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Supply Chain Management

Demand Forecasting
in a Supply Chain

Outline
The role of forecasting in a supply chain
Characteristics of forecasts
Components of forecasts and forecasting methods
Basic approach to demand forecasting
Time series forecasting methods
Measures of forecast error
Forecasting demand at Tahoe Salt
Forecasting in practice
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Role of Forecasting
in a Supply Chain
The basis for all strategic and planning decisions in a
supply chain
Used for both push and pull processes
Examples:
Production: scheduling, inventory, aggregate planning
Marketing: sales force allocation, promotions, new production
introduction
Finance: plant/equipment investment, budgetary planning
Personnel: workforce planning, hiring, layoffs

All of these decisions are interrelated

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Characteristics of Forecasts
Forecasts are always wrong. Should include
expected value and measure of error.
Long-term forecasts are less accurate than shortterm forecasts (forecast horizon is important)
Aggregate forecasts are more accurate than
disaggregate forecasts

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Forecasting Methods
Qualitative: primarily subjective; rely on judgment and
opinion
Time Series: use historical demand only
Static
Adaptive

Causal: use the relationship between demand and some


other factor to develop forecast
Simulation
Imitate consumer choices that give rise to demand
Can combine time series and causal methods

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Components of an Observation
Observed demand (O) =
Systematic component (S) + Random component (R)
Level (current deseasonalized demand)
Trend (growth or decline in demand)
Seasonality (predictable seasonal fluctuation)
Systematic component: Expected value of demand
Random component: The part of the forecast that deviates
from the systematic component
Forecast error: difference between forecast and actual demand
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Time Series Forecasting


Quarter
II, 1998
III, 1998
IV, 1998
I, 1999
II, 1999
III, 1999
IV, 1999
I, 2000
II, 2000
III, 2000
IV, 2000
I, 2001
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Demand Dt
8000
13000
23000
34000
10000
18000
23000
38000
12000
13000
32000
41000

Forecast demand for the


next four quarters.

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Time Series Forecasting


50,000
40,000
30,000
20,000
10,000
0

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Forecasting Methods
Static
Adaptive

Moving average
Simple exponential smoothing
Holts model (with trend)
Winters model (with trend and seasonality)

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Basic Approach to
Demand Forecasting
Understand the objectives of forecasting
Integrate demand planning and forecasting
Identify major factors that influence the demand
forecast
Understand and identify customer segments
Determine the appropriate forecasting technique
Establish performance and error measures for the
forecast

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Time Series
Forecasting Methods
Goal is to predict systematic component of demand
Multiplicative: (level)(trend)(seasonal factor)
Additive: level + trend + seasonal factor
Mixed: (level + trend)(seasonal factor)

Static methods
Adaptive forecasting

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Static Methods
Estimating level and trend
Estimating seasonal factors

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Estimating Level and Trend


Before estimating level and trend, demand data
must be deseasonalized
Deseasonalized demand = demand that would
have been observed in the absence of seasonal
fluctuations
Periodicity (p)
the number of periods after which the seasonal cycle
repeats itself
for demand at Tahoe Salt (Table 7.1, Figure 7.1) p = 4

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Time Series Forecasting


(Table 7.1)
Quarter
II, 1998
III, 1998
IV, 1998
I, 1999
II, 1999
III, 1999
IV, 1999
I, 2000
II, 2000
III, 2000
IV, 2000
I, 2001
2007 Pearson Education

Demand Dt
8000
13000
23000
34000
10000
18000
23000
38000
12000
13000
32000
41000

Forecast demand for the


next four quarters.

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Time Series Forecasting


(Figure 7.1)
50,000
40,000
30,000
20,000
10,000
0

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Estimating Level and Trend


Before estimating level and trend, demand data
must be deseasonalized
Deseasonalized demand = demand that would
have been observed in the absence of seasonal
fluctuations
Periodicity (p)
the number of periods after which the seasonal cycle
repeats itself
for demand at Tahoe Salt (Table 7.1, Figure 7.1) p = 4

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Deseasonalizing Demand

[Dt-(p/2) + Dt+(p/2) + 2Di] / 2p for p even


Dt =

(sum is from i = t+1-(p/2) to t+1+(p/2))

Di / p for p odd
(sum is from i = t-(p/2) to t+(p/2)), p/2 truncated to lower integer

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Deseasonalizing Demand
For the example, p = 4 is even
For t = 3:
D3 = {D1 + D5 + Sum(i=2 to 4) [2Di]}/8
= {8000+10000+[(2)(13000)+(2)(23000)+(2)(34000)]}/8
= 19750
D4 = {D2 + D6 + Sum(i=3 to 5) [2Di]}/8
= {13000+18000+[(2)(23000)+(2)(34000)+(2)(10000)]/8
= 20625

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Deseasonalizing Demand
Then include trend
Dt = L + tT
where Dt = deseasonalized demand in period t
L = level (deseasonalized demand at period 0)
T = trend (rate of growth of deseasonalized demand)
Trend is determined by linear regression using deseasonalized
demand as the dependent variable and period as the
independent variable (can be done in Excel)
In the example, L = 18,439 and T = 524

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Time Series of Demand


(Figure 7.3)
50000

Demand

40000
30000

Dt
Dt-bar

20000
10000
0
1 2 3 4 5 6 7 8 9 10 11 12
Period

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Measures of Forecast Error


Forecast error = Et = Ft - Dt
Mean squared error (MSE)
MSEn = (Sum(t=1 to n)[Et2])/n
Absolute deviation = At = |Et|
Mean absolute deviation (MAD)
MADn = (Sum(t=1 to n)[At])/n
= 1.25MAD

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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 in Practice
Collaborate in building forecasts
The value of data depends on where you are in the
supply chain
Be sure to distinguish between demand and sales

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Summary of Learning Objectives


What are the roles of forecasting for an enterprise and
a supply chain?
What are the components of a demand forecast?
How is demand forecast given historical data using
time series methodologies?
How is a demand forecast analyzed to estimate
forecast error?

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