DEMAND MANAGEMENT

Prof. Kaushik Paul

Associate Professor
Operations Area
E-Mail: kaushik.paul@igsm.in
Phone: 43559308
 OBJECTIVES

 Demand Management

 Qualitative Forecasting Methods

 Simple & Weighted Moving Average Forecasts

 Exponential Smoothing

 Simple Linear Regression

 Web-Based Forecasting

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 DEMAND MANAGEMENT

Independent Demand:
Finished Goods

A Dependent Demand:
Raw Materials,
Component parts,
B(4) C(2) Sub-assemblies, etc.

D(2) E(1) D(3) F(2)

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INDEPENDENT DEMAND: WHAT A FIRM CAN DO TO MANAGE IT?

 Can take an active role to influence demand

 Can take a passive role and simply respond to demand

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 TYPES OF FORECASTS

 Qualitative (Judgmental)

 Quantitative

 Time Series Analysis

 Causal Relationships

 Simulation

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 COMPONENTS OF DEMAND

 Average demand for a period of time

 Trend

 Seasonal element

 Cyclical elements

 Random variation

 Autocorrelation

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 FINDING COMPONENTS OF DEMAND

Seasonal variation

x
x x Linear
x x
x x Trend
x x
Sales

x x x
x
x
xx
x xx x x
x
x
x x x x x x
x x x x x x
x x x
x xxxxx
x
x x

1 2 3 4
Year
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 QUALITATIVE METHODS

Executive Judgment Grass Roots

Qualitative Market Research

Historical analogy
Methods

Delphi Method Panel Consensus

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 DELPHI METHOD

1. Choose the experts to participate

representing a variety of knowledgeable
people in different areas

3. Through a questionnaire (or E-mail),

obtain forecasts (and any premises or
qualifications for the forecasts) from all
participants

5. Summarize the results and redistribute

them to the participants along with
appropriate new questions

7. Summarize again, refining forecasts and

conditions, and again develop new
questions

9. Repeat Step 4 as necessary and

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distribute the final results to all
 TIME SERIES ANALYSIS

 Time series forecasting models try to predict the

future based on past data
 You can pick models based on:

1. Time horizon to forecast

3. Data availability

5. Accuracy required

7. Size of forecasting budget

9. Availability of qualified personnel

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 SIMPLE MOVING AVERAGE FORMULA

 The simple moving average model assumes an

average is a good estimator of future behavior

 The formula for the simple moving average is:

A t-1 + A t-2 + A t-3 +...+A t- n

Ft =
n
Ft = Forecast for the coming period
N = Number of periods to be averaged
A t-1 = Actual occurrence in the past period for up to “n”
periods

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 SIMPLE MOVING AVERAGE PROBLEM (1)

A t-1 + A t-2 + A t-3 +...+A t- n

Ft =
Week Demand n
1 650 Question: What are the 3-
2 678 week and 6-week moving
3 720 average forecasts for
4 785 demand?
5 859
Assume you only have 3
6 920
7 850
weeks and 6 weeks of
8 758
actual demand data for
9 892 the respective forecasts
10 920
11 789
12 844
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Calculating the moving averages gives us:
Week Demand 3-Week 6-Week
1 650 F4=(650+678+720)/3
2 678
=682.67
3 720 F7=(650+678+720
4 785 682.67 +785+859+920)/6
5 859 727.67
=768.67
6 920 788.00
7 850 854.67 768.67
8 758 876.33 802.00
9 892 842.67 815.33
10 920 833.33 844.00
11 789 856.67 866.50
12 844 867.00 854.83
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©The McGraw-Hill Companies, Inc., 2004
 Plotting the moving averages and comparing
them shows how the lines smooth out to reveal
the overall upward trend in this example

1000
900
Demand
800
Demand

3-Week
700
6-Week
600
500 Note how the
1 2 3 4 5 6 7 8 9 10 11 12 3-Week is
Week smoother than
the Demand,
and 6-Week is
even smoother
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SIMPLE MOVING AVERAGE PROBLEM (2) DATA

Question: What is the

3 week moving
Week Demand average forecast for
1 820 this data?
2 775 Assume you only have
3 680 3 weeks and 5
4 655 weeks of actual
5 620 demand data for the
6 600 respective forecasts
7 575

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SIMPLE MOVING AVERAGE PROBLEM (2) SOLUTION

Week Demand 3-Week 5-Week

1 820 F4=(820+775+680)/3
2 775 =758.33
3 680 F6=(820+775+680
+655+620)/5
4 655 758.33 =710.00
5 620 703.33
6 600 651.67 710.00
7 575 625.00 666.00

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 WEIGHTED MOVING AVERAGE FORMULA

While the moving average formula implies an equal

weight being placed on each value that is being averaged,
the weighted moving average permits an unequal
weighting on prior time periods

The formula for the moving average is:

Ft = w1A t-1 + w 2 A t-2 + w 3A t-3 +...+w n A t-n

n
wt = weight given to time period “t”
occurrence (weights must add to one)
∑w
i=1
i =1

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 WEIGHTED MOVING AVERAGE PROBLEM (1) DATA

Question: Given the weekly demand and weights, what is

the forecast for the 4th period or Week 4?

Week Demand Weights:

1 650
2 678 t-1 .5
3 720 t-2 .3
4 t-3 .2

Note that the weights place more emphasis on the

most recent data, that is time period “t-1”

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 WEIGHTED MOVING AVERAGE PROBLEM (1) SOLUTION

Week Demand Forecast

1 650
2 678
3 720
4 693.4

F4 = 0.5(720)+0.3(678)+0.2(650)=693.4
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WEIGHTED MOVING AVERAGE PROBLEM (2) DATA

Question: Given the weekly demand information and

weights, what is the weighted moving average forecast
of the 5th period or week?

Week Demand Weights:

1 820 t-1 .7
2 775 t-2 .2
3 680
t-3 .1
4 655

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WEIGHTED MOVING AVERAGE PROBLEM (2) SOLUTION

Week Demand Forecast

1 820
2 775
3 680
4 655
5 672

F5 = (0.1)(755)+(0.2)(680)+(0.7)(655)= 672

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 EXPONENTIAL SMOOTHING MODEL

Ft = Ft-1 + α(At-1 - Ft-1)

Where :
Ft = Forcast value for the coming t time period
Ft - 1 = Forecast value in 1 past time period
At - 1 = Actual occurance in the past t time period
α = Alpha smoothing constant
 Premise: The most recent observations might have the
highest predictive value
 Therefore, we should give more weight to the more recent
time periods when forecasting

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EXPONENTIAL SMOOTHING PROBLEM (1) DATA

Week Demand Question: Given the

1 820 weekly demand data,
2 775 what are the
3 680 exponential smoothing
4 655 forecasts for periods
5 750 2-10 using α=0.10 and
6 802 α=0.60?
7 798 Assume F1=D1
8 689
9 775
10
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Answer: The respective alphas columns denote the forecast values. Note
that you can only forecast one time period into the future.

Week Demand 0.1 0.6

1 820 820.00 820.00
2 775 820.00 820.00
3 680 815.50 793.00
4 655 801.95 725.20
5 750 787.26 683.08
6 802 783.53 723.23
7 798 785.38 770.49
8 689 786.64 787.00
9 775 776.88 728.20
10 776.69 756.28
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EXPONENTIAL SMOOTHING PROBLEM (1) PLOTTING

Note how that the smaller alpha results in a smoother line

in this example

900
800 Demand
700 0.1
Demand

600 0.6
500
1 2 3 4 5 6 7 8 9 10
Week

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EXPONENTIAL SMOOTHING PROBLEM (2) DATA

Question: What are the

Week Demand
exponential smoothing
1 820
forecasts for periods 2-5
2 775 using a =0.5?
3 680
4 655
5 Assume F1=D1

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 EXPONENTIAL SMOOTHING PROBLEM (2) SOLUTION

F1=820+(0.5)(820-820)=820 F3=820+(0.5)(775-820)=797.75

Week Demand 0.5

1 820 820.00
2 775 820.00
3 680 797.50
4 655 738.75
5 696.88
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 The MAD Statistic to Determine
Forecasting Error
n
1 MAD ≈ 0.8 standard deviation
∑A t - Ft
MAD = t=1 1 standard deviation ≈ 1.25 MAD
n

 The ideal MAD is zero which would

mean there is no forecasting error

 The larger the MAD, the less the

accurate the resulting model

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MAD Problem Data

Question: What is the MAD value given

the forecast values in the table below?

Month Sales Forecast

1 220 n/a
2 250 255
3 210 205
4 300 320
5 325 315
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 MAD PROBLEM SOLUTION

Month Sales Forecast Abs Error

1 220 n/a
2 250 255 5
3 210 205 5
4 300 320 20
5 325 315 10

40

n
Note that by itself, the MAD
∑A
t=1
t - Ft
40 only lets us know the mean
MAD = = = 10 error in a set of forecasts
n 4

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 TRACKING SIGNAL FORMULA

 The Tracking Signal or TS is a measure that

indicates whether the forecast average is
keeping pace with any genuine upward or
downward changes in demand.

 Depending on the number of MAD’s

selected, the TS can be used like a quality
control chart indicating when the model is
generating too much error in its forecasts.

 The TS formula is:

RSFE Running sum of forecast errors

TS = =
MAD Mean absolute deviation
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 SIMPLE LINEAR REGRESSION MODEL
Y
The simple linear regression
model seeks to fit a line
through various data over a
time 0 1 2 3 4 5 x (Time)

Yt = a + bx Is the linear regression model

Yt is the regressed forecast value or dependent variable in

the model, a is the intercept value of the the regression
line, and b is similar to the slope of the regression line.
However, since it is calculated with the variability of the
data in mind, its formulation is not as straight forward as
our usual notion of slope.

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SIMPLE LINEAR REGRESSION FORMULAS FOR
CALCULATING “a” and “b”

a = y - bx

∑ xy - n(y)(x)
b= 2 2
∑ x - n(x )

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 SIMPLE LINEAR REGRESSION PROBLEM DATA

Question: Given the data below, what is the simple linear

regression model that can be used to predict sales in future
weeks?

Week Sales
1 150
2 157
3 162
4 166
5 177
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 35

Answer: First, using the linear regression formulas, we

can compute “a” and “b”
Week Week*Week Sales Week*Sales
1 1 150 150
2 4 157 314
3 9 162 486
4 16 166 664
5 25 177 885
3 55 162.4 2499
Average Sum Average Sum

b=
∑ xy - n(y)(x) 2499 - 5(162.4)(3) 63
= = = 6.3
∑ x - n(x )
2 2
55 − 5(9) 10

a = y - bx = 162.4 - (6.3)(3) = 143.5

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 36

The resulting regression model

is: Yt = 143.5 + 6.3x
Now if we plot the regression generated forecasts against the
actual sales we obtain the following chart:
180
175
170
165
160 Sales
Sales

155 Forecast
150
145
140
135
1 2 3 4 5
Period
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 WEB-BASED FORECASTING: CPFR
 Collaborative Planning, Forecasting, and
Replenishment (CPFR) a Web-based tool used
to coordinate demand forecasting, production
and purchase planning, and inventory
replenishment between supply chain trading
partners.

 Used to integrate the multi-tier or n-Tier

supply chain, including manufacturers,
distributors and retailers.

 CPFR’s objective is to exchange selected

internal information to provide for a reliable,
longer term future views of demand in the
supply chain.

 CPFR uses a cyclic and iterative approach to

derive consensus forecasts. 37
 WEB-BASED FORECASTING:
STEPS IN CPFR

1. Creation of a front-end partnership agreement

3. Joint business planning

5. Development of demand forecasts

7. Sharing forecasts

9. Inventory replenishment
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References: ‘Operations Management for
Competitive Advantage’
By Chase, Jacobs & Aquilano, 11e

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