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PEMP-EMM2506

Demand forecasting & Aggregate


planning in a Supply chain

Session Speaker
Prof.P.S.Satish
M.S Ramaiah School of Advanced Studies - Bangalore

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Introduction
Forecasting provides an estimate of future demand
Factors that influence demand and whether these factors will
continue to influence demand must be considered when
forecasting.
Improved forecasts benefit all trading partners in the supply
chain.
Better forecasts result in lower inventories,
reduced stock-outs,
smoother production plans,
reduced costs,
and improved customer service.
Walmarts Strategy
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Demand Planning and Forecasting


Demand Planning
Involves forecasting and other activities like Promotion etc.

Types: 1. Independent Demand ( Ex: Finished goods)


2. Dependent or Derived Demand
(Ex: components or subassemblies)
Independent Demand items are forecasted whereas the
Dependent items can be derived from the latter

100 Refrigerators = 100 Compressors


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Approach to Demand Forecasting


Understand the Objective of Forecasting
Integrate Demand Planning and forecasting
Identify factors that influence demand forecast
viz Demand, Supply and Product Side
Understand and Identify customer segments
Determine the appropriate forecasting technique
Establish Performance and error measures for the
forecast.

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Classification of Forecasting
Short range ( up to 1 year )

Medium range ( up to 3 years )


Long range ( more than 3 years )

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Forecasting Types
Economic Forecast IMF

Technological Forecast Euro Engines


Demand Forecast Matching Supply and Demand

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Forecasting Techniques
Qualitative forecasting is based on opinion and intuition.
Quantitative forecasting uses mathematical models and
historical data to make forecasts.
Time series models are the most frequently used among all
the forecasting models.

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Forecasting Techniques- Cont.


Qualitative Forecasting Methods
Generally used when data are limited, unavailable, or not
currently relevant.

Forecast depends on skill and experience of forecaster(s) and


available information.

Four qualitative models used are:


1.
2.
3.
4.

Jury of executive opinion


Delphi method
Sales force composite
Consumer survey
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Forecasting Techniques- Cont.


Quantitative Methods
Time series forecasting- based on the assumption that the
future is an extension of the past. Historical data is used to
predict future demand.
Associative (causal) forecasting- assumes that one or more
factors (independent variables) predict future demand.
It is generally recommended to use a combination of
quantitative and qualitative techniques.

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Quantitative Methods
Moving Average Method
Exponential Smoothing
Trend Projection

Time series model

Linear Regression

Causal model

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Forecasting Techniques- Cont.


Components of Time Series- Data should be plotted to detect
for the following components:
Trend variations: either increasing or decreasing

Cyclical variations: wavelike movements that are longer


than a year
Seasonal variations: show peaks and valleys that repeat
over a consistent interval such as hours, days, weeks,
months, years, or seasons

Random variations: due to unexpected or unpredictable


events
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Forecasting Techniques- Cont.


Time Series Forecasting Models
Simple Moving Average Forecasting Model. Simple
moving average forecasting method uses historical data
to generate a forecast.
Works well when demand is fairly stable over time.

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Moving Average Method Calculations

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Sales of Washing Machine at Arvee Electronics

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Forecasting Techniques- Cont.

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Forecasting Techniques- Cont.


Time Series Forecasting Models
Weighted Moving Average Forecasting ModelWhenever there is a detectable trend or pattern, in
order to be responsive, weights can be used.

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Forecasting Techniques- Cont.

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Disadvantage of moving average


Lengthy calculations involved
Need to keep historical Data
Equal weightage or no basis for weightage
for the Data
To overcome these difficulties, exponential
smoothing is used

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Forecasting Techniques- Cont.


Time Series Forecasting Models
Exponential Smoothing Forecasting Model- a weighted
moving average in which the forecast for the next
periods demand is the current periods forecast adjusted
by a fraction of the difference between the current
periods actual demand and its forecast.
Only two data points are needed.
Ft+1 = Ft+(At-Ft)
Where
Ft+1 = forecast for Period t + 1
Ft = forecast for Period t
At = actual demand for Period t
= a smoothing constant (0 1).

= 2/(N+1)
Where N=
period of
moving
average ;
Typically 0.1
to 0.4

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Forecasting Techniques- Cont.

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Trend Projections

Least square method for finding the best-fitting line


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Least Square Method

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An Example

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Seasonal Variations in Data


Monthly sales and demand of IBM notebook computer in
Bangalore is as shown below for 1999-2000.
Calculate 2001 demand for selling 1200 notebooks.
Month

Jan

Feb

Mar

Apr

May

Jun

Jul

Aug

Sep

Oct

Nov

Dec

Sale
1999

80

75

80

90

115

110

100

90

85

75

75

80

Demand
2000

100

85

90

110

131

120

110

110

95

85

85

80

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Create a table in this format


Month

Sale
1999

Demand
2000

Avg.
1999-2000

Avg.
Monthly
Demand

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Avg.
Seasonal
Index

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IBM Notebook exercise Contd

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Causal Forecasting Model


-Regression Analysis

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Causal Forecasting Model


Considers several variables that are related
Explains cause of time series
Ex: Sale of a product depends on:
Firms Advertising budget
Price charged
Competitors price
Promotional Strategies etc.
Regression Analysis is a tool to develop causal model

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Forecasting Techniques- Cont.


Associative Forecasting Models- One or several external
variables are identified that are related to demand
Simple (linear) regression. Only one explanatory variable
is used and is similar to the previous trend model. The
difference is that the x variable is no longer a time but an
explanatory or independent variable.
= a + b1 x
where
= forecast or dependent variable
x = explanatory or independent variable
a = y-axis intercept of the line
b1 = slope of the line
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Forecasting Techniques- Cont.


Associative Forecasting Models Multiple regression. Where several explanatory variables are
used to make the forecast.
= a + b1x1 + b2x2 + . . . bkxk
where
= forecast or dependent variable
xk = kth explanatory or independent variable
a = Y-axis intercept of the line
bk = regression coefficient of the independent
variable xk
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Scatter Diagram
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Forecast Accuracy
The formula for forecast error, defined as the difference between
actual demand and the forecast, follows:
Forecast error, et = At - Ft
where
et = forecast error for Period t
At = actual demand for Period t
Ft = forecast for Period t
Several measures of forecasting accuracy follow:
Mean absolute deviation (MAD)- a MAD of 0 indicates
the forecast = predicted demand.

= (forecast error) / n, where n is number of period.


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Formulae for Monitoring and Controlling forecast


MAD = ( Sum of forecast errors / n ).
Mean squared error (MSE)
= ( ( Sum of forecast error ) 2 / n ).

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Aggregate Planning

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Introduction

Aggregate planning is done for period of 6 to


18 months
It translates business plan and strategic intent
to operational decisions
Purpose is to specify combination of
production rate, workforce and inventory in
hand needed
In planning total expected demand is reckoned
without regard to product mix that makes up
the figure
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Aggregate Planning
What is it?
Once long term decisions are made, it is necessary to make intermediate
range plans that are consistent with long-range policies
Management must work within the resources allocated by long-range
decisions
Given the sales forecasts, the factory capacity, aggregate inventory levels,
and the size of the workforce, the manager must decide at what rate of
production to operate the plant over the intermediate term
This intermediate-range planning is generally known as aggregate
planning

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Why Aggregate Planning is necessary?


Fully load facilities and minimize overloading and
underloading
Make sure enough capacity available to satisfy
expected demand
Plan for the orderly and systematic change of
production capacity to meet the peaks and valleys of
expected customer demand
Get the most output for the amount of resources
available
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Why Aggregate Planning necessary?


To meet demand fluctuations like in festivals
Capacity fluctuations Number of working
days in month, unexpected shutdowns..
Production rate cannot be changed without
proper planning
Planning helps to manage anticipated demand

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Aggregate Planning
Purpose
Aggregate plans and master schedules provide common points at which
capacity and inventories are considered jointly in the light of firms longrange plans, and they provide inputs to the financial plan, the marketing
plan, and requirements planning and detailed scheduling decisions
Several crucial decisions have to be made while generating an aggregate
plan
Management may ask many inventory- and workforce- related questions
To what extent should inventories be used for absorbing changes in demand
that might occur during the intermediate term?
Should we absorb the fluctuations by varying the size of the workforce*

Generally a mixture of strategies is preferred and is feasible


An aggregate plan is a valuable procedure to help in the development of
operating budgets
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Aggregate Planning
Purpose
Products or services can be aggregated into a set of relatively
broad product families without getting into too much of detail
A company can organize labour in various ways based on
flexibility to handle different products/services, or, based on
product lines
When time is considered, the planning horizon is an important
aspect. It is the length of time covered by an aggregate plan. A
company will usually look at time in the aggregate months,
quarters, or seasons (rather than days or hours)
Some companies use monthly planning periods for the near portion
of the planning horizon and quarterly periods for the later portion
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Aggregate Planning
Purpose
In practice, planning periods reflect a balance between the needs for
a limited number of decision points to reduce planning complexity
flexibility to adjust output rates and the workforce levels when
demand forecasts exhibit seasonal variations
Relationship of aggregate to other plans is in figure below

Business or
Annual plan
Aggregate
plan
MPS or
Workforce schedule

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Aggregate Planning
Managerial inputs from various functional areas to aggregate
plans
Operations
Current, future
& workforce
capacities

Materials
Supplier capabilities
Storage capacity
Materials availability

Distribution and
Marketing
Customer needs,
Demand, Competition

Aggregate plan

Accounting and
Finance
Cost data, financial
Condition of firm

Human resources
Labour market
Conditions, training
capacity

Engineering
New products, design changes
machine standards

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Aggregate planning process


The process for preparing aggregate plans is dynamic
and continuing, as aspects of the plan are updated
periodically when new information becomes available
and new opportunities emerge*
The steps are:

Determining demand requirements


Identifying alternatives, constraints and costs
Preparing an acceptable plan
Implementing and updating the plan

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Aggregate planning process


The process flow chart
Determine
requirements for
planning horizon

Identify
alternatives,
constraints and
costs

Prepare
prospective plan
for planning
horizon

No
Move ahead to
Next
planning session

Implement and
update the plan

Is the plan
acceptable?
Yes
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Aggregate planning process


Determining demand requirements
The first step in the planning process is to determine the
demand requirements for each period of the planning horizon
For production plans, the requirements represent the demand
for finished goods and the external demand for replacement
parts
For staffing plans, the planner bases forecasts of staff
requirements for each workforce group on historical levels of
demand, managerial judgment and existing backlogs for
services
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Aggregate planning process


Identifying alternatives, constraints and costs
Constraints represent physical limitations or managerial
policies associated with the aggregate plan
Examples of physical constraints might include training facilities
capable of handling only so many new hires at a time, machine
capacities that limit maximum output, or inadequate inventory storage
space

A planner usually considers several types of costs when


preparing aggregate plans
Regular-time costs
Overtime costs typically 150% of regular time wages
Hiring (advertising jobs, interviews, etc.) and layoff (exit interviews,
severance pay, etc.) costs
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Aggregate planning process


Identifying alternatives, constraints and costs
A planner usually considers several types of costs .
Inventory holding costs that vary with the level of inventory
investment: the costs of capital tied up in inventory, variable storage
and warehousing, etc.
Backorder and stock out costs like the costs of lost sales and the
potential cost of losing the customers sales to competitors
Hiring (advertising jobs, interviews, etc.) and layoff (exit interviews,
severance pay, etc.) costs
Preparing an acceptable plan
This is an iterative process (plans may need to go through several revisions
and adjustments

Implementing and updating the plan which requires the commitment of


all functional area managers
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Aggregate planning process


Developing and evaluating the level production plan
One possible level strategy, which uses a constant number of
employees that will satisfy demand during the planning
horizon, is determined by using the maximum amount of
overtime in the peak period
Under time is used in slack periods
Level strategy can lead to considerable under time
Cost of this unused capacity depends on whether under time
is paid or unpaid
The planning can be done with a spreadsheet^
Example problem follows
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Aggregate planning
Details
A manufacturing firms aggregate plan, called a production plan
focusses on production rates and inventory holdings
A service firms aggregate plan, called a staffing plan, centers on
staffing and other labour related factors
Based on the long-term goals of a company, the aggregate plan
specifies how the company will work for the next year or so
toward these goals within existing equipment and facility capacity
constraints
For manufacturing companies, the aggregate plan links strategic
goals and objectives with production plans for individual products
and the specific components that go into them
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Aggregate Planning
Details
For service firms the aggregate plan links strategic goals with detailed
workforce schedules
When we say aggregate, the sense is that the planning activities at this
early stage are concerned with homogeneous categories, such as gross
volumes of products or number of customers served
Illustration below gives the aggregate plan of a motor manufacturer

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Aggregate planning
Strategies
Many aggregate planning strategies are available to the
manager
The many functional areas in an organization that give input
to the aggregate plan typically have conflicting objectives for
the use of the organizations resources
The objectives could be:
Minimize costs/maximize profits If customer demand is not affected
by the plan, minimizing costs will also maximize profits
Maximize customer service Improving delivery time and on-time
delivery may require additional workforce, machine capacity, or
inventory resources
Minimize inventory investment Inventory accumulations are
expensive because the money could be used for more productive
investments
Maximize utilization of plant and equipment Processes based on a
line flow strategy require uniformly high utilization of plant and
equipment
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Aggregate planning
Strategies
The objectives (contd):
Minimize changes in production rates Frequent changes in
production rates can cause difficulties in coordinating the
supplies of materials and require production line rebalancing
Minimize changes in workforce levels Fluctuating workforce
levels may cause lower productivity because new employees
typically need time to become fully productive

Balancing these various objectives to arrive at an acceptable


aggregate plan involves consideration of various alternatives
A classification scheme is shown in the next slide
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Aggregate planning-Meeting Demand


Pure Strategy : One of the variable say workforce is
changed to absorb demand fluctuation
Mixed Strategy : Here more than one variable say
workforce and inventory are changed to absorb
fluctuations
This is mostly used in Industries

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Aggregate planning-Meeting demand


Chase Strategy : Match the production rate
needed by hiring and laying off employees as
the order rate varies. For this pool of trained
people must be available as volume increases.
Has motivational issues.

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Aggregate planning-Meeting Demand


Level Strategy : Making a stable workforce
working at constant output rate. Shortages
and surpluses are absorbed by fluctuating
inventory levels, order backlogs and lost
sales. Potential implication decreased
customer service level and increased
inventory costs

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Aggregate Planning-Meeting Demand


Stable workforce Variable work hours :
Vary the output by varying number of hours
worked through flexible work schedules or
overtime. Better employee motivation.
Overtime cost extra

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Medium-Term Capacity Adjustments


Workforce level
Hire or layoff full-time workers
Hire or layoff part-time workers
Hire or layoff contract workers

Utilization of the work force


Overtime
Idle time (under time)
Reduce hours worked

. . . more
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Medium-Term Capacity Adjustments


Inventory level
Finished goods inventory
Backorders/lost sales

Subcontract

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Aggregate Plans for services


For standardized services, aggregate planning may be simpler
than in systems that produce products
For customized services,
there may be difficulty in specifying the nature and extent
of services to be performed for each customer
customer may be an integral part of the production system
Absence of finished-goods inventories as a buffer between
system capacity and customer demand

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Yield Management
It is a process of allocating right type of
capacity to the right type of customer at the
right price and time to maximize revenue or
yield
E.g. :- Airlines booking in advance at
cheaper prices
- Hotel booking in advance

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Yield Management
Yield Management is most effective when :
Demand can be segmented by customer
Fixed costs are high and variable costs are
low
Inventory is perishable
Product can be sold in advance
Demand is highly variable
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Session Summary

Analysing demand forecasts has been explained

Time series and causal models have been demonstrated


with examples.

Strategies adopted in aggregate planning has been


elucidated

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