DEMAND FORECASTING

IN A SUPPLY CHAIN
THE ROLE OF FORECASTING IN A SUPPLY CHAIN:

 All push processes in the supply chain are performed in anticipation of the customer demand

 All pull processes, are performed in response to the customer demand

 For push process a manager must plan the level of the activity, be it production, transportation or outsourcing

 For pull process, a manager must plan the level of available capacity & inventory, but not the actual amount to
be executed

 In both the processes the first step a manager must take is to forecast what customer demand will be
CHARACTERISTICS OF FORECAST IN ORDER TO DESIGN &
MANAGE HIS/HER SUPPLY CHAIN :
 Forecast are always inaccurate & should thus include both the expected value of the forecast & a measure for
forecast error
 Long term forecast are usually less accurate than short term forecast, that is long term forecast have a larger
standard deviation of error relative to the mean than short term forecast. Forecasting demand a month into the
future is harder than forecasting demand a day into the future.
 Aggregate forecasts are usually more accurate than disaggregate, as they tend to have a smaller standard
deviation of error relative to the mean
 In general the further up in the supply chain a company is (or further it is from the consumer)the greater the
distortion of information it receives
COMPONENTS OF FORECAST METHODS
 To forecast demand, companies must first identify the factors that influence future demand & then ascertain the
relationship between these factors & future demand.
 Companies must balance subjective & objective factors when forecasting demand
 Factors that are related to the demand forecast are
 Past demand
 Leadtime of production replenishment
 Planned advertising or market efforts
 Planned price discounts
 State of economy
 Action that competitors have taken

 It is important to recognize that the past demand is not the same as the past sales. Often a mistake is made of
looking into the companies historical sales & assuming that this is what the historical demand was. To get true
demand, however adjustments need to be made for unmet demand due to stockout, competitors action, pricing &
promotion. Failure to do so results in forecast that do not represent the current reality. Similarly a company must
also account for all factors that are likely to effect demand before it can select an appropriate forecasting
methodology
COMPONENTS OF FORECASTING METHODS

FORECASTING
METHODS

TIME SERIES CASUAL SIMULATION QUALITATIVE

Observed demand (O) =Systematic Component(S) + Random Component(R)

 Systematic Component : It measures the expected value of demand & consist of level, the current decentralized demand;
the trend the rate of growth or decline in demand for the next period; seasonality, the p[predictable seasonal fluctuations
in demand
 Random Component : It is a part of forecast that deviates the random component, All a company can predict is the
random component’s expected size & variability, which provides a measure of forecast error. The objective of forecasting
is to filter out the random component(noise) & estimate the systematic error
 The forecast error : It measures the difference between the forecast & actual demand.
POINTS THAT NEEDS TO BE INCORPORATED INTO THE
FORECASTING PROCESS
 Understand the objective of forecasting

 Integrate demand planning & forecasting throughout the supply chain

 Identify the major factors that influence the demand forecast

 Forecast at the appropriate level of aggregation

 Establish performance & error measures for the forecast

TIME SERIES FORECASTING METHODS:
Time series forecasting methods that primarily use historical demand data to come up with a forecast. The goal of any
forecasting method is to predict the systematic component of demand & estimate the expected value of the random
component.
The systematic component of demand data contains a level, a trend 7 a seasonal factor. The equation for calculating the
systematic component may take a variety of forms
 Multiplicative: Systematic component = level X trend X seasonal factor
 Additive : Systematic component = Level +level+ seasonal factor
 Mixed : Systematic component = (Level trend) x seasonal factor

The specific form of the systematic component applicable to a given forecast depends on the nature of demand .

Companies may develop both static & adaptive forecasting method for each form.
STATIC METHOD:
A static method assumes that the estimates of level, trend & seasonality with the systematic component do not vary as new
demand is observed. In this case, we estimate each of these parameters based on historical data & then use the same values
for all the future forecasts.

Systematic component = (level + trend) x seasonal factor

Where,
L = estimate of level at T=0 (the decentralized demand estimate in Period t for demand in period (T=0)
T = estimate the trend ( increase or decrease in demand per period)
St = estimate of seasonal factor for period t
Dt = actual demand observed in Period t
Ft = forecast of demand for Period t

In a static forecasting method, the forecast in Period t for demand in period t+l is a product of the level in Period
t+l & the seasonal factor for period t+l. Let L be the level at period 0. The level in period t+l is the sum of the
level in Period 0(L) & (t+l) times the trend T. The forecast in period t for demand in Period t+l is thus given as

Ft+l = [L+(t+l)T]St+l
To describe the following two steps required to estimate each of the 3 parameters –
level, trend, & seasonal factors
 Deseasonalize demand & run linear regression to estimate level & trend
 Estimate seasonal factors
ESTIMATING LEVEL & TREND
The objective of this process is to estimate the level at Period 0 & the trend. We start by Deseasonalizing the demand data i.e.,
The demand that would have been observed in the absence of seasonal fluctuations

The periodicity(p) is the number of periods after which the seasonal cycle repeats.

For Tahoe Salt’s demand, the pattern repeats every year. Given that we are measuring demand on a quarterly basis, the
periodicity for the demand is p=4
Dt = deseasonalized demand & not the actual demand in Period t
L = The level or deseasonalised demand at Period 0 & T represent the rate of growth of deseasonalised demand or trend

Dt = 18439+524t
ESTIMATING SEASONAL FACTORS :
St = Dt / Dt,

Where seasonal factor St for Period t is the ratio of the actual demand Dt to deseasonalised
demand Dt
ADAPTIVE FORECASTING
 In adaptive forecasting the estimates of level, trend & seasonality are updated after each demand observation.

 The main advantage of adaptive forecasting is that it estimates incorporate all new data that are observed

Lets assume that we have a set of historical data for n period & that demand is seasonal, with periodicity p. Given the quarterly
data, wherein the pattern repeats itself every year, we have periodicity of p=4
We begin by defying a few terms

Lt =estimate of level at the end of the period t

Tt = estimate of trend at the end of the period t
St = estimate of seasonal factor for period t
Ft= forecast of demand for period t (made in period t-1 or earlier)
Dt = actual demand observed in Period t
Et = Ft-Dt = Forecast error in period t

In adaptive method the forecast for period t+l in period t uses the estimate of level & trend in Period t (Lt & Tt respectively)
and is given as

Ft+l = (Lt+lT)St+1
 MOVING AVERAGE
The moving average method is used when demand has no observable trend or seasonality. In this case

Systematic component of demand = Level

In this method, the level in Period t is estimated as the average demand over the mist recent N period . This represents an N
period moving average & is evaluated as follows:

Lt =(Dt+Dt-1+…………+Dt-N+1)/N

The current forecast for all future periods is the same & is based oon the current estimate of level. The forecast is stated as

Ft+1 = Lt & Ft+n =Lt

After observation the demand for the period t+1, we revise the estimates as follows

Lt+1 = (Dt+1+ Dt+…….+Dt-N+2/N, Ft+2 = Lt+1

To compute the new average we are sampling adding the latest & dropping the oldest one. The revised moving average serves
as the next forecast.
FORECASTING
METHODS
QUANTITAVTIVE FORECASTING METHODS

Time series is a set of data taken after specific

and uniform time space or in common time
intervals such as months, years or weeks.

Time series forecasting is the use of model to

predict future values based on previously
observed values.
SIMPLE MOVING AVERAGE

Simple moving average method of forecasting is suitable under

situation where there is neither growth nor any positive or
negative trend. In this cast the forecast value is based on the
average of the values of some period as defined. If the average
period is of 4-5 period moving average then the average of the
recent 4-5 times is taken as a forecast for the next period. In
general forecast during “n” time period is given by

Ft = (At-1+At-2+At-3+………At-n)/n
ERRORS IN FORCASTING
RUNNING SUM OF FORECAST ERRORS (RSFE)

MEAN FORECAST ERROR(MFE)

MEAN ABSOLUTE DEVIATION (MAD)

MEAN SQUARE ERROR (MSE)

ROOT MEAN SQUARE ERROR(RMSE)

MEAN ABSOLUTE PERCENTAGE ERROR (MAPE)

WEIGHTED MEAN AVERAGE METHOD
One of the disadvantage of the Simple Moving Average
method is that it gives equal weightage to all the past
period. However, if a recent happening has more effect
on the demand for the next period, then it is prudent to
give more weightage to the most recent data rather than
equal weightage to all the past data.
WEIGHTED MEAN AVERAGE METHOD
Here we assign the weightage to the recent time period & estimate or
forecast is the sum of the product of the weightage 7 the actual data of
the corresponding period

Ft = (W1XAt-1 + W2XAt-2 + W3XAt-3+………WnXAt-n)/n

Where W1, W2, W3…………Wn are weights attached to each past time period totalling to 1

Note W1>W2>W3………Wn

Recent most given the most weightage data

SIMPLE EXPONENTIAL SMOOTHING
The drawback of both the earlier method is that in case of an error in
forecast, the model are no self correcting . In this simple exponential
smoothing method, the forecast error is calculated at every stage & a
factor (percentage) of this error is added into the forecast for the next
period.

This percentage depends on the exponential smoothing constant

‘alpha’ & the value of this is between 0&1
SIMPLE EXPONENTIAL SMOOTHING
Since the elements gets incorporated at every stage which results in an
exponential effect, as we proceed to later periods , this method is known as
exponential smoothing method. In general the exponential smoothing is taken as
0.3.

Symbolically ,
Ft+1= Alpha X At + (1-Alpha)Ft
Where alpha is exponential smoothing constant &
0 <= Alpha <=1
THANK YOU