Chapter 3: Demand management and forecasting

Demand management: Concerned with processing, influencing,

and anticipating demand.

Processing demand or, in more common terms, order processing

or order fulfillment
Chapter 3: Demand management and forecasting

What do we mean by demand?

• Demand is the total number of requests for a resource.
• Demand management is all about making choices.

Request: an act of asking politely or formally for something

Chapter 3: Demand management and forecasting

Traditional Demand Management

• how a firm integrates information from and about its
customers, internal and external to the firm, into the
manufacturing planning and control systems.

• How a firm integrates information from its customers with

information about the firms goals and capabilities, to
determine what should be produced in the future.
Chapter 3: Demand management and forecasting

Demand Management
• Demand Management is based on “forecast” and plans.
• In DM, forecasts of the quantities and timing of customer
demand are developed.
• What do we actually plan to deliver to customers each period
is the output of the process.
 Chapter 3: Demand management and forecasting

DM is:
• The process of ensuring the match b/n market demand and the
company’s capabilities
• Recognizing all demands for products and services to support the
marketplace.
• Doing what is required to help make the demand happen
• Prioritizing demand when supply is lacking.
• Planning and using resources for profitable business results.
 Chapter 3: Demand management and forecasting
Demand management components
• Goal customer service levels
• New product introductions
• Distribution resource planning
• Customer order entry
• Sales and marketing plans
• Inventory targets
• Product commitments
• Interplant shipments
• Demand forecasting
 Chapter 3: Demand management and forecasting

COMPONENTS OF DEMAND
• Demand that adds value is desirable and met
• Demand that adds value, is desirable, but cannot be met
• Demand that does not add value, undesirable, and should not be
met.
 Chapter 3: Demand …
WHY FORECAST AND PLANS ARE IMPORTANT

• Demand management is a concept that integrates project

proposals, portfolio analysis, and project management through
workflows.

• Typical demand management phases are create, select, plan,

and manage.
 Chapter 3: Demand …
WHY FORECAST AND PLANS ARE IMPORTANT
• The goal of demand management is to enable customers to
propose, view, categorize, prioritize, select, and track projects
within their organization.

• Demand management is based on a forecast and planning.

• But operations manager cannot be held responsible for not
getting a forecast right.

• Operations manager can and should be held responsible for

making their plans.
Chapter 3: Demand …
Following figure shows the four phases of demand management and how they fit together.
 Chapter 3: Demand …

BENEFITS OF DEMAND MANAGEMENT…

• Control over product availability
• Confidence of sales force in ability to deliver product
• Smoother product introductions
• Improved ability to respond to change
• A single game plan, based on the same set of numbers
 Chapter 3: Demand …
BENEFITS OF DEMAND MANAGEMENT…
• With the Demand Management, organizations can streamline
approval processes, while ensuring that Information Technologies
(IT) priorities are aligned with the broader business objectives and
that approved initiatives will deliver maximum business value.

Streamline: make (an organization or system) more efficient and

effective by employing faster or simpler working methods

Priority: a thing that is regarded as more important than another

 Chapter 3: Demand …

What is Forecasting?
• Process of predicting a future event based on historical (past) data
• Educated Guessing
• Underlying basis of all business decisions
• Production
• Inventory
• Personnel
• Facility
 Chapter 3: Demand …
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.

Forecasting: Always remember that managers are decision makers

and sound decisions are based on good forecasts.
 Chapter 3: Demand …

Forecasting

• Predict the next number in the pattern:

a) 3.7, 3.7, 3.7, 3.7, 3.7, ?

b) 2.5, 4.5, 6.5, 8.5, 10.5, ?

c) 5.0, 7.5, 6.0, 4.5, 7.0, 9.5, 8.0, 6.5, ?

Chapter 3: Demand …

Forecasting
• Predict the next number in the pattern:

a) 3.7, 3.7, 3.7, 3.7, 3.7, 3.7

b) 2.5, 4.5, 6.5, 8.5, 10.5, 12.5
 Chapter 3: Demand …
Importance of Forecasting in OM
•Throughout the day we forecast very different things such as
weather, traffic, stock market, state of our company from different
perspectives.

•Every business attempt is based on forecasting.

•Not all of them are derived from sophisticated methods.

•However, “Best" educated guesses about future are more

valuable for purpose of Planning.

•If there is no forecasts, then there is no planning.

Chapter 3: Demand …
Importance of Forecasting in OM
Departments throughout the organization depend on forecasts to
formulate and execute their plans.

Finance needs forecasts to project cash flows and capital

requirements.

Human resources need forecasts to anticipate hiring needs.

Production needs forecasts to plan production levels, workforce,

material requirements, inventories, and etc.
 Chapter 3: Demand …
Importance of Forecasting in OM

Demand is not the only variable of interest to forecasters.

Manufacturers also forecast:

• machine availability,
•material costs,
•transportation
•production lead times,
•worker absenteeism and others.

Service providers are also interested in forecasts of population, of

other demographic variables, of weather, and others.
 Chapter 3: Demand …

Types of forecasting:

1. Time series forecasting:

• Naïve,
• Moving average
• Exponential smoothing

2. Regression analysis

20
 Chapter 3: Demand …
Types of Forecasts by Time Horizon
Quantitative
• Short-range forecast
methods
– Usually < 3 months
• Job scheduling, worker assignments
Detailed
• Medium-range forecast use of
system
– 3 months to 2 years
• Sales/production planning
• Long-range forecast
– > 2 years
• New product planning Design
of system
Qualitative
Methods
 Chapter 3: Demand …
Forecasting during the life cycle of a product
Introduction Growth Maturity Decline

Qualitative models Quantitative models

- Executive judgment
- Time series analysis
- Market research
- Regression analysis
-Survey of sales force
-Delphi method
Sales

Time
Chapter 3: Demand …

Types of forecasts:
1. Qualitative forecasting:
• e.g. Delphi technique

2. Quantitative forecasting:
A. Time-Series forecasting
•Moving Average
•Exponential Smoothing
B. Regression analysis
 Chapter 3: Demand …
Qualitative methods are:

Executive Judgment: Opinion of a group of high level experts or

managers is pooled.

Sales Force Composite: Each regional salesperson provides his/her

sales estimates. Those forecasts are then reviewed to make sure they
are realistic. All regional forecasts are then pooled at the district and
national levels to obtain an overall forecast.

Market Research/Survey: Solicits input from customers pertaining

to their future purchasing plans.

It involves the use of questionnaires, consumer panels and tests of

new products and services.
.
 Chapter 3: Demand …
Delphi Method:

• As opposed to regular panels where the individuals involved are in

direct communication,

• this method eliminates the effects of group potential dominance

of the most vocal members.

• The group involves individuals from inside as well as outside a

firm.
 Chapter 3: Demand …

The procedure consists of the following steps:

• Each expert in the group makes his/her own forecasts in form of
statements
The coordinator collects all group statements and
summarizes them
The coordinator provides this summary and gives another set
of questions to each group member including feedback as to
the input of other experts.
The above steps are repeated until a consensus is reached.
 Chapter 3: Demand …
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
Chapter 3: Demand …

Quantitative
Forecasting

Time Series Regression

Models Models

2. Moving 3. Exponential
1. Naive
Average Smoothing
a) simple a) level
b) weighted b) trend
c) seasonality
 Chapter 3: Demand …
Time Series Models
Try to predict the future based on past data
• Assume that factors influencing the past will continue to
influence the future
 Chapter 3: Demand …

Time Series Models: Components

Random Trend

Composite
Seasonal
 Chapter 3: Demand …

Product Demand over Time

Demand for product or service

Year Year Year Year

1 2 3 4
Chapter 3: Demand …

Trend component
Seasonal peaks
Demand for product or service

Actual
Random demand line
variation
Year Year Year Year
1 2 3 4
Now let’s look at some time series approaches to forecasting…
Chapter 3: Demand …

1. Naive Approach
• Demand in next period is the same as demand in most
recent period June forecast = 48
 May sales = 48 →

• Usually not good

 Chapter 3: Demand …

2a. Simple Moving Average

• Assumes an average is a good estimator of future behavior
– Used if little or no trend
– Used for smoothing

A t + A t -1 + A t -2 + ... + A t -n 1
Ft 1 =
n

Ft+1 = Forecast for the upcoming period, t+1

n = Number of periods to be averaged
At = Actual occurrence in period t
Chapter 3: Demand … A t + A t -1 + A t -2 + ... + A t -n 1
Ft 1 =
n
2a. Simple Moving Average
You want to forecast sales for months 4-6 using a 3-
period moving average.
Sales
Month (000)
1 4
2 6
3 5
4 ?
5 ?
6 ?
Chapter 3: Demand …
A t + A t -1 + A t -2 + ... + A t -n 1
Ft 1 =
n
2a. Simple Moving Average
You want to forecast sales for months 4-6 using a 3-
period moving average.
Sales Moving Average
Month (000) (n=3)
1 4 NA
2 6 NA
3 5 NA
4 ? (4+6+5)/3=5
5 ?
6 ?
 Chapter 3: Demand …

2a. Simple Moving Average: What if sales were actually 3 in month 4

Sales Moving Average

Month (000) (n=3)
1 4 NA
2 6 NA
3 5 NA
4 3? 5
5 ?
6 ?
 Chapter 3: Demand …
2a. Simple Moving Average
Forecast for Month 5?

Sales Moving Average

Month (000) (n=3)
1 4 NA
2 6 NA
3 5 NA
4 3 5
5 ? (6+5+3)/3=4.667
6 ?
 Chapter 3: Demand …

2a. Simple Moving Average

Actual Demand for Month 5 is 7

Sales Moving Average

Month (000) (n=3)
1 4 NA
2 6 NA
3 5 NA
4 3 5
5 ?7 4.667
6 ?
 Chapter 3: Demand …

2a. Simple Moving Average

Forecast for Month 6?

Sales Moving Average

Month (000) (n=3)
1 4 NA
2 6 NA
3 5 NA
4 3 5
5 7 4.667
6 ? (5+3+7)/3=5
 Chapter 3: Demand …
2b. Weighted Moving Average: Gives more emphasis to recent data
• Weights
– decrease for older data
– sum to 1.0

Ft 1 = w1At + w 2At -1 + w3At -2 + ... + w n At -n 1

Simple moving
average models
weight all previous
periods equally
 Chapter 3: Demand …
2b. Weighted Moving Average: 3/6, 2/6, 1/6

Month Sales Weighted

(000) Moving
Average
1 4 NA
2 6 NA
3 5 NA
4 ? 31/6 = 5.167
5 ?
6 ?
Ft 1 = w1At + w 2At-1 + w3At-2 + ... + w n At -n1
 Chapter 3: Demand …
2b. Weighted Moving Average: 3/6, 2/6, 1/6

Month Sales (000) Weighted Moving Average

1 4 NA
2 6 NA
3 5 NA
4 3 31/6 = 5.167
5 7 25/6 = 4.167
6 32/6 = 5.333
Ft 1 = w1At + w 2At -1 + w3At -2 + ... + w n At -n 1
 Chapter 3: Demand …
3a. Exponential Smoothing: Assumes the most recent
observations have the highest predictive value.
• gives more weight to recent time periods

Ft+1 = Ft + a(At - Ft)

et

Ft+1 = Forecast value for time t+1

Needs initial
At = Actual value at time t
forecast Ft
 = Smoothing constant to start.
Chapter 3: Demand …
3a. Exponential Smoothing: Example 1

i Ai Ft+1 = Ft + (At - Ft)

Week Demand
1 820 Given the weekly demand
2 775 data what are the exponential
3 680 smoothing forecasts for
4 655 periods 2-10 using a=0.10?
5 750
6 802
Assume F1=D1
7 798
8 689
9 775
10
 Chapter 3: Demand …

3a. Exponential Smoothing: Example 1…

Ft+1 = Ft + a(At - Ft)
i Ai Fi

Week Demand  = 0.1 0.6

1 820 820.00 820.00
2 775 820.00 820.00
F2 = F1+ (A1–F1)
3 680 815.50 793.00=820+.1(820–820)
4 655 801.95 725.20=820
5 750 787.26 683.08
6 802 783.53 723.23
7 798 785.38 770.49
8 689 786.64 787.00
9 775 776.88 728.20
10 776.69 756.28
Chapter 3: Demand …
3a. Exponential Smoothing: Example 1…

i Ai Fi
Ft+1 = Ft + (At - Ft)
Week Demand  = 0.1 0.6
1 820 820.00 820.00
2 775 820.00 820.00
3 680 F3 =815.50
F2+ (A2–F2) 793.00=820+.1(775–820)
4 655 801.95 725.20
=815.5
5 750 787.26 683.08
6 802 783.53 723.23
7 798 785.38 770.49
8 689 786.64 787.00
9 775 776.88 728.20
10 776.69 756.28
 Chapter 3: Demand …

3a. Exponential Smoothing: Example 1…

Ft+1 = Ft + a(At - Ft)
i Ai Fi
Week Demand  = 0.1 0.6
1 820 820.00 820.00
2 775 820.00 820.00
3 680 815.50 793.00
4 655 801.95 725.20
5 750 787.26 683.08
6 802 783.53 This process continues
723.23
7 798 785.38 through week 10
770.49
8 689 786.64 787.00
9 775 776.88 728.20
10 776.69 756.28
 Chapter 3: Demand …
3a. Exponential Smoothing: Example 1
Ft+1 = Ft + a(At - Ft)
i Ai Fi Fi
Week Demand  = 0.1  = 0.6
1 820 820.00 820.00
2 775 820.00 820.00
3 680 815.50 793.00
4 655 801.95 725.20
5 750 787.26 683.08 What if the
6 802 783.53 723.23  constant
7 798 785.38 770.49 equals 0.6
8 689 786.64 787.00
9 775 776.88 728.20
10 776.69 756.28
3a. Exponential Smoothing: Example 2

Ft+1 = Ft + a(At - Ft)

i Ai Fi
Month Demand  = 0.3  = 0.6
January 120 100.00 100.00
February 90 106.00 112.00
March 101 101.20 98.80
April 91 101.14 100.12
May 115 98.10 94.65 What if the
June 83 103.17 106.86  constant
July 97.12 92.54 equals 0.6
August
September
3a. Exponential Smoothing: Example 3

Example 3: Assume that the long run demand for a given product
is relatively stable and a smoothing constant (alpha) of 0.05 is
considered appropriate.

If the exponential smoothing method were used as a continuing

policy, a forecast would have been made for last month.

Assume that last month’s forecast (Ft-1) was 1,050 units, and
1,000 units were actually demanded (At-1).
• The forecast for this month then would be calculated as
follows:

Ft+1 = Ft + a(At - Ft)

3a. Exponential Smoothing: Example 3

=1050 + .05( 1,000-1050)

= 1050 + .05(-50)
=1,047.5 units

52
 Chapter 3: Demand …

3a. Exponential Smoothing

• How to choose α
– depends on the emphasis you want to place on the most recent
data
• Increasing α makes forecast more sensitive to recent data
Chapter 3: Demand …
To Use a Forecasting Method
• Collect historical data
• Select a model
– Moving average methods
• Select n (number of periods)
• For weighted moving average: select weights
– Exponential smoothing
• Select 
• Selections should produce a good forecast

…but what is a good forecast?

Chapter 3: Demand …

A Good Forecast:

 Has a small error

 Error = Demand - Forecast
 Chapter 3: Demand …
et
Measures of Forecast Error
n

a. MAD = Mean Absolute Deviation A

t=1
t - Ft
MAD =
n

 A - Ft 
2
t
b. MSE = Mean Squared Error MSE = t =1
n

c. RMSE = Root Mean Squared Error RMSE = MSE

 Ideal values =0 (i.e., no forecasting error)
Chapter 3: Demand … n

A
t=1
t - Ft = 40 =10
MAD = 4
n

MAD Example: What is the MAD value given the forecast

values in the table below?
At Ft
Month Sales Forecast |At – Ft|
1 220 n/a
2 250 255 5
3 210 205 5
4 300 320 20
5 325 315 10
= 40
 n

MSE and RMSE Example 

 A t - Ft 2
= 550
MSE = t =1 =137.5
n 4

RMSE = √137.5
What is the MSE value?
=11.73
At Ft
Month Sales Forecast |At – Ft| (At – Ft)2
1 220 n/a
2 250 255 5 25
3 210 205 5 25
4 300 320 20 400
5 325 315 10 100
= 550
Chapter 3: Demand …
Measures of Error
1. Mean Absolute Deviation
(MAD)
n
t At Ft et |et| et2  e 84 t
MAD  1 = 14
Jan 120 100 20 20 400 n 6
-16 16
Feb 90 106 256 2a. Mean Squared Error
-1 1 1 (MSE)
Mar 101 102 n

-10 10 100 
 te  2

April 91 101 MSE  1 1,446

17 17 289 n = 241
May 115 98 6
-20 20 400
2b. Root Mean Squared Error
June 83 103 (RMSE)
-10 84 1,446
RMSE  MSE
= SQRT(241)
=15.52
 Chapter 3: Demand …
An accurate forecasting system will have small:
• MAD, MSE and RMSE;
• ideally equal to zero.

A large error may indicate that either the forecasting method used
or the parameters (such as α) used in the method are wrong.

Note: In the above, n is the number of periods, which is 6 in our

example.

60
 Chapter 3: Demand …
Regression Analysis as a Method for Forecasting

Regression analysis takes advantage of the r/ship b/n two variables.

Demand is then forecasted based on the knowledge of this

relationship and for the given value of the related variable.

E.g. 1: Sale of Tires (Y), Sale of Autos (X) are obviously related.
• If we analyze the past data of these variables and establish a
relationship between them, we may use that relationship to
forecast the sales of tires given the sales of automobiles.

E.g. 2. Construction permits issued versus the demand for cement.

The simplest form of the relationship is, of course, linear, hence it is

referred to as a regression line.
 Chapter 3: Demand …

Simple Linear Regression Model

Y

The simple linear regression

model seeks to fit a line a
through various data over time 0 1 2 3 4 5 x (Time)

Yt = a + bx
The simple linear regression model seeks to
fit a line through various data over time

•Yt is the regressed forecast value or dependent variable in the model

• a is the intercept value of the regression line, and
• b is similar to the slope of the regression line.
• Y= 441 + 359.7X equation of the forecast

63
Simple Linear Regression Formulas for Calculating “a” and “b”

a = y - bx

b =
 xy - n( y)( x )
 x - n( x )2 2
Simple Linear Regression Problem Data
Question: Given the data below, what is the simple linear
regression model that can be used to predict sales in future
weeks?

Week (x) Sales (y)

1 150
2 157
3 162
4 166
5 177
 Answer: First, using the linear regression formulas, we
can compute “a” and “b”

Week x*x y x*y

1 1 150 150
2 4 157 314
3 9 162 486
4 16 166 664
5 25 177 885
3 55 162.4 2499
Average Sum Average Sum

b=
 xy - n( y)( x) = 2499 - 5(162.4)(3)

63
= 6.3
 x - n( x )
2 2
55  5( 9 ) 10

a = y - bx = 162.4 - (6.3)(3) = 143.5

 67

The resulting regression model is: Yt = 143.5 + 6.3x

Now if we plot the regression generated forecasts

against the actual sales we obtain the following chart:

180
175
170
165
160 Sales
Sales

155 Forecast
150
145
140
135
1 2 3 4 5
Period
Chapter 3: Demand …
Forecast line for the sale of Tires (Y)

Sales of Autos (100,000)

Chapter 3: Demand …
Formulas
y=a+bx

b
 xy  n x y
 x  nx
2 2

Where:

Y= Sale of Tires a  y  bx
X= Sale of Autos

b= slope of equation of regression line

a= intercept of the equation

Chapter 3: Demand …
Regression: e.g. Ads and sales
b
 xy  n x y a  y  bx
y = a+ b X
 x  nx
2 2

2
Month Advertising Sales X XY
January 3 1 9.00 3.00
February 4 2 16.00 8.00
March 2 1 4.00 2.00
April 5 3 25.00 15.00
May 4 2 16.00 8.00
June 2 1 4.00 2.00
July
TOTAL 20 10 74 38
 Permits Sales (units)
Year (x) Y x.x x.y
2006 18 14000 324 252000
2007 15 12000 225 180000
2008 12 11000 144 132000
2009 10 8000 100 80000
2010 20 12000 400 240000
2011 28 16000 784 448000
2012 35 18000 1225 630000
2013 30 19000 900 570000
2014 20 13000 400 260000
2015 25 ? ∑ x2= 4502 ∑ x.y= 2792000
∑x =188
× ∑ Y=123000
71
Y= 5,576 + 387.2X is the equation of the forecast line
If in year 2015 the number of permits issued are expected to be 25,

• what will be the level of forecast for sales in 2015?

• what will be the level of forecast for sales in 2016 if permits to be

issued are 28?

• Y= 5,576 + 387.2 (number of permits issues in that year)

• Y=15,256 tons will be demanded in year 2015!!!
72
 Time series regression
We forecast based on the assumption that change on a certain
variable varies across time periods.

• Based exclusively on “what” happened in the past; not at all on

“why.”

• Need to select a base year.

73
Time series regression
Year Sales for T X Y XY X.X
1 2005 10 -5 10 -50 25
2 2006 14 -4 14 -56 16
3 2007 12 -3 12 -36 9
4 2008 14 -2 14 -28 4
5 2009 10 -1 10 -10 1
6 2010 20 0 20 0 0
7 2011 22 1 22 22 1
8 2012 16 2 16 32 4
9 2013 24 3 24 72 9
10 2014 20 4 20 80 16
11 2015 18 5 18 90 25
12 2016 23 6 180 116 110
13 2017 ? 7
14 2018 ? 8
Av.Y= Sum sum
n=11 X=0 16.36 XY=116 x.x=110

74
Time series regression
Year Sales for T X Y XY X.X
1 2005 10 -5 10 -50 25
2 2006 14 -4 14 -56 16
3 2007 12 -3 12 -36 9
4 2008 14 -2 14 -28 4
5 2009 10 -1 10 -10 1
6 2010 20 0 20 0 0
7 2011 22 1 22 22 1
8 2012 16 2 16 32 4
9 2013 24 3 24 72 9
10 2014 20 4 20 80 16
11 2015 ? 18 90 25
12 2016 ? 180 116 110
13 2017 ?
14 2018 ?
Av.Y= Sum sum
n=11 X=0 16.36 XY=116 x.x=110

75
76
Multiple regression analysis

Multiple regression analysis

• More than one independent variable is considered.

77
 Multiple regression analysis

Example: Gross sales for a year as being influenced by four

(independent) variables

78
 Multiple regression analysis

Where
S= Gross sales for year
A = Base sales, a starting point from which other factors have
influence
M=Marriages during the year
I= Annual disposable personal income
T= Time trend (first year =1, second year =2, third year=3 and so
on)

79
 Multiple regression analysis

• Bm, bh, bi and bt represent the influence on expected sales

of the number of marriages, housing starts, income and
trend, respectively.

• Forecasting by multiple regression is very appropriate when a

number of factors might influence a variable of interest (in
our case sales).

80
Chapter 3: Demand …

General Guiding Principles for Forecasting

1. Forecasts are more accurate for larger groups of items.

2. Forecasts are more accurate for shorter periods of time.

3. Every forecast should include an estimate of error.

4. Before applying any forecasting method, the total system should

be understood.

5. Before applying any forecasting method, the method should be

tested and evaluated.