Demand Forecasting in Retail Logistics

Demand forecasting is the activity of estimating the quantity of a product or service that consumers will purchase. Demand forecasting involves techniques including both informal methods, such as educated guesses, and quantitative methods, such as the use of historical sales data or current data from test markets. Demand forecasting may be used in making pricing decisions, in assessing future capacity requirements, or in making decisions on whether to enter a new marke
t.

The Role of Forecasting in a Supply Chain

Demand forecasts from the basis of all supply chain planning. Consider the push/pull view of supply chain. All push processes in the supply chain are performed in anticipation of customer demand, whereas all pull processes are performed in response to customer demand. For push processes, a manager must plan the level of activity, be it production, transportation or any other planned activity. For pull processes, a manager must plan the level of available capacity and inventory but not the actual amount to be executed. In both cases, the first step a manager must take is to forecast what customer demand will be.

For e.g. Dell orders PC components in anticipation of customer orders, whereas it performs assembly in response to customer orders. Dell uses a forecast of future demand to determine the quantity of components to have on hand (a push process) and to determine the capacity needed in its plants (for pull production).

Characteristics of Forecasts
1. Forecasts are always inaccurate and should thus include both the expected value of the forecast and a measure of forecast error. To understand the importance of forecast error, consider two car dealers. One of them expects sales to range b/w 100 and 1900 units, whereas the other expects sales to range b/w 900 and 1100 units. Even though both dealers anticipate average sales of 1000, the sourcing policies for each dealer should be very different in forecast accuracy. Long term forecast are usually less accurate than short-term forecasts. Aggregate forecasts are usually more accurate than disaggregate forecasts. In general, the farther up the supply chain a company is, the greater is the distortion of information it receives.

2. 3. 4.

Components of a Forecasts
1. Average: the mean of the observations over time 2. Trend: a gradual increase or decrease in the average over time 3. Seasonal influence: predictable short-term cycling behaviour due to time of day, week, month, season, year, etc. 4. Cyclical movement: unpredictable long-term cycling behaviour due to business cycle or product/service life cycle 5. Random error: remaining variation that cannot be explained by the other four components

Forecasting Methods
I. QUALITATIVE FORECASTING METHODS qualitative forecasting methods are based on educated opinions of appropriate persons 1. Delphi method: forecast is developed by a panel of experts who anonymously

answer a series of questions; responses are fed back to panel members who then
may change their original responses - very time consuming and expensive - new groupware makes this process much more feasible 2. Market research: panels, questionnaires, test markets, surveys, etc. 3. Product life-cycle analogy: forecasts based on life-cycles of similar products, services, or processes 4. Expert judgement by management, sales force, or other knowledgeable persons

II. QUANTITATIVE FORECASTING METHODS

Time Series Forecasting Methods

Time series forecasting methods use historical demand to make a forecast. They are based on the assumption that past demand history is a good indicator of future demand. These methods are most appropriate when the basic demand pattern does not vary significantly from one year to next.

Goal is to predict systematic component of demand

Multiplicative: (level)(trend)(seasonal factor) Additive: level + trend + seasonal factor Mixed: (level + trend)(seasonal factor)

Static methods Adaptive forecasting

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Static Methods
Assume a mixed model: Systematic component = (level + trend)(seasonal factor) Ft+l = [L + (t + l)T]St+l = forecast in period t for demand in period t + l L = estimate of level for period 0 T = estimate of trend St = estimate of seasonal factor for period t Dt = actual demand in period t Ft = forecast of demand in period t

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Static Methods
Estimating level and trend Estimating seasonal factors

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Estimating Level and Trend

Before estimating level and trend, demand data must be deseasonalized Deseasonalized demand = demand that would have been observed in the absence of seasonal fluctuations Periodicity (p)
the number of periods after which the seasonal cycle repeats itself for demand at Tahoe Salt (Table 7.1, Figure 7.1) p = 4

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Time Series Forecasting (Table 7.1)

Quarter II, 1998 III, 1998 IV, 1998 I, 1999 II, 1999 III, 1999 IV, 1999 I, 2000 II, 2000 III, 2000 IV, 2000 I, 2001
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Demand Dt 8000 13000 23000 34000 10000 18000 23000 38000 12000 13000 32000 41000

Forecast demand for the next four quarters.

Adaptive Forecasting
The estimates of level, trend, and seasonality are adjusted after each demand observation General steps in adaptive forecasting Moving average Simple exponential smoothing Trend-corrected exponential smoothing (Holts model) Trend- and seasonality-corrected exponential smoothing (Winters model)

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Basic Formula for Adaptive Forecasting

Ft+1 = (Lt + lT)St+1 = forecast for period t+l in period t Lt = Estimate of level at the end of period t Tt = Estimate of trend at the end of period t St = Estimate of seasonal factor for period t Ft = Forecast of demand for period t (made period t-1 or earlier) Dt = Actual demand observed in period t Et = Forecast error in period t At = Absolute deviation for period t = |Et| MAD = Mean Absolute Deviation = average value of At

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Moving Average
Moving average techniques forecast demand by calculating an average of actual demands from a specified number of prior periods

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Moving Average
Used when demand has no observable trend or seasonality Systematic component of demand = level The level in period t is the average demand over the last N periods (the N-period moving average) Current forecast for all future periods is the same and is based on the current estimate of the level Lt = (Dt + Dt-1 + + Dt-N+1) / N Ft+1 = Lt and Ft+n = Lt After observing the demand for period t+1, revise the estimates as follows: Lt+1 = (Dt+1 + Dt + + Dt-N+2) / N Ft+2 = Lt+1

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Simple Exponential Smoothing

exponential smoothing gives greater weight to demand in more recent periods, and less weight to demand in earlier periods Used when demand has no observable trend or seasonality Systematic component of demand = level Initial estimate of level, L0, assumed to be the average of all historical data L0 = [Sum(i=1 to n)Di]/n Current forecast for all future periods is equal to the current estimate of the level and is given as follows: Ft+1 = Lt and Ft+n = Lt

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