7.

1 The Role of Forecasting in a Supply Chain

Demand forecasts form the basis of all supply chain planning
push processes & pull processes In both instances, the first step a manager must take is to
forecast what customer demand will be.
Leaders in many supply chains, from electronics manufacturers to packaged-goods
retailers, have improved their ability to match supply and demand by moving toward
collaborative forecasting.
Role of Forecasting in a Supply Chain
• The basis for all planning decisions in a supply chain
• Used for both push and pull processes
– Production scheduling, inventory, aggregate planning
– Sales force allocation, promotions, new production introduction
– Plant/equipment investment, budgetary planning
– Workforce planning, hiring, layoffs
• All of these decisions are interrelated

Characteristics of Forecasts Companies and supply chain managers should be aware of the
following 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 between 100 and 1,900 units,
whereas the other expects sales to range between 900 and 1,100 units. Even though both
dealers anticipate average sales of 1,000, the sourcing policies for each dealer should be
very different, given the difference in forecast accuracy. Thus, the forecast error (or demand
uncertainty) is a key input into most supply chain decisions. Unfortunately, most firms do not
maintain any estimates of forecast error.
2. Long-term forecasts are usually less accurate than short-term forecasts; that is, longterm
forecasts have a larger standard deviation of error relative to the mean than short-term
forecasts. Seven-Eleven Japan has exploited this key property to improve its performance.
The company has instituted a replenishment process that enables it to respond to an order
within hours. For example, if a store manager places an order by 10 a.m., the order is
delivered by 7 p.m. the same day. Therefore, the manager has to forecast what will sell that
night only less than 12 hours before the actual sale. The short lead time allows a manager
to take into account current information that could affect product sales, such as the weather.
This forecast is likely to be more accurate than if the store manager had to forecast demand
a week in advance.
3. Aggregate forecasts are usually more accurate than disaggregate forecasts, as they tend
to have a smaller standard deviation of error relative to the mean. 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. The GDP is an aggregation across many
companies, and the earnings of a company are an aggregation across several product lines.
The greater the aggregation, the more accurate the forecast.

4. In general, the farther up the supply chain a company is (or the farther it is from the
consumer), the greater the distortion of information it receives. One classic example of this
phenomenon is the bullwhip effect (see Chapter 10), in which order variation is amplified as
orders move farther from the end customer. Collaborative forecasting based on sales to the
end customer helps upstream enterprises reduce forecast error.

The further up the supply chain a company is (or the further

they are from the consumer), the greater the distortion of
information they receive. This is because as information
passes through various levels of the supply chain, it can be
misinterpreted, altered, or lost, leading to greater distortions
the further away from the consumer the company is. For
example, a manufacturer may receive orders from a
distributor, who in turn receives demand forecasts from
retailers, who interact directly with consumers. As this
information travels up the supply chain, each intermediary may
add their own assumptions or interpretations, which can
distort the original message.

Rather, 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.
Companies must balance objective and subjective factors when forecasting demand.
A company must be knowledgeable about numerous factors that are related to the demand
forecast, including the following:
• Past demand
• Lead time of product replenishment
• Planned advertising or marketing efforts
• Planned price discounts
• State of the economy
• Actions that competitors have taken
7.3 Components of a Forecast and Forecasting Methods
Forecasting is a key driver of virtually every design and planning decision made in both an
enterprise and a supply chain. Enterprises have always forecast demand and used it to
make decisions. A relatively recent phenomenon, however, is to create collaborative
forecasts for an entire supply chain and use these as the basis for decisions. Collaborative
forecasting greatly increases the accuracy of forecasts and allows the supply chain to
maximize its performance. Without collaboration, supply chain stages farther from demand
will likely have poor forecasts that will lead to supply chain inefficiencies and a lack of
responsiveness.
Forecasting methods are classified according to the following four types

Qualitative methods are:

  Jury of Executive opinion
 The Delphi Technique
 Poll of Sales force opinion
 Survey of customers buying plan

1. Qualitative: Qualitative forecasting methods are primarily subjective and rely on human
judgment. They are most appropriate when little historical data are available or when
experts have market intelligence that may affect the forecast. 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 to the next. These are the simplest methods to implement
and can serve as a good starting point for a demand forecast.

Components of Time Series Analysis

Let’s look at the various components of Time Series Analysis:

 Trend: In which there is no fixed interval and any divergence within the given dataset
is a continuous timeline. The trend would be Negative or Positive or Null Trend
  Seasonality: In which regular or fixed interval shifts within the dataset in a continuous
timeline. Would be bell curve or saw tooth

 Cyclical: In which there is no fixed interval, uncertainty in movement and its pattern

 Irregularity: Unexpected situations/events/scenarios and spikes in a short time span.

The equation for calculating the systematic component may take a variety of forms:

3. Causal: Causal forecasting methods assume that the demand forecast is highly
correlated with certain factors in the environment (the state of the economy, interest rates,
etc.). 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.
4. Simulation: Simulation forecasting methods imitate the consumer choices that give rise to
demand to arrive at a forecast. Using simulation, a firm can combine time-series and causal
methods to answer such questions as: What will be the impact of a price promotion? What
will be the impact of a competitor opening a store nearby? Airlines simulate customer
buying behavior to forecast demand for higher-fare seats when no seats are available at
lower fares.
Therefore, any observed demand can be broken down into a systematic and a random
component:
Observed demand 1O2 = systematic component 1S2 + random component 1R2
The systematic component measures the expected value of demand and consists of what
we will call level, the current deseasonalized demand; trend, the rate of growth or decline in
demand for the next period; and seasonality, the predictable seasonal fluctuations in
demand. The random component is the part of the forecast that deviates from the
systematic part.
 A company cannot (and should not) forecast the direction of the random component. All a
company can predict is the random component’s size and variability, which provides a
measure of forecast error. The objective of forecasting is to filter out the random component
(noise) and estimate the systematic component. The forecast error measures the difference
between the forecast and actual demand. On average, a good forecasting method has an
error whose size is comparable to the random component of demand. A

Error measures MAD Mean Squared Error (MSE) Mean Absolute Percentage Error
(MAPE), Bias , Tracking Signal

7.4 Basic Approach to Demand Forecasting The following five points are important for an
organization to forecast effectively:
1. Understand the objective of forecasting.
2. Integrate demand planning and forecasting throughout the supply chain.
3. Identify the major factors that influence the demand forecast.
4. Forecast at the appropriate level of aggregation.
5. Establish performance and error measures for the forecast.

1. Understand the role of forecasting for both an enterprise and a supply chain.
Forecasting is a key driver of virtually every design and planning decision made in both an
enterprise and a supply chain. Enterprises have always forecast demand and used it to
make decisions. A relatively recent phenomenon, however, is to create collaborative
forecasts for an entire supply chain and use these as the basis for decisions. Collaborative
forecasting greatly increases the accuracy of forecasts and allows the supply chain to
maximize its performance. Without collaboration, supply chain stages farther from demand
will likely have poor forecasts that will lead to supply chain inefficiencies and a lack of
responsiveness.
2. Identify the components of a demand forecast. Demand consists of a systematic and a
random component.
The systematic component measures the expected value of demand. The random
component measures fluctuations in demand from the expected value. The systematic
component consists of level, trend, and seasonality. Level measures the current
deseasonalized demand. Trend measures the current rate of growth or decline in demand.
Seasonality indicates predictable seasonal fluctuations in demand.
3. Forecast demand in a supply chain given historical demand data using time-series
methodologies.
Time-series methods for forecasting are categorized as static or adaptive. In static methods,
the estimates of parameters and demand patterns are not updated as new demand is
observed. Static methods include regression. In adaptive methods, the estimates are
updated each time a new demand is observed. Adaptive methods include moving averages,
simple exponential smoothing, Holt’s model, and Winter’s model. Moving averages and
simple exponential smoothing are best used when demand displays neither trend nor
seasonality. Holt’s model is best when demand displays a trend but no seasonality. Winter’s
model is appropriate when demand displays both trend and seasonality.
4. Analyze demand forecasts to estimate forecast error. Forecast error measures the
random component of demand.
This measure is important because it reveals how inaccurate a forecast is likely to be and
what contingencies a firm may have to plan for. The MSE, MAD, and MAPE are used to
estimate the size of the forecast error. The bias and TS are used to estimate if the forecast
consistently over- or underforecasts or if demand has deviated significantly from historical
norms.
A seasonal monthly index is a numerical value that compares a specific month
to the average month, highlighting the relative strength of demand during that
period. A seasonal index value greater than 1 indicates higher demand
compared to the average, whereas a value less than 1 signifies lower
demand. The average value of a seasonal index is 1, which can be converted
into a percentage for easier interpretation. For example, a seasonal index of
1.3 (or 130%) would indicate that that season had 30% more than the
seasonal average.
Seasonal monthly Index = (Monthly average for the specific month/Average of monthly averages) *100

Seasonal Index = (Monthly Ave/ Ave of monthly ave) x 100