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What is a Forecast?
Forecast An estimate of future demand. A forecast can be determined by mathematical means using historical data, it can be created subjectively by using estimates from informal sources, or it can represent a combination of both techniques. Forecast Error The difference between actual demand and forecast demand, stated as an absolute value or as a percentage. Forecast Management The process of making, checking, correcting, and using forecasts. It also includes determination of the forecast horizon.
Why Forecast?
To plan for the future by reducing uncertainty To facilitate a company in taking control of operations. Without forecast, it would be a chaos. To anticipate and manage change To increase communication and integration of planning teams To anticipate inventory and capacity demands and manage lead times To project costs of operations into budgeting processes To improve competitiveness and productivity through decreased costs and improved delivery and responsiveness to customer needs
Investment decisions Capital equipment decisions Inventory planning Capacity planning Operations budgets Lead-time management
Determine information that needs to be forecasted Assign responsibility for the forecast Set up forecast system parameters Select forecasting models and techniques Collect data Test models Record actual demand Report accuracy Determine root cause of variance Review forecasting system for improved performance
Qualitative Techniquesbased on intuitive or judgmental evaluation Quantitative Techniquesbased on computational projection of a numeric relationship
Qualitative Techniques
Expert opinion Market research Focus groups Historical analogy Delphi method Panel consensus
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Quantitative Techniques
Moving average Exponential smoothing Regression analysis Adaptive smoothing Graphical methods Econometric modeling Life-cycle modeling
Intrinsic forecasting methods are based on historical patterns of the data itself from company data Extrinsic forecasting methods are based on external patterns from information outside the company such as published data and data available from the Internet
Qualitative and quantitative forecasts may be generated based on intrinsic or extrinsic information.
Product life-cycle management Planned price changes Changes in the sales force Resource constraints Marketing and sales promotion Advertising
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Competition New customers Plans of major customers Government policies Regulatory concerns Economic conditions Environmental issues Weather conditions Global trends
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Leading Indicators
Indicator (Causal Factor) Housing starts Birth rate Health trends Desire for Healthier lifestyle Influences volume of Building materials Home furnishings Baby products Medical supplies Nutritional products Fitness products
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Demand
A need for a particular product or component
Independent demand is demand for an item that is unrelated to the demand for other items. Independent demand items are saleable products or services that are added to the master schedule. Dependent demand can be calculated directly from the demand for other products. It is related to the bill of material structure.
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Sources of Demand
Demand can come from many sources:
Demand Characteristics
Internal Factors
External Factors
Random fluctuation Seasonality Trend Economic cycle Changing customer preferences and demands
Seasonality
Sales in cases by month
800 700 600 500 400 300 200 100 0 J F M A M J J A S O N D
Year 1 Year 2
Seasonality Calculation
Measures seasonal variation of demand Relates the average demand in a particular period to the average demand for all periods
period average demand The Seasonal Index ! average demand for all periods
Seasonality Exercise
Economic Cycle
Sales by Quarter
35 30 25 20 15 10 5 0 1 3 5 7 9 11 13 15 17 19 Quarter
Pyramid Forecasting
Total business volume (dollars)
Pyramid Forecasting
Pyramid Forecasting
X1 X2
15,000 8,200 = 9,429 units 13,045 15,000 4,845 = 5,571 units 13,045
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Management has determined that next years demand will be $10,000 total. CALCULATE the projected demand in units for products A and B in each region.
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A: Region 1 = 1.19 150 = 178.5 Region 2 = 1.19 300 = 357.0 B: Region 1 = 1.19 300 = 357.0 Region 2 = 1.19 450 = 535.5 178.5 + 357.0 = 535.5 $4.50 = $2,409.75 357.0 + 535.5 = 892.5 $8.50 = $7,586.25 $9,996.00
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A simple technique that is easy to calculate It can be used to filter out random variation Longer periods provide more smoothing If a trend exists, it is hard to detect Moving averages lag trends
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Limitations
Exponential Smoothing
New Forecast = x Actual Demand + (1 - ) x Old Forecast x (Actual Demand Old Forecast) New Forecast = Old Forecast +
Provides a routine method of updating item forecasts Alpha is a weighting factor applied to the demand element Works well for items with fairly constant demand Is satisfactory for short-range forecasts Lags trends
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Smoothing Factor
Referred to as Alpha (E Determines the weight of historical data on projection Sets responsiveness to changes in demand Range 0
E 1
2 E= n+1
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Determines how many periods of actual demand will influence forecast 1.00 = 1 period 0.50 = 3 periods 0.29 = 6 periods 0.15 = 12 periods 0.10 = 19 periods
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0.1 Low weighting -most smoothing 0.9 High weighting - close to actual
Actual sales
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Time
Focus ForecastingAssumptions/Methods
Assumptions
The most recent past is the best indicator of the future One forecasting model is better than the others All forecasting models for all items forecasted will be compared against recent sales history The model that achieves the closest fit will be used to forecast this item this time Next time, a different model may be selected
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Methods
Availability of data Consistency of data Amount of history required Forecast frequency Frequency of model reevaluation Cost and time issues Recording true demand Order date vs. ship date Product units vs. financial units Level of aggregation Customer partnering
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Short
Mid
Long
Planning Horizon
Weeks
Months
Quarters
1 2 3 4 5 6 7 8 9 1011 12 13 17 21 25 29 33 37 41 45 49 53 65
78
91 104
Record sales data in same periods as forecast data (daily, weekly, or monthly) Monitor demand, not sales and/or shipments Record the circumstances of exceptional demand Record demand separately for unique customer groupings and market sectors
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25 20 15 10 5 0 J F M A M J J A S O N D J F M A M J J A S O N D
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Decomposition of Data
Purify the data Adjust the data Take out the baseline and components Identify demand components
Trend Seasonality Nonannual cycle Random error
Session 2 Review
You should now be able to Explain why forecasting is important Identify and describe general methods of forecasting Identify factors influencing demand Describe considerations in using data for forecasts Outline the process of data decomposition
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