Demand Forecasting

SO
WHAT

IS DEMAND

FORECASTING?

Forecasting customer demand for products and services is a proactive process of determining what products are needed where, when, and in what quantities. Consequently, demand forecasting is a customerfocused activity. Demand forecasting is also the foundation of a companys entire logistics process. It supports other planning activities such as capacity planning, inventory planning, and even overall business planning.

Characteristics of demand
5 main characters of demand areAverage Demand tends to cluster around a specific level. Trend Demand consistently increases or decreases over time. Seasonality Demand shows peaks and valleys at consistent intervals. These intervals can be hours, days, weeks, months, years, or seasons. Cyclicity Demand gradually increases and decreases over an extended period of time, such as years. Business cycles (recession/expansion) product life cycles influence this component of demand. Elasticity Degree of responsiveness of demand to a corresponding proportionate change in factors effecting it.

TYPES OF FORECASTS

PASSIVE FORECASTS
Where the factors being forecasted are assumed to be constant over a period of time and changes are ignored.

ACTIVE FORECASTS
Where factors being forecasted are taken as flexible and are subject to changes.

Why Study forecasting?

Reduces

future uncertainties, helps study markets that are dynamic, volatile and competitive

Allows

operating levels to be set to respond to demand variations Allows managers to plan personnel, operations of purchasing & finance for better control over wastes inefficiency and conflicts. Inventory Control-reduces reserves of slack resources to meet uncertain demand
Effective
Setting

forecasting builds stability in operations.

Sales Targets, Pricing policies, establishing controls and incentives

How?

THE FORECAST

Step 6 Monitor the forecast Step 5 Prepare the forecast Step 4 Gather and analyze data Step 3 Select a forecasting technique Step 2 Establish a time horizon Step 1 Determine purpose of forecast

LEVELS OF FORECASTING
AT FIRMS LEVEL AT INDUSTRY LEVEL
AT TOTAL MARKET LEVEL

KEY FACTORS FOR SELECTING A RIGHT METHOD

TIME PERIOD
SHORT TERM 3-6 Months, Operating Decisions, E.g- Production planning

MEDIUM TERM
6 months-2 years, Tactical Decision E.g.- Employment changes

LONG TERM
Above 2 years, Strategic Decision E.g.- Research and Development

DATA REQUIREMENTS Techniques differ by virtue of how much data is required to successfully employ the technique. Judgmental techniques require little or no data whereas methods such as Time series analysis or Regression models require a large amount of past or historical data.

PURPOSE OF STUDY
It means the extent of explanation required from the study. Some techniques are based purely on the pattern of past data and may do quite well at forecasting, whereas many a times these are not useful by themselves since it is difficult to explain the causal factors underlying the forecast.

PATTERN OF DATA STUDIED The pattern of historical data is an important factor to consider. Though most of the times, the major pattern is that of a trend, there are also cyclic and seasonal patterns in the data. Certain techniques are best suited for capturing the different patterns in the data. Regression methods incorporates all these variations in data whereas trend analysis methods study these factors individually.

SO ,WE KNOW WHAT ITS ALL ABOUT!!! NOW LETS ANALYSE THE
METHODS OF DEMAND

FORECASTING.

2 MAIN CATEGORIES
MICROECONOMIC METHODS (QUANTITATIVE)
- involves the prediction of activity of particular firms, branded products, commodities, markets, and industries. - are much more reliable than macroeconomic methods because the dimensionality of factors is lower and often can easily be incorporated into a model.

MACROECONOMIC METHODS
(QUALITATIVE)

- involves the prediction of economic aggregates such as inflation, unemployment, GDP growth, short-term interest rates, and trade flows. - is very difficult because of the complex interdependencies in the overall economic factors

QUALITATIVE METHODS
SURVEY OF BUYERS INTENSIONS EXPERTS OPINION METHOD DELPHI METHOD MARKET EXPERIMENTATION METHOD - COLLECTIVE OPINIONS METHOD

QUANTITATIVE METHODS
- TIME SERIES MODELS
- TREND ANALYSIS - MOVING AVERAGES METHODS - EXPONENTIAL SMOOTHING

- CAUSAL MODELS
- REGRESSION MODELS

BUYERS INTENSION SURVEY

FEATURES

EMPLOYS SAMPLE SURVEY TECHNIQUES FOR GATHERING DATA. DATA IS COLLECTED FROM END USERS OF GOODS - CONSUMER, PRODUCER,MIXED. DATA PORTRAYS BIASES AND PREFERENCES OF CUSTOMERS. IDEAL FOR SHORT AND MEDIUM TERM DEMAND FORECASTING, IS COST EFFECTIVE AND RELIABLE.

ADVANTAGES
HELPS

IN APPROXIMATING FUTURE REQUIREMENTS EVEN WITHOUT PAST DATA. ACCURATE METHOD AS BUYERS NEEDS AND WANTS ARE CLEARLY IDENTIFIED & CATERED TO. MOST EFFECTIVE WAY OF ASSESSING DEMAND FOR NEW FIRMS

LIMITATIONS
People

may not know what they are going to purchase They may report what they want to buy, but not what they are capable of buying Customers may not want to disclose real information Effects of derived demand may make forecasting difficult

EXPERTS OPINION METHOD

FEATURES

PANEL OF EXPERTS IN SAME FIELD WITH EXPERIENCE & WORKING KNOWLEDGE. COMBINES INPUT FROM KEY INFORMATION SOURCES. EXCHANGE OF IDEAS AND CLAIMS. FINAL DECISION IS BASED ON MAJORITY OR CONSENSUS, REACHED FROM EXPERTS FORECASTS

ADVANTAGES
CAN BE UNDERTAKEN EASILY WITHOUT THE USE OF ELABORATE STATISTICAL TOOLS.

INCORPORATES A VARIETY OF EXTENSIVE OPINIONS FROM EXPERT IN THE FIELD.

LIMITATIONS
JUDGEMENTAL BIASES FOR EXAMPLE
Availability

heuristic

Involves using vivid or accessible events as a basis for the judgment.

Law

of small numbers

People expect information obtained from a small sample to be typical of the larger population

COMPETATIVE BIASES Over reliance on personal opinions. Possibility of undue influence in certain cases.
STATISTICAL INADEQUACY Lack of statistical and quantifiable data or figures to substantiate the forecasts made.

DELPHI METHOD
PANEL OF EXPERTS IS SELECTED. ONE CO-ORDINATOR IS CHOSEN BY MEMBERS OF THE JURY ANONYMOUS FORECASTS ARE MADE BY EXPERTS BASED ON A COMMON QUESTIONNAIRE. CO-ORDINATOR RENDERS AN AVERAGE OF ALL FORECASTS MADE TO EACH OF THE MEMBERS.

3 CONSEQUENCES- DIVERSION, CONSENSUS OR NO AGREEMENT. 2 TO 3 CYCLES ARE UNDERTAKEN. CONVERGENCE AND DIVERSION IS ACCEPTABLE. FORECASTS ARE REVISED UNTIL A CONSENSUS IS REACHED BY ALL.

ADVANTAGES ELIMINATES NEED FOR GROUP MEETINGS. ELIMINATES BIASES IN GROUP MEETINGS PARTICIPANTS CAN CHANGE THEIR OPINIONS ANONYMOUSLY.

LIMITATIONS
TIME CONSUMING -REACHING A CONSENSUS TAKES A LOT OF TIME. PARTICIPANTS MAY DROP OUT.

MARKET EXPERIMENTATION
INVOLVES ACTUAL EXPERIMENTS & SIMULATIONS. COUPONS ARE ISSUED TO FEW SELECT CUSTOMERS. SELECTED CUSTOMERS PURCHASE THE PRODUCTS. PROXIMITY WITH CONSUMERS MAKES INFORMATION COLLECTED RELIABLE. INFORMATION FROM INTERACTIONS BETWEEN SALES PERSONNEL & CUSTOMERS IS USED FOR FORECASTING. BEST USED IF SALES PERSONNEL ARE HIGHLY SPECIALISED AND WELL TRAINED.

ADVANTAGES
USES KNOWLEDGE OF THOSE CLOSEST TO THE MARKET. HELPS ESTIMATING ACTUAL POTENTIAL FOR FUTURE SALES.

PROVIDES FEEDBACK FOR IMPROVING CUSTOMIZING & OFFERING MADE TO CUSTOMERS.

COLLECTIVE OPINIONS METHOD

OPINIONS FROM MARKETING & SALES SPECIALISTS ARE COMPILED. 2 TYPES OF TARGETS ESTIMATED AMBITIOUS TARGETS. CONSERVATIVE TARGETS. COMBINES EXPERTISE OF HIGHER LEVEL MANAGEMENT & SALES EXECUTIVES.

LIMITATIONS
POWER STRUGGLES MAY OCCUR BETWEEN SPECIALISTS. CONSENSUS MAY NOT BE REACHED IN GOOD TIME. DIFFERENCES AND PREJUDICES IN OPINIONS MAY ALSO EXIST.

ARE YOU STILL THERE??

THAT FINISHES THE QUALITATIVE METHODS.

NOW LETS LOOK AT THE

QUANTITATIVE METHODS

TIME SERIES MODELS

Past data is used to make future predictions . Known or Independent variables are used for predicting Unknown or dependent variables, using the trend equation- Predictive analysis Based on trend equation, we find Line of Best Fit and then it is projected in a scatter diagram, dividing points equally on both sides

TREND ANALYSIS

TREND EQUATION

Y^ = a + bX + E
Y^ = Estimated value of Y a = Constant or Intercept b = slope of trend line X = independent variable E = Error term

= EXPLAINED VARIATION

1-

= UNEXPLAINED VARIATION

Explained variation - means the extent to which the independent variable explains the relative change in the dependent variable. Higher the explained variation, lower the error value leading to accurate forecast

MOVING AVERAGE METHOD Data from a number of consecutive past periods is combined to provide forecast for coming periods.Higher the amount of previous data, better is the forecast. Since the averages are calculated on a moving basis, the seasonal and cyclical variations are smoothened out.

EXPONENTIAL SMOOTHING
Used in cases where the variable under forecast doesnt follow a trend. 2 Types- Simple and Weighted
Simple

smoothing- simple average of specific observation called order.

Weighted

assigned in decreasing order as

smoothing- weights

one moves from current period observations to previous observations.

The equation for exponential smoothing follows a Geometric Progression.Values may be written as-

a, a (1-a), a(1-a)^2.. a(1-n) where, a = value of weight assigned to the observation a(1-a) = weight assigned to 1 period previous observation a(1-a)^2 = weight assigned to 2 periods previous observation Sum of all weights always equals Unity.

CASUAL MODELS
REGRESSION MODEL
It is a statistical technique for quantifying the relationship between variables. In simple regression analysis, there is one dependent variable (e.g. sales) to be forecast and one independent variable. The values of the independent variable are typically those assumed to "cause" or determine the values of the dependent variable.

For example Assuming that the amount of advertising dollars spent on a product determines the amount of its sales, we could use regression analysis to quantify the precise nature of the relationship between advertising and sales. For forecasting purposes, knowing the quantified relationship between the variables allows us to provide forecasting estimates

STEPS IN REGRESSION ANALYSIS 1.Identification of variables influencing demand for product under estimation. 2.Collection of historical data on variables. 3.Choosing an appropriate form of function 4.Estimation of the function.

REGRESSION EQUATION

Y =
Where
x x

Y= value being forecasted

= constant value
= coefficients of regression = independent variable

BENEFITS OF EFFECTIVE DEMAND FORECASTING HIGHER REVENUES

SALES MAXIMIZATION
REDUCED INVESTMENTS FOR SAFETY STOCKS IMPROVED PRODUCTION PLANNING EARLY RECOGNITION OF MARKET TRENDS BETTER MARKET POSITIONING IMPROVED CUSTOMER SERVICE LEVELS