Demand Forecasting in a Supply Chain

Forecasting is a vital component of supply chain management, helping companies fill orders on
time, avoid unnecessary inventory expenses and plan for price fluctuations. Proper forecasting
helps ensure you have enough supply on hand to satisfy demand. Business analysts use supply
chain management systems and other tools to forecast demand weeks and months in advance.

Role of Forecasting in Supply Chain

A good forecasting package provides across a wide range of products that are updated in real time
by incorporating any new demand information. This helps firms respond quickly to changes in the
market place and avoid the cost of delay.
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.

Push processes:
Push-model supply chain is one where projected demand determines what needs to enters the
process. For example, umbrellas get pushed to retailers a month before the raining season starts.
A manager must plan the level of activity, be it production, transportation, or any other planned
activity.

Pull processes:
Pull strategy is related to the just-in-time school of inventory management that minimizes stock
on hand, focusing on last-second deliveries. For example, a direct computer seller that waits until
it receives an order to actually build a custom computer for the consumer. Manufacturers might
decide to create inventories of raw material, wait until the price goes up, and then release it. A
manager must plan the level of available capacity and inventory but not the actual amount to be
executed.

Mature products with stable demand, such as milk or paper towels, are usually easiest to forecast.
Forecasting and the accompanying managerial decisions are extremely difficult when either the
supply of raw materials or the demand for the finished product is highly unpredictable. Fashion
goods and many high-tech products are examples of items that are difficult to forecast. In both
instances, an estimate of forecast error is essential when designing the supply chain and planning
its response.

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 Characteristics of Forecasts

1. Forecasts are Inaccurate:

Forecasts are always inaccurate and should thus include both the expected value of the forecast
and a measure of forecast error. If you have forecasted selling 1,531 units of a product next
month, what happens if it turns out to be 1,450? That's only a 5% error, but it could cost you
in extra inventory if you planned on it being exactly 1,531. This could be especially costly if
you're trying to reduce inventory on the product, as in a seasonal or end-of-life product. Thus,
the forecast error (or demand uncertainty) must be a key input into most supply chain decisions.
Unfortunately, most firms do not maintain any estimate of forecast error.

2. Long term Forecasts are Less Accurate than Short term:

Long-term forecasts are usually less accurate than short-term forecasts because a. short-term
forecasts have a larger standard deviation of error relative to the mean than long-term forecasts.
In Long-term forecast the e forecast is done long before the actual incident so many uncertain,
seasonal and current situational factors get ignored which don’t in Short-term forecasting.

3. Aggregate Forecast are More Accurate than Disaggregate Forecast:

Forecasting the demand for a product at a national level is more accurate than forecasting it at
each individual retail outlet. The variation of demand at each sales point is smoothed when
aggregated with other locations, providing a more accurate prediction. You can achieve a
similar improvement by forecasting the aggregate demand for all the variations of a product
combined. For example, it is easy to forecast the gross domestic product (GDP) of the United
States for a given year with less than a 2 percent error. However, it is much more difficult to
forecast yearly revenue for a company with less than a 2 percent error, and it is even harder to
forecast revenue for a given product with the same degree of accuracy. The key difference
among the three forecasts is the degree of aggregation.

4. Supply Chain Upward Distance Creates Distortion of Information:

The farther up the supply chain a company is the greater is the distortion of information it
receives. When an unusual order by a significant customer goes to retailer then retailer to
distributor to manufacturer the distortion of information happens. Retailer might forecast
increasing demand based to a customer’s sudden large purchase so that the distributor and
order a large amount then usual to be made by the manufacturer. But when the extra amount

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 is made the customer demand will not be same because of distortion of information. As a result
the inventory will be increased for the manufacturer. This whole thing is named as Bullwhip
Effect.

Components of Forecast and Forecasting Methods

Customer demand is influenced by a variety of factors and can be predicted, at least with some
probability, if a company can determine the relationship between these factors and future demand.
To forecast demand, companies must first identify the factors that influence future demand and
then ascertain the relationship between these factors and future demand.

Factors related to the demand forecast:

 Past demand
 Lead time of product replenishment
 Planned advertising or marketing efforts
 Planned price discounts
 State of the economy
 Actions that competitors have taken
What a firm knows about its customers’ past behavior, however, sheds light on their future
behavior. Demand does not arise in a vacuum.

Forecasting Methods:
Forecasting methods are classified according to the following four types:

1. Qualitative:
It is a statistical technique to make predictions about the future which uses expert judgment
instead of numerical analysis. This method of forecasting depends on the opinions and
knowledge of highly qualified and experienced employees to predict the future outcomes. Such
methods may also be necessary to forecast demand several years into the future in a new
industry.

2. Time Series:
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

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to the next. These are the simplest methods to implement and can serve as a good starting point
for a demand forecast.

3. Casual:
Causal forecasting is the technique that assumes that the variable to be forecast has a cause-
effect relationship with one or more other independent variables. Causal forecasting methods
find this correlation between demand and environmental factors and use estimates of what
environmental factors will be to forecast future demand. For example, product pricing is
strongly correlated with demand. Companies can thus use causal methods to determine the
impact of price promotions on demand. Causal techniques usually take into consideration all
possible factors that can impact the dependent variable.

4. Simulation:
Simulation forecasting methods means the consumer choices that give rise to demand to arrive
at a forecast. This is a combination of time-series and causal methods. Simulation forecast
finds out the impact of a price promotion and the impact of a competitors. Airlines simulate
customer buying behavior to forecast demand for higher fare seats when there are no seats
available at the lower fares.

Basic Approach to Demand Forecasting

To forecast effectively the following five points are important for an organization:

1. Understand the Objective of Forecasting:

Before forecasting at the beginning the motive of the forecasting should be clear. It is important
to identify the forecast decisions clearly. The decisions include decisions include how much of
a particular product to make, how much to inventory, and how much to order. All parties
affected by a supply chain decision
Should be aware of the link between the decision and the forecast. Suppose a FMCG company
is planning to give discount on one of their products in the middle of the year. So the planning
must be shared with the manufacturer, the transporter, and others involved in filling demand,
as they all must make decisions that are affected by the forecast of demand.

2. Integrate Demand Planning and Forecasting Throughout the Supply

Chain:

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A company should link its forecast to all planning activities throughout the supply chain. These
include capacity planning, production planning, promotion planning, and purchasing, among
others. A retailer develops forecasts based on promotional activities, whereas a manufacturer,
unaware of these promotions, develops a different forecast for its production planning based
on historical orders. This leads to a mismatch between supply and demand, resulting in poor
customer service. To accomplish integration, it is a good idea for a firm to have a cross-
functional team, with members from each affected function responsible for forecasting demand

3. Identify Major Factors That Influence the Demand Forecast:

Company must identify demand, supply, and product-related phenomena that influence the
demand forecast. On the demand side, a company must ascertain whether demand is growing
or declining or has a seasonal pattern. On the supply side, a company must consider the
available supply sources to decide on the accuracy of the forecast desired. On the product side,
a firm must know the number of variants of a product being sold and whether these variants
substitute for or complement one another. If demand for a product influences or is influenced
by demand for another product, the two forecasts are best made jointly.

4. Forecast at the Appropriate Level of Aggregation:

Aggregate forecasts are more accurate than disaggregate forecasts. Forecasting the demand for
a product at a national level is more accurate than forecasting it at each individual retail outlet.

5. Establish Performance and Error Measures for the Forecast:

Clear performance measures should be considered to evaluate the accuracy and timeliness of
the forecast. These measures should be highly correlated with the objectives of the business
decisions based on these forecasts. Consider a mail-order company that uses a forecast to place
orders with its suppliers up the supply chain. Suppliers take two months to send in the orders.
The mail-order company must ensure that the forecast is created at least two months before the
start of the sales season because of the two-month lead time for replenishment. At the end of
the sales season, the company must compare actual demand to forecasted demand to estimate
the accuracy of the forecast. Then plans for decreasing future forecast errors or responding to
the observed forecast errors can be put into place.

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 Risk Management in Forecasting
Forecasting errors can cause significant misallocation of resources in inventory, facilities,
transportation, sourcing, pricing, and even in information management. Forecast errors during
network design may cause too many, too few, or the wrong type of facilities to be built. Long lead
times require forecasts to be made further in advance, thus decreasing the reliability of the forecast.
Seasonality also tends to increase forecast error. Forecast errors increase when product life cycles
are short, because there are few historical data to build on when producing a forecast.

Strategies Used to Reduce Forecast Risk:

1. Increasing the responsiveness of the supply chain.
2. Utilizing opportunities for pooling of demand

Forecasting In Practice

Collaborate in building forecasts:

Collaboration with your supply chain partners can often create a much more accurate forecast. It
takes an investment of time and effort to build the relationships with your partners to begin sharing
information and creating collaborative forecasts. However, the supply chain benefits of
collaboration are comparatively more than cost.

Share only the data that truly provide value:

Data and information should be shared to the person who need it. We must know what data should
be provided to whom and what is more valuable. Irrelevant data creates misconception and waste
time.

Be sure to distinguish between demand and sales:

Distinguishing between demand and sales must be performed. Often, companies make the mistake
of looking at historical sales and assuming that this is what the historical demand was. To get true
demand, adjustments need to be made for unmet demand due to stock outs, competitor actions,
pricing, and promotions.

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 Conclusion

Proper demand forecasting enables better planning and utilization of resources for business to be
competitive. Forecasting is an integral part of demand management since it provides an estimate
of the future demand and the basis for planning and making sound business decisions. A mismatch
in supply and demand could result in excessive inventory and stock outs and loss of profit and
goodwill. Both qualitative and quantitative methods are available to help companies forecast
demand better. Since forecasts are seldom completely accurate, management must monitor
forecast errors and make the necessary improvement to the forecasting process.

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