Demand Management

and FORECASTING

Operations Management Dr. Ron Tibben-Lembke

Demand Management
Coordinate sources of demand for supply chain to run efficiently, deliver on time Independent Demand
Things demanded by end users

Dependent Demand
Demand known, once demand for end items is known

Affecting Demand
Increasing demand
Marketing campaigns Sales force efforts, cut prices

Changing Timing of demand

Incentives for earlier or later delivery At capacity, dont actively pursue more

Predicting the Future

We know the forecast will be wrong. Try to make the best forecast we can,
Given the time we want to invest Given the available data

Time Horizons
Different decisions require projections about different time periods: Short-range: who works when, what to make each day (weeks to months) Medium-range: when to hire, lay off (months to years) Long-range: where to build plants, enter new markets, products (years to decades)

Forecast Impact
Finance & Accounting: budget planning Human Resources: hiring, training, laying off employees Capacity: not enough, customers go away angry, too much, costs are too high Supply-Chain Management: bringing in new vendors takes time, and rushing it can lead to quality problems later

Qualitative Methods
Sales force composite / Grass Roots Market Research / Consumer market surveys & interviews Jury of Executive Opinion / Panel Consensus Delphi Method Historical Analogy - DVDs like VCRs Nave approach

Quantitative Methods
Time Series Methods 0. All-Time Average 1. Simple Moving Average 2. Weighted Moving Average 3. Exponential Smoothing 4. Exponential smoothing with trend 5. Linear regression Causal Methods Linear Regression

Time Series Forecasting

Assume patterns in data will continue, including:
Trend (T) Seasonality (S) Cycles (C) Random Variations

All-Time Average
To forecast next period, take the average of all previous periods Advantages: Simple to use Disadvantages: Ends up with a lot of data Gives equal importance to very old data

Moving Average
Compute forecast using n most recent periods
Jan Feb Mar Apr May Jun Jul

3 month Moving Avg: June forecast: FJun = (AMar + AApr + AMay)/3 If no cycles to demand, quite a bit of freedom to choose n

Moving Average
Advantages:
Ignores data that is too old Requires less data than simple average More responsive than simple average

Disadvantages:
Still lacks behind trend like simple average, (though not as badly) The larger n is, more smoothing, but the more it will lag The smaller n is, the more over-reaction

Simple and Moving Averages

Period Demand All-Time 1 10 2 12 10 3 14 11.0 4 15 12.0 5 16 12.8 6 17 13.4 7 19 14.0 8 21 14.7 9 23 15.5 10 16.3 3MA

12.0 13.7 15.0 16.0 17.3 19.0 21.0

Centered Moving Average

Take average of n periods, Plot the average in the middle period Not useful for forecasting More stable than actuals If seasonality, n = season length (4wks, 12 mo, etc.)

CMA - # Periods to Average

What if data has 12-month cycle?

Ja F

M Ap My Jn Jl Au

O N

Ja F

Avg of Jan-Dec gives average of month 6.5: (1+2+3+4+5+6+7+8+9+10+11+12)/12=6.5 Avg of Feb-Jan gives average of month 6.5: (2+3+4+5+6+7+8+9+10+11+12+13)/12=7.5 How get a July average? Average of other two averages

Centered Moving Average

To center even-number of periods 12: take half each of 1 and 13, plus sum of 2-12. F14 = 0.5 A1 + A2 + A3 + A4 + A5 + A6 + A7 + A8 + A9 + A10 + A11 + A12 + 0.5A13 This is exactly the same as what you get by taking the average of the averages from previous slide

Old Data
Comparison of simple, moving averages clearly shows that getting rid of old data makes forecast respond to trends faster Moving average still lags the trend, but it suggests to us we give newer data more weight, older data less weight.

Weighted Moving Average

FJun = (AMar + AApr + AMay)/3 = (3AMar + 3DApr + 3AMay)/9 Why not consider: FJun = (2AMar + 3AApr + 4AMay)/9 FJun = 2/9 AMar + 3/9 AApr + 4/9 AMay Ft = w1At-3 + w2At-2 + w3At-1 Complicated: Have to decide number of periods, and weights for each Weights have to add up to 1.0 Most recent probably most relevant, gets most weight Carry around n periods of data to make new forecast

Weighted Moving Average

Period Demand 3WMA 1 10 2 12 3 14 4 15 12.6 5 16 14.1 6 17 15.3 7 19 16.3 8 21 17.8 9 23 19.6 10 21.6

Wts = 0.5, 0.3, 0.2

Exponential Smoothing

Ft ! Ft 1  E At 1  Ft 1 Ft !   E Ft 1  E At 1 1
At-1 Actual demand in period t-1 Ft-1 Forecast for period t-1 E Smoothing constant >0, <1 Forecast is old forecast plus a portion of the error of the last forecast. Formulas are equivalent, give same answer

Exponential Smoothing
Smoothing Constant between 0.1-0.3 Easier to compute than moving average Most widely used forecasting method, because of its easy use F1 = 1,050, E = 0.05, A1 = 1,000 F2 = F1 + E(A1 - F1) = 1,050 + 0.05(1,000 1,050) = 1,050 + 0.05(-50) = 1,047.5 units BTW, we have to make a starting forecast to get started. Often, use actual A1

Weighted Moving Average

Period Demand 1 10 2 12 3 14 4 15 5 16 6 17 7 19 8 21 9 23 10 ES 10.0 10.0 10.6 11.6 12.6 13.6 14.7 16.0 17.5 19.1

Alpha = 0.3

Weighted Moving Average

Period Demand 1 10 2 12 3 14 4 15 5 16 6 17 7 19 8 21 9 23 10 ES 10.0 10.0 11.0 12.5 13.8 14.9 15.9 17.5 19.2 21.1

Alpha = 0.5

Exponential Smoothing
We take:

Ft ! E At 1    E Ft 1 1
Ft 1 ! E At  2    E Ft  2 1
2

And substitute in to get:

Ft ! E At 1  E   E At  2    E Ft  2 1 1
2 3 4

and if we continue doing this, we get:

Ft ! E At 1  E   E At  2  E   E At 3  E   E At 3  E   E At 3  ... 1 1 1 1

Older demands get exponentially less weight

Choosing E
Low E: if demand is stable, we dont want to get thrown into a wild-goose chase, over-reacting to trends that are really just short-term variation High E: If demand really is changing rapidly, we want to react as quickly as possible

Averaging Methods
Simple Average Moving Average Weighted Moving Average Exponentially Weighted Moving Average (Exponential Smoothing) They ALL take an average of the past
With a trend, all do badly Average must be in-between
30 20 10

Trend-Adjusted Ex. Smoothing

FITt ! Ft T t Forecast Including Trend Ft ! Exp. Smoothed forecast for t Tt ! Exp. Smoothed Trend Estimate Ft ! FITt 1  E At 1  FITt 1 ! (1  E ) FITt 1  E At 1 T t ! T t 1H Ft  FITt 1 where E and H are smoothing constants

Trend-Adjusted Ex. Smoothing

F1 ! 100 T1 ! 10 E ! 0.20 H ! 0.30
Forecast including trend for period 1 is

FIT1 ! F1 T 1! 100  10 ! 110

Suppose actual demand is 115, A1=115

 2 ! FITt1  E At1  FITt1 ! FIT1  E A1  FIT1 F

! 110  0.2 *(115 110) ! 110  1 ! 111.0
T 2 ! T t 1H Ft  FITt 1 !T 1H F2  FIT1 ! 10  0.30 * (111  110) ! 10  0.3 ! 10.3

FIT2 ! F2 T 2! 111 10.3 ! 121.3

Trend-Adjusted Ex. Smoothing

Forecast including trend for period 1 is

F2 ! 111.0 T2 ! 10.3

E ! 0.20 H ! 0.30

FIT2 ! F2 T 2! 111  10.3 ! 121.3

Suppose actual demand is 120, A2=120

F3 ! FIT2  E A2  FIT2
T 3 ! T 2H F3  FIT2

! 121.3  0.2 *(120  121.3) ! 121.3  0.2 *1.3 ! 121.04

! 10.3  0.30 * (121.04  121.3) ! 10.3  0.078 ! 10.22

FIT3 ! F3 T 3! 121.04  10.22 ! 131.26

Selecting E and H
You could:
Try an initial value for each parameter. Try lots of combinations and see what looks best. But how do we decide what looks best?

Lets measure the amount of forecast error. Then, try lots of combinations of parameters in a methodical way.
Let E = 0 to 1, increasing by 0.1
x For each E value, try H = 0 to 1, increasing by 0.1

Evaluating Forecasts
How far off is the forecast?
Forecasts

Demands

What do we do with this information?

Evaluating Forecasts
Mean Absolute Deviation Mean Squared Error Mean Absolute Percent Error

MAD ! (1/n) At  Ft
i!1

MSE ! (1/n) At  Ft
i!1

n  At  Ft  MAPE !  (1/n) v100 Di   i!1

Tracking Signal
To monitor, compute tracking signal
RSFE Tracking Signal ! MAD n

RSFE ! At  Ft
t !1

If >4 or <-4 something is wrong Top should sum to 0 over time. If not, forecast is biased.

Monitoring Forecast Accuracy

Monitor forecast error each period, to see if it becomes too great
10 Upper Limit 0

Forecast Error

-10 Forecast Period

Lower Limit

Updating MAD
Simplified calculation avoids keeping running total of all errors and demands:

MADt ! MADt 1  E Actual  Forecast t  MADt 1

Standard Deviation can be estimated from MAD:

W ! 1.25  MAD

Techniques for Trend

Determine how demand increases as a function of time

yt ! a  bt

t = periods since beginning of data b = Slope of the line a = Value of yt at t = 0

Computing Values

xy  n x y b! x  nx y  b x ! y  b x a!
2 2

S yx !

( yi  Yi ) i !1 n2

Linear Regression
Three methods
Type in formulas for trend, intercept Tools | Data Analysis | Regression Graph, and R click on data, add a trendline, and display the equation. Use intercept(Y,X) and slope(Y,X) commands

Fits a trend and intercept to the data. Gives all data equal weight. Exp. smoothing with a trend gives more weight to recent, less to old.

Causal Forecasting
Linear regression seeks a linear relationship between the input variable and the output quantity.

yc ! a  bx
R2 measures the percentage of change in y that can be explained by changes in x.

Video sales of Shrek 2?

Shrek did $500m at the box office, and sold almost 50 million DVDs & videos Shrek2 did $920m at the box office
Box Office $ Millions
1000 900 800 700 600 500 400 300 200 100 0 Shrek Shrek2

Video sales of Shrek 2?

Assume 1-1 ratio:
920/500 = 1.84 1.84 * 50 million = 92 million videos? Fortunately, not that dumb.

January 3, 2005: 37 million sold! March analyst call: 40m by end Q1 March SEC filing: 33.7 million sold. Oops. May 10 Announcement:
In 2nd public Q, missed earnings targets by 25%. May 9, word started leaking Stock dropped 16.7%

Lessons Learned
Flooded market with DVDs Guaranteed Sales
Promised the retailer they would sell them, or else the retailer could return them Didnt know how many would come back

5 years ago
Typical movie 30% of sales in first week Animated movies even lower than that

2004/5 50-70% in first week

Shrek 2: 12.1m in first 3 days American Idol ending, had to vote in first week

Washoe Gaming Win, 1993-96

300 280 260 240 220 200 180 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4

What did they mean when they said it was down three quarters in a row?

1993

1994

1995

1996

Seasonality
Seasonality is regular up or down movements in the data Can be hourly, daily, weekly, yearly Nave method
N1: Assume January sales will be same as December N2: Assume this Fridays ticket sales will be same as last

Seasonal Factors
Seasonal factor for May is 1.20, means May sales are typically 20% above the average Factor for July is 0.90, meaning July sales are typically 10% below the average

Seasonality & No Trend

Spring Summer Fall Winter Total Avg Sales 200 350 300 150 Factor 200/250 = 0.8 350/250 = 1.4 300/250 = 1.2 150/250 = 0.6

1,000 1,000/4=250

Seasonality & No Trend

If we expected total demand for the next year to be 1,100, the average per quarter would be 1,100/4=275 Forecast Spring 275 * 0.8 = 220 Summer 275 * 1.4 = 385 Fall 275 * 1.2 = 330 Winter 275 * 0.6 = 165 Total 1,100

Trend & Seasonality

Deseasonalize to find the trend
1. Calculate seasonal factors 2. Deseasonalize the demand 3. Find trend of deseasonalized line

Project trend into the future

4. Project trend line into future 5. Multiply trend line by seasonal component.

Washoe Gaming Win, 1993-96

300 280 260 240 220 200 180 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4

Looks like a downhill slide -Silver Legacy opened 95Q3 -Otherwise, upward trend
1993 1994 1995 1996

Source: Comstock Bank, Survey of Nevada Business & Economics

Washoe Win 1989-1996

290000 270000 250000 230000 210000 190000 170000 150000 1989 1990 1991 1992 1993 1994 1995 1996

Definitely a general upward trend, slowed 93-94

1989-2007

1989-2007

1998-2007

Cache Creek

9/11

Thunder CC Valley Expands

2003Q3 - 2007Q3

2003Q2 - 2007Q3

2003-2007
For each Q:
Date Quarter 59 60 2004 61 62 63 64 2005 65 66 67 68 2006 69 70 71 72 2007 73 74 75 Win 276,371 235,766 240,221 259,350 279,758 245,811 231,608 259,687 297,414 260,149 245,775 269,670 294,839 257,015 244,643 273,116 284,734

Compute Indexes
Q 1 2 3 4 Total Avg. Avg 240,562 265,456 289,187 254,325 262,382 Index 0.9168 1.0117 1.1022 0.9693

Compute Avg Win for each Q Divide Avg by Total Avg to get Index: 240,562/262,382 = 0.9168 Deseasonalize: Divide Win by Index 276,371 / 1.1022 = 250,755

2003-2007
Do LR on deseasonalized data
period 59 60 2004 61 62 63 64 2005 65 66 67 68 2006 69 70 71 72 2007 73 74 75 Win 276,371 235,766 240,221 259,350 279,758 245,811 231,608 259,687 297,414 260,149 245,775 269,670 294,839 257,015 244,643 273,116 284,734 Deseasonalized 250,755 243,236 262,010 256,347 253,828 253,598 252,616 256,681 269,847 268,391 268,069 266,548 267,511 265,157 266,834 269,954 258,343 Linear 251,613 252,733 253,853 254,972 256,092 257,212 258,332 259,452 260,572 261,692 262,812 263,932 265,052 266,172 267,291 268,411 269,531 270,651 271,771 272,891 274,011

intercept slope rsq

185,538.00 1,119.91 0.497

Create Linear Forecasts Int + slope * period

Seasonal Forecast
2004 58 59 60 61 62 63 64 65 66 67 68 69 70 71 72 73 74 75 76 77 78 79 257,062 276,371 235,766 240,221 259,350 279,758 245,811 231,608 259,687 297,414 260,149 245,775 269,670 294,839 257,015 244,643 273,116 284,734 Deseasonalized Linear Forecast 250,755 251,613 277,317 243,236 252,733 244,972 262,010 253,853 232,741 256,347 254,972 257,959 253,828 256,092 282,254 253,598 257,212 249,314 252,616 258,332 236,848 256,681 259,452 262,491 269,847 260,572 287,191 268,391 261,692 253,656 268,069 262,812 240,956 266,548 263,932 267,023 267,511 265,052 292,129 265,157 266,172 257,998 266,834 267,291 245,063 269,954 268,411 271,556 258,343 269,531 297,066 270,651 262,340 271,771 263,425 272,891 264,511 274,011 265,596

Q 1 2 3 4

Index 0.9168 1.0117 1.1022 0.9693

Multiply Linear forecast by indexes

251,613 * 1.1022 = 277,317 267,291 * 0.9168 = 245,063

2005

2006

2007

2008