Demand Forecasting

(The Starting Point for All Planning)

Empirical study of demand forecasting Design and developing the forecasting system Forecasting Models Numericals Linear regression Forecast error

1.Factors
-Internal eg-installed capacity and capacity projections of all players, excise and customs duties . -External eg exchange rate fluctuations , geopolitical movements.

2. Assumptions on factors to derive the total market for a stipulated time period. 3.Analysis of supply demand position 4.Forecasting demand .

Stage 1 Developing the forecasting logic by identifying the purpose , data and models to be used. Stage 2 Establish control mechanism to obtain reliable forecasts. Stage 3 Incorporate managerial considerations in using forecasting system .

Inputs: Market, Economic, Other

Forecast Method(s)

Demand Estimates

Sales Forecast

Management Team

Business Strategy

Production Resource Forecasts

Nature of forecast

Technology forecast Economic forecast Demand forecast

Factors affecting forecast Business cycle Customers plan Products life cycle Quality Competitions Advertising Sales effort Reputation for service

 A time series is a set of numbers where the order or sequence of the numbers is important, e.g., historical demand Analysis of the time series identifies patterns Once the patterns are identified, they can be used to develop a forecast.

Historical pattern eg sale of salt .

forecast
variable

time

Seasonal demand pattern- eg sale of A.C. , wool items.

forecast variable

time

Cyclical pattern eg gross national product .

forecast variable

time

Trend pattern eg stock prices.

forecast variable

time

Time Horizon
Long-Range

Time Span

Item Being Forecast

Product lines Factory capacities Planning for new products Capital expenditures Facility location or expansion R&D Product groups Department capacities Sales planning Production planning and budgeting

Units of Measure
Rupees, Dollars, tons, etc.

Years

MediumRange

Months

Rupees, Dollars, tons, etc.

Short-Range

Weeks

Specific product quantities Machine capacities Planning Purchasing Scheduling Workforce levels Production levels Job assignments

Physical units of products

 Qualitative Approaches Quantitative Approaches

 Delphi Method : A forecasting technique applied to subjective nature of demand values.

E.g.: Technology forecasting , where there is no quantitative data based on which the future technology can be predicted.

 An averaging period (AP) is given or selected The forecast for the next period is the arithmetic average of the AP most recent actual demands It is called a simple average because each period used to compute the average is equally weighted It is called moving because as new demand data becomes available, the oldest data is not used

Week 1 2 3 4 5 6 7 8 9 10 11 12

Demand 650 678 720 785 859 920 850 758 892 920 789 844

A t-1 + A t-2 + A t-3 +...+A t- n Ft = n

Lets develop 3-week moving average forecasts for demand. Assume you only have 3 weeks of actual demand data for the respective forecasts

Week 1 2 3 4 5 6 7 8 9 10 11 12

Demand 650 678 720 785 859 920 850 758 892 920 789 844

3-Week

Ft

682.67 727.67 788.00 854.67 876.33 842.67 833.33 856.67 867.00 682.67 727.67 788.00 854.67 876.33 842.67 833.33 856.67

 This is a variation on the simple moving average where instead of the weights used to compute the average being equal, they are not equal This allows more recent demand data to have a greater effect on the moving average, therefore the forecast

Ft = w 1 A t-1 + w 2 A t- 2 + w 3 A t-3 + ...+ w n A t- n

Determine the 3-period weighted moving average forecast for period 4 Week Demand Weights (adding up to 1.0): 1 650 t-1: .5 2 678 t-2: .3 3 720 4 t-3: .2

Week 1 2 3 4

Demand 650 678 720

Forecast

693.4

F4 = .5(720)+.3(678)+.2(650)

 The weights used to compute the forecast (moving average) are exponentially distributed The forecast is the sum of the old forecast and a portion of the forecast error Ft = Ft-1 + a(Dt-1 - Ft-1) The smoothing constant, a, must be between 0.0 and 1.0 (excluding 0.0 and 1.0)

A firm uses simple exponential smoothing with a= .2 to forecast demand . the forecast for the first week of January was 400 units , where as the actual demand turned out to be 450 units .

Forecast the demand for the second week of January .

The forecast for the second week of January is computed as shown below Ft = Ft-1 + a(Dt-1 - Ft-1) F2 = 400 + .2 (450 400) = 410 units .

Adjusted exponential smoothed forecast model actually projects the next period forecast by adding a trained component to the current period smoothed forecast , Ft. Ft+1=Ft + Tt where Ft = aDt-1 + (1-a) (Ft-1 +Tt-1) Tt (trend adjustment) =b(Ft Ft-1) + (1-b) Tt-1 Where a and b are smoothing constants. The trend adjustment Tt utilizes a second smoothing coefficient b.

Compute the adjusted exponential forecast for the first week of march for a firm with the following data. Assume the forecast for the first week of January ( F0) as 600 and corresponding initial trend (T0) as 0 . Let a=.1 and b= .2.
JAN 2 3 600 550
MONTH

WEEK 1 DEMAND 650

4 650

1 625

FEB 2 3 4 675 700 710

FIRST WEEK OF JAN : Ft = aDt-1 + (1-a) (Ft-1 +Tt-1) =0 .1(650 )+0.9(600+0) =605 Tt =b(Ft Ft-1) + (1-b) Tt-1 =0.2(605-600)+0.8(0)= 1 Ft+1=Ft + Tt = 605 +1 = 606

Week

Previous Avg (Ft-1)

Actual demand

Smoothed avg

Smoothed trend

Jan week 1
Week 2 Week 3 Week 4 Feb week 1 Week 2 Week 3 Week 4

600
605 605.4 600.65 605.36 607.99 615.70 626.33

Dt-1 650
600 550 650 625 675 700 710

Ft 605
605.4 600.65 605.36 607.99 615.70 626.33 738.37

Next period projection Ft+1

1.000
.880 -.246 .742 1.120 2.440 4.480 5.670

606.00
606.38 600.40 606.10 609.11 618.14 630.41 644.04

 Relationship between one independent variable, X, and a dependent variable, Y. Assumed to be linear (a straight line) Form: Y = a + bX
Y = dependent variable X = independent variable a = y-axis intercept b = slope of regression line

Yt = a + bx

b is similar to the slope. However, since it is calculated with the variability of the data in mind, its formulation is not as straight-forward as our usual notion of slope

0 1 2 3 4 5 (weeks)

a = y - bx
xy - n(y)(x) x - n(x )
2 2

b=

Week 1 2 3 4 5

Sales 150 157 162 166 177

Develop a regression equation to predict sales based on these five points.

Regression Equation Example

Week 1 2 3 4 5 3 Average
b=

Week*Week 1 4 9 16 25 55 Sum

Sales Week*Sales 150 150 157 314 162 486 166 664 177 885 162.4 2499 Average Sum

xy - n( y)(x) = x - n( x )
2 2

2499 - 5(162.4)(3) 63 = = 6.3 55 5( 9 ) 10

a = y - bx = 162.4 - (6.3)(3) = 143.5

Regression Equation Example

y = 143.5 + 6.3x
180 175 170 165 160 155 150 145 140 135
1 2 3 4 5

Sales

Sales Forecast

Period

 Forecast error for a period t , e t denotes the difference between the demand D , and the forecast Ft , for the period. ei= Dt-Ft SFE=S ei A positive value indicates underestimation of demand and vice-versa.

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