FORECASTING AND DEMAND PLANNING

CHAPTER 11

DAVID A. COLLIER AND JAMES R. EVANS

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 CHAPTER 11 FORECASTING AND DEMAND PLANNING

11-1 Describe the importance of forecasting to the

value chain.
11-2 Explain basic concepts of forecasting and time
series.
11-3 Explain how to apply simple moving average and
exponential smoothing models.
11-4 Describe how to apply regression as a forecasting
approach.
11-5 Explain the role of judgment in forecasting.
11-6 Describe how statistical and judgmental
forecasting techniques are applied in practice.

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 CHAPTER 11 FORECASTING AND DEMAND PLANNING

he demand for rental cars in Florida and other warm

climates peaks during college spring break season. Call
centers and rental offices are flooded with customers
wanting to rent a vehicle. National Car Rental took a unique
approach by developing a customer-identification forecasting
model, by which it identifies all customers who are young and rent
cars only once or twice a year. These demand analysis models
allow National to call this target market segment in February,
when call volumes are lower, to sign them up again. The
proactive strategy is designed to both boost repeat rentals and
smooth out the peaks and valleys in call center volumes.

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 CHAPTER 11 FORECASTING AND DEMAND PLANNING

What do you think?

Think of a pizza delivery

franchise located near a
college campus. What
factors that influence
demand do you think
should be included in
trying to forecast demand
for pizzas?

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 CHAPTER 11 FORECASTING AND DEMAND PLANNING

Forecasting and Demand Planning

Forecasting is the process of projecting the
values of one or more variables into the future.
Types of forecasts:
• Long-range forecasts in total sales dollars (top
management level)
• Aggregate forecasts of sales volume (middle
management level)
• Forecasts of individual units (operational level)

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 CHAPTER 11 FORECASTING AND DEMAND PLANNING

Exhibit 11.1 The Need for Forecasts in a Value Chain

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 CHAPTER 11 FORECASTING AND DEMAND PLANNING

Basic Concepts in Forecasting

• The planning horizon is the length of time on
which a forecast is based.
 This spans from short-range forecasts with a
planning horizon of under 3 months to long-
range forecasts of 1 to 10 years.
• The time bucket is the unit of measure for the
time period used in a forecast.

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 CHAPTER 11 FORECASTING AND DEMAND PLANNING

Basic Concepts in Forecasting

• A time series is a set of observations measured at
successive points in time or over successive periods
of time.
• A time series pattern may have one or more of the
following five characteristics:
 Trend
 Seasonal patterns
 Cyclical patterns
 Random variation (or noise)
 Irregular (one time) variation

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 CHAPTER 11 FORECASTING AND DEMAND PLANNING

Basic Concepts in Forecasting

• A trend is the underlying pattern of growth or decline in
a time series.
• Seasonal patterns are characterized by repeatable
periods of ups and downs over short periods of time.
• Cyclical patterns are regular patterns in a data series
that take place over longer periods of time.
• Random variation (sometimes called noise) is the
unexplained deviation of a time series from a predictable
pattern, such as a trend, seasonal, or cyclical pattern.
• Irregular variation is a one-time variation that is
explainable

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 CHAPTER 11 FORECASTING AND DEMAND PLANNING

Exhibit 11.2 Example Linear and Nonlinear Trend Patterns

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 CHAPTER 11 FORECASTING AND DEMAND PLANNING

Exhibit 11.3 Seasonal Pattern of Home Natural Gas Usage

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 CHAPTER 11 FORECASTING AND DEMAND PLANNING

Exhibit Extra
Trend and Business Cycle Characteristics (each data point is 1 year apart)

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 CHAPTER 11 FORECASTING AND DEMAND PLANNING

Exhibit 11.4
Call Center Volume

Example of a
time series
with trend and
seasonal
components

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 CHAPTER 11 FORECASTING AND DEMAND PLANNING

Exhibit 11.5 Chart of Call Volume

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 CHAPTER 11 FORECASTING AND DEMAND PLANNING

Basic Concepts in Forecasting

• Forecast error is the difference between the observed
value of the time series and the forecast, or At – Ft.
• Mean Square Error (MSE)
Σ(At – Ft )2
MSE = [11.1]
T
• Mean Absolute Deviation Error (MAD)
Σ‫(׀‬At – Ft ) ‫׀‬ [11.2]
MAD =
T
• Mean Absolute Percentage Error (MAPE)

MAPE = Σ‫(׀‬At – Ft )/At ‫׀‬ X 100 [11.3]

T
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 CHAPTER 11 FORECASTING AND DEMAND PLANNING

Exhibit 11.6 Forecast Error of Example Time-Series Data

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 CHAPTER 11 FORECASTING AND DEMAND PLANNING

Basic Concepts in Forecasting

• MSE is influenced much more by large forecasts errors
than by small errors (because the errors are squared).
• The measurement scale factor in MAPE is eliminated by
dividing the absolute error by the time-series data value,
making it easier to interpret.
• The selection of the best measure of forecast accuracy is
not a simple matter; indeed, forecasting experts often
disagree on which measure should be used.

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 CHAPTER 11 FORECASTING AND DEMAND PLANNING

Statistical Forecasting Models

• Statistical forecasting is based on the
assumption that the future will be an
extrapolation of the past.
• Judgmental forecasting relies upon
opinions and expertise of people in
developing forecasts.

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 CHAPTER 11 FORECASTING AND DEMAND PLANNING

Single Moving Average

• A moving average (MA) forecast is an
average of the most recent “k” observations in a
time series.
Ft+1 = ∑(most recent “k” observations)/k
= (At + At–1 + At–2 1 ... 1 At–k+1)/k [11.4]
• MA methods work best for short planning horizons when there
is no major trend, seasonal, or business cycle pattern.
• As the value of “k” increases, the forecast reacts slowly to
recent changes in the time series data.

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 CHAPTER 11 FORECASTING AND DEMAND PLANNING

Exhibit 11.7 Summary of Three-Month Moving Average Forecasts

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 CHAPTER 11 FORECASTING AND DEMAND PLANNING

Solved Problem
Develop three-period and four-period moving-average
forecasts and single exponential smoothing forecasts with α
= 0.5. Compute the MAD, MAPE, and MSE for each. Which
method provides a better forecast?
Period Demand Period Demand
1 86 7 91
2 93 8 93
3 88 9 96
4 89 10 97
5 92 11 93
6 94 12 95
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 CHAPTER 11 FORECASTING AND DEMAND PLANNING

Solved Problem

Using the Excel Moving Average and Exponential

Smoothing templates, we find that the MSE for a
three-period moving average is 5.98, the MSE for a
four-period moving average is 6.21, and the MSE for
the exponential-smoothing model is 9.65.

Based on these error metrics (MAD, MSE, MAPE), the 3-

month moving average is the best method among the
three.

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 CHAPTER 11 FORECASTING AND DEMAND PLANNING

Exhibit 11.10 Excel Moving Average Forecasting Template

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 CHAPTER 11 FORECASTING AND DEMAND PLANNING

Single Exponential Smoothing

Single Exponential Smoothing (SES) is a
forecasting technique that uses a weighted
average of past time-series values to forecast the
value of the time series in the next period.

Ft+1 = At + (1 – )Ft

= Ft +  (At – Ft) [11.5]

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 CHAPTER 11 FORECASTING AND DEMAND PLANNING

Exhibit 11.9 Summary of Single Exponential Smoothing Milk-Sales Forecasts with

α = 0.2

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 CHAPTER 11 FORECASTING AND DEMAND PLANNING

Regression as a Forecasting Approach

Regression analysis is a method for building a statistical
model that defines a relationship between a single
dependent variable and one or more independent variables,
all of which are numerical.
Yt = a + bt (11.7)
• Simple linear regression finds the best values of a and b
using the method of least squares.
• Excel provides a very simple tool to find the best-fitting
regression model for a time series by selecting the Add
Trendline option from the Chart menu.

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 CHAPTER 11 FORECASTING AND DEMAND PLANNING

Exhibit 11.11 Factory Energy Costs

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 CHAPTER 11 FORECASTING AND DEMAND PLANNING

Exhibit 11.12 Add Trendline Dialog

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 CHAPTER 11 FORECASTING AND DEMAND PLANNING

Exhibit 11.13 Least-Squares Regression Model for Energy Cost Forecasting

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 CHAPTER 11 FORECASTING AND DEMAND PLANNING

Causal Forecasting with Multiple Regression

A linear regression model with more than one
independent variable is called a multiple linear
regression model.
• Multiple regression models can include other
independent variables such as economic indexes
or demographic factors that may influence the
time series.

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 CHAPTER 11 FORECASTING AND DEMAND PLANNING

Exhibit 11.14 Gasoline Sales Data

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 CHAPTER 11 FORECASTING AND DEMAND PLANNING

Exhibit 11.15 Chart of Sales versus Time

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 CHAPTER 11 FORECASTING AND DEMAND PLANNING

Exhibit 11.16 Multiple Regression Results

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 CHAPTER 11 FORECASTING AND DEMAND PLANNING

Judgmental Forecasting
• Judgmental forecasting relies upon opinions
and expertise of people in developing forecasts.
• Grass Roots forecasting is simply asking those
who are close to the end consumer, such as
salespeople, about the customers’ purchasing plans.

• The Delphi method consists of forecasting by

expert opinion by gathering judgments and opinions
of key personnel based on their experience and
knowledge of the situation.

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 CHAPTER 11 FORECASTING AND DEMAND PLANNING

Forecasting in Practice
• Managers use a variety of judgmental and
quantitative forecasting techniques.
• Statistical methods alone cannot account for
such factors as sales promotions, competitive
strategies, unusual economic disturbances, new
products, large one-time orders, labor
complications, etc.
• Statistical forecasts are often adjusted to
account for qualitative factors.

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 CHAPTER 11 FORECASTING AND DEMAND PLANNING

Forecasting in Practice
A tracking signal provides a method for
monitoring a forecast by quantifying bias—the
tendency of forecasts to consistently be larger or
smaller than the actual values of the time series.

Tracking signal = Σ(At – Ft)/MAD [11.8]

Tracking signals between plus and minus 4 indicate an

adequate forecasting model.

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 CHAPTER 11 FORECASTING AND DEMAND PLANNING

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 CHAPTER 11 FORECASTING AND DEMAND PLANNING

BankUSA: Forecasting Help Desk Demand by Day

Case Study
1. What are the service management
1. What are the service
characteristics ofmanagement
the CSR job?characteristics
2.of Define
the CSRthejob?
mission statement and strategy
2. Define theHelp
of the mission statement
Desk. Why isand thestrategy
Help Deskof the
Help Desk contact
important? Whocenter.
are itsWhy is the Help Desk
customers?
3.important?
How would Who arehandle
you its customers?
the customer
3. How would you
affected handle
by the the customer
inaccurate stockaffected
price inby
thethe
inaccurate stockaccount
bank’s trust price in the banksWould
system? trust
account system?
you take Wouldoryou
a possive take a passive
proactive or
approach?
proactive approach?
Justify your answer.Justify your answer.
4.4.Using the the
Using datadata
on Call
on Volume in theat right, how
call volume
accompanying table, how
would you forecast would youdemand?
short-term forecast
short-term demand?

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