Forecasting

N.K.Agarwal

Forecasting
All supply chain decisions based on estimates of future demands Historical demand information can be used to forecast future demands For push/pull philosophy of supply chain
Push processes are performed in anticipation of demand Pull processes performed in response to the customer demand Dell orders components for computers in anticipation of customer demand, while Assembly is performed in response to a customer demand

Forecasting
When individual stages in the supply chain make their independent forecast of demand, there is always a mismatch between the supply and demand Collaborative forecast for the entire chain partners tends to be much more accurate Decisions for functions like Production, Marketing, Finance, Personnel are best taken based on collaborative forecast Mature products with stable demand are usually easiest to forecast
Staple products like food grains, sugar at superbazars

Forecasting
Forecasting and accompanying managerial decisions are extremely difficult when either the supply of raw materials or the demand for the finished product is highly variable
Fashion garments, high tech products etc.

Good forecasting is important for products with short life cycle, like fashion goods Products with a long life cycle have less significant effect from forecasting errors

Forecasting- Characteristics
Forecasts are always wrong and should include both the expected value and a measure of the forecast error Long term forecasts are usually less accurate than short term forecasts The greater the degree of aggregation , the more accurate is the forecast
Easier to forecast the GNP in a year of a country within 2% accuracy than the annual revenue of a company

The greater up the supply chain a company is, the greater the distortion of information they receive
Bullwhip effect

Bullwhip Effect
Amount of = inventory

Tier 2 Suppliers

Tier 1 Suppliers

Producer

Distributor

Customers

Ordering

Forecasting- Components
Companies need to first
Identify the factors that influence the future demand, and then Ascertain the relationship between these factors and future demand

Some of the factors that need to be looked into

Past demand Lead time of products Planned advertising or marketing efforts State of economy Planned price discounts Action competitors have taken

Demand Forecasting Basic Forecasting

Six step approach for effective forecasting
Understand the objective of forecasting Integrate demand planning and forecasting throughout the supply chain Understand and identify customer segments Identify the major factors that influence the demand forecast Determine the appropriate forecasting technique Establish performance and error measures for the forecast

Forecasting- Methods
Qualitative Method
Qualitative forecasting methods are primarily subjective and rely on human judgment Most appropriate when there is little historical data available or when experts have market intelligence that is critical in making forecast Used to forecast future demand for long term in a new industry

Time Series
Use historical demand to forecast Method appropriate when the demand pattern does not vary significantly from one year to the next

Forecasting- Methods
Causal
Method assumes that the demand forecast is highly correlated with certain factors in the environment State of economy, interest rates etc. Used to determine the impact of price promotions on demand

Simulation
Methods imitate the consumer choices that give rise to demand to arrive at a forecast Simulation is used to combine time series and causal methods to find answers to Impact of price promotion, competitors stores coming up in the vicinity etc. Forecast demand for higher fare seats when there are no seats available at economy class fare Modeling makes use of computers

Time Series Forecasting Methods

A time series is a time-ordered sequence of observations taken at regular intervals over a period of time
Data may be measurement of demand, earnings, profits, outputs etc.

Analysis of time series data requires identification of the underlying behaviour of the series
Done by plotting the data with time and examining for some pattern Trend, Seasonal variations, Cycles, and Random or Irregular variations ( errors)

Time Series Forecasting Methods

Trend
Refers to gradual, long term, upward or downward movement in the data over time Changes in income, population etc.

Seasonality
Refers to short term fairly regular variations related to factors such as weather, holidays, vacations etc. Variations can be daily, weekly or monthly

Cycles
Wave like variations of more than one years duration or which occur every year Business cycle related to economic, political or agricultural conditions

Random variations
Residual variations which are blips in the data caused by chance and unusual situations

Seasonal Trend

Constant Trend

Time

Demand Patterns

Quantitative Methods
Pattern continuous when it is constant and does not consistently increase or decrease Sales of a product in the mature stage of its life cycle may show this Linear pattern emerges when demand increases or decreases from one period to the next Sales of product in the growth stage of the product life cycle shows increasing while in the decline stage show decreasing trend Cyclical pattern pertains to influence of seasonal factors Demand of woolen wears will be high in winter and low during summer

Time Series Forecasting Methods

Forecasts in time series methods based on averages smoothened through averaging Three techniques used for Averaging
Naive Forecasts Simplest method Assumption of demand for the next period based on the actual demand in the most recent period Moving Average method Simple moving average Weighted moving average

Time Series Forecasting Methods

Simple Moving Average (SMA)
Forecasts for the next month is the arithmetic average of the actual sales for a specific number of recent past time periods SMA =Sum of demands for all periods/Chosen number of periods SMA = in=1/n =(D1+D2+D3Dn)/n,
where , n=the chosen number of periods, i= 1 is the oldest period in the n-period average i= n is the most recent period D1= the demand in the i th period

Time Series Forecasting Methods

Weighted Moving Average (WMA)
A weighted average of past sales is the forecast for the next time period A WMA allows for varying, not equal weightage of old demands WMA= in=1 Ci Di , where Di is the demand during time period i, Ci is the weight given to that demand and n is the chosen number of periods Also 0 Ci 1 , and in=1 Ci =1

Time Series Forecasting Methods

Exponential Smoothing Models
Forecasted sales for the last period modified by information about the forecast error of the last periods Modification of the last years forecasts are the forecast for the next time periods Weight assigned to a previous periods demand decreases exponentially as that data gets older Recent demand data receive a higher weight than does the older demand data Normally only three items of data are required This periods forecast, the actual demand for this period and which is referred to as smoothening constant and having a value between 0 and 1

Time Series Forecasting Methods

Formula used is Next periods forecast = This period's forecast + ( this periods actual demand this periods forecast) Or Ft =Ft-1 + ( At-1 Ft-1) Where Ft = Forecast for this period (t) Ft-1 = Forecast for the previous period (t-1) At-1 = Actual demand for the previous period ( t-1) = Smoothening constant Smoothening constant selection is a matter of judgment Commonly used values range between 0.05 0.5

Common Time Series Models

Regression Analysis
A forecasting technique that establishes a relationship between variables- one dependent and others independent Only one independent variable in simple regression Population, advertising expenses affecting sales More than one independent variable in multiple regression Population, income and sales force affecting sales It involves fitting a straight line equation ( in simple linear regression analysis) to explain sales fluctuations in terms of related and presumable causal variables Three major steps in regression analysis Identifying variables which are causally related to the firms sales Determine / estimate the values of these variables related to sales Derive the sales forecast from these estimates

Common Time Series Models

A linear regression assumes the relationship between dependent and independent variables a straight line ( known a simple linear regression analysis) A curvilinear relationship is a non-linear regression producing a curve

Forecasting- Adaptive Method

Adaptive method uses more sophisticated approach compared to static methods Popular models used in this method Holts Model
This is a Trend corrected Exponential smoothened model Appropriate when demand is assumed to have a level and a trend but no seasonality Systematic component of demand = Level + Trend In period t, given estimate of level Lt and trend Tt, the forecast for future periods is expressed as Ft+1 = Lt + Tt and Ft+n = Lt+ nTt

Forecasting- Adaptive Method

After observing for Period t, the estimate for level and trend is corrected as Lt+1 = Dt+1 + (1- )(Lt + Tt) Tt+1 = (Lt+1 Lt) + (1- )Tt , Where is a smoothening constant for the level, and is a smoothening constant for trend and varies from 0 to 1 like

Winters Model
Trend and Seasonality Corrected Exponential Smoothened model Method appropriate when the demand is assumed to have a level, trend and a seasonal factor

Forecasting- Adaptive Method

Systematic component of the demand = ( Level + trend) x seasonal factor Assume periodicity of demand to be p, initial estimates of level L0, trend T0 and seasonal factors ( S1.Sn) In period t, the forecast for future periods is given by Ft+1 = (Lt + Tt)* St+1, and Ft+l = (Lt + lTt)*St+l On observing the demand for period t+1, the estimates for level, trend and seasonal factors are revised as Lt+1 = (Dt+1 /St+1) + (1- )(Lt-Tt) Tt+1 = (Lt+1 Lt) + (1- )*Tt St+p+1 = (Dt+1 / Lt+1) + (1- )*St+1, Where is a smoothening constant for seasonal factor varying from 0 -1

Measure of Forecasting Errors

Managers perform a thorough error analysis on a forecast to
Determine whether the current forecasting method is accurately predicting the systematic components of demand A method consistently giving positive error can indicate over prediction by the method and manager can make necessary corrections Estimate forecast error as any contingency plan must account for such an error Contracting with an outsource agency , even though more expensive, to supply shortfalls in the order on urgent basis

Measure of Forecasting Errors

Forecasting Error is simply the difference between the forecast and actual demand for a given period
et = Ft At , where et = forecast error for the period t, At = actual demand for period t, and Ft = the forecast for the period t

Mean Error (ME) = 1/n nt=1 et Cumulative Sum or Error (CFE) = nt=1 et

CFE is useful in measuring the bias in a forecast MAD is merely the average error for each forecast. Popular because it is easy to understand

Mean Absolute Deviation (MAD) = 1/n nt=1 | et | Mean Squared Error (MSE) = 1/n nt=1 et2

Used as an estimate of the variance of the random error et which is 2

Measure of Forecasting Errors

Mean Absolute Percentage Error (MAPE)
=1/n t=1 ( |et| / At) X100 MAPE is useful for putting forecast performance in the proper perspective Forecast error of 100 when the actual demand is 200 units results in larger percentage error than the error occurring when the demand was 1000 units

Qualitative or Judgemental Methods

Not based on quantitative numbers exclusively
Based on judgment about the causal factors that underline the sales of particular products or services, and On opinions about the relative likelihood of these causal factors being present in the future Useful when historical data are not available

Qualitative or Judgemental Methods

Executive Committee Consensus
A committee of executives from different departments constituted and entrusted with the responsibility of developing a forecast Uses inputs from all parts of organisation and analysts analyse data as required Such forecasts tend to be compromised ones, not reflecting the extremes that might be present Most commonly used method of forecast

Qualitative or Judgemental Methods

The Delphi Method
Method seeks to remove the undesirable consequences of group thinking existing in committees Committee consists of experts from within and outside the organisation Expert in one aspect of the problem and no one conversant with all aspects of the issue Each expert makes independent predictions in the form of brief statements Coordinator edits and clarifies these statements Coordinator provides a series of questions in writing to the experts that includes feedback supplied by other experts Above repeated several times till consensus reached

Qualitative or Judgemental Methods

Survey of Salesforce/ Field Expectation Method
Individual members of the salesforce required to submit sales forecasts of their respective regions These combined to form total estimate of sales Estimates transformed into sales forecasts to ensure realistic estimates A popular method for companies having good communication system and salesforce directly selling to customers

Qualitative or Judgemental Methods

Survey of Customers/Users Expectation Method
Estimates of future sales obtained directly from customers through survey Sales forecast determined by combining individual customers responses Method useful where customers are limited in number

Qualitative or Judgemental Methods

Historical Analogy
Estimates of future sales of product tied to knowledge of a similar products sales Knowledge of one products sales during various stages of its product life cycle applied to estimates of sale for a similar product Method useful for a new product

Qualitative or Judgemental Methods

Market Surveys
Questionnaires, telephone talks or field interviews form the basis for predicting market demand for products Normally preferred for new products or existing products in new markets

Demand Forecasting
Forecasting is a key driver of virtually every design and planning decision made in both an enterprise and a supply chain Collaborative forecasting taking all partners in the supply chain give benefits an order of magnitude higher than the cost Value of data depends upon where one is in the supply chain Demand is not the same as sales
True demand can be obtained by making adjustments for the unmet demands due to stock outs, competitors actions, pricing, promotions etc.

References
Supply Chain Management : Chopra / Meindl Logistics and Supply Chain Management : K. Shridhara Bhat Supply Chain Management : Rahul V. Altekar Google web site

Thank You