Demand forecasting & Aggregate planning in a Supply chain. Session Speaker Prof.P.S.Satish

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1 Demand forecasting & Aggregate planning in a Supply chain Session Speaker Prof.P.S.Satish 1

2 Introduction PEMP-EMM2506 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. Walmart s Strategy 4

3 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 9

4 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. 10

5 Classification of Forecasting Short range ( up to 1 year ) Medium range ( up to 3 years ) Long range ( more than 3 years ) 12

6 Forecasting Types Economic Forecast IMF Technological Forecast Euro Engines Demand Forecast Matching Supply and Demand 13

7 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. 14

8 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. Jury of executive opinion 2. Delphi method 3. Sales force composite 4. Consumer survey 15

9 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. 16

10 Quantitative Methods Moving Average Method Exponential Smoothing Trend Projection Time series model Linear Regression Causal model 17

11 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 18

12 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. 19

13 Moving Average Method Calculations 20

14 Sales of Washing Machine at Arvee Electronics 21

15 Forecasting Techniques- Cont. PEMP-EMM

16 Forecasting Techniques- Cont. Time Series Forecasting Models Weighted Moving Average Forecasting Model- Whenever there is a detectable trend or pattern, in order to be responsive, weights can be used. 23

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19 Forecasting Techniques- Cont. PEMP-EMM

20 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 27

21 Forecasting Techniques- Cont. PEMP-EMM2506 Time Series Forecasting Models Exponential Smoothing Forecasting Model- a weighted moving average in which the forecast for the next period s demand is the current period s forecast adjusted by a fraction of the difference between the current period s 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

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23 Forecasting Techniques- Cont. 30

24 Trend Projections Least square method for finding the best-fitting line 31

25 Least Square Method 32

26 An Example 33

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28 Seasonal Variations in Data Monthly sales and demand of IBM notebook computer in Bangalore is as shown below for Calculate 2001 demand for selling 1200 notebooks. Month Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Sale Demand

29 Create a table in this format Month Sale 1999 Demand 2000 Avg Avg. Monthly Demand Avg. Seasonal Index 36

30 37

31 IBM Notebook exercise Contd 38

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33 Causal Forecasting Model -Regression Analysis 40

34 Causal Forecasting Model Consider s several variables that are related Explain s cause of time series Ex: Sale of a product depends on: Firm s Advertising budget Price charged Competitor s price Promotional Strategies etc. Regression Analysis is a tool to develop causal model 41

35 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. Ŷ = a + b 1 x where Ŷ = forecast or dependent variable x = explanatory or independent variable a = y-axis intercept of the line b 1 = slope of the line 42

36 Forecasting Techniques- Cont. Associative Forecasting Models- Multiple regression. Where several explanatory variables are used to make the forecast. Ŷ = a + b 1 x 1 + b 2 x b k x k where Ŷ = forecast or dependent variable x k = k th explanatory or independent variable a = Y-axis intercept of the line b k = regression coefficient of the independent variable x k 43

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38 Scatter Diagram 45

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41 Forecast Accuracy PEMP-EMM2506 The formula for forecast error, defined as the difference between actual demand and the forecast, follows: Forecast error, e t = A t - F t where e t = forecast error for Period t A t = actual demand for Period t F t = 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. 48

42 Formulae for Monitoring and Controlling forecast MAD = ( Sum of forecast errors / n ). Mean squared error (MSE) = ( ( Sum of forecast error ) 2 / n ). 49

43 Aggregate Planning 50

44 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 51

45 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 52

46 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 53

47 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 54

48 Aggregate Planning Purpose Aggregate plans and master schedules provide common points at which capacity and inventories are considered jointly in the light of firm s 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 55

49 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 56

50 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 57

51 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 Engineering New products, design changes machine standards Accounting and Finance Cost data, financial Condition of firm Human resources Labour market Conditions, training capacity 58

52 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 59

53 Aggregate planning process The process flow chart Determine requirements for planning horizon Identify alternatives, constraints and costs Prepare prospective plan for planning horizon Move ahead to Next planning session Implement and update the plan No Is the plan acceptable? Yes 60

54 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 61

55 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 62

56 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 customer s 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 63

57 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 64

58 Aggregate planning Details A manufacturing firm s aggregate plan, called a production plan focusses on production rates and inventory holdings A service firm s 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 65

59 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 66

60 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 organization s 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 67

61 Aggregate planning PEMP-EMM2506 Strategies The objectives (cont d): 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 68

62 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 69

63 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. 70

64 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 71

65 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 72

66 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 73

67 Medium-Term Capacity Adjustments Inventory level Finished goods inventory Backorders/lost sales Subcontract 74

68 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 75

69 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 76

70 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 77

71 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 80

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