Chapter 15

Demand Management and Forecasting

McGraw-Hill/Irwin Copyright © 2011 The McGraw-Hill Companies, All Rights Reserved

Learning Objectives

1. Understand the role of forecasting as a basis for

supply chain planning.
2. Compare the differences between independent and
dependent demand.
3. Identify the basic components of independent
demand: average, trend, seasonal, and random
variation.
4. Describe the common qualitative forecasting
techniques such as the Delphi method and
Collaborative Forecasting.
5. Show how to make a time series forecast using
regression, moving averages, and exponential
smoothing.
6. Use decomposition to forecast when trend and
seasonality is present.

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 Demand Management

• Strategic forecasts: forecasts used to help

set the strategy of how demand will be met
• Tactical forecasts: forecasted needed for
how a firm operates processes on a day-to-
day basis
• The purpose of demand management is to
coordinate and control all sources of demand
• Two basic sources of demand
– Dependent demand: the demand for a product or
service caused by the demand for other products or
services
– Independent demand: the demand for a product
or service that cannot be derived directly from that
of other products
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 Demand Management Continued

• Not much a firm can do about

dependent demand
– It is demand that must be met
• There is a lot a firm can do about
independent demand
1. Take an active role to influence demand
2. Take a passive role and respond to
demand

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 Types of Forecasts

• Four basic types

1. Qualitative
2. Time series analysis
3. Causal relationships
4. Simulation
• Time series analysis is based on the
idea that data relating to past demand
can be used to predict future demand
– Primary focus of this chapter

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 Components of Demand

1. Average demand for a period of time

2. Trend
3. Seasonal element
4. Cyclical elements
5. Random variation
6. Autocorrelation

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 Linear Regression Analysis

• Regression: functional relationship between

two or more correlated variables
• It is used to predict one variable given the
other
• Y = a + bX
– Y is the value of the dependent variable
– a is the Y intercept
– b is the slope
– X is the independent variable
• Assumes data falls in a straight line

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 Decomposition of a Time Series

• Time series: chronologically ordered

data that may contain one or more
components of demand
• Decomposition: identifying and
separating the time series data into
these components
• Seasonal variation
– Additive: the seasonal amount is constant
– Multiplicative: the seasonal variation is a
percentage of demand

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 Decomposition Using Least
Squares Regression

1. Determine the seasonal factor

2. Deseasonalize the original data
3. Develop a least squares regression
line for the deseasonalized data
4. Project the regression line through the
period of the forecast
5. Create the final forecast by adjusting
the regression line by the seasonal
factor
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 Simple Moving Average

• Useful when demand is neither growing

nor declining rapidly and does not have
seasonal characteristics
• Moving averages can be centered or
used to predict the following period
• Important to select the best period
– Longer gives more smoothing
– Shorter reacts quicker to trends

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 Weighted Moving Average

• The moving average formula implies an

equal weight being placed on each
value that is being averaged
• The weighted moving average permits
an unequal weighting on prior time
periods
– All the weights must sum to one

Ft = w 1 A t -1 + w 2 A t - 2 + w 3 A t -3 + ...+ w n A t- n

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 Exponential Smoothing

• Most used of all forecasting techniques

• Integral part of all computerized forecasting
programs
• Widely used in retail and service
• Widely accepted because…
1. Exponential models are surprisingly accurate
2. Formulating an exponential model is relatively
easy
3. The user can understand how the model works
4. Little computation is required to use the model
5. Computer storage requirements are small
6. Tests for accuracy are easy to compute
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 Trend Effects in Exponential
Smoothing

• An trend in data causes the exponential forecast to

always lag the actual data
– Can be corrected by adding in a trend adjustment
• To correct need two constants: alpha and beta
FITt  Ft  Tt
Ft  FITt 1    At 1  FITt 1 
Tt  Tt 1   Ft  FITt 1 

Ft  The exponentia lly smoothed forecast for period t

Tt  The exponentia lly smoothed trend for period t
FITt  The forecast including trend for period t
FITt -1  The forecast including trend made for the prior period
A t -1  The actual demand for the prior period
  Smoothing constant
  Smoothing constant
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 Forecast Error

• Bias errors: when a consistent mistake

is made
• Random errors: errors that cannot be
explained by the forecast model being
used
• Measures of error
– Mean absolute deviation (MAD)
– Mean absolute percent error (MAPE)
– Tracking signal

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 Tracking Signal

• The tracking signal (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

RSFE Running sum of forecast errors

TS = =
MAD Mean absolute deviation
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