LESSON 2

DEMAND – SUPPLY PLANNING AND FORECASTING

Introduction

Demand planning, which forms part of an overall management strategy and

affects many individuals and functions within an organization, is just one

element - albeit an important one – within demand management.

Demand planning is the management process within an organization which

enables that organization to tailor its capacity, either production or service, to

meet variations in demand or alternatively to manage the level of demand using

marketing or supply chain management strategies to smooth out the peaks and

troughs (CIPS, 2013)

Demand drives the entire supply chain from suppliers to manufacturing,

marketing, inventory, distribution and service to customers. An organization

needs to be able to forecast demand accurately but to do these needs to

understand demand patterns, and how factors such as new products,

competition, and changing market conditions affect these patterns.

1|P ag e
Essence of Demand and Supply Planning

• Margin realization continues to be high on the retail agenda, especially in

the run-up to special events such as Valentine’s Day and Easter.

• Naturally, retailers will want to maximize sales and not run out of stock.
But vendors are left with product and need to ship goods back to
warehouses, costs really start mounting up.

• Gauging the right stock level is especially critical. Likewise, from a network
capacity perspective, careful planning is needed to manage the intensive
volume of goods passing through the supply chain.

Types of demand planning:

There are two types of planning:

a) Structured analytical planning such as time series analysis and moving

monthly averages (based on historical data)

b) Gut feeling

Both have their advantages and uses and it is not possible to say that one is
right or wrong, and while the less structured intuitive approach may be more
suited to a small or entrepreneurial business, both approaches can go hand in
hand.

Quite often the structured analytical planning will result in a forecast which is a
projection of

Patterns of past events into the future. Forecasts can enable a company to have
a more reliable idea about future demand than might otherwise be the case.

2|P ag e
Demand Influencing Factors
• Holidays
• Temperature Changes
• Promotions
• Incorporated these into the forecasting and replenishment system
• Competition
 New products

Independent and dependent demand

When forecasting the future requirements for supplies, we have to distinguish
between Independent demand and dependent demand. Demand may be either
independent or dependent.
1) Independent demand for an item is influenced by market conditions and
not related to production decisions for any other item held in stock. In
manufacturing, only end items, i.e., the final product sold to the customer,
have exclusively independent demand. Associated with ABC Analysis,
Fixed Order Quantities, continuous and Periodic review systems
2) Dependent demand for an item derives from the product decisions for its
‘parents’. The term ‘parent’ is an item manufactured from one or more
component items. Associated with: Materials Requirement Planning,
Manufacturing Resource Planning, ERP

Forecasting is the process of making predictions of the future based on past and
present data and analysis of trends. Lysons & Farrington (2016) define
forecasting as the prediction of future outcomes, and is the basis of all planning
and decision making

When forecasting is used to predict demand, it requires understanding of

demand patterns and the way factors such as product life cycles, competition,
and changing market dynamics impact on these patterns (Boyer and Verma,
2010; Lysons and Farrington, 2006).

3|P ag e
Forecasting is prediction of events which are to occur in the future and there

are many variables to be predicted in an organization e.g.

Here are some examples of uses of forecasts in business organizations:

 Accounting. New product/process cost estimates, profit projections, cash
management.
 Finance. Equipment/equipment replacement needs, timing and amount
of funding/
 Human resources. Hiring activities, including recruitment, interviewing,
and training; layoff planning, including outplacement counseling.
 Marketing. Pricing and promotion, e-business strategies, global
competition strategies.
 MIS. New/revised information systems, Internet services.
 Operations. Schedules, capacity planning, work assignments and
workloads, inventory planning, make-or-buy decisions, outsourcing,
project management.
 Product/service design. Revision of current features, design of new
products or services.
The need for forecasting arises from the fact that decisions are about the future

which in many cases is uncertain. Thus forecasting can be viewed as an effort to

reduce uncertainty so as to make more accurate decisions. This gives the firm

the competitive advantage in the market.

Forecasts are a basic input in the decision processes of operations management

because they provide information on future demand. The importance of

forecasting to operations management cannot be overstated. The primary goal of

operations management is to match supply to demand.

4|P ag e
Features Common to All Forecasts

1. Forecasting techniques generally assume that the same underlying causal

system that existed in the past will continue to exist in the future.

2. Forecasts are not perfect; actual results usually differ from predicted
values; the presence of randomness precludes a perfect forecast.
Allowances should be made for forecast errors.

3. Forecasts for groups of items tend to be more accurate than forecasts for
individual items because forecasting errors among items in a group
usually have a canceling effect. Opportunities for grouping may arise if
parts or raw materials are used for multiple products or if a product or
service is demanded by a number of independent sources.

4. Forecast accuracy decreases as the time period covered by the forecast—

the time horizon —increases. Generally speaking, short-range forecasts
must contend with fewer uncertainties than longer-range forecasts, so
they tend to be more accurate.

Elements of a good forecast

A properly prepared forecast should fulfill certain requirements:
1. The forecast should be timely. Usually, a certain amount of time is
needed to respond to the information contained in a forecast. For example,
capacity cannot be expanded overnight, nor can inventory levels be
changed immediately. Hence, the forecasting horizon must cover the time
necessary to implement possible changes.
2. The forecast should be accurate, and the degree of accuracy should be
stated. This will enable users to plan for possible errors and will provide
a basis for comparing alternative forecasts.
3. The forecast should be reliable; it should work consistently. A technique
that sometimes provides a good forecast and sometimes a poor one will

5|P ag e
 leave users with the uneasy feeling that they may get burned every time
a new forecast is issued.
4. The forecast should be expressed in meaningful units. Financial
planners need to know how many dollars will be needed, production
planners need to know how many units will be needed, and schedulers
need to know what machines and skills will be required. The choice of
units depends on user needs.
5. The forecast should be in writing. Although this will not guarantee that
all concerned are using the same information, it will at least increase the
likelihood of it. In addition, a written forecast will permit an objective basis
for evaluating the forecast once actual results are in.
6. The forecasting technique should be simple to understand and use.
Users often lack confidence in forecasts based on sophisticated
techniques; they do not understand either the circumstances in which the
techniques are appropriate or the limitations of the techniques.Misuse of
techniques is an obvious consequence. Not surprisingly, fairly simple
forecasting techniques enjoy widespread popularity because users are
more comfortable working with them.
7. The forecast should be cost-effective: The benefits should outweigh the
costs.
Six basic steps in the forecasting process:
1. Determine the purpose of the forecast. How will it be used and when
will it be needed? This step will provide an indication of the level of detail
required in the forecast, the amount of resources (personnel, computer
time, dollars) that can be justified,
and the level of accuracy necessary.
2. Establish a time horizon. The forecast must indicate a time interval,
keeping in mind that accuracy decreases as the time horizon increases.
3. Obtain, clean, and analyze appropriate data. Obtaining the data can
involve significant effort. Once obtained, the data may need to be

6|P ag e
 “cleaned” to get rid of outliers and obviously incorrect data before
analysis.
4. Select a forecasting technique.
5. Make the forecast.
6. Monitor the forecast errors. The forecast errors should be monitored to
determine if the forecast is performing in a satisfactory manner.

Forecast Accuracy
Accuracy and control of forecasts is a vital aspect of forecasting, so forecasters
want to minimize forecast errors. However, the complex nature of most real-
world variables makes it almost impossible to correctly predict future values of
those variables on a regular basis. Moreover, because random variation is always
present, there will always be some residual error, even if all other factors have
been accounted for.

Forecast error is the difference between the value that occurs and the value
that was
predicted for a given time period. Hence, Error = Actual -Forecast:

 Three commonly used measures for summarizing historical errors are the
mean absolute deviation (MAD) ,
 mean squared error (MSE)
 Mean absolute percent error (MAPE) .

MAD is the average absolute error, MSE is the average of squared errors, and
MAPE is the average absolute percent error. The formulas used to compute MAD,
1 MSE, and MAPE are as follows:

7|P ag e
8|P ag e
Approaches to Forecasting

FORECASTING TECHNIQUES

Lysons & Farrington (2016) note that forecasting techniques are in two broad categories

Qualitative Forecasting Methods

‘Soft’ information – for example, human opinion, hunches that may provide information and
insights not obtainable by quantitative approaches. Appropriate when little historical data is
available like in the case of demand forecasts for new products or the estimation of sales from a
newly developed internet based electronic channel (Shah, 2009) .

9|P ag e
Qualitative methods consist mainly of subjective inputs, which often defy precise
numerical description.
Quantitative methods involve either the projection of historical data or the
development of associative models that attempt to utilize causal (explanatory)
variables to make a forecast.
Qualitative techniques include:
 Expert opinion
 Executive Opinions
A small group of upper-level managers (e.g., in marketing, operations, and
finance) may meet and collectively develop a forecast. This approach is often used
as a part of long-range planning and new product development. It has the
advantage of bringing together the considerable knowledge and talents of various
managers. However, there is the risk that the view of one person will prevail, and
the possibility that diffusing responsibility for the forecast over the
entire group may result in less pressure to produce a good forecast
 Market surveys/ Consumer Surveys
Because it is the consumers who ultimately determine demand, it seems
natural to solicit input from them. In some instances, every customer or
potential customer can be contacted.
Other Approaches
Delphi method
Delphi method – named after the ancient Greek religious site where the gods
were believed to communicate answers to humans’ questions about the future,
this technique involves the following four steps.
1) Estimates or forecasts are solicited from knowledgeable people within a
company or industry about the matter under consideration. The names of
the people approached are not known to each other.
2) Statistical averages of the forecasts are computed. If there is a high level
of agreement

10 | P a g e
 about the forecasts, the procedure ends there.
3) If, as often happens, there is considerable divergence between the
forecasts, the group averages are presented to the individuals who made
the original forecasts, asking them why their forecasts differ from the
average or group consensus and asking for new estimates.
4) Steps 2 and 3 are repeated until agreement is reached.

Quantitative Forecasting Methods

Hard’ information that eliminates the personal biases associated with

qualitative approaches Quantitative techniques includes time series. A time
series is a set of observations measured at successive times over successive
periods.
Time series forecasting methods make the assumption that past patterns in
data can be used to
Forecast future data points. The most frequently used methods of calculating
time series are moving averages and exponentially weighted averages.

When using time series modelling, it is important to remember that it is an

iterative process with feedback and interaction occurring between each of the
relevant stages (Salas et al., 1997).

Naive Methods
A simple but widely used approach to forecasting is the naive approach. A naive
forecast uses a single previous value of a time series as the basis of a forecast.
The naive approach can be used with a stable series (variations around an
average), with seasonal variations, or with trend. With a stable series, the last
data point becomes the forecast for the next period. Thus, if demand for a
product last week was 20 cases, the forecast for this week is 20 cases.

11 | P a g e
High Low Method
For this method, we obtain a straight line connecting the highest and the lowest
values of the observations according to the predictor variable x
Calculate the value of a and b to fit the linear function y= a + bx

Moving Averages
Moving averages. A moving average is an artificially constructed time series in
which each annual (or monthly, daily, etc) figure is replaced by the average or
mean of itself and values corresponding to a number of preceding and succeeding
periods.
For example the usage of a ‘dongle’ for six successive periods was
83,85,90,86,102 and 108. If a five period moving average is required, the average
of the first term will be: 83+85+90+86+102 = 89.2 5. The average for the second
term will be: 85+90+86+102+108 = 94.2 5. At each step, one term of the original
series is dropped and another introduced.

Exponentially weighted average method (EWAM)

The moving average method has been largely discarded for inventory applications
as it
has a number of disadvantages:
It requires a large number of separate calculations
A true forecast cannot be made until the required number of time periods have
elapsed
All data are equally weighted, but, in practice, the older the demand data, the
less relevant it becomes in forecasting future requirements
These difficulties are overcome by using a series of weights with decreasing
values that converge at infinity to produce a total sum of one. Such a series,
known as an exponential series, takes the form:

12 | P a g e
With exponential smoothing, all that is necessary is to adjust the previous
forecast by a fraction of the difference between the old forecast and the actual
demand for the previous period; that is, the new average forecast is:

Example
The actual demand for a stock item during the month of January was 400
against a forecast
Of 380. Assuming a weighting of 0.2, what will be the average demand forecast
for February?
Solution
0.2(400) + (1 - 0.2)(380) = 80 + 304

13 | P a g e