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Demand forecasting, also known as demand planning and sales forecasting

(DP&SF),[1] involves the prediction of the quantity of goods and services that
will be demanded by consumers or business customers at a future point in
time.[2] More specifically, the methods of demand forecasting entail using
predictive analytics to estimate customer demand in consideration of key
economic conditions. This is an important tool in optimizing business
profitability through efficient supply chain management. Demand forecasting
methods are divided into two major categories, qualitative and quantitative
methods:

Qualitative methods are based on expert opinion and information gathered

from the field. This method is mostly used in situations when there is
minimal data available for analysis, such as when a business or product has
recently been introduced to the market.
Quantitative methods use available data and analytical tools in order to
produce predictions.

Demand forecasting may be used in resource allocation, inventory

management, assessing future capacity requirements, or making decisions
on whether to enter a new market.[3]

Importance of demand forecasting for businesses

Methods for forecasting demand

See also

References

Bibliography

Last edited 4 months ago by Giant death lizard

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Demand forecasting

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Download PDF

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This article includes a list of general references, but it lacks sufficient

corresponding inline citations. (May 2022)

Demand forecasting, also known as demand planning and sales forecasting

(DP&SF),[1] involves the prediction of the quantity of goods and services that
will be demanded by consumers or business customers at a future point in
time.[2] More specifically, the methods of demand forecasting entail using
predictive analytics to estimate customer demand in consideration of key
economic conditions. This is an important tool in optimizing business
profitability through efficient supply chain management. Demand forecasting
methods are divided into two major categories, qualitative and quantitative
methods:

Qualitative methods are based on expert opinion and information gathered

from the field. This method is mostly used in situations when there is
minimal data available for analysis, such as when a business or product has
recently been introduced to the market.

Quantitative methods use available data and analytical tools in order to

produce predictions.

Demand forecasting may be used in resource allocation, inventory

management, assessing future capacity requirements, or making decisions
on whether to enter a new market.[3]

Importance of demand forecasting for businesses

Edit

Demand forecasting plays an important role for businesses in different

industries, particularly with regard to mitigating the risks associated with
particular business activities. However, demand forecasting is known to be a
challenging task for businesses due to the intricacies of analysis, specifically
quantitative analysis.[4] Nevertheless, understanding customer needs is an
indispensable part of any industry in order for business activities to be
implemented efficiently and more appropriately respond to market needs. If
businesses are able to forecast demand effectively, several benefits can be
accrued. These include, but are not limited to, waste reduction, optimized
allocation of resources, and potentially large increases in sales and revenue.

Some of the reasons why businesses require demand forecasting include:

Meeting goals – Most successful organisations will have pre-determined

growth trajectories and long-term plans to ensure the business is operating
at an ideal output. By having an understanding of future demand markets,
businesses can be proactive in ensuring that goals will be met in this
business environment.

Business decisions – In reference to meeting goals, by having a thorough

understanding of future industry demand, management and key board
members can make strategic business decisions that encourage higher
profitability and growth. These decisions are generally associated with the
concepts of capacity, market targeting, raw material acquisition and
understanding vendor contract direction.

Growth – By having an accurate understanding of future forecasts,

companies can gauge the need for expansion within a timeframe that allows
them to do so cost effectively.[5]

Human capital management – If there is a rapid demand increase in an

industry but a business does not have enough employees to satisfy the sales
orders, consumer loyalty may be adversely affected as customers are forced
to purchase from competitors.[6]

Financial planning – It is crucial to understand demand forecasts in order to

efficiently budget for future operations in terms of factors such as cash flow,
inventory accounting and general operational costs.[7] The use of an
accurate demand forecasting model can result in significant decreases in
operational costs for businesses, since less safety stock is required to be
held.[8]

Methods for forecasting demand

Edit
There are various statistical and econometric analyses used to forecast
demand.[9] Forecasting demand can be broken down into seven stage
process, the seven stages are described as:

Stage 1: statement of a theory or hypothesis

Edit

The first step to forecast demand is to determine a set of objectives or

information to derive different business strategies. These objectives are
based on a set of hypotheses that usually come from a mixture of economic
theory or previous empirical studies. For example, a manager may wish to
find what the optimal price and production amount would be for a new
product, based on how demand elasticity affected past company sales.

Stage 2: model specification

Edit

There are many different econometric models which differ depending on the
analysis that managers wish to perform. The type of model that is chosen to
forecast demand depends on many different aspects such as the type of data
obtained or the number of observations, etc.[10] In this stage it is important
to define the type of variables that will be used to forecast demand.
Regression analysis is the main statistical method for forecasting. There are
many different types of regression analysis, but fundamentally they provide
an analysis of how one or multiple variables affect the dependent variable
being measured. An example of a model for forecasting demand is M.
Roodman’s (1986) demand forecasting regression model for measuring the
seasonality affects on a data point being measured.[11] The model was
based on a linear regression model, and is used to measure linear trends
based on seasonal cycles and their affects on demand i.e. the seasonal
demand for a product based on sales in summer and winter.

The linear regression model is described as:

Y
I

{\displaystyle Y_{i}=\beta _{0}+\beta _{1}X_{i}+e}

Where

{\displaystyle Y_{i}} is the dependent variable,

{\displaystyle \beta _{0}} is the intercept,

{\displaystyle \beta _{1}} is the slope coefficient,

{\displaystyle X_{i}} is the independent variable and e is the error term.

M. Roodman’s demand forecasting model is based on linear regression and is
described as:

And

Mod

,
…

{\displaystyle \lambda _{q}=\{t\mid t=1,\dots ,n{\text{ and }}t{\bmod

{Q}}=q\}\qquad q=1,\dots ,Q}

{\displaystyle \lambda _{q}} is defined as the set of all t – indices for quarter
q. The process that generates the data for all periods t that fall in quarter q is
given by:

{\displaystyle Y_{t}=(\beta +\tau \times t)\times \sigma _{q}+e}

Y
T

{\displaystyle Y_{t}} = the datum for period

Β = base demand at the beginning of the time series horizon

Τ = the linear trend per quarter

{\displaystyle \sigma _{q}} = the multiplicative seasonal factor for the

quarter

E = a disturbance term

Stage 3: data collection

Edit

Once the type of model is specified in stage 2, the data and the method of
collecting data must be specified. The model must be specified first in order
to determine the variables which need to be collected. Conversely, when
deciding on the desired forecasting model, the available data or methods to
collect data need to be considered in order to formulate the correct model.
Gathering Time series data and cross-sectional data are the different
collection methods that may be used. Time series data are based on
historical observations taken sequentially in time. These observations are
used to derive relevant statistics, characteristics, and insight from the data.
[12] The data points that may be collected using time series data may be
sales, prices, manufacturing costs, and their corresponding time intervals
i.e., weekly, monthly, quarterly, annually, or any other regular interval.
Cross-sectional data refers to data collected on a single entity at different
periods of time. Cross-sectional data used in demand forecasting usually
depicts a data point gathered from an individual, firm, industry, or area. For
example, sales for Firm A during quarter 1. This type of data encapsulates a
variety of data points which resulted in the final data point. The subset of
data points may not be observable or feasible to determine but can be a
practical method for adding precision to the demand forecast model.[13] The
source for the data can be found via the firm's records, commercial or private
agencies, or official sources.

Stage 4: estimation of parameters

Edit

Once the model and data are obtained then the values can be computed to
determine the effects the independent variables have on the dependent
variable in focus. Using the linear regression model as an example of
estimating parameters, the following steps are taken:

Linear regression formula:

{\displaystyle Y_{i}=\beta _{0}+\beta _{1}X_{i}+e}

The first step is to find the line that minimizes the sum of the squares of the
difference between the observed values of the dependent variable and the
fitted values from the line.[9] This is expressed as

=
Β

{\displaystyle {\hat {Y}}_{i}=\beta _{0}+\beta _{1}{X_{i}}} which

minimizes

{\displaystyle \Sigma (Y_{i}-{\hat {Y_{i}}})^{2}} and

0
{\displaystyle {\hat {Y_{i}}}=\beta _{0}}, the fitted value from the
regression line.

{\displaystyle \beta _{0}} and

{\displaystyle \beta _{1}} also need to be represented to find the intercept

and slope of the line. The method of determining

{\displaystyle \beta _{0}} and

{\displaystyle \beta _{1}} is to use partial differentiation with respect to

both

{\displaystyle \beta _{0}} and

{\displaystyle \beta _{1}} by setting both expressions equal to zero and

solving them simultaneously. The method for omitting these variables is
described below:

1
=

−
Β

{\displaystyle {\begin{aligned}\beta _{1}&={\frac {n\Sigma XY-\Sigma X\

Sigma y}{n\Sigma X^{2}-(\Sigma X)^{2}}}\\\beta _{0}&={\frac {\Sigma
Y}{n}}-{\frac {\beta _{1}\Sigma X}{n}}\end{aligned}}}

Stage 5: checking the accuracy of the model

Edit

Calculating demand forecast accuracy is the process of determining the

accuracy of forecasts made regarding customer demand for a product.[14]
[15] Understanding and predicting customer demand is vital to
manufacturers and distributors to avoid stock-outs and to maintain adequate
inventory levels. While forecasts are never perfect, they are necessary to
prepare for actual demand. In order to maintain an optimized inventory and
effective supply chain, accurate demand forecasts are imperative.

Calculating the accuracy of supply chain forecasts

Edit

Forecast accuracy in the supply chain is typically measured using the Mean
Absolute Percent Error or MAPE. Statistically, MAPE is defined as the average
of percentage errors.

Most practitioners, however, define and use the MAPE as the Mean Absolute
Deviation divided by Average Sales, which is just a volume-weighted MAPE,
also referred to as the MAD/Mean ratio. This is the same as dividing the sum
of the absolute deviations by the total sales of all products. This calculation

A—
F

{\displaystyle {\frac {\sum {|A-F|}}{\sum {A}}}}, where A is the actual

value and F the forecast, is also known as WAPE, or the Weighted Absolute
Percent Error.

Another interesting option is the weighted

MAPE

)
{\displaystyle {\text{MAPE}}={\frac {\sum (w\cdot |A-F|)}{\sum (w\cdot
A)}}}. The advantage of this measure is that can weight errors. The only
problem is that for seasonal products you will create an undefined result
when sales = 0 and that is not symmetrical. This means that you can be
much more inaccurate if sales are higher than if they are lower than the
forecast. So sMAPE also known as symmetric Mean Absolute Percentage
Error, is used to correct this.

Finally, for intermittent demand patterns, none of the above are particularly
useful. In this situation, a business may consider MASE (Mean Absolute
Scaled Error) as a key performance indicator to use. However, the use of this
calculation is challenging as it is not as intuitive as the above-mentioned.[16]
Another metric to consider, especially when there are intermittent or lumpy
demand patterns at hand, is SPEC (Stock-keeping-oriented Prediction Error
Costs).[17] The idea behind this metric is to compare predicted demand and
actual demand by computing theoretical incurred costs over the forecast
horizon. It assumes, that predicted demand higher than actual demand
results in stock-keeping costs, whereas predicted demand lower than actual
demand results in opportunity costs. SPEC takes into account temporal shifts
(prediction before or after actual demand) or cost-related aspects and allows
comparisons between demand forecasts based on business aspects as well.

Calculating forecast error

Edit

The forecast error needs to be calculated using actual sales as a base. There
are several forms of forecast error calculation methods used, namely Mean
Percent Error, Root Mean Squared Error, Tracking Signal and Forecast Bias.

Stage 6: hypothesis testing

Edit

Once the model has been determined, the model is used to test the theory or
hypothesis stated in the first stage. The results should describe what is trying
to be achieved and determine if the theory or hypothesis is true or false. In
relation to the example provided in the first stage, the model should show
the relationship between demand elasticity of the market and the correlation
it has to past company sales. This should enable managers to make an
informed decisions regarding the optimal price and production levels for the
new product.

Stage 7: forecasting

Edit

The final step is to then forecast demand based on the data set and model
created. In order to forecast demand, estimations of a chosen variable are
used to determine the effects it has on demand. Regarding the estimation of
the chosen variable, a regression model can be used or both qualitative and
quantitative assessments can be implemented. Examples of qualitative and
quantitative assessments are:

Qualitative assessment

Edit

Unaided judgment

Marketing research

Delphi technique

Game theory

Judgmental bootstrapping

Simulated interaction

Intentions and expectations survey

Jury of executive method

Quantitative assessment

Edit

Discrete event simulation

Extrapolation

Group method of data handling (GMDH)

Reference class forecasting

Quantitative analogies

Rule-based forecasting

Diffusion of innovation

Neural networks

Data mining

Conjoint analysis

Causal models

Segmentation

Exponential smoothing models

Box–Jenkins models

Hybrid models

Others

Edit

Others include:

Moving average

Moving average

Time series projection methods

Moving average method

Exponential smoothing method

Trend projection methods

Leading indicator

Leading indicator

Causal methods

Chain-ratio method

Consumption level method

End use method

Leading indicator method

See also

References

Edit

Marien, E. J., Demand Planning and Sales Forecasting: A Supply Chain

Essential, Supply Chain Management Review, Winter 1999, accessed on 13
November 2024

Acar, A. Zafer; Yilmaz, Behlül; Kocaoglu, Batuhan (2014-06-16). “DEMAND

FORECAST, UP-TO-DATE MODELS, AND SUGGESTIONS FOR IMPROVEMENT AN
EXAMPLE OF A BUSINESS” (PDF). Journal of Global Strategic Management. 1
(8): 26–26. Doi:10.20460/JGSM.2014815650. ISSN 1307-6205.

Adhikari, Nimai Chand Das; Domakonda, Nishanth; Chandan, Chinmaya;

Gupta, Gaurav; Garg, Rajat; Teja, S.; Das, Lalit; Misra, Ashutosh (2019),
Smys, S.; Bestak, Robert; Chen, Joy Iong-Zong; Kotuliak, Ivan (eds.), “An
Intelligent Approach to Demand Forecasting”, International Conference on
Computer Networks and Communication Technologies, vol. 15, Singapore:
Springer Singapore, pp. 167–183, doi:10.1007/978-981-10-8681-6_17, ISBN
978-981-10-8680-9, retrieved 2023-04-27

Ivanov, Dmitry; Tsipoulanidis, Alexander; Schönberger, Jörn (2021), Ivanov,

Dmitry; Tsipoulanidis, Alexander; Schönberger, Jörn (eds.), “Demand
Forecasting”, Global Supply Chain and Operations Management: A Decision-
Oriented Introduction to the Creation of Value, Cham: Springer International
Publishing, pp. 341–357, doi:10.1007/978-3-030-72331-6_11#doi, ISBN 978-
3-030-72331-6, retrieved 2023-04-27

“Demand Forecasting: An Industry Guide”. Demand Caster.

“The Advantages of Demand Forecasting”. Small Business – Chron.com.

Retrieved 2023-04-27.

Diezhandino, Ernesto (2022-07-04). “Importance and Benefits of Forecasting

Customer Demand”. Keepler | Cloud Data Driven Partner. Retrieved 2023-04-
27.

Hamiche, Koussaila; Abouaïssa, Hassane; Goncalves, Gilles; Hsu, Tienté

(2018-01-01). “A Robust and Easy Approach for Demand Forecasting in
Supply Chains”. IFAC-PapersOnLine. 16th IFAC Symposium on Information
Control Problems in Manufacturing INCOM 2018. 51 (11): 1732–1737.
Doi:10.1016/j.ifacol.2018.08.206. ISSN 2405-8963.

Wilkinson, Nick (2005-05-05). Managerial Economics: A Problem-Solving

Approach (1 ed.). Cambridge University Press.
Doi:10.1017/cbo9780511810534.008. ISBN 978-0-521-81993-0.

Sukhanova*, E.I.; Shirnaeva, S.Y.; Zaychikova, N.A. (2019-03-20). “Modeling

And Forecasting Financial Performance Of A Business: Statistical And
Econometric Approach”. The European Proceedings of Social and Behavioural
Sciences. Cognitive-Crcs: 487–496. Doi:10.15405/epsbs.2019.03.48. S2CID
159058405.

Roodman, Gary M. (1986). “Exponentially smoothed regression analysis for

demand forecasting”. Journal of Operations Management. 6 (3–4): 485–497.
Doi:10.1016/0272-6963(86)90019-7.

Ngan, Chun-Kit, ed. (2019-11-06). Time Series Analysis – Data, Methods, and
Applications. IntechOpen. Doi:10.5772/intechopen.78491. ISBN 978-1-78984-
778-9. S2CID 209066704.

Johnston, Richard G. C.; Brady, Henry E. (2006). Capturing Campaign Effects.

Ann Arbor: University of Michigan Press. ISBN 978-0-472-02303-5.

Hyndman, R.J., Koehler, A.B (2005) “Another look at measures of forecast

accuracy”, Monash University.

Hoover, Jim (2009) “How to Track Forecast Accuracy to Guide Process

Improvement”, Foresight: The International Journal of Applied Forecasting.

You can find an interesting discussion here.

Martin, Dominik; Spitzer, Philipp; Kühl, Niklas (2020). “A New Metric for
Lumpy and Intermittent Demand Forecasts: Stock-keeping-oriented
Prediction Error Costs”. Proceedings of the 53rd Annual Hawaii International
Conference on System Sciences. Doi:10.5445/IR/1000098446.

Bibliography

Last edited 4 months ago by Giant death lizard

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