UNIT II

DEMAND FORECASTING
Prof. A.Paramasivan, B.E., M.B.A., PGDTPM.,PGDTQM.,

Six-Sigma Black-belt, ISO 9001-2008 Certified
Lead Auditor
Sri Venkateswara Group of Institutions
Tel: 90470 50507, 9994 337788
Email: paramasivan200567@gmail.com
Website: www.srivenkateswara.in
SRI VENKATESWARA
COLLEGE OF COMPUTER APPLICATIONS AND MANAGEMENT
Approved by AICTE, New Delhi and Affiliated to AUT, Coimbatore
Forecasting
Components of an Observation
Observed demand (O) =
Systematic component (S) + Random component (R)
7-3
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
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
SVCCAM, Coimbatore

4
Time Series Forecasting
Quarter Demand D
t
II, 1998 8000
III, 1998 13000
IV, 1998 23000
I, 1999 34000
II, 1999 10000
III, 1999 18000
IV, 1999 23000
I, 2000 38000
II, 2000 12000
III, 2000 13000
IV, 2000 32000
I, 2001 41000
7-5
Forecast demand for
the
next four quarters.
FORECASTING
A forecast is an estimate of an event which
will happen in future.
Example. The event may be demand of a
product, rainfall at a particular place,
Population of a country, or growth of a
technology.
SVCCAM, Coimbatore

6
Types of forecasting
Technology forecast
Economic forecast
Demand forecast
SRI VENKATESWARA COLLEGE
OF COMPUTER APPLICATIONS AND
MANAGEMENT An exclusive Institute
for world class MCA & MBA
7
Forecast Errors
Cumulative Sum of Forecast Error (CFE) and
Mean Error (ME)
Mean Square Error (MSE)
Mean Absolute Deviation (MAD)measure of
deviation in units.
Mean Absolute Percentage Error (MAPE)
Tracking Signal (TS)relative measure of bias
11-8
Forecast Errors: Formulas
11-9
t
n
=1 i
e = CFE

Cumulative sum of
Forecast Errors
n
t
n
=1 i
e
= MSE
2

Mean Square Error

n
|
e
|
= MAD
t
n
=1 i

Mean Absolute
Deviation
n
|
D
e
|
= MAPE
t
t
n
1 = i
100

Mean Absolute
Percentage Error
MAD
e
= TS
t
n
=1 i

Tracking Signal
n
t
n
1 = i
e
= ME

Mean Error
Technology forecast
Technology is a combination of hardware and
software.
Hardware is any physical product
Saftware is the Know- how, technique or
procedure
Technological forecast is a predication of the
future characteristics of useful
machines,products,process,procedures or
technique.
SRI VENKATESWARA COLLEGE
OF COMPUTER APPLICATIONS AND
MANAGEMENT An exclusive Institute
for world class MCA & MBA
10
Economic forecast
Government agencies and other organizations
involve in collecting data and prediction of
estimate on the general business
environment.
Use for tax revenues, level of business growth,
level of employment, level of inflation, ect.
SVCCAM, Coimbatore

11
Demand forecast
The demand forecast gives the expected level
of demand for goods and service.
Basic input for business planning and control.
Hence , the decisions for all the factions of any
corporate house are influenced by the
demand forecast.
SRI VENKATESWARA COLLEGE
OF COMPUTER APPLICATIONS AND
MANAGEMENT An exclusive Institute
for world class MCA & MBA
12
Factors Affecting Forecast (Demand)
Business cycle
Random variation
Customers plan
products life cycle
Competitions efforts and attitude
Quality
Credit policy
Design of goods or services
Reputation for service
Sales effort and Advertising


SRI VENKATESWARA COLLEGE
OF COMPUTER APPLICATIONS AND
MANAGEMENT An exclusive Institute
for world class MCA & MBA
13
Types of forecasting In Decision
making
Marketing
1. Demand forecasting of products
2. Forecast of market share
3. Forecasting trend in prices
Production
1. Forecast of materials requirements
2. Trends in material and labour costs
3. Maintenance requirement
4. Plant capacity
SRI VENKATESWARA COLLEGE
OF COMPUTER APPLICATIONS AND
MANAGEMENT An exclusive Institute
for world class MCA & MBA
14
Types of forecasting In Decision
making
Finance
1. Cash flow
2. Rates of expenses
3. Revenues
Personnel
1. Number of workers in each category
2. Labour
3. absenteeism
SRI VENKATESWARA COLLEGE
OF COMPUTER APPLICATIONS AND
MANAGEMENT An exclusive Institute
for world class MCA & MBA
15
Forecasting Demand
Forecasting -- extrapolating the
past into future using
statistical and mathematical
methods
Objectives:
Ignore random
fluctuations in demand
But be responsive to
real change
Eight Steps to Forecasting
Determine the use of the forecast
What objective are we trying to obtain?
Select the items or quantities that are to be forecasted.
Determine the time horizon of the forecast.
Short time horizon 1 to 30 days
Medium time horizon 1 to 12 months
Long time horizon more than 1 year
Select the forecasting model or models
Gather the data to make the forecast.
Validate the forecasting model
Make the forecast
Implement the results

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
SVCCAM, Coimbatore

18
Characteristics of Forecasts
Forecasts are always wrong. Should include
expected value and measure of error.
Long-term forecasts are less accurate than
short-term forecasts (forecast horizon is
important)
Aggregate forecasts are more accurate than
disaggregate forecasts
SVCCAM, Coimbatore

19
Forecasting Techniques and Routes
20
Techniques Routes
Top-down route
Bottom-up route
Quantitative
Qualitative
Simple regressions
Multiple regressions
Time trends
Moving averages
Delphi method
Nominal group
technique
Jury of executive
opinion
Scenario projection

Overview of Forecasting Models
Forecasting
Techniques
Qualitative
Models
Time Series
Methods
Causal
Methods
Delphi
Method
Jury of Executive
Opinion
Sales Force
Composite
Consumer Market
Survey
Naive
Moving
Average

Weighted
Moving Average

Exponential
Smoothing

Trend Analysis

Seasonality
Analysis

Simple
Regression
Analysis
Multiple
Regression
Analysis
Multiplicative
Decomposition
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
SVCCAM, Coimbatore

22
Model Differences
Qualitative incorporates judgmental &
subjective factors into forecast.
Time-Series attempts to predict the future
by using historical data.
Causal incorporates factors that may
influence the quantity being forecasted into
the model
Qualitative Forecasting Models
Delphi method
Iterative group process allows experts to make forecasts
Participants:
decision makers: 5 -10 experts who make the forecast
staff personnel: assist by preparing, distributing, collecting, and
summarizing a series of questionnaires and survey results
respondents: group with valued judgments who provide input to
decision makers
Qualitative Forecasting Models (cont)
Jury of executive opinion
Opinions of a small group of high level managers, often in combination
with statistical models.
Result is a group estimate.
Sales force composite
Each salesperson estimates sales in his region.
Forecasts are reviewed to ensure realistic.
Combined at higher levels to reach an overall forecast.
Consumer market survey.
Solicits input from customers and potential customers regarding
future purchases.
Used for forecasts and product design & planning

Forecast Error
Bias - The arithmetic sum of the
errors
Mean Square Error - Similar to
simple sample variance
Variance - Sample variance
(adjusted for degrees of freedom)
Standard Error - Standard
deviation of the sampling
distribution
MAD - Mean Absolute Deviation
MAPE Mean Absolute
Percentage Error


T F A
MSE
t t
T
t
/ ) (
/T | error forecast |
2
1
T
1 t
2
=
=

=
=
t t
F A Error Forecast =
T F A MAD
t t
T
t
/ | | /T | error forecast |
1
T
1 t
= =

= =
T A F A MAPE
t t t
T
t
/ ] / | [| 100
1
=

=
Quantitative Forecasting Models
Time Series Method
Nave
Whatever happened
recently will happen again
this time (same time
period)
The model is simple and
flexible
Provides a baseline to
measure other models
Attempts to capture
seasonal factors at the
expense of ignoring trend
data Monthly :
data Quarterly :
12
4

=
=
t t
t t
Y F
Y F
1
=
t t
Y F
Nave Forecast
Wallace Garden Supply
Forecasting
Period
Actual
Value
Nave
Forecast Error
Absolute
Error
Percent
Error
Squared
Error
January 10 N/A
February 12 10 2 2 16.67% 4.0
March 16 12 4 4 25.00% 16.0
April 13 16 -3 3 23.08% 9.0
May 17 13 4 4 23.53% 16.0
June 19 17 2 2 10.53% 4.0
July 15 19 -4 4 26.67% 16.0
August 20 15 5 5 25.00% 25.0
September 22 20 2 2 9.09% 4.0
October 19 22 -3 3 15.79% 9.0
November 21 19 2 2 9.52% 4.0
December 19 21 -2 2 10.53% 4.0
0.818 3 17.76% 10.091
BIAS MAD MAPE MSE
Standard Error (Square Root of MSE) = 3.176619
Storage Shed Sales
Nave Forecast Graph
Wallace Garden - Naive Forecast
0
5
10
15
20
25
February March April May June July August September October November December
Period
S
h
e
d
s
Actual Value
Nave Forecast
Quantitative Forecasting Models
Time Series Method
Moving Averages
Assumes item forecasted
will stay steady over time.
Technique will smooth
out short-term
irregularities in the time
series.

/k periods) k previous in value (Actual average moving period - k
k
1

=
=
k
Moving Averages
Wallace Garden Supply
Forecasting
Period
Actual
Value Three-Month Moving Averages
January 10
February 12
March 16
April 13 10 + 12 + 16 / 3 = 12.67
May 17 12 + 16 + 13 / 3 = 13.67
June 19 16 + 13 + 17 / 3 = 15.33
July 15 13 + 17 + 19 / 3 = 16.33
August 20 17 + 19 + 15 / 3 = 17.00
September 22 19 + 15 + 20 / 3 = 18.00
October 19 15 + 20 + 22 / 3 = 19.00
November 21 20 + 22 + 19 / 3 = 20.33
December 19 22 + 19 + 21 / 3 = 20.67
Storage Shed Sales
Moving Averages Forecast
Wallace Garden Supply
Forecasting 3 period moving average
Input Data Forecast Error Analysis
Period Actual Value Forecast Error
Absolute
error
Squared
error
Absolute %
error
Month 1 10
Month 2 12
Month 3 16
Month 4 13 12.667 0.333 0.333 0.111 2.56%
Month 5 17 13.667 3.333 3.333 11.111 19.61%
Month 6 19 15.333 3.667 3.667 13.444 19.30%
Month 7 15 16.333 -1.333 1.333 1.778 8.89%
Month 8 20 17.000 3.000 3.000 9.000 15.00%
Month 9 22 18.000 4.000 4.000 16.000 18.18%
Month 10 19 19.000 0.000 0.000 0.000 0.00%
Month 11 21 20.333 0.667 0.667 0.444 3.17%
Month 12 19 20.667 -1.667 1.667 2.778 8.77%
Average 12.000 2.000 6.074 10.61%
Next period 19.667 BIAS MAD MSE MAPE
Actual Value - Forecast
Moving Averages Graph
Three Period Moving Average
0
5
10
15
20
25
1 2 3 4 5 6 7 8 9 10 11 12
Time
V
a
l
u
e
Actual Value
Forecast
Weighted Moving Average
Wallace Garden Supply
Forecasting
Period
Actual
Value Weights Three-Month Weighted Moving Averages
January 10 0.222
February 12 0.593
March 16 0.185
April 13 2.2 + 7.1 + 3 / 1 = 12.298
May 17 2.7 + 9.5 + 2.4 / 1 = 14.556
June 19 3.5 + 7.7 + 3.2 / 1 = 14.407
July 15 2.9 + 10 + 3.5 / 1 = 16.484
August 20 3.8 + 11 + 2.8 / 1 = 17.814
September 22 4.2 + 8.9 + 3.7 / 1 = 16.815
October 19 3.3 + 12 + 4.1 / 1 = 19.262
November 21 4.4 + 13 + 3.5 / 1 = 21.000
December 19 4.9 + 11 + 3.9 / 1 = 20.036
Next period 20.185
Sum of weights = 1.000
Storage Shed Sales
Quantitative Forecasting Models
Time Series Method
Weighted Moving Averages
Assumes data from some periods are more
important than data from other periods (e.g.
earlier periods).
Use weights to place more emphasis on some
periods and less on others.

(weights) / periods) k previous in value i)(Actual period each for (Weight
average moving weighted period - k
k
1 i
k
1

= =
=
i
Weighted Moving Average
Wallace Garden Supply
Forecasting
Period
Actual
Value Weights Three-Month Weighted Moving Averages
January 10 0.222
February 12 0.593
March 16 0.185
April 13 2.2 + 7.1 + 3 / 1 = 12.298
May 17 2.7 + 9.5 + 2.4 / 1 = 14.556
June 19 3.5 + 7.7 + 3.2 / 1 = 14.407
July 15 2.9 + 10 + 3.5 / 1 = 16.484
August 20 3.8 + 11 + 2.8 / 1 = 17.814
September 22 4.2 + 8.9 + 3.7 / 1 = 16.815
October 19 3.3 + 12 + 4.1 / 1 = 19.262
November 21 4.4 + 13 + 3.5 / 1 = 21.000
December 19 4.9 + 11 + 3.9 / 1 = 20.036
Next period 20.185
Sum of weights = 1.000
Storage Shed Sales
Weighted Moving Average
Wallace Garden Supply
Forecasting 3 period weighted moving average
Input Data Forecast Error Analysis
Period Actual value Weights Forecast Error
Absolute
error
Squared
error
Absolute
% error
Month 1 10 0.222
Month 2 12 0.593
Month 3 16 0.185
Month 4 13 12.298 0.702 0.702 0.492 5.40%
Month 5 17 14.556 2.444 2.444 5.971 14.37%
Month 6 19 14.407 4.593 4.593 21.093 24.17%
Month 7 15 16.484 -1.484 1.484 2.202 9.89%
Month 8 20 17.814 2.186 2.186 4.776 10.93%
Month 9 22 16.815 5.185 5.185 26.889 23.57%
Month 10 19 19.262 -0.262 0.262 0.069 1.38%
Month 11 21 21.000 0.000 0.000 0.000 0.00%
Month 12 19 20.036 -1.036 1.036 1.074 5.45%
Average 1.988 6.952 6.952 10.57%
Next period 20.185 BIAS MAD MSE MAPE
Sum of weights = 1.000
Quantitative Forecasting Models
Time Series Method
Exponential Smoothing
Moving average technique that requires little record
keeping of past data.
Uses a smoothing constant with a value between 0
and 1. (Usual range 0.1 to 0.3)
) - t period for forecast - - t period in value (actual - t period for forecast
t period for Forecast
1 1 1 o +
=
Exponential Smoothing Data
Wallace Garden Supply
Forecasting
Exponential Smoothing
Period
Actual
Value F
t A
t
F
t
F
t+1
January 10 10 0.1
February 12 10 + 0.1 *( 10 - 10 ) = 10.000
March 16 10 + 0.1 *( 12 - 10 ) = 10.200
April 13 10 + 0.1 *( 16 - 10 ) = 10.780
May 17 11 + 0.1 *( 13 - 11 ) = 11.002
June 19 11 + 0.1 *( 17 - 11 ) = 11.602
July 15 12 + 0.1 *( 19 - 12 ) = 12.342
August 20 12 + 0.1 *( 15 - 12 ) = 12.607
September 22 13 + 0.1 *( 20 - 13 ) = 13.347
October 19 13 + 0.1 *( 22 - 13 ) = 14.212
November 21 14 + 0.1 *( 19 - 14 ) = 14.691
December 19 15 + 0.1 *( 21 - 15 ) = 15.322
Storage Shed Sales
Exponential Smoothing
Wallace Garden Supply
Forecasting Exponential smoothing
Input Data Forecast Error Analysis
Period Actual value Forecast Error
Absolute
error
Squared
error
Absolute
% error
Month 1 10 10.000
Month 2 12 10.000 2.000 2.000 4.000 16.67%
Month 3 16 10.838 5.162 5.162 26.649 32.26%
Month 4 13 13.000 0.000 0.000 0.000 0.00%
Month 5 17 13.000 4.000 4.000 16.000 23.53%
Month 6 19 14.675 4.325 4.325 18.702 22.76%
Month 7 15 16.487 -1.487 1.487 2.211 9.91%
Month 8 20 15.864 4.136 4.136 17.106 20.68%
Month 9 22 17.596 4.404 4.404 19.391 20.02%
Month 10 19 19.441 -0.441 0.441 0.194 2.32%
Month 11 21 19.256 1.744 1.744 3.041 8.30%
Month 12 19 19.987 -0.987 0.987 0.973 5.19%
Average 2.608 9.842 14.70%
Alpha 0.419 MAD MSE MAPE
Next period 19.573
Exponential Smoothing
Exponential Smoothing
0
5
10
15
20
25
J
a
n
u
a
r
y
F
e
b
r
u
a
r
y
M
a
r
c
h
A
p
r
i
l
M
a
y
J
u
n
e
J
u
ly
A
u
g
u
s
t
S
e
p
t
e
m
b
e
r
O
c
t
o
b
e
r
N
o
v
e
m
b
e
r
D
e
c
e
m
b
e
r
S
h
e
d
s
Actual value
Forecast
Trend & Seasonality
Trend analysis
technique that fits a trend equation (or curve) to a series
of historical data points.
projects the curve into the future for medium and long
term forecasts.
Seasonality analysis
adjustment to time series data due to variations at
certain periods.
adjust with seasonal index ratio of average value of the
item in a season to the overall annual average value.
example: demand for coal & fuel oil in winter months.

Linear Trend Analysis
Midwestern Manufacturing Sales
Scatter Diagram
Actual
value (or)
Y
Period
number
(or) X
74 1995
79 1996
80 1997
90 1998
105 1999
142 2000
122 2001
Sales(in units) vs. Time
0
20
40
60
80
100
120
140
160
1994 1996 1998 2000 2002
Period number (or) X
Least Squares for Linear Regression
Midwestern Manufacturing
Least Squares Method
Time
V
a
l
u
e
s

o
f

D
e
p
e
n
d
e
n
t

V
a
r
i
a
b
l
e
s
Least Squares Method
bX a Y
^
+ =
Where

Y
^
= predicted value of the dependent variable (demand)
X = value of the independent
variable (time)

a = Y-axis intercept

b = slope of the regression line
] X n - XY [
_ _
Y

_
2 2
X n - X
b =
Linear Trend Data & Error Analysis
Midwestern Manufacturing Company
Forecasting Linear trend analysis
Input Data Forecast Error Analysis
Period
Actual value
(or) Y
Period number
(or) X Forecast Error
Absolute
error
Squared
error
Absolute
% error
Year 1 74 1 67.250 6.750 6.750 45.563 9.12%
Year 2 79 2 77.786 1.214 1.214 1.474 1.54%
Year 3 80 3 88.321 -8.321 8.321 69.246 10.40%
Year 4 90 4 98.857 -8.857 8.857 78.449 9.84%
Year 5 105 5 109.393 -4.393 4.393 19.297 4.18%
Year 6 142 6 119.929 22.071 22.071 487.148 15.54%
Year 7 122 7 130.464 -8.464 8.464 71.644 6.94%
Average 8.582 110.403 8.22%
Intercept 56.714 MAD MSE MAPE
Slope 10.536
Next period 141.000 8
Least Squares Graph
Trend Analysis
y = 10.536x + 56.714
0
20
40
60
80
100
120
140
160
1 2 3 4 5 6 7
Time
V
a
l
u
e
Actual values Linear (Actual values)
Seasonality Analysis
Eichler Supplies
Year Month
Demand
Average
Demand
Ratio
Seasonal
Index
1 January 80 94 0.851 0.957
February 75 94 0.798 0.851
March 80 94 0.851 0.904
April 90 94 0.957 1.064
May 115 94 1.223 1.309
June 110 94 1.170 1.223
July 100 94 1.064 1.117
August 90 94 0.957 1.064
September 85 94 0.904 0.957
October 75 94 0.798 0.851
November 75 94 0.798 0.851
December 80 94 0.851 0.851
2 January 100 94 1.064
February 85 94 0.904
March 90 94 0.957
April 110 94 1.170
May 131 94 1.394
June 120 94 1.277
July 110 94 1.170
August 110 94 1.170
September 95 94 1.011
October 85 94 0.904
November 85 94 0.904
December 80 94 0.851
Seasonal Index ratio of the
average value of the item in a
season to the overall average
annual value.

Example: average of year 1
January ratio to year 2 January
ratio.
(0.851 + 1.064)/2 = 0.957
Ratio = demand / average demand
If Year 3 average monthly demand is
expected to be 100 units.
Forecast demand Year 3 January:
100 X 0.957 = 96 units
Forecast demand Year 3 May:
100 X 1.309 = 131 units
Deseasonalized Data
Going back to the conceptual model, solve for
trend:
Trend = Y / Season (96
units/ 0.957 = 100.31)
This eliminates seasonal variation and isolates
the trend
Now use the Least Squares method to
compute the Trend
Forecast
Now that we have the Seasonal Indices and
Trend, we can reseasonalize the data and
generate the forecast
Y = Trend x Seasonal Index
Time Series Forecasting
0
10,000
20,000
30,000
40,000
50,000
9
7
,
2
9
7
,
3
9
7
,
4
9
8
,
1
9
8
,
2
9
8
,
3
9
8
,
4
9
9
,
1
9
9
,
2
9
9
,
3
9
9
,
4
0
0
,
1
7-51
Forecasting Methods
Static
Adaptive
Moving average
Simple exponential smoothing
Holts model (with trend)
Winters model (with trend and seasonality)
7-52
Capacity planning
Capacity is the maximum output rate of a facility
Capacity planning is the process of establishing the
output rate that can be achieved at a facility:
Capacity is usually purchased in chunks
Strategic issues: how much and when to spend
capital for additional facility & equipment
Tactical issues: workforce & inventory levels, & day-
to-day use of equipment

Wiley 2007