Demand Forecasting

Introduction
Demand estimates for products and services are
the starting point for all the other planning in
operations management.
Management teams develop sales forecasts
based in part on demand estimates.
The sales forecasts become inputs to both
business strategy and production resource
forecasts.

Some Reasons Why
Forecasting is Essential in OM
New Facility Planning It can take 5 years to design
and build a new factory or design and implement a new
production process.
Production Planning Demand for products vary from
month to month and it can take several months to
change the capacities of production processes.
Workforce Scheduling Demand for services (and the
necessary staffing) can vary from hour to hour and
employees weekly work schedules must be developed in
advance.

Examples of Production
Resource Forecasts
Long
Range
Medium
Range
Short
Range
Years
Months
Days,
Weeks
Product Lines,
Factory Capacities
Forecast
Horizon
Time
Span
Item Being
Forecasted
Unit of
Measure
Product Groups,
Depart. Capacities
Specific Products,
Machine Capacities
Rupees,
Tons
Units,
Pounds
Units,
Hours
Forecasting Methods
Extrapolative or Time Series Methods
Causal or Explanatory Methods
Qualitative or Judgmental Methods
Time Series Forecasting
Methods
Based on the assumption that the forces that
generated the past demand will generate the
future demand, i.e., history will tend to repeat
itself
Analysis of the past demand pattern provides a
good basis for forecasting future demand
Requires large amount of past data
A time series is a set of numbers where the
order or sequence of the numbers is important,
e.g., historical demand
Analysis of the time series identifies patterns
Once the patterns are identified, they can be
used to develop a forecast
Generally useful for short range forecasts
Time Series Analysis
Demand of the product or service is assumed to
be caused by other explanatory variables
Some of the explanatory variables can be leading
or lagging indicators
If the demand can be estimated as a function
of the causal or explanatory variables, it can be
forecast if the future values of these variables
are known
Generally useful for medium range forecasts
Causal Methods
Different Approaches:
Regression simple or multiple
Simultaneous Equations models
Simulation
Causal Methods
Qualitative Methods
Usually based on judgments about causal factors that
underlie the demand of particular products or services
Do not require a demand history for the product or
service, therefore are useful for new products/services
Approaches vary in sophistication from scientifically
conducted surveys to intuitive hunches about future
events
The approach/method that is appropriate depends on a
products life cycle stage
Generally useful for long range forecasts
Qualitative Methods
Educated guess
Executive committee consensus
Delphi method
Survey of sales force
Survey of customers
Historical analogy
Market research
intuitive
hunches
scientifically
conducted
surveys
Delphi Method
l. Choose the experts to participate. There should be 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 if necessary. Distribute the final results
to all participants.
Ranging Forecasts
Forecasts for future periods are only estimates
and are subject to error.
One way to deal with uncertainty is to develop
best-estimate forecasts and the ranges within
which the actual data are likely to fall.
The ranges of a forecast are defined by the
upper and lower limits of a confidence interval.
Components of a Time Series
Trends are noted by an upward or downward
sloping line.
Cycle is a data pattern that may cover several
years before it repeats itself.
Seasonality is a data pattern that repeats itself
over the period of one year or less.
Random fluctuation (noise) results from random
variation or unexplained causes.
Length of Time Number of
Before Pattern Length of Seasons
Is Repeated Season in Pattern

Year Quarter 4
Year Month 12
Year Week 52
Month Day 28-31
Week Day 7

Seasonal Patterns
Time Series Methods
Simple Moving Average
Weighted Moving Average
Exponential Smoothing (exponentially weighted
moving average)
Exponential Smoothing with Trend
Exponential Smoothing with Seasonality
Exponential Smoothing with Trend and
Seasonality
Evaluating Forecast-Model
Performance
Short-range forecasting models are evaluated
on the basis of four characteristics:
Impulse response
Noise-dampening ability
Accuracy
Precision
Evaluating Forecast-Model
Performance
Impulse Response and Noise-Dampening
Ability
If forecasts have little period-to-period fluctuation,
they are said to be noise dampening.
Forecasts that respond quickly to changes in data are
said to have a high impulse response.
A forecast system that responds quickly to data
changes necessarily picks up a great deal of random
fluctuation (noise).
Hence, there is a trade-off between high impulse
response and high noise dampening.

Evaluating Forecast-Model
Performance
Accuracy and Precision
Accuracy and precision are the typical criteria
for judging the performance of a forecasting
model
Accuracy measures the performance of the
forecasting model on an average
Precision measures how well the forecasted
values match the actual values
Forecast Errors
e
t
= Forecast error in period t
= (Actual Demand in period t
Forecast for period t)
= D
t
- F
t
Monitoring Accuracy or Bias
Accuracy can be measured by one of the
following:

Average Error (AE)

Running Sum of
Forecast Errors (RSFE)
Monitoring Precision
Precision of a forecasting model needs to be
monitored to assess the confidence you can have
in its forecasts and changes in the market may
require reevaluation of the approach
Precision can be measured in several ways
Mean absolute deviation (MAD)
Mean squared error (MSE)
Mean Absolute Percentage Error (MAPE)
Monitoring Precision
Mean Absolute Deviation (MAD)
n
periods n for deviation absolute of Sum
= MAD


Mean Squared Error (MSE)



Monitoring Precision

Mean Absolute Percentage error (MAPE)



A small value for MAD, MSE or MAPE
means actual demand figures are tightly
grouped around the forecast figures and error
range is small.
Monitoring Precision
The weights used to compute the forecast
(moving average) are exponentially
distributed.
The forecast is the sum of the old forecast
and a portion (o) of the forecast error (D
t-1
-
F
t-1
).

F
t
= F
t-1
+ o(D
t-1
- F
t-1
)

. . . more
Exponential Smoothing
Exponential Smoothing
The smoothing constant, o, must be between
0.0 and 1.0.
A large o provides a high impulse response
forecast.
A small o provides a low impulse response
forecast.
Example: Central Call Center
Exponential Smoothing
If a smoothing constant value of .25 is used and
the exponential smoothing forecast for Day 11 was
180.76 calls, what is the exponential smoothing
forecast for Day 13?

F
12
= 180.76 + .25(198 180.76) = 185.07
F
13
= 185.07 + .25(159 185.07) = 178.55
Example: Central Call Center
Forecast Precision - MAD
Which forecasting method (the AP = 3
moving average or the o = .25 exponential
smoothing) is preferred, based on the MAD
over the most recent 9 days? (Assume that the
exponential smoothing forecast for Day 3 is the
same as the actual call volume.)

Example: Central Call Center
AP = 3 o = .25
Day Calls Forec. |Error| Forec. |Error|
4 161 187.3 26.3 186.0 25.0
5 173 188.0 15.0 179.8 6.8
6 157 173.3 16.3 178.1 21.1
7 203 163.7 39.3 172.8 30.2
8 195 177.7 17.3 180.4 14.6
9 188 185.0 3.0 184.0 4.0
10 168 195.3 27.3 185.0 17.0
11 198 183.7 14.3 180.8 17.2
12 159 184.7 25.7 185.1 26.1
MAD 20.5 18.0
Criteria for Selecting
a Forecasting Method
Cost
Accuracy and Precision
Data available
Time span
Nature of products and services
Impulse response and noise dampening
Criteria for Selecting
a Forecasting Method
Cost, Accuracy and Precision
There is a trade-off between cost and precision;
generally, more forecast precision can be obtained at
a cost.
High-precision approaches have disadvantages:
Use more data
Data are ordinarily more difficult to obtain
The models are more costly to design, implement, and
operate
Take longer to use
Criteria for Selecting
a Forecasting Method
Cost and Precision
Low/Moderate-Cost Approaches statistical
models, historical analogies, executive-committee
consensus
High-Cost Approaches complex econometric
models, Delphi, and market research


Criteria for Selecting
a Forecasting Method
Data Available
Is the necessary data available or can it be
economically obtained?
If the need is to forecast sales of a new product, then
a customer survey may not be practical; instead,
historical analogy or market research may have to be
used.

Criteria for Selecting
a Forecasting Method
Time Span
What operations resource is being forecast and for
what purpose?
Short-term staffing needs might best be forecast
with moving average or exponential smoothing
models.
Long-term factory capacity needs might best be
predicted with regression or executive-committee
consensus methods.
Criteria for Selecting
a Forecasting Method
Nature of Products and Services
Is the product/service high cost or high volume?
Where is the product/service in its life cycle?
Does the product/service have seasonal demand
fluctuations?
Criteria for Selecting
a Forecasting Method
Impulse Response and Noise Dampening
An appropriate balance must be achieved between:
How responsive we want the forecasting model to be to
changes in the actual demand data
Our desire to suppress undesirable chance variation or
noise in the demand data


Monitoring and Controlling
a Forecasting Model
Tracking Signal (TS)
The TS measures the cumulative forecast error over
n periods in terms of MAD



If the forecasting model is performing well, the TS
should be around zero
The TS indicates the direction of the forecasting
error; if the TS is positive -- increase the forecasts, if
the TS is negative -- decrease the forecasts.
Monitoring and Controlling
a Forecasting Model
Tracking Signal
The value of the TS can be used to automatically
trigger new parameter values of a model, thereby
correcting model performance.
If the limits are set too narrow, the parameter values
will be changed too often.
If the limits are set too wide, the parameter values
will not be changed often enough and accuracy will
suffer.

Computer Software for
Forecasting
Examples of computer software with forecasting
capabilities
Forecast Pro
Autobox
SmartForecasts for Windows
SAS
SPSS
SAP
POM Software Libary
Primarily for
forecasting
Have
Forecasting
modules
SIMPLE EXPONENTIAL SMOOTHING
Model:
Actual Demand = Base Demand + Error
Forecast = Base
Using Symbols,




t t
S F =
1 ,
( )
( )| |
( ) ( )
( )
1 0
... 1
1 1
) 1 ( 1
1
3
3
2
2
1
2 1
1
s s
+ +
+ + =
+ + =
+ =

o
o o
o o o
o o o
o
where
D
D D D
S D D
S D S
t
t t t
t t t
t t t
1
) 1 (
3 2 1 ,

+ =
= =
t t t
t t,m
S D S Finally,
,...... , , m , S F Also
EXPONENTIAL SMOOTHING WITH TREND
Model:
Actual Demand = Base Demand + Trend + Error
Forecast = Base + Trend
Using Symbols,




t t t
T S F + =
1 ,
t t t,m
mT S F and + =
( )
1 , 1
1 ,

+ =
t t t
F D S Finally o
( )( )
1 1
1

+ + =
t t t
T S D o
( ) ( )
1 1
1

+ =
t t t t
T S S T and | |
1 0
1 0
s s
s s
|
o
and
where
EXPONENTIAL SMOOTHING WITH
SEASONALITY
Model:
Actual Demand = Base Demand X Seasonality Index + Error
Forecast = Base X Seasonality Index
Using Symbols,
m L t t m t L t t t
I S F I S F
+ +
= = . ; .
, 1 1 ,
( )
L t
t
t
t
I
S
D
I and

+
|
|
.
|

\
|
= 1
1 0
1 0
s s
s s

o
and
where
( )
1
1

+
|
|
.
|

\
|
=
t
L t
t
t
S
I
D
S o
Finally,
EXPONENTIAL SMOOTHING WITH TREND
& SEASONALITY (WINTERS MODEL)
Model:
Actual Demand = (Base Demand + Trend) X Seasonality Index + Error
Forecast = (Base + Trend) X Seasonality Index
Using Symbols,
( )
1 1 ,
.
+
+ =
L t t t t
I T S F
( )
L t
t
t
t
I
S
D
I and

+
|
|
.
|

\
|
= 1
1 0 ; 1 0 ; 1 0 s s s s s s | o and where
( ) ) ( 1
1 1

+ +
|
|
.
|

\
|
=
t t
L t
t
t
T S
I
D
S o
( )
m L t t t m t
I mT S F
+
+ = .
,
( ) ( )
1 1
1

+ =
t t t t
T S S T | |
Finally,