Section : Managing The Supply Chain

Chapter 13: Forecasting

Importance of Forecasting
Any management decision in any business
organization depends on forecasts for the
organizations products.
It is the basis of long-run planning, budgetary
planning and control.
-To plan new products, deciding about
advertisement strategy (Marketing)
-Process selection, capacity planning, facility layout,
production planning, inventory management
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(Production and Operation)
Forecasts
A perfect forecast is usually impossible. There
are many random factors in any business
environment.
For that, it is very important to establish the
practice of continual review of forecasts and to
learn to live with inaccurate forecasts.
A good strategy is to use two or three methods
and try to take a common-sense view.

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Demand Management
To coordinate and control all of the sources of
demand so that the productive system can be
used efficiently and the product delivered on
time.
There are two basic sources of demand:
Dependent demand and Independent demand.
Dependent Demand- The demand for a product or
service caused by the demand for other
products.
Independent Demand- The demand for a product
or service does not depend on any other
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product.
Demand Management: Active and
Passive Role To Influence Demand
Active role - Apply pressure on sales force, offer
incentive to customer and own employee,
wage campaign to sell products, cut price (to
increase demand); price increase, reduced sales
effort (to decrease demand)
Passive role - Accept what happens; when
running on full capacity, market size is fixed and
static, demand is beyond control
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Demand Management
Coordination is required to manage demand.
Demands originate internally and externally in the
form new product sales from marketing, repair
parts for previously sold products from product
service, restocking from the factory warehouse,
and supply items for manufacturing.

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Types of Forecasting
Qualitative subjective and judgmental, based
on estimates and opinions.
Time Series Analysis data relating to past
demand can be used to predict future demand;
past data may include trend, seasonal, and/or
cyclical components.
Causal Forecasting assumes that demand
related to some underlying factor in the
environment.
Simulation allow the forecaster to run
through a range of assumptions about the
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condition of the forecast.
Components of Demand
Average demand for a product - The average portion of the
demand
Trend Increment or decrement of demand with time
Seasonal element Increment or decrement of demand in
a particular season during a year
Cyclical element Increment or decrement of demand for
occurrences like political elections, war, economic
condition, sociological pressure, etc.
Autocorrelation - Denotes the persistence of occurrence;
the value expected at any point is highly correlated with
its own past values
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Random Uncertain portion of the demand
Trend
Trend lines are the starting point and then adjusted for
seasonal, cyclical, and any other expected event that may
influence demand.
Linear trend Straight continuous relationship
S-curve Typical of product growth and maturity cycle;
changes in trend line are the critical points
Asymptotic trend Highest demand growth at the beginning
but then tapers off; this can happen when a firm enters an
existing market with the objective of saturating and
capturing a large share of the market
Exponential trend For products with explosive growth;
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demand will continue to increase
Trend (Continued)
A widely used forecasting method plots data and then
searches for the standard distribution that fits best.

The attractiveness of this method is that because the

mathematics for the curve are known, solving for future
time periods is easy.

When data does not seem to fit any of the standard type,
effective forecast can be obtained by plotting data.

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Qualitative Techniques
Grass Roots
Builds the forecasts by adding successively from
the bottom
The person closest to the end user knows its
future needs best. In many instances its a valid
assumption.
Forecast at the bottom level are summed and
given to the next level. This continues up to top
level.

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Market Research
Firms specializing in market research conduct
forecasting survey.

It is mostly for product research (new product ideas,

likes and dislikes about existing product, preference
about competitive products, etc.)

Data collection methods are primarily surveys and

interviews.

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Panel Consensus
The idea that two heads are better than one is
extrapolated to the idea that a panel of people from a
variety of positions can produce a more reliable
forecast.
Forecasts are developed through open meetings with
free exchange of ideas from all levels of management
and individual.
A concern is that lower levels employees might be
intimidated by higher level employees.
When forecasting are at a broader and higher level
(introducing a new product line, strategic product
decisions), the term executive judgment is used. 12
Historical Analogy
In developing forecast for a new product, demand for
existing products or generic products can be used as
model.

For example, demand for DVD players are somewhat

related to demand for DVDs.

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Delphi Method
Similar to panel consensus but the identities of
the individuals attending the study are
concealed.
No intimidation by the higher level of
management.
Everybodys opinion has the same weight.

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Step-by-Step Procedure
Choose the expert to participate. There should be a
variety of knowledgeable person in different areas.
Through a questionnaire (or E-mail), obtain forecasts
from all participants.
Summarize the results and redistribute them to the
participants along with appropriate new questions.
Summarize again, refining forecasts and conditions,
and again develop new questions.
Repeat the previous step if necessary. Distribute the
final results to all participants.

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Quantitative Techniques
Time Series Analysis
Time series forecasting models try to predict the
future based on past data.
-Sales figures collected for the last twelve weeks can
be used to predict the demand in the thirteenth
week.
Forecasting can be done for short-term (under three
months), medium-term (three months to two
years), and long-term (more than two years).

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Time Series Analysis (Continued)
Choosing a forecasting model depends on
Time horizon to forecast

Data availability
Accuracy required

Size of forecasting period

Availability of qualified personnel

Degree of flexibility (response time to change in
demand) of the organization

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Simple Moving Average
It is used when demand for a product is neither
growing or declining rapidly.
Forecast for the next period is the average of the
past n periods.
The longer the moving average period, the greater
the random elements are smoothed.
-But, if there is a trend in the data, the moving
average has the adverse characteristic of lagging
the trend.
Data availability and storing is crucial in using
moving average method. 18
Weighted Moving Average
A weighted moving average allows any weights to be
placed on each data, providing, of course, that the
sum of all weights equals 1.

Ft= w1 At-1+ w2 At-2+ w3 At-3++ wn At-n

Choosing Weights:
-Experience and trial and error are the simplest ways.
-Most recent past values might get the highest weight.
-If the data has seasonal influence, weights should be
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established accordingly.
Exponential Smoothing Technique
Most recent occurrences are more indicative of the future than
those in the more distant past.
In exponential smoothing, each increment in the past is
decreased by (1-), where is the smoothing constant.
Advantages:
-Exponential models are surprisingly accurate.
-Formulating an exponential model is relatively easy.
-The user can understand how the model works.
-Little computation is required to use the model.
-Computer storage requirements are small because of the limited
use of historical data.
-Test for accuracy as to how well the model is performing are easy
to compute. 20
Exponential Smoothing Technique (Continued)
Three pieces of data are needed: most recent forecast,
actual demand that occurred for that forecast, and a
smoothing constant ().
Ft = Ft-1 + (At-1 Ft-1)
determines the level of smoothing and the speed of
reaction to differences between forecast and actual
performance.
is determined both by the nature of the product and
by the management sense of what constitutes a good
response.
-For a standard item with relatively stable demand,
reaction rate will be small.
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-If the product is experiencing growth, the reaction rate
will be higher.
Choosing The Smoothing Constant
Single exponential smoothing has the
shortcoming of lagging changes in demand.
The higher the values of , the more closely the
forecast follows the actual.
To more closely track actual demand, a trend
factor may be added.
FITt = Ft +Tt
Ft = FITt-1 +(At-1- FITt-1)
Tt = Tt-1 +(At-1- FITt-1)
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Example
Exponential smoothed forecast for the month of
September was 100 units. Trend effect for
September was 10 units. But, actual demand in
September turned out to be 115. Calculate forecast
including trend for October. The values of and
are 0.20 and 0.30 respectively.

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Adaptive Forecasting
Two or more predetermined values of The
amount of error between the forecast and the
actual demand is measured. If the error is large,
large value of (0.8) is used; if the error is small,
small value of (0.2) is used.

Compute values for A tracking computes

whether the forecast is keeping pace with
genuine upward or downward changes in
demand. The tracking is defined as the
exponentially smoothed actual error divided by
the exponentially smoothed absolute error. It can
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range from 0 to 1.
Forecast Errors
The difference the forecast value and what actually
occurred. If the error is within confidence limit,
this is not really an error.
Demand for a product is generated through the
interaction of a number of factors too complex to
describe accurately in a model. Therefore, all
forecasts certainly contain some error.

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Sources of Errors
One source is projecting past trends into future.
-In regression analysis, it is common to attach a
confidence band to the regression line to reduce the
unexplained error. The error may not be defined
correctly by the projected confidence band. As
confidence interval is based on past data, it may not
provide same confidence for the future value.
-Error can be classified as bias or random.
-Bias error occurs when a consistent mistake is made.
Random errors cannot be explained by the
forecasting model. 26

-
Measurement of Error
Mean absolute deviation (MAD) The average absolute
error.
(At Ft)
MAD =
- n
Tracking signal (TS) A measurement that indicates
whether the forecast average is keeping pace with any
genuine upward or downward changes in demand. It is
the number of MAD that the forecast value is above or
below the occurrence.
RSFE 27
TS =
MAD
Measurement of Error (Continued)
Acceptable limits for the tracking signal depend on
the size of the demand being forecast (high-
volume or high-revenue items should be
monitored frequently) and the amount of
personal time available.

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Linear Regression Analysis
Regression can be defined as a functional
relationship between two or more correlated
variables. The relationship is usually developed
from observed data.
Linear regression refers to the special class of
regression where the relationship between
variables forms a straight line.
Y = a + bX
X= Independent variable, Y= Dependent variable,
a= Y-axis intercept, b= Slope 29

-
Advantages and Disadvantages
-Linear regression is useful for long-term
forecasting of major occurrences and aggregate
planning. It would be very useful to forecast
demands for product families.
- The major restriction is that past data and future
projections are assumed to fall about a straight
line.

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Linear Regression Model
Y = a + bX
a = y - bx
xy nx.y
b=
x2-nx2

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Example
A firms sales for a product during the last 12 quarters of
the past 3 years were as follows:
Quarter Sales Quarter Sales Quarter Sales
1 600 5 2400 9 3800
2 1550 6 3100 10 4500
-
3 1500 7 2600 11 4000
4 1500 8 2900 12 4900

The firm wants to forecast sales for each quarter for the
next year using linear regression technique.

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Example Trend and Seasonal Effect
A firms sales for a product during the last 8 quarters of the
past 2 years were as follows:
Quarter Sales Quarter Sales
I-2011 300 I-2012 520
II-2011 200 II-2012 420
-
III-2011 220 III-2012 400
IV-2011 530 IV-2012 700

The firm wants to forecast sales for each quarter for the
next year.

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