Chapter 6: Supply and Demand

Management

Assoc. Prof. Nguyen Phuc

Nguyen, Ph.D
 Responding to Predictable
Variability in a Supply Chain
Supply chain management- [Link]. Nguyen Phuc Nguyen

➢ Predictable variability is change in demand that can

be forecasted
➢ Can cause increased costs and decreased
responsiveness in the supply chain
➢ A firm can handle predictable variability using two
broad approaches:
➢ Manage supply using capacity, inventory, subcontracting,
and backlogs
➢ Manage demand using short-term price discounts and trade
promotions
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 Demand forecast
Supply chain management- [Link]. Nguyen Phuc Nguyen

➢ Qualitative forecasting is based on opinion &

intuition.
➢ Quantitative forecasting uses mathematical
models & historical data to make forecasts.
➢ Time series models are the most frequently used
among all the forecasting models.

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 Demand forecast
Supply chain management- [Link]. Nguyen Phuc Nguyen

➢ Qualitative Forecasting Methods

Generally used when data are limited, unavailable, or
not currently relevant. Forecast depends on skill &
experience of forecaster(s) & available information

➢ Four qualitative models used are –

1. Jury of executive opinion
2. Delphi method
3. Sales force composite
4. Consumer survey
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 Demand forecast (Continued)
Supply chain management- [Link]. Nguyen Phuc Nguyen

➢ Jury of executive opinion

Group of senior management executives who are
knowledgeable about their markets, competitors, and
the business environment collectively develop the
forecast
➢ Delphi method
Group of internal and external experts are surveyed
during several rounds in terms of future events and
long-term forecasts of demand, to develop a forecast

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 Demand forecast (Continued)
Supply chain management- [Link]. Nguyen Phuc Nguyen

➢ Sales force composite

Forecast is based on the sales force’s knowledge of
the market and estimates of customer needs.
➢ Consumer survey
Forecasts are developed from the results surveying
customers on future purchasing needs, new product
ideas and opinions about existing or new products

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 Time Series Forecasting Models
Supply chain management- [Link]. Nguyen Phuc Nguyen

➢ Naïve Forecast: The estimate of the next period is

equal to the demand in the past period.
Ft+1 = At
Where Ft+1 = forecast for period t+1
At = actual demand for period t
➢ Simple Moving Average Forecast – uses historical
data to generate a forecast. Works well when
demand is stable over time.

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Supply chain management- [Link]. Nguyen Phuc Nguyen

Simple Moving Average

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 Weighted Moving Average Forecast
Supply chain management- [Link]. Nguyen Phuc Nguyen

➢ Weighted Moving Average Forecast – is based

on an n-period weighted moving average

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Supply chain management- [Link]. Nguyen Phuc Nguyen

Weighted Moving Average Forecast

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 Exponential Smoothing Forecast Forecast
Supply chain management- [Link]. Nguyen Phuc Nguyen

➢ Exponential Smoothing Forecast – a type of

weighted moving average where only two data
points are needed
Ft+1 = Ft+(At - Ft) or Ft+1 = At + (1 – ) Ft
Where Ft+1 = forecast for Period t + 1
Ft = forecast for Period t
At = actual demand for Period t
 = smoothing constant (0 ≤  ≤1)

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Supply chain management- [Link]. Nguyen Phuc Nguyen

Exponential Smoothing Forecast Forecast

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 Linear Trend Forecast
Supply chain management- [Link]. Nguyen Phuc Nguyen

➢ Linear Trend Forecast – trend can be

estimated using simple linear regression to fit a
line to a time series.
Ŷ = b0 + b1x
Where Ŷ = forecast or dependent variable
x = time variable
b0 = intercept of the line
b1 = slope of the line

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Supply chain management- [Link]. Nguyen Phuc Nguyen

Linear Trend Forecast

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 Multiple regression Forecast
Supply chain management- [Link]. Nguyen Phuc Nguyen

➢ Multiple regression – several

explanatory variables are used to make
the forecast.
Ŷ = b0 + b1x1 + b2x2 + . . . Bkxk
Where
Ŷ = forecast or dependent variable
xk = kth explanatory or independent
variable
b0 = intercept of the line
bk = regression coefficient of the
independent variable xk
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 Forecast Accuracy
Supply chain management- [Link]. Nguyen Phuc Nguyen

➢ Forecast error, the difference between actual

quantity & the forecast,
Forecast error, et = At - Ft
Whereet = forecast error for Period t
At = actual demand for Period t
Ft = forecast for Period t
➢ Several measures of forecasting accuracy follow
✓ Mean absolute deviation (MAD)- a MAD of 0 indicates the
forecast exactly predicted demand
✓ Mean absolute percentage error (MAPE)- provides a
perspective of the true magnitude of the forecast error
✓ Mean squared error (MSE)- analogous to variance, large
forecast errors are heavily penalized 16
 Forecast Accuracy (cont.)
Supply chain management- [Link]. Nguyen Phuc Nguyen

➢ Mean absolute deviation (MAD)

➢ Mean absolute percentage error (MAPE)

➢ Mean squared error (MSE)

Where et = forecast error for period t

At = actual demand for period t
n = number of periods of evaluation 17
 Forecast Accuracy (cont.)
Supply chain management- [Link]. Nguyen Phuc Nguyen

➢ Running Sum of Forecast Errors (RSFE) – indicates

bias in the forecasts or the tendency of a forecast to
be consistently higher or lower than actual demand.
n

Running Sum of Forecast Errors, RSFE = e

t =1
t

➢ Tracking signal: determines if forecast is within acceptable

control limits. If the tracking signal falls outside the pre-set control
limits, there is a bias problem with the forecasting method and an
evaluation of the way forecasts are generated is warranted.
RSFE
Tracking Signal =
MAD
Where et = forecast error for period t 18
 Managing supply
Supply chain management- [Link]. Nguyen Phuc Nguyen

➢ Supply chains can influence demand by using

pricing and other forms of promotion. The goal here
is to move demand from the peak period to the off-
peak period.
➢ The increase in demand results from a combination
of the following three factors
➢ Market growth: An increase in consumption of the product
occurs from either new or existing customers.
➢ Stealing share: Customers substitute the firm’s product for a
competitor’s product.
➢ Forward buying: Customers move up future purchases to
the present.
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 Managing supply
Supply chain management- [Link]. Nguyen Phuc Nguyen

➢ Managing capacity
✓ Time flexibility from workforce
✓ Use of seasonal workforce
✓ Use of subcontracting
✓ Use of dual facilities – dedicated and flexible
✓ Designing product flexibility into production processes
➢ Managing inventory
✓ Using common components across multiple products
✓ Building inventory of high demand or predictable demand
products

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 Managing supply
Supply chain management- [Link]. Nguyen Phuc Nguyen

➢ Inventory/Capacity Trade-off
✓ Leveling capacity forces inventory to build up in
anticipation of seasonal variation in demand
✓ Carrying low levels of inventory requires capacity
to vary with seasonal variation in demand or
enough capacity to cover peak demand during
season

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 Demand Management
Supply chain management- [Link]. Nguyen Phuc Nguyen

➢ Supply chains can influence demand by using

pricing and other forms of promotion. The goal here
is to move demand from the peak period to the off-
peak period.
➢ The increase in demand results from a combination
of the following three factors
➢ Market growth: An increase in consumption of the product
occurs from either new or existing customers.
➢ Stealing share: Customers substitute the firm’s product for a
competitor’s product.
➢ Forward buying: Customers move up future purchases to
the present.
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 Demand Management
Supply chain management- [Link]. Nguyen Phuc Nguyen

➢ Factors influencing the timing of a promotion

➢ Impact of the promotion on demand
➢ Cost of holding inventory
➢ Cost of changing the level of capacity
➢ Product margins
➢ If a promotion primarily results in forward buying,
it is best to use promotions to reduce the
seasonal peak by offering a price discount
during low-demand periods.

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 Demand Management
Supply chain management- [Link]. Nguyen Phuc Nguyen

➢ Pricing and aggregate planning must be done

jointly
➢ Factors affecting discount timing
✓ Product margin: Impact of higher margin ($40 instead of $31)
✓ Consumption: Changing fraction of increase coming from
forward buy (100% increase in consumption instead of 10%
increase)
✓ Forward buy

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 Demand Management
Supply chain management- [Link]. Nguyen Phuc Nguyen

➢ Red Tomato case:

✓ Red Tomato sells each tool through retailers for $40. It has a starting
inventory in January of 1,000 tools. At the beginning of January, the
company has a workforce of 80 employees.
✓ The plant has a total of 20 working days in each month, and each
employee earns $4 per hour regular time. Each employee works 8
hours/day on straight time and the rest on overtime. The capacity of the
production operation is determined by total labor hours worked. Machine
capacity does not limit the capacity of the production operation. No
employee works more than 10 hours of overtime per month.
✓ The supply chain manager’s goal is to obtain the optimal aggregate plan
that allows Red Tomato to end June with at least 500 units (i.e., no
stockouts at the end of June and at least 500 units in inventory). 9-25
Supply chain management- [Link]. Nguyen Phuc Nguyen

Red Tomato case (cont.)

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 Red Tomato case- Objective function
Supply chain management- [Link]. Nguyen Phuc Nguyen

➢ Regular-time labor cost. Workers are paid a regular-time

wage of $640 ($4/hour * 8 hours/day * 20 days/month)
per month. Because Wt is the number of workers in
Period t, the regular-time labor cost over the planning
horizon is given by
➢ Overtime labor cost. As overtime labor cost is $6 per
hour and Ot represents the number of overtime hours
worked in Period t, the overtime cost over the planning
horizon is

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 Red Tomato case- Objective function
Supply chain management- [Link]. Nguyen Phuc Nguyen

➢ Cost of hiring and layoffs. The cost of hiring a worker is

$300 and the cost of laying off a worker is $500. Ht and
Lt represent the number hired and the number laid off,
respectively, in Period t. Thus, the cost of hiring and
layoff is given by
➢ Cost of materials and subcontracting. The material cost
is $10 per unit and the subcontracting cost is $30/unit. Pt
represents the quantity produced and Ct represents the
quantity subcontracted in Period t. Thus, the material
and subcontracting cost is
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 Red Tomato case- Objective function
Supply chain management- [Link]. Nguyen Phuc Nguyen

➢ The Total cost. The total cost incurred during the

planning horizon is the sum of all the aforementioned
costs and is given by

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 Red Tomato case- Constraints
Supply chain management- [Link]. Nguyen Phuc Nguyen

➢ Workforce, hiring, and layoff constraints. The workforce

size Wt in Period t is obtained by adding the number
hired Ht in Period t to the workforce size Wt-1 in Period
t-1, and subtracting the number laid off Lt in Period t as:

The starting workforce size is given by W0 = 80.

➢ Capacity constraints. Each worker can produce 40 units
per month on regular time and one unit for every four
hours of overtime

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 Red Tomato case- Constraints
Supply chain management- [Link]. Nguyen Phuc Nguyen

➢ Inventory balance constraints. Net demand for Period t is

obtained as the sum of the current demand Dt and the
previous backlog St-1.

The starting inventory is given by I0 = 1,000, the ending

inventory must be at least 500 units (i.e., I6>=500), and
initially there are no backlogs (i.e., S0 = 0).
➢ Overtime limit constraints. No employee work more than
10 hours of overtime each month

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Supply chain management- [Link]. Nguyen Phuc Nguyen

Red Tomato case- Result

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 Red Tomato case- Results
Supply chain management- [Link]. Nguyen Phuc Nguyen

➢ The average seasonal inventory during the planning

horizon

➢ The average flow time for this aggregate plan over the
planning horizon

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Supply chain management- [Link]. Nguyen Phuc Nguyen

Higher demand variability

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Demand Management (cont.)
Supply chain management- [Link]. Nguyen Phuc Nguyen

Higher demand variability (cont.)

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 Higher demand variability (cont.)
Supply chain management- [Link]. Nguyen Phuc Nguyen

➢ The average seasonal inventory during the planning

horizon

➢ The average flow time for this aggregate plan over the
planning horizon

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 Demand Management (cont.)
Supply chain management- [Link]. Nguyen Phuc Nguyen

Impact of Lower Costs of Hiring and Layoff

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Supply chain management- [Link]. Nguyen Phuc Nguyen

and Layoff
Impact of Lower Costs of Hiring

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 Higher demand variability (cont.)
Supply chain management- [Link]. Nguyen Phuc Nguyen

➢ The average seasonal inventory during the planning

horizon

➢ The average flow time for this aggregate plan over the
planning horizon

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 Demand Management (cont.)
Supply chain management- [Link]. Nguyen Phuc Nguyen

Off-Peak (January) Discount from $40 to $39

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 Off-Peak (January) Discount
from $40 to $39
Supply chain management- [Link]. Nguyen Phuc Nguyen

Cost = $422,080; Revenue = $643,400; Profit = $221,320

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 Demand Management (cont.)
Supply chain management- [Link]. Nguyen Phuc Nguyen

Peak (April) Discount from $40 to $39

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 Peak (April) Discount from $40 to $39
Supply chain management- [Link]. Nguyen Phuc Nguyen

Cost = $438,920; Revenue = $650,140; Profit = $211,220

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 Demand Management (cont.)
Supply chain management- [Link]. Nguyen Phuc Nguyen

January Discount: 100% Increase in

Consumption, Sale Price = $40 ($39)

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 January Discount campaign: 100% Increase
in Consumption, Sale Price = $40 ($39)
Supply chain management- [Link]. Nguyen Phuc Nguyen

Cost = $456,880; Revenue = $699,560; Profit = $242,680

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 Demand Management (cont.)
Supply chain management- [Link]. Nguyen Phuc Nguyen

Peak (April) Discount campaign: 100% Increase

in Consumption, Sale Price = $40 ($39)

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 Peak (April) Discount campaign: 100% Increase
in Consumption, Sale Price = $40 ($39)
Supply chain management- [Link]. Nguyen Phuc Nguyen

Cost = $536,200; Revenue = $783,520; Profit = $247,320

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Supply chain management- [Link]. Nguyen Phuc Nguyen

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Performance Under Different Scenarios
Supply chain management- [Link]. Nguyen Phuc Nguyen

Factors Affecting Promotion Timing

 Balance supply and demand
Supply chain management- [Link]. Nguyen Phuc Nguyen

➢ Factors Influencing Discount Timing

✓ Impact of discount on consumption
✓ Impact of discount on forward buy
✓ Product margin
➢ Implementing Solutions to Predictable Variability in
Practice
✓ Coordinate planning across enterprises in the supply chain
✓ Take predictable variability into account when making
strategic decisions
✓ Preempt, do not just react to, predictable variability

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