7

Demand
Forecasting
in a Supply Chain

PowerPoint presentation to accompany

Chopra and Meindl Supply Chain Management, 5e
Copyright 2013 Pearson Education, Inc. publishing as Prentice Hall.

1-1
7-1
 Learning Objectives
1. Understand the role of forecasting for both an
enterprise and a supply chain.
2. Identify the components of a demand
forecast.
3. Forecast demand in a supply chain given
historical demand data using time-series
methodologies.
4. Analyze demand forecasts to estimate
forecast error.

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 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
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 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
2. Long-term forecasts are usually less accurate than
short-term forecasts
3. Aggregate forecasts are usually more accurate than
disaggregate forecasts
4. In general, the farther up the supply chain a
company is, the greater is the distortion of
information it receives

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 Components and Methods
Companies must identify the factors that
influence future demand and then ascertain
the relationship between these factors and
future demand
Past demand
Lead time of product replenishment
Planned advertising or marketing efforts
Planned price discounts
State of the economy
Actions that competitors have taken

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 Components and Methods
1. Qualitative
Primarily subjective
Rely on judgment
2. Time Series
Use historical demand only
Best with stable demand
3. Causal
Relationship between demand and some other
factor
4. Simulation
Imitate consumer choices that give rise to
demand
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 Components of an Observation
Observed demand (O) = systematic component (S)
+ random component (R)

Systematic component expected value of demand

Level (current deseasonalized demand)
Trend (growth or decline in demand)
Seasonality (predictable seasonal fluctuation)
Random component part of forecast that deviates
from systematic component
Forecast error difference between forecast and actual
demand

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 Basic Approach
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.

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 Time-Series Forecasting Methods

Three ways to calculate the systematic

component
Multiplicative
S = level x trend x seasonal factor
Additive
S = level + trend + seasonal factor
Mixed
S = (level + trend) x seasonal factor

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 Time-Series Forecasting Methods
Additive Model During the development of additive models
there is an implicit assumption that the different components
affect the time series additively

Data = Seasonal effect + Trend + Cyclical + Residual

For example, for monthly data, an additive model assumes that
the difference between the January and July values is
approximately the same each year. In other words, the amplitude
of the seasonal effect is the same each year.

The model similarly assumes that the residuals are roughly the
same size throughout the series -- they are a random component
that adds on to the other components in the same way at all parts
of the series.
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 Time-Series Forecasting Methods
Multiplicative models - In many time series involving
quantities (e.g. money, wheat production, etc.), the absolute
differences in the values are of less interest and importance
than the percentage changes.

For example, in seasonal data, it might be more useful to

model that the July value is the same proportion higher than
the January value in each year, rather than assuming that
their difference is constant. Assuming that the seasonal and
other effects act proportionally on the series is equivalent to
a multiplicative model,

Data = Seasonal effect * Trend * Cyclical * Residual

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 Static Methods
Systematic component (level trend) seasonal factor

Ftl [L (t l)T]Stl

where

L = estimate of level at t = 0
T = estimate of trend
St = estimate of seasonal factor for Period t
Dt = actual demand observed in Period t
Ft = forecast of demand for Period t

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 Tahoe Salt
Year Quarter Period, t Demand, Dt
1 2 1 8,000
1 3 2 13,000
1 4 3 23,000
2 1 4 34,000
2 2 5 10,000
2 3 6 18,000
2 4 7 23,000
3 1 8 38,000
3 2 9 12,000
3 3 10 13,000
3 4 11 32,000
4 1 12 41,000
Table 7-1
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 Tahoe Salt

Figure 7-1

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 Estimate Level and Trend
Periodicity p = 4, t = 3

t 1 ( p / 2 )

Dt ( p / 2 ) Dt ( p / 2 ) 2 Di /( 2 p ) for p even
i t 1 ( p / 2 )
Dt t [( p 1) / 2 ]

Di / p for p odd
i t [( p 1) / 2 ]

t 1 ( p / 2 )

Dt Dt ( p / 2 ) Dt ( p / 2 ) 2D i /( 2 p )
i t 1 ( p / 2 )

4
D1 D5 2D
i 2
i /8

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 Tahoe Salt

Figure 7-2

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 Tahoe Salt

Figure 7-3

A linear relationship exists between the deseasonalized

demand and time based on the change in demand over time
Dt L Tt

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 Estimating Seasonal Factors
Di
St
Dt

Figure 7-4

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 Estimating Seasonal Factors
r 1

j 0
S jp 1

Si
r
S1 (S1 S5 S9 ) / 3 (0.42 0.47 0.52) / 3 0.47
S2 (S2 S6 S10 ) / 3 (0.67 0.83 0.55) / 3 0.68
S3 (S3 S7 S11) / 3 (1.15 1.04 1.32) / 3 1.17
S4 (S4 S8 S12 ) / 3 (1.66 1.68 1.66) / 3 1.67

F13 (L 13T)S13 (18,439 13 524)0.47 11,868

F14 (L 14T)S14 (18,439 14 524)0.68 17,527
F15 (L 15T)S15 (18,439 15 524)1.17 30,770
F16 (L 16T)S16 (18,439 16 524)1.67 44,794

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 Adaptive Forecasting
The estimates of level, trend, and
seasonality are adjusted after each
demand observation
Estimates incorporate all new data that
are observed

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 Adaptive Forecasting
Ft1 (Lt lTt )St1
where

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 = Ft Dt = forecast error in Period t
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 Steps in Adaptive Forecasting
Initialize
Compute initial estimates of level (L0), trend (T0),
and seasonal factors (S1,,Sp)
Forecast
Forecast demand for period t + 1
Estimate error
Compute error Et+1 = Ft+1 Dt+1
Modify estimates
Modify the estimates of level (Lt+1), trend (Tt+1), and
seasonal factor (St+p+1), given the error Et+1

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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
Lt = (Dt + Dt-1 + + DtN+1) / N
Ft+1 = Lt and Ft+n = Lt
After observing the demand for period t + 1, revise the
estimates
Lt+1 = (Dt+1 + Dt + + Dt-N+2) / N, Ft+2 = Lt+1

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 Moving Average Example
A supermarket has experienced weekly
demand of milk of D1 = 120, D2 = 127, D3 =
114, and D4 = 122 gallons over the past
four weeks
Forecast demand for Period 5 using a four-
period moving average
What is the forecast error if demand in Period
5 turns out to be 125 gallons?

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 Moving Average Example
L4 = (D4 + D3 + D2 + D1)/4
= (122 + 114 + 127 + 120)/4 = 120.75

Forecast demand for Period 5

F5 = L4 = 120.75 gallons

Error if demand in Period 5 = 125 gallons

E5 = F5 D5 = 125 120.75 = 4.25

Revised demand
L5 = (D5 + D4 + D3 + D2)/4
= (125 + 122 + 114 + 127)/4 = 122
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 Simple Exponential Smoothing
Used when demand has no observable
trend or seasonality
Systematic component of demand = level
Initial estimate of level, L , assumed to 0
be the average of all historical data

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 Simple Exponential Smoothing
1 n
Given data for Periods 1 to n L0 Di
n i1

Current forecast Ft1 Lt and Ftn Lt

Revised forecast
using smoothing Lt1 Dt1 (1 )Lt
constant 0 < < 1
t1

Thus Lt1 (1 ) n Dt1n (1 )t D1

n0

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 Simple Exponential Smoothing
Supermarket data
4
L0 Di / 4 120.75
i1

F1 L0 120.75

E1 = F1 D1 = 120.75 120 = 0.75

L1 D1 (1 )L0
0.1120 0.9 120.75 120.68
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 Trend-Corrected Exponential Smoothing
(Holts Model)

Appropriate when the demand is

assumed to have a level and trend in
the systematic component of demand
but no seasonality

Systematic component of demand = level + trend

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 Trend-Corrected Exponential Smoothing
(Holts Model)
Obtain initial estimate of level and trend by
running a linear regression
Dt = at + b
T0 = a, L0 = b
In Period t, the forecast for future periods is
Ft+1 = Lt + Tt and Ft+n = Lt + nTt
Revised estimates for Period t
Lt+1 = Dt+1 + (1 )(Lt + Tt)
Tt+1 = (Lt+1 Lt) + (1 )Tt
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 Trend-Corrected Exponential Smoothing
(Holts Model)

MP3 player demand

D1 = 8,415, D2 = 8,732, D3 = 9,014,
D4 = 9,808, D5 = 10,413, D6 = 11,961
= 0.1, = 0.2
Using regression analysis
L0 = 7,367 and T0 = 673
Forecast for Period 1
F1 = L0 + T0 = 7,367 + 673 = 8,040

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 Trend-Corrected Exponential Smoothing
(Holts Model)

Revised estimate
L1 = D1 + (1 )(L0 + T0)
= 0.1 x 8,415 + 0.9 x 8,040 = 8,078
T1 = (L1 L0) + (1 )T0
= 0.2 x (8,078 7,367) + 0.8 x 673 = 681
With new L1
F2 = L1 + T1 = 8,078 + 681 = 8,759
Continuing
F7 = L6 + T6 = 11,399 + 673 = 12,072
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 Trend- and Seasonality-Corrected
Exponential Smoothing

Appropriate when the systematic

component of demand is assumed to
have a level, trend, and seasonal factor

Systematic component = (level + trend) x seasonal factor

Ft+1 = (Lt + Tt)St+1 and Ft+l = (Lt + lTt)St+l

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 Trend- and Seasonality-Corrected
Exponential Smoothing

After observing demand for period t + 1, revise

estimates for level, trend, and seasonal factors
Lt+1 = (Dt+1/St+1) + (1 )(Lt + Tt)
Tt+1 = (Lt+1 Lt) + (1 )Tt
St+p+1 = (Dt+1/Lt+1) + (1 )St+1
= smoothing constant for level
= smoothing constant for trend
= smoothing constant for seasonal factor

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 Winters Model

L0 = 18,439 T0 = 524
S1= 0.47, S2 = 0.68, S3 = 1.17, S4 = 1.67
F1 = (L0 + T0)S1 = (18,439 + 524)(0.47) = 8,913
The observed demand for Period 1 = D1 = 8,000
Forecast error for Period 1
= E1 = F1 D1
= 8,913 8,000 = 913

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 Winters Model
Assume = 0.1, = 0.2, = 0.1; revise estimates
for level and trend for period 1 and for seasonal
factor for Period 5
L1 = (D1/S1) + (1 )(L0 + T0)
= 0.1 x (8,000/0.47) + 0.9 x (18,439 + 524) = 18,769
T1 = (L1 L0) + (1 )T0
= 0.2 x (18,769 18,439) + 0.8 x 524 = 485
S5 = (D1/L1) + (1 )S1
= 0.1 x (8,000/18,769) + 0.9 x 0.47 = 0.47
F2 = (L1 + T1)S2 = (18,769 + 485)0.68 = 13,093

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 Time Series Models

Forecasting Method Applicability

Moving average No trend or seasonality
Simple exponential No trend or seasonality
smoothing
Holts model Trend but no seasonality
Winters model Trend and seasonality

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 Measures of Forecast Error
Et Ft Dt
n
Et
MSEn
1

n
Et2 Dt
100
n t1 MAPEn t1

n
n
1 n
At Et MADn At biasn Et
n t1
t1

biast
1.25MAD TSt
MADt
t1 1
Declining alpha t
t1 1 t
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 Selecting the Best Smoothing Constant

Figure 7-5

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 Selecting the Best Smoothing Constant

Figure 7-6

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 Forecasting Demand at Tahoe Salt

Moving average
Simple exponential smoothing
Trend-corrected exponential
smoothing
Trend- and seasonality-corrected
exponential smoothing

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 Forecasting Demand at Tahoe Salt

Figure 7-7

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 Forecasting Demand at Tahoe Salt

Moving average
L12 = 24,500
F13 = F14 = F15 = F16 = L12 = 24,500
= 1.25 x 9,719 = 12,148

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 Forecasting Demand at Tahoe Salt

Figure 7-8

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 Forecasting Demand at Tahoe Salt

Single exponential smoothing

L0 = 22,083
L12 = 23,490
F13 = F14 = F15 = F16 = L12 = 23,490
= 1.25 x 10,208 = 12,761

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 Forecasting Demand at Tahoe Salt

Figure 7-9

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 Forecasting Demand at Tahoe Salt

Trend-Corrected Exponential Smoothing

L0 = 12,015 and T0 = 1,549
L12 = 30,443 and T12 = 1,541
F13 = L12 + T12 = 30,443 + 1,541 = 31,984
F14 = L12 + 2T12 = 30,443 + 2 x 1,541 = 33,525
F15 = L12 + 3T12 = 30,443 + 3 x 1,541 = 35,066
F16 = L12 + 4T12 = 30,443 + 4 x 1,541 = 36,607
= 1.25 x 8,836 = 11,045
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 Forecasting Demand at Tahoe Salt

Figure 7-10

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 Forecasting Demand at Tahoe Salt

Trend- and Seasonality-Corrected

L0 = 18,439 T0 =524
S1 = 0.47 S2 = 0.68 S3 = 1.17 S4 = 1.67
L12 = 24,791 T12 = 532
F13 = (L12 + T12)S13 = (24,791 + 532)0.47 = 11,940
F14 = (L12 + 2T12)S13 = (24,791 + 2 x 532)0.68 = 17,579
F15 = (L12 + 3T12)S13 = (24,791 + 3 x 532)1.17 = 30,930
F16 = (L12 + 4T12)S13 = (24,791 + 4 x 532)1.67 = 44,928
= 1.25 x 1,469 = 1,836
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 Forecasting Demand at Tahoe Salt

Forecasting Method MAD MAPE (%) TS Range

Four-period moving 9,719 49 1.52 to 2.21
average
Simple exponential 10,208 59 1.38 to 2.15
smoothing
Holts model 8,836 52 2.15 to 2.00
Winters model 1,469 8 2.74 to 4.00

Table 7-2

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 The Role of IT in Forecasting
Forecasting module is core supply chain
software
Can be used to best determine forecasting
methods for the firm and by product
categories and markets
Real time updates help firms respond
quickly to changes in marketplace
Facilitate demand planning

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 Risk Management
Errors in forecasting can cause significant
misallocation of resources in inventory, facilities,
transportation, sourcing, pricing, and information
management
Common factors are long lead times,
seasonality, short product life cycles, few
customers and lumpy demand, and when orders
placed by intermediaries in a supply chain
Mitigation strategies increasing the
responsiveness of the supply chain and utilizing
opportunities for pooling of demand
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 Forecasting In Practice

Collaborate in building forecasts

Share only the data that truly provide
value
Be sure to distinguish between
demand and sales

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 Summary of Learning Objectives

1. Understand the role of forecasting for both

an enterprise and a supply chain
2. Identify the components of a demand
forecast
3. Forecast demand in a supply chain given
historical demand data using time-series
methodologies
4. Analyze demand forecasts to estimate
forecast error

Copyright 2013 Pearson Education, Inc. publishing as Prentice Hall. 7-54

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