So what does a BAD forecast look like?

Time

Actual Sales

Old Forecast
New Forecast “BIAS”

Qty

No response can be planned to a

biased forecast….
….they must be
found and “fixed”
Cricketing quote…..

“You can’t set a field for a bad bowler”

 What you should remember
about Exponential Smoothing

• It is a MOVING AVERAGE technique

• Averaging techniques lag trend
• The “a” (alpha) factor determines the
sensitivity of the forecast
• The higher the alpha factor, the more
sensitive the forecast
Switch to JB’s explanation…….

…..just a different way of explaining

“Standard Deviation” in terms of safety
stock
MENT SET STOCK LEVELS?

nticapation of “demand”) as having 2

Safety Stock to
cover forecast error

New forecast

ock to cover forecast

cast error is a “measure” of the

buted” around the forecast. (ie: as

forecast.) This forecast technique is
WHAT IS A “STANDARD DEVIATION” , AND HOW DOES IT HELP?

To understand the use of a “standard Deviation” we need to understand the “Normal Distribution Curve”………

The NORMAL DISTRIBUTION CURVE

As applied to forecast error and safety stock setting

The normal distribution curve is a graphical representation of “PROBABILITY”

In forecasting terms, the probability of demand being within certain values of mean, or average,
demand.

Test of understanding….
What percentage of demands
will be between the mean and
plus 1 Std Deviation?

Note: Final Test of

percentage understanding….
figures are
rounded If the mean demand was
The curve is divided into probability zones by mathematicians. 1000, and 1 Std Dev was 200,
Each division shown on the curve is known as a “Standard Deviation” and has the symbol: “ “ what percentage of demands
(Greek lower case ‘s’…”Sigma”)
would be covered by a stock
These probability zones denote the probability of demand “deviating” from the mean. level of 1,200?
Eg:
68% of all demands will be within 1 Std Dev. of the mean demand.

95% of all demands will be within 2 Std Devs. of the mean demand.

99% of all demands will be within 3 Std Devs. of the mean demand.

If a value was known for 1 Std Deviation in terms of “pieces”, then the percentage of demand
that would be covered by a given stock level could be predicted. (ie; predicting service level)
How can the normal distribution curve help?

It has to be assumed that the “Mean Demand” is the forecast. This is so because
the forecast has already been found to have no “Bias”, and the errors are “normally”
(equally) distributed above and below the forecasts.

If “mean demand” is equal to the forecast, and we know that, for example, 34% of all
“demands” will be one standard deviation above the forecast and the rest will be
below the forecast, we also know the following……..
• 50% of demands will be below the forecast….and we have these covered by
the “stock to cover forecast”.
• A further 34% of demands will be within one “standard deviation” of the
forecast.
• With the stock we have to cover the forecast, plus one “standard deviation”
worth of stock, we will cover 84% (50% + 34%) of demands. (ie; we will
achieve an 84% “customer service” level.

What we DON’T know is: How many pieces make up one “standard deviation”?

Two ways to find out……..

• Use the formula in the study guide
• Multiply “MAD” (Mean Absolute Deviation) by 1.25
The latter is the more attractive!

To take this further…….

By 2 standard deviations of safety stock we could raise the customer service level to
97.5%. (50% + half of 95%)
WHAT ARE THE STEPS FOR SETTING STOCK LEVELS?

From the diagram we have derived that we must set one component of stock at the
forecast level (this covers 50% of demands that are likely to occur)

The other component is safety stock.

Below are the steps to set safety stock……..

• Measure the forecast error over selected past periods and determine the
“MAD” (average of errors regardless of sign)

• Multiply the MAD by 1.25 to determine a (very) close approximation of the

standard deviation in “pieces”. (quantity of parts)

• Choose how many standard deviations we need to achieve the desired customer service level. The chart
below may help….
67% 0.5 Std Deviations
84% 1 Std Deviations
95% 1.5 Std Deviations
97.5% 2 Std Deviations

The result is the safety stock component. Add this to the stock to cover the forecast
and you have the total stock required for the desired service level.
Likely exam questions on forecast error measurement and demand probability……

• With a stock level set at 1 Std deviation above the mean, what percentage of demands are
likely to be satisfied?

• What is the probability of demand being within plus or minus 3 Std deviations of the
forecast when the forecast error is normally distributed about the mean?

• True or False? “Safety stocks must be increased if excessive bias exists in the forecast”

4. What would be the safety stock for the following product?….

Mean demand = 1500
Mean Absolute Deviation = 352
Desired service level = 84%

• 1 Std deviation is approximately…..

1. Mean Demand divided by 3
2. Cumulative sum of error divided by MAD
3. MAD X 1.25
4. The Absolute Error squared.

Answers;
1. 84% (50% plus half of 68%)
2. 99%
3. False (Safety stock cannot be set for a biased forecast)
4. 440 (The total stock level would be 1940)
5. c.