Supply Chain Management: Strategy,
Planning, and Operation
Seventh Edition
Chapter 7
Demand Forecasting in a
Supply Chain
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Learning Objectives
7.1 Understand the role of forecasting for both an
enterprise and a supply chain.
7.2 Identify the components of a demand forecast and
some basic approaches to forecasting.
7.3 Forecast demand using time-series methodologies
given historical demand data in a supply chain.
7.4 Analyze demand forecasts to estimate forecast error.
7.5 Use Excel to build time-series forecasting models.
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Role of Forecasting in a Supply Chain
• The basis for all planning decisions in a supply chain
• Used for both push and pull processes
– Production scheduling, inventory, aggregate planning
– Sales force allocation, promotions, new production
introduction
– Plant/equipment investment, budgetary planning
– Workforce planning, hiring, layoffs
• All of these decisions are interrelated
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Characteristics of Forecasts
1. Forecasts are always inaccurate and should thus include both
the expected value of the forecast and a measure of forecast
error
2. Long-term forecasts are usually less accurate than short-term
forecasts
3. Aggregate forecasts are usually more accurate than
disaggregate forecasts
4. In general, the farther up the supply chain a company is, the
greater is the distortion of information it receives
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Summary of Learning Objective 1 (1 of 2)
Forecasting is a key input for virtually every design and planning
decision made in a supply chain. It is important to recognize that
all forecasts are likely to be wrong. Thus, an estimation of
forecast error is essential to effectively use the forecast. Reducing
the forecast horizon (by reducing the lead time of the associated
decision) and aggregation are two effective approaches to
decrease forecast error.
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Summary of Learning Objective 1 (2 of 2)
A relatively recent phenomenon, however, is to create
collaborative forecasts for an entire supply chain and use
these as the basis for decisions. Collaborative forecasting
greatly increases the accuracy of forecasts and allows the
supply chain to maximize its performance. Without
collaboration, supply chain stages farther from demand will
likely have poor forecasts that will lead to supply chain
inefficiencies and a lack of responsiveness.
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Components and Methods (1 of 2)
• Companies must identify the factors that influence future
demand and then ascertain the relationship between these
factors and future demand
– Past demand
– Lead time of product replenishment
– Planned advertising or marketing efforts
– Planned price discounts
– State of the economy
– Actions that competitors have taken
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Components and Methods (2 of 2)
1. Qualitative
– Primarily subjective
– Rely on judgment
2. Time Series
– Use historical demand only
– Best with stable demand
3. Causal
– Relationship between demand and some other factor
4. Simulation
– Imitate consumer choices that give rise to demand
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Components of An Observation
Observed demand (O) = systematic component (S)
+ random component (R)
• Systematic component – expected value of demand
– Level (current deseasonalized demand)
– Trend (growth or decline in demand)
– Seasonality (predictable seasonal fluctuation)
• Random component – part of forecast that deviates
from systematic part
• Forecast error – difference between forecast and actual
demand
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Five Important Points in the Forecasting
Process
1. Understand the objective of forecasting.
2. Integrate demand planning and forecasting throughout the
supply chain.
3. Identify the major factors that influence the demand forecast.
4. Forecast at the appropriate level of aggregation.
5. Establish performance and error measures for the forecast.
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Summary of Learning Objective 2
Demand consists of a systematic and a random component. The
systematic component measures the expected value of demand. The
random component measures fluctuations in demand from the expected
value. The systematic component consists of level, trend, and
seasonality. Level measures the current de-seasonalized demand. Trend
measures the current rate of growth or decline in demand. Seasonality
indicates predictable seasonal fluctuations in demand. The goal of
forecasting is to estimate the systematic component and the size (not
direction) of the random component (in the form of a forecast error).
Good forecasting requires a clear understanding of the objective of the
forecast and should be integrated across the supply chain.
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Time-Series Forecasting Methods
• Three ways to calculate the systematic component
– Multiplicative
S = level × trend × seasonal factor
– Additive
S = level + trend + seasonal factor
– Mixed
S = (level + trend) × seasonal factor
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Static Methods
Systematic component = (level+trend)×seasonal factor
Ft l [L (t l )T ]St l
Where
L = estimate of level at t = 0
T = estimate of trend
St = estimate of seasonal factor for Period t
Dt = actual demand observed in Period t
Ft = forecast of demand for Period t
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Tahoe Salt (1 of 5)
Table 7-1 Quarterly Demand for Tahoe Salt
Year Quarter Period, t Demand, Dt
1 2 1 8,000
1 3 2 13,000
1 4 3 23,000
2 1 4 34,000
2 2 5 10,000
2 3 6 18,000
2 4 7 23,000
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Tahoe Salt (2 of 5)
Table 7-1 [continued]
Year Quarter Period, t Demand, Dt
3 1 8 38,000
3 2 9 12,000
3 3 10 13,000
3 4 11 32,000
4 1 12 41,000
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Tahoe Salt (3 of 5)
Figure 7-1 Quarterly Demand at Tahoe Salt
1. Deseasonalize demand and run linear regression to estimate level and
trend.
2. Estimate seasonal factors.
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Estimate Level and Trend (1 of 2)
Periodicity p = 4, t = 3
p
t –1
2
D
t – p D p
t
p i
2D
2 2 i t 1–
2
(2 p ) for p even
Dt
( p –1)
t 2
( p –1)
Di
i t –
2
p for p odd
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Estimate Level and Trend (2 of 2)
p
t –1
2
Dt – p Dt p p 2Di
2 2
i t 1–
2
Dt
(2 p )
4
D1 D5 2Di
i 2
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Tahoe Salt (4 of 5)
Figure 7-2 Excel Workbook with Deseasonalized Demand for Tahoe
Salt
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Tahoe Salt (5 of 5)
Figure 7-3 Deseasonalized Demand for Tahoe Salt
A linear relationship exists between the deseasonalized demand and
time based on the change in demand over time
Dt L Tt
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Estimating Seasonal Factors (1 of 3)
Di
St
Dt
Figure 7-4 Deseasonalized Demand and Seasonal Factors for Tahoe
Salt
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Estimating Seasonal Factors (2 of 3)
r –1
S
j 0
jp i
Si
r
(S1 S5 S9 ) (0.42 0.47 0.52)
S1 0.47
3 3
(S2 S6 S10 ) (0.67 0.83 0.55)
S2 0.68
3 3
(S S7 S11 ) (1.15 1.04 1.32)
S3 3 1.17
3 3
(S S8 S12 ) (1.66 1.68 1.66)
S4 4 1.67
3 3
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Estimating Seasonal Factors (3 of 3)
F13 (L 13T )S13 (18,439 13 524)0.47 11,868
F14 (L 14T )S14 (18,439 14 524)0.68 17,527
F15 (L 15T )S15 (18,439 15 524)1.17 30,770
F16 (L 16T )S16 (18,439 16 524)1.67 44,794
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Adaptive Forecasting (1 of 2)
• The estimates of level, trend, and seasonality are updated after
each demand observation
• Estimates incorporate all new data that are observed
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Adaptive Forecasting (2 of 2)
Ft +1 (Lt + lTt )St +1
Where
Lt = estimate of level at the end of Period t
Tt = estimate of trend at the end of Period t
St = estimate of seasonal factor for Period t
Ft = forecast of demand for Period t (made
Period t – 1 or earlier)
Dt = actual demand observed in Period t
Et = Ft – Dt = forecast error in Period t
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Steps in Adaptive Forecasting
• Initialize
– Compute initial estimates of level (L0), trend (T0), and
seasonal factors (S1,…,Sp)
• Forecast
– Forecast demand for period t + 1
• Estimate error
– Compute error Et+1 = Ft+1 – Dt+1
• Modify estimates
– Modify the estimates of level (Lt+1), trend (Tt+1), and
seasonal factor (St+p+1), given the error Et+1
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Moving Average
• Used when demand has no observable trend or seasonality
Systematic component of demand = level
• The level in period t is the average demand over the last N periods
(Dt Dt 1 … Dt – N +1 )
Lt
N
Ft 1 Lt and Ft n Lt
• After observing the demand for period t + 1, revise the estimates
(Dt +1 Dt … Dt N 2 )
Lt +1 , Ft 2 Lt +1
N
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Moving Average Example (1 of 2)
• A supermarket has experienced weekly demand of milk of D1
= 120, D2 = 127, D3 = 114, and D4 = 122 gallons over the past
four weeks
– Forecast demand for Period 5 using a four-period moving
average
– What is the forecast error if demand in Period 5 turns out to
be 125 gallons?
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Moving Average Example (2 of 2)
(D D3 D2 D1 )
L4 4
4
122 114 127 120 120.75
4
• Forecast demand for Period 5
– F5 = L4 = 120.75 gallons
• Error if demand in Period 5 = 125 gallons
– E5 = F5 – D5 = 120.75 – 125 = – 4.25
– Revised demand
(D5 D4 D3 D2 )
L5
4
125 122 114 127 122
4
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Simple Exponential Smoothing (1 of 3)
• Used when demand has no observable trend or seasonality
Systematic component of demand = level
• Initial estimate of level, L0, assumed to be the average of all
historical data
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Simple Exponential Smoothing (2 of 3)
1 n
Given data for Periods 1 to n L0 Di
n i 1
Current forecast Ft 1 Lt and Ft n Lt
Revised forecast
using smoothing Lt 1 Dt 1 (1 – )Lt
constant (0 < α < 1)
t –1
Thus Lt 1 (1 – )n Dt 1– n (1 – )t D1
n 0
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Simple Exponential Smoothing (3 of 3)
• Supermarket data
4
Di
L0 120.75
i 1 4
F1 = L0 = 120.75
E1 = F1−D1 = 120.75−120 = 0.75
L1 = αD1+(1−α)L0
= 0.1×120+0.9 ×120.75=120.68
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Trend-Corrected Exponential Smoothing
(Holt’s Model) (1 of 4)
• Appropriate when the demand is assumed to have a level
and trend in the systematic component of demand but no
seasonality
Systematic component of demand = level + trend
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Trend-Corrected Exponential Smoothing
(Holt’s Model) (2 of 4)
• Obtain initial estimate of level and trend by running a linear
regression
Dt = at + b
T0 = a, L0 = b
• In Period t, the forecast for future periods is
Ft+1 = Lt + Tt and Ft+n = Lt + nTt
• Revised estimates for Period t
Lt 1 Dt 1 1 α Lt Tt
Tt +1 Lt 1 Lt 1 Tt
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Trend-Corrected Exponential Smoothing
(Holt’s Model) (3 of 4)
• Smartphone player demand
D1 = 8,415, D2 = 8,732, D3 = 9,014, D4 = 9,808,D5 = 10,413, D6 =
11,961, α = 0.1, β = 0.2
• Using regression analysis
L0 = 7,367 and T0 = 673
• Forecast for Period 1
F1 = L0 + T0 = 7,367 + 673 = 8,040
• Period 1 error
E1 = F1 – D1 = 8,040 – 8,415 = –375
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Trend-Corrected Exponential Smoothing
(Holt’s Model) (4 of 4)
• Revised estimate
L1 D1 1 L0 T0
0.1 8,415 0.9 8,040 8,078
T1 L1 L0 1 T0
0.2 8,078 7,367 0.8 673 681
• With new L1
F2 = L1 + T1 = 8,078 + 681 = 8,759
• Continuing
F7 = L6 + T6 = 11,399 + 673 = 12,072
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Trend- and Seasonality-Corrected
Exponential Smoothing (1 of 2)
• Appropriate when the systematic component of demand
has a level, trend, and seasonal factor
Systematic component = (level + trend) × seasonal factor
Ft +1 (Lt Tt )St +1 and Ft +l (Lt lTt )St +l
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Trend- and Seasonality-Corrected
Exponential Smoothing (2 of 2)
• After observing demand for period t + 1, revise estimates for level,
trend, and seasonal factors
D
Lt +1 t 1 1 Lt Tt
St 1
Tt +1 Lt 1 Lt 1 Tt
Dt 1
St +p+1 1 St 1
Lt 1
α = smoothing constant for level
β = smoothing constant for trend
γ = smoothing constant for seasonal factor
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Winter’s Model (1 of 3)
L0 = 18,439 T0 = 524
S1= 0.47, S2 = 0.68, S3 = 1.17, S4 = 1.67
F1 = (L0 + T0)S1 = (18,439 + 524)(0.47) = 8,913
The observed demand for Period 1 = D1 = 8,000
Forecast error for Period 1
= E1 = F1 – D1
= 8,913 – 8,000 = 913
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Winter’s Model (2 of 3)
• Assume α = 0.1, β = 0.2, γ = 0.1; revise estimates for level and
trend for period 1 and for seasonal factor for Period 5
D
L1 1 1 L0 T0
S1
8,000
0.1 0.9 18,439 524 18,769
0.47
T1 L1 L0 1 β T0
0.2 18,769 18,439 0.8 524 485
D
S5 1 1 S1
L1
8,000
0.1 0.9 0.47 0.47
18,769
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Winter’s Model (3 of 3)
Forecast demand for Period 2
F2 = (L1 + T1)S2 = (18,769 + 485)(0.68) = 13,093
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Time Series Models
Forecasting Method Applicability
Moving average No trend or seasonality
Simple exponential smoothing No trend or seasonality
Holt’s model Trend but no seasonality
Winter’s model Trend and seasonality
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Summary of Learning Objective 3
Time-series methods for forecasting are categorized as static or
adaptive. In static methods, the estimates of parameters are not
updated as new demand is observed. Static methods include
regression. In adaptive methods, the estimates are updated each
time a new demand is observed. Adaptive methods include
moving averages, simple exponential smoothing, Holt’s model,
and Winter’s model. Moving averages and simple exponential
smoothing are best used when demand displays neither trend nor
seasonality. Holt’s model is best when demand displays a trend
but no seasonality. Winter’s model is appropriate when demand
displays both trend and seasonality.
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Measures of Forecast Error (1 of 2)
• Forecast errors contain valuable information and must be
analyzed for two reasons:
1. Managers use error analysis to determine whether the
current forecasting method is predicting the
systematic component of demand accurately
2. All contingency plans must account for forecast error
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Measures of Forecast Error (2 of 2)
Et Ft – Dt n
Et
1 n
Dt
100
t 1
MSEn Et2 MAPEn
n t 1 n
At Et
1 n
MADn At biasn Et
n t 1 t 1
1.25MAD biast
TSt
MADt
t –1 1–
Declining alpha t
t –1 1 – t
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Summary of Learning Objective 4
Forecast error measures the random component of demand. This
measure is important because it reveals how inaccurate a forecast
is likely to be and what contingencies a firm may have to plan
for. The MSE, MAD, and MAPE are used to estimate the size of
the fore- cast error. The bias and TS are used to estimate if the
forecast consistently over- or under- forecasts or if demand has
deviated significantly from historical norms.
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Selecting the Best Smoothing Constant (1 of 2)
Figure 7-5 Selecting Smoothing Constant by Minimizing MSE
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Selecting the Best Smoothing Constant (2 of 2)
Figure 7-6 Selecting Smoothing Constant by Minimizing MAD
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Forecasting Demand at Tahoe Salt (1 of 10)
• Moving average
• Simple exponential smoothing
• Trend-corrected exponential smoothing
• Trend- and seasonality-corrected exponential smoothing
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Forecasting Demand at Tahoe Salt (2 of 10)
Figure 7-7 Tahoe Salt Forecasts Using Four-Period Moving Average
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Forecasting Demand at Tahoe Salt (3 of 10)
Moving average
L12 = 24,500
F13 = F14 = F15 = F16 = L12 = 24,500
σ = 1.25 × 9,719 = 12,148
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Forecasting Demand at Tahoe Salt (4 of 10)
Figure 7-8 Tahoe Salt Forecasts Using Simple Exponential Smoothing
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Forecasting Demand at Tahoe Salt (5 of 10)
Simple exponential smoothing
α = 0.1
L0 = 22,083
L12 = 23,490
F13 = F14 = F15 = F16 = L12 = 23,490
σ = 1.25 × 10,208 = 12,761
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Forecasting Demand at Tahoe Salt (6 of 10)
Figure 7-9 Trend-Corrected Exponential Smoothing
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Forecasting Demand at Tahoe Salt (7 of 10)
Trend-Corrected Exponential Smoothing
L0 = 12,015 and T0 = 1,549
L12 = 30,443 and T12 = 1,541
F13 = L12 + T12 = 30,443 + 1,541 = 31,984
F14 = L12 + 2T12 = 30,443 + 2 × 1,541 = 33,525
F15 = L12 + 3T12 = 30,443 + 3 × 1,541 = 35,066
F16 = L12 + 4T12 = 30,443 + 4 × 1,541 = 36,607
σ = 1.25 × 8,836 = 11,045
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Forecasting Demand at Tahoe Salt (8 of 10)
Figure 7-10 Trend- and Seasonality-Corrected Exponential Smoothing
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Forecasting Demand at Tahoe Salt (9 of 10)
Trend- and Seasonality-Corrected
L0 = 18,439 T0 =524
L12 = 24,791 T12 = 532
S1 = 0.47 S2 = 0.68 S3 = 1.17 S4 = 1.67
F13 = (L12 + T12)S13 = (24,791 + 532)0.47 = 11,902
F14 = (L12 + 2T12)S13 = (24,791 + 2 × 532)0.68 = 17,581
F15 = (L12 + 3T12)S13 = (24,791 + 3 × 532)1.17 = 30,873
F16 = (L12 + 4T12)S13 = (24,791 + 4 × 532)1.67 = 44,955
σ = 1.25 × 1,469 = 1,836
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Forecasting Demand at Tahoe Salt (10 of 10)
Table 7-2 Error Estimates for Tahoe Salt Forecasting
Forecasting Method MAD MAPE (%) TS Range
Four-period moving 9,719 49 –1.52 to 2.21
average
Simple exponential 10,208 59 –1.38 to 2.15
smoothing
Holt’s model 8,836 52 –2.15 to 2.00
Winter’s model 1,469 8 –2.74 to 4.00
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The Role of Software Tools in Forecasting
• Software is important
– Large amounts of data
– Frequency of forecasts
– Importance of high-quality results
• Can forecast demand by products and markets
• Real time updates help firms respond quickly to changes in
marketplace
• Facilitates demand planning
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Summary of Learning Objective 5
Given the repetitive nature of time-series forecasting methods,
they can easily be modeled in Microsoft Excel with simple
formulae that are copied across rows or columns. For regular
forecasting at companies, however, it may be more effective to
select among a wide variety of software packages available
today.
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Copyright
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