Demand forecasting in supply chain

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Demand forecasting in supply chain

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Content

Characteristics of forecasts

Components of forecasts and forecasting methods

Basic approach to demand forecasting

Time series forecasting methods

Measures of forecast error

Forecasting demand at Tahoe Salt

Demand forecasting in Indian Retail Industry

Role of forecasting

The basis for all strategic and planning decisions in a

supply chain

Used for both push and pull processes

Examples:

Production: scheduling, inventory, aggregate

planning

Marketing: sales force allocation, promotions, new

production introduction

Finance: plant/equipment investment, budgetary

planning

Personnel: workforce planning, hiring, layoffs

All of these decisions are interrelated

Characteristics of forecasting

Forecasts are always wrong. Should include expected

value and measure of error.

Long-term forecasts are less accurate than short-term

forecasts (forecast horizon is important)

Aggregate forecasts are more accurate than

disaggregate forecasts

Forecasting methods

Qualitative: primarily subjective; rely on judgment and

opinion

Time Series: use historical demand only

Static

Adaptive

Causal: use the relationship between demand and some

other factor to develop forecast

Simulation

Can combine time series and causal methods

Components of a demand

O=S+R+E

O= Observed demand

S = Systematic component: expected value of demand

R = Random component: part of the forecast that deviates from

the systematic component

E = Forecast Error: difference between forecast and actual

demand

Systematic component

Level

Trend

Seasonality

(current deseasonalized demand) (growth or decline in the demand) (predictable seasonable fluctuation)

1. Understand the objectives of forecasting

2. Integrate demand planning and forecasting

3. Identify major factors that influence the demand

forecast

4. Understand and identify customer segments

5. Determine the appropriate forecasting technique

6. Establish performance and error measures for the

forecast

Goal is to predict systematic component of demand

Additive: level + trend + seasonal factor

Mixed: (level + trend)(seasonal factor)

Static methods

Adaptive forecasting

Static Methods

Assume a mixed model:

Systematic component = (level + trend)(seasonal factor)

Ft+l = [L + (t + l)T]St+l

= forecast in period t for demand in period t + l

L = estimate of level for period 0

T = estimate of trend

St = estimate of seasonal factor for period t

Dt = actual demand in period t

Ft = forecast of demand in period t

7-9

Static Methods

Estimating seasonal factors

7-10

Before estimating level and trend, demand data must be

deseasonalized

Deseasonalized demand = demand that would have

been observed in the absence of seasonal fluctuations

Periodicity (p)

repeats itself

Quarter

II, 1998

III, 1998

IV, 1998

I, 1999

II, 1999

III, 1999

IV, 1999

I, 2000

II, 2000

III, 2000

IV, 2000

I, 2001

Demand Dt

8000

13000

23000

34000

10000

18000

23000

38000

12000

13000

32000

41000

next four quarters.

(Figure 7.1)

50,000

40,000

30,000

20,000

10,000

0

Deseasonalizing Demand

for p even (sum is from i = t+1-(p/2) to t+1+(p/2))

Dt =

S Di / p

for p odd (sum is from i = t-(p/2) to t+(p/2)), p/2 truncated to

lower integer

Deseasonalizing Demand

For the example, p = 4 is even

For t = 3:

D3 = {D1 + D5 + Sum(i=2 to 4) [2Di]}/8

= {8000+10000+[(2)(13000)+(2)(23000)+(2)(34000)]}/8

= 19750

D4 = {D2 + D6 + Sum(i=3 to 5) [2Di]}/8

= {13000+18000+[(2)(23000)+(2)(34000)+(2)(10000)]/8

= 20625

7-15

Deseasonalizing Demand

Then include trend

Dt = L + tT

Where

Dt = deseasonalized demand in period t

L = level (deseasonalized demand at period 0)

T = trend (rate of growth of deseasonalized demand)

Trend is determined by linear regression using deseasonalized

demand as the dependent variable and period as the

independent variable

In the example, L = 18,439 and T = 524

7-16

50000

Demand

40000

30000

Dt

Dt-bar

20000

10000

0

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

Period

7-17

Use the previous equation to calculate deseasonalized

demand for each period

St = Dt / Dt = seasonal factor for period t

In the example,

D2 = 18439 + (524)(2) = 19487

D2 = 13000

S2 = 13000/19487 = 0.67

The seasonal factors for the other periods are calculated

in the same manner

7-18

t

1

2

3

4

5

6

7

8

9

10

11

12

Dt Dt-bar S-bar

8000 18963 0.42 = 8000/18963

13000 19487 0.67 = 13000/19487

23000 20011 1.15 = 23000/20011

34000 20535 1.66 = 34000/20535

10000 21059 0.47 = 10000/21059

18000 21583 0.83 = 18000/21583

23000 22107 1.04 = 23000/22107

38000 22631 1.68 = 38000/22631

12000 23155 0.52 = 12000/23155

13000 23679 0.55 = 13000/23679

32000 24203 1.32 = 32000/24203

41000 24727 1.66 = 41000/24727

7-19

The overall seasonal factor for a season is then obtained

by averaging all of the factors for a season

If there are r seasonal cycles, for all periods of the form pt+i,

1<i<p, the seasonal factor for season i is

Si = [Sum(j=0 to r-1) Sjp+i]/r

In the example, there are 3 seasonal cycles in the data and

p=4, so

S1 = (0.42+0.47+0.52)/3 = 0.47

S2 = (0.67+0.83+0.55)/3 = 0.68

S3 = (1.15+1.04+1.32)/3 = 1.17

S4 = (1.66+1.68+1.66)/3 = 1.67

7-20

Using the original equation, we can forecast the next four

periods of demand:

F14 = (L+14T)S2 = [18439+(14)(524)](0.68) = 17527

F15 = (L+15T)S3 = [18439+(15)(524)](1.17) = 30770

F16 = (L+16T)S4 = [18439+(16)(524)](1.67) = 44794

7-21

Adaptive Forecasting

The estimates of level, trend, and seasonality are

adjusted after each demand observation

General steps in adaptive forecasting

Moving average

Simple exponential smoothing

Trend-corrected exponential smoothing (Holts model)

Trend- and seasonality-corrected exponential smoothing

(Winters model)

7-22

Ft+1 = (Lt + lT)St+1 = forecast for period t+l in period t

Lt = Estimate of level at the end of period t

Tt = Estimate of trend at the end of period t

St = Estimate of seasonal factor for period t

Ft = Forecast of demand for period t (made period t-1 or

earlier)

Dt = Actual demand observed in period t

Et = Forecast error in period t

At = Absolute deviation for period t = |Et|

MAD = Mean Absolute Deviation = average value of At

1. Initialize: Compute initial estimates of level (L 0), trend (T0),

and seasonal factors (S1,,Sp). This is done as in static

forecasting.

2. Forecast: Forecast demand for period t+1 using the

general equation

3. Estimate error: Compute error Et+1 = Ft+1- Dt+1

4. Modify estimates: Modify the estimates of level (L t+1),

trend (Tt+1), and seasonal factor (St+p+1), given the error

Et+1 in the forecast

Repeat steps 2, 3, and 4 for each subsequent period

Moving Average

Used when demand has no observable trend or

seasonality

Systematic component of demand = level

The level in period t is the average demand over the last N

periods (the N-period moving average)

Current forecast for all future periods is the same and is

based on the current estimate of the level

Lt = (Dt + Dt-1 + + Dt-N+1) / N

Ft+1 = Lt and Ft+n = Lt

After observing the demand for period t+1, revise the

estimates as follows:

Lt+1 = (Dt+1 + Dt + + Dt-N+2) / N

Ft+2 = Lt+1

From Tahoe Salt example (Table 7.1)

At the end of period 4, what is the forecast demand for periods

5 through 8 using a 4-period moving average?

L4 = (D4+D3+D2+D1)/4 = (34000+23000+13000+8000)/4 =

19500

F5 = 19500 = F6 = F7 = F8

Observe demand in period 5 to be D5 = 10000

Forecast error in period 5, E5 = F5 - D5 = 19500 - 10000 =

9500

Revise estimate of level in period 5:

L5 = (D5+D4+D3+D2)/4 = (10000+34000+23000+13000)/4 =

20000

F6 = L5 = 20000

Used when demand has no observable trend or seasonality

Systematic component of demand = level

Initial estimate of level, L0, assumed to be the average of all

historical data

L0 = [Sum(i=1 to n)Di]/n

Current forecast for all future periods is equal to the current

estimate of the level and is given as follows:

Ft+1 = Lt and Ft+n = Lt

After observing demand Dt+1, revise the estimate of the

level:

Lt+1 = aDt+1 + (1-a)Lt

Lt+1 = Sum(n=0 to t+1)[a(1-a)nDt+1-n ]

From Tahoe Salt data, forecast demand for period 1 using

exponential smoothing

L0 = average of all 12 periods of data

= Sum(i=1 to 12)[Di]/12 = 22083

F1 = L0 = 22083

Observed demand for period 1 = D1 = 8000

Forecast error for period 1, E1, is as follows:

E1 = F1 - D1 = 22083 - 8000 = 14083

Assuming a = 0.1, revised estimate of level for period 1:

L1 = aD1 + (1-a)L0 = (0.1)(8000) + (0.9)(22083) = 20675

F2 = L1 = 20675

Note that the estimate of level for period 1 is lower than in

period 0

Appropriate when the demand is assumed to have a level

and trend in the systematic component of demand but no

seasonality

Obtain initial estimate of level and trend by running a linear

regression of the following form:

Dt = at + b

T0 = a

L0 = b

In period t, the forecast for future periods is expressed as

follows:

Ft+1 = Lt + Tt

Ft+n = Lt + nTt

7-29

After observing demand for period t, revise the estimates for

level and trend as follows:

Lt+1 = aDt+1 + (1-a)(Lt + Tt)

Tt+1 = b(Lt+1 - Lt) + (1-b)Tt

a = smoothing constant for level

b = smoothing constant for trend

Example: Tahoe Salt demand data. Forecast demand for

period 1 using Holts model (trend corrected exponential

smoothing)

Using linear regression,

L0 = 12015 (linear intercept)

T0 = 1549 (linear slope)

7-30

Forecast for period 1:

F1 = L0 + T0 = 12015 + 1549 = 13564

Observed demand for period 1 = D1 = 8000

E1 = F1 - D1 = 13564 - 8000 = 5564

Assume a = 0.1, b = 0.2

L1 = aD1 + (1-a)(L0+T0) = (0.1)(8000) + (0.9)(13564) =

13008

T1 = b(L1 - L0) + (1-b)T0 = (0.2)(13008 - 12015) + (0.8)

(1549)

= 1438

F2 = L1 + T1 = 13008 + 1438 = 14446

F5 = L1 + 4T1 = 13008 + (4)(1438) = 18760

7-31

Smoothing

Appropriate when the systematic component of demand is

assumed to have a level, trend, and seasonal factor

Systematic component = (level+trend)(seasonal factor)

Assume periodicity p

Obtain initial estimates of level (L0), trend (T0), seasonal

factors (S1,,Sp) using procedure for static forecasting

In period t, the forecast for future periods is given by:

Ft+1 = (Lt+Tt)(St+1) and Ft+n = (Lt + nTt)St+n

7-32

Smoothing (continued)

After observing demand for period t+1, revise estimates for

level, trend, and seasonal factors as follows:

Lt+1 = a(Dt+1/St+1) + (1-a)(Lt+Tt)

Tt+1 = b(Lt+1 - Lt) + (1-b)Tt

St+p+1 = g(Dt+1/Lt+1) + (1-g)St+1

a = smoothing constant for level

b = smoothing constant for trend

g = smoothing constant for seasonal factor

Example: Tahoe Salt data. Forecast demand for period 1

using Winters model.

Initial estimates of level, trend, and seasonal factors are

obtained as in the static forecasting case

7-33

Example

L0 = 18439 T0 = 524

The observed demand for period 1 = D1 = 8000

Forecast error for period 1 = E1 = F1-D1 = 8913 - 8000 = 913

Assume a = 0.1, b=0.2, g=0.1; revise estimates for level and

trend for period 1 and for seasonal factor for period 5

L1 = a(D1/S1)+(1-a)(L0+T0) = (0.1)(8000/0.47)+(0.9)

(18439+524)=18769

T1 = b(L1-L0)+(1-b)T0 = (0.2)(18769-18439)+(0.8)(524) = 485

S5 = g(D1/L1)+(1-g)S1 = (0.1)(8000/18769)+(0.9)(0.47) = 0.47

F2 = (L1+T1)S2 = (18769 + 485)(0.68) = 13093

7-34

Forecast error = Et = Ft - Dt

Mean squared error (MSE)

MSEn = (Sum(t=1 to n)[Et2])/n

Absolute deviation = At = |Et|

Mean absolute deviation (MAD)

MADn = (Sum(t=1 to n)[At])/n

s = 1.25MAD

7-35

MAPEn = (Sum(t=1 to n)[|Et/ Dt|100])/n

Bias

Shows whether the forecast consistently under- or

overestimates demand; should fluctuate around 0

biasn = Sum(t=1 to n)[Et]

Tracking signal

Should be within the range of +6

Otherwise, possibly use a new forecasting method

TSt = bias / MADt

Moving average

Simple exponential smoothing

Trend-corrected exponential smoothing

Trend- and seasonality-corrected exponential

smoothing

7-37

Retail - The sale of goods or commodities in small

quantities directly to consumers.

Retailers in India

Shoppers Stop

Westside (Trent)

Pantaloon (Big Bazaar)

Lifestyle

RPG Retail (Foodworld, Musicworld)

Crossword

1. Beginning Early

2. Taking expert inputs

3. The tools used for demand forecasting cannot replace

domain expertise

4. Thinking of multiple solutions

5. Being on the field

Questionnaire

How is the forecasting done?

Past data and Targeted growth

Tastes and trends are subjective terms

What are some tips for developing a forecasting model for new

product?

try out different forecasting techniques

What is the period of time in the future for which you do forecasting?

a six monthly basis, place orders at 2 months in advance

Questionnaire

Does the volume of sale have a bearing on the rack

space you allocate to a good?

They have a fixed rack space and that dictates how much they can stock.

Could you relate a failure story?

Conclusion

The increasing competition in Indian Retail Sector is

compelling retailers to use demand forecasting tools.

Retailers who have their own brand labels use the

forecasting techniques of the kind we study in theory.

On the other hand, small scale retailers can employ

qualitative techniques on the historical data and

considering the behavior trends in the market.

References

Supply Chain Management by Sunil Chopra, Peter

Meindl, Dharam Vir Kalra

Images retail. http://www.imagesretail.com/india retail

report.htm.

www.sciencedirect.com

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