Integrated Planning – Module 2

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 Agenda
• Forecasting,
• Factors influencing Demand
• Basic Demand Patterns
• Basic Principles of Forecasting
• Principles of Data Collection
• Basic Forecasting Techniques, Seasonality
• Sources & Types of Forecasting Errors
Forecasting can be conducted at
various levels
Required for Examples
• Product life cycle • Product line transitions
• Long-term capacity • Annual volume out
planning 3-5 years
• Capital asset/equipment/ • Buy/build/lease
Strategic human resource decisions
management

• Budgeting • Total annual/monthly

• Financial reporting volume
Financial
• Working capital • Projected product mix
management

• Production scheduling • Weekly/monthly SKU-

• Purchasing level demand
• Resource planning • Order size and
• Customer service frequency
Operational management (product
allocations)

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 Role of Forecasting in Supply Chain,
• Basis for Strategic & Planning Decisions in SCM
• Decisions needing Forecast as Base
• Production
- Scheduling
-Inventory Control
-- Aggregate Planning
- Purchasing
• Marketing
-Allocation of Sales-Force
-- Promotion Activities
-- New Product Launching
• Finance
-Plant & Equipment Investment
-- Budgetary Planning
• HR
-Workforce Planning
-- Recruitment
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- Lay-Offs
 Forecasting Impact Directly impacted by
demand management

Demand management
Sales
history/ Forecasting Demand planning Sales and operations
orders planning

Production management

Aggregate planning

Distribution management
Master production
Inventory management scheduling (MPS)

BOM
Materials requirement inventory
planning (MRP) routing

Capacity requirements
Distribution/transport planning (CRP)
network

Shop floor scheduling Purchasing

and control

Production

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 Higher forecast accuracy improves
service levels at lower inventory
Percent
Monthly average forecast error Reducing forecast error
100 Excellent Far Poor will permit
20% 40% 50%
1 Reduced inventory to a given
99 1
3 service level
2
2 Increased service level for a
98 given inventory level
3 Both reduced inventory and
97 improved service level

96

95

0
94
2 4 6 8 10 12
Required average inventory
Weeks
Forecasting error must be measured at different
levels
Forecasting error
Percent Forecasting tips
Mean forecasting error • Measure forecasting error as the
mean absolute percent error
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50 (Forecast – actual sales)

SKU/DC (12 oz. Forecast
ketchup bottle in
40 Dallas warehouse)* • Error of forecasting can be
measured at various levels:
30 SKU level product family, brand, SKU,
(12 oz. bottle) SKU/DC and will improve at higher
Brand level levels of consolidation
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(ketchup) • Frequency of measurement is
10 usually monthly; however, best
Product family level (all practitioners are doing weekly
condiments) forecasts
0
-12 -10 -8 -6 -4 -2 -0 • Measure bias as the mean
percent error**
Manufacturing (Forecast – actual sales)
lead time
Forecast

* Required level of detail for planning

** A consistently positive or negative bias indicates a tendency to7 over- or under-forecast which may be easily remedied
 Range of algorithms can be used
COMMON FORECAST ALGORITHMS

Model Calculation/description
Simple • Last year plus percent • Last year‟s same period demand* increased by a flat
percentage

• Last 3 months • Last 3-month moving average of demand

• Experiential smoothing • Last 12-month moving average with most recent
2-3 months more heavily weighted

• Seasonality with trend • Experiential smoothing with a seasonality factor that

weights periods differently based on relative
historical demand throughout the year

• Regression • Incorporates variables other than historical demand

(e.g., price promotional activity) to best fit historical
demand patterns

• Time series • Uses Fourier transforms to best fit historical demand

patterns

• Real-time regression using • Modifies above models with changes in customer

Complex POS data takeaway based on Nielsen; IRI data

* Demand can be sales, shipments, orders depending on what works best and data available

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Regression-based forecasting on high-promotion
items Fiscal year 1
Fiscal year 2
Fiscal year 3
National cases shipped/week – ketchup example
90,000
Off-invoice
80,000 promotions

70,000 Key business drivers

• Off-invoice promotions
60,000 – Before a summer holiday
Post-promotion – Without holiday
50,000
period
• Promotion month end week
40,000
• Postpromotion period
30,000

20,000

10,000

0 Actual peak shipment week is

1 10 20 30 40 5052
last week of fiscal month
Fiscal
week Higher peaks prior to
Memorial Day and
Labor Day

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Forecasting implementation requires three success
factors

Tools and • “Single-point” forecast to manage (i.e., consistency

methodologies across functioning)
• Skills to balance art and science of forecasting

Process • Driven by analytics, supported by market events

• Explicit reconciliation steps

Accountability • Accountability for both forecast error and inventory; need

to balance trade-off
• Rigorous measurement and tracking

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 Characteristics of demand
Sources of demand
- Customers
- Spare parts
- Promotions
- Intra-company
- Test samples
- Others…
 All the sources of demand must be
identified.
 Characteristics of demand
Factors influencing demand
- General business and economic conditions
- Competitive factors
- Market trends
- Firm‟s own plans
- Government regulations
- Technology changes
- Others…
 Characteristics of demand
Components of demand
- Trend 40
- Seasonality 35
30
- Random variation 25
20
- Cyclical variation 15
10
5
0
2002 2003 2004 2005

Q1 Q2 Q3 Q4

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Characteristics of Demand
Trend

Seasonal Demand

Time 7
Characteristics of Demand
Dynamic

Stable

Average Demand

Time 8
 Characteristics of demand
Demand Patterns
- Stable versus Dynamic
> Stable demand has certain general pattern over time
> Dynamic demand tends to be erratic

- Independent versus Dependent

> Demand for an item unrelated to demand for other
items. This is independent demand.
> Demand that is directly related to derived from the bill
of material structure of other items or end items. This is
dependent demand.

 Only Independent demand needs to be forecasted.

Dependent demand can be calculated.
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 Characteristics of demand
Level of planning and forecast contents
Forecast Time Frame
Business plan Market direction 2 to 10 years

Sales and operations Product lines and 1 to 2 years

families

Master production End item and Months

schedule option

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 Characteristics of demand
Why Forecast?
• Before making plans, an estimate must be made of what
conditions will exist over some future period
• Most firms cannot wait until orders are actually received
before they start to plan what to produce
• Manufacturers must anticipate future demand and plan
to provide the capacity and resources to meet the
demand
• Firms that make standard products need to have salable
goods immediately available / with shorter delivery time
• Firms that MTO, must have labor and equipment to meet
demand

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Working without Forecast

DemandForecasting Model 12
Principles of Forecasting and Data
Collection
Forecasts..
- Are rarely 100% accurate over time
- Should include an estimate of error
- Are more accurate for product lines and families
- Are more accurate for nearer periods of time

While collecting data..

- Record data in terms needed for the forecast
- Record circumstances relating to the data
- Record demand separately for different customer
groups
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 Forecasting Techniques
Classification:
- Quantitative Techniques
- Qualitative Techniques
- Intrinsic Techniques
- Extrinsic Techniques
- Short-range Techniques
- Long-range Techniques

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 Qualitative Techniques
• Are based on intuition and informed opinion
• Tend to be subjective
• Are used for business planning and
forecasting for new products
• Are used for medium-term to long-term
forecasting

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 Quantitative Techniques
• Based on historical data usually available in
the company
• Assume future will repeat past

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 Extrinsic Techniques
• Based on external indicators
• Useful in forecasting total company demand
or demand for families of products

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 Forecasting Techniques
Moving Average: (Quantitative, Intrinsic)
3-period moving average
Period Demand Simple Weighted
1 265
2 240
3 295
4 265 267 281
5 310 267 269
6 285 290 300
7 304 287 288
8 312 300 301
9 328 300 308
10 299 315 322
11 313 306
Period Weightage
-3 0.1
-2 0.2
-1 0.7

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 Forecasting Techniques
Moving Average: (Quantitative, Intrinsic)
• Lags the actual sales. More the number of
previous periods included, more is the lag
• Can be used to filter out random variation
• If a trend exists, it is hard to detect
• Calculations become cumbersome when
dealing with many time periods. More data
storage required
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 Problem 1
• Over the past three months, the demand for a
product has been 255,219 & 231.Calculate the
three month moving average forecast for month
4
• If the actual demand in month 4 is 228,calculate
the forecast for month 5
Answer
Moving Average Demand for 3 months= (255+219+231)/3
= 705/3
= 235
Moving Average for fourth month= (219+231+228)/3
=678/3
=226
Forecast for month 5 is 226

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 Forecasting Techniques
Exponential Smoothing : (Quantitative, Intrinsic)
Period Demand Forecast (FT+1) = FT + alpha (DT - FT)
( FT )

alpha
(T) ( DT ) 0.1 0.5 0.9

DT alpha= 0.1 alpha= 0.5 alpha= 0.9

1 190 180 180 180

2 160 181 185 189
3 220 179 173 163
4 200 183 196 214
5 300 185 198 201
6 240 196 249 290
7 270 201 245 245
8 200 208 257 268
9 290 207 229 207
10 275 215 259 282
11 305 221 267 276
 Forecasting Techniques
Exponential Smoothing: (Quantitative,
Intrinsic)
• A type of moving average
• Routine method for updating item forecasts
• Satisfactory for short range forecasting
• Can detect trends, but will lag them
• Calculation and data requirements are
manageable
• Easy to „tune‟
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 Problem 3
If the forecast for February was 122 and actual demand was 135,what
would be forecast for March if smoothing constant is 0.15, with
exponential smoothing techniques.

Answer
In Exponential smoothing, forecast is calculated by formula
(FT+1) = FT + alpha (DT - FT)
= 122 + 0.15( 135-122)
= 122 + 1.95
= 123.95 say 124

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 Seasonality
Key concepts:
- Seasonality is variation in demand based on
the season.
- Seasonality may be annual, monthly, or even
daily!
- „Seasonal Index‟ is a measure of seasonal
variation. Period average sales
- Seasonal Index =
Average sales for all periods

- For forecasting purpose, de-seasonalized

data is required.
 Seasonality
Illustration:
Month Year1 Year2 Year3 Monthly Seasonal
Average Index

Jan 10 12 11 11.00 0.327

Feb 13 13 11 12.33 0.367

Mar 33 38 29 33.33 0.992

Apr 45 54 47 48.67 1.448

Period average sales
May 53 56 55 54.67 1.626
Seasonal Index =
Jun 57 56 55 56.00 1.666 Average sales for all periods
Jul 33 27 34 31.33 0.932

Aug 20 18 19 19.00 0.565

Sep 19 22 20 20.33 0.605

Oct 18 18 15 17.00 0.506

Nov 46 50 55 50.33 1.498

Dec 48 53 47 49.33 1.468

Total 395 417 398 403.33 12

Average Sales for all months = 33.6

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 Seasonality
Forecasting with Seasonality:
- Historical data is influenced by seasonality;
hence can‟t be used „as-it-is‟ for forecasting
- Following steps are necessary:
# Deseasonalize historical data
# Forecast deseasonalized demand
(Baseline Forecast)
# Calculate the seasonal forecast by
applying the Seasonal Index to the
base forecast.
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 Problem 4
Month Average Demand Seasonal Index Forecast
January 30
February 50
March 85
April 110
May 125
June 245
July 255
August 135
September 110
October 90
November 60
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December 30
Month Monthly Seasonal Index New Av. Forecast
Demand Demand
January 30 0.27 166.67 45.28
February 50 0.45 166.67 75.47
March 85 0.77 166.67 128.30
April 110 1.00 166.67 166.04
May 125 1.13 166.67 188.68
June 245 2.22 166.67 369.81
July 255 2.31 166.67 384.90
August 135 1.22 166.67 203.77
September 110 1.00 166.67 166.04
October 90 0.82 166.67 135.85
November 60 0.54 166.67 90.57
December 30 0.27 166.67 45.28
Total 1325 2000.00
Average Sales for Month= 110.42
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 Tracking the Forecast
Limitations of forecasts:
- For several reasons, forecasts tend to go wrong.
- We need methods to know how good the
forecasting method is.
- „Tracking‟ is the process of comparing actual
demand with the forecast
- Forecast Error is the difference between actual
demand and forecast demand
- Error can occur in two ways:
# Bias
# Random Variation
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 Bias
Bias exist when the cumulative Actual Demand
varies from Cumulative Forecast
Month Forecast Actual
Monthly Cumulative Monthly Cumulative
1 100 100 110 110
2 100 200 125 235
3 100 300 120 355
4 100 400 125 480
5 100 500 130 610
6 100 600 110 720
Total 600 720
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 Bias

FORECAST
ACTUAL DEMAND

MONTHS 31
 Random Variation
In a period actual demand will vary against
average demand based on Demand pattern
Month Forecast Actual Variation
(Error)
1 100 105 5
2 100 94 -6
3 100 98 -2
4 100 104 4
5 100 103 3
6 100 96 -4
Total 600 600 0 32
 Random Variation

FORECAST

105 104 103

100

98 96
94

ACTUAL

MONTHS 33
 Tracking the Forecast
Bias:
- Bias is a systematic error in which the actual
demand is consistently above or below the
forecast demand
- When bias is noticed, forecasting method
should be changed to improve the forecast
accuracy
- For a unbiased forecasting method, the
Cumulative Sum of Errors (CSE) will be zero

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 Tracking the Forecast
Bias: (Illustration)
Period Forecast (F) Actual Sales Error
Interpretation:
1 1000 1200 200
The bias (Average CSE) indicates
2 1000 1000 0
that the there is an underforecast /
3 1000 800 -200 positive bias of 20 per period.
4 1000 900 -100

5 1000 1400 400

6 1000 1200 200

7 1000 1100 100

8 1000 700 -300

9 1000 1000 0
Cumulative Sum
10 1000 900 -100 of Errors (CSE)
Total 10000 10200 200

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 Forecast Error Measurement
• Mean Absolute Deviation
• Normal Distribution

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 Mean Absolute Deviation
• Forecast Error must be measured before it is
used for planning or to revise the forecast
• Mean Absolute Deviation ( MAD) commonly
used for Error Measurement
• Mean implies Average
• Absolute means without reference to plus or
minus
• Deviation refers to the Error
• MAD= Sum of Absolute Deviations
Number of Observations
in Earlier case,
MAD = 5+6+2+4+3+4 = 24 = 4
6 6 37
 Normal Distribution

1% 4% 15% 30% 30% 15% 4% 1%

-3 -2 -1 0 1 2 3
+/- 1 MAD of the Average about 60% of the time
+/- 2 MAD of the Average about 90% of the time
+/- 3 MAD of the Average about 98% of the time

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 Use of MAD
• Tracking Signal
- to monitor Quality of Forecast
• Tracking Signal= Algebraic Sum of Forecast Errors
MAD
• Past Six Month Consumption is - 105,110,103,105,107,
and 115 ,where Forecast is 100 per month.
• If MAD is 5
• Tracking Signal =(5+10+3+5+7+15)/5
= 45/5
=9
• Contingency Planning
- Manufacturing Department can devise contingency
plan for Capacity Utilization based on information
regarding MAD of Forecast
• Safety Stocks
- Demand Variation is to be guarded by Safety Stocks 39
with Inventory Investment Decisions
 Tracking the Forecast
Mean Absolute Deviation (MAD):
- MAD is a measure of random variation.
- It measures the total error irrespective of the
direction
- For a normally distributed random variation,
Standard Deviation (Sigma) = 1.25*MAD
- MAD can be used to determine:
# Tracking Signal
# Safety Stock
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 Tracking the Forecast
Tracking Signal:
- It is difficult to determine whether the variation
is due to bias or random variation.
- If the variation is due to random variation, the
error will correct itself.
- If the variation is due to bias, the forecasting
method needs to be corrected.
- A tracking signal can be used to monitor the
quality of the forecast.
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 Tracking the Forecast
Tracking Signal: (Illustration)
Period Forecast Sales Abs. Deviation CSE
CSE
T W T W T W Tracking Signal =

1 1000 1200 1200 200 200 200 200

MAD

2 1000 1000 1000 0 0 200 200

3 1000 800 1200 200 200 0 400

200
4 1000 900 900 100 100 -100 300

5 1000 1400 1400 400 400 300 700 Tracking Signal (T) = 160
6 1000 1200 1200 200 200 500 900 = 1.25
7 1000 1100 1100 100 100 600 1000
1200
8 1000 700 1300 300 300 300 1300

9 1000 1000 1000 0 0 300 1300 Tracking Signal (W) = 160

10 1000 900 900 100 100 200 1200
= 7.5
MAD= 160 160

 A tracking signal between +/- 4 means that the forecast is matching the
actual data received.
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 Tracking the Forecast
More about forecasts…..
- Forecasts forecast average demand
- Forecasts ignore random variations
- Forecasting methods need to be continuously tracked
and improved
- Multiple forecasts should be avoided in a supply
chain
- If forecasting does not happen at right place,
someone else is forced to do it
- Certain operations are most affected by the forecast
errors; postpone them as much as possible
- The main aim of all the forecasting methods is to beat
the naïve forecast
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Thank You

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