10/30/2019 How to Predict Sales Using Markov Chain - Supply Chain Link Blog - Arkieva

How to Predict Sales Using Markov Chain

The Supply chain is driven by demand, supply, and inventory planning. Under demand planning,
the importance of sales forecasting is undeniable. It provides a basis for the production process
regulating quantities, inventory and maximizes the efficiency of the resources available.

The sales forecasting process is often focused on estimating sale quantities for production
planning.

But what if we were more interested in the chances of sales happening rather than estimating
quantities of future sales?

This type of sales prediction could be beneficial for sales teams interested in cold calling and
customer interaction. While there are many tried and tested methods used for forecasting, a fairly
unused method is the Markov Chain method.

Read: Demand Forecasting: The Art and Science That Keeps You Guessing

What is a Markov Chain?

Markov Chain is a hermit in the world of statistics, but its potential is immense. A Markov
Chain is a stochastic model describing a sequence of possible events in which the
probability of each event depends only on the state attained in the previous event.

Lost in translation?

Well let’s put it this way, Markov Chains are mathematical systems that hop or “transition”
from one “state” (a situation or set of values) to another.Hence if we have the total number of
states of a system (called state space), it is possible to mimic the systems phenomena and provide
long term statistics.

Still lost? Let’s try an example:

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10/30/2019 How to Predict Sales Using Markov Chain - Supply Chain Link Blog - Arkieva

Markov Chain Example

The Land of Oz is blessed by many things, but not by good weather. They never have two nice
days in a row. If they have a nice day, they are just as likely to have snow as rain the next day. If
they have snow or rain, they have an even chance of having the same the next day. If there is a
change from snow or rain, only half of the time does this change to a nice day. With this
information, we form a Markov chain as follows: we take states as the kinds of weather Rain(R),
Nice (N), and Snow (S). From the above information, we determine the transition probabilities.
These are most conveniently represented in a square array as:

The matrix P is called the transition probability matrix which basically shows the probabilities
of transitioning from one state to another. Markov Chains are such that given the present state,
the future is conditionally independent of the past states.

So if we assume the initial state of the system to be, then the state vector for the next time period
would be:

xn+1 = xn .P

Read Also: The ‘Secret Sauce’ to Improving Demand Planning

How do we use the Markov Chain for Sales Prediction?

Let’s consider an organization which sells raw materials as products to its customers. Now let’s
take the sales history of one product to a particular customer:

Product Name Shipment Quantity Date of Shipment

Product 1 500 1/2/17
Product 1 24 1/4/17
Product 1 139 1/7/17
So, to establish a Markov chain, we need to base it on a set time series or time buckets. Since
we’re experimenting with data at a high detail level, we’ll consider daily time buckets.

Since we’re not going to consider the quantity being shipped, there are only 2 possible states in
this system:

1 – Sale was made on that day

0 – Sale was not made on that day

Let’s format the sales history to reflect the states over a week in January:

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10/30/2019 How to Predict Sales Using Markov Chain - Supply Chain Link Blog - Arkieva

Date State
1/1/17 0
1/2/17 1
1/3/17 0
1/4/17 1
1/5/17 0
1/6/17 0
1/7/17 1

The Transition Probability matrix would look as so:

P=

  No Sale Sale
No Sale 0.25 0.75
Sale 1 0

Now if we consider the initial state to be the state on 1/17/17 which is:

X=

No Sale Sale
0 1

Therefore according to the Markov property, the state of the system on 1/8/17 is:

xn+1 = xn .P

No Sale Sale
1 0

Related: 5 Reasons Collaboration Can Make Your Forecast Better

This means the Markov chain predicts a no sale on 1/8/17

Using the Markov chain, the sales department can develop an elaborate system gives them an
advantage in predicting when a customer should have placed an order. Imagine a hectic day at
the office for the operations team at the customer side, where customers haven’t placed orders
for extra raw materials. An unexpected call from the sales team to find out why the customer
hasn’t placed an order would bolster a strong client-customer relationship. Customer approval
and trust is the foundation of any successful business and Markov Chains could help.

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