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MAIN TOPIC 4: FORECASTING DEMAND

 What is forecasting?
• FORECASTING is the art and science of predicting future
events. Forecasting may involve taking historical data and
projecting them into the future with some sort of
mathematical model. It may subjective or intuitive
prediction. Or it may involve a combination of these – that
is a mathematical model adjusted by a manager’s good
judgment.
 Principle of Forecasting
• Good forecasts are of critical importance in all aspects of
a business: The forecast is the only estimate of demand
until actual deman becomes known. Forecasts of demand
therefore drive decisions in many areas including (1)
human resources, (2) capacity, and (3) supply chain
management.
 Human Resources
• Hiring, training, and laying off workers all depend on
anticipated demand. If he human resources department
must hire additional workers without warning, the amount
of training declines and the quality of the workforce
suffers.
• A large Louisiana chemical firm almost lost its biggest
customer when a quick expansion to around-the-clock
shifts led to a total breakdown in quality control on the
second and third shifts.
 Capacity
• When capacity is inadequate, the resulting shortages can
lead to loss of customers and market share. This is exactly
what happened to Nabisco when it underestimated the
huge demand for its new low-fat Snackwell Devil’s Food
Cookies. Even with production lines working overtime,
Nabisco could not keep up with the demand, and it lost
customers.
• On the other hand, when excess capacity exists, costs can
skyrocket.
 Supply Chain Management
• Good supply relations and the ensuing price advantages
for materials and parts depend on accurate forecasts.
• In the global marketplace, where expensive components
for Boeing 787 jets are manufactured in dozens of
countries, coordination driven by forecasts is critical.
Scheduling transportation to Seattle for final assembly at
the lowest possible cost means no last-minute surprises
that can harm already-low profit margin.
Steps in the Forecasting Process
• Forecasting follows seven basic steps. These seven steps
presents a systematic way of initiating, designing, and
implementing a forecasting system. When the system is to
be used to generate forecasts regularly over time, data
must be routinely collected. The actual computations are
usually made by computer.
1. Determine the use of the forecast
• Walt Disney World uses park attendance forecasts to drive
decisions about staffing, opening times, ride availability, and food
supplies.
Steps in the Forecasting Process
2. Select the items to be forecasted
• For Disney World, there are six main parks. A forecast of daily
attendance at each is the main number that determines labor,
maintenance, and scheduling.
3. Determine the time horizon of the forecast
• Is it short, medium or long-term? Disney develops daily, weekly,
monthly, annual, and 5-year forecasts.
Steps in the Forecasting Process
4. Select the forecasting model(s)
• Disney uses a variety of statistical models, including moving
averages, econometrics, and regression analysis. It also employs
judgmental or nonquantitative models.
5. Gather the data needed to make the forecast
• Disney’s forecasting team employs 35 analysts and 70 field
personnel to survey 1 million people/businesses every year. It also
uses a firm called Global Insights for travel industry forecasts and
gathers data on exchange rates, arrivals into the U.S. airline
specials, Wall Street trends, and school vacation schedules.
Steps in the Forecasting Process
6. Make the forecast
7. Validate and implement the results
• At Disney, forecasts are reviewed daily at the highest level to
make sure that the model, assumptions, and data are valid. Error
measures are applied; then the forecasts are used to schedule
personnel down to 15-minute intervals.
 Forecasting Process
• Regardless of the system that firms like Walt Disney World use, each
company faces several realities:
• Forecasts are seldom perfect. This means that outside factors that we cannot predict or
control often impact the forecast. Companies need to allow for this reality.
• Most forecasting techniques assume that there is some underlying stability in the
system. Consequently, some firms automate their predictions using computerized
forecasting software, then closely monitor only the product items whose demand is
erratic.
• Both product family and aggregated forecasts are more accurate than individual
product forecasts. Disney, for example, aggregates daily attendance forecasts by park.
This approach helps balance the over- and underpredictions of each of the six
attractions.
 Types of Forecasting Methods
• Qualitative Forecast
• It incorporates such factors as the decision maker’s intuition,
emotions, personal experiences, and value system in reaching a
forecast
• Quantitative Forecast
• Use a variety of mathematical models that rely on historical data
and/or associative variables to forecast demand.
 Qualitative Forecast Techniques
• Jury of executive opinion
• The opinions of a group of high level experts or managers, often in combination with
statistical models, are pooled to arrive at a group estimate of demand
• Delphi method
• There are three different types of participants in this method: (1) decision makers,
(2)staff personnel, and (3) respondents.
• Decision makers usually consist of a group of 5 to 10 experts who wil be making he actual
forecast.
• Staff personnel assist decision makers by preparing, distributing, collecting, and
summarizing a series of questionnaires and survey results.
• The respondents are a group of people, often located in different places, whose judgments
are valued. This group provides inputs to the decision makers before the forecast is made
Qualitative Forecast Techniques
• Sales force composite
• Each sales person estimates what sales will be in his/her region.
These forecasts are then reviewed to ensure that they are realistic.
Then they are combined at the district and national levels to reach
an overall forecast.
• Consumer market survey
• Solicits input from customers or potential customers regarding
future purchasing plans. It can help not only in preparing as forecast
but also in improving product design and planning for new products.
 Quantitative Forecasting
Methods
• They fall into two categories:
1. Time Series Models
a) Naïve approach
b) Moving averages
c) Exponential Smoothing
d) Trend progression
2. Casual Models
a) Linear regression
 Moving averages
• Moving averages – uses a number of historical actual data
values to generate a forecast.
= ∑ demand in previous n periods
n
where n is the number of periods in the moving average
 Time Series Models
• Time series models predict on the assumption that the
future is a function of the past. They look at what
happened over a period of time and use a series of past
data to make a forecast.
• Naïve approach – a forecasting technique which assumes that
demand in the next period is equal to demand in the most recent
period. For some product lines, this approach is the most cost-
effective and efficient objective forecasting model. It provides a
starting point against which more sophisticated models that follow
can be compared.
Example 1. Donna’s Garden Supply wants a 3-month moving average
forecast, including a forecast for next Janaury, for shed sales.
APPROACH: Storage shed sales are shown in the middle column of the
table below. A 3-month moving average appears on the right.
Month Actual Shed Sales 3-month Moving Average
January 10
February 12
March 13
April 16 (10 + 12 + 13) ÷ 3 = 11 ⅔
May 19 (12 + 13 + 16) ÷ 3 = 13 ⅔
June 23 (13 + 16 +19) ÷ 3 = 16
July 26 (16 + 19 + 23) ÷ 3 = 19 ⅓
August 30 (19 + 23 +26) ÷ 3 = 22 ⅔
September 28 (23 + 26 + 30) ÷ 3 = 26 ⅓
October 18 (26 + 30 + 28) ÷ 3 = 28
November 16 (30 + 28 + 18) ÷ 3 = 25 ⅓
December 14 (28 + 18 + 16) ÷ 3 = 20 ⅔
 Weighted Moving Average
• When a detectable trend or pattern is present, weights
can be used to place more emphasis on recent values. This
practice makes forecasting techniques more responsive to
changes because more recent periods may be more
heavily weighted. Choice of weights is somewhat arbitrary
because there is no set formula to determine them.
Therefore, deciding which weights to use requires some
experience. For example, if the latest month or period is
weighted too heavily, the forecast may reflect a large
unusual change in the demand or sales pattern too
quickly.
Weighted Moving Average
= ∑ (weight for period n)(Demand in period n)
∑ Weights
Example 2. Donna’s Garden Supply wants to forecast storage shed
sales by weighting the past 3 months, with more weight given to recent
data to make them more significant.
APPROACH: Assign more weight to recent data, as follows:

Weights Applied Period

3 Last Month
2 Two months ago
1 Three months ago
6 Sum of weights
Forecast for this month =
3 x Sales last mo. ÷ 2 x Sales 2 mos. Ago + 1 x Sales 3 mos. ago
Sum of the weights
INSIGHT: In this particular forecasting situation, you can
see that more heavily weighting the latest month provides a
much more accurate projection.
Month Actual Shed Sales 3-month Weighted Moving Average
January 10
February 12
March 13
April 16 (3 x 13) ÷ (2 x 12) + (1 x 10) / 6 = 12 ⅙
May 19 (3 x 16) ÷ (2 x 13) + (1 x 12) / 6 = 14 ⅓
June 23 (3 x 19) ÷ (2 x 16) + (1 x 13) / 6 = 17
July 26 (3 x 23) ÷ (2 x 19) + (1 x 16) / 6 = 20 ⅟2
August 30 (3 x 26) ÷ (2 x 23) + (1 x 19) / 6 = 23 ⅚
September 28 (3 x 30) ÷ (2 x 26) + (1 x 23) / 6 = 27 ⅟2
October 18 (3 x 28) ÷ (2 x 30) + (1 x 26) / 6 = 28 ⅓
November 16 (3 x 18) ÷ (2 x 28) + (1 x 30) / 6 = 23 ⅓
December 14 (3 x 16) ÷ (2 x 18) + (1 x 28) / 6 = 18 ⅔
 Moving averages
• Both simple and weighted moving averages are effective in smoothing
out sudden fluctuation in the demand pattern to provide stable
estimates. Moving averages do, however, present three problems:
1. Increasing the size of n (the number of periods averaged) does smooth out
fluctuations better, but it makes the method less sensitive to real changes in
the data.
2. Moving averages cannot pick up trends very well. Because they are averages,
they will always stay within past levels and will not predict changes to either
higher or lower levels. That is, they lag the actual values.
3. Moving averages require extensive records of past data.
A plot of the data in Examples 1 and 2 ilustrates the lag effect of the moving
average models. Note that both the moving average and weighted moving
average lines lag the actual demand. the weighted moving average, however,
usually reacts more quickly to demand changes. even in periods of downturn
(see November and December), it more closely tracks the demand.
 Exponential Smoothing
• A sophisticated weighted moving average forecasting technique in which data
points are weighted by an exponential function. It involves very little record
keeping of past data.

New forecast = Last period’s forecast

+ α (Last period’s actual demand – Last period’s forecast)

where α is a weight, or smoothing constant, chosen by the forecaster, that has

a value between 0 and 1
 Exponential Smoothing
• Exponential smoothing equation can also written mathematically as:
= -1 + -1 - -1 )
where = new forecast
-1 = previous period’s forecast
= smoothing (or weighting) constant
-1 = previous period’s actual demand
• The concept is not complex. The latest estimate of demand is equal to
the old estimate adjusted by a fraction of the difference between the
last period’s actual demand and the old estimate.
In January, a car dealer predicted February demand for 142 Ford
Mustangs. Actual February demand was 153 autos. using a smoothing
constant chose by management of ( = 20), the dealer wants to frecast
March demand using the exponential smoothing model.

New forecast (for March demand) = 142 + .2 (153 - 142)

= 142 + 2.2
= 144.2
Thus, the March demand forecast for Ford Mustangs is
rounded to 144.
INSIGHT: Using just two pieces of data, the forecast and
the actual demand, plus a smoothing constant, we
developed a forecast of 144 Ford Mustangs for March.
The smoothing constant, , is generally in the range from 0.05
to .50 for business applications. It can be changed to give more
weight to recent data (when is high) or more weight to past data
(when is low).
The following table helps illustrate this concept. For example,
when = .5, we can see that the new forecast is based almost
entirely on demand in the last three or four periods. When = .1, the
forecast places little weight on recent demand and takes many
periods (about 19) of historical values into account.
 Selecting the Smoothing
Constant
• The exponential smoothing approach is easy to use, and it
has been successfully applied in virtually every type of
business. However, the appropriate value of the smoothing
constant, , can make the difference between an accurate
forecast and an inaccurate forecast. High values of are
chosen when the underlying average is fairly stable. In
picking a value for the smoothing constant, the objective
is to obtain the most accurate forecast.
 Trend Projections
• This technique fits a trend line to a sewries of historical
data points and then projects the line into the future for
medium to long-range forecasts.
• If we decide to develop a linear trend line by a precise
statistical method, we can apply the least-squares method.
This approach results in a straight line that minimizes the
sum of the squares of the vertical differencesor deviations
from the line to each of the actual observations.
 Causal Models
• Causal models or associative models incorporate the
variables or factors that might influence the quantity
being forecast.
Causal Models
 Focus Forecasting
• Focus forecasting is based on two pricnciples:
1. Sophisticated forecasting models are not always better than
simple ones.
2. There is no single technique that should be used for all products
or services
 Forecasting Software
• Forecast calculations are seldom performed by hand.
Most operation managers turn to software packages such
as SAP, SPSS, or Excel.
Collaborative Planning, Forecasting
and Replenishment (CPFR)
• A practice developed to
reduce supply chain costs
through collaboration
among what may be many
partners in a single supply
chain.
Four key elements to practicing
CPFR in supply chain operations
Benefits of CPFR
 Exercises
1. Refer to the table on page 18. What is the new forecast
in January:
a) If actual sales in December is 18.
b) If the actual sales in December is 20.
c) If the actual sales in November is 22.