PLANNING DEMAND AND

SUPPLY IN A SUPPLY CHAIN

THE ROLE OF FORECASTING IN
A SUPPLY CHAIN
• Consider the push/pull view of the supply chain
discussed in Part - 1.
• All push processes in the supply chain are
performed in anticipation of customer demand,
whereas all pull processes are performed in
response to customer demand.
• For push processes, a manager must plan the
level of activity, be it production, transportation,
or any other planned activity.
Cont…
For pull processes, a-manager must plan the level
of available capacity and inventory but not - the
actual amount to be executed.
In both instances, the first step a manager must
take is to forecast what customer demand will be.
• When each stage in the supply chain makes its
own separate forecast, these forecasts are often
very different.
• The result is a mismatch between supply and
demand.
Cont…
• When all stages of a supply chain work together
to produce a collaborative forecast, it tends to be
much more accurate.
• The resulting forecast accuracy enables supply
chains to be both more responsive and more
efficient in serving their customers.
• Leaders in many supply chains, from PC
manufacturers to packaged-goods retailers, have
improved their ability to match supply and
demand by moving toward collaborative
forecasting.
Cont….
• For example, consider the value of collaborative
forecasting for Coca-Cola and its bottlers.
• Coca-Cola decides on the timing of various
promotions based on the demand forecast over the
coming quarter.
• Promotion decisions are then incorporated into an
updated demand forecast.
• The updated forecast is essential for the bottlers to
plan their capacity and production decisions.
• Mature products with stable demand, such as milk
or paper towels, are usually easiest to forecast.
Cont…..
• Forecasting and the accompanying managerial
decisions are extremely difficult when either the
supply of raw materials or the demand for the
finished product is highly unpredictable.
• Fashion goods and many high-tech products are
examples of items that are difficult to forecast.
• Good forecasting is very important in these cases
because the time window for sales is narrow.
• If a firm has over- or under - produced, it has little
chance to recover.
• For a product with stable demand, in contrast, the
impact of a forecasting error is less significant.
CHARACTERISTICS OF FORECASTS
Companies and supply chain managers should be
aware of the following characteristics of forecasts.
1.Forecasts are always wrong 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; that is, long-term forecasts
have a larger standard deviation of error relative
to the mean than short-term forecasts.
Cont…..
3. Aggregate forecasts are usually more
accurate than disaggregate forecasts, as they
tend to have a smaller standard deviation of
error relative to the mean.
4. In general, the farther up the supply chain a
company is (or the farther it is from the
consumer), the greater is the distortion of
information it receives.
As a result, the farther up the supply chain an
enterprise is, the larger is the forecast error.
COMPONENTS OF A FORECAST
AND FORECASTING METHODS
• One may be tempted to treat demand
forecasting as magic or art and leave
everything to chance.
• What a firm knows about its customers' past
behavior, however, sheds light on their future
behavior.
• Demand does not arise in a vacuum.
Cont….
• Rather, customer demand is influenced by a
variety of factors and can be predicted, at
least with some probability, if a company can
determine the relationship between these
factors and future demand.
• To forecast demand, companies must:
o first identify the factors that influence
future demand and
o then ascertain the relationship between
these factors and future demand.
Cont….
• Companies must balance objective and subjective
factors when forecasting demand.
• Although we focus on quantitative forecasting
methods in this chapter, companies must include
human input when they make their final forecast.
• Seven-Eleven Japan provides its store managers
with a state-of-the-art decision support system
that makes a demand forecast and provides a
recommended order.
Cont…..
• A company must be knowledgeable about
numerous factors that are related to the
demand forecast.
• Some of these factors are listed next:
o Past demand
o Lead time of product
o Planned advertising or marketing efforts
o State of the economy
o Planned price discounts
o Actions that competitors have taken
Types of Forecasting methods
Forecasting methods are classified according to the
following two types:
1. Qualitative: Qualitative forecasting methods are
primarily subjective and rely on human judgment.
•They are most appropriate when little historical
data is available or when experts have market
intelligence that may affect the forecast.
•Such methods may also be necessary to forecast
demand several years into the future in a new
industry.
Qualitative of Forecasting methods
1. Grass Roots: drive a forecast by compiling input
from those at the end of the hierarchy of the
organization who deal with what is being forecasted.
This is done by adding successively forecasts from
the bottom.
For instance, combining inputs from each
salesperson, who is closest to his/her own territory,
may derive an overall sales forecast.
Cont…
2. Market Research - When market research
technique is adopted data is collected in various
ways (interviews, etc) to test hypothesis about the
market.
This is used to ascertain value perceived quality
and demand.
This is typically used to forecast long-range and
new product sales.
3. Historical Analogy - This method ties the
forecast of one item to the forecast of a similar
item.
It is important in planning new products where a
forecast may be derived by using the history of a
similar product.
Cont...
4. Panel Consensus - are developed through open
meetings with free exchange of ideas from all levels of
management and individuals with the belief that
people from different positions can develop a more
reliable forecast than a small group.
The difficulty with this open discussion is that higher
levels of management may intimidate lower
employee levels.
For example, a salesperson in a particular product
line may have a good estimate of future product
demand but may not have the courage to refute a
much different estimate given by the vice president
of marketing.
Cont…
A statement or opinion of higher-level person will
likely be weighted more than that of a lower -
level person.
5. Delphi Method - Delphi method conceals the
identity of the individuals participating in the
study.
This method eliminates the undesirable effects of
interaction between members of the participants
because experts need not to meet - face - to - face
or need they know who the other expertise are.
Delphi method proceeds through a series of rounds
such as the following:
1.Experts of variety of knowledge are chosen to
participate.
2.All participants in the panel provide a written
response to the questions asked through a
questionnaire (or E-mail)
3.Results are summarized along with statistics on the
mean, median, inter–quartile, range and standard
deviation and distributed to the participants along
with appropriate new questions. Here, each member
in the panel is asked to reconsider his/her previous
answers and to respond once again to the questions.
Cont…
4. Results are summarized again, refining forecasts
and conditions, and new questions are developed
again.
5. The procedure is repeated for a reasonable
number of rounds (a minimum of three) until
sufficient convergence is achieved. The estimates
from the last round are then used as the forecasts.
2. Quantitative
1. Time series
Time-series forecasting methods use historical
demand to make a forecast.
They are based on the assumption that past
demand history is a good indicator of future
demand.
These methods are most appropriate when the
basic demand pattern does not vary significantly
from one year to the next.
These are the simplest methods to implement and
can serve as a good starting point for a demand
forecast.
Cont….
2. Causal:
• Causal forecasting methods assume that the
demand forecast is highly correlated with certain
factors in the environment (the state of the
economy, interest rates, etc.).
• Causal forecasting methods find this correlation
between demand and environmental factors and
use estimates of what environmental factors will
be to forecast future demand.
• For example, product pricing is strongly
correlated with demand.
Cont….
3. Simulation:
 Simulation forecasting methods imitate the
consumer choices that give rise to demand to
arrive at a forecast.
 Using simulation, a firm can combine time-
series and causal methods to answer such
questions as:
o What will be the impact of a price promotion?
o What will be the impact of a competitor
opening a store nearby on customer buying
behavior ?
Cont….
• A company may find it difficult to decide which
method is most appropriate for forecasting.
• In fact, several studies have indicated that using
multiple forecasting methods to create a
combined forecast is more effective than using
any one method alone.
• In this chapter we deal primarily with time-series
methods, which are most appropriate when future
demand is related to historical demand, growth
patterns, and any seasonal patterns.
Cont….
With any forecasting method, there is always a
random element that cannot be explained by
historical demand patterns.
Therefore, any observed demand can be broken
down into a systematic and a random
component:
Observed demand ( 0) = Systematic component
(S) + Random component (R)
Cont….
The systematic component measures the
expected value of demand and consists of what we
will call
level, the current deseasonalized demand;
trend, the rate of growth or decline in demand
for the next period; and
seasonality, the predictable seasonal
fluctuations in demand.
Cont….
• The random component is that part of the
forecast that deviates from the systematic part.
• A company cannot forecast the direction of the
random component.
• All a company can predict is the random
component's size and variability, which provides a
measure of forecast error.
• On average, a good forecasting method has an
error whose size is comparable to the random
component of demand.
Cont….
• A manager should be skeptical of a forecasting
method that claims to have no forecasting error on
historical demand.
• In this case, the method has merged the historical
random component with the systematic component.
• As a result, the forecasting method will likely
perform poorly.
• The objective of forecasting is to filter out the
random component (noise) and estimate the
systematic component.
• The forecast error measures the difference between
the forecast and actual demand.
BASIC APPROACH TO DEMAND
FORECASTING
The following basic, six-step approach helps an
organization perform effective forecasting.
1.Understand the objective of forecasting.
2. Integrate demand planning and forecasting
throughout the supply chain.
3. Understand and identify customer segments.
4. Identify the major factors that influence the
demand forecast.
5. Determine the appropriate forecasting technique.
6. Establish performance and error measures for the
forecast.
1. UNDERSTAND THE OBJECTIVE OF
FORECASTING
• Every forecast supports decisions that are based on
the forecast, so an important first step is to identify
these decisions clearly.
• Examples of such decisions include how much of a
particular product to make, how much to inventory,
and how much to order.
• All parties affected by a supply chain decision
should be aware of the link between the decision
and the forecast.
2. INTEGRATE DEMAND PLANNING
AND FORECASTING THROUGHOUT
THE SUPPLY CHAIN
• A company should link its forecast to all planning
activities throughout the supply chain.
• These include capacity planning, production
planning, promotion planning, and purchasing,
among others.
• This link should exist at both the information
system and the human resources management
level.
3. UNDERSTAND AND IDENTIFY
CUSTOMER SEGMENTS
• A firm must identify the customer segments the
supply chain serves.
• Customers may be grouped by similarities in
service requirements, demand volumes, order
frequency, demand volatility, seasonality, and so
forth.
• In general, companies may use different
forecasting methods for different segments.
• A clear understanding of the customer segments
facilitates an accurate and simplified approach to
forecasting.
4. IDENTIFY MAJOR FACTORS THAT
INFLUENCE THE DEMAND FORECAST
• Next, a firm must identify demand, supply, and
product-related phenomena that influence the
demand forecast.
• On the demand side, a company must ascertain
whether demand is growing, declining, or has a
seasonal pattern.
• These estimates must be based on demand-not sales
data. For example, a supermarket promoted a certain
brand of cereal in July 2005.
• As a result, the demand for this cereal was high while
the demand for other, comparable cereal brands was
low in July.
5. DETERMINE THE APPROPRIATE
FORECASTING TECHNIQUE
• In selecting an appropriate forecasting technique, a
company should first understand the dimensions that
are relevant to the forecast.
• These dimensions include geographic area, product
groups, and customer groups.
• The company should understand the differences in
demand along each dimension and will likely want
different forecasts and techniques for each dimension.
• At this stage, a firm selects an appropriate forecasting
method.
• As mentioned earlier, using a combination of these
methods is often most effective.
6. ESTABLISH PERFORMANCE AND
ERROR MEASURES FOR THE
FORECAST
• Companies should establish clear performance
measures to evaluate the accuracy and timeliness
of the forecast.
• These measures should be highly correlated with
the objectives of the business decisions based on
these forecasts.
• For example, consider a mail-order company that
uses a forecast to place orders with its suppliers
up the supply chain.
• Suppliers take two months (lead time) to send in
the orders.