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Demand Management and Forecasting

McGraw-Hill/Irwin

2009 The McGraw-Hill Companies, All Rights Reserved

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OBJECTIVES Demand Management Qualitative Forecasting Methods Simple & Weighted Moving Average Forecasts Exponential Smoothing Simple Linear Regression Web-Based Forecasting
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Demand Management

Independent Demand: Finished Goods


A

B(4)

C(2)

Dependent Demand: Raw Materials, Component parts, Sub-assemblies, etc.

D(2)

E(1)

D(3)

F(2)

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Independent Demand: What a firm can do to manage it?

Can take an active role to influence demand

Can take a passive role and simply respond to demand

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Types of Forecasts

Qualitative (Judgmental) Quantitative Time Series Analysis Causal Relationships Simulation

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Components of Demand

Average demand for a period of time Trend Seasonal element Cyclical elements Random variation Autocorrelation
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Finding Components of Demand

Seasonal variation

x x x x x

Linear
x x x

Sales

x x x

xx x x xx x x x x x x x xxx x x x x x xxxx

x x

x
x x

x x

Trend

Year
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Qualitative Methods

Executive Judgment

Grass Roots

Historical analogy

Qualitative
Methods

Market Research

Delphi Method

Panel Consensus

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Delphi Method

l. Choose the experts to participate representing a variety of knowledgeable people in different areas 2. Through a questionnaire (or E-mail), obtain forecasts (and any premises or qualifications for the forecasts) from all participants 3. Summarize the results and redistribute them to the participants along with appropriate new questions 4. Summarize again, refining forecasts and conditions, and again develop new questions 5. Repeat Step 4 as necessary and distribute the final results to all participants
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Time Series Analysis

Time series forecasting models try to predict the future based on past data You can pick models based on: 1. Time horizon to forecast 2. Data availability 3. Accuracy required 4. Size of forecasting budget 5. Availability of qualified personnel
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Simple Moving Average Formula The simple moving average model assumes an average is a good estimator of future behavior The formula for the simple moving average is:

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


Ft = Forecast for the coming period N = Number of periods to be averaged A t-1 = Actual occurrence in the past period for up to n periods

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Simple Moving Average Problem (1)

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

Demand 650 678 720 785 859 920 850 758 892 920 789 844

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


Question: What are the 3week and 6-week moving average forecasts for demand? Assume you only have 3 weeks and 6 weeks of actual demand data for the respective forecasts

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Calculating the moving averages gives us:

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

Demand 3-Week 6-Week 650 F4=(650+678+720)/3 678 =682.67 720 F7=(650+678+720 +785+859+920)/6 785 682.67 859 727.67 =768.67 920 788.00 850 854.67 768.67 758 876.33 802.00 892 842.67 815.33 920 833.33 844.00 789 856.67 866.50 844 867.00 854.83
The McGraw-Hill Companies, Inc., 2004

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Plotting the moving averages and comparing them shows how the lines smooth out to reveal the overall upward trend in this example

1000 900
Deman d

800 700 600 500 1 2 3 4 5 6 7 8 9 10 11 12 Week

Demand 3-Week 6-Week

Note how the 3-Week is smoother than the Demand, and 6-Week is even smoother
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Simple Moving Average Problem (2) Data

Week 1 2 3 4 5 6 7

Demand 820 775 680 655 620 600 575

Question: What is the 3 week moving average forecast for this data? Assume you only have 3 weeks and 5 weeks of actual demand data for the respective forecasts
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Simple Moving Average Problem (2) Solution

Week 1 2 3 4 5 6 7

Demand 820 775 680 655 620 600 575

3-Week
=758.33

5-Week

F4=(820+775+680)/3

758.33 703.33 651.67 625.00

F6=(820+775+680 +655+620)/5 =710.00

710.00 666.00
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Weighted Moving Average Formula

While the moving average formula implies an equal weight being placed on each value that is being averaged, the weighted moving average permits an unequal weighting on prior time periods

The formula for the moving average is:


Ft = w 1 A t -1 + w 2 A t - 2 + w 3 A t -3 + ...+ w n A t - n
wt = weight given to time period t occurrence (weights must add to one)

w
i=1

=1
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Weighted Moving Average Problem (1) Data

Question: Given the weekly demand and weights, what is the forecast for the 4th period or Week 4?
Week 1 2 3 4 Demand 650 678 720

Weights: t-1 .5 t-2 .3 t-3 .2

Note that the weights place more emphasis on the most recent data, that is time period t-1

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Weighted Moving Average Problem (1) Solution

Week 1 2 3 4

Demand Forecast 650 678 720 693.4

F4 = 0.5(720)+0.3(678)+0.2(650)=693.4
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Weighted Moving Average Problem (2) Data

Question: Given the weekly demand information and weights, what is the weighted moving average forecast of the 5th period or week?
Week 1 2 3 4 Demand 820 775 680 655

Weights: t-1 .7 t-2 .2 t-3 .1

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Weighted Moving Average Problem (2) Solution

Week 1 2 3 4 5

Demand Forecast 820 775 680 655 672

F5 = (0.1)(755)+(0.2)(680)+(0.7)(655)= 672

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Exponential Smoothing Model

Ft = Ft-1 + a(At-1 - Ft-1)


Where : Ft Forcast va for thecoming t time period lue Ft - 1 Forecast v in 1 past time period alue At - 1 Actual occurancein the past t time period

a Alpha smoothing constant


Premise: The most recent observations might have the highest predictive value Therefore, we should give more weight to the more recent time periods when forecasting

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Exponential Smoothing Problem (1) Data

Week 1 2 3 4 5 6 7 8 9 10

Demand 820 775 680 655 750 802 798 689 775

Question: Given the weekly demand data, what are the exponential smoothing forecasts for periods 2-10 using a=0.10 and a=0.60? Assume F1=D1

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Answer: The respective alphas columns denote the forecast values. Note that you can only forecast one time period into the future.

Week 1 2 3 4 5 6 7 8 9 10

Demand 820 775 680 655 750 802 798 689 775

0.1 820.00 820.00 815.50 801.95 787.26 783.53 785.38 786.64 776.88 776.69

0.6 820.00 820.00 793.00 725.20 683.08 723.23 770.49 787.00 728.20 756.28
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Exponential Smoothing Problem (1) Plotting

Note how that the smaller alpha results in a smoother line in this example

900
Deman d

800 700 600 500 1 2 3 4 5 6 7 8 9 10 Week

Demand 0.1 0.6

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Exponential Smoothing Problem (2) Data

Week 1 2 3 4 5

Question: What are the Demand exponential smoothing 820 forecasts for periods 2-5 775 using a =0.5? 680 655 Assume F1=D1

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Exponential Smoothing Problem (2) Solution

F1=820+(0.5)(820-820)=820

F3=820+(0.5)(775-820)=797.75

Week 1 2 3 4 5

Demand 820 775 680 655

0.5 820.00 820.00 797.50 738.75 696.88


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The MAD Statistic to Determine Forecasting Error

A
MAD =
t=1

- Ft

1 MAD 0.8 standard deviation 1 standard deviation 1.25 MAD

The ideal MAD is zero which would mean there is no forecasting error The larger the MAD, the less the accurate the resulting model

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MAD Problem Data

Question: What is the MAD value given the forecast values in the table below?
Month
1 2 3 4 5

Sales Forecast 220 n/a 250 255 210 205 300 320 325 315
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MAD Problem Solution Month 1 2 3 4 5 Sales 220 250 210 300 325 Forecast Abs Error n/a 255 5 205 5 20 320 315 10

40

A
MAD =
t=1

- Ft

40 = = 10 4

Note that by itself, the MAD only lets us know the mean error in a set of forecasts

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Tracking Signal Formula

The Tracking Signal or TS is a measure that indicates whether the forecast average is keeping pace with any genuine upward or downward changes in demand. Depending on the number of MADs selected, the TS can be used like a quality control chart indicating when the model is generating too much error in its forecasts. The TS formula is:

RSFE Running sum of forecast errors TS = = MAD Mean absolute deviation


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Simple Linear Regression Model

The simple linear regression model seeks to fit a line through various data over time

a
0 1 2 3 4 5 x (Time)

Yt = a + bx

Is the linear regression model

Yt is the regressed forecast value or dependent variable in the model, a is the intercept value of the the regression line, and b is similar to the slope of the regression line. However, since it is calculated with the variability of the data in mind, its formulation is not as straight forward as our usual notion of slope.
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Simple Linear Regression Formulas for Calculating a and b

a = y - bx
xy - n(y)(x) x - n(x )
2 2

b=

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Simple Linear Regression Problem Data

Question: Given the data below, what is the simple linear regression model that can be used to predict sales in future weeks?

Week 1 2 3 4 5

Sales 150 157 162 166 177


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Answer: First, using the linear regression formulas, we can compute a and b

Week Week*Week Sales Week*Sales 1 1 150 150 2 4 157 314 3 9 162 486 4 16 166 664 5 25 177 885 3 55 162.4 2499 Average Sum Average Sum xy - n( y)(x) = 2499 - 5(162.4)(3) 63 = 6.3 b= 55 5(9 ) 10 x 2 - n(x )2
a = y - bx = 162.4 - (6.3)(3) = 143.5

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The resulting regression model is:

Yt = 143.5 + 6.3x

Now if we plot the regression generated forecasts against the actual sales we obtain the following chart: 180 175 170 165 Sales 160 155 Forecast 150 145 140 135 1 2 3 4 5 Perio d Sales

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Web-Based Forecasting: CPFR

Collaborative Planning, Forecasting, and Replenishment (CPFR) a Webbased tool used to coordinate demand forecasting, production and purchase planning, and inventory replenishment between supply chain trading partners. Used to integrate the multi-tier or nTier supply chain, including manufacturers, distributors and retailers. CPFRs objective is to exchange selected internal information to provide for a reliable, longer term future views of demand in the supply chain. CPFR uses a cyclic and iterative approach to derive consensus forecasts.

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Web-Based Forecasting: Steps in CPFR

1. Creation of a front-end partnership agreement 2. Joint business planning 3. Development of demand forecasts

4. Sharing forecasts
5. Inventory replenishment

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End of Chapter 15

McGraw-Hill/Irwin

2009 The McGraw-Hill Companies, All Rights Reserved

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