Demand Management

and
FORECASTING

Operations Management
Dr. Ron Lembke
Demand Management
• Coordinate sources of demand for supply chain
to run efficiently, deliver on time
• Independent Demand
▫ Things demanded by end users
• Dependent Demand
▫ Demand known, once demand for end items is
known
Affecting Demand
• Increasing demand
▫ Marketing campaigns
▫ Sales force efforts, cut prices
• Changing Timing of demand
▫ Incentives for earlier or later delivery
▫ At capacity, don’t actively pursue more
Predicting the Future
We know the forecast will be wrong.
Try to make the best forecast we can,
▫ Given the time we want to invest
▫ Given the available data
• The “Rules” of Forecasting:
1. The forecast will always be wrong
2. The farther out you are, the worse your forecast
is likely to be.
3. Aggregate forecasts are more likely to accurate
than individual item ones
Time Horizons
Different decisions require projections about
different time periods:
• Short-range: who works when, what to make each
day (weeks to months)
• Medium-range: when to hire, lay off (months to
years)
• Long-range: where to build plants, enter new
markets, products (years to decades)
Forecast Impact
Finance & Accounting: budget planning
Human Resources: hiring, training, laying off
employees
Capacity: not enough, customers go away angry,
too much, costs are too high
Supply-Chain Management: bringing in new
vendors takes time, and rushing it can lead to
quality problems later
Qualitative Methods
• Sales force composite / Grass Roots
• Market Research / Consumer market surveys &
interviews
• Jury of Executive Opinion / Panel Consensus
• Delphi Method
• Historical Analogy - DVDs like VCRs
• Naïve approach
Quantitative Methods
Time Series Methods
0. All-Time Average
1. Simple Moving Average
2. Weighted Moving Average
3. Exponential Smoothing
4. Exponential smoothing with trend
5. Linear regression

Causal Methods
Linear Regression
Time Series Forecasting
Assume patterns in data will continue, including:

Trend (T)
Seasonality (S)
Cycles (C)
Random
Variations
All-Time Average
To forecast next period, take the average of all
previous periods

Advantages: Simple to use

Disadvantages: Ends up with a lot of data

Gives equal importance to very old data
 4/7/2009

2009 Farm Angels:

Ty: 1.000, Jacob 0.833, Noah 0.667
(6 at bats)
End of 2008 season
Moving Average
Compute forecast using n most recent periods

Jan Feb Mar Apr May Jun Jul

3 month Moving Avg:

June forecast:
FJun = (AMar + AApr + AMay)/3
If no seasonality, freedom to choose n
If seasonality is N periods, must use N, 2N, 3N etc.
number of periods
Moving Average
Advantages:
▫ Ignores data that is “too” old
▫ Requires less data than simple average
▫ More responsive than simple average
Disadvantages:
▫ Still lacks behind trend like simple average,
(though not as badly)
▫ The larger n is, more smoothing, but the more it
will lag
▫ The smaller n is, the more over-reaction
Simple and Moving Averages

Period Demand All-Time 3MA

1 10
2 12 10
3 14 11.0
4 15 12.0 12.0
5 16 12.8 13.7
6 17 13.4 15.0
7 19 14.0 16.0
8 21 14.7 17.3
9 23 15.5 19.0
10 16.3 21.0
Centered MA
• CMA smoothes out
variability
• Plot the average of 5
periods: 2 previous, the
current, and the next two
• Obviously, this is only in
hindsight
• FRB Dalls graphs
Stability vs. Responsiveness
• Responsive
▫ Real-time accuracy
▫ Market conditions
• Stable
▫ Forecasts being used throughout the company
▫ Long-term decisions based on forecasts
▫ Don’t whipsaw those folks
Old Data
Comparison of simple, moving averages clearly
shows that getting rid of old data makes forecast
respond to trends faster

Moving average still lags the trend, but it suggests

to us we give newer data more weight, older data
less weight.
Weighted Moving Average
FJun = (AMar + AApr + AMay)/3
= (3AMar + 3AApr + 3AMay)/9
Why not consider:
FJun = (2AMar + 3AApr + 4AMay)/9
FJun = 2/9 AMar + 3/9 AApr + 4/9 AMay
Ft = w1At-3 + w2At-2 + w3At-1

Complicated:
• Have to decide number of periods, and weights for each
• Weights have to add up to 1.0
• Most recent probably most relevant, gets most weight
• Carry around n periods of data to make new forecast
Weighted Moving Average
Period Demand 3WMA
1 10
2 12
3 14
4 15 12.6
5 16 14.1
6 17 15.3
7 19 16.3
8 21 17.8
9 23 19.6
10 21.6

Wts = 0.5, 0.3, 0.2

Setting Parameters
• Weighted Moving Average
▫ Number of Periods
▫ Individual weights
• Trial and Error
▫ Evaluate performance of forecast based on some
metric
Exponential Smoothing
Ft  Ft 1    At 1  Ft 1 
F10 = F9 + 0.2 (A9 - F9)

Ft  1   Ft 1   At 1
F10 = 0.8 F9 + 0.2 (A9 - F9)

At-1 Actual demand in period t-1

Ft-1 Forecast for period t-1
 Smoothing constant >0, <1
Forecast is old forecast plus a portion of the
error of the last forecast.
Formulas are equivalent, give same answer
Exponential Smoothing
• Smoothing Constant between 0.1-0.3
• Easier to compute than moving average
• Most widely used forecasting method, because of
its easy use
• F1 = 1,050,  = 0.05, A1 = 1,000
• F2 = F1 + (A1 - F1)
• = 1,050 + 0.05(1,000 – 1,050)
• = 1,050 + 0.05(-50) = 1,047.5 units
• BTW, we have to make a starting forecast to get
started. Often, use actual A1
Exponential Smoothing
Period Demand ES
1 10 10.0
2 12 10.0
3 14 10.6
4 15 11.6
5 16 12.6
6 17 13.6
7 19 14.7
8 21 16.0
9 23 17.5
10 19.1

Alpha = 0.3
Exponential Smoothing
Period Demand ES
1 10 10.0
2 12 10.0
3 14 11.0
4 15 12.5
5 16 13.8
6 17 14.9
7 19 15.9
8 21 17.5
9 23 19.2
10 21.1

Alpha = 0.5
 Exponential Smoothing

We take:
F12   A11  1   F11
And substitute in F11   A10  1   F10
F12   A11   1   A10  1    F10
to get: 2

and if we continue doing this, we get:

F12   A11   1   A10   1    A9   1    A8   1    A7  ...
2 3 4

Older demands get exponentially less weight

Choosing 
• Low : if demand is stable, we don’t want to get
thrown into a wild-goose chase, over-reacting to
“trends” that are really just short-term variation
• High : If demand really is changing rapidly, we
want to react as quickly as possible
Averaging Methods
• Simple Average
• Moving Average
• Weighted Moving Average
• Exponentially Weighted Moving Average
(Exponential Smoothing)
• They ALL take an average of the past
▫ With a trend, all do badly
30
▫ Average must be in-between
20
10
Trend-Adjusted Ex. Smoothing
St  exp. smoothed Level, forecast as of t
Tt  exp. smoothed Trend
1. St  TAFt    At  TAFt 
 (1   )TAFt   At
2. T t  T t 1  TAFt  TAFt 1  Tt 1 
3. TAFt 1  St  Tt
where  and  are smoothing constants
Trend-Adjusted Ex. Smoothing
S1  100 T1 10 TAF1  100   0.20   0.30
Trend-Adjusted Forecast for period 2 was
TAF2  S1 T 1 100  10  110
Suppose actual demand is 115, A2=115
 
1. S 2  TAF2    A2  TAF2  
 110  0.2 *(115  110)  110  1  111.0
2. T 2  T 1  TAF2  TAF1  T1 
 10  0.30 * (110  100  10)  10  0.3 * 0  10
3. TAF3  S2 T 2 111  10  121
Trend-Adjusted Ex. Smoothing
S2  100 T2  10 TAF3  121   0.20   0.30
Suppose actual demand is 120, A3=120

1. S3  TAF3    A3  TAF3  

 121  0.2 *(120  121)  121  0.2  120.8
2. T 3  T 2  TAF3  TAF2  T2 
 10  0.30 * (121  110  10)  10  0.3 *1  10.3
3. TAF3  S2 T 2 120.8  10.3  131.1
 TAF6=F5+T5
F6
A5

F5
 Selecting  and β
• You could:
▫ Try an initial value for each parameter.
▫ Try lots of combinations and see what looks best.
▫ But how do we decide “what looks best?”
• Let’s measure the amount of forecast error.
• Then, try lots of combinations of parameters in a
methodical way.
▫ Let  = 0 to 1, increasing by 0.1
 For each  value, try  = 0 to 1, increasing by 0.1
Evaluating Forecasts
How far off is the forecast?

Forecasts

Demands

What do we do with this information?

Measuring the Errors
Period A-F A-F
Method 1 Method 2
1 100 10 • Method 1 forecasts are low,
2 -100 10 high, etc.
• Method 2 forecasts always too
3 100 10
low.
4 -100 10
• Running Sum of Forecast
5 100 10 Errors, RSFE
6 -100 10 ▫ Sum of all periods
7 100 10 ▫ Also known as the Bias
8 -100 10 n
9 100 10 RSFE   At  Ft
10 -100 10 t 1
RSFE 0 100
Evaluating Forecasts

n
Mean Absolute MAD  (1 / n)
Deviation

t 1
At  Ft
n
Mean Squared MSE  (1 / n)  At  Ft 
2

Error t 1

Mean Absolute  n
At  Ft 
Percent Error MAPE  (1 / n)  Dt
 100
 t 1 
MAD of examples
Period |A-F| |A-F|
Method 1 Method 2
1 100 10 • MAD shows that method 1 is
2 100 10 off by a larger amount
• Method 2 was biased
3 100 10
• However, overall, Method 2
4 100 10
seems preferable
5 100 10
n
MAD  (1 / n) At  Ft
6 100 10
7 100 10
t 1
8 100 10
9 100 10
10 100 10
MAD 100 10
 Tracking Signal
• To monitor, compute tracking signal
RSFE
Tracking Signal 
n
MAD
RSFE   At  Ft
t 1

• If >4 or <-4 something is wrong

• Top should sum to 0 over time. If not, forecast is
biased.
 Monitoring Forecast Accuracy
• Monitor forecast error each period, to see if it
becomes too great

4
Forecast Error

Upper Limit

-4 Lower Limit
Forecast Period
Techniques for Trend
• Determine how demand increases as a function
of time
yt  a  bt
t = periods since beginning of data
b = Slope of the line
a = Value of yt at t = 0
Computing Values

b
 xy  n x  y

 x  nx
2 2

a
 y  b x
 y  bx
n


n
( y  Y ) 2

S yx  i 1 i i

n2
Linear Regression
• Four methods
1. Type in formulas for trend, intercept
2. Tools | Data Analysis | Regression
3. Graph, and R click on data, add a trendline, and
display the equation.
4. Use intercept(Y,X), slope(Y,X) and RSQ(Y,X)
commands
• Fits a trend and intercept to the data.
• R2 measures the percentage of change in y that
can be explained by changes in x.
• Gives all data equal weight.
• Exp. smoothing with a trend gives more weight
to recent, less to old.
Causal Forecasting
• Linear regression seeks a linear relationship
between the input variable and the output
quantity.
yc  a  bx

• For example, furniture sales correlates to

housing sales
• Not easy, multiple sources of error:
▫ Understand and quantify relationship
▫ Someone else has to forecast the x values for you
Video sales of Shrek 2?
• Shrek did $500m at the box office, and sold
almost 50 million DVDs & videos
• Shrek2 did $920m at the box office
Box Office $ Millions

1000
900
800
700
600
500
400
300
200
100
0
Shrek Shrek2
Video sales of Shrek 2?
• Assume 1-1 ratio:
▫ 920/500 = 1.84
▫ 1.84 * 50 million = 92 million videos?
▫ Fortunately, not that dumb.
• January 3, 2005: 37 million sold!
• March analyst call: 40m by end Q1
• March SEC filing: 33.7 million sold. Oops.
• May 10 Announcement:
▫ In 2nd public Q, missed earnings targets by 25%.
▫ May 9, word started leaking
▫ Stock dropped 16.7%
Lessons Learned
• Flooded market with DVDs
• Guaranteed Sales
▫ Promised the retailer they would sell them, or else the
retailer could return them
▫ Didn’t know how many would come back
• 5 years ago
▫ Typical movie 30% of sales in first week
▫ Animated movies even lower than that
• 2004/5 50-70% in first week
▫ Shrek 2: 12.1m in first 3 days
▫ American Idol ending, had to vote in first week
The Human Element
• Colbert says you have more nerve endings in
your gut than in your brain
• Limited ability to include factors
▫ Can’t include everything
• If it feels really wrong to your gut, maybe your
gut is right
Washoe Gaming Win, 1993-96
300
What did they
280 mean when they
260 said it was down
240 three quarters
220 in a row?
200

180
1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4
1993 1994 1995 1996
Seasonality
• Seasonality is regular up or down
movements in the data
• Can be hourly, daily, weekly, yearly
• Naïve method
▫ N1: Assume January sales will be same as
December
▫ N2: Assume this Friday’s ticket sales will be
same as last
Seasonal Relatives
• Seasonal relative for May is 1.20, means May
sales are typically 20% above the average
• Factor for July is 0.90, meaning July sales are
typically 10% below the average
Seasonality & No Trend
Sales Relative
Spring 200 200/250 = 0.8
Summer 350 350/250 = 1.4
Fall 300 300/250 = 1.2
Winter 150 150/250 = 0.6

Total 1,000
Avg 1,000/4=250
Seasonality & No Trend
If we expected total demand for the next year to be
1,100, the average per quarter would be
1,100/4=275
Forecast
Spring 275 * 0.8 = 220
Summer 275 * 1.4 = 385
Fall 275 * 1.2 = 330
Winter 275 * 0.6 = 165
Total 1,100
Trend & Seasonality
• Deseasonalize to find the trend
1. Calculate seasonal factors
2. Deseasonalize the demand
3. Find trend of deseasonalized line
• Project trend into the future
4. Project trend line into future
5. Multiply trend line by seasonal component.
Washoe Gaming Win, 1993-96
300
Looks like a
280 downhill slide
260 -Silver Legacy
240 opened 95Q3
220 -Otherwise,
200 upward trend
180
1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4
1993 1994 1995 1996

Source: Comstock Bank, Survey of Nevada Business & Economics

Washoe Win 1989-1996
290000

270000
250000

230000
210000

190000
170000

150000
1989 1990 1991 1992 1993 1994 1995 1996

Definitely a general upward trend, slowed 93-94

1989-2007
1989-2007
1998-2007

Cache Thunder CC
9/11
Creek Valley Expands
2003-2010
350,000,000

300,000,000

250,000,000

200,000,000

150,000,000 Washoe Win

Deseas

100,000,000

50,000,000

-
2003 2004 2005 2006 2007 2008 2009 2010
 2003-2010
350,000,000

300,000,000
y = -2E+06x + 3E+08
R² = 0.6154
250,000,000

200,000,000

150,000,000 Washoe Win

Deseas
Linear (Deseas)
100,000,000

50,000,000

-
2003 2004 2005 2006 2007 2008 2009 2010
2003-2010
350,000,000

300,000,000

250,000,000

200,000,000

150,000,000

Washoe Win

100,000,000 Linear

Seasonal Forecast

50,000,000

-
2003 2004 2005 2006 2007 2008 2009 2010
Q Win
Washoe Win
350,000,000

300,000,000

250,000,000

200,000,000

Washoe Win
150,000,000

100,000,000

50,000,000

-
2003 2004 2005 2006 2007 2008
How Good Was It?
320,000,000

300,000,000

280,000,000

Actual
260,000,000
2009 Forecast
2008 Forecast

240,000,000

220,000,000

200,000,000
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24
Summary
1. Calculate indexes
2. Deseasonalize
1. Divide actual demands by seasonal indexes
3. Do a LR
4. Project the LR into the future
5. Seasonalize
1. Multiply straight-line forecast by indexes