DEMAND FORECASTING

Demand Forecasting
Prediction of future demand for a firms product or products are called demand forecasts. We can define, Demand Forecasting as the scientific and analytical estimation of demand for a product (good or service) for a particular period of time.

Why Forecast? Lead times require that decisions be made in advance of uncertain events. Forecasting is an important for all strategic and planning decisions in a supply chain. Forecasts of product demand, materials, labor, financing are an important inputs to scheduling, acquiring resources, and determining resource requirements.
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Forecasting Horizons
Short Term (0 to 3 months): for inventory management and scheduling. Medium Term (3 months to 2 years): for production planning, purchasing, and distribution. Long Term (2 years and more): for capacity planning, facility location, and strategic planning.
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Categorisation by level of forecasting

Firm level Industry level Economy level

Techniques or methods of forcasting demandMethods of forecasting demand for established goodsThere are two basic methods of forecasting demand for established goods i. Interview and Survey Approach(short period forecasts) ii. Projection Approach (long period forecasts)

Interview and Survey Approach (short period forecasts) Opinion-polling Collective opinion Experts Opinion Method 1. Group Discussion 2. Delphi method Market Simulation Test Marketing

Consumers Opinion Survey

In consumers opinion survey buyers are asked about their future buying intentions of products. Merits: Simple to administer and comprehend. The results obtained are realistic Suitable for short term decisions regarding product and promotion.
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Demerits: Surveying is often an expensive proposition both in terms of resources and time. This method is unsuitable for long term forecasting. Buyers may not often divulge their real buying intentions and may even give incorrect responses. Investigators bias regarding choice of sample and questions cannot be fully eliminated.

Sales Force Composite

Salespersons are in direct contact with the customers and hence are in a better position to forecast demand for any product. Merits This method is simple to administer. It is very cost effective. Such estimated figures are more reliable.
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Demerits: The results may be conditioned by the bias of optimism (or pessimism) of salespersons. Salespersons may be unaware of the economic environment of the business. This method is ideal for short term.

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Experts Opinion Method

(1) Group Discussion- Experts meet as a group to find out future demand level. Decisions may be taken with the help of brainstorming sessions or by structured discussions.

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(2) Delphi Technique- This technique is considered to be superior to conventional brainstorming session, as the latter may be dominated by views of some of the experts. Delphi is a way of getting the opinion of experts without their face to face interaction.

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Merits Decisions are enriched with the experince of competent experts. The firm need not spend time and resources in collection of data by survey. Very useful when the product is absolutely new to all the markets.

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Demerits This technique relies more on the experts than on available data, and may thus involve some amount of bias. In case external experts are invited for opinion, the firm may be exposed to the risk of loss of confidential information.

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Market Simulation
It is like laboratory testing of consumer behaviour. Firms may create an artificial market, in which the consumers are instructed to shop with some money. MeritMarket experiments often provide useful information on consumer behaviour regarding a proposed change in any of the determinants of demand.
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Demerits Experiments may take considerable amount of time and money to be conducted. People behave differently when they are being observed hence their behaviour may not be very reliable.

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Test Marketing
In test marketing the product is actually sold in certain segments of the market, regarded as test market. MeritIt is the most reliable among qualitative methods as it is based on real sales proceeds.

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Demerits Test marketing is very costly. It is time consuming to observe the actual buying pattern of consumers. Especially in a country like India, which has widely varying markets across its geographical regions, a product that may perform well in one region may not perform equally well in other market.

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Projection Approach (long period forecasts) Time Series analysis Regression analysis

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Time Series Analysis

Arrangement of statistical data in chronological order i.e., in accordance with occurrence of time, is known as Time Series. Hourly temperature reading, daily sales, monthly production are examples of time series. Number of factors affect the observations of time series continuously, some with equal intervals of time and others are erratic studying, interpreting analyzing the factors is called Analysis of Time Series.

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Components of Time series: Secular Trend or Long - Term movement or simply Trend Seasonal Variation Cyclical Variations Irregular or erratic or random movements (fluctuations)

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Secular Trend: It is a long term movement in Time series. The general tendency of the time series is to increase or decrease or stagnate during a long period of time is called the secular trend or simply trend. Population growth, improved technological progress, changes in consumers taste are the various factors of upward trend. We may notice downward trend relating to deaths, epidemics, due to improved medical facilities and sanitations.

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Methods of Measuring Trend: Trend is measured by the following mathematical methods. 1. Graphical method 2. Method of Semi-averages 3. Method of moving averages 4. Method of Least Squares

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Graphical Method:

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Method of semi averages: In this method, the given data is divided into two parts, preferably with the same number of years. In case of odd number of years like 5,7,9,11 etc, two equal parts can be made simply by omitting the middle year. After the data have been divided into two parts, an average of each parts is obtained.

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METHOD OF SEMI-AVERAGES
Estimate value for 2000. If the actual sales figures is 35000 units, how do you account for the difference between the figures obtained?

Years Sales

1993 1994 1995 1996 1997 1998 20 24 22 30 28 32

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Year 1993 1994 1995 1996 1997 1998

Sales (000s) 20 24 22 30 28 32

3 yearly semi-total

Semi-average

(30-22) = 8 8/3 = 2.667

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22

90

30

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Year 1993 1994 1995 1996 1997 1998 1999 2000

Trend Values (000s) 22 2.667 19.333 22 22 22 + 2.667 24.667 30 - 2.667 27.333 30 30 30 + 2.667 32.667 32.667 + 2.667 35.334 35.334 + 2.667 38

The difference is because of the assumption that there is a linear relationship between the given time series values. Moreover, the effects of seasonal, cyclical and irregular variations have been completely neglected.

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SEMI-AVERAGES METHOD

ORIGINAL DATA TREND LINE

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Method of Moving Averages: This method is very simple. It is based on Arithmetic mean. Theses means are calculated from overlapping groups of successive time series data. Each moving average is based on values covering a fixed time interval, called period of moving average and is shown against the center of the interval.

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Method of Least Square: This method is widely used. It plays an important role in finding the trend values of economic and business time series. It helps for forecasting and predicting the future values. The trend line by this method is called the line of best fit.

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The equation of the trend line is y = a + bx, where the constants a and b are to be estimated so as to minimize the sum of the squares of the difference between the given values of y and the estimate values of y by using the equation. The constants can be obtained by solving two normal equations. y = na + bx . (1) xy = ax + bx2 (2) Here x represent time point and y are observed values. n is the number of pair- values.
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Fit a linear trend from the following data. Estimate the production for the year 1999.
Year 1990 1992 1994 1996 1998

Production

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21

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27

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ANSWER: Let us consider the year 1994 to be the mid point (It would be nice to take this as the mid point as there are odd number of years).

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Year Prodn 1990 1992 1994 1996 1998 18 21 23 27 16 105

x -4 -2 0 2 4

x2 16 4 0 4 16 40

xy -72 -42 0 54 64 4

Trend Values (y-ye) 20.6 20.8 21 21.2 21.4 -2.6 0.2 2 5.8 -5.4 0
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Fitting of Linear Trend: y = a + b x To find a & b: y = n a + b x xy = a x + b x2 4 = a*0 + b*40 b = 0.1

105 = a*5 + b*0 a = 21

Therefore the equation will be given by: y = 21 + 0.1x Estimated production of 1999: y = 21 + 0.1*5 y=21.5 thousands of units.

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Simple Linear Regression Linear regression analysis establishes a relationship between a dependent variable and one or more independent variables. In simple linear regression analysis there is only one independent variable. If the data is a time series, the independent variable is the time period. The dependent variable is whatever we wish to forecast.
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Regression line X on Y.
The regression line of X on Y is given by:X= a + b Y where, a & b are constants. Here, Y is the independent variable and X is dependent variable.

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Regression Equation Example

Week 1 2 3 4 5

Sales 150 157 162 166 177

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Develop a regression equation to predict sales based on these five points.

Linear Regression
y = a + bx
a = y-bx xy b = nxy where x2 a = intercept nx2 b = slope of the line x = x n y = mean of the x data = mean of the y data
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y = n

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 xy - n( y)(x) = 2499 - 5(162.4)(3) = 63 = 6.3 b= 55 5(9 ) 10 x2 - n(x )2
a = y - bx = 162.4 - (6.3)(3) = 143.5
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y = 143.5 + 6.3t
180 175 170 165 160 155 150 145 140 135 1 2 3 Period 4 5

Sales

Sales Forecast

What is the forecast for period 6?

143.5 + 6.3(6) = 181.3 47

Example: College Enrollment

Simple Linear Regression At a small regional college enrollments have grown steadily over the past six years, as evidenced below. Use time series regression to forecast the student enrollments for the next three years.

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Year 1 2 3

Enrolled (1000s) 2.5 2.8 2.9

Year 4 5 6

Enrolled 3.2 3.3 3.4

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Limitations Of Demand Forecasting

Change in Fashion Consumers Psychology Uneconomical Lack Of experts Lack Of past data

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