18–1

Chapter Eighteen
McGraw-Hill/Irwin Copyright © 2014 by The McGraw-Hill Companies, Inc. All rights reserved.
18–2
• LO18–1: Understand how forecasting is essential to
supply chain planning

• LO18–2: Evaluate demand using quantitative

forecasting models

• LO18–3: Apply qualitative techniques to forecast

demand

• LO18–4: Apply collaborative techniques to forecast

demand
18–3
• Forecasting is a vital function and affects every significant
management decision.
– Finance and accounting use forecasts as the basis for
budgeting and cost control.
– Marketing relies on forecasts to make key decisions such as
new product planning and personnel compensation.
– Production uses forecasts to select suppliers; determine
capacity requirements; and drive decisions about purchasing,
staffing, and inventory.

• Different roles require different forecasting approaches.

– Decisions about overall directions require strategic forecasts.
– Tactical forecasts are used to guide day-to-day decisions.

18–4
• Decoupling point: Point at which inventory is
stored, which allows SC to operate independently.

• The choice of the decoupling point in a SC is

strategic.

• Forecasting helps determine the level of inventory

needed at the decoupling points.

• The decision will be affected by the error produced

in the forecast and the type of product (easily
inventoried or easily perishable).
18–5
• There are four basic types of forecasts.
– Qualitative
– Time series analysis (primary focus of this
chapter)
– Causal relationships
– Simulation

• Time series analysis is based on the idea

that data relating to past demand can be
used to predict future demand.
18–6
 Average
demand for a Trend
period of time

Seasonal Cyclical
element elements

Random
Autocorrelation
variation Excel: Components
of Demand

For the Excel template visit

[Link]/sie-chase14e
18–7
• Identification of trend lines is a common
starting point when developing a forecast.
• Common trend types include linear, S-curve,
asymptotic, and exponential.

18–8
• Using the past to predict the future
Short term – forecasting less than 3 months

• Used mainly for tactical decisions

Medium term – forecasting 3 months to 2 years

• Used to develop a strategy that will be implemented over the

next 6 to 18 months (e.g., meeting demand)

Long term – forecasting greater than 2 years

• Useful for detecting general trends and identifying major

turning points

18–9
• Choosing an appropriate forecasting
model depends upon
– Time horizon to be forecast
– Data availability
– Accuracy required
– Size of forecasting budget
– Availability of qualified personnel

18–10
 Amount of Historical Forecast
Forecasting Method Data Pattern
Data Horizon
6 to 12 months; Stationary (i.e.,
Simple moving
weekly data are often no trend or Short
average
used seasonality)
Weighted moving
average and simple 5 to 10 observations
Stationary Short
exponential needed to start
smoothing
Exponential 5 to 10 observations Stationary,
smoothing with needed to start Seasonality Short
trend Trend
Stationary,
Short to
Linear regression 10 to 20 observations trend, and
medium
seasonality

18–11
• Forecast is the average of a fixed number of past
periods.

• Useful when demand is not growing or declining

rapidly and no seasonality is present.

• Removes some of the random fluctuation from

the data.

• Selecting the period length is important.

– Longer periods provide more smoothing.
– Shorter periods react to trends more quickly.
18–12
•

18–13
18-14
18–14
• The simple moving average formula implies
equal weighting for all periods.
• A weighted moving average allows unequal
weighting of prior time periods.
– The sum of the weights must be equal to one.
– Often, more recent periods are given higher
weights than periods farther in the past.

𝐹𝑡 = 𝑤1𝐴𝑡 − 1 + 𝑤2𝐴𝑡 − 2 + …+
𝑤𝑛𝐴𝑡 − 𝑛

18–15
• Experience and/or trial-and-error are the
simplest approaches.

• The recent past is often the best indicator

of the future, so weights are generally
higher for more recent data.

• If the data are seasonal, weights should

reflect this appropriately.

18–16
• A weighted average method that includes all
past data in the forecasting calculation

• More recent results weighted more heavily

• The most used of all forecasting techniques

• An integral part of computerized forecasting

18–17
• Well accepted for six reasons
– Exponential models are surprisingly accurate
– Formulating an exponential model is relatively
easy
– The user can understand how the model works
– Little computation is required to use the model
– Computer storage requirements are small
– Tests for accuracy are easy to compute

18–18
18-19
18–19
Week Demand Forecast
1 820 820
2 775 820
3 680 811
4 655 785
5 750 759
6 802 757
7 798 766
8 689 772
9 775 756
10 760

18-20
18–20
• Step 1: Compute the initial estimate of the
mean (or level)n of the series at time period t = 0
 yt
 0 = y = t =1
n
• Step 2: Compute the updated estimate by using
the smoothing equation

T =  yT + (1 −  ) T −1

where  is a smoothing constant between 0 and 1.

Slide 21
18–21
Note that

T =  yT + (1 −  ) T −1

=  yT + (1 −  )[ yT −1 + (1 −  ) T −2 ]
=  yT + (1 −  ) yT −1 + (1 −  )2 T −2

=  yT + (1 −  ) yT −1 + (1 −  )2 yT −2 + ... + (1 −  )T −1 y1 + (1 −  )T 0

The coefficients measuring the contributions of the
observations decrease exponentially over time.

Slide 22
18–22
• Point forecast made at time T for yT+p
yˆT + p (T ) = T ( p = 1, 2,3,...)
• SSE, MSE, and the standard errors at time T
T
SSE =  [ y t − yˆ t (t − 1)]2
t =1

SSE
MSE = , s = MSE
T −1
Note: There is no theoretical justification for dividing SSE by
(T – number of smoothing constants). However, we use this
divisor because it agrees to the computation of s in Box-Jenkins
models introduced later.

Slide 23
18–23
• The presence of a trend in the data causes the
exponential smoothing forecast to always lag behind
the actual data
• This can be corrected by adding a trend adjustment
– The trend smoothing constant is delta (δ)

18–24
• Calculate the new forecast, assuming the
following:
– The previous forecast including trend (FITt-1) is 110
and the previous estimate of the trend (Tt-1) is 10
– α = 0.2 and δ = 0.3
– Actual demand for period t-1 is 115

Ft = Ft-1 + α(At-1 – FITt-1) = 110 + 0.2(115-110) = 111.0

Tt = Tt-1 + δ(Ft-1 – FITt-1) = 10 + 0.3(111-110) = 10.3

FITt = Ft + Tt = 111.0 + 10.3 = 121.3

18–25
• Relatively small values for α and δ are
common
– Usually in the range 0.1 to 0.3
• α depends upon how much random
variation is present
• δ depends upon how steady the trend is
• Measurement of forecast error can be used
to select values of α and δ to minimize
overall forecast error

18–26
• Regression is used to identify the functional
relationship between two or more correlated variables,
usually from observed data.
• One variable (the dependent variable) is predicted for
given values of the other variable (the independent
variable).
• Linear regression is a special case that assumes the
relationship between the variables can be explained
with a straight line.

Y = a + bt

18–27
Sales = 10 + 1.2*Adv+ 0.9*Incentives

18–28
• Forecast error is the difference between the forecast
value and what actually occurred.
• All forecasts contain some level of error.
• Sources of error
– Bias – when a consistent mistake is made
– Random – errors that are not explained by the model
being used
• Measures of error
– Mean absolute deviation (MAD)
– Mean absolute percent error (MAPE)
– Tracking signal

18–29
• Ideally, MAD will be zero (no • MAPE scales the forecast error to
forecasting error). the magnitude of demand.
• Larger values of MAD
indicate a less accurate
model.

• Tracking signal indicates whether

forecast errors are accumulating
over time (either positive or
negative errors).

18–30
18–31
18–32
• Causal relationship forecasting uses
independent variables other than time to
predict future demand.
– This independent variable must be a leading
indicator.

• Many apparently causal relationships are

actually just correlated events – care must be
taken when selecting causal variables.

18–33
• Often, more than one independent
variable may be a valid predictor of
future demand.

• In this case, the forecast analyst may

utilize multiple regression.
– Analogous to linear regression analysis, but
with multiple independent variables.
– Multiple regression supported by statistical
software packages.
18–34
• Generally used to take advantage of expert
knowledge.
• Useful when judgment is required, when
products are new, or if the firm has little
experience in a new market.
• Examples
– Market research
– Panel consensus
– Historical analogy
– Delphi method

18–35
• A web-based process used to coordinate the
efforts of a supply chain.
– Demand forecasting
– Production and purchasing
– Inventory replenishment
• Integrates all members of a supply chain –
manufacturers, distributors, and retailers.
• Depends upon the exchange of internal
information to provide a more reliable view of
demand.

18–36
Creation of a
Development
front-end Joint business Sharing Inventory
of demand
partnership planning forecasts replenishment
forecasts
agreement

18–37
• Forecasting is a fundamental step in any planning
process.

• Forecast effort should be proportional to the

magnitude of decisions being made.

• Web-based systems (CPFR) are growing in importance

and effectiveness.

• All forecasts have errors – understanding and

minimizing this error is the key to effective
forecasting processes.
18–38