Master Planning of Resources

Session 2 Forecasting Demand

Master Planning of Resources

Session 1: The Business Planning Process Session 2: Forecasting Demand Session 3: Demand Management and Customer Service Session 4: Distribution Planning Session 5: The Sales and Operations Planning Process Session 6: The Master Scheduling Process Session 7: Managing the Master Scheduling Process Session 8: Measuring Performance and Validating the Plan
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Session 2 Objectives

Explain why forecasting is important Identify and describe general methods of forecasting Identify demand characteristics Describe considerations in using data for forecasts Outline the process of data decomposition

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What Is a Forecast?
An estimate of future demand. A forecast can be determined by mathematical means using historical data, it can be created subjectively by using estimates from informal sources, or it can represent a combination of both techniques.
APICS Dictionary, 9th ed.
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What Is a Forecast?
Lead Time is reason for planning and forecasting. Forecasting is an important aid in
effective and efficient planning

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Why Forecast?

To plan for the future by reducing uncertainty To anticipate and manage change To increase communication and integration of planning teams To anticipate inventory and capacity demands and manage lead times To project costs of operations into budgeting processes To improve competitiveness and productivity through decreased costs and improved delivery and responsiveness to customer needs
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Areas Impacted by the Forecast

Investment decisions Capital equipment decisions Inventory planning Capacity planning Operations budgets Lead-time management Scheduling Acquiring resources

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Forecast System Design Issues

Determine information that needs to be forecasted Assign responsibility for the forecast Set up forecast system parameters Select forecasting models and techniques Collect data Test models Record actual demand Report accuracy Determine root cause of variance Review forecasting system for improved performance
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General Forecasting Techniques

Qualitativebased on intuitive or judgmental evaluation Quantitativebased on computational projection of a numeric relationship Quantitative: time series predicting the continuation of historical pattern Explanatory understanding relation between dependent and independent variables
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General Forecasting Data Sources

Intrinsicbased on historical patterns of the data itself from company data Extrinsicbased on external patterns from information outside the company

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Demand
A need for a particular product or component

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Sources of Demand
Demand can come from many sources:

Consumers Customers Referrers Dealers Distributors Interplant Service parts

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Demand Characteristics
Internal Factors

External Factors

Product promotion Product substitution

Random fluctuation Seasonality Trend Economic cycle Changing customer preferences and demands

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General Forecasting Steps

Problem definition Gathering information Preliminary ( Exploratory ) analysis Choosing and fitting model Using and evaluating model

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General Forecasting Steps

Time series : Historical data will consist of a sequence of observations over time .This is called such a sequence as time series Assumption the past pattern repeat in future The time scale is equally spaced There are two types of data 1. Time related 2. Cross-sectional( Observation at same time)

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General Forecasting Steps

Four types of time series data pattern can be distinguished 1. Horizontal(random). 2.Seasonal. 3. Cyclic . 4. Trend Difference between seasonal and cyclic

Measure of error MAD mean absolute deviation, MSD mean square deviation Both MAD and S provide measure of spread
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General Forecasting Steps

Approximately 2/3 of observations must lie within one S from mean Approximately 95 % of observations within 2 S from mean. Plot of ACF it provides useful check for seasonality and other pattern. Measure of accuracy and precision

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General Forecasting Steps

Accuracy ME,MAE,MSE Relative accuracy MPE,MAPE For Forecasting data to be divided into two sets one for forecasting model and other for assessing error ( first set is called initializing and other set is called as test or holdout)

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Seasonality
Sales in cases by month
800 700 600 500 400 300 200 100 0 J F M A M J J A S O N D
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Year 1 Year 2

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Seasonality Calculation
Measures seasonal variation of demand Relates the average demand in a particular period to the average demand for all periods
period average demand The Seasonal Index average demand for all periods

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Calculation of Seasonal Index

Sales of Ice Cream
Month January February March April May June July August September October November December Total Average Year 1 10 10 10 50 150 400 600 700 350 100 10 10 2400 Year 2 12 12 12 55 160 420 620 730 360 105 12 12 2510 Total Calculation Index 22 22/409 0.05 22 22/409 0.05 22 22/409 0.05 105 105/409 0.26 310 310/409 0.76 820 820/409 2.00 1220 1220/409 2.98 1430 1430/409 3.50 710 710/409 1.74 205 205/409 0.50 22 22/409 0.05 22 22/409 0.05 4910 409.1667 Round to 409
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Economic Cycle
Sales by Quarter
35 30 25 20 15 10 5 0 1 3 5 7 9 11 13 15 17 19 Quarter
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Pyramid Forecasting
Total business volume (dollars)

Product family volume (units/dollars)

Product/item volume (units)

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TechniquePyramid Forecasting Example

ROLL-UP Product-level forecast X1 units8,200 price$20.61 Family-level forecast Family-adjusted forecast FORCE-DOWN

X2 units4,845 price$10.00 units13,045 Family avg price$16.67 units15,000

X1

15,000 8,200 = 9,429 units 13,045

X2 15,000 4,845 = 5,571 units 13,045

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Pyramid Forecasting Using Revenue

A X1 units 1 2 3 4 9,430 $20.61 5,572 $10.00 15,002 price units 8,200 $20.61 B C X2 price D E Totals Qty $ $217,452 1.15 $250,000 $250.070 F

4,845 $10.00 13,045

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Pyramid Forecasting Exercise

Historical Demand Product A Region 1 150 Region 2 300 Selling Price $4.50 Product B Region 1 300 Region 2 450 Selling Price $8.50

Management has determined that next years demand will be $10,000 total. CALCULATE the projected demand in units for products A and B in each region.

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Pyramid Forecasting ExerciseSolution

Based upon historical demand A = 150 + 300 = 450 $4.50 = $2,025 B = 300 + 450 = 750 $8.50 = $6,375 Total = $8,400 $10,000 $8,400

= 1.19 (19% increase)

A: Region 1 = 1.19 150 = 178.5 Region 2 = 1.19 300 = 357.0 B: Region 1 = 1.19 300 = 357.0 Region 2 = 1.19 450 = 535.5
178.5 + 357.0 = 536.5 $4.50 = $2,414.25 357.0 + 535.5 = 892.5 $8.50 = $7,586.25 $10,000.50
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Quantitative Techniques

Moving average Exponential smoothing Regression analysis Adaptive smoothing Graphical methods Econometric modeling Life-cycle modeling
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Moving Average Forecasting

Advantages

A simple technique that is easy to calculate It can be used to filter out random variation Longer periods provide more smoothing
If a trend exists, it is hard to detect Moving averages lag trends
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Limitations

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Exponential Smoothing
NEW FORECAST = a ACTUAL DEMAND + (1-a) OLD FORECAST NEW FORECAST = OLD FORECAST + a (ACTUAL DEMAND - OLD FORECAST)

Provides a routine method of updating item forecasts Alpha is a weighting factor applied to the demand element Works well for items with fairly constant demand Is satisfactory for short-range forecasts Lags trends
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Smoothing Factor

Referred to as Alpha (a) Determines the weight of historical data on projection Sets responsiveness to changes in demand Range 0 a 1 2 a= n+1

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Smoothing Factor (cont.)

Determines how many periods of actual demand will influence forecast 1.00 = 1 period 0.50 = 3 periods 0.29 = 6 periods 0.15 = 12 periods 0.10 = 19 periods

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Comparison of Exponential Smoothing Alpha Factors

0.1 Low weighting -most smoothing 0.9 High weighting - close to actual

Actual sales

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Exponential Smoothing Examples

New forecast = Old forecast + smoothing factor (a) (actual sales - old forecast) Example: old forecast = 160, actual = 200, a = 0.1 new forecast = 160 + (0.1 (200 - 160)) = 160 + (0.1 40) = 164 Example: old forecast = 160, actual = 200, a = 0.8 new forecast = 160 + (0.8 (200 - 160)) = 160 + (0.8 40) = 192
Adapted from: Manufacturing for Survival, B.R. Williams, Addison Wesley, 1996
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Qualitative Techniques

Expert opinion Market research Focus groups Historical analogy Delphi method Panel consensus

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Internal (Intrinsic) Factors

Product life-cycle management Planned price changes Changes in the sales force Resource constraints Marketing and sales promotion Advertising
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External (Extrinsic) Factors

Competition New customers Plans of major customers Government policies Regulatory concerns Economic conditions Environmental issues Weather conditions Global trends
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Leading Indicators
Indicator (Causal Factor) Housing starts Birth rate Hits on a Web site Health trends Healthier lifestyle
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Influences volume of
Building materials Home furnishings Baby products e-commerce sales Medical supplies Nutritional products Fitness products
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New Product Introduction

Every new product/service is a calculated risk. Every new product/service has the potential to be the next

Blockbuster Lifesaver Money loser Disaster Liability nightmare.

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Product Life Cycle

Volume Introduction Growth Maturity Decline

Product Life Cycle Stages

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Focus ForecastingAssumptions/Methods
Assumptions

The most recent past is the best indicator of the future One forecasting model is better than the others All forecasting models for all items forecasted will be compared against recent sales history The model that achieves the closest fit will be used to forecast this item this time Next time, a different model may be selected
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Methods

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Data Issues for Forecasting

Availability of data Consistency of data Amount of history required Forecast frequency Frequency of model reevaluation Cost and time issues Recording true demand Order date vs. ship date Product units vs. financial units Level of aggregation Customer partnering
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Planning Horizon and Time Periods

Forecast Length

Short

Mid

Long
Planning Horizon

Weeks

Months

Quarters

1 2 3 4 5 6 7 8 9 1011 12 13 17 21 26 30 34 39 43 47

52 65

78

91 104

Time Periods (week numbers)

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Data Preparation and Collection

Record sales data in same periods as forecast data (daily, weekly, or monthly) Monitor demand, not sales and/or shipments Record the circumstances of exceptional demand Record demand separately for unique customer groupings and market sectors
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Dealing with Outliers

55 50

25 20 15 10 5 0 J F M A M J J A S O N D J F M A M J J A S O N D
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Decomposition of Data

Purify the data Adjust the data Take out the baseline Identify demand components
Trend Seasonality Nonannual cycle Random error

Measure the random error Project the series Recompose

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Session 2 Review
You should now be able to:

Explain why forecasting is important Identify and describe general methods of forecasting Identify demand characteristics Describe considerations in using data for forecasts Outline the process of data decomposition

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