Master Planning of Resources

Session 2
Forecasting Demand
What is a Forecast?

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.
Forecast Error The difference between actual
demand and forecast demand, stated as an absolute
value or as a percentage.
Forecast Management The process of making,
checking, correcting, and using forecasts. It also
includes determination of the forecast horizon.
Why Forecast?
To plan for the future by reducing uncertainty
To facilitate a company in taking control of operations.
Without forecast, it would be a chaos.
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
Areas Impacted by the Forecast

Investment decisions
Capital equipment decisions
Inventory planning
Capacity planning
Operations budgets
Lead-time management
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
General Forecasting Techniques

Qualitative Techniquesbased on intuitive

or judgmental evaluation
Quantitative Techniquesbased on
computational projection of a numeric
relationship
Qualitative Techniques

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

2-7
Quantitative Techniques

Moving average
Exponential smoothing
Regression analysis
Adaptive smoothing
Graphical methods
Econometric modeling
Life-cycle modeling
General Forecasting Data Methods

Intrinsic forecasting methods are based on

historical patterns of the data itself from
company data
Extrinsic forecasting methods are based on
external patterns from information outside
the company such as published data and
data available from the Internet
Qualitative and quantitative forecasts may be generated based on intrinsic
or extrinsic information.
Internal (Intrinsic) Factors
Product life-cycle
management
Planned price
changes
Changes in the sales
force
Resource constraints
Marketing and sales
promotion
Advertising

2-10
External (Extrinsic) Factors
Competition
New customers
Plans of major
customers
Government policies
Regulatory concerns
Economic conditions
Environmental issues
Weather conditions
Global trends
2-11
Leading Indicators
Indicator
(Causal Factor) Influences volume of

Housing starts Building materials

Home furnishings
Birth rate Baby products
Health trends Medical supplies
Desire for Nutritional products
Healthier lifestyle Fitness products

2-12
Demand
A need for a particular product or component

Independent demand is demand for an item that is unrelated to the demand for
other items. Independent demand items are saleable products or services that are
added to the master schedule.

Dependent demand can be calculated directly from the demand for other products.
It is related to the bill of material structure.

2-13
Sources of Demand

Demand can come from many sources:

Consumers
Customers
Referrers
Dealers
Distributors
Interplant
Service parts
Demand Characteristics
Internal Factors External Factors
Product promotion Random fluctuation
Product substitution Seasonality
Trend
Economic cycle
Changing customer
preferences and demands
 Seasonality
Sales in cases by month

800
700
600
500
400 Year 1
300 Year 2
200
100
0
J F M A M J J A S O N D
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
Calculation of Seasonal Index
Sales of Ice Cream

Month Year 1 Year 2 Total Calculation Index

January 10 12 22 22/409 0.05
February 10 12 22 22/409 0.05
March 10 12 22 22/409 0.05
April 50 55 105 105/409 0.26
May 150 160 310 310/409 0.76
June 400 420 820 820/409 2.00
July 600 620 1220 1220/409 2.98
August 700 730 1430 1430/409 3.49
September 350 360 710 710/409 1.74
October 100 105 205 205/409 0.50
November 10 12 22 22/409 0.05
December 10 12 22 22/409 0.05
Total 2400 2510 4910
Average 409.17 Round to 409
Seasonality Exercise
Economic Cycle
Sales by Quarter

35
30
25
20
15
10
5
0
1 3 5 7 9 11 13 15 17 19
Quarter
Pyramid Forecasting

Total
business
volume
(dollars)

Product family volume

(units/dollars)

Product/item volume
(units)
Pyramid Forecasting
Pyramid Forecasting
TechniquePyramid Forecasting Example
ROLL-UP
Product-level forecast

X1 units8,200 X2 units4,845
price$20.61 price$10.00
Family-level forecast units13,045
Family avg price$16.67
Family-adjusted forecast units15,000
FORCE-DOWN
15,000
X1 8,200 = 9,429 units
13,045

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

13,045
Pyramid Forecasting Using Revenue

A B C D E F
X1 X2 Totals
units price units price Qty $
1 8,200 $20.61 4,845 $10.00 13,045 $217,452
2 1.15
3 9,429 $20.61 5,571 $10.00 15,000 $250,042
4 $250,070

2-25
Pyramid Forecasting Exercise
Historical Demand
Product A Product B
Region 1 150 Region 1 300
Region 2 300 Region 2 450
Selling Price $4.50 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.

2-26
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
= 1.19 (19% increase)
$8,400
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 = 535.5 $4.50 = $2,409.75

357.0 + 535.5 = 892.5 $8.50 = $7,586.25
$9,996.00
2-27
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
Limitations
If a trend exists, it is hard to detect
Moving averages lag trends

2-28
Moving Average Exercise
Actual sales Next months variation
forecast
Jan 100
Feb 500
Mar 1000
Apr 1500
May 2800
June 5100
Jul 6200
Aug 5700
Sep 3200
Oct 1200
Nov 500
Dec 100
Exponential Smoothing
New Forecast = x Actual Demand + (1 - ) x Old Forecast
New Forecast = Old Forecast + x (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

2-31
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

2-32
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

2-33
Comparison of Exponential Smoothing Alpha Factors

0.1 Low weighting -most smoothing

0.9 High weighting - close to actual

Actual sales

2-34
Exponential Smoothing Examples
New forecast = Old forecast + smoothing factor (a)
(actual demand - 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

2-35
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.

2-36
Product Life Cycle
Volume
Introduction Growth Maturity Decline

Product Life Cycle Stages Time

2-37
Focus ForecastingAssumptions/Methods

Assumptions
The most recent past is the best indicator of the
future
One forecasting model is better than the others
Methods
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
2-38
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
2-39
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 25 29 33 37 41 45 49 53 65 78 91 104

Time Periods (week numbers)

2-40
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

2-41
Dealing with Outliers
55

50

25

20

15

10

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

2-42
Decomposition of Data
Purify the data
Adjust the data
Take out the baseline and components
Identify demand components
Trend
Seasonality
Nonannual cycle
Random error
Measure the random error
Project the series
Recompose
2-43
Session 2 Review
You should now be able to
Explain why forecasting is important

Identify and describe general methods of

forecasting
Identify factors influencing demand

Describe considerations in using data for

forecasts
Outline the process of data decomposition

2-44