CTL.

SC1x -Supply Chain & Logistics Fundamentals

Introduction to
Demand Planning
& Forecasting

MIT Center for

Transportation & Logistics
Demand Process Three Key Questions
Demand Planning
n Product & Packaging
What should we do to shape and n Promotions
create demand for our product? n Pricing
n Place

Demand Forecasting
What should we expect demand to n Strategic, Tactical, Operational
be given the demand plan in place? n Considers internal & external factors
n Baseline, unbiased, & unconstrained

Demand Management
n Balances demand & supply
How do we prepare for and act n Sales & Operations Planning (S&OP)
on demand when it materializes? n Bridges both sides of a firm

Material adapted from Lapide, L. (2006) Course Notes, ESD.260 Logistics Systems.

CTL.SC1x - Supply Chain and Logistics Fundamentals Lesson: Demand Forecasting Basics 2
 Forecasting Levels
Level Horizon Purposes
Business Planning
Strategic Year/Years Capacity Planning
Investment Strategies

Brand Plans
Quarterly Budgeting
Sales Planning
Tactical Manpower Planning

Short-term Capacity Planning

Months/Weeks Master Planning
Inventory Planning

Operational Days/Hours
Transportation Planning
Production Planning
Inventory Deployment
Material adapted from Lapide, L. (2006) Course Notes, ESD.260 Logistics Systems.

CTL.SC1x - Supply Chain and Logistics Fundamentals Lesson: Demand Forecasting Basics 3
 Agenda

Forecasting Truisms
Subjective vs. Objective Approaches
Forecast Quality
Forecasting Metrics

CTL.SC1x - Supply Chain and Logistics Fundamentals Lesson: Demand Forecasting Basics
 Forecasting Truisms 1:
Forecasts are always wrong

CTL.SC1x - Supply Chain and Logistics Fundamentals Lesson: Demand Forecasting Basics 5
 1. Forecasts are always wrong
Why?
n Demand is essentially a continuous variable
n Every estimate has an error band
n Forecasts are highly disaggregated
w Typically SKU-Location-Time forecasts
n Things happen . . .
OK, so what can we do?
n Dont fixate on the point value
n Use range forecasts
n Capture error of forecasts
n Use buffer capacity or stock

CTL.SC1x - Supply Chain and Logistics Fundamentals Lesson: Demand Forecasting Basics 6
 Forecasting Truisms 2:
Aggregated forecasts
are more accurate
CTL.SC1x - Supply Chain and Logistics Fundamentals Lesson: Demand Forecasting Basics 7
2. Aggregated forecasts are more accurate
Aggregation by SKU, Time, Location, etc.
Coefficient of Variation (CV)
n Definition: Standard Deviation / Mean = /
n Provides a relative measure of volatility or uncertainty
n CV is non-negative and higher CV indicates higher volatility

Red: =100, =45, CV=0.45 Blue: =100, =1, CV=0.01

200
180
160
140
Daily Demand

120
100
80
60
40
20
-
2/26/11 3/28/11 4/27/11 5/27/11 6/26/11 7/26/11 8/25/11

CTL.SC1x - Supply Chain and Logistics Fundamentals Lesson: Demand Forecasting Basics 8
 Aggregating by SKU
Coffee Cups and Lids @ the Sandwich Shop
n Large ~N(80, 30) CV = 0.38
n Medium ~N(450, 210) CV = 0.47
n Small ~N(250, 110) CV = 0.44

800

700

600

500
Small
400 Medium

300 Large

200

100

-
8/14/13 9/13/13 10/13/13 11/12/13 12/12/13 1/11/14 2/10/14 3/12/14 4/11/14 5/11/14 6/10/14

CTL.SC1x - Supply Chain and Logistics Fundamentals Lesson: Demand Forecasting Basics 9
 Aggregating by SKU
What if I design cups with a common lid?
Large ~N(80, 30) CV=0.38
Common Lid ~N(780, 239) CV = 0.31 Med. ~N(450, 210) CV=0.47
Small ~N(250, 110) CV=0.44
n = (80 + 450 + 250) = 780 units/day
Lids ~N(780, 239) CV=0.31
n = sqrt(302 + 2102 + 1102) = 239 units/day
1,600
1,400
1,200
1,000
800
600
400
200
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8/14/13 9/13/13 10/13/13 11/12/13 12/12/13 1/11/14 2/10/14 3/12/14 4/11/14 5/11/14 6/10/14

Example of Modularity or Parts Commonality

Reduces the relative variability
Increases forecasting accuracy
Lowers safety stock requirements

CTL.SC1x - Supply Chain and Logistics Fundamentals Lesson: Demand Forecasting Basics 10
 Forecasts with longer time
Aggregating by Time buckets have better
forecast accuracy.
1,600 Daily Demand for Lids ~N(780, 239) CV=0.31 The time bucket used
1,200 should match the situation.
800

400

-
8/14/13 9/13/13 10/13/13 11/12/13 12/12/13 1/11/14 2/10/14 3/12/14 4/11/14 5/11/14 6/10/14

8,000
Weekly Demand for Lids ~N(5458, 632) CV=0.12
6,000

4,000

2,000

-
1 5 9 13 17 21 25 29 33 37 41 45 49

30,000 Monthly Demand for Lids ~N(21840, 1264) CV=0.06

25,000
20,000
15,000
10,000
5,000
-
1 2 3 4 5 6 7 8 9 10 11 12
CTL.SC1x - Supply Chain and Logistics Fundamentals Lesson: Demand Forecasting Basics 11
 CV reduces as we
Aggregating by Locations aggregate over SKUs,
time, or locations.
Suppose we have three sandwich shops
n Weekly lid demand at each ~N(5458, 632) CV=0.12

~N(5458, 632) ~N(5458, 632) ~N(5458, 632)

~N(16374, 1095)

What if demand is pooled at a common Distribution Center?

n Weekly lid demand at DC ~N(16374, 1095) CV=0.07

n CVind
CVind = CVagg = = =
n n n
CTL.SC1x - Supply Chain and Logistics Fundamentals Lesson: Demand Forecasting Basics 12
 Forecasting Truisms 3:
Shorter horizon forecasts
are more accurate
CTL.SC1x - Supply Chain and Logistics Fundamentals Lesson: Demand Forecasting Basics 13
 3. Shorter horizon forecasts are
more accurate

21 22 23 24 1 2 3 4 5 6 7 8 9 10 11 12

CTL.SC1x - Supply Chain and Logistics Fundamentals Lesson: Demand Forecasting Basics 14
 3. Shorter horizon forecasts are
more accurate
Postponed final customization to
closer time of consumption
Risk pooling of component (e.g.,
ham) increases forecast accuracy.

21 22 23 24 1 2 3 4 5 6 7 8 9 10 11 12

CTL.SC1x - Supply Chain and Logistics Fundamentals Lesson: Demand Forecasting Basics 15
 Forecasting Truisms

Forecasts are always wrong

Use ranges & track forecast error

Aggregated forecasts are more accurate
Risk pooling reduces CV
Shorter time horizon forecasts are more
accurate
Postpone customization until as
late as possible

CTL.SC1x - Supply Chain and Logistics Fundamentals Lesson: Demand Forecasting Basics 16
 Subjective & Objective Approaches

CTL.SC1x - Supply Chain and Logistics Fundamentals Lesson: Demand Forecasting Basics 17
 Fundamental Forecasting Approaches
Subjective Objective
Judgmental Causal / Relational
n Sales force surveys n Econometric Models
n Jury of experts n Leading Indicators
n Delphi techniques n Input-Output Models

Experimental Time Series

n Customer surveys n Black Box Approach
n Focus group sessions n Past predicts the future
n Test marketing n Identify patterns

Often times, you will need to use a combination of approaches

CTL.SC1x - Supply Chain and Logistics Fundamentals Lesson: Demand Forecasting Basics
 Forecasting Quality

CTL.SC1x - Supply Chain and Logistics Fundamentals Lesson: Demand Forecasting Basics 19
 Cost of Forecasting vs Inaccuracy
Overly Nave Models Good Region Excessive Causal Models

Total Cost
Cost

Cost of Errors Cost of Forecasting

In Forecast

Forecast Accuracy
CTL.SC1x - Supply Chain and Logistics Fundamentals Lesson: Demand Forecasting Basics
How do we determine if a forecast is good?
What metrics should we use?
Example - Which is a better forecast?
n Squares & triangles are different forecasts
n Circles are actual values

1100

1000

900

time

CTL.SC1x - Supply Chain and Logistics Fundamentals Lesson: Demand Forecasting Basics
 Accuracy versus Bias
n Accuracy - Closeness to actual observations
n Bias - Persistent tendency to over or under predict

Accurate

Not Accurate

Biased Not Biased

CTL.SC1x - Supply Chain and Logistics Fundamentals Lesson: Demand Forecasting Basics
 Forecasting Metrics

CTL.SC1x - Supply Chain and Logistics Fundamentals Lesson: Demand Forecasting Basics 23
 Forecasting Metrics et = At Ft

Mean Deviation n Mean Absolute n
(MD)
e t
Deviation (MAD) e
t =1
t

MD = t =1 MAD =
n n
Mean Squared n
Root Mean
Error (MSE) 2 Squared n

e t Error (RMSE) e
t 2

t =1
MSE = t =1 RMSE =
n n

n
Mean Percent et Mean Absolute n et
Error (MPE) A Percent Error (MAPE) A
t=1
MPE = t=1 t MAPE = t

n n
Notation:
At = Actual value for obs. t et = Error for observation t
Ft = Forecasted value for obs. t n = Number of observations
CTL.SC1x - Supply Chain and Logistics Fundamentals Lesson: Demand Forecasting Basics
 Example: Forecasting Bagels
For the bagel forecast and actual values
shown below, find the:
n Mean Absolute Deviation (MAD) n

n Root Mean Square of Error (RMSE) e

t =1
t
n Mean Absolute Percent Error (MAPE) MAD =
n
Forecast Actual n
2
Monday e
t
50 43 t =1
Tuesday RMSE =
50 42 n
Wednesday 50 66
Thursday 50 38 n et
Friday 75 86 A
t=1
MAPE = t
n
CTL.SC1x - Supply Chain and Logistics Fundamentals Lesson: Demand Forecasting Basics 25
 Example: Forecasting Bagels
Solution: 90

1. Graph it. Forecast Actual

80
2. Extend data table:
w Error: et=At-Ft

Daily Bagel Demand

70

w Abs[error] = |et|
60
w Sqr[error] = e2
w AbsPct[error] = |et/At| 50

3. Sum and find means

40

Ft At et |et| e2 |et/At|
30
Monday 50 43 -7 7 49 16.3% Monday Tuesday Wednesday Thursday Friday

Tuesday 50 42 -8 8 64 19.0%
Wednesday 50 66 16 16 256 24.2%
MAD = 54/5 = 10.8
Thursday 50 38 -12 12 144 31.6% RMSE = sqrt(126.8) = 11.3
Friday 75 86 11 11 121 12.8% MAPE = 104%/5 = 21%
Sum 0 54 634 104%
Mean 0 10.8 126.8 21%
CTL.SC1x - Supply Chain and Logistics Fundamentals Lesson: Demand Forecasting Basics 26
 Key Points from Lesson

CTL.SC1x - Supply Chain and Logistics Fundamentals Lesson: Demand Forecasting Basics 27
 Key Points
Forecasting is a means not an end
Forecasting Truisms
n Forecasts are always wrong
n Aggregated forecasts are more accurate
n Shorter horizon forecasts are more accurate
Subjective & Objective Approaches
n Judgmental & experimental
n Causal & time series
Forecasting metrics
n Capture both bias & accuracy
n MAD, RMSE, MAPE
CTL.SC1x - Supply Chain and Logistics Fundamentals Lesson: Demand Forecasting Basics
 CTL.SC1x -Supply Chain & Logistics Fundamentals

Questions, Comments, Suggestions?

Use the Discussion!

Janie
Photo courtesy Yankee Golden
Retriever Rescue (www.ygrr.org)
MIT Center for
Transportation & Logistics caplice@mit.edu