Demand Management

and
FORECASTING
Operations Management
Dr. Ron Tibben-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, dont 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

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
Nave 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

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 cycles to demand, quite a bit of freedom to
choose n

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

Centered Moving Average

Take average of n periods,

Plot the average in the middle period
Not useful for forecasting
More stable than actuals
If seasonality, n = season length (4wks, 12 mo, etc.)

CMA - # Periods to Average

What if data has 12-month cycle?

Ja F M Ap My Jn Jl Au S O N D
M
Avg of Jan-Dec gives average of month 6.5:

Ja F

(1+2+3+4+5+6+7+8+9+10+11+12)/12=
Avg of Feb-Jan gives average of month 6.5:
6.5
(2+3+4+5+6+7+8+9+10+11+12+13)/12

=7.5
How get a July average? Average of other two averages

Centered Moving Average

To center even-number of periods
12: take half each of 1 and 13, plus sum of 2-12.
F14 = 0.5 A1 + A2 + A3 + A4 + A5 + A6 + A7 +
A8 + A9 + A10 + A11 + A12 + 0.5A13
This is exactly the same as what you get by
taking the average of the averages from previous
slide

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 + 3DApr + 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

Wts = 0.5, 0.3, 0.2

Exponential Smoothing

Ft Ft 1 At 1 Ft 1
Ft 1 Ft 1 At 1

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

Weighted Moving Average

Alpha = 0.3

Weighted Moving Average

Alpha = 0.5

Exponential Smoothing
Ft At 1 1 Ft 1

We take:
And substitute in
to get:

Ft 1 At 2 1 Ft 2

Ft At 1 1 At 2 1 Ft 2
2

and if we continue doing this, we get:

Ft At 1 1 At 2 1 At 3 1 At 3 1 At 3 ...
2

Older demands get exponentially less weight

Choosing
Low : if demand is stable, we dont 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
Average must be in-between

30
20
10

Trend-Adjusted Ex. Smoothing

FITt Ft T t Forecast Including Trend
Ft Exp. Smoothed forecast for t
Tt Exp. Smoothed Trend Estimate
Ft FITt 1 At 1 FITt 1
(1 ) FITt 1 At 1

T t T t 1 Ft FITt 1
where and are smoothing constants

Trend-Adjusted Ex. Smoothing

F1 100 T1 10 0.20 0.30

Forecast including trend for period 1 is

FIT1 F1 T1 100 10 110

Suppose actual demand is 115, A1=115

F2 FITt1 At1 FITt1 FIT1 A1 FIT1

110 0.2 *(115 110) 110 1 111.0

T 2 T t 1 Ft FITt 1 T 1 F2 FIT1

10 0.30 * (111 110 ) 10 0.3 10.3

FIT2 F2 T 2 111 10.3 121.3

Trend-Adjusted Ex. Smoothing

F2 111 .0 T2 10.3

0.20 0.30

Forecast including trend for period 1 is

FIT2 F2 T 2 111 10.3 121.3

Suppose actual demand is 120, A2=120

F3 FIT2 A2 FIT2

121.3 0.2 *(120 121.3) 121.3 0.2 *1.3 121.04

T 3 T 2 F3 FIT2
10.3 0.30 * (121.04 121.3) 10.3 0.078 10.22

FIT3 F3 T 3 121.04 10.22 131.26

Selecting and
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?

Lets 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?

Evaluating Forecasts
n

Mean Absolute
Deviation

MAD (1/n) At Ft
i1
n

Mean Squared
Error

MSE (1/n) At Ft

Mean Absolute
Percent Error

At Ft
MAPE (1/n)
100
Di

i1

i1

Tracking Signal
To monitor, compute tracking signal
RSFE
Tracking Signal
MAD
n

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

Forecast Error

Monitor forecast error each period, to see if it

becomes too great
10

Upper Limit

-10
Forecast Period

Lower Limit

Updating MAD
Simplified calculation avoids keeping
running total of all errors and demands:

MADt MADt 1 Actual Forecast t MADt 1

Standard Deviation can be estimated
from MAD:

1.25 MAD

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
xy n x y

b
x nx
y b x

a
y bx
2

S yx

(
y

Y
)
i
i
i 1
n2

Linear Regression
Three methods

Type in formulas for trend, intercept

Tools | Data Analysis | Regression
Graph, and R click on data, add a trendline, and
display the equation.
Use intercept(Y,X) and slope(Y,X) commands

Fits a trend and intercept to the data.

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

R2 measures the percentage of change in y that

can be explained by changes in x.

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

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
Didnt 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

Washoe Gaming Win, 1993-96

What did they
mean when they
said it was down
three quarters
in a row?

1993

1994

1995

1996

Seasonality
Seasonality is regular up or down
movements in the data
Can be hourly, daily, weekly, yearly
Nave method
N1: Assume January sales will be same as
December
N2: Assume this Fridays ticket sales will be
same as last

Seasonal Factors
Seasonal factor 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

Spring
Summer
Fall
Winter

Sales
Factor
200200/250 = 0.8
350350/250 = 1.4
300300/250 = 1.2
150150/250 = 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

Looks like a
downhill slide
-Silver Legacy
opened 95Q3
-Otherwise,
upward trend
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
Creek

9/11

Thunder CC
Valley Expands

2003Q3 - 2007Q3

2003Q2 - 2007Q3

2003-2007

Compute Indexes
Q

For each Q:
Date

Quarter

Win

59276,371
60235,766
2004

61240,221
62259,350
63279,758
64245,811

2005

65231,608
66259,687
67297,414
68260,149

2006

69245,775
70269,670

Avg

Index

1240,562

0.9168

2265,456

1.0117

3289,187

1.1022

Compute Avg Win for each Q

4254,325

0.9693

Divide
Total Avg by Total Avg to get Ind
240,562/262,382
Avg.
262,382 = 0.9168

Deseasonalize: Divide Win by Inde

276,371 / 1.1022 = 250,755

2003-2007
period

Win

59276,371

2004

2005

2006

Deseasonalize
d
250,755

60235,766

243,236

61240,221

262,010

62259,350

256,347

63279,758

253,828

64245,811

253,598

65231,608

252,616

66259,687

256,681

67297,414

269,847

68260,149

268,391

69245,775

268,069

70269,670

266,548

71294,839

267,511

Do LR on deseasonalized da
Linear

intercept

185,538.00

slope

1,119.91

251,613
252,733
253,853
254,972
256,092
257,212
258,332
259,452
260,572
261,692
262,812
263,932
265,052
266,172

rsq
0.497
Create
Linear
Forecasts
Int + slope * period

Seasonal Forecast

2004

2005

2006

58257,062

Deseasonalized Linear

Forecast

59276,371

250,755

251,613

277,317

60235,766

243,236

252,733

244,972

61240,221

262,010

253,853

232,741

62259,350

256,347

254,972

257,959

63279,758

253,828

256,092

282,254

64245,811

253,598

257,212

249,314

65231,608

252,616

258,332

236,848

66259,687

256,681

259,452

262,491

67297,414

269,847

260,572

287,191

68260,149

268,391

261,692

253,656

69245,775

268,069

262,812

240,956

70269,670

266,548

263,932

267,023

Q
1
2
3
4

Index
0.9168
1.0117
1.1022
0.9693

Multiply Linear
forecast by
indexes
251,613 * 1.1022
= 277,317
267,291 * 0.9168
= 245,063