Demand Forecasting

What is Forecasting?

Forecasting is the art and

science of predicting future
events.
The principal use of forecasts in
Supply Chain is in predicting the
demand for manufactured
products and services for time
horizons ranging from several
years down to 1 day.
2

Forecasting Horizons
Long Term
5+ years into the future
R&D, plant location, product planning
Principally judgment-based

Medium Term
1 season to 2 years
Aggregate planning, capacity planning,
sales forecasts
Mixture of quantitative methods and
judgment

Short Term
1 day to 1 year, less than 1 season
Demand forecasting, staffing levels,
purchasing, inventory levels

Strategic importance of forecasting?

Human resource management

Capacity planning
Supply chain management

Forecasting Approaches

Quantitative forecasting
based on data, statistics

Qualitative forecasting
based on experience, judgement,
knowledge

Qualitative forecasting

Little or no historical data on

the phenomenon to be forecast
exist.
The relevant environment is
likely to be unstable during the
forecast horizon.
The forecast has a long time
horizon, such as more than three

Qualitative forecastingapproaches
Jury of executive opinion
This method takes the opinions of a
small group of high-level managers,
often in combination with statistical
models, and results in a group
estimate of demand.

Sales force composite

In this approach, each salespeople
estimates what sales will be in his or
her region.
7

Qualitative forecastingapproaches
Delphi method
This is an iterative group process. There are
three different types of participants in the
Delphi process:
1.Decision makers (experts making actual forecast)
2.Staff personnel(distributing, collecting, and summarizing
a series of questionnaires and survey results. )
3.Respondents (This group provides inputs to the decision
makers before the forecast is made. )

Qualitative forecastingapproaches
Consumer market survey
This method take input from customers or
potential customers regarding their future
purchasing plans

Nave approach
It assumes that demand in the next
period is the same as demand in the most
recent period.
9

Quantitative Methods

10

Quantitative Methods

Time series model

(future is a function of the past. )
1. Moving averages
2. Exponential smoothing
3. Trend projection
Causal model
(variables or relationships that might
influence the quantity being forecast. )
4. Linear regression
11

Steps in Forecasting

Determine the use of the forecast

Select the items that are to be
forecasted
Determine the time horizon of the
forecast
Select the forecasting model
Gather the data needed to make the
forecast
Validate the forecasting model
Make the forecast
Implement the results
12

Time Series Forecasting

A time series is based on a sequence of evenly

spaced (weekly, monthly, quarterly, and so on)
data points. Forecasting time series data
implies that future values are predicted only
from past values and that other variables, no
matter how potentially valuable, are ignored.
Decomposition of a Time Series
There are four main ways of decomposing
the time series:
Trend
Seasonality
Cycles
Random variations

13

Two general forms of time series models are used in statistics.

Multiplicative model: which

assumes that demand is the product
of the four components:
Demand = T x R x C x S
where T = Trend
S = Season
C = Cycles
R = Random variables
14

Two general forms of time series

models are used in statistics.
Additive model :provides an
estimate by adding the components
together. It is stated as:
Demand = T + S + C + R
where T = Trend
S = Season
C = Cycles
R = Random variables
15

Moving Averages

Moving averages are useful if we can

assume that market demands will stay
fairly steady over time. Moving average
can be defined as the summation of
demands of total periods divided by the
total number of periods.
Mathematically,
Moving average = Demand in previous
n periods

n
16

Moving Average
Include n most recent observations
Weight equally
Ignore older observations
weight
1/n

...

today
17

Example
Month

Actual Washing
machine sales,
units

January

10

February

12

March

13

April

16

May

19

June

23

July

26

August

30

September

28

October

18

November

16

Three-month
moving average

18

Example
Month

Actual Washing
machine sales,
units

January

10

February

12

March

13

April

16

May

19

June

23

July

26

August

30

September

28

October

18

November

16

Three-month
moving average

(10 + 12 + 13) / 3
= 11.67

19

Example
Month

Actual Washing
machine sales,
units

Three-month
moving average

January

10

February

12

March

13

April

16

(10 + 12 + 13) / 3
= 11.67

May

19

(12 + 13 + 16) / 3
= 13.67

June

23

July

26

August

30

September

28

October

18

November

16

20

Example
Month

Actual Washing
machine sales,
units

Three-month
moving average

January

10

February

12

March

13

April

16

(10 + 12 + 13) / 3
= 11.67

May

19

(12 + 13 + 16) / 3
= 13.67

June

23

(13 + 16 + 19) / 3
= 16

July

26

August

30

September

28

October

18

21

Example
Month

Actual Washing
machine sales,
units

Three-month
moving average

January

10

February

12

March

13

April

16

(10 + 12 + 13) / 3
= 11.67

May

19

(12 + 13 + 16) / 3
= 13.67

June

23

(13 + 16 + 19) / 3
= 16

July

26

(16 + 19 + 23) / 3
= 19.33

August

30

(19 + 23 + 26) / 3
= 22.67

September

28

(23 + 26 + 30) / 3
= 26.33

22

Weighted Moving Averages

When there is a detectable trend or pattern,

weights can be used to place more emphasis
on recent values. This makes the techniques
more responsive to changes since more
recent periods may be more heavily
weighted. Deciding which weights to use
requires some experience and a bit of luck.
Choice of weights is somewhat arbitrary
since there is not set formula to determine
them.
23

Weighted Moving Averages

Mathematically,
Weighted Moving average =
(weight for period n) x (Demand
in period n)
weights

24

Weighted Moving
Averages

Include all past observations

Weight recent observations much more
heavily than very old observations:
weight
Decreasing weight given
to older observations

today

Example
Month

Actual Washing
machine sales,
units

January

10

February

12

March

13

April

16

May

19

June

23

July

26

August

30

September

28

October

18

November

16

Three-month
weighted moving
average

26

Example
Weighting the past three months
as follows:
Weights applied
Period
3
Last month
2
Two months ago
1
Three months ago
6
Sum of weights
27

Example
Month

Actual
Three-month weighted moving
Washing
average
machine sales,
units

January

10

February

12

March

13

April

16

May

19

June

23

July

26

August

30

Septembe 28
r
October

18

28

Example
Month

Actual
Three-month weighted moving
Washing
average
machine sales,
units

January

10

February

12

March

13

April

16

May

19

June

23

July

26

August

30

(1 x 10 + 2 x 12 + 3 x 13) / 6 =
12.16

Septembe 28
r
October

18

29

Example
Month

Actual
Three-month weighted moving
Washing
average
machine sales,
units

January

10

February

12

March

13

April

16

(1 x 10 + 2 x 12 + 3 x 13) / 6 =
12.16

May

19

(1 x 12 + 2 x 13 + 3 x 16) / 6 =
14.33

June

23

July

26

August

30

Septembe 28
r

30

Example
Month

Actual
Three-month weighted moving
Washing
average
machine sales,
units

January

10

February

12

March

13

April

16

(1 x 10 + 2 x 12 + 3 x 13) / 6 =
12.16

May

19

(1 x 12 + 2 x 13 + 3 x 16) / 6 =
14.33

June

23

(1 x 13 + 2 x 16 + 3 x 19) / 6 =
17

July

26

August

30

Septembe 28
r

31

Example
Month

Actual
Three-month weighted moving
Washing
average
machine sales,
units

January

10

February

12

March

13

April

16

(1 x 10 + 2 x 12 + 3 x 13) / 6 =
12.16

May

19

(1 x 12 + 2 x 13 + 3 x 16) / 6 =
14.33

June

23

(1 x 13 + 2 x 16 + 3 x 19) / 6 =
17

July

26

(1 x 16 + 2 x 19+3x23) / 6 =
20.5

August

30

(1x19+2x23+3x26)/6=23.83

Septembe 28
r

(1x23+2x26+3x30)/6=27.5

32

Limitations
less sensitive to real changes in
the data.
cannot pick up trends very well.
require extensive records of past
data.

33

Exponential Smoothing

A new forecast is based on the

forecast of the previous period.
The following relationship exists
between the two:
New forecast = Last periods
forecast + (Last periods actual
demand last periods forecast)
Where, denotes a weight, or
smoothing constant.
34

Exponential Smoothing
Mathematically :
Ft = Ft-1 + (At-1 Ft-1 )
0 < = < =1
where
Ft = New forecast
F t-1 = Previous forecast
= Smoothing constant (0 <= <= 1)
At-1 = Previous periods actual demand
The smoothing constant, , is generally in
the range from .05 to .50 for business
applications.
35

Week Sales
t
(1000s of
gallons)
1

17

21

19

23

18

16

20

18

22

10

20

11

15

12

22

Exponential
smoothing forecast
Ft using = .2

Exponential
smoothing forecast Ft
using = .5

36

Week Sales
t
(1000s of
gallons)

Exponential
smoothing forecast
Ft using = .2

Exponential
smoothing forecast Ft
using = .5

17

17

17

21

19

23

18

16

20

18

22

10

20

11

15

12

22

37

Week Sales
t
(1000s of
gallons)

Exponential
smoothing forecast
Ft using = .2

Exponential
smoothing forecast Ft
using = .5

17

17

17

21

17+.2(17-17)=17

17+.5(17-17)=17

19

23

18

16

20

18

22

10

20

11

15

12

22

38

Week Sales
t
(1000s of
gallons)

Exponential
smoothing forecast
Ft using = .2

Exponential
smoothing forecast Ft
using = .5

17

17

17

21

17+.2(17-17)=17

17+.5(17-17)=17

19

19+.2(21-17)=17.8

19+.5(21-17)=19

23

18

16

20

18

22

10

20

11

15

12

22

39

Week Sales
t
(1000s of
gallons

Exponential
smoothing forecast
Ft using = .2

Exponential
smoothing forecast
Ft using = .5

17

17

17

21

17+.2(17-17)=17

17+.5(17-17)=17

19

17+.2(21-17)=17.8

17+.5(21-17)=19

23

17.8 + .2(19 17.8)

= 18.04

19 + .5(19 19) = 19

18

18.04 + .2(23
18.04) = 19.03

19 + .5(23 19) = 21

16

19.03 + .2(18
19.03) = 18.83

21 + .5(18 21) =
19.5

20

18.83 + .2(16
18.83) = 18.26

19.5 + .5(16 19.5)

= 17.75

18

18.26 + .2(20
18.26) = 18.61

17.75 + .5(20
17.75) = 18.88

22

18.61 + .2(18
18.61) = 18.49

18.88 + .5(18
18.88) = 18.44

10

20

18.49 + .2(22
18.49) = 19.19

18.44 + .5(22
18.44) = 20.22

11

15

19.19 + .2(20

20.22 + .5(20

40

Selecting the smoothing constant

The exponential smoothing

approach is easy to use, and
has been successfully
applied in many
organizations. Selection of a
suitable constant is the
pre-requisite for the success
of smoothing technique.
41

The forecast error

The overall accuracy of a

forecasting model can be
determined by comparing the
forecasted values with the actual
or observed values.
Forecast error = Demand
Forecast

42

Measures of forecast error

Mean absolute deviation (MAD)

This is computed by taking the sum of
the absolute values of the individual
forecast errors and dividing by the
number of periods of data (n):
MAD= |Forecast errors| / n

Mean squared error (MSE)

MSE is the average of the squared
differences between the forecasted
and observed values. The formula is:
MSE = (Forecast errors)2 / n
43

Week Sales
t
(1000s of
gallons

Exponential
smoothing forecast
Ft using = .2

Exponential
smoothing forecast
Ft using = .5

17

17

17

21

17+.2(17-17)=17

17+.5(17-17)=17

19

17+.2(21-17)=17.8

17+.5(21-17)=19

23

17.8 + .2(19 17.8)

= 18.04

19 + .5(19 19) = 19

18

18.04 + .2(23
18.04) = 19.03

19 + .5(23 19) = 21

16

19.03 + .2(18
19.03) = 18.83

21 + .5(18 21) =
19.5

20

18.83 + .2(16
18.83) = 18.26

19.5 + .5(16 19.5)

= 17.75

18

18.26 + .2(20
18.26) = 18.61

17.75 + .5(20
17.75) = 18.88

22

18.61 + .2(18
18.61) = 18.49

18.88 + .5(18
18.88) = 18.44

10

20

18.49 + .2(22
18.49) = 19.19

18.44 + .5(22
18.44) = 20.22

11

15

19.19 + .2(20

20.22 + .5(20

44

Week t Sales
1000s of gallons

RF with = .2

RF with = .5

17

17

17

21

17

17

19

18

19

23

18

19

18

19

21

16

19

20

20

18

18

18

19

19

22

18

18

10

20

19

20

11

15

19

20

12

22

18

21

45

Wee
k t

Sales
1000s of
gallons

RF with
= .2

Absolute
Deviation
for =.2

RF with
= .5

17

17

17

21

17

17

19

18

19

23

18

19

18

19

21

16

19

20

20

18

18

18

19

19

22

18

18

10

20

19

20

11

15

19

20

12

22

18

21

Absolute
Deviation
for =.5

46

Wee
k t

Sales
1000s of
gallons

RF with
= .2

Absolute
Deviation
for =.2

RF with
= .5

Absolute
Deviation
for =.5

17

17

17

21

17

17

19

18

19

23

18

19

18

19

21

16

19

20

20

18

18

18

19

19

22

18

18

10

20

19

20

11

15

19

20

12

22

18

4
Sum=30

21

1 Sum=28
47

For =.2
MAD=30/12=2.5
For =.5
MAD=28/12=2.33
On the basis of this analysis, a
smoothing constant of = .5 is
preferred to = .2 because its
MAD is smaller.
48

Trend Projections.

This technique fits a trend line to

a series of historical data points
and then projects the line into
the future for medium - to long
range forecasts.
Several mathematical trend
equations can be developed (for
example, exponential and
quadratic), but we will discuss a
linear (straight line) trends only.
49

Trend Projections
Using the standard method of
Least Square
Assuming Time period as
independent variable
And actual demand as dependent
variable
50

The least square method

A least squares line is described in terms of its

y intercept (the height at which it intercepts
the y axis) and its slope (the angle of the
line). If we can compute y intercept and
slope, we can express the line as
Y = a + bX
where
y = Computed value of the variable to be
predicted (called the dependent variable)
a = y axis intercept
b = slope of the regression line
X = independent variable (which is time here)
51

The least square method

Xi=Time periods(i=1,2,3,n)
Yi=Actual demand during period Xi

X
Y
n
X
Y
i
i
Slope b=
Xi 2 - n X2
Intercept a=Y- b X
X=Xi/n

Y=Yi/n
52

Example
The demand for electrical power
at Delhi over the period 1990
1996 is shown below, in
megawatts. Let us fit a straight
line trend to these data and
forecast
1997
Year
1990 1991
1992 demand
1993 1994 1995 1996
Electric
al
power
Deman
d

74

79

80

90

105

142

122

53

Solution
Year

Time
Period(
X)

Electrical
power
Demand(Y)

X2

XY

54

Solution
Year

Time
Period(
X)

Electrical
power
Demand(Y)

1990

74

1991

79

1992

80

1993

90

1994

105

1995

142

1996

122

X2

XY

55

Solution
Year

Time
Period(
X)

E8lectrical
power
Demand(Y)

X2

1990

74

1991

79

1992

80

1993

90

16

1994

105

25

1995

142

36

1996

122

49

XY

56

Solution
Year

Time
Period(
X)

E8lectrical
power
Demand(Y)

X2

XY

1990

74

74

1991

79

158

1992

80

240

1993

90

16

360

1994

105

25

525

1995

142

36

852

1996

122

49

854

57

Solution
Year

Time
Period(
X)

E8lectrical
power
Demand(Y)

X2

XY

1990

74

74

1991

79

158

1992

80

240

1993

90

16

360

1994

105

25

525

1995

142

36

852

1996

122

49

854

X=

Y=

X2 =

XY =

58

Solution
Year

Time
Period(
X)

E8lectrical
power
Demand(Y)

X2

XY

1990

74

74

1991

79

158

1992

80

240

1993

90

16

360

1994

105

25

525

1995

142

36

852

1996

122

49

854

X=28

Y=692

X2
=140

XY
=3063

59

Solution
Year

Time
Period(
X)

E8lectrical
power
Demand(Y)

X2

XY

1990

74

74

1991

79

158

1992

80

240

1993

90

16

360

1994

105

25

525

1995

142

36

852

1996

122

49

854

X=28

Y=692

X2
=140

XY
=3063

X=Xi/n = 28/7=4
Y=Yi/n=692/7=98.86

60

Solution
Year

Time
Period(
X)

E8lectrical
power
Demand(Y)

X2

XY

1990

74

74

1991

79

158

1992

80

240

1993

90

16

360

1994

105

25

525

1995

142

36

852

1996

122

49

854

X=28

Y=692

X2
=140

XY
=3063

X=Xi/n = 28/7=4
Y=Yi/n=692/7=98.86
Slope
b=

Xi Yi - n X
YX 2 - n X2
i

=295/28=1
0.54

61

Solution
Year

Time
Period(
X)

E8lectrical
power
Demand(Y)

X2

XY

1990

74

74

1991

79

158

1992

80

240

1993

90

16

360

1994

105

25

525

1995

142

36

852

1996

122

49

854

X=28

Y=692

X2
=140

XY
=3063

Intercept a =Y- b X=98.86

10.54(4) = 56.7
62

Demand in 1997

Y=a + b X
Y= 56.7+10.54 X
Y= 56.7+10.54 (8)
Y=141.02
Then we estimate the demand in
1997 is
141 megawatts.

63

Example

64

Example

Example

66

Example

Moving Average Input and

Output

Moving Average

Exponential Smoothing Input, Output,

and Chart

Exhibit 2-4 Exponential Smoothing Preparation Wizard

Example
Monthly demand for Dans Doughnuts over the past nine months
for trays (six dozen per tray) of sugar doughnuts was
Mar 112
Apr 125
May 120
Jun
133
Jul
136
Aug 146
Sept 140
Oct 155
Nov 152
1. Plot the data to determine if a linear
trend equation is appropriate.
2.Obtain a trend equation.
3.Forecast demand for the next two
months.

Example
Solution
1.The data seem to show an upward, roughly
linear trend:

Example

Data for Linear Trend/Regression

Analysis

Scatter Plot Development

Scatter Plot

Scatter Plot Titles, Axes, and

Labels

Scatter Diagram

Scatter Diagram

Regression Output

Example
Example 2-4
2-4

Example
Example 2-5
2-5
The manager of a
parking lot has
computed daily
relatives for the number
of cars per day for his
lot. The computations
are repeated here
(about three weeks are
shown for illustration). A
seven-period centered
moving average is used
because there are
seven days (seasons)
per
week.
The
estimated

Friday relative is
136 + 140 + 133 +
3 + 136. Relative
for other days can
be computed in a
similar manner. For
example, the
estimated Monday
relative is 0.77 +
0.72 + 0.69/3 =

Figure 29 A Centered Moving Average Closely Tracks the Data

Example
Example 2-6
2-6

Exhibit 213 Seasonal Relative Computations

Explanatory Models
Simple Linear Regression
A model of two variables thought to be related.
Dependent variable: the variable to be forecasted.
Independent variable is used to explain or predict the
value of the dependent variable.

Using the regression approach

Identify an independent variable or variables.
Obtain a sample of at least 10 observations.
Develop an equation.
Identify any restrictions on predictions.
Measure accuracy in a given forecast.

Table 22

Data for Regression Problem

Figure 210

A Linear Relationship Appears to Exist

Table 22

Calculations for Regression Coefficients

Figure 211

Graph of Regression Line

Table 24

Selected Values of t.025 for n-2 Degrees of Freedom (df)

Figure 212 The Conditional Distributions of ys Are

Assumed to be Normal

Regression Assumptions
Normality
For any given value of x, there is a distribution of possible y
values that has a mean equal to the expected value (i.e., y
= a + bx) and the distribution is normal.

Homoscedasticity
The conditional distributions for all values of x have the
same dispersion.

Linearity.
The requirement of uniform scatter also means that there
should not be any patterns around the line.

Independence.
Values of y should not be correlated over time. If they are, it
may be more appropriate to use a time series model.

Figure 213

The Scatter around the Line Is Not Uniform

Figure 214

There Should Not Be Any Patterns around the Line

Exhibit 214 Linear Regression-Explanatory Model Output

Table 25

Expansion of Data Used in Simple Regression Section

Exhibit 215 Input Box for Multiple Regression

Exhibit 216 Multiple Regression Output with Excel

Summarizing Forecast Accuracy

The mean absolute
deviation (MAD)
measures the average
forecast error over a
number of periods,
without regard to the
sign of the error:

The mean squared

error (MSE)
is the average squared
error experienced over
a number of periods.

Example
Example 2-7
2-7

Figure 215 Monitoring Forecast Errors

Relative Measures of Forecast

Accuracy
Percentage error (PE)
for a given time series
data measures the
percentage point
deviation of the
forecasted value from
the actual value.

Mean percentage error

(MPE)
measures the forecast
bias

Mean absolute
percentage error
(MAPE)
measures overall
forecast accuracy.

Example
Example 2-8
2-8

Example
Example 2-8
2-8 contd
contd

Example
Example 2-8
2-8 contd
contd

Tracking Signal
The tracking signal
Is the ratio of cumulative forecast error at any point in time to the
corresponding MAD at that point in time.
A value of a tracking signal that is beyond the action limits
suggests the need for corrective action.

Example
Example 2-9
2-9