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**Chapter 15. Demand Management and Forecasting
**

Demand Management

Independent vs. dependent demand

Qualitative Techniques

Market research, focus groups, Delphi technique, …

Quantitative Techniques

1. Time series based models

2. Associative (causal) Models

Accuracy and Control of Forecast (errors)

1. Measuring and comparing forecast errors using MAD,

MAPE, MSE, RMSE

2. Controlling Forecasting Process via Tracking Signal

2

A

B(4) C(2)

D(2) E(1) D(3) F(2)

Dependent Demand:

Raw Materials,

Component parts,

Sub-assemblies, etc.

Independent Demand:

Finished Goods

Demand Management

3

Demand Management

Active role to influence demand.

Examples from seasonal goods or services

Campaigns, discounts, etc.

Incentives to sales personnel

Passive role, limited or no action taken.

Why?

4

Qualitative Methods

Grass Roots

Market Research

Panel Consensus

Executive Judgment

Historical analogy

Delphi Method

Qualitative

Methods

5

Delphi Method

1. Choose the experts to participate representing 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 as necessary and distribute the final

results to all participants

6

Quantitative forecasting methods

Time series models

Past predicts future

Uses time series data

Key variable: time (t)

Easier to apply

Less accurate

Examples:

Moving averages

Exponential smoothing

Causal models

Examines potential cause => effect

relationships

Requires cross sectional data

Key variables are usually denoted

as X

1

, X

2

, X

3

, …

More difficult

Takes more time

But worth it since it provides

insight to the system (process)

under study

Examples:

Various regression models

7

Quantitative techniques

Basic time series approaches

i. Moving averages, simple &weighted

ii. Exponential smoothing, simple & trend adjusted

iii. Linear regression (linear trend model)

iv. Techniques for seasonality and trend -

Decomposition of time series

Causal approach

i. Simple Linear Regression

ii. Multiple Linear Regression

8

Finding Components of a Time Series

1 2 3 4

x

x

x

x

x

x

x x

x

x

x

x x x

x

x

x

x

x

x x

x

x

x

x x x

x

x

x

x

x

x

x

x

x

x

x

x

x

x

x

x

x

x

x

x

Year

S

a

l

e

s

Seasonal variation

Linear

Trend

15-8

9

What to look for in a time series

Trend - long-term movement in data

Seasonality - short-term regular and repetitive variations in data

Cyclical variations – long(er) term, occasionally caused by

unusual circumstances, (war, economic downturn, etc.)

Autocorrelation – denotes persistence of occurrence (momentum

driven)

Random variations - caused by chance

10

Moving Averages

Simple moving average (MA)

F

t

= Forecast for the coming period

n = Number of periods to be averaged

A

t-1

= Actual occurrence in the past

period for up to “n” periods

Weighted moving average (WMA)

permits an unequal weighting on

prior time periods

Excel time!

Problem 20.

n

A + ... + A + A + A

= F

n - t 3 - t 2 - t 1 - t

t

1 = w

A w + ... + A w + A w + A w = F

n

1 = i

i

n - t n 3 - t 3 2 - t 2 1 - t 1 t

¿

where

11

Exponential Smoothing Models

Simple exponential smoothing

model

Alpha is the smoothing constant

Whenever appropriate more weight

can be given to the more recent

data (time periods)

Double exponential smoothing

(Holt’s model)

Adds trend component, T and delta

(gamma) as the smoothing constant

for trend

Forecast Including Trend (FIT)

Excel time!

Problem 20, continued.

) F A ( F F

1 1 1 ÷ ÷ ÷

÷ + =

t t t t

o

1 0 where s so

) FIT F ( T T

1 1 ÷ ÷

÷ + =

t t t t

o

) FIT A ( FIT F

1 1 1 ÷ ÷ ÷

÷ + =

t t t t

o

t t t

T F FIT + =

12

Measuring Accuracy, Forecast Errors

To compare different time series techniques or to select the

“best” set of initial values for the parameters, use a combination

of the the following four metrics:

Mean Absolute Deviation

Most popular but

Mean Absolut Percent Error

Should be used in tandem with MAD

Mean Square Error

Root Mean Square Error

n

F A

= MAD

1

¿

=

÷

n

i

i i

¿

=

÷

n

i

i

i i

n

1

A

F A

100

= MAPE

( )

n

F A

= MSE

1

2

¿

=

÷

n

i

i i

MSE RMSE=

13

Tracking Signal

The Tracking Signal or TS is a measure that indicates

whether the forecast average is keeping pace with any

genuine upward or downward changes in demand.

Depending on the number of MAD’s selected, the TS can be

used like a quality control chart indicating when the model

is generating too much error in its forecasts.

TS is a monitoring system.

The TS formula is:

Deviation Absolute Mean

Errors Forecast of Sum Running

= TS

14

Regression analysis

Identify factors (independent variables) that can be used to

predict the values for the forecast variable (e.g., sales).

Regression applied to “causal” data requires different kinds of

data

Regression applied to “time series” data is also know as

“trend line analysis”

We will use Excel (Tools/Data analysis) to obtain the

regression line and all relevant statistics.

15

A simple regression example

The first example applies regression to “time series” data.

Whenever possible, plot and observe the data.

The scatter plot shows a linear relation between advertising and

sales. So the following regression model is suggested by the data,

which refers to the true relationship between the entire population of

advertising and sales values.

Other common formats are:

i

i

c | | + + =

1 1 0 i

X Y

t b a Y

X b a Y

+ =

+ =

16

Decomposition of a Time Series

Demand has both trend and seasonal components.

View data via Excel.

1. Compute overall average

2. Compute average of the same seasons of each cycle (e.g., year)

3. Compute seasonal indexes (seasonal averages / overall avg.)

4. Deseasonalize data (actual values /seasonal indexes)

5. Apply regression to deseasonalized data

6. Compute (project) deseasonalized forecasts using the regression

equation

7. Reseasonalize the forecasts by multiplying them with the

seasonal indexes.

Excel time.

Problem 21.

17

Multiple regression

Most regression problems involve more than one independent

variable.

If each independent variables varies in a linear manner with Y, the

estimated regression function in this case is:

Where b

0

is the intercept (also called constant)

The optimal values for the b

i

(slopes) can again be found using the

least squares method

k k

b b b b X X X Y

2 2 1 1 0

+ + + + =

18

Steps in multiple regression analysis

1. Hypotheses for testing whether a general linear model is useful is

predicting Y:

1. H

o

: ß

1

= ß

2

= ß

3

= ... = ß

k

= 0 (means there is NOTHING useful)

2. H

A

: At least one of the ß parameters in H

o

is nonzero.

2. Test statistic: F-statistic = MSR / MSE

3. If the model is deemed adequate (passes the F-test; rejected H

0

)

then go to step 4 (otherwise, none of variables have any impact on Y )

4. Conduct t-tests (significance tests) on ß parameters (slopes).

5. Remove the most insignificant independent variable, re-run the

regression, and go to step 4.

6. Repeat steps 4 & 5 until all remaining independent variable

parameters (slopes) are significant, then go to step 7

7. If the intercept (ß

0

) is insignificant then remove it, run regression one

more time.

Excel time!

19

What Forecasters Should Do

Determine what elements of historical data provide repeatable

patterns and utilize this to make extrapolations.

Make a list of the possible independent variables that may have

influenced the historical data and may influence future

outcomes.

Statistically correlate the independent variables to the outcome

history using regression analysis to validate their importance

and to calibrate their effects.

Make estimates of forecast error wherever possible using MAD

or standard deviation measures.

Make clear presentations of the results and assumptions and

listen to feedback.

20

Forecasting

Always remember that you (managers) are decision makers and

sound decisions are based on good forecasts

Suggested problems:

2, 3, 4, 7, 11, 12, 14, 17, 20, 21, 27

Demand Management

**Independent Demand: Finished Goods
**

A

B(4)

C(2)

Dependent Demand: Raw Materials, Component parts, Sub-assemblies, etc.

D(2)

E(1)

D(3)

F(2)

2

Incentives to sales personnel Passive role.Demand Management Active role to influence demand. discounts. limited or no action taken. etc. Examples from seasonal goods or services Campaigns. Why? 3 .

Qualitative Methods Grass Roots Market Research Qualitative Historical analogy Methods Panel Consensus Delphi Method Executive Judgment 4 .

Delphi Method 1. Repeat Step 4 as necessary and distribute the final results to all participants 5 . and again develop new questions 5. Summarize the results and redistribute them to the participants along with appropriate new questions 4. refining forecasts and conditions. Through a questionnaire (or E-mail). Choose the experts to participate representing a variety of knowledgeable people in different areas 2. obtain forecasts (and any premises or qualifications for the forecasts) from all participants 3. Summarize again.

X2 . … More difficult Takes more time But worth it since it provides insight to the system (process) under study Examples: Various regression models 6 .Quantitative forecasting methods Time series models Past predicts future Uses time series data Key variable: time (t) Easier to apply Less accurate Examples: Moving averages Exponential smoothing Causal models Examines potential cause => effect relationships Requires cross sectional data Key variables are usually denoted as X1 . X3 .

iv. ii. 7 .Quantitative techniques Basic time series approaches i. iii. simple &weighted Exponential smoothing. Moving averages. simple & trend adjusted Linear regression (linear trend model) Techniques for seasonality and trend Decomposition of time series Simple Linear Regression Multiple Linear Regression Causal approach i. ii.

15-8 Finding Components of a Time Series Seasonal variation x x x x x Linear x x x Sales x x x xx x x xx x x x x x x x xxx x x x x x xxxx x x x x x x x x x x x Trend 1 2 3 4 Year 8 .

(war.What to look for in a time series Trend .) Autocorrelation – denotes persistence of occurrence (momentum driven) Random variations . occasionally caused by unusual circumstances.caused by chance 9 . economic downturn. etc.short-term regular and repetitive variations in data Cyclical variations – long(er) term.long-term movement in data Seasonality .

10 ..Moving Averages Simple moving average (MA) A t -1 + A t -2 + A t -3 + ...+ A t -n Ft = n Weighted moving average (WMA) permits an unequal weighting on prior time periods Ft = w1A t -1 + w 2 A t -2 + w 3A t -3 + .+ w n A t -n Excel time! Ft = Forecast for the coming period n = Number of periods to be averaged A t-1 = Actual occurrence in the past period for up to “n” periods where w i =1 n i =1 Problem 20..

.Exponential Smoothing Models Simple exponential smoothing model Alpha is the smoothing constant Ft Ft 1 (At 1 Ft 1 ) where 0 1 Whenever appropriate more weight can be given to the more recent data (time periods) Double exponential smoothing (Holt’s model) Ft FITt 1 (At 1 FITt 1 ) Adds trend component. continued. T and delta (gamma) as the smoothing constant for trend Tt Tt 1 (Ft FITt 1 ) Forecast Including Trend (FIT) Excel time! FITt Ft Tt 11 Problem 20.

Forecast Errors To compare different time series techniques or to select the “best” set of initial values for the parameters. use a combination of the the following four metrics: n Mean Absolute Deviation A F Most popular but i 1 i i MAD = n Mean Absolut Percent Error Should be used in tandem with MAD 100 n A i Fi MAPE = n i 1 A i Mean Square Error A i Fi 2 MSE = i 1 n n Root Mean Square Error RMSE MSE 12 .Measuring Accuracy.

The TS formula is: TS = Running Sum of ForecastErrors Mean Absolute Deviation 13 . TS is a monitoring system. Depending on the number of MAD’s selected.Tracking Signal The Tracking Signal or TS is a measure that indicates whether the forecast average is keeping pace with any genuine upward or downward changes in demand. the TS can be used like a quality control chart indicating when the model is generating too much error in its forecasts.

Regression analysis Identify factors (independent variables) that can be used to predict the values for the forecast variable (e.. sales). Regression applied to “causal” data requires different kinds of data Regression applied to “time series” data is also know as “trend line analysis” We will use Excel (Tools/Data analysis) to obtain the regression line and all relevant statistics.g. 14 .

So the following regression model is suggested by the data. which refers to the true relationship between the entire population of advertising and sales values. plot and observe the data. The scatter plot shows a linear relation between advertising and sales. Whenever possible.A simple regression example The first example applies regression to “time series” data. Yi 0 1X1i i Other common formats are: Y a bX Y a bt 15 .

. 1. 5. View data via Excel. 6. 16 . 3. 4. Compute overall average Compute average of the same seasons of each cycle (e. Reseasonalize the forecasts by multiplying them with the seasonal indexes. Problem 21.) Deseasonalize data (actual values /seasonal indexes) Apply regression to deseasonalized data Compute (project) deseasonalized forecasts using the regression equation 7.g. 2.Decomposition of a Time Series Demand has both trend and seasonal components. year) Compute seasonal indexes (seasonal averages / overall avg. Excel time.

If each independent variables varies in a linear manner with Y. the estimated regression function in this case is: Y b0 b1X1 b2 X 2 bk X k Where b0 is the intercept (also called constant) The optimal values for the bi (slopes) can again be found using the least squares method 17 .Multiple regression Most regression problems involve more than one independent variable.

Repeat steps 4 & 5 until all remaining independent variable parameters (slopes) are significant. HA : At least one of the ß parameters in Ho is nonzero.Steps in multiple regression analysis 1. 6. If the model is deemed adequate (passes the F-test. Remove the most insignificant independent variable. Hypotheses for testing whether a general linear model is useful is predicting Y: 1. Conduct t-tests (significance tests) on ß parameters (slopes). none of variables have any impact on Y ) 4. and go to step 4. Test statistic: F-statistic = MSR / MSE 3. 5. rejected H0 ) then go to step 4 (otherwise. Excel time! 18 . re-run the regression. run regression one more time. 2.. Ho : ß1 = ß2 = ß3 = . then go to step 7 7.. If the intercept (ß0 ) is insignificant then remove it. = ßk = 0 (means there is NOTHING useful) 2.

Make clear presentations of the results and assumptions and listen to feedback. 19 . Make a list of the possible independent variables that may have influenced the historical data and may influence future outcomes. Make estimates of forecast error wherever possible using MAD or standard deviation measures. Statistically correlate the independent variables to the outcome history using regression analysis to validate their importance and to calibrate their effects.What Forecasters Should Do Determine what elements of historical data provide repeatable patterns and utilize this to make extrapolations.

Forecasting Always remember that you (managers) are decision makers and sound decisions are based on good forecasts Suggested problems: 2. 21. 12. 4. 17. 14. 3. 11. 27 20 . 7. 20.

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