Chapter 18

181
Chapter Eighteen
McGraw-Hill/Irwin Copyright 2014 by The McGraw-Hill Companies, Inc. All rights reserved.
182
Copyright 2014 by McGraw Hill Education (India) Private Limited. All rights reserved.
LO181: Understand how forecasting is essential to
supply chain planning
LO182: Evaluate demand using quantitative

forecasting models
LO183: Apply qualitative techniques to forecast

demand
LO184: Apply collaborative techniques to forecast

demand
183
Forecasting is a vital function and affects every significant
management decision.
Finance and accounting use forecasts as the basis for
budgeting and cost control.
Marketing relies on forecasts to make key decisions such as
new product planning and personnel compensation.
Production uses forecasts to select suppliers; determine
capacity requirements; and drive decisions about purchasing,
staffing, and inventory.
Different roles require different forecasting approaches.

Decisions about overall directions require strategic forecasts.
Tactical forecasts are used to guide day-to-day decisions.
184
Decoupling point: Point at which inventory is
stored, which allows SC to operate independently.
The choice of the decoupling point in a SC is

strategic.
Forecasting helps determine the level of inventory

needed at the decoupling points.
The decision will be affected by the error produced

in the forecast and the type of product (easily
inventoried or easily perishable).
185
There are four basic types of forecasts.
Qualitative
Time series analysis (primary focus of this
chapter)
Causal relationships
Simulation
Time series analysis is based on the idea

that data relating to past demand can be
used to predict future demand.
186
Average
demand for a Trend
period of time
Seasonal Cyclical
element elements
Random
Autocorrelation
variation Excel: Components
of Demand
For the Excel template visit

www.mhhe.com/sie-chase14e
187
Identification of trend lines is a common
starting point when developing a forecast.
Common trend types include linear, S-curve,
asymptotic, and exponential.
188
Using the past to predict the future
Short term forecasting less than 3 months
Used mainly for tactical decisions
Medium term forecasting 3 months to 2 years
Used to develop a strategy that will be implemented over the

next 6 to 18 months (e.g., meeting demand)
Long term forecasting greater than 2 years
Useful for detecting general trends and identifying major

turning points
189
Choosing an appropriate forecasting
model depends upon
Time horizon to be forecast
Data availability
Accuracy required
Size of forecasting budget
Availability of qualified personnel
1810
Amount of Historical Forecast
Forecasting Method Data Pattern
Data Horizon
6 to 12 months; Stationary (i.e.,
Simple moving
weekly data are often no trend or Short
average
used seasonality)
Weighted moving
average and simple 5 to 10 observations
Stationary Short
exponential needed to start
smoothing
Exponential 5 to 10 observations
Stationary and
smoothing with needed to start Short
trend
trend
Stationary,
Short to
Linear regression 10 to 20 observations trend, and
medium
seasonality
1811
Forecast is the average of a fixed number of past
periods.
Useful when demand is not growing or declining

rapidly and no seasonality is present.
Removes some of the random fluctuation from

the data.
Selecting the period length is important.

Longer periods provide more smoothing.
Shorter periods react to trends more quickly.
1812

1813
18-14
1814
The simple moving average formula implies
equal weighting for all periods.
A weighted moving average allows unequal
weighting of prior time periods.
The sum of the weights must be equal to one.
Often, more recent periods are given higher
weights than periods farther in the past.
= 1 1 + 2 2 + +

1815
Experience and/or trial-and-error are the
simplest approaches.
The recent past is often the best indicator

of the future, so weights are generally
higher for more recent data.
If the data are seasonal, weights should

reflect this appropriately.
1816
A weighted average method that includes all
past data in the forecasting calculation
More recent results weighted more heavily
The most used of all forecasting techniques
An integral part of computerized forecasting
1817
Well accepted for six reasons
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
Tests for accuracy are easy to compute
1818
18-19
1819
Week Demand Forecast
1 820 820
2 775 820
3 680 811
4 655 785
5 750 759
6 802 757
7 798 766
8 689 772
9 775 756
10 760
18-20
1820
The presence of a trend in the data causes the
exponential smoothing forecast to always lag behind
the actual data
This can be corrected by adding a trend adjustment
The trend smoothing constant is delta ()
1821
Calculate the new forecast, assuming the
following:
The previous forecast including trend (FITt-1) is 110
and the previous estimate of the trend (Tt-1) is 10
= 0.2 and = 0.3
Actual demand for period t-1 is 115
Ft = Ft-1 + (At-1 FITt-1) = 110 + 0.2(115-110) = 111.0
Tt = Tt-1 + (Ft-1 FITt-1) = 10 + 0.3(111-110) = 10.3
FITt = Ft + Tt = 111.0 + 10.3 = 121.3

1822
Relatively small values for and are
common
Usually in the range 0.1 to 0.3
depends upon how much random
variation is present
depends upon how steady the trend is
Measurement of forecast error can be used
to select values of and to minimize
overall forecast error
1823
Regression is used to identify the functional
relationship between two or more correlated variables,
usually from observed data.
One variable (the dependent variable) is predicted for
given values of the other variable (the independent
variable).
Linear regression is a special case that assumes the
relationship between the variables can be explained
with a straight line.
Y = a + bt
1824
The least squares method Quarter Sales Quarter Sales
determines the parameters a 1 600 7 2,600
and b such that the sum of the 2 1,550 8 2,900
squared errors is minimized 3 1,500 9 3,800
least squares 4 1,500 10 4,500
5 2,400 11 4,000
6 3,100 12 4,900
1825
1 600 600 1 360,000 801.3
2 1,550 3,100 4 2,402,500 1,160.9
3 1,500 4,500 9 2,250,000 1,520.5
4 1,500 6,000 16 2,250,000 1,880.1
5 2,400 12,000 25 5,760,000 2,239.7
6 3,100 18,600 36 9,610,000 2,599.4
7 2,600 18,200 49 6,760,000 2,959.0
8 2,900 23,200 64 8,410,000 3,318.6

The forecast is extended to periods 13-16
9 3,800 34,200 81 14,440,000 3,678.2
10 4,500 45,000 100 20,250,000 4,037.8
11 4,000 44,000 121 16,000,000 4,397.4
12 4,900 58,800 144 24,010,000 4,757.1

Sum 78 33,350 268,200 650 112,502,500
18-26
1826
Microsoft
Excel
includes data
analysis
tools, which
can perform
least squares
regression on
a data set.
1827
Chronologically ordered data are referred
to as a time series.
A time series may contain one or many
elements.
Trend, seasonal, cyclical, autocorrelation, and
random
Identifying these elements and separating
the time series data into these components
is known as decomposition.
1828
Seasonal variation may be either
additive or multiplicative (shown here
with a changing trend).
1829
The seasonal factor (or index) is the ratio of
the amount sold during each season divided by
the average for all seasons.
Average Sales for
Season Past Sales Seasonal Factor
Each Season
1000 200
Spring 200 = 250 = 0.8
4 250
1000 350
Summer 350 = 250 = 1.4
4 250
1000 300
Fall 300 = 250 = 1.2
4 250
1000 150
Winter 150 = 250 = 0.6
4 250
Total 1000
1830
Expected Average Next
Demand Sales for Seasonal Years
for Each Season Factor Seasonal
Next Year (1,100y4) Forecast
Spring 275 X 0.8 = 220
Summer 275 X 1.4 = 385
Fall 275 X 1.2 = 330
Winter 275 X 0.6 = 165
1100
1831
Decompose the time series into its
components
Find seasonal component
Deseasonalize the demand
Find trend component
Forecast future values of each component

Project trend component into the future
Multiply trend component by seasonal
component
1832
Using the data for periods 1-12, apply time series
analysis (decomposition, linear regression, trend
estimate & seasonal indices) to forecast for periods 13-16
1833
Develop a least squares regression line for the
deseasonalized data.
Project the regression line through the period of the
forecast.
Regression Results:
Y = 555.0 + 342.2t
Forecast for
periods 13-16
1834
Create the final forecast by adjusting
the regression line by the seasonal
factor.
Seasonal Forecast (F x
Period Quarter Y from Regression
Factor Seasonal Factor
13 I 5,003.5 0.82 4,102.87
14 II 5,345.7 1.10 5,880.27
15 III 5,687.9 0.97 5,517.26
16 IV 6,030.1 1.12 6,753.71
1835
Forecast error is the difference between the forecast
value and what actually occurred.
All forecasts contain some level of error.
Sources of error
Bias when a consistent mistake is made
Random errors that are not explained by the model
being used
Measures of error
Mean absolute deviation (MAD)
Mean absolute percent error (MAPE)
Tracking signal
1836
Ideally, MAD will be zero (no MAPE scales the forecast error to
forecasting error). the magnitude of demand.
Larger values of MAD
indicate a less accurate
model.
Tracking signal indicates whether

forecast errors are accumulating
over time (either positive or
negative errors).
1837
1838
Causal relationship forecasting uses
independent variables other than time to
predict future demand.
This independent variable must be a leading
indicator.
Many apparently causal relationships are

actually just correlated events care must be
taken when selecting causal variables.
1839
Often, more than one independent
variable may be a valid predictor of
future demand.
In this case, the forecast analyst may

utilize multiple regression.
Analogous to linear regression analysis, but
with multiple independent variables.
Multiple regression supported by statistical
software packages.
1840
Generally used to take advantage of expert
knowledge.
Useful when judgment is required, when
products are new, or if the firm has little
experience in a new market.
Examples
Market research
Panel consensus
Historical analogy
Delphi method
1841
A web-based process used to coordinate the
efforts of a supply chain.
Demand forecasting
Production and purchasing
Inventory replenishment
Integrates all members of a supply chain
manufacturers, distributors, and retailers.
Depends upon the exchange of internal
information to provide a more reliable view of
demand.
1842
Creation of a
Development
front-end Joint business Sharing Inventory
of demand
partnership planning forecasts replenishment
forecasts
agreement
1843
Forecasting is a fundamental step in any planning
process.
Forecast effort should be proportional to the

magnitude of decisions being made.
Web-based systems (CPFR) are growing in importance

and effectiveness.
All forecasts have errors understanding and

minimizing this error is the key to effective
forecasting processes.
1844

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181

LO182: Evaluate demand using quantitative

LO183: Apply qualitative techniques to forecast

LO184: Apply collaborative techniques to forecast

Different roles require different forecasting approaches.

The choice of the decoupling point in a SC is

Forecasting helps determine the level of inventory

The decision will be affected by the error produced

Time series analysis is based on the idea

For the Excel template visit

Used mainly for tactical decisions

Medium term forecasting 3 months to 2 years

Used to develop a strategy that will be implemented over the

Long term forecasting greater than 2 years

Useful for detecting general trends and identifying major

Useful when demand is not growing or declining

Removes some of the random fluctuation from

Selecting the period length is important.

The recent past is often the best indicator

If the data are seasonal, weights should

More recent results weighted more heavily

The most used of all forecasting techniques

An integral part of computerized forecasting

Ft = Ft-1 + (At-1 FITt-1) = 110 + 0.2(115-110) = 111.0

Tt = Tt-1 + (Ft-1 FITt-1) = 10 + 0.3(111-110) = 10.3

FITt = Ft + Tt = 111.0 + 10.3 = 121.3

2 1,550 3,100 4 2,402,500 1,160.9

3 1,500 4,500 9 2,250,000 1,520.5

4 1,500 6,000 16 2,250,000 1,880.1

5 2,400 12,000 25 5,760,000 2,239.7

6 3,100 18,600 36 9,610,000 2,599.4

7 2,600 18,200 49 6,760,000 2,959.0

8 2,900 23,200 64 8,410,000 3,318.6

10 4,500 45,000 100 20,250,000 4,037.8

11 4,000 44,000 121 16,000,000 4,397.4

12 4,900 58,800 144 24,010,000 4,757.1

Forecast future values of each component

Tracking signal indicates whether

Many apparently causal relationships are

In this case, the forecast analyst may

Forecast effort should be proportional to the

Web-based systems (CPFR) are growing in importance

All forecasts have errors understanding and

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