
53.39
=
11
= 4.85

For previous Caselet, MAD value for Exponential Smoothing with

 = 0.5 is 4.04

For previous Caselet, MAD value for Linear Trend Line is

2.29
12-46
 MAPD
Mean absolute percent deviation (MAPD)
|Dt - Ft|
MAPD =
Dt
MAPD is Absolute error as a percentage of
demand.
Expresses in percent; lower value is
desirable

12-47
 MAPD

For previous Caselet, MAPD value for Exponential

Smoothing with  = 0.3 is 9.6%

For previous Caselet, MAD value for Linear Trend

Line is 4.9 %

12-48
 Cumulative error
Cumulative error is summation of forecast errors
Cumulative error E = et

Where et = (Dt - Ft)

A large positive E indicates forecast is biased low

A large negative E indicates forecast is biased
high

12-49
 Cumulative error

For previous Caselet, MAPD value for Exponential

Smoothing with  = 0.3 is 49.31

12-50
 Average error

et
Average error = E =
n

Average error or bias is per period average of

cumulative error
Can be positive or negative
Low value is desirable for accurate forecast

12-51
 Comparison of Forecasts
For Caselet 2
FORECAST MAD MAPD E (Avg. E)
Exponential smoothing ( = 0.30) 4.85 9.6% 49.31 4.48
Exponential smoothing ( = 0.50) 4.04 8.5% 33.21 3.02
Linear trend line 2.29 4.9% – –
3 Month Moving Avg. 3.93 8.05 % 28 3.11
5 Month Moving Avg. 5.49 10.76 % 38.4 5.49

Note- E will always be near zero for Linear Trend Line, hence
not calculated
 Additional & Optional;
not to be covered as per course outline

12-53
 Regression Methods
• Regression
• Establishes mathematical relationship between two or
more variables

• Linear regression
• Simplest form
• mathematical technique that relates a dependent
variable to an independent variable in the form of a
linear equation or equation of straight line

• Correlation
• a measure of the strength of the relationship between
independent and dependent variables

12-54
 Linear Regression

y = a + bx a = y-bx
 xy - nxy
b =
 x2 - nx2
where
a = intercept
b = slope of the line
x
x = = mean of the x data
n
y
y = n = mean of the y data

12-55
 Linear Regression
Caselet 3
The state university athletic department wants to
develop its budget for the coming year using forecast
of football attendance. Football attendance accounts
for the largest portion of its revenues and the athletic
director believes that attendance is directly related to
the number of wins by the team. The business
manager has accumulated total average attendance
figures for past eight years.
The athletic Director believes that team will win atleast
7 games next year. Forecast the attendance for the
next year.

12-56
 Linear Regression Example

x y
(WINS) (ATTENDANCE) xy x2
4 36.3 145.2 16
6 40.1 240.6 36
6 41.2 247.2 36
8 53.0 424.0 64
6 44.0 264.0 36
7 45.6 319.2 49
5 39.0 195.0 25
7 47.5 332.5 49
49 346.7 2167.7 311

12-57
Linear Regression Example
49
x= = 6.125
8
346.9
y= = 43.36
8

xy - nxy2
b=
x2 - nx2
(2,167.7) - (8)(6.125)(43.36)
= (311) - (8)(6.125)2
= 4.06

a = y - bx
= 43.36 - (4.06)(6.125)
= 18.46

12-58
 Linear Regression Example
60,000 –

50,000 –

40,000 –
Attendance, y

30,000 – Linear regression line, y

= 18.46 + 4.06x

20,000 – Attendance forecast for 7 wins

y = 18.46 + 4.06(7)
10,000 – = 46.88, or 46,880

| | | | | | | | | | |
0 1 2 3 4 5 6 7 8 9 10
Wins, x

12-59
 Correlation and Coefficient of
Determination
• Correlation, r
• Measure of strength of relationship between
independent and dependent variable
• Varies between -1.00 and +1.00
• +1 = Strong positive relationship
• -1 = Strong negative relationship

• Coefficient of determination, r2
• Percentage of variation in dependent variable resulting
from changes in the independent variable
• E.g. if r2 is 90% , it means that 90% of amount of
variation in the dependent variable can be attributed to
independent variable

12-60
 Computing Correlation
For Caselet 3 continued
n xy -  x y
r=
[n x2 - ( x)2] [n y2 - ( y)2]

(8)(2,167.7) - (49)(346.9)
r=
[(8)(311) - (49)2] [(8)(15,224.7) - (346.9)2]

r = 0.947

Coefficient of determination
r2 = (0.947)2 = 0.897

12-61
 Multiple Regression

Study the relationship of demand to two or more

independent variables

y = 0 + 1x1 + 2x2 … + kxk

where
0 = the intercept
1, … , k = parameters for the
independent variables
x1, … , xk = independent variables

12-62
THANKS

12-63