School of Management and Economics

Demand Forecasting
- A study at Alfa Laval in Lund

Bachelor Thesis, FE 3583, 15hp Spring 2008 Authors: Hana Klimsova, 780329 Stacey Lobban, 740819 Tutor: Peter Berling Examinator: Petra Andersson

SUMMARY
Vxj University, School of Management and Economics, FE3583, Spring 2008 Authors: Hana Klimsova and Stacey Lobban Tutor: Peter Berling Title: Demand Forecasting- A study at Alfa Laval in Lund Background: Accurate forecasting is a real problem at many companies and that includes Alfa Laval in Lund. Alfa Laval experiences problems forecasting for future raw material demand. Management is aware that the forecasting methods used today can be improved or replaced by others. A change could lead to better forecasting accuracy and lower errors which means less inventory, shorter cycle times and better customer service at lower costs. Purpose: The purpose of this study is to analyze Alfa Lavals current forecasting models for demand of raw material used for pressed plates, and then determine if other models are better suited for taking into consideration trends and seasonal variation. Delimitations: Due to the large number of articles that go into the production of plate heat exchangers, this study will only focus on forecasting of selected raw material (coils or sheets) demand for pressed plates. Method: This is an action research study using an interpretive scientific perspective, a deductive approach, and a quantitative research strategy. The scientific credibility of the study will hinge on providing a workable solution for the studied companys problem. Conclusion: The companys current error evaluation method differs greatly from theory and is probably wrong. Forecasting of raw material demand can be improved by using better input data. Of the 12 items tested, triple exponential smoothing provided the lowest forecasting error in 8 of the cases. Future Work: In our demand forecasting analyses, we adjusted each smoothing constant to come up with the best error accuracy for individual items. For future studies, one might use the same smoothing constants across all products to see if these can be standardized so that forecasting work can be done even more efficiently and effectively. Keywords: Alfa Laval, demand forecasting, time series analysis, moving average, exponential smoothing, autocorrelation, forecasting accuracy, plate heat exchangers

ACKNOWLEDGEMENTS

This Batchelor Thesis has been written during Spring 2008 and is a result of hard work and dedication. It would not have been possible without support and constructive feedback from a number of people. First of all, we would like to take this opportunity to give thanks and show gratitude to our tutor, Peter Berling, for his guidance and substantial feedback throughout the entire process. Furthermore, we are grateful for the additional guidance of our examinator, Petra Andersson, for her suggestions on how to structure our thesis. We would also like to express our gratitude to Ivan Kruzela, associate professor at Malm University, for his conceptual and moral support. In addition, our appreciation goes to our opponents, who have given us constructive criticism and support in finalizing our thesis. We also appreciate the feedback of our fellow seminar members. Finally, our gratitude goes to all the people who took time to help us perform our research, including all interviewees at Alfa Laval OM-CP unit: Tobias Augustsson, Martin Jnsson, and Lars Hedberg. They provided essential value in the development of our thesis by sharing their knowledge and always made themselves available to answer countless questions and provide feedback throughout various stages of the process. Vxj, May 2008

Hana Klimsova

Stacey Lobban

TABLE OF CONTENTS

SUMMARY.............................................................................................................................. 2 ACKNOWLEDGEMENTS.................................................................................................... 3 TABLE OF CONTENTS........................................................................................................ 4 1. Introduction ......................................................................................................................... 7 1.1 Background........................................................................................................................ 7 1.2 Alfa Laval - company presentation.................................................................................. 9 1.3 Problem discussion .......................................................................................................... 11 1.4 Problem questions ........................................................................................................... 12 1.5 Purpose............................................................................................................................. 12 1.6 Delimitations .................................................................................................................... 12 1.7 Time plan ......................................................................................................................... 13 1.8 Definition of Concepts..................................................................................................... 13 1.9 Disposition........................................................................................................................ 14 2. Methodology ...................................................................................................................... 16 2.1 Scientific perspective - Positivism vs. Interpretivism .................................................. 16 2.1.1 Our perspective - Interpretivism ................................................................................ 16 2.2 Scientific approach Deductive vs. Inductive .............................................................. 17 2.2.1 Our scientific approach - Deductive .......................................................................... 17 2.3 Research strategy Quantitative vs. Qualitative ......................................................... 17 2.3.1 Our research strategy - Quantitative ......................................................................... 18 2.4 Research method - Action Research.............................................................................. 18 2.4.1 Our motivation of research method ........................................................................... 20 2.5 Data Collection- Theoretical and Empirical................................................................. 21 2.5.1 Our data collection method........................................................................................ 21 2.6 Scientific Credibility ....................................................................................................... 22 2.6.1 Our choice of scientific credibility ............................................................................. 23

2.7 Summary of Methodology .............................................................................................. 24 3. Theory ................................................................................................................................ 25 3.1 Demand forecasting - Subjective and Objective........................................................... 25 3.1.1 Subjective forecasting approach ................................................................................ 25 3.1.2 Objective forecasting approach ................................................................................. 26 3.1.3 Summary of subjective and objective approaches...................................................... 27 3.2 Time series analysis......................................................................................................... 28 3.3 Definition of Time Series Behaviours ............................................................................ 28 3.4 Models for Time Series Forecasting .............................................................................. 30 3.4.1 Moving average.......................................................................................................... 31 3.4.2 Exponential smoothing............................................................................................... 32 3.4.3 Autocorrelation .......................................................................................................... 36 3.5 Evaluating forecasting accuracy .................................................................................... 36 3.6 Theoretical framework ................................................................................................... 39 4. Empirical............................................................................................................................ 40 4.1 Reintroduction of Alfa Laval ......................................................................................... 40 4.2 Interviewees ..................................................................................................................... 41 4.3 Ordering Raw Material at Alfa Laval........................................................................... 41 4.3.1 How an order is placed .............................................................................................. 41 4.3.2 How forecasting of raw material demand is done ..................................................... 42 4.3.3 What the forecast sent to suppliers is based on ......................................................... 42 4.3.4 Forecasting accuracy calculations ............................................................................ 42 4.3.5 Six Sigma .................................................................................................................... 43 4.3.6 Results of poor forecasting at Alfa Laval................................................................... 43 4.4 Current forecasting models ............................................................................................ 44 4.4.1 Summary of the forecasting methods used by Alfa Laval........................................... 46 4.5 Items to be analyzed ........................................................................................................ 46 4.6 Gathering of data ............................................................................................................ 47 5. Analysis .............................................................................................................................. 49 5.1 Foundation of analysis .................................................................................................... 49 5.2 Raw material analyzed.................................................................................................... 50 5.3 The analytical process..................................................................................................... 51

5.4 Summary and discussion of analysis ............................................................................. 60 6. Conclusion.......................................................................................................................... 63 6.1 Results .............................................................................................................................. 63 6.2 Reflections ........................................................................................................................ 64 6.3 Client Validity.................................................................................................................. 65 6.4 Future work ..................................................................................................................... 65 REFERENCES ...................................................................................................................... 66 APPENDIX 1 - Interview questions APPENDIX 2 - Historical data (one item) APPENDIX 3 and 4 - Raw material analysis (one item) APPENDIX 5 - Analysis of evaluating method

1. Introduction

he introduction chapter is intended to provide an overview of the subject, motivation, and process of this thesis. It opens with a background of forecasting, giving the reader insight to the important role of forecasting for demand. Thereafter is a presentation of the company. Subsequently, this chapter leads to a discussion of the problem, followed

by problem questions, delimitations of the research, and key definitions.

1.1 Background
Forecasting Forecasting plays an integral role in our daily lives. We make decisions about what to wear the next day or what to pack for a trip based on weather forecasts. We decide when to make investments based on forecasts or listen to traffic reports to determine which route to take to work in the morning. Of course, not everything can be accurately forecasted. Sometimes forecasts are accurate; most often they are not. Similarly forecasting plays an important role in business operations. All business planning is based on forecasts, sales of existing and new products, requirements and availability of raw materials, capacity requirements to name a few.1 Larger firms employ forecasting for different purposes and for different levels (in terms of time, product and market) compared to smaller ones. The type of industry impacts the forecasting methods as well. Manufacturing firms use more complex techniques than service firms. Uncertainty and environmental turbulence are also issues to be considered, as there is a correlation between environmental turbulences and judgmental adjustments of quantitative forecasting techniques.2 A companys operations and production managements main focus is to forecast product demand. Even though it is very likely that demand will be random in most circumstances,

forecasting methods are still of value. Although some portions of the demand process may be unpredictable, other portions may be predictable. Trends, cycles, and seasonal variation

1 2

Nahmias, S. (2005:53) Zotteri, K. (2007:85)

may be present and will prove advantageous to making predictions of outcomes.

Such

forecasting outcomes are important information for the use of purchasing raw material. As goods move from raw material processors through to manufacturers and further down the supply chain to the end customer, extensive coordination is required among ordering, demand forecasting and inventory decisions at every level.4 The importance of demand forecasting manifests itself in the purchasing function and can have a strong influence a companys competitive advantage. Over-purchasing not only negatively affects inventory and storage space, but also spending on unnecessary procurement activities. On the other hand, under-purchasing can cause a shortage in raw material, which could cause interruptions in the manufacturing process and lead to unfinished or delayed products.5 Good demand forecasting helps to find the right balance. Along with improving forecasting accuracy, there should be an overall strategy of demand management. This would include making an increasingly larger proportion of product demand firm while at the same time decreasing the percentage of products that have to be forecasted.6 To predict future demand accurately is crucial for effective purchasing planning since it leads to customer satisfaction and decreasing costs. Many companies invest in expensive forecasting software that use statistical methods, however their forecasts are often adjusted by using personal judgment and market knowledge to improve accuracy.7 Many times business managers make the comment: If only we could do a better job of forecasting demand. This statement is based on the fact that they too often experience unnecessarily high errors in their forecasts. Accurate forecasting is a real problem at many companies.8 Improving forecast accuracy is the goal, but one must also take into consideration that there are limits. The better forecast always includes some measure of the forecast error.9

Alfa Laval also experiences the same problem of forecasting for future demand. The managers here are aware of the fact that the forecasting methods they use today can be improved or replaced by others. A change could lead to better forecasting accuracy and lower
3 4

Nahmias, S. (2005:53) Fenstermacher, K., & Zeng, D. (2000:4) 5 Kengpol, A., Kaoien, P., & Touminen, M., (2007:1605) 6 Martin, J. (2008:231) 7 Fildes, R. & Goodwin, P. (2007:42) 8 Lapide, L. (2007:16) 9 Nahmias, S. (2005:51)

errors which means less inventory, shorter cycle times and better customer service at lower costs. These factors will play an important role in the company gaining competitive advantages and flexibility.

1.2 Alfa Laval - company presentation

Gustaf de Laval founded Alfa Laval in 1883. Its success was based on his invention of the continuous separators. Over the years, heat transfer and fluid handling has been added to the expertise in separation. Alfa Lavals equipment, systems and services are used by customers to optimize the performance of their processes. For example, heat transfer and fluid handling solutions help customers heat, cool, separate and transport products such as food and beverages, chemicals and petrochemicals, pharmaceuticals, starch, sugar and ethanol. Alfa Laval sells its products to more than 20,000 customers including BASF, Bayer, BP, Heineken and Tetra Laval.
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Today the company has about 10,000 employees of whom many are

located in Sweden, India, Denmark, USA and France. Almost 50 per cent of total sales are made in Europe, 30 per cent in Asia and 20 per cent in North and South America.11 Alfa Laval in Lund Alfa Lavals facility in Lund specializes in the production of plate heat exchangers in different sizes and types depending on the purpose of use. The company offers both standardized plates and those made according to customer specifications. This facility is comprised of mainly two divisions: CU (Component Unit) and SU (Supply Unit). Both divisions are divided into two business units. This study will focus on one business unit, OM - CP (Operation Manufacturing - Component Unit Plates). This unit is responsible for ordering and receiving raw material (a variety of metals - stainless steel, titanium, etc.) in form of coils or sheets to be cut and pressed into plates of different technical parameters and characteristics. After that they are welded or outfitted with gaskets to become finished plates. These plates are delivered to the SU (Supply Unit), of which there are several worldwide locations, where they are assembled; the plates are put together with frames to form the final product plate

10 11

http://www.alfalaval.com, 2008-04-06 Alfa Laval Annual Report 2006

heat exchangers. These are quality controlled and prepared for delivery to an end customer. In the below value added chain, this studys focus will be on unit highlighted in red.

Suppliers

Component Unit - CU

OM - CP (Component Unit Plates)

OM - CF (Component Unit Frames)

Supply Unit - SU

OM - SE (Supply Equipment)

OM - SP (Supply Process Technology)

End customer
Figure 1.1: Alfa Lavals Value Added Chain.

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1.3 Problem discussion

As mentioned earlier, this study will focus on business unit OM-CP (Operation Manufacturing-Component Unit Plates). The OM-CP unit is experiencing problems with how to handle trends and seasonal variations in forecasting outputs. There are other problems as well. The final forecasts generated by the ERP system have to be subjectively adjusted to meet actual demand. This is time consuming and the human factor involved in this task can become a source of mistakes. Today the OM-CP business unit uses mainly two types of forecasting methods to forecast demand of raw material to be purchased for the different families of plate heat exchangers. The forecasting methods were developed internally and resemble variations of moving average methods. One method weights the previous 12-month demand to forecast demand for one year ahead. The weight factor attaches different importance to each month. There is an established rule that the biggest weight is put on the three preceding months. The further back in the history (always 12 months), the lower the weight factor is. It is assumed that the forecast for the next three months will be more accurate if it is based on demand development during the preceding three moths. Generally, using this method, the demand forecast for one year ahead is very similar to the actual demand in the past twelve months. The other method distributes the weight evenly on all twelve past periods. However, the automatic calculation of both demand forecasts has to be manually adjusted in order to take into consideration the value of known orders of the next months. In addition, the current weight factor methods seem not to account for trends and seasonal variations in demand. The monthly forecasting accuracy evaluation reports show negative trend caused by using these methods. In other words, forecasting errors are simply too high.12 Alfa Lavals current forecasting situation results in many questions: Is the manner of capturing historical demand sufficient to forecast future demand? Are there better forecasting methods to take trends and seasonal variations into account? Which methods work well and which do not in which situation? Which of the forecasting methods provides better results than the current method?

12

Interview with Martin Jnsson, 2008-04-04

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By evaluating the present situation and answering these and other questions, we hope to suggest more appropriate forecasting methods for Alfa Laval.

1.4 Problem questions

How does Alfa Laval currently forecast for demand? How can the demand forecasting for raw material purchases be improved and which method/methods results in lower forecasting errors while taking into consideration trends and seasonal variations?

1.5 Purpose
The purpose of this study is to analyze Alfa Lavals current forecasting models for demand of raw material used for pressed plates, and then determine if other models are better suited for taking into consideration trends and seasonal variation.

1.6 Delimitations
Due to the large number of articles that go into the production of plate heat exchangers, this study will only focus on forecasting of raw material (coils or sheets) demand for pressed plates (those classified by Alfa Laval as A or B products using the ABC classification system).

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1.7 Time plan

Chapter 1 2 3 4 5 6 Title Introduction Research Methodology Theory Empirical Findings Analysis Conclusions and Recommendations Data Collection PM Tutoring 0 1 2 3 March Week 11 12 April 13 14 15 16 17 18 May 19 20 21 22

1.8 Definition of Concepts

Coil: a roll of raw material (metal, titanium, etc) to be cut and pressed into plates Sheet: raw material in form of flat metal plates Plate heat exchanger: The basic plate heat exchanger consists of a series of thin, corrugated plates that are gasketed, welded together (or any combination of these) or brazed together depending on application. The plates are then compressed together in a rigid frame to create an arrangement of parallel flow channels. One fluid travels in the odd numbered channels, the other in the even.

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1.9 Disposition
The thesis will be organized as follows (see Figure 1.2): Chapter 2 The Methodology chapter describes the scientific research approach chosen for this study. Furthermore it presents methods used for data collection and empirical findings. The chapter concludes by summarizing the chosen method and discussing the validity and reliability of the study. Chapter 3 The Theory chapter provides relevant theories applied to our study. We will discuss different theories for forecasting of future demand using time series analysis. At the end of the chapter we set up an analysis model based on applicable theories. Chapter 4 The Empirical Findings chapter describes the current order process and demand forecasting for raw material. It also presents the current forecasting techniques used by Alfa Laval and introduces the raw material selection for this study. Chapter 5 The Analysis chapter tests various forecasting methods using the historical data provided in Appendix 2. From theory and empirical evidence, we propose other forecasting methods for raw material demand taking into consideration trends and seasonal variations. Chapter 6 The Conclusion and recommendation chapter presents a review of the study and proposes forecasting recommendations to Alfa Laval. The proposals are based on theory, our data observations, and interviews with people involved in the OM-CP business unit. Recommendations for future studies give feasible ideas for studies of demand forecasting in this or another closely related subject area.

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Introduction Chapter 1

Methodology Chapter 2

Theoretical Study Chapter 3

Interviews Empirical Findings Chapter 4 Internal Data

Analysis of Data Chapter 5

Conclusions, Recommendations Chapter 6

Figure 1.2: Disposition of Study

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2. Methodology

n this chapter we describe the methodology choices for this study. Areas covered include scientific perspective, scientific approach, and research strategy. Next the action research method is described and the manner in which data was collected.

Thereafter we present scientific credibility of the thesis. At the end is a summary of methodological choices.

2.1 Scientific perspective - Positivism vs. Interpretivism

Interpretivism is an alternative to positivism in that it requires the researcher to take into consideration the subjective meaning of social action. Positivism dictates that knowledge comes from strict scientific methods.13 Practical action research seeks to improve practice through the application of the personal wisdom of the participants14. Action research gains new understanding of a practice and tends to have a lasting influence on the changes that result. The implemented changes are naturally connected to the individuals involved in the change process because the result provides a solution to their immediate problem. Practical action research encourages professional development by emphasizing personal judgment on decisions to act for the good of the client.15

2.1.1 Our perspective - Interpretivism

We chose the interpretivist perspective because it is consistent with our research question of solving a practical demand-forecasting problem at Alfa Laval. Although theory plays a strong role in providing a solution, the result also cannot take place without input from the practitioners. This requires us, the researchers, to closely collaborate with the practitioners to fully understand the meanings of their input and the empirical data gathered. The action research process thus creates a langue shared between practitioners and researchers that identifies the meaning throughout the inquiry process.16
13 14

Bryman, A (2007: 19) Grundy, S. (1982:357) 15 http://www.scu.edu.au/schools/gcm/ar/arr/arow/rmasters.html (2008-04-15) 16 Greenwood, D. (1998:80)

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2.2 Scientific approach Deductive vs. Inductive

By using an inductive research approach, data is collected to build theory; not test it. Inductive research also involves an iterative process, which requires the researcher to move back and forth between theory and data.17 Deductive research seeks to apply theory to observations or findings.18 A deductive process is usually linear meaning that one step follows the other in a logical sequence. However, there are some situations where this does not happen. Sometimes a researchers view of theory changes as a result of analyzing the collected data. For example, data may not fit the initial hypothesis or the relevancy of the data for a theory may become clear only after the data was collected.19

2.2.1 Our scientific approach - Deductive

Our scientific approach is deductive in that we are analyzing forecasting models that are based on proven theory. We have in mind forecasting theories that can be better suited to the current problem, but until all data has been assembled and we have tested the forecasting theory, we do not know if we ought to test other forecasting theories. We will propose more appropriate forecasting models to solve the current problem. We will not create any new theories.

2.3 Research strategy Quantitative vs. Qualitative

Qualitative research places emphasis on words in the gathering and analysis of data rather than quantification. In quantitative research, the emphasis is on quantification of the gathering and analysis of data. Another differentiation between qualitative and quantitative research comes up from the relationship that qualitative researchers have with their research subjects. The qualitative approach allows the subjects to play a greater role in designing the research and influencing results of the process. This is a particular trait of action research.20 The practitioners (those working at the organization) have the local knowledge and every day experience, and the researcher has the technical skills in research procedures and comparative knowledge of the subject under investigation.21 Although action research is
17 18

Bryman, A & Bell, E. (2007:581) Bryman, A & Bell, E. (2007:14) 19 Bryman, A & Bell, E. (2007:13) 20 Bryman, A & Bell, E. (2007:427) 21 Greenwood, D. (1998:77)

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likened to qualitative research, it can employ the gathering of both qualitative and quantitative data.22 Data collection can include such things as analyzing documents, participant observation recordings, unstructured and structured interviews, case studies23, written description of meetings and interviews (can be given to participants to validate information gathered), a collection of documents related to the situation, or a diary of objective impressions24.

2.3.1 Our research strategy - Quantitative

Our research is mostly quantitative in terms of data collection and the analysis to be conducted. We are collecting and analyzing historical data of demand and using known theoretical formulas to find better solutions to the action research problem. However, this study also employs qualitative information gathering insofar as we are participating in our observations by gathering some of the necessary data ourselves; requiring that we receive training and learn how to locate and sort needed information from the companys ERP system. Other information we obtained from the companys intranet or website in addition to mostly unstructured interviews with three employees in the OM-CP business unit.

2.4 Research method - Action Research

A research method concerns choosing a technique to be used for data collection.25 As a research method, action research requires communication and collaboration between insiders (responders) and outsiders (the researcher) to diagnose a research problem and develop a solution. The diagnosis evolves through the close interaction of both parties. The researcher brings knowledge of theories and the responders bring their own personal experiences.26 Action Research, in social science, is a method that emphasizes combining science and practice27 and can further be defined as having the following characteristics:28

22 23

Bryman, A. & Bell, E. (2007:429) http://www.web.net/~robrien/papers/arfinal.html#_Toc26184652 (2008-04-15) 24 Bryman, A. & Bell, E. (2007:429) 25 Bryman, A. & Bell, E. (2007:40) 26 Bryman, A. & Bell, E. (2007:428) 27 Argyris, C., et al. (1985, preface x) 28 Greenwood, D., et al. (1998: 75-76)

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Action Research (AR) Core Characteristics

AR is context bound and addresses real-life problems. AR is inquiry where participants and researchers co-generate knowledge through collaborative communicative processes in which all participants contributions are taken seriously. AR treats the diversity of experience and capacities within the local group as an opportunity for the enrichment of the research-action process The meanings constructed in the inquiry process lead to social action, or these reflections on action lead to the construction of new meanings. The credibility-validity of AR knowledge is measured according to whether actions that arise from it solve problems (workability) and increase participants control over their own situation.
Figure 2.1: Action Research - Core Characteristics Source: Greenwood, D.(1998:75)

There is a special kind of question that action researchers ask in order to identify the particular research design, to name a couple: 29 How can I improve my personal practice? How can I improve my understanding of this?

This is because action research is a type of practitioner research that works as a tool to help improve professional activities in various types of workplaces.30 A quality criteria used to judge how good the theory is will focus on its ability to provide a practical solution in reallife situation.31 Greenwood goes further to argue that it is far more likely than conventional forms of social research to produce reliable and useful interpretations of social phenomena because the research validity can be tested in action.32

29 30

Mc Niff, J. (1996:16) Mc Niff, J. (1996:7) 31 Greenwood, D., et al. (1998:19) 32 Greenwood, D., et al. (1998:54)

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Action research can be considered as a process that contains five phases: diagnosing, action planning, action taking, evaluating, and specifying learning.33

Figure 2.2: Cyclical Process of Action Research

Source: Susman,G., (1981:146)

2.4.1 Our motivation of research method

The motivation for using Action research as a research method is because our subject company, Alfa Laval, has diagnosed a practical problem they are experience and we have the task of solving it. Our work is characterized by finding a better solution for the current situation.

33

Susman, G. (1981:146)

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2.5 Data Collection- Theoretical and Empirical

Doing research requires the collection of different data sorts; theoretical and empirical. The empirical evidence, similar to what was mentioned under qualitative analysis, can come from documents, archival records, interviews, direct observations, participant-observation, etc.34 Data may fall into the category of primary or secondary data collection. Primary data is collected from research, surveys, content analysis, etc. conducted by the researcher for his/her own purposes. Secondary data, is this case, is data already collected by the studied organization for its own purposes. Some benefits to secondary data is that it reduces collection time and cost, and leaves more time for data analysis.35 Some limitations include lack of familiarity with the data, complexity of the data, no control over data quality and absence of key variables.36

2.5.1 Our data collection method

Our data collection method is composed mostly of secondary data. Here, secondary data applies to previous demand forecasts and historical demand data taken from the subject companys ERP system. It is raw data and classified in a way that meets the needs of the company. Therefore, information from different places in the ERP system have to be gathered and sorted by us as much as possible before it can suit the objective of the study and be used in our analysis. Due to confidentiality concerns, some information pertaining to the demand forecasting and historical demand data will not appear in this paper. Theoretical data collection consists of information found in previous papers, books, articles, and also on the Internet. Vaxjo University library is the primary source for these media. Besides books, we have used the ELIN, and E-brary to locate articles. Our data collection will focus on books or peer-to-peer articles concerning purchasing, and application of various forecasting theories.

34 35

Yin, R. (2003:86) Bryman, A.. (2007: 328-333) 36 Bryman, A.. (2007: 334-336)

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2.6 Scientific Credibility

The aim of all research is to create new knowledge. The social intent of research is to improve a particular situation. Features of traditional research are replicability and generalizability. If the method and its finding can be generalized to all situations, then the research is proven to have external validity. Research of high quality is characterized by meeting replicability meaning that it enables other people to do the same thing with the same results. However, the criteria for high quality research are not appropriate for action research. The replication or generalisation is not possible, nor desirable. The aim is to understand rather than to predict. Action researchers do research with other people to understand and contribute to improvement of their social practices.37 Researchers share peoples knowledge collaboratively. This results in the construction of collective knowledge. Action research is not build of replicability and generalisability but of knowledge constituted of case studies. The stories of all people involved in a particular research are accumulated and demonstrate a culture of collective knowledge.38 Greenwood describes credibility in action research as the arguments and the processes necessary for having someone trust research results. First there is knowledge that has internal credibility to the group generating it. This is vitally important to action research because of the collaborative nature of the research. Second, there is external credibility knowledge capable of convincing someone outside the project that the results are believable.39 As seen in Figure 2.2, action research operates in cycles. The pattern of each cycle is the identification of an issue, imagination of solution, implementation of solution, gathering of evidence, evaluation of solution resulting into the modification of practice. It is recommended to make intermediate progress reports throughout each cycle. These reports represent formative evaluations to check that one is in line with answering the research question. 40

37 38

Mc Niff, J. (1996:106) ibid (1996: 107) 39 Greenwood, D., et al. (1998:80-81) 40 Mc Niff, J. (1996:108)

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Some forms of validation:41 Self - validation: Researcher should be able to show to his own satisfaction that he has been done the things he set out to do. Up-liner validation: To show to managers and authorities that an intervention has been done to improve the practice and the way of working could be adopted. Client validation: The intervention should contribute to improvement of quality of clients life. Academic validation: This validation is done by the academic community in terms of whether it agrees that the researcher has contributed to a new knowledge.

2.6.1 Our choice of scientific credibility

This paper will use the form of client validation. Our recommendation should improve the current forecasting situation at the OM-CP business unit. To guarantee internal credibility, we will present to Alfa Laval a description of their current forecasting situation. On a regular basis, we will provide updates about our partial findings and progress and solicit feedback on our interpretation. All empirical findings and analyses will be documented and made available to the client in order to increase the credibility of our research. Collaboration between the company and us is critical to ensure our full understanding of the clients current situation and demands. We believe that all these steps will lead to final knowledge that convinces observers outside the project that the studys results are believable and useful in contributing to new knowledge.

41

Mc Niff, J. (1996:108)

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2.7 Summary of Methodology Methodology in General

Scientific Perspective Scientific Approach Research Strategy Research Method Theoretical Data Collection Empirical Data Collection Scientific Credibility
Figure 2.3: Summary of methodology

Methodology in this Thesis

Interpretative Deductive Quantitative Action Research Articles, books, ELIN, Internet Unstructured interviews, secondary data, brochures Client validity

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3. Theory

he theory chapter aims to present different methods for forecasting demand. We discuss two types of demand forecasting: subjective and objective. Next we identify behaviors that impact time series analyses. It is followed by several well-known

methods to evaluate forecasting error. Subsequently, a theoretical framework is provided to summarize the connection between the theories.

3.1 Demand forecasting - Subjective and Objective

When the result of an action is of consequence, but cannot be known in advance with precision, forecasting may reduce decision risk by supplying additional information about the possible outcome.42 There are two main approaches to forecasting, subjective or objective, and sometimes a company may opt to use a combination of both approaches to predict demand. It should be noted here that some authors use the terms objective and subjective43 while others use the terms quantitative and qualitative44, and still others use the terms judgemental and statistical.45 For the sake of consistency, we use the terms subjective and objective in this study. A discussion of both approaches follows.

3.1.1 Subjective forecasting approach

Subjective forecasting is based on human judgement. There are various types of subjective techniques:46 Sales force composites The sales force is in direct contact with customers so they have an advantage of having a pulse on consumer preferences. Based on this information members of the sales force can provide a sales estimate of products they plan to sell in the forthcoming year.

42 43

Kalekar, P., (2004:1) Nahmias, S. (2005:51) 44 Martin, J. (2008:222) 45 Armstrong, J. (2001:22) 46 Nahmias, S. (2005:55-56)

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Customer surveys These surveys or questionnaires, if properly conducted, can indicate future trends and oscillating preference patterns.

Jury of executive opinion If there is no past history data (such as for a new product) then expert opinions can be used as a source of information to derive a forecast. These opinions are collected from individual sources in several ways. One is for the person assembling the information to interview the managers directly, the second is to hold a group meeting for the managers to come to a consensus.

Delphi method This is similar to the jury of executive opinion in that it is based on expert opinions. It differs in that the managers are individually surveyed - no group meeting - so that no personality can influence another in the group.

In short, subjective technique can encompass simply asking for managers opinions, polling an organizations sales force, or bringing people together who have knowledge of a particular customer segment.47

3.1.2 Objective forecasting approach

Objective forecasting is derived from analyzing data from past history and generally falls under two categories of analysis time series analysis and regression models (causal). Time series analysis uses only the past history of the series to be forecasted.48 The goal is to identify repeatable and predictable patterns in preferably several years of past data. An example of time series forecasting is to predict sales for the next quarter based on sales from this quarter.49 Regression models typically include the past history of other series. Therefore a model can be constructed to predict one phenomenon based on the development of other phenomenon.50 An example would be predicting inflation (dependent variable)

47 48

Martin, J. (2008:222) Nahmias, S. (2005:51) 49 Martin, J. (2008:222) 50 Nahmias, S. (2005:51)

26

based on various factors such fiscal policies, agricultural performance, etc (independent variables). In this study we will focus on the objective forecasting approach using times series analysis. This analysis model is further discussed under section 3.2 Time series analysis.

3.1.3 Summary of subjective and objective approaches

In summary one can say that each approach has unique advantages (see Figure 3.1). For instance, subjective approach is good when used to estimate a new product or service demand. It also provides an opportunity for the company to develop relationships with clients through closer communication. The objective approach is good when used to estimate demand of existing products; however one need several years of demand patterns and it may encounter accuracy concerns. In addition, it is difficult to use when considering unusual events that impact customer demand, i.e. a recession.51 Description Applicability Subjective Approach Used when situation is vague and little data exist (e.g., new products and technologies) Considerations Techniques Involves intuition and experience Jury of executive opinion Sales force composite Delphi method Consumer market survey
Figure 3.1: Summary of qualitative and quantitative forecasting approaches Source: SME Toolkit.org52

Objective Approach Used when situation is stable and historical data exist (e.g. existing products, current technology) Involves mathematical techniques Time series models Causal models

51 52

Martin, J. (2008:224) http://www.smetoolkit.org/smetoolkit/en/content/en/416/Demand-Forecasting (2008-04-29)

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3.2 Time series analysis

As mentioned under 3.1.2 Objective forecasting approach, time series analysis and regression models are used to analyze past series of data. However, time series forecasting has the largest number of applications of any approach to forecasting encompassing production planning, budgeting, inventory management, distribution, sales and marketing, which all depend on accurate forecasts.53 Time series analysis better suits this study due to predicting demand for coming periods based on demand for same units in past periods. Time series methods of analysis assume that a time series is a combination of a pattern and some random behaviour.54 The goal is to separate the pattern from the white noise by understanding the patterns trend, its long-term increase or decrease, and its seasonality. Because it requires no other information than the past observations of the phenomena being analyzed, time series methods are often referred to as nave methods.55 When demand is stable and few changes are expected to adjust the timing and volume of demand, the time series analysis may be the most accurate input into demand planning.56 This type of forecasting is also a necessity for companies that produce hundreds or more of items.

3.3 Definition of Time Series Behaviours

It is useful when conducting time series forecasting to understand the causes of demand variations.57 These demand variations can be broken out into components (otherwise called patterns or behaviours). Some of these components are trend, seasonality, cycles and randomness. They are defined as:58 Trend Refers to a tendency to show a stable pattern of growth or decline. Seasonality Pattern that repeats at fixed intervals, i.e. ice cream consumption exhibits a seasonal pattern with increased demand during the summer.

53 54

Armstrong, J. (2001:209) Kalekar, P., (2004:2) 55 Nahmias, S. (2005:57) 56 Crum, C., (2003:32) 57 Lapide, L., (1999:29) 58 Nahmias, S. (2005:58-59)

28

Cycles Variations similar to seasonality except the length and magnitude of the cycle may vary. For example: a long-term economic business cycle that may be present in addition to seasonal fluctuations.

Randomness - A series where data shows no recognizable pattern. One can generate patterns purely at random that often appear to have structure.

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3.4 Models for Time Series Forecasting

Below is a summary of major time series models and their applications. It should be noted that much more involved models exist; however, the main ones are presented below. Trend plot Time series decomposition Plots time series data versus time without creating mathematical model Breaks a time series into its level, trend, seasonal, and irregular components. It models both trend and seasonal patterns using constants calculated from the decomposition. A time series model created by taking the average of observations from the time series to smooth out seasonal or other data patterns. Models a level (stationary) time series, i.e., no trend or seasonality, using one smoothing parameter. Models a level (stationary) time series with a trend but no seasonality using two smoothing parameters. Models a level (stationary) time series with a trend and seasonality using three smoothing parameters. Statistically based time series models that model level, trend, and seasonal components of a time series.
Source: Martin,J. (2008:240)

Moving average models

Simple exponential smoothing

Double exponential smoothing (Holts method) Triple exponential smoothing (Winters method) Autoregressive integrated moving average (ARIMA) models
Figure 3.2: Major Time Series Models

Of these models, the following appear in the empiric and analysis of this study: Moving average (and weighted moving average) models, Simple exponential smoothing, Double exponential smoothing, and Triple exponential smoothing.

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3.4.1 Moving average

Moving average is the simplest forecasting method. The moving average of demand N is calculated as the average of the most recent N data observations.59 It is good at matching the average level of the time series period by period and it will follow the up- and downward movement of a time series.60 A common disadvantage of this method is that one must recalculate the average of the last N observations each time a new demand observation becomes available.61 The N parameter (representing the number of periods) in moving averages is similar to the smoothing parameter of used in exponential smoothing (discussed below in 3.4.2 - Simple exponential smoothing). A small N puts more weight on recent observations, whereas a bigger N puts greater weight on past observations. Ft is the forecast made for period t in period t-1 and it is given by:
t-1

Ft = (1/N)*

Di = (1/N)*(Dt-1 + Dt-2 + + Dt-N)

i = t -N

The formula represents a one-step-ahead forecast. Dt = observed values of demand during periods of time t (Dt, t 1) N = number of all past observations di = value of all past demand observations
Source: Nahmias, S. (2005:64)

59 60

Nahmias, S. (2005:63) Martin, J. (2008:245) 61 Nahmias, S. (2005:64)

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Weighted moving average A weighted moving average adjusts the moving average method to reflect fluctuations more closely by assigning weights to the most recent data, meaning that the older data is usually less important. weights.63 Forecast in period t : Ft = (*(Dt-1+ + Dt-3) + *(Dt-4++ Dt-6) + *(Dt-7 +...+ Dt-12))/12
62

The weights lie between 0.0 and 1.0 for a total of 1.0. The higher the

weight, then the higher importance we place on more recent data; similarly, for lower

3.4.2 Exponential smoothing

Exponential smoothing is another well-used forecasting method for stationary time series. The current forecast is the weighted average of the last forecast and the current value of demand.64 It is a good technique for continually revising a forecast when taking into consideration more recent experiences. In other words, recent observations are given more weight in a forecasting than older observations.

Simple exponential smoothing Simple exponential smoothing constructs the forecast as a combination of previous demand weighted by a smoothing parameter . The larger the , the more heavily recent demand will be weighted in a forecast. This is good for short-range forecasting; usually a month into the future.65 The smaller the , the more heavily past demand will be weighted and forecasts are more stable. Therefore, having a value of between 0.1 and 0.2 generally represents a stable forecast and is recommended for production planning purposes.66 A drawback to simple exponential smoothing is that it is not designed to forecast time series exhibiting trend or seasonal behaviours.

62 63

http://www.smetoolkit.org/smetoolkit/en/content/en/416/Demand-Forecasting, 2008-04-29 http://shmula.com/308/forecasting-unweighted-and-weighted-moving-average-model, 2008-04-29 64 Nahmias, S. (2005:66) 65 Kalekar, P., (2004:3) 66 Nahmias, S. (2005:69)

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Formula:

Ft = *Dt-1 + (1-)*Ft-1
That is: New forecast = (Current observation of demand) + (1 - )(Last forecast)

Smoothing constant:

0< 1
Source: Nahmias, S. (2005:66)

Double exponential smoothing (Holts method) Double exponential smoothing, Holts method, is designed to track time series with linear trend. In other words, it is best used when data shows a pattern of trend. It works like simple exponential smoothing except that two components, level of the time series (expressed as the intercept) and trend (expressed as the slope), must be updated each period. Below is a figure demonstrating an intercept and slope. The green line represents demand, red represents forecast. An example of the slope and intercept are shown at the tail end of the forecast.
Sales

Intercept

Slope

Figure 3.3: Intercept and Slope

Extracted from Lawrence, S. (2008:23)

A drawback using this analysis, similar to simple exponential smoothing, is how to first get the method started. The best way to combat this is to establish a set of initial periods as a

33

starting point and use regression analysis to make estimates of the slope and intercept using the starting point data.67 Also this method does not consider seasonal behaviours.

Formula: -step-ahead forecast made in period t Intercept: Slope: Smoothing constants:

Ft, t+ = St + Gt

St = *Dt + (1-)*(St-1 + Gt-1) Gt = *(St-St-1) + (1-)Gt-1

0< 1 0< <= 1
Source: Nahmias, S. (2005:76)

St = the value of the intercept at time t Gt = the value of the slope at time t Note: When the smoothing constant is close to 1.0, more weight is given to recent observations (quick dampening). When it is close to 0.0, relatively less weight is given to recent observations (slow dampening). 68 Triple exponential smoothing (Winters method) Winters method is built on the previous Holt method and is designed to handle time series base, trend, and seasonal behaviours by using three smoothing parameters: to smooth base, to smooth trend, and to smooth seasonality.69 This method provides an advantage in that it is easy to update as new data is received.70 The following model is assumed:

Dt = ( + Gt)*Ct + t
67 68

Nahmias, S. (2005:77) http://openforecast.sourceforge.net/docs/net/sourceforge/openforecast/models/DoubleExponentialSmoothingM odel.html, 2008-05-23 69 Martin, J. (2008:247) 70 Nahmias, S. (2005:83)

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There is the base signal or intercept at time t = 0 excluding seasonality, Gt is the trend or slope component, Ct is the multiplicative seasonal component i period t, and the error term is expressed as t.71 To initiate the model, one must obtain a building block of estimates for the series, the slope and the seasonal factors. It is suggested that one must have at least two seasons of data to initiate the model; however, it is not the only way to start.72 Seasonal factors could be determined by a moving average method, or by using the slope and intercept values as proposed in Holts double exponential smoothing model. A drawback to using this model is that the calculations become tedious since one has to test many combinations of the three parameters. In addition, there is no assurance that the best values of the smoothing parameters based on past data will be the best values to use in future forecasts. The best assurance in this scenario is to choose smoothing parameters between 0.1 and 0.2.73 Formula:

Ft, t+ = (St + Gt)*Ct+-N St = *(Dt/Ct-N)+(1-)*(St-1 + Gt-1) Gt = *(St-St-1) + (1-)Gt-1 ct = *(Dt/St) + (1-)*Ct-N

Smoothing constant:

0< < 1 0< < 1 0<<1

Source: Nahmias, S. (2005:84)

Ft = the forecast made in period t for any future period t + , it assumes tN St = smoothes the base forecast; the current level of deseasonalized serie Gt = smoothes the trend forecast

ct = smoothes the seasonal forecast

71 72

Nahmias, S. (2005:83) ibid (2005:86) 73 ibid (2005:88)

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3.4.3 Autocorrelation
Before using Winters method, it is recommend to first test for autocorrelation. Autocorrelation is the correlation of a time series with its own past and future values.74 In other words, the autocorrelation function helps test for the presence of patterns, seasonality. For example, if low values in historical data tend to be followed by low values two periods later, then the series exhibit a positive autocorrelation. A positive autocorrelation denotes the presence of seasonality and therefore triple exponential smoothing method is recommended. Under the right circumstances it may outperform simpler forecasting methods. A negative autocorrelation would denote the lack of seasonality; therefore triple exponential smoothing would not be recommended. At least 72 periods of observation are recommended in order to get a reasonable estimate using the autocorrelation function. 75 An autocorrelation is calculated as some value between -1 and +1. The value +1 indicates strong positive autocorrelation; -1 indicates strong opposite (negative) autocorrelation; 0 means no autocorrelation.76

Rn =COR(Dt, Dt-n) = COV(Dt, Dt-n)/(STD(Dt)*STD(Dt-n)) COV = covariance of Dt and Dt-n STD = standard deviation of Dt and Dt-n
Source: Hoff, J. (1983:280)

3.5 Evaluating forecasting accuracy

One should take precautions to conduct unbiased forecasts and one way to test this is through measurements of forecasting error. Forecasting error in period t, et is the difference between the forecast value for that period and the actual demand for that period. The formula for obtaining the forecast error for onestep-ahead forecast is following:

et = Ft - Dt
74

http://64.233.183.104/search?q=cache:aYWnjh43K6oJ:www.ltrr.arizona.edu/~dmeko/notes_3.pdf , 2008-05-23 75 Nahmias, S. (2005:91) 76 Hoff, J.C. (1983:55)

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There are three often-used measurements of forecasting accuracy MAD, MSE, and MAPE. Although MAD and MSE are most commonly used, MAD is usually preferred because it does not require squaring. MAPE is a measurement not dependent on the magnitude of the values of demand. 77 1. MAD (mean absolute deviation) measures average absolute deviation of forecast from actuals. It is the average of all forecast errors divided by n periods. All errors are treated as a positive value.78
n

MAD = (1/n) |ei|

i=1

2. MSE (mean squared error) measures variance of forecast error. It is the average of the sum of the squared errors divided by n periods.79 This method puts more weight to large errors.80
n

MSE = (1/n) ei2

i=1

3. MAPE (mean absolute percentage error) measures absolute error as a percentage of the forecast. It is the average of all the ratios 100ei/Di, where Di is the value of demand and ei is the forecast error at period i divided by n periods.81
n

MAPE = [(1/n) |ei / Di|] x 100

i=1

As mentioned earlier, one should have an unbiased forecast. To that end, there are different ways of tracking a forecast method. One of them is to graph the values of forecast error ei over time. Forecast errors should fluctuate randomly above and below zero if the method is unbiased. Another method is to sum all the forecast errors, ei. If the value of this moves too far away from zero (either above or below), it indicates that the forecasting method is
77 78

Nahmias, S. (2005:60) Hoff, J.C. (1983:262) 79 ibid (1983:272) 80 Andersson, G. (1994:206) 81 Hoff, J.C. (1983:263)

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biased.82 MAPE puts less weight to large forecast errors than MSE. It is useful to use for comparing between different time series because the error is divided by corresponding demand value.83

82 83

Nahmias, S. (2005:61) Andersson, G. (1994:206)

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3.6 Theoretical framework

To facilitate a clear understanding for our readers, we present the following model to visualize the connection between different parts of the forecasting theoretical framework. The highlighted areas directly affect our action research study.

Demand forecasting

Subjective (Human judgment)

Objective (Mathematical)

Time series methods Characterized by patterns: -Trend -Seasonal -Cycles -Randomness

Regression (Causal) Characterized by dependent variables and independent variables

Time Series Models of Analysis -Simple Moving Average -Weighted Moving Average -Simple Exponential Smoothing -Double Exponential Smoothing (Holts method) -Triple Exponential Smoothing (Winters method)

Evaluating forecast accuracy -MAD -MAPE -MSE

Figure 3.3: Theoretical framework

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4. Empirical

a short reintroduction of the company; followed by information about the current ordering process for raw materials, demand forecasting, and forecast and error evaluation models currently used at Alfa Laval. Then we introduce the items to be analyzed and discuss how data was gathered.

his chapter contains the empirical data collected throughout the action research study at Alfa Laval in Lund. The questions can be seen in Appendix 1. We begin with

4.1 Reintroduction of Alfa Laval

Alfa Laval employs 10,000 people worldwide. The company provides various products and solutions for centrifugal separation, filtration, fluid handling, and heat transfer. The facility in Lund, Sweden employs 1,100 people and is responsible for the production of plate heat exchangers, which fall under the category of heat transfer. Purchasing and storage of raw material, and production take mostly place at the facilities in Lund. The facility at this location is responsible for the production and storage of plate heat exchangers. Several components such as stainless plates (i.e.: steel, titanium etc), frames and gaskets go into the production of these plate heat exchangers. The OMCP business unit is responsible for ordering and receiving these materials to meet customer demand. This study will focus only on the raw material demand of stainless steel plates (a variety of metals - stainless steel, titanium, etc.) in form of coils or sheets to be later transformed into plates used for heat exchanger products. OM-CPs manufactures the plate heat exchangers per orders from the internal customer, the SU (Supply Unit), located at the same location in Lund. The SU then produces the plate heat exchangers per client specifications and is responsible for quality control and subsequent delivery to the end customers. The customers represent companies in various sectors such as hospitals, brewery, food industry, oil and gas industry, marine etc.

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4.2 Interviewees
We received assistance from Tobias Augustsson, Martin Jnsson, and Lars Hedberg of the OM-CP unit throughout this study.

4.3 Ordering Raw Material at Alfa Laval

Alfa Laval has a plethora of product offerings, so for the purpose of this case we will only focus on the purchase of stainless steel coil that fall into the A or B category (using A-B-C classification). This means that for all stocked items, A items represent 80% of the volume value, and B items represents 15% of the volume value. In other words, these items of higher value will give more frequent procurement and therefore need more attention in inventory management.

4.3.1 How an order is placed

The OM-CP unit receives internal orders from SU per customer specifications. An order handler keys the order into Jeeves, the ERP system. Next, a purchaser reviews the order in Jeeves. Purchasers are assigned responsibility for different plate types. At OM-CP two purchasers are assigned to stainless steel products and they also handle product forecasting. Upon review, if the required raw material component is below the necessary stock level, then the purchaser must place an order to one of the stainless steel suppliers (currently five or six available). The order quantity is communicated to suppliers in terms of kilograms. In Jeeves it is recorded as quantity in kilograms and also converted into quantity of pieces for internal communication purposes. Below is a diagram overview of the order process.

Figure 4.1: Current order and forecasting process

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4.3.2 How forecasting of raw material demand is done

Forecasting for all Alfa Laval suppliers is conducted once a month. The forecasting is based on data found in Jeeves and recorded as items delivered from stock. However, delivered from stock is not necessarily a true representation of the demand since situations arise where orders gets placed, but not fulfilled due to lack of stock. The SU places orders to stock, however the measure of demand is calculated based on what has actually been delivered from stock. For example, if SU places an order for a plate product but this product is not in stock, then demand is recorded as zero (0) because for the purpose of forecasting, Alfa Laval considers demand based on what is delivered from stock.

4.3.3 What the forecast sent to suppliers is based on

A one year forecast is automatically generated in Jeeves using different forecasting methods. The value is then divided by fifty (50 weeks/year) in order to get an average forecast for one week. This value will later be used to calculate two and three month forecasts. In order to get forecast for the three following months (two and then one), the one week forecast is multiplied by the number of weeks of the two nearest months and in the same manner also by the number of weeks in the third month. Purchasers have to manually adjust (subjective forecast) this statistical forecasting every month to take into consideration known information such as current orders. However, the purchasers do not record their subjective forecast adjustments in the system. The adjustments are only recorded in excel spreadsheets, not in Jeeves. Therefore, it is not possible for the database to capture a real history of how much the demand was adjusted up or down. These manipulated (subjective) forecasts are sent to a supplier containing raw material demand one-month, three-months and 12-months ahead. Updating of forecasts for suppliers is done on a monthly basis.

4.3.4 Forecasting accuracy calculations

Forecasting accuracy (testing the level of forecasting error) is also updated once a month. The accuracy result measurement is currently about 50% correct so there is a lot of room for improvement. However, the accuracy of measurement is based only on data registered in Jeeves, which does not take into consideration manual adjustments of forecasts.

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Calculation: Each month is the forecast value for the next 12 months divided by 4 in order to get a 3 month forecast. This value is then compared to real demand (delivery from stock) during the past 3 months. Next, the error is expressed as a percentage of the forecast. There is a limit for accepted forecast error. It should have an accuracy of 30 %. In Jeeves, the values falling within the limit are classified as 0 and those exceeding the limit as 1. See Appendix 5 for further explanation and analysis of Alfa Lavals accuracy evaluation method. Alfa Lavals formula for estimating the forecast error as a percentage (%):

et =((D3m F3m)/F3m)*100
et = forecast error in period t

D3m = Demand (Delivery from Stock) - sum of the past three months F3m = Forecast - usage one year ahead divided by four

4.3.5 Six Sigma

Forecasting error is measured in the DPMO-measurement system (defects per million units) within the Six Sigma program. This quality control also contains an assessment of how large a forecasting error has been made (the forecasting errors exceeding the limit of 30 % are registered in Six Sigma). Unfortunately, current forecasting does not show any improvement what so ever. Incorrect forecastings are at 50%.

4.3.6 Results of poor forecasting at Alfa Laval

If a forecast is too high and the supplier produces the volume, then most likely Alfa Laval has to follow through with the purchase even if that quantity is not required at present. However, there is a certain margin built into the forecasting in terms of + and - quantity. The margin is negotiated with each supplier. There is no universal margin across all suppliers. Under forecasting can lead to shortages in stock, which halts production because of lack of material. However, this is a very rare occurrence.

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4.4 Current forecasting models

Alfa Laval has a selection of four different forecasting models. Two of them are named after facilities located in Lund. In other words, the products manufactured at the facility located at resundsvg were forecasted using a method named -vg method. In the same manner, products manufactured at a facility in Gunnesbo used Gunnesbo method. This manner of using a model based on where the production takes place is no longer in use. However, these forecast models have been grand-fathered into the system, meaning that current employees dont really know when or how they came into being, only that the methods seems to be appropriate for current demand forecasting needs. The four forecasting models are: 1. resundsvg (-vg) resembles weighted moving average in which the most weight is placed on the last three months. Forecast in period t: Ft = (*(Dt-1+ + Dt-3) + *(Dt-4++ Dt-6) + *(Dt-7 +...+ Dt-12))/12

Dt = Demand (Delivered from Stock) in period t

Weighted factors: =2 =1 = 0,5

2. Gunnesbo (G-BO) weighted moving average in the same manner as resundsvg method the most weight is placed on the last three months. We have found no evidence of this method being used. Forecast in period t: Ft = (*(Dt-1+ + Dt-3) + *(Dt-4++ Dt-6) + *(Dt-7 +...+ Dt-9) + + *(Dt-10 +...+ Dt-12))/12

Weighted factors:

= 1,25 = 1,10 = 0,9 = 0,75

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3. RAK straight moving average the weight is distributed evenly on all the twelve past periods. Forecast in period t: Ft = (*(Dt-1+ + Dt-12))/12 Weighted factor: =1

4. Exponential smoothing the forecast in period t is the weighted average of the forecast in period t-1 and the current value of demand in period t-1. Ft = *(Dt-1+ (1- )*Ft-1 Smoothing constant: = 0,1

However, this method, though available in Jeeves is not used. Note: Theory dictates that the smoothing constant values should be >0 and <1 and that the average of weighted factors should be 1.

45

4.4.1 Summary of the forecasting methods used by Alfa Laval

Note: -01 represents the most recent past month; -12 represents 12 months ago. Each column to the right of Period represents a weight assigned to that period. Exponential smoothing is not listed as we saw no evidence of its use. (see Figure 4.2) Period -12 -11 -10 -09 -08 -07 -06 -05 -04 -03 -02 -01 Gunnesbo (G-BO) Weighted factors 0,75 0,75 0,75 0,90 0,90 0,90 1,10 1,10 1,10 1,25 1,25 1,25 RAK Weighted factors 1 1 1 1 1 1 1 1 1 1 1 1 resundsvg (-vg) Weighted factors 0,5 0,5 0,5 0,5 0,5 0,5 1,0 1,0 1,0 2,0 2,0 2,0

Figure 4.2: Summary of the forecasting methods used by Alfa Laval

4.5 Items to be analyzed

Below is a summary of selected raw materials and the corresponding forecasting method used at Alfa Laval. Alfa Laval suggested these items for the purpose of conducting the analysis. As mentioned earlier, these items were selected based on high order quantity and value. Data was obtained from the ERP system, Jeeves. To respect Alfa Lavals confidentiality agreement, original item names and numbers will not be presented in this study. Instead, they are replaced by numbers of convenience.

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Raw Material Item Number 3 105 208 310 413 487 590 693 796 899 973 1014 1117 1220 1266 1369 1473

Current Forecasting Method Rak -vg -vg -vg -vg Rak -vg Rak -vg -vg -vg -vg -vg Rak Rak -vg Rak

Raw Material Item Number 1577 1681 1784 1806 1827 1906 2009 2103 2207 2229 2332 2410 2513 2591 2713 2816 2846

Current Forecasting Method -vg Rak -vg Rak Rak -vg Rak Rak Rak Rak -vg -vg Rak -vg Rak Rak Rak

Rak: Straight Moving Average

-vg: Weighted Moving Average

Figure 4.3: Current forecasting methods for selected raw material items

4.6 Gathering of data

There are 34 raw material items to be analyzed in this study. Approximately half are currently being forecasted using the resundsvg forecast; the others use Rak method. The data for this study is a compilation of secondary data (i.e. data we extracted from Jeeves and transferred to Excel sheets) and primary data information gathered from unstructured interviews, which influence our approach on how to analyze the data. We received training to use Jeeves to extract past demand history for the raw material items.

47

The historical data we gathered and sorted are presented in Appendix 2 and have the following characteristics: Observations of only one phenomena demand of raw material items based on past values of Delivered from Stock Historical data is chronologically sorted (ie: 2001 - 2008) The quantity of available past data varies (ie: varied numbers of observation) Several zero (0) values are presented (ie: recorded as 0 delivered from stock)

After the historical data for demand of raw material was obtained and chronologically sorted, it was of great importance to identify patterns (seasonality, trend) in data. This will be discussed further in Chapter 5.

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5. Analysis

n the analysis chapter we use various forecasting theories to analyze demand for raw material items presented in the empirical chapter. We will seek to offer options of

theoretical model that can provide better forecasting accuracy in practical applications.

Note: Due to the huge amount of data produced during our study, the Appendix 2, 3 and 4 in this report will present the analysis of one raw material item only to illustrate our approach. The data and the complete analysis of all items are included on the CD.

5.1 Foundation of analysis

Our analysis was based on time series methods because the objects of our study have historical observations of repeatable demand that span several years. As mentioned in the theory chapter, time series analysis is a necessity for companies that produce hundreds or more of items. Both criteria are suitable for the raw material analyzed in this study. At Alfa Laval, demand is measured as delivered from stock. This poses a challenge when evaluating demand this way because we can only conduct an evaluation based on what has been shipped from stock causing a blind spot that makes it difficult to perform a proper analysis of periods where no demand was recorded as shipped from stock. In other words, it means that technically the actual demand is not captured. This caused some difficulty in the analysis and forced us to consider using different methods of analysis better suited for the perception of 0demand. It also prevented us from being able to evaluate some of the other selected coils as many periods showed a zero value, when in actuality there is a demand, but it was not captured in the system because nothing was delivered from stock. If the correct amount demanded is not available, then 0 product is delivered from stock. In addition, our evaluation of such coils was hampered in that the periods of 0 value sometimes spanned a significant number of periods, thereby reducing the number of historical periods available for evaluation making time series method of analysis inappropriate for some coils.

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5.2 Raw material analyzed

We had a selection of 34 coils (raw material items, in the following) to evaluate. Based on the time required to fully analyze each coil, the behaviour exhibited by some coils during our analysis, and the 0 value problem, our study refocused on the analysis of 12 of the raw material items (see Figur 5.1).Nine of them have all past demand values available and three contain 0 values in the original data. The remaining items contain too little historical data or too many zero demand values and therefore they are not appropriate for analyzing with time series forecasting methods. The following 12 raw material items were analyzed:

Raw Material Item Number 3 105 208 310 487 590 693 796 1117 1266 2410 2513

Current Forecasting Method Rak -vg -vg -vg Rak -vg Rak -vg -vg Rak -vg Rak

Figure 5.1: Raw material item numbers and current forecasting methods

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5.3 The analytical process

Following is the step-by-step process we took to analyze the raw material items. A snapshot of the physical analysis accompanies a written description. Appendix 3 contains complete analysis of one raw material item. (See the note in the beginning of this chapter.) Step 1 Demand data was gathered and sorted in chronological order from Jeeves database. Demand is based on delivery from stock (see Figure 5.2 and also Appendix 2 for complete list of historical demand data for one item).

Figure 5.2: Historical demand data - snapshot

Step 2 Where demand is positive in most periods and there were some 0periods, these periods were corrected to an average of the before and after period, or as a multiple-period average. The reason for correcting 0periods is because they would otherwise disrupt the formula for

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computing the forecasting accuracy (MAPE). Another reason is that the time series methods require more or less constant demand. As seen below, the new demand data to be used for analysis appears under the column Data Correction. See enclosed CD for complete data for all raw material items.

Figure 5.3: Historical demand with corrected values

Step 3 After each raw material item was scrubbed and 0 periods corrected, a diagram was created of the demand data to show if a trend or season in demand exists. If a trend exists, this is a good indication that Holts method ought to be used. (see Figure 5.4)
Delivery from Stock (Item Nr.3)
60000

50000

40000

Pcs

30000

Delivery from stock Linjr (Delivery from stock)

20000

10000

0 1 5 9 13 17 21 25 29 33 37 41 45 49 53 57 61 65 69 73 77 81 85 89 93 97 Months

Figure 5.4: Delivery from stock (raw material item nr. 3) with increasing linear trend

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Step 4 We then programmed time series methods formulas and autocorrelation into an excel spreadsheet. Each of the twelve raw material items is analyzed by each of the six methods: Moving average, Simple exponential smoothing, Double exponential smoothing, Rak, -vg, and Triple exponential smoothing (see enclosed CD). Recall that Rak and -vg are methods currently being used at Alfa Laval. All the six forecasting methods are programmed in excel to work automatically. However, some adjustments have to be made in order for the methods to perform correctly for each specific item. Such adjustments are: The demand data must be pasted to the column Delivered from Stock. This applies to each method. If required, the parameter and number of periods (n) have to be adjusted. To start the Single and Triple exponential smoothing methods, initial values are required. To start the value, for single exponential smoothing, we take the average of the ten first demand observations; and for triple exponential smoothing, we take the demand average of two separate seasons (V1, V2). After the initial data are selected, the different parameters such as smoothing constants (, , and ) have to be tested in order to get the demand forecast with the lowest error. A snapshot of one of the analyzing methods, a moving average, of one raw material item is in Figure 5.5.

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Figure 5.5: Snapshot of moving average analysis

Before triple exponential smoothing (Winters method) is applied, we use an autocorrelation test of the data looking for evidence of seasonality. With autocorrelation we test if a relationship between the data exists. By removing the trend from data we can see if there is some other pattern left such as seasonality or just pure randomness (See Appendix 3). If seasonality exists, the correlation should not be 0. Then Winters method can be recommended.

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Step 5 Evaluating forecast error As mention above, depending on the method applied, we then had to adjust alpha, beta, and gamma (smoothing constants) and use MAD, MAPE, and MSE to determine the lowest forecast error of each method for each item. To evaluate the single, double exponential smoothing, -vg and Rak methods we calculate the value of MAD, MSE and MAPE both on one-month and three-month bases (see Figure 5.6). Since the moving average analysis doesnt require a smoothing constant, we tested different n - step ahead moving averages in order to determine which of them gives us the lowest error.

Figure 5.6: Snapshot of MAD, MSE and MAPE in double exponential smoothing analysis

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Evaluating Alfa Lavals forecasting methods (-vg and Rak) We used three alternatives to evaluate Alfa Lavals forecasting methods: 1. Alfa Lavals internal error evaluation method for forecast accuracy: Each month is the forecast value for the next 12 months divided by 4 in order to get a 3 months forecast. This value is then compared to delivery from stock values (real demand) during the past 3 months. Next, the error is expressed as a percentage of the forecast. *Note: It seams this evaluation method is probably incorrect. In Appendix 5 we provide a detailed mathematical analysis of the methods in order to demonstrate the incorrectness of this method. This is the reason why we compute the forecast accuracy using another method (explained below) based on the theory as presented in the Theory Chapter 3.5. 2. Theory based error evaluation (1 month): In the second alternative, we divide the one-year ahead forecast by 12 in order to get forecast in period t. Next the forecast is compared to the real demand in period t. 3. Theory based error evaluation (3 months): The last alternative is the same as the previous but calculated on a three month basis. *When Alfa Laval evaluates the forecasting accuracy, the forecast error is divided by the value of the forecast - not by the demand value as the common practice dictates. (See Appendix 3 - MAPE (/D) and MAPE (/F)). The result of using this method is demonstrated in Figure 5.7. The figure is explained below.
Item_no Fct_usage_one_yr_ah_DIV_4 sum_three_month compare diff Late

XXX

4327,5

680

0,842865

3647,5

Figure 5.7:Forecast accuracy, 01/ 2007

Extracted from Alfa Lavals database

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As previously mentioned in the Empirical Chapter 4.3.4, Alfa Laval evaluates the forecast accuracy (%) using following formula:

et =((D3m F3m)/F3m)*100
et = forecast error in period t

D3m = Demand (Delivery from Stock) - sum of the past three months F3m = Forecast - usage one year ahead divided by four Using the values presented in Figure 5.7, we obtain the following result:

et = ((680 - 4327,5)/ 4327,5)*100 = - 84%

It means the error compared to the forecast is - 84%. But in fact, the true error is actually much higher using the common practice of error evaluation as presented in the Theory Chapter 3.5. The forecast error should be divided by the demand not by the forecast, in order to estimate how high the error is compared to the real demand, as shown here:

et = ((680 - 4327,5)/ 680)*100 = - 536%

Both alternatives are presented in our analysis. This example goes to prove that Alfa Lavals method for evaluating error results in very low forecasting errors compare to errors obtained using the common practice of evaluating errors (see also Appendix 4).

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Step 6 For each analysis, we created a graph showing both demand and forecast in order to visually asses how closely the forecast followed demand. (see Figure 5.8 and enclosed CD) We also graph the forecast error over time in order to determine if the method is unbiased. As we explained in the Theory Chapter 3.5, the method is unbiased when the forecast error fluctuate randomly above and below zero.

Item Nr. 3 (2exp)

60000

50000

40000 Delivery from Stock

Pcs

30000

Forecast Linjr (Delivery from Stock)

20000

10000

0 1 4 7 10 13 16 19 22 25 28 31 34 37 40 43 46 49 52 55 58 61 64 67 70 73 76 79 82 85 88 91 94 97 Months

Figure 5.8: Graph showing forecast and demand in upward trend. Forecast made by double exponential smoothing (2exp)

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Step 7 After a raw material item was analyzed using each method, we then created a summary chart to evaluate error accuracy of all methods applied. See Appendix 4 - Raw Material Analysis (Analysis table). In Figure 5.9 below, the orange highlighted value is our observation of the lowest forecasting error. However, depending on other factors in a real life situation, another of the evaluations of accuracy (MAD, MAPE, MSE) may be more appropriate to Alfa Laval.

Note: 3 months MAPE evaluation is provided for comparison since it is a measurement used at Alfa Laval.

Figure 5.9: Analysis of raw material items

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5.4 Summary and discussion of analysis

Based on our analysis, below is summary chart of lowest forecast error results for the 12 raw material items.
Forecasting methods
Item Nr. 3 Forecast Accuracy Evaluating MSEn MADn MAPEn % 105 MSE MAD MAPE % 208 MSE MAD MAPE % 310 MSE MAD MAPE % 487 MSE MAD MAPE % 590 MSEn MADn MAPEn % 693 MSE MAD MAPE % 796 MSE MAD MAPE % 1117 MSE MAD MAPE % MAPE % (3 months)/D 1266 MSE MAD MAPE % 2410 MSE MAD MAPE % 2513 MSEn MADn MAPEn % 5per Mav 5per Mav 5per Mav 330198 418 49 = 0,9 , = 0,1 , = 0,9 = 0,7 , = 0,1 , = 0,1 = 0,2 , = 0,1 9202567 2182 90 37 4843015 1442 71 1522779 844 57 13756486 3012 41 3588770 1451 30 940763 655 36 5726137 1936 28 1615093 983 21 395257 434 21 = 0,8 , = 0,2 , = 0,1 5per Mav 12per Mav 5per Mav = 0,9 , = 0,1 , = 0,9 6504583 1726 39 19947452 3297 40 6031122 1853 29 = 0,9 , = 0,1 , =0,7 = 0,9 , = 0,2 , = 0,7 = 0,9 , =0,1 , = 0,1 14 per Mav 12 per Mav 5 per Mav = 0,9 , = 0,1 , = 0,9 Parameters Moving Average 77172831 6554 32 Double exp smoothing Triple exp smoothing Rak method -vg method

228272046 99077664 12503 7992 19 12

95752687 235368856 1,12E+08 7517 11858 8121 33 39360646 4214 36 24968106 3237 39 34870514 4670 39 16 11 66815561 31394540 6266 4319 15 10

36908608 15783089 4382 2860 17 11 78422544 35771303 7278 4968 19 14385157 2275 16 13 6199812 1544 11

40283391 17921812 5378 3597 21 15

31332630 13594254 4556 2984 22 21329880 3515 28 14 8977227 2339 19

Figure 5.10: Summary of the raw material items and the best forecasting methods

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According to the summary above, the forecasting methods providing the lowest errors are Alfa Lavals methods (Rak and -vg). The reason for this result is that the evaluating method of forecasting accuracy employed by Alfa Laval is not correct. (See Appendix 5). Using the evaluating method, corresponding to the common practice, reveals the fact that other time series analysis methods provide better results. (See Appendix 3 and 4) According to the theory presented in Theory Chapter 3.4, one would expect that the best forecasting method should be determined with the help of following rules of thumb: 1) The moving average and single exponential smoothing forecasting methods should be used if the data exhibits no trend. 2) Double exponential smoothing (Holts method) accounts for a trend in the time series data. 3) Triple exponential smoothing is an appropriate forecasting method if the data exhibits seasonal pattern with or without trend. However, the result of analyzing the 12 raw material items using time series forecasting methods is in contrast to our expectations. In the summary above, five periods moving average gives the lowest forecast error for items 3, 590 and 2513 despite the fact that all of them exhibit slightly increasing trend. Moving average is supposed to lag behind the trend. Items 1266 and 2410 exhibit very high forecast error compared to other items. The reason is the character of the historical data. They have many zero values, which had to be adjusted manually by averaging observations. This negatively impacts the performance of the forecasting methods. Item number 1117 exhibits a lot of varying demand over time. Using triple exponential smoothing gives low error by 35% (MAPE). However, the relatively low error leads to negative forecast values, which are not desirable. Trying different smoothing constants in order to eliminate the negative values doesnt help the situation. We decided to manipulate smoothing constants at double exponential smoothing instead. Using this method guarantees the positive forecast values even if the forecast error is very high, 90% (MAPE).

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Altogether we tested six forecasting methods, inclusive of Alfa Lavals methods, on 12 raw material items. The triple exponential smoothing method provides the lowest forecasting error in 8 out of 12 cases. This result contradicts theory, which states this method is successful with data that has seasonal pattern, which is not our case. We carefully examined the available historical data spotted by graphing in order to answer the following question: Why dont these forecasting methods work according to theory? According to theory, presented in Theory Chapter 3.2, the time series forecasting methods require more constant demand over time. Our historical data, based on delivered from stock values, in most of the cases dont comply with this requirement. The only method that seems to have the ability to cope with our data is triple exponential smoothing. The method is based on three smoothing constants (, , ), which can be manipulated in order to get the lowest forecast error. The combination of high value of and law value of provides the best result. This probably makes the method more flexible to provide better results than the other methods.

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6. Conclusion

suggestions for continued research. Finally are our reflections concerning the writing of this thesis, and then some observations on conducting the data analysis, client validity, and future work.

his chapter concludes our findings and answers our research questions. We address the validity of our research and give recommendations to Alfa Laval. Then we provide

6.1 Results
We begin this chapter with a reminder to the reader of the research questions posed at the beginning of this thesis and the response. 1) How does Alfa Laval currently forecast for demand? For the selected raw materials evaluated in this study, we have found evidence that Alfa Laval currently uses two of four internally devised forecasting models. The two models are internally referred to as Rak - which resembles Straight Moving Average; and -vg - which resembles Weighted Moving Average. The disadvantage of using these models is that they are not the best tools to consider trends or seasonality, which are exhibited in some of the raw materials analyzed. This lack of adequate measurement contributes to the 50% accuracy Alfa Laval is currently experiencing. Additionally, it was observed that Alfa Lavals current error evaluation method differs greatly from theory and is probably incorrect, since the formula is comparing the future data with the past data. Furthermore, Alfa Laval divides the forecast error by the value of the forecast - not by the value of demand as theory and common practice dictate. Our recommendation is to compare the demand data at period t to the forecast data at the same time period t. In order to get the most reliable result of the forecasting method, the forecasting error should be related to the demand instead of to the forecast.

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2) How can the demand forecasting for raw material purchases be improved and which method/methods results in lower forecasting errors while taking into consideration trends and seasonal variations? The demand forecasting for raw material purchases can be improved by using other input data than Delivery from Stock. Currently, all forecasting is based on the Delivery from stock values. Doing so leads to some periods (months) with zero values in the input data. The zero values signify there is no raw material delivered from stock. However, it does not mean there werent any orders placed in that particular month. The zero problem will be solved at most of the cases using placed orders as a source of input data instead of Delivery from stock values. This will also lead to better knowledge about the real demand. As mentioned in the analysis, we tested four standard forecasting methods as well as two of Alfa Lavals own methods on 12 raw material items. The triple exponential smoothing method provides the lowest forecasting error in 8 out of 12 cases. However, this is based on the Delivered from Stock data. If the analysis had been based on different input, other methods could have been more appropriate, but in this situation, triple exponential smoothing seemed to provide the greatest flexibility.

6.2 Reflections
A great amount of time was required to create Excel spreadsheet functions to be able to use the forecasting methods. To make the analysis as simple a process as possible we tried to express all formulas in a user friendly way before doing the analyses so that only historical data and other parameters needed to be pasted in and adjusted as necessary. This was a quality control effort to make sure that opportunities for human error were at a minimum. Because Alfa Laval records historical data in Jeeves in a way that suits their own business and administrative needs and not to aid forecasting, it was time consuming to make data suitable for the purpose of this study (for example: current forecasting error per each raw material studied). It required looking in different places of the ERP system, collecting the information, and then sorting, recalculating and analyzing it. 64

6.3 Client Validity

The functions programmed in the Excel spreadsheets, as mentioned earlier, were designed to make it simple to use and all the user needs to do is to paste in necessary data. It is a usable tool for Alfa Laval for future forecasting and allows them to test different models for suitability depending on the raw material demand they wish to forecast. The Excel spreadsheet functions can also be used to forecast other products in Alfa Laval or in other external organizations that wish to forecast and evaluate error accuracy for products that can use time series related forecasting methods for historical demand data.

6.4 Future work

In our analysis of the raw materials, we adjusted each smoothing constant to come up with the best error accuracy for a particular item. For future studies, it could be a good idea to use the same smoothing constants across all products to see if these can be standardized.

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REFERENCES
Literature: Andersson, G. & Jorner U. & gren A., Regressions- och tidsserieanalys, Studentlitteratur, 1994 Bryman, A. & Bell, E.,Business Research Methods, Oxford University Press, 2007. Greenwood, D. & Morten, L., Introduction to Action Research, Sage Publications, 1998. Grundy, S. Three Modes of Action Research, Deakin University Press, Geelong, 1982. Hoff John C. A Practical Guide to Box-Jenkins Forecasting, Wadsworth, 1983 Nahmias, S., Production and Operations Analysis, McGraw-Hill Irwin, 2005. Yin, R., Case Study Research: Design and Methods, Sage Publications, 2003.

E-books: Argyris,C., Putnam, R., Smith, D. Action Science Concepts, Methods, and Skills for Research and Intervention, Jossey-Bass Inc., Publishers, 1985. Armstrong, J., Principles of Forecasting. A Handbook for Researchers and Practitioners, Kluwer Academic Publishers, 2001. Crum, C., Demand Management Best Practices: Process, Principles, and Collaboration, J. Ross Publishing, 2003. McNiff Jean, You and Your Action Research Project, Routledge Falmer Publisher, 1996.

Articles: Fawcett, S. & Fawcett, S., The firm as a value-added system: Integrating logistics, operations and purchasing, 1995 Fenstermacher, K. & Zeng, D., Know Your Supply Chain, Eller College of Business and Public Administration, University of Arizona Fildes, R., Goodwin, P., Forecasting, Financial Management Caspian Publisher, 2007 Kalekar, P., Time Series Forecasting Using Holt-Winters Exponential Smoothing, December 6, 2004 Kengpol, A., Kaoien, P., & Touminen, M., A Procurement Planning Improvement by Using Linear Programming and Forecasting Models, PICMET, 2007

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Lapide, L., New Developments in Business Forecasting, The Journal of Business Forecasting, Winter 1998-99 Lapide L., Dont just measure forecast errors, The Journal of Business Forecasting, Graceway Publishing Comapny, February 2007 Martin, J., Operational Excellence: Using Lean Six Sigma to Translate Customer Value through Global Supply Chains, 2008 Susman, G., Planned Change: Prospects for the 1980s, Management Science, Vol. 27. No.2, 1981. Zotteri, G., Kalchschmidt, M., Forecasting practices: Empirical evidence and framework for research, International Journal of Production Economics, January 2007 Other: www.alfalaval.com http://www.web.net/~robrien/papers/arfinal.html#_Toc26184652 2008-04-15 http://www.scu.edu.au/schools/gcm/ar/arr/arow/rmasters.html 2008-04-15 http://www.smetoolkit.org/smetoolkit/en/content/en/416/Demand-Forecasting2008-04-29 http://shmula.com/308/forecasting-unweighted-and-weighted-moving-average-model, 200804-29 http://openforecast.sourceforge.net/docs/net/sourceforge/openforecast/models/DoubleExpone ntialSmoothingModel.html, 2008-05-23 http://64.233.183.104/search?q=cache:aYWnjh43K6oJ:www.ltrr.arizona.edu/~dmeko/notes_ 3.pdf ,2008-05-23 Demand Forecasting Time Series Models, power point presentation by Professor S. Lawrence, College of Business Administration, University of Colorado, USA Alfa Laval Annual Report 2006 Interviews with Martin Jnsson and Tobias Augustsson at Alfa Laval

Figures: Figure 1.1: Alfa Lavals Value Added Chain Figure 1.2: Disposition of Study Figure 2.1: Action Research - Core Characteristics Figure 2.2: Cyclical Process of Action Research Figure 2.3: Summary of methodology Figure 3.1: Summary of qualitative and quantitative forecasting approaches

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Figure 3.2: Major Time Series Models Figure 3.3: Intercept and Slope Figure 3.4: Theoretical framework Figure 4.1: Current order and forecasting process
Figure 4.2: Summary of the forecasting methods used by Alfa Laval Figure 4.3: Current forecasting methods for selected raw material items Figure 5.1: Raw material item numbers and current forecasting methods Figure 5.2: Historical demand data - snapshot Figure 5.3: Historical demand with corrected values Figure 5.4: Delivery from stock (raw material item nr. 3) with increasing linear trend Figure 5.5: Snapshot of moving average analysis Figure 5.6: Snapshot of double exponential smoothing analysis Figure 5.7:Forecast accuracy, 01/ 2007 Figure 5.8: Graph showing forecast and demand in upward trend. Forecast made by double exponential smoothing (2exp) Figure 5.9: Analysis of raw material items Figure 5.10: Summary of the raw material items and the best forecasting methods

List of Abbreviations
CU SU OM-CP MAPE MAD MSE Component Unit Supply Unit Operation Manufacturing - Component Unit Plates Mean Absolute Percentage Error Mean Absolute Deviation Mean Squared Error

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APPENDIX 1 - Interview questions

GENERAL QUESTIONS ABOUT THE ORDERING AND FORECASTING PROCESS Questions from interview with Martin Jnsson and Tobias Augustsson These questions were used throughout the study during unstructured interviews. 1. Please describe the ordering process for raw materials. 2. Who is responsible for placing orders? 3. How many suppliers are available? 4. What are the current forecasting models? How are they weighted? 5. Upon what basis and when were the current forecasting models created? 6. How is demand measured? Using what metrics? 7. What ERP system do you use? 8. Based on what facts are prognoses created in Jeeves adjusted? 9. Are adjustments documented? 10. What do suppliers think of the prognoses? 11. Which products are to be analyzed and why? 12. What are the results of poor forecasting at Alfa Laval?

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APPENDIX 2 - Historical data (one item) APPENDIX 3 and 4 - Raw material analysis (one item)

This report contains historical data and raw material analysis for one item only. The complete results can be found on the enclosed CD

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APPENDIX 5 - Analysis of evaluating method

Analysis of Alfa Lavals accuracy evaluation method Formula for estimating the forecast error as a percentage (%):

et =((D3m F3m)/F3m)*100
et = forecast error at period t (three months)

D3m = Demand (Delivery from Stock) - sum of the past three months F3m = Forecast - usage one year ahead divided by four Forecast for the next three months is: Ft3m = (2*(12+11+10) + 1*(9+8+7) + 0,5*(6+5+4+3+2+1)) / 4 Let us call (12+11+10) for a and 1*(9+8+7) + 0,5*(6+5+4+3+2+1) for b Than we can write Ft3m as (2a+b) / 4 D3m is (12+11+10) = a Formula for the forecast evaluation is: (D3m-Ft3m) / Ft3m Substituting in the formula we obtain: (a -(2a+b) / 4) / ((2a+b) / 4) = ((4a -2a - b) / 4) / ((2a +b) / 4) = (2a-b) / (2a+b) It means that the evaluation method is probably incorrect; formula is comparing the forecasted future data (next three months 13, 14 and 15) to the past data (months 10, 11 and 12). There is no indication of how accurate the prediction Ft3m is, it should be compared to recorded real data in months 15, 14 and 13 which it forecasts.
1 2 3 4 5 6 7 8 9 10 D3m 11 e/F3m = (D3m-F3m)/F3m 12 13 Forecast F3m 14 (2a+b)/4 15

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