Demand Forecasting

Provided by SME.com.ph

What is a demand forecast?

A demand forecast is the prediction of what will happen to your company's existing
product sales. It would be best to determine the demand forecast using a multi-functional
approach. The inputs from sales and marketing, finance, and production should be
considered. The final demand forecast is the consensus of all participating managers. You
may also want to put up a Sales and Operations Planning group composed of
representatives from the different departments that will be tasked to prepare the demand
forecast.

Determination of the demand forecasts is done through the following steps:

• Determine the use of the forecast

• Select the items to be forecast

• Determine the time horizon of the forecast

• Select the forecasting model(s)

• Gather the data

• Make the forecast

• Validate and implement results

The time horizon of the forecast is classified as follows:

Description Forecast Horizon

Short-range Medium-range Long-range
Duration Usually less than 3 3 months to 3 years More than 3 years
months, maximum of
1 year
Applicability Job scheduling, Sales and production New product
worker assignments planning, budgeting development, facilities
planning

How is demand forecast determined?

There are two approaches to determine demand forecast – (1) the qualitative approach,
(2) the quantitative approach. The comparison of these two approaches is shown below:

Description Qualitative Approach Quantitative Approach

Applicability Used when situation is vague & Used when situation is stable &
little data exist (e.g., new products historical data exist
and technologies)
(e.g. existing products, current
technology)
Considerations Involves intuition and experience Involves mathematical techniques
Techniques Jury of executive opinion Time series models

Sales force composite Causal models

Delphi method

Consumer market survey

Qualitative Forecasting Methods

Your company may wish to try any of the qualitative forecasting methods below if you
do not have historical data on your products' sales.

Qualitative Method Description

Jury of executive The opinions of a small group of high-level managers are
opinion pooled and together they estimate demand. The group uses
their managerial experience, and in some cases, combines the
results of statistical models.
Sales force composite Each salesperson (for example for a territorial coverage) is
asked to project their sales. Since the salesperson is the one
closest to the marketplace, he has the capacity to know what
the customer wants. These projections are then combined at
the municipal, provincial and regional levels.
Delphi method A panel of experts is identified where an expert could be a
decision maker, an ordinary employee, or an industry expert.
Each of them will be asked individually for their estimate of
the demand. An iterative process is conducted until the
experts have reached a consensus.
Consumer market The customers are asked about their purchasing plans and
survey their projected buying behavior. A large number of
respondents is needed here to be able to generalize certain
results.

Quantitative Forecasting Methods

There are two forecasting models here – (1) the time series model and (2) the causal
model. A time series is a s et of evenly spaced numerical data and is o btained by
observing responses at regular time periods. In the time series model , the forecast is
based only on past values and assumes that factors that influence the past, the present and
the future sales of your products will continue.

On the other hand, t he causal model uses a mathematical technique known as the
regression analysis that relates a dependent variable (for example, demand) to an
independent variable (for example, price, advertisement, etc.) in the form of a linear
equation. The time series forecasting methods are described below:

Description

Time Series
Forecasting
Method
Naïve Approach Assumes that demand in the next period is the same as demand in
most recent period; demand pattern may not always be that stable

For example:

If July sales were 50, then Augusts sales will also be 50

Description

Time Series
Forecasting
Method
Moving Averages MA is a series of arithmetic means and is used if little or no trend is
(MA) present in the data; provides an overall impression of data over time

A simple moving average uses average demand for a fixed sequence

of periods and is good for stable demand with no pronounced
behavioral patterns.
 Equation:

F 4 = [D 1 + D2 + D3] / 4

F – forecast, D – Demand, No. – Period

(see illustrative example – simple moving average)

A weighted moving average adjusts the moving average method to

reflect fluctuations more closely by assigning weights to the most
recent data, meaning, that the older data is usually less important.
The weights are based on intuition and lie between 0 and 1 for a total
of 1.0

Equation:

WMA 4 = (W) (D3) + (W) (D2) + (W) (D1)

WMA – Weighted moving average, W – Weight, D – Demand, No. –

Period

(see illustrative example – weighted moving average)

Exponential The exponential smoothing is an averaging method that reacts more
Smoothing strongly to recent changes in demand by assigning a smoothing
constant to the most recent data more strongly; useful if recent
changes in data are the results of actual change (e.g., seasonal
pattern) instead of just random fluctuations

F t + 1 = a D t + (1 - a ) F t

Where

F t + 1 = the forecast for the next period

D t = actual demand in the present period

F t = the previously determined forecast for the present period

• = a weighting factor referred to as the smoothing constant

(see illustrative example – exponential smoothing)

Time Series The time series decomposition adjusts the seasonality by
Decomposition multiplying the normal forecast by a seasonal factor
(see illustrative example – time series decomposition)