Lecture – 07

Demand 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
 Forecasts are always inaccurate, so 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
 The farther up the supply chain a company is (or the farther
it is from the consumer), the greater the distortion of
information it receives
 Numerous factors influence the demand forecast,
including the following:
 Past demand
 Lead time of product replenishment
 Planned advertising or marketing efforts
 Planned price discounts
 State of the economy
 Actions that competitors have taken
 A company must understand such factors before it can
select an appropriate forecasting methodology.
 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
Observed demand (O) =
Systematic component (S) + Random component (R)
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
 The following five points are important for an
organization to forecast effectively:
 Understand the objective of forecasting.
 Integrate demand planning and forecasting throughout
the supply chain.
 Identify the major factors that influence the demand
forecast.
 Forecast at the appropriate level of aggregation.
 Establish performance and error measures for the
forecast.
 The goal of any forecasting method is to predict the
systematic component of demand and estimate the random
component.
 The systematic component of demand data contains a level, a
trend, and a seasonal factor.
 Systematic component = level * trend * seasonal factor
 Systematic component = level + trend + seasonal factor
 Systematic component = 1level + trend2 * seasonal factor
 The specific form of the systematic component applicable to
a given forecast depends on the nature of demand.
 Companies may develop both static and adaptive forecasting
methods for each form.
 Assume a mixed model:
Systematic component = (level + trend)(seasonal factor)
Ft+l = [L + (t + l)T]St+l
= forecast in period t for demand in period t + l
L = estimate of level for period 0
T = estimate of trend
St = estimate of seasonal factor for period t
Dt = actual demand in period t
Ft = forecast of demand in period t
 Before estimating level and trend, demand data must be
deseasonalized
 Deseasonalized demand = demand that would have
been observed in the absence of seasonal fluctuations
 Periodicity (p)
 the number of periods after which the seasonal cycle
repeats itself
 for demand at Tahoe Salt (Table 7.1, Figure 7.1) p = 4
 Use the previous equation to calculate deseasonalized
demand for each period
St = Dt / Dt = seasonal factor for period t
 The seasonal factors for the other periods are calculated in
the same manner
 The overall seasonal factor for a “season” is then obtained by
averaging all of the factors for a “season”
 If there are r seasonal cycles, for all periods of the form pt+i,
1<i<p, the seasonal factor for season i is
Si = [Sum(j=0 to r-1) Sjp+i]/r
 The estimates of level, trend, and seasonality are adjusted after
each demand observation
 General steps in adaptive forecasting:
 Initialize
 Forecast
 Estimate error
 Modify estimates

 Examples:
 Moving average
 Simple exponential smoothing
 Trend-corrected exponential smoothing (Holt’s model)
 Trend- and seasonality-corrected exponential smoothing (Winter’s
model)