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McGraw-Hill/Irwin ©2009 The McGraw-Hill Companies, All Rights Reserved 1-1


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Chapter 15

Demand Management
and
Forecasting

McGraw-Hill/Irwin ©2009 The McGraw-Hill Companies, All Rights Reserved 1-2


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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
Sales

x
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

l. Choose the experts to participate


representing a variety of knowledgeable
people in different areas
2. Through a questionnaire (or E-mail), obtain
forecasts (and any premises or
qualifications for the forecasts) from all
participants
3. Summarize the results and redistribute them
to the participants along with appropriate
new questions
4. Summarize again, refining forecasts and
conditions, and again develop new
questions
5. Repeat Step 4 as necessary and distribute
the final results to all participants
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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
2. Data availability
3. Accuracy required
4. Size of forecasting budget
5. 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
6 920 Assume you only have 3
7 850 weeks and 6 weeks of
8 758 actual demand data for the
9 892 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
©The McGraw-Hill Companies, Inc., 2004
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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
Demand

800
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
1 820 for this data?
2 775
3 680 Assume you only
4 655 have 3 weeks and
5 620 5 weeks of actual
6 600 demand data for
7 575 the respective
forecasts

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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 = w 1 A t -1 + w 2 A t - 2 + w 3 A 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
t-1 .5
2 678
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 + a(At-1 - Ft-1)


Where :
Ft  Forcast va lue for the coming t time period
Ft - 1  Forecast value in 1 past time period
At - 1  Actual occurance in the past t tim e period
a  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
1 820 Question: Given the
2 775 weekly demand
3 680 data, what are the
4 655 exponential
5 750 smoothing
6 802 forecasts for
7 798 periods 2-10 using
8 689
a=0.10 and a=0.60?
9 775
Assume F1=D1
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
Demand

700 0.1
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
Assume F1=D1
5

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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

1 MAD  0.8 standard deviation


n

A
t=1
t - Ft
1 standard deviation  1.25 MAD
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

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A
Note that by itself, the MAD
t - Ft only lets us know the mean
t=1 40
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

The simple linear regression Y


model seeks to fit a line
through various data over
time
a
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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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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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
Perio
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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. 1-38
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Web-Based Forecasting:
Steps in CPFR

• 1. Creation of a front-end partnership


agreement
• 2. Joint business planning
• 3. Development of demand forecasts
• 4. Sharing forecasts
• 5. Inventory replenishment

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End of Chapter 15

McGraw-Hill/Irwin ©2009 The McGraw-Hill Companies, All Rights Reserved 1-40

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