7 Demand Forecasting in a

Supply Chain

PowerPoint presentation
to accompany
Chopra and Meindl
Supply Chain Management, 6e
Copyright © 2016 Pearson Education, Inc. 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 part
• 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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 Forecasting Models
FIGURE . Forecasting Models

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 Qualitative Models (1 of 3)
• Incorporate judgmental or subjective factors
– Opinions by experts, individual experiences and
judgments, and other subjective factors may be
considered
– Useful when subjective factors are important or
accurate quantitative data is difficult to obtain
• Common qualitative techniques
1. Delphi method
2. Jury of executive opinion
3. Sales force composite
4. Consumer market surveys

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 Qualitative Models (2 of 3)
• Delphi Method
– Iterative group process (decision makers - 5 to 10
experts, staff personnel - assistants, and respondents
are people whose judgments are valued)
– Respondents provide input to decision makers
– Repeated until consensus is reached
• Jury of Executive Opinion
– Collects opinions of a small group of high-level
managers
– May use statistical models for analysis

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 Qualitative Models (3 of 3)
• Sales Force Composite
– Allows individual salespersons estimates
– Reviewed for reasonableness
– Data is compiled at a district or national level
• Consumer Market Survey
– Information on purchasing plans solicited from
customers or potential customers
– Used in forecasting, product design, new product
planning

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 Time-Series Models
• Predict the future based on the past
• Uses only historical data on one variable
• Extrapolations of past values of a series

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 Time-Series Models - Scatter Diagrams

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 Time-Series Models - Scatter Diagrams

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 Time-Series Models - Scatter Diagrams

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 Measures of Forecast Accuracy (1 of 5)
• Compare forecasted values with actual values
– See how well one model works
– To compare models
Forecast error = Actual value − Forecast value
• Measure of accuracy
– Mean absolute deviation (MAD):

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 Measures of Forecast Accuracy (2 of 5)
TABLE 5.1 Computing the Mean Absolute Deviation (MAD)
ACTUAL ABSOLUTE VALUE OF
SALES OF WIRELESS ERRORS (DEVIATION), (ACTUAL −
MONTH SPEAKERS FORECAST SALES FORECAST)
1 110 — —
2 100 110 |100 − 110| = 10
3 120 100 |120 − 100| = 20
4 140 120 |140 − 120| = 20
5 170 140 |170 − 140| = 30
6 150 170 |150 − 170| = 20
7 160 150 |160 − 150| = 10
8 190 160 |190 − 160| = 30
9 200 190 |200 − 190| = 10
10 190 200 |190 − 200| = 10
11 — 190 —
Blank Blank Blank Sum of |errors| = 160
Blank Blank Blank MAD = 160÷9 = 17.8

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 Measures of Forecast Accuracy (3 of 5)
TABLE 5.1 Computing the Mean Absolute Deviation (MAD)
ACTUAL ABSOLUTE VALUE OF
SALES OF WIRELESS ERRORS (DEVIATION), (ACTUAL −
MONTH SPEAKERS FORECAST SALES FORECAST)
1 110 —
2 100 110
3 120 100
4 140 120 • Forecast based on
5 170 140 naïve model
6
7
150
160
170
150
• No attempt to adjust
for time series
8 190 160
components
9 200 190
10 190 200
11 — 190
Blank Blank Blank
Blank Blank Blank

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 Measures of Forecast Accuracy (4 of 5)
TABLE 5.1 Computing the Mean Absolute Deviation (MAD)
ACTUAL ABSOLUTE VALUE OF
SALES OF WIRELESS ERRORS (DEVIATION), (ACTUAL −
MONTH SPEAKERS FORECAST SALES FORECAST)
1 110 — —
2 100 110 |100 − 110| = 10
3 120 100 |120 − 100| = 20
4 140 120 |140 − 120| = 20
5 170 140 |170 − 140| = 30
6 150 170 |150 − 170| = 20
7 160 150 |160 − 150| = 10
8 190 160 |190 − 160| = 30
9 200 190 |200 − 190| = 10
10 190 200 |190 − 200| = 10
11 — 190 —
Blank Blank Blank Sum of |errors| = 160
Blank Blank Blank MAD = 160÷9 = 17.8

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 Measures of Forecast Accuracy (5 of 5)
• Other common measures
– Mean squared error (MSE)

– Mean absolute percent error (MAPE)

– Bias is the average error (not a good measure)

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 Components of a Time Series (1 of 3)
• Sequence of values recorded at successive
intervals of time
• Four possible components
– Trend (T): gradual upward or downward movement of
the data over time.
– Seasonal (S): pattern of the demand fluctuation above
or below the trend line that repeats at regular intervals
– Cyclical (C): patterns in annual data that occur every
several years. They are usually tiedinto the business
cycle
– Random (R): “blips” in the data caused by chance and
unusual situations; they follow no discernible pattern.

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 Time-Series Models
• Two basic forms
– Multiplicative
Demand = T × S × C × R
– Additive
Demand = T + S + C + R
– Combinations are possible

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 Components of a Time Series (2 of 3)

FIGURE 5.2
Scatter
Diagram for
Four Time
Series of
Quarterly
Data

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 Components of a Time Series (3 of 3)
FIGURE 5.3 Scatter Diagram of a Time Series with
Cyclical and Random Components

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 Forecasting Random Variations
• If all variations in a time series are due to
random variations, with no trend, seasonal, or
cyclical component, some type of averaging or
smoothing model would be appropriate.
• Averaging techniques smooth out forecasts
– Moving averages
– Weighted moving averages
– Exponential smoothing

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 Moving Averages (1 of 2)
• Used when demand is relatively steady over time
– The next forecast is the average of the most
recent n data values from the time series
– Smooths out short-term irregularities in the data
series

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 Moving Averages (2 of 2)
• Mathematically

where
Ft+1 = forecast for time period t + 1
Yt = actual value in time period t
n = number of periods to average

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 Wallace Garden Supply (1 of 4)
• Wallace Garden Supply wants to forecast
demand for its Storage Shed
– Collected data for the past year
– Use a three-month moving average (n = 3)

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 Wallace Garden Supply (2 of 4)
TABLE 5.2 Wallace Garden Supply Shed Sales
MONTH ACTUAL SHED SALES 3-MONTH MOVING AVERAGE
January 10

February 12

March 13
April 16 (10 + 12 + 13)÷3 = 11.67
May 19 (12 + 13 + 16)÷3 = 13.67

June 23 (13 + 16 + 19)÷3 = 16.00

July 26 (16 + 19 + 23)÷3 = 19.33

August 30 (19 + 23 + 26)÷3 = 22.67
September 28 (23 + 26 + 30)÷3 = 26.33

October 18 (26 + 30 + 28)÷3 = 28.00

November 16 (30 + 28 + 18)÷3 = 25.33

December 14 (28 + 18 + 16)÷3 = 20.67

January — (18 + 16 + 14)÷3 = 16.00

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 Weighted Moving Averages
• Weighted moving averages use weights to put more emphasis
on previous periods
– typically assigns greater weight to more recent observation
– Often used when a trend or other pattern is emerging

– Mathematically

where
wi = weight for the ith observation

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 Wallace Garden Supply (3 of 4)
• Use a 3-month weighted moving average model to forecast
demand
– Weighting scheme

WEIGHT APPLIED Blank PERIOD

Blank 3 Last month

Blank 2 2 months ago
Blank 1 3 months ago
3 × Sales last month + 2 × Sales 2 months ago + 1 × Sales 3 months ago
Blank 6 Blank
Blank Blank Sum of the weights

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 Wallace Garden Supply (4 of 4)
TABLE 5.3 Weighted Moving Average Forecast for Wallace Garden Supply
MONTH ACTUAL SHED SALES 3-MONTH WEIGHTED MOVING AVERAGE
January 10

February 12

March 13
April 16 [(3 × 13) + (2 × 12) + (10)]÷6 = 12.17
May 19 [(3 × 16) + (2 × 13) + (12)]÷6 = 14.33

June 23 [(3 × 19) + (2 × 16) + (13)]÷6 = 17.00

July 26 [(3 × 23) + (2 × 19) + (16)]÷6 = 20.5

August 30 [(3 × 26) + (2 × 23) + (19)]÷6 = 23.83
September 28 [(3 × 30) + (2 × 26) + (23)]÷6 = 27.5

October 18 [(3 × 28) + (2 × 30) + (26)]÷6 = 28.33

November 16 [(3 × 18) + (2 × 28) + (30)]÷6 = 23.33

December 14 [(3 × 16) + (2 × 18) + (28)]÷6 = 18.67

January — [(3 × 14) + (2 × 16) + (18)]÷6 = 15.33

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 Weighted Moving Averages
• Choosing the weights obviously has an important impact on the
forecasts. One way to choose weights is to try various
combinations of weights, calculate the MAD for each, and select
the set of weights that results in the lowest MAD
• The weights can be forced to sum to 1
• 2 problems: First, increasing the size of n (the number of
periods averaged) does smooth out fluctuations better, but it
makes the method less sensitive to real changes in the data
should they occur.
• Second, moving averages cannot pick up trends very well.
Because they are averages, they will always stay within past
levels and will not predict a change to either a higher or a lower
level.

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 Exponential Smoothing (1 of 2)
• Exponential smoothing
– A type of moving average
– Easy to use
– Requires little record keeping of data

New forecast = Last period’s forecast

+ α(Last period’s actual demand
−Last period’s forecast)

• α is a weight (or smoothing constant) with a value 0 ≤ α ≤ 1

• It gives more weight to recent data when the value is high or more
weight to past data when it is low.

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 Exponential Smoothing (2 of 2)
• Mathematically

where
Ft+1 = new forecast (for time period t + 1)
Yt = previous forecast (for time period t)
α = smoothing constant (0 ≤ α ≤ 1)
Yt = previous period’s actual demand

The idea is simple – the new estimate is the old estimate plus
some fraction of the error in the last period

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 Exponential Smoothing Example (1 of
2)

• In January, February’s demand for a certain car model was

predicted to be 142
• Actual February demand was 153 autos
• Using a smoothing constant of α = 0.20, what is the forecast for
March?
New forecast (for March demand) = 142 + 0.2(153 − 142)
= 144.2 or 144 autos
• If actual March demand = 136
New forecast (for April demand) = 144.2 + 0.2(136 − 144.2)
= 142.6 or 143 autos

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 Exponential Smoothing Example (2 of
2)

• Selecting the appropriate value for α is key to

obtaining a good forecast
• The objective is always to generate an
accurate forecast
• The general approach is to develop trial
forecasts with different values of α and select
the α that results in the lowest MAD

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 Port of Baltimore Example (1 of 2)
TABLE 5.4 Port of Baltimore Exponential Smoothing Forecasts
for α = 0.10 and α = 0.50
ACTUAL FORECAST
TONNAGE FORECAST USING
QUARTER UNLOADED USING α = 0.10 α = 0.50
1 180 175 175
2 168 175.5 = 175.00 + 0.10(180 − 175) 177.5
3 159 174.75 = 175.50 + 0.10(168 − 175.50) 172.75
4 175 173.18 = 174.75 + 0.10(159 − 174.75) 165.88
5 190 173.36 = 173.18 + 0.10(175 − 173.18) 170.44
6 205 175.02 = 173.36 + 0.10(190 − 173.36) 180.22
7 180 178.02 = 175.02 + 0.10(205 − 175.02) 192.61
8 182 178.22 = 178.02 + 0.10(180 − 178.02) 186.30
9 ? 178.60 = 178.22 + 0.10(182 − 178.22) 184.15

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 Port of Baltimore Example (2 of 2)
TABLE 5.5 Absolute Deviations and MADs for the Port of Baltimore Example
ACTUAL ABSOLUTE ABSOLUTE
TONNAGE FORECAST DEVIATIONS FOR α FORECAST DEVIATIONS FOR
QUARTER UNLOADED WITH α = 0.10 = 0.10 WITH α = 0.50 α = 0.50
1 180 175 5 175 5
2 168 175.5 7.5 177.5 9.5
3 159 174.75 15.75 172.75 13.75
4 175 173.18 1.82 165.88 9.12
5 190 173.36 16.64 170.44 19.56
6 205 175.02 29.98 180.22 24.78
7 180 178.02 1.98 192.61 12.61
8 182 178.22 3.78 186.30 4.3
Sum of
absolute Blank Blank 82.45 Blank 98.63
deviations
Blank Blank Blank

Best choice

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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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 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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