Chapter Outline (Ch 12+ Ch 11)

 Forecasting
 Strategic Role of Forecasting in Supply
Chain Management and TQM
 Components of Forecasting Demand
 Time Series Methods
 Forecast Accuracy
 Regression Methods
 What is Forecasting?
► Process of predicting a
future event
► Underlying basis
of all business
decisions
► Production
► Inventory
► Personnel
► Facilities
Forecasting Time Horizons
1. Short-range forecast
► Up to 1 year, generally less than 3 months
► Purchasing, job scheduling, workforce levels,
job assignments, production levels
2. Medium-range forecast
► 3 months to 3 years
► Sales and production planning, budgeting
3. Long-range forecast
► 3+ years
► New product planning, facility location,
research and development
 Distinguishing Differences
1. Medium/long range forecasts deal with more
comprehensive issues and support
management decisions regarding planning
and products, plants and processes
2. Short-term forecasting usually employs
different methodologies than longer-term
forecasting and tend to be more accurate
than longer-term forecasts
Strategic Importance of
Forecasting
► Supply-Chain Management – Good
supplier relations, advantages in product
innovation, cost and speed to market
► Human Resources – Hiring, training,
laying off workers
► Capacity – Capacity shortages can result
in undependable delivery, loss of
customers, loss of market share
 Forecasting and Supply Chain
 Supply chain is all facilities, functions,
activities, associated with flow and
transformation of goods and services
from raw materials to customer, as well
as the associated information flows
 An integrated group of processes to
“source,” “make,” and “deliver” products
 Accurate forecasting determines how
much inventory a company must keep at
various points along its supply chain
10-7
Supply Chain Illustration
10-8
Supply
Chain
for
Denim
Jeans

10-9
Supply
Chain
for
Denim
Jeans
(cont.)

10-10
Supply Chain Processes

10-11
 Value vs. Supply Chain

 Value chain
 every step from raw materials to the eventual end
user
 ultimate goal is delivery of maximum value to the
end user
 Supply chain
 activities that get raw materials and subassemblies
into manufacturing operation
 Terms are used interchangeably

10-12
 Supply Chain
Management (SCM)
 Managing flow of information through supply
chain in order to attain the level of
synchronization that will make it more
responsive to customer needs while lowering
costs
 Keys to effective SCM
 information
 communication
 cooperation
 trust

10-13
 Supply Chain Uncertainty

 One goal in SCM:  Factors that contribute to

 respond to uncertainty in uncertainty
customer demand  inaccurate demand
without creating costly forecasting
excess inventory  long variable lead times
 Negative effects of  late deliveries
uncertainty  incomplete shipments
 lateness  product changes batch
 incomplete orders ordering
 Inventory
 price fluctuations and
discounts
 insurance against supply  inflated orders
chain uncertainty

10-14
 Bullwhip Effect

Occurs when slight demand variability is magnified as information

moves back upstream

10-15
 Supply Chain Integration

 Information sharing among supply chain

members
 Reduced bullwhip effect
 Early problem detection
 Faster response
 Builds trust and confidence
 Collaborative planning, forecasting,
replenishment, and design
 Reduced bullwhip effect
 Lower Costs (material, logistics, operating, etc.)
 Higher capacity utilization
 Improved customer service levels

10-16
 Forecasting and TQM

 Accurate forecasting customer demand is a

key to providing good quality service
 Continuous replenishment and JIT
complement TQM
 eliminates the need for buffer inventory, which, in
turn, reduces both waste and inventory costs, a
primary goal of TQM
 smoothes process flow with no defective items
 meets expectations about on-time delivery, which is
perceived as good-quality service
 Forecasting Approaches
Quantitative Methods
► Used when situation is ‘stable’ and
historical data exist
► Existing products
► Current technology
► Involves mathematical techniques
► e.g., forecasting sales of color
televisions
 Overview of Quantitative
Approaches
1. Naive approach
2. Moving averages
3. Exponential Time-
smoothing series
models
4. Trend projection
Associative
5. Linear regression model
 Forecasting Approaches
Qualitative Methods
► Used when situation is vague and
little data exist
► New products
► New technology
► Involves intuition, experience
► e.g., forecasting sales on Internet
Overview of Qualitative Methods

1. Jury of executive opinion

► Pool opinions of high-level experts,
sometimes augmented by statistical
models
2. Delphi method
► Respondents queried iteratively
Overview of Qualitative Methods

3. Sales force composite

► Estimates from individual salespersons
are reviewed for reasonableness, then
aggregated
4. Market Survey
► Ask the customer
 Delphi Method
► Iterative group
Decision Makers
process, continues (Evaluate responses
until consensus is and make decisions)

reached
Staff
► Three types of (Administering
survey)
participants
► Decision makers
► Staff
► Respondents Respondents
(People who can
make valuable
judgments)
Forecasting Methods

 Depend on
 time frame
 demand behavior
 causes of behavior
 Time Frame

 Indicates how far into the future is

forecast
 Short- to mid-range forecast
 typically encompasses the immediate future
 daily up to two years

 Long-range forecast
 usually encompasses a period of time longer
than two years
 Demand Behavior

 Trend
 a gradual, long-term up or down movement of
demand
 Random variations
 movements in demand that do not follow a pattern
 Cycle
 an up-and-down repetitive movement in demand
 Seasonal pattern
 an up-and-down repetitive movement in demand
occurring periodically
 Forms of Forecast Movement

Demand
Demand

Random
movement

Time Time
(a) Trend (b) Cycle

Demand
Demand

Time Time
(c) Seasonal pattern (d) Trend with seasonal pattern
 Quantitative Forecasting Methods

 Time series
 statistical techniques that use historical demand data
to predict future demand
 Regression methods
 attempt to develop a mathematical relationship
between demand and factors that cause its behavior
Forecasting Process
1. Identify the 2. Collect historical 3. Plot data and identify
purpose of forecast data patterns

6. Check forecast 5. Develop/compute 4. Select a forecast

accuracy with one or forecast for period of model that seems
more measures historical data appropriate for data

7.
Is accuracy of No 8b. Select new
forecast forecast model or
acceptable? adjust parameters of
existing model
Yes
9. Adjust forecast based 10. Monitor results
8a. Forecast over
on additional qualitative and measure forecast
planning horizon
information and insight accuracy
 Basis of Time Series method

 Assume that what has occurred in the past will

continue to occur in the future
 Relate the forecast to only one factor - time
 Include
 moving average
 exponential smoothing
 linear trend line
 Moving Average

 Naive forecast
 demand the current period is used as next
period’s forecast
 Simple moving average
 stable demand with no pronounced
behavioral patterns
 Weighted moving average
 weights are assigned to most recent data
Moving Average:
Naïve Approach
ORDERS
MONTH PER MONTH FORECAST

Jan 120 -
Feb 90 120
Mar 100 90
Apr 75 100
May 110 75
June 50 110
July 75 50
Aug 130 75
Sept 110 130
Oct 90 110
Nov - 90
Simple Moving Average

n

i=1
Di
MAn =
n
where

n =number of periods
in the moving
average
Di =demand in period i
 3-month Simple Moving Average

3
ORDERS MOVING
AVERAGE
 Di
i=1
MONTH PER MA3 =
Jan 120 – 3
MONTH
–
Feb 90 – 90 + 110 + 130
103.3 = 3
Mar 100 88.3
95.0
Apr 75 78.3 = 110 orders
78.3 for Nov
May 110 85.0
105.0
June 50 110.0

July 75
 5-month Simple Moving Average

ORDERS MOVING
AVERAGE 5
MONTH
Jan
PER
120 –
 Di
MONTH i=1
– MA5 =
Feb 90 –
5
–
90 + 110 + 130+75+50
Mar 100 – =
99.0
5
Apr 75 85.0
82.0 = 91 orders
May 110 88.0 for Nov
95.0
June 50 91.0

July 75
 Smoothing Effects
150 –

5-month
125 –

100 –
Orders

75 –

3-month
50 –

Actual
25 –

| | | | | | | | | | |
0–
Jan Feb Mar Apr May June July Aug Sept Oct Nov
Month
 Weighted Moving Average

 Adjusts WMAn =  Wi Di
i=1 i=1
moving
average where
method to Wi = the weight for period i,
more closely between 0 and 100
percent
reflect data
fluctuations
 W = 1.00
i
Weighted Moving Average Example

MONTH WEIGHT DATA

August 17% 130
September 33% 110
October 50% 90
3
November Forecast WMA3 =  Wi Di
i=1

= (0.50)(90) + (0.33)(110) + (0.17)(130)

= 103.4 orders
 Exponential Smoothing

 Averaging method
 Weights most recent data more strongly
 Reacts more to recent changes
 Widely used, accurate method
 Exponential Smoothing (cont.)

Ft +1 = Dt + (1 - )Ft
where:
Ft +1 = forecast for next period
Dt = actual demand for present period
Ft = previously determined forecast for
present period
= weighting factor, smoothing constant
 Effect of Smoothing Constant

0.0  1.0

If = 0.20, then Ft +1 = 0.20Dt + 0.80 Ft

If = 0, then Ft +1 = 0Dt + 1 Ft = Ft

Forecast does not reflect recent data

If = 1, then Ft +1 = 1Dt + 0 Ft =Dt

Forecast based only on most recent data
 Exponential Smoothing (α=0.30)

PERIOD MONTH F2 = D1 + (1 - )F1

DEMAND
= (0.30)(37) + (0.70)(37)
1 Jan 37 = 37

2 Feb 40 F3 = D2 + (1 - )F2

= (0.30)(40) + (0.70)(37)
3 Mar 41
= 37.9
4 Apr 37
F13 = D12 + (1 - )F12

5 May 45 = (0.30)(54) + (0.70)(50.84)

= 51.79
6 Jun 50

7 Jul 43
Exponential Smoothing
(cont.)
FORECAST, Ft + 1
PERIOD MONTH DEMAND ( = 0.3) ( = 0.5)
1 Jan 37 – –
2 Feb 40 37.00 37.00
3 Mar 41 37.90 38.50
4 Apr 37 38.83 39.75
5 May 45 38.28 38.37
6 Jun 50 40.29 41.68
7 Jul 43 43.20 45.84
8 Aug 47 43.14 44.42
9 Sep 56 44.30 45.71
10 Oct 52 47.81 50.85
11 Nov 55 49.06 51.42
12 Dec 54 50.84 53.21
13 Jan – 51.79 53.61
 Exponential Smoothing (cont.)
70 –

Actual  = 0.50
60 –

50 –
Orders

40 –
 = 0.30
30 –

20 –

10 –

| | | | | | | | | | | | |
0–
1 2 3 4 5 6 7 8 9 10 11 12 13
Month
Adjusted Exponential Smoothing

AFt +1 = Ft +1 + Tt +1
where
T = an exponentially smoothed trend factor

Tt +1 = (Ft +1 - Ft) + (1 - ) Tt
where
Tt = the last period trend factor
= a smoothing constant for trend
 Adjusted Exponential
Smoothing (β=0.30)
T3 = (F3 - F2) + (1 - ) T2
PERIOD MONTH
= (0.30)(38.5 - 37.0) + (0.70)(0)
DEMAND
= 0.45
1 Jan 37
AF3 = F3 + T3 = 38.5 + 0.45
2 Feb 40 = 38.95

3 Mar 41 T13 = (F13 - F12) + (1 - ) T12

= (0.30)(53.61 - 53.21) + (0.70)
4 Apr 37 (1.77)
= 1.36
5 May 45
AF13 = F13 + T13 = 53.61 + 1.36 = 54.96
6 Jun 50
 Adjusted Exponential Smoothing:
Example
FORECAST TREND ADJUSTED
PERIOD MONTH DEMAND Ft +1 Tt +1 FORECAST AFt +1

1 Jan 37 37.00 – –
2 Feb 40 37.00 0.00 37.00
3 Mar 41 38.50 0.45 38.95
4 Apr 37 39.75 0.69 40.44
5 May 45 38.37 0.07 38.44
6 Jun 50 38.37 0.07 38.44
7 Jul 43 45.84 1.97 47.82
8 Aug 47 44.42 0.95 45.37
9 Sep 56 45.71 1.05 46.76
10 Oct 52 50.85 2.28 58.13
11 Nov 55 51.42 1.76 53.19
12 Dec 54 53.21 1.77 54.98
13 Jan – 53.61 1.36 54.96
 Adjusted Exponential Smoothing
Forecasts
70 –
Adjusted forecast ( = 0.30)
60 –
Actual

50 –
Demand

40 –

Forecast ( = 0.50)
30 –

20 –

10 –

| | | | | | | | | | | | |
0–
1 2 3 4 5 6 7 8 9 10 11 12 13
Period
 Linear Trend Line

xy - nxy
y = a + bx b =
x2 - nx2
a = y-bx
where
a = intercept where
b = slope of the line n = number of periods
x = time period
x
y = forecast for x = = mean of the x values
demand for period x n
y
y = n = mean of the y values
Least Squares Example
x(PERIOD) y(DEMAND) xy x2
1 73 37 1
2 40 80 4
3 41 123 9
4 37 148 16
5 45 225 25
6 50 300 36
7 43 301 49
8 47 376 64
9 56 504 81
10 52 520 100
11 55 605 121
12 54 648 144
78 557 3867 650
 Least Squares Example
(cont.)
78
x = = 6.5
12
557
y = = 46.42
12
xy - nxy 3867 - (12)(6.5)(46.42)
b = = =1.72
x - nx
2 2
650 - 12(6.5) 2

a = y - bx
= 46.42 - (1.72)(6.5) = 35.2
 Linear trend line y = 35.2 + 1.72x
Forecast for period 13 y = 35.2 + 1.72(13) = 57.56 units

70 –

60 – Actual

50 –
Demand

40 –
Linear trend line
30 –

20 –

10 – | | | | | | | | | | | | |
1 2 3 4 5 6 7 8 9 10 11 12 13
Period
0–
 Seasonal Adjustments

 Repetitive increase/ decrease in demand

 Use seasonal factor to adjust forecast

Di
Seasonal factor = Si =
D
 Seasonal Adjustment (cont.)
DEMAND (1000’S PER QUARTER)
YEAR 1 2 3 4 Total
2002 12.6 8.6 6.3 17.5 45.0
2003 14.1 10.3 7.5 18.2 50.1
2004 15.3 10.6 8.1 19.6 53.6
Total 42.0 29.5 21.9 55.3 148.7

D1 42.0 D3 21.9
S1 = = = 0.28 S3 = = = 0.15
D 148.7 D 148.7
D2 29.5 D4
55.3
S2 = = = 0.20 S4 = = = 0.37
D 148.7 D 148.7
 Seasonal Adjustment (cont.)

For 2005

y = 40.97 + 4.30x = 40.97 + 4.30(4) = 58.17

SF1 = (S1) (F5) = (0.28)(58.17) = 16.28

SF2 = (S2) (F5) = (0.20)(58.17) = 11.63
SF3 = (S3) (F5) = (0.15)(58.17) = 8.73
SF4 = (S4) (F5) = (0.37)(58.17) = 21.53
 Forecast Accuracy

 Forecast error
 difference between actual demand and forecast
 MAD
 mean absolute deviation
 MAPD
 mean absolute percent deviation
 Cumulative error
 Average error or bias
Mean Absolute Deviation
(MAD)

 Dt - Ft 
MAD = n
where
t = period number
Dt = demand in period t
Ft = forecast for period t
n = total number of periods
= absolute value
 MAD Example
PERIOD DEMAND, Dt Ft ( =0.3) (Dt - Ft) | Dt - Ft |
1 37 – –
2 40 37.00 3.00 3.00
3 41 37.90 3.10 3.10
4 37
 D
 38.83t - Ft  -1.83 1.83
5 MAD
45 = n38.28 6.72 6.72
6 50 40.29 9.69 9.69
7 43 53.39 43.20 -0.20 0.20
=
8 47 1143.14 3.86 3.86
9 56 44.30 11.70 11.70
10 52 = 4.85 47.81 4.19 4.19
11 55 49.06 5.94 5.94
12 54 50.84 3.15 3.15
557 49.31 53.39
 Other Accuracy Measures

Mean absolute percent deviation (MAPD)

|Dt - Ft|
MAPD =
Dt
Cumulative error
E = et
Average error
et
E=
n
 Comparison of Forecasts

FORECAST MAD MAPD E (E)

Exponential smoothing (= 0.30) 4.85 9.6% 49.31 4.48
Exponential smoothing (= 0.50) 4.04 8.5% 33.21 3.02
Adjusted exponential smoothing 3.81 7.5% 21.14 1.92
(= 0.50, = 0.30)
Linear trend line 2.29 4.9% – –
 Forecast Control

 Tracking signal
 monitors the forecast to see if it is biased
high or low
(Dt - Ft) E
Tracking signal = =
MAD MAD
 1 MAD ≈ 0.8 б

 Control limits of 2 to 5 MADs are used most

frequently
 Tracking Signal Values
DEMAND FORECAST, ERROR E = TRACKING
PERIOD Dt Ft Dt - Ft (Dt - Ft) MAD SIGNAL

1 37 – – – –
2 40 37.00 3.00 3.00 3.00 1.00
3 41 37.90 3.10 6.10 3.05 2.00
4 37 38.83 -1.83 4.27 2.64 1.62
5 45 38.28
Tracking 6.72 for period
signal 10.99 3 3.66 3.00
6 50 40.29 9.69 20.68 4.87 4.25
7 43 43.20 -0.20 20.48 4.09 5.01
6.10
8 47 TS3 = 3.86 =24.34
43.14 2.00 4.06 6.00
9 56 44.30 3.05 36.04
11.70 5.01 7.19
10 52 47.81 4.19 40.23 4.92 8.18
11 55 49.06 5.94 46.17 5.02 9.20
12 54 50.84 3.15 49.32 4.85 10.17
 Tracking Signal Plot

3 –
Tracking signal (MAD)

2 – Exponential smoothing ( = 0.30)

1 –

0 –

-1 –

-2 – Linear trend line

-3 –
| | | | | | | | | | | | |
0 1 2 3 4 5 6 7 8 9 10 11 12
Period
 Statistical Control Charts

(Dt - Ft)2
=
n-1

 Using  we can calculate statistical

control limits for the forecast error
 Control limits are typically set at  3
 Statistical Control Charts

18.39 –
UCL = +3
12.24 –

6.12 –
Errors

0–

-6.12 –

-12.24 –
LCL = -3
-18.39 –
| | | | | | | | | | | | |
0 1 2 3 4 5 6 7 8 9 10 11 12
Period
 Regression Methods

 Linear regression
 a mathematical technique that relates a
dependent variable to an independent
variable in the form of a linear equation
 Correlation
 a measure of the strength of the relationship
between independent and dependent
variables
 Linear Regression

y = a + bx a = y-bx
xy - nxy
b =
x2 - nx2
where
a = intercept
b = slope of the line
x
x = = mean of the x data
n
y
y = n = mean of the y data
 Linear Regression Example
x y
(WINS) (ATTENDANCE) xy x2
4 36.3 145.2 16
6 40.1 240.6 36
6 41.2 247.2 36
8 53.0 424.0 64
6 44.0 264.0 36
7 45.6 319.2 49
5 39.0 195.0 25
7 47.5 332.5 49
49 346.7 2167.7 311
Linear Regression Example (cont.)
49
x= = 6.125
8
346.9
y= = 43.36
8

xy - nxy2
b=
x2 - nx2
(2,167.7) - (8)(6.125)(43.36)
=
(311) - (8)(6.125)2
= 4.06

a = y - bx
= 43.36 - (4.06)(6.125)
= 18.46
 Linear Regression Example (cont.)
Regression equation Attendance forecast for 7 wins
y = 18.46 + 4.06x y = 18.46 + 4.06(7)
= 46.88, or 46,880
60,000 –

50,000 –

40,000 –
Attendance, y

30,000 –
Linear regression line,
20,000 –
y = 18.46 + 4.06x

10,000 –

| | | | | | | | | | |
0 1 2 3 4 5 6 7 8 9 10
Wins, x
 Correlation and Coefficient of
Determination
 Correlation, r
 Measure of strength of relationship
 Varies between -1.00 and +1.00
 Coefficient of determination, r2
 Percentage of variation in dependent
variable resulting from changes in the
independent variable
 Computing Correlation
n xy -  x y
r=
[n x2 - ( x)2] [n y2 - ( y)2]

(8)(2,167.7) - (49)(346.9)
r=
[(8)(311) - (49)2] [(8)(15,224.7) - (346.9)2]

r = 0.947

Coefficient of determination
r2 = (0.947)2 = 0.897
The University Bookstore Student Computer
Purchase Program
The University Bookstore is owned and operated by State
University through an independent corporation with its
own board of directors. The bookstore has three locations
on or near the State University campus. It stocks a range
of items, including textbooks, trade books, logo apparel,
drawing and educational supplies, and computers and related
products such as printers, modems, and software.
The bookstore has a program to sell personal computers
to incoming freshmen and other students at a substantial
educational discount partly passed on from computer
manufacturers. This means that the bookstore just covers
computer costs with a very small profit margin
remaining.
Each summer all incoming freshmen and their parents
come to the State campus for a three-day orientation
program. The students come in groups of 100
throughout the summer. During their visit the students
and their parents are given details about the bookstore’s
computer purchase program. Some students
place their computer orders for the fall semester at this
time, while others wait until later in the summer. The
bookstore also receives orders from returning students
throughout the summer. This program presents a challenging
supply chain management problem for the
bookstore.
Orders come in throughout the summer, many only a
few weeks before school starts in the fall, and the computer
suppliers require at least six weeks for delivery.
Thus, the bookstore must forecast computer demand to
build up inventory to meet student demand in the fall. The
student computer program and the forecast of computer
demand have repercussions all along the bookstore supply
chain. The bookstore has a warehouse near campus where
it must store all computers since it has no storage space at
its retail locations. Ordering too many computers not only
ties up the bookstore’s cash reserves, but also takes up
limited storage space and limits inventories for other
bookstore products during the bookstore’s busiest sales
period. Since the bookstore has such a low profit margin
on computers, its bottom line depends on these other
products. As competition for good students has increased,
the university has become very quality-conscious and insists
that all university facilities provide exemplary student
service, which for the bookstore means meeting all student
demands for computers when the fall semester
starts. The number of computers ordered also affects
the number of temporary warehouse and bookstore workers
that must be hired for handling and assisting with
PC installations. The number of truck trips from the
warehouse to the bookstore each day of fall registration is
also affected by computer sales.
The bookstore student computer purchase program
has been in place for 14 years. Although the student population
has remained stable during this period, computer
sales have been somewhat volatile. Following is the historical
sales data for computers during the first month of
fall registration:

Develop an appropriate forecast model for bookstore

management to use to forecast computer demand for the
next fall semester and indicate how accurate it appears
to be. What other forecasts might be useful to the bookstore
in managing its supply chain?