1

McGraw-Hill/Irwin ©2009 The McGraw-Hill Companies, All Rights Reserved 1-1

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Chapter 15

Demand Management
and
Forecasting

McGraw-Hill/Irwin ©2009 The McGraw-Hill Companies, All Rights Reserved 1-2

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OBJECTIVES
• Demand Management
• Qualitative Forecasting
Methods
• Simple & Weighted Moving
Average Forecasts
• Exponential Smoothing
• Simple Linear Regression
• Web-Based Forecasting

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Demand Management

Independent Demand:
Finished Goods

A Dependent Demand:
Raw Materials,
Component parts,
B(4) C(2) Sub-assemblies, etc.

D(2) E(1) D(3) F(2)

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Independent Demand:
What a firm can do to manage it?

• Can take an active role to influence

demand

• Can take a passive role and simply

respond to demand

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Types of Forecasts

• Qualitative (Judgmental)

• Quantitative
– Time Series Analysis
– Causal Relationships
– Simulation

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Components of Demand

• Average demand for a period of

time
• Trend
• Seasonal element
• Cyclical elements
• Random variation
• Autocorrelation

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Finding Components of Demand

Seasonal
Seasonalvariation
variation

x
x x Linear
Linear
x x
x x Trend
x x Trend
Sales

x x x
x
x
xx
x xx x x
x
x
x x x x x x
x x x x x x
x x x
x xxxxx
x
x x

1 2 3 4
Year
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Qualitative Methods

Executive Judgment Grass Roots

Historical analogy Qualitative Market Research

Methods

Delphi Method Panel Consensus

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Delphi Method

l. Choose the experts to participate representing

a variety of knowledgeable people in different
areas
2. Through a questionnaire (or E-mail), obtain
forecasts (and any premises or qualifications
for the forecasts) from all participants
3. Summarize the results and redistribute them
to the participants along with appropriate new
questions
4. Summarize again, refining forecasts and
conditions, and again develop new questions
5. Repeat Step 4 as necessary and distribute the
final results to all participants

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Time Series Analysis

• Time series forecasting models try

to predict the future based on past
data
• You can pick models based on:
1. Time horizon to forecast
2. Data availability
3. Accuracy required
4. Size of forecasting budget
5. Availability of qualified personnel

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Simple Moving Average Formula

• The simple moving average model assumes an

average is a good estimator of future behavior
• The formula for the simple moving average is:

A
A t-1 +
+ A
A t-2 +
+ AAt-3 +...+A
+...+At-n
FFtt == t-1 t-2 t-3 t-n
nn

Ft = Forecast for the coming period

N = Number of periods to be averaged
A t-1 = Actual occurrence in the past period for up to “n”
periods

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Simple Moving Average Problem (1)

A
A t-1 +
+ A
A t-2 +
+ AAt-3 +...+A
+...+At-n
FFtt == t-1 t-2 t-3 t-n
Week Demand nn
1 650 Question:
Question: What
What are
are the
the 3-
3-
2 678 week
week and
and 6-week
6-week moving
moving
3 720 average
average forecasts
forecasts forfor
4 785
demand?
demand?
5 859
6 920 Assume
Assume youyou only
only have
have 33
7 850 weeks
weeks and
and 66 weeks
weeks of of
8 758 actual
actual demand
demand data
data for
for the
the
9 892 respective
10 920
respective forecasts
forecasts
11 789
12 844
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Calculating the moving averages gives us:
Week Demand 3-Week 6-Week
1 650 F4=(650+678+720)/3
2 678
=682.67
3 720 F7=(650+678+720
4 785 682.67 +785+859+920)/6
5 859 727.67
=768.67
6 920 788.00
7 850 854.67 768.67
8 758 876.33 802.00
9 892 842.67 815.33
10 920 833.33 844.00
11 789 856.67 866.50
12 844 867.00 854.83
©The McGraw-Hill Companies, Inc., 2004
 15

Plotting
Plottingthe
themoving
movingaverages
averagesandandcomparing
comparing
them
themshows
showshow
howthe
thelines
linessmooth
smooth out
outto
toreveal
reveal
the
theoverall
overallupward
upwardtrend
trendin
inthis
thisexample
example

1000
900
Demand
800
Demand

3-Week
700
6-Week
600
500 Note
Notehow
howthethe
1 2 3 4 5 6 7 8 9 10 11 12 3-Week
3-Weekisis
Week smoother
smootherthan
than
the
theDemand,
Demand,
and
and6-Week
6-Weekisis
even
evensmoother
smoother
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Simple Moving Average Problem (2) Data

Question:
Question: WhatWhat isis the
the
33 week
week moving
moving
Week Demand average
average forecast
forecast
1 820 for
2 775
for this
this data?
data?
3 680 Assume
Assume you you only
only
4 655 have
have 33 weeks
weeks andand
5 620 55 weeks
weeks of of actual
actual
6 600 demand
demand data data for
for
7 575 the
the respective
respective
forecasts
forecasts

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Simple Moving Average Problem (2) Solution

Week Demand 3-Week 5-Week

1 820 F4=(820+775+680)/3
2 775 =758.33
3 680 F6=(820+775+680
+655+620)/5
4 655 758.33 =710.00
5 620 703.33
6 600 651.67 710.00
7 575 625.00 666.00

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Weighted Moving Average Formula

While
While the
the moving
moving average
average formula
formula implies
implies an an equal
equal
weight
weight being
being placed
placed on on each
each value
value that
that isis being
being averaged,
averaged,
the
the weighted
weighted moving
moving average
average permits
permits an
an unequal
unequal
weighting
weighting on
on prior
prior time
time periods
periods
The
The formula
formula for
for the
the moving
moving average
average is:
is:

FFt t == w
w11A
At-1 + w A t-2 ++ w
t-1 + w22 At-2 w33A
At-3 +...+w A t-n
t-3 +...+wnn At-n

nn
wwt ==weight
t weightgiven
occurrence
givento
totime
timeperiod
period“t”
“t” 
ww ==11
ii
occurrence(weights
(weightsmust
mustadd
addtotoone)
one) i=1
i=1

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Weighted Moving Average Problem (1) Data

Question:
Question:Given
Giventhetheweekly
weeklydemand
demandand
andweights,
weights,what
whatisis
the
the forecast for the 4 period
forecast for the 4 thth
periodor
orWeek
Week4?
4?

Week Demand Weights:

1 650
t-1 .5
2 678
3 720 t-2 .3
4 t-3 .2

Note
Notethat
thatthe
theweights
weightsplace
placemore
moreemphasis
emphasison
onthe
the
most
mostrecent
recentdata,
data,that
thatisistime
timeperiod
period“t-1”
“t-1”

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Weighted Moving Average Problem (1) Solution

Week Demand Forecast

1 650
2 678
3 720
4 693.4

F4 = 0.5(720)+0.3(678)+0.2(650)=693.4

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Weighted Moving Average Problem (2) Data

Question:
Question:Given
Giventhe theweekly
weeklydemand
demandinformation
informationand
and
weights,
weights,what
whatisisthe
theweighted
weightedmoving
movingaverage
averageforecast
forecast
of
ofthe
the55thperiod
th
periodor orweek?
week?

Week Demand Weights:

1 820 t-1 .7
2 775 t-2 .2
3 680
t-3 .1
4 655

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Weighted Moving Average Problem (2) Solution

Week Demand Forecast

1 820
2 775
3 680
4 655
5 672

F5 = (0.1)(755)+(0.2)(680)+(0.7)(655)= 672

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Exponential Smoothing Model

FFtt == FFt-1
t-1
+
+ (A
(A t-1
t-1
-
- F
F )
t-1)
t-1
Where :
Ft  Forcast value for the coming t time period
Ft - 1  Forecast value in 1 past time period
At - 1  Actual occurance in the past t time period
  Alpha smoothing constant
• Premise: The most recent observations might
have the highest predictive value
• Therefore, we should give more weight to the
more recent time periods when forecasting
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Exponential Smoothing Problem (1) Data

Week Demand
1 820 Question:
Question: Given
Given the
the
2 775 weekly
weekly demand
demand
3 680 data,
data, what
what are
are the
the
4 655 exponential
exponential
5 750 smoothing
smoothing
6 802 forecasts
forecasts for
for
7 798 periods
periods 2-10
2-10 using
using
8 689 =0.10
9 775
and =0.60?
=0.10 and =0.60?
Assume
Assume FF11=D
=D11
10

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Answer:
Answer:The
Therespective
respectivealphas
alphascolumns
columnsdenote
denotethe
theforecast
forecastvalues.
values. Note
Note
that
thatyou
youcan
canonly
onlyforecast
forecastone
onetime
timeperiod
periodinto
intothe
thefuture.
future.
Week Demand 0.1 0.6
1 820 820.00 820.00
2 775 820.00 820.00
3 680 815.50 793.00
4 655 801.95 725.20
5 750 787.26 683.08
6 802 783.53 723.23
7 798 785.38 770.49
8 689 786.64 787.00
9 775 776.88 728.20
10 776.69 756.28
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Exponential Smoothing Problem (1) Plotting

Note
Notehow
howthat
thatthe
thesmaller
smalleralpha
alpharesults
resultsin
inaa smoother
smootherline
line
in
inthis
thisexample
example

900
800 Demand
Demand

700 0.1
600 0.6
500
1 2 3 4 5 6 7 8 9 10
Week

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Exponential Smoothing Problem (2) Data

Question:
Question: What
What are
are the
the
Week Demand exponential
exponential smoothing
smoothing
1 820 forecasts
forecasts for
for periods
periods 2-5
2-5
2 775 using
using aa =0.5?
=0.5?
3 680
4 655
Assume
Assume FF11=D
=D11
5

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Exponential Smoothing Problem (2) Solution

F1=820+(0.5)(820-820)=820 F3=820+(0.5)(775-820)=797.75

Week Demand 0.5

1 820 820.00
2 775 820.00
3 680 797.50
4 655 738.75
5 696.88
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The MAD Statistic to Determine Forecasting Error

nn
1 MAD  0.8 standard deviation

 AA --FF
t=1
tt tt
1 standard deviation  1.25 MAD
MAD
MAD == t=1
nn

• The ideal MAD is zero which would mean

there is no forecasting error

• The larger the MAD, the less the

accurate the resulting model

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MAD Problem Data

Question:
Question: What
What isis the
the MAD
MAD value
value given
given
the
the forecast
forecast values
values inin the
the table
table below?
below?

Month Sales Forecast

1 220 n/a
2 250 255
3 210 205
4 300 320
5 325 315
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MAD Problem Solution

Month Sales Forecast Abs Error

1 220 n/a
2 250 255 5
3 210 205 5
4 300 320 20
5 325 315 10

40

nn
Note
Notethat
thatby
byitself,
itself,the
theMAD
t=1

AAt t--FFt t
40
40
only
onlylets
letsus
usknow
knowthe
MAD
themean
mean
MAD
MAD== t=1 == ==10
10 error
error in
inaaset
setofofforecasts
forecasts
n n 4 4

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Tracking Signal Formula

• The Tracking Signal or TS is a measure that
indicates whether the forecast average is
keeping pace with any genuine upward or
downward changes in demand.
• Depending on the number of MAD’s
selected, the TS can be used like a quality
control chart indicating when the model is
generating too much error in its forecasts.
• The TS formula is:

RSFE
RSFE Running
Running sum
sum of
of forecast
forecast errors
errors
TS
TS == ==
MAD
MAD Mean
Mean absolute
absolute deviation
deviation
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Simple Linear Regression Model

The
Thesimple
simplelinear
linearregression
regression Y
model
modelseeks
seeksto
tofit
fitaaline
line
through
throughvarious
variousdata
dataover
over
time
a
time
0 1 2 3 4 5 x (Time)

Yt = a + bx Is
Isthe
thelinear
linearregression
regressionmodel
model

Yt is the regressed forecast value or dependent

variable in the model, a is the intercept value of the
the regression line, and b is similar to the slope of the
regression line. However, since it is calculated with
the variability of the data in mind, its formulation is
not as straight forward as our usual notion of slope.

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Simple Linear Regression Formulas for Calculating “a” and “b”

aa == yy-- bx
bx

xy
 xy -- n(y)(x)
n(y)(x)
bb == 22 22
xx -- n(x
 n(x))

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Simple Linear Regression Problem Data

Question:
Question:Given
Giventhe
thedata
databelow,
below,what
whatisisthe
thesimple
simplelinear
linear
regression
regressionmodel
modelthat
thatcan
canbe
beused
usedto
topredict
predictsales
salesin
infuture
future
weeks?
weeks?

Week Sales
1 150
2 157
3 162
4 166
5 177
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Answer:
Answer: First,
First, using
using the
thelinear
linear regression
regressionformulas,
formulas, we
we
can
can compute
compute“a” “a”and
and“b”
“b”
Week Week*Week Sales Week*Sales
1 1 150 150
2 4 157 314
3 9 162 486
4 16 166 664
5 25 177 885
3 55 162.4 2499
Average Sum Average Sum

bb==

 xy
xy--n( n(y)(x)
y)(x) 2499
= 2499 --5(162.4)(3)
5(162.4)(3) 
63
63= 6.3
= 10 = 6.3
 x - n(x )
x 22
- n(x ) 22
55  5( 9
55  5(9 ) ) 10

aa== yy--bx
bx==162.4
162.4--(6.3)(3)
(6.3)(3)==143.5
143.5
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The resulting regression model

is: Yt = 143.5 + 6.3x
Now if we plot the regression generated forecasts against the
actual sales we obtain the following chart:
180
175
170
165
160 Sales
Sales

155 Forecast
150
145
140
135
1 2 3 4 5
Period
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Web-Based Forecasting: CPFR

• Collaborative Planning, Forecasting, and

Replenishment (CPFR) a Web-based tool used
to coordinate demand forecasting, production
and purchase planning, and inventory
replenishment between supply chain trading
partners.
• Used to integrate the multi-tier or n-Tier supply
chain, including manufacturers, distributors
and retailers.
• CPFR’s objective is to exchange selected
internal information to provide for a reliable,
longer term future views of demand in the
supply chain.
• CPFR uses a cyclic and iterative approach to
derive consensus forecasts.

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Web-Based Forecasting:
Steps in CPFR

• 1. Creation of a front-end partnership

agreement
• 2. Joint business planning
• 3. Development of demand forecasts
• 4. Sharing forecasts
• 5. Inventory replenishment

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End of Chapter 15

McGraw-Hill/Irwin ©2009 The McGraw-Hill Companies, All Rights Reserved 1-40