Demand Forecasting

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Characteristics of Forecasts
Demand Forecasting is an essential tool
to estimate the future level of demand on
the basis of past as well as present
knowledge & experience to avoid both
under-production and over-production.

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Its essence - estimating future events on
the basis of past patterns & applying
judgement to those projections.
Business firms can estimate and
minimize the future risk and uncertainty
through forecasting and forward
planning.

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 Forecasts v/s Guesses
Guesses are estimates of future events,
but they are not necessarily unbiased
or objectively calculated.
Guesses are not forecasts - neither
systematic nor objective measurement
of facts.

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Forecasts v/s Guesses
They are mere opinions.

Good forecasts are built by applying

sound scientific procedures so as to
minimize the error of estimation.

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 Demand Forecasts
The goal is to better managements ability to
plan and control operations.
They are integral part of corporate planning and
decision-making.
Forecasting is a crucial activity for planning,
survival and growth of a corporate unit.
It assumes greater relevance where demand
conditions are more uncertain than supply
conditions.

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 Need for Demand Forecasting

Demand forecasting should be taken as

a serious function of the management:
It is considered to be a part of
business management &
a systematic plan or forecast made is
better than no plan at all.

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 Need

1. Achievement of targets/goals/planned
objectives.
Every firm has certain pre-determined
objectives. The attainment of these targets,
goals or objectives would depend on a
reasonably accurate forecast for the firm in
particular or the trends of the economy in
general.
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 Need
2. Preparation of a Budget.
Every firm needs to prepare a well-conceived
budget considering the costs of production
and the expected revenue.
The expectations of revenue must be backed
by forecasts of annual sales and prices of the
product. Such a budget can help keep
control over its cost.

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 Need
3. Stabilization of Production &
employment of resources.
Market demand keeps on fluctuating due
to various changes in the economy.
An annual demand forecast can help plan a
production policy for the set period of time and
seasonal variations dealt with efficiently
without affecting the annual revenue/earnings.

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 Need
4. Sales Budgeting.
Demand forecasting is crucial for sales
budgeting.
Sales budgets help determine production
and inventory plans and level of costs and
employment. Further, it would help in the
preparation of capital budgets, future cash
flows and sources of funds.
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 Need
5. Control of inventories.
A satisfactory method of control of raw
materials, other goods and the final goods
would largely depend on the estimate of
future requirements and availability at the
right time and cost.
Forecasting can help introduce great business
discipline and scientific management.
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 Short-term Forecasts
Plan for production policy
Plan for price policy
Cost effectiveness and cost-control
Need for finance-short-term credit
Market & Distribution network

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Long-term Forecasts

Expansion Plans or Business Planning

Financial Planning
Planning manpower requirements

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Nature &Scope of Demand
Forecasting
Time Frame Classification of

Level of Forecasts Products

General or Specific Established or New

Forecasts Products
Special Factors

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 Methods of Demand Forecasting
For Established Product
A] Interview and Survey B] Projecting Past
Approach Experience as a method
Buyers Interview/ of forecasting
Survey of Buyers - Correlation Analysis
Intentions Regression Analysis
Sales Force Polling Projection of Future
Consumer Field Trends
Surveys Barometric Techniques
Panel of Experts
Controlled Experiments
Composite
Management Opinion

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 Buyers Interviews

A firm directly asks consumers, what and

how much they plan to buy at various prices
of the product for the forthcoming time
period.
The survey may involve a complete
enumeration of all consumers of the given
product, whose demand is to be forecasted.

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It is a direct method of assessing information
from primary sources.
It is not based on past historical data.
It saves time and cost by conducting surveys
on a representative sample.

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 Buyers InterviewsDrawbacks
There may be sampling errors, if the sample
is not properly chosen.
There is personal bias of the consumers in
answering questions from questionnaires.
This method only gives information about
demand for a product of the industry.
Survey method may not be directly useful for
estimating demand for a particular firm.
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 Sales Force Polling
Firms having sales staff can take advantage of
their services.
Experienced salesmen with technical background
& some training in conducting interviews can
perform this task satisfactorily.
Dealers in different areas also at times can be part
of such a method.
Forecasts can be made on the information
collected/ given by salesmen and dealers.
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 Sales Force Polling
It does not involve any statistical complexities.
Information collected is from those very close to
the sales and marketing processes. Forecasts are
likely to be very close to reality.
This method is better for short-term forecasts.
The method is entirely subjective and likely to
carry the seller/salesmen/dealers bias while
making estimates on future demand.
The job of the salesmen is to sell the product.

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 Consumer Surveys
When the customer base is very large and the
product a standardized this method is an ideal one.
It is difficult to reach out the large number of
consumers and hence sample surveying is adopted.

The method of a statistical sample survey removes

these inconveniences and helps to collect the
necessary information in a reasonable period of
time and within reasonable costs.

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 Consumer Surveys
It is possible to use sample surveys profitably for
getting a reasonably accurate demand forecast.
The success of a sample survey depends upon the
responses of the informants.
There is the need of a good investigator and good
interview techniques to be adopted.
There may be mistakes in surveys such as faulty
selection of samples, creation of information that is
irrelevant/unimportant, any shortcoming of sample
survey, etc.
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 Panel of Experts
Demand forecasting can be assigned to a panel
of experts who take up the activity as a
specialized job/function.
These experts might be employees of the firm
itself or may be experts from some other firm or
organization or consultancy organisation.
The experts have the necessary experience and
exposure on the basis of which they conduct the
exercise.
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 Panel of Experts
The method adopted by the panel of expert would
decide the success of the forecast.
There is need for a careful examination of the
forecast by the firm to know the details, the
assumptions, the circumstances and the logic of
reasoning adopted by the panel of experts in making
the forecast.
It is an expensive method; consultants charge very
high fees for taking up such activities.
Here, there is an element of subjectivity.

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 Composite Management Opinion
Opinions of senior management cadre of firms are
involved in making demand forecasts of the firm.
Small committees or groups work together to
achieve the objectives.
This method is a time saving and cost-effective.
Senior management officials have the necessary
experience and exposure.
The method does not involve statistical methods.
The experience and opinions are important.

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Forecasting Methods

Judgmental
Causal
Simulation
Time series

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Judgmental
When there is little hard data
Often based on experience and gut feel
Sales following a promotion
Delphi method
Group of experts
Focus groups

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Causal
For example, appliances sales track
housing starts
Regression equations relate a dependent
variable to one or more independent
variables
Beer sales depend on:
Weather, price of wine, state laws

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Simulation
Can try effects of various assumptions
Simulation models may incorporate time
series and causal models

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Time Series

Static
Adaptive

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 Components of an Observation

Observed demand (O) =

Systematic component (S) + random component (R)

Level (current de seasonalized demand)

Trend (growth or decline in demand)

Seasonal (predictable seasonal fluctuation)

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 Time Series Forecasting
Quarter Demand Dt
II, 1998 8000
III, 1998 13000 Forecast demand for the
IV, 1998 23000 next four quarters.
I, 1999 34000
II, 1999 10000
III, 1999 18000
IV, 1999 23000
I, 2000 38000
II, 2000 12000
Gas Example
III, 2000 13000
IV, 2000 32000
I, 2001 41000
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 Plot of Data

50,000
40,000
30,000
20,000
10,000
0

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Static vs. Dynamic Models
Static
Keep same constants
Dynamic or adaptive
Adjust constants
New data

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A Static Model
Can include
Level
Trend
Seasonal
Can add components or multiply them
Our model:
(Level + trend)* seasonal

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Building a Static Model
Use moving averages over the seasonal cycle to
get deseasonalized data
If number of seasons is even, end points are weighted
by half
Use regression analysis of deseasonalized data
with respect to time
This gives a trend line
The trend line includes both a level and trend element

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Seasonality in the Static Model
Ratio of actual data to trend line
Seasonal factor
Average seasonal factors for each season
Multiply prediction from trend line by
appropriate seasonal factor
Gives predicted demand
Use predicted demand equation to predict
demand in future years

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Result of Static Model

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Prediction Using Model

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Moving Average
Average results over a period
Year
Week
Add new data; drop old data
Add April 2003 sales
Drop April 2002 sales
Advantage: smooths out seasonality

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Exponential Smoothing Models
1. Predict using past data
2. Get error in prediction
3. Adjust prediction using error

Gas Example

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Exponential Smoothing Models
They take both recent and older data into
account
Coefficients give the relative weights of
recent data vs. historical data
: Level
: Trend
: Season
Prediction incorporates all historical data

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Simple Exponential Smoothing
Takes both recent and older data into account
is the weight of the actual demand for last
period
(1-) is the weight of the prediction for last period
is between 0 and 1
If =1, the prediction is the actual demand for last
period
If =0, the prediction is the prediction for last period

Lt 1 Dt 1 (1 ) Lt
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Simple Exponential Smoothing
(Cont)
The prediction includes all past predictions
and demands
How do you start the series (what is the
first prediction)?
Different models initialize differently
Text example: use average of all demands
Others: average first few demands

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 Result of Exponential Smoothing

Actual Vs. P redic ted

45,000

40,000

35,000

30,000

25,000 DemandD

20,000 Exponential Smoothing

15,000

10,000

5,000

0
1 2 3 4 5 6 7 8 9 10 11 12

Per i od

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Holts Model: Level Portion
Adds trend to exponential smoothing
is the weight of the actual demand for the
period
(1-) is the weight of the total predicted
level and trend for last period
Together, they give the level term

Lt 1 Dt 1 (1 )( Lt Tt )

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Holts Model: Trend Portion
is the weight of the difference in level
predictions for last two periods
(1- ) is the weight of the predicted trend
for last period
These give the trend term

Tt 1 ( Lt 1 Lt ) (1 )Tt

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Holts Model Forecast
Sum of level and trend prediction from
previous period
If forecast is for more than 1 period later,
multiply trend by number of periods in gap

Ft n Lt nTt

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Holts Model Initialization
Different models initialize differently
Can use regression analysis on demands
Level is intercept
Trend is slope
Or use first few data points

Gas Example

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Holt Model Results

Actual Vs. P redic ted

Demand Holt's Method

45,000
40,000
35,000
30,000
25,000
20,000
15,000
10,000
5,000
0
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16

Per i od

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Winters Model
Adds trend and seasonality to
exponential smoothing
is the weight of the seasonally
adjusted actual demand for last period
(1-) is the weight of the predicted level
and trend for last period

Lt 1 ( Dt 1 / S t 1 ) (1 )( Lt Tt )

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Winters Model: Trend Part
is the weight of the difference in level
predictions for last two periods
(1- ) is the weight of the predicted trend
for last period

Tt 1 ( Lt 1 Lt ) (1 )Tt

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Winters Model: Seasonality
is the weight of the ratio of actual
demand to level predictions one season
ago
(1- ) is the weight of the predicted
seasonal forecast one season ago

S t p 1 ( Dt 1 / Lt 1 ) (1 ) S t 1

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Winters Model Initialization
Can use results from static model
Or use first few data points

Gas Example

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Winters Model Forecast
Multiply sum of level and trend predictions
by predicted seasonal factor
If forecast for more than 1 period, multiply
trend by number of periods in gap
Seasonal factor used is prediction for
comparable season

Ft n ( Lt nTt ) S t n

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Winter Model Results

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Error measures
Error is difference between actual and prediction
MAD
Take absolute values of error
Get average
Mean Squared Error (MSE)
Square error
Get average
Use to judge how good the model is

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 More Error Measures

Mean Absolute Percentage Error (MAPE)

Divide absolute error by actual demand
Get average
Bias
Average error
Error measures can be calculated based on:
All data and predictions
Data and predictions up to point (text)

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