Demand Forecasting. An Art or Science - Essay Example

Logistic assignment Table of Contents Part A 3 Group Strategy 3 Breakeven Quantity at Level 3 7 Inventory Holding Level 9 Part B 11 Demand Forecasting. An Art or Science? 11 Principle of Forecasting 13 Types of forecasting 13 Methods of Forecasting 14 Qualitative methods 14 Quantitative Methods 15 Reference 16 Bibliography 18 Part A Group Strategy The manufacturing group is into the business of manufacturing electronic car aerials. The production process of the group involves three assembling of three basic components like that of main body, the aerials and the accessories. The company has a team of professionals to manage the various functions like that of production schedule, materials ordering, controlling of stocks and over all management of resources. The group had categorized several levels of difficulties. At present it is manufacturing only the standard model. The level of difficulty for the standard model is that of one. In future, the group plans to get into the process of higher levels of difficulties. According to the plan, with prior approval of umpire, the company plans to move into level two and then level three. The strategy has both strengths and weaknesses. The strengths of the strategy undertaken by the company at present, is that the company is involved in producing the standardised model. It means the methodologies involved are relatively simpler. So, the production is higher. Also, the cost of holding is comparatively lesser and there are no such wastage of resources for reworks, machine down times and scrap. The cost of labour is much lower in the present level of difficulty. Also, it is found that the semi fixed costs are also lower in the first level of difficulty. As the products are standardised, the demand of the products are also higher by almost double. Apart from the strengths, there are also many weaknesses related with the present strategy. As the present strategy caters to the standard model of products, the market is getting to be extinct sooner or later. Therefore, the company have to diversify into advanced models. Also, in the present strategy, the production capacity is lower. As there were both positives as well as negatives for the present strategy, the manufacturing group is moving towards the developed strategy which includes modern concepts like that of forecasting, scheduling and capacity. Forecasting – Though often thought to be alike and confused, forecasting is much different from goal. Forecasting is the way to predict the happenings in the future. Forecasting is part of the decision making mechanism of the company. The major implementation of the function of forecasting is that in the inventory control, requirements of manpower and the selection of capacity and the location of facility (Loerch, n.d.). It is good for the manufacturing group that it has incorporated forecasting with in the future strategies. To have the function run properly, the company should have adequate amount of past information and should be able to make the future guess correctly. Though the company has imbibed forecasting as the major tool, the system prevalent in the company should also be flexible so that it can respond to the changes. Capacity – Another important aspect of the future strategy that the company is to evolve and execute is that of a proper capacity planning. Capacity is often regarded as the very broad and vague term and therefore is vey tough to predict. Capacity planning or capacity management can be referred as the product of demand, part quantity and process time for man or machines. As it not very easy to predict capacity of any organisation especially that of manufacturing company there fore several steps can be taken to maintain the desired level. The policies might include employing sub-contract level with short term contracts. The company can maintain a lower base of employee and make then work overtime. Also, many companies resort to policies like hire and fire. The manufacturing group should be able to forecast its demand and the process time so that it can have proper capacity planning. To remove the need of varying capacity the company can always maintain the excess demand and try to reduce or at least smooth the fluctuations. The present demand of the advanced model of the product is almost half of the standard model. But the management should keep in mind that with time the demand of the XL model would increase. So, the capacity planning should be made accordingly. The last desired for the management would be to fail to cater need of the customers. Scheduling – There are three major tools of logistics and operations management namely inventory, capacity and scheduling. The scheduling is required in the business organisations so that the flow of operations is maintained and the organisation functions swiftly. As it is done in the modern day companies, the manufacturing group also follows that of Material Resource Planning. Material Resource Planning helps to schedule different aspects of the business optimally. For the purpose of material resource planning, the company would, at the outset, ensure proper functioning of material production scheduling or MPS. MPS is derived from policy decisions and forecast of demands. Material production schedule in turn leads to material resource planning which ultimately helps top amend purchase orders. As the company is in the mode of diversification, from the standard model to the advanced XL model, so the management should give extreme importance to the different methods of scheduling. With proper scheduling the company can optimise the production and operations and thereby minimise wastage of resources. Breakeven Quantity at Level 3 As per the problem, Fixed Cost = £ 75,000 Semi Fixed Cost = £ 27,000 Total Cost = Fixed Cost + Semi Fixed Cost = £ 75,000 + £ 27,000 = £ 102,000 Variable Cost per unit = Cost of Materials + Cost of Labour per unit. Cost of Labour per unit = £ 14 Cost of materials = £ 8 + £ (6 x 2) + £ 1 [Cost of Main Body = £ 8, Cost of Aerial = £ 6, = £ 21 Cost of Accessories = £ 1] Variable Cost per unit = £ 14 + £ 21 = £ 35 Selling Price per unit = £ 55 Contribution per unit = £ 55 - £ 35 = £ 20 Break even Volume = Total Cost/ Contribution per unit = 102,000/20 = 5100 units is the break even volume at level 3 Inventory Holding Level From the perspective of the company, capital is very precious. Accumulating funds for the companies (be it own capital or loan capital) is equally tough. But if the company plans to expend its business and scale of its operations, the need of capital is always felt. One of the major operations of the capital is that of manufacturing process. Considerable amount of the working capital of the company is locked up ion the day – to- day process of manufacturing. But the companies take considerable time to generate revenue from the process. The reason behind it is that primarily companies follow a particular operating cycle and secondly, most of the sales are in the form of credit sales which again calls for extra time. Therefore the companies always strive to optimise the operating cycle. One of the most followed and referred way of optimising the production cycle is to have the optimum inventory level. To sale a product, companies always have to keep certain amount of the finished good as the stock. These finished goods are also known as inventories. Having more of inventories in the stock might be looked as the indicator of the strong position of the company but it also means the company’s cash resources are blocked up. So, various methods of calculating the optimum stock level have come up with time. The most important way to ascertain the optimum quantity level is that of economic order quantity. The economic order quantity is depended on host of factors like the annual demand, cost of holding and the cost of carrying cost. The economic order quantity is related with inventory control which is in turn done to reduce the cost of inventory (Ashram, n.d.). The formula for economic order quantity as follows: EOQ = √(2AD) / C Where, A = Set up cost, D = Demand and C= Holding Cost The level of EOQ is the safe level of inventory for the company. As the company has reached the EOQ level, it should again re-order to procure more stocks. Therefore, the optimum stock holding level is the level of economic order quantity for any business especially that of manufacturing concern. Part B Demand Forecasting. An Art or Science? Demand is an economic term which quantifies the amount of goods and services those consumers wants to buy at a given price. Whereas forecasting is an art of predicting that what will happen in the future. By combining these two words we get what is known as demand forecasting. The terminology means predicting how much the consumers will buy in future. This may seem quite vague that how can one predict how much the consumer will buy in the future, but the fact is that companies are trying to forecast the demands in order to gear them up for facing the intense rivalry between competitors. Doing business in this dynamic and rapidly changing environment is becoming more complex day by day. Sustainability is the major issue that companies need to address now a day to survive in the market. This is not where the problem ends. Consumers are being flooded with options due to the increasing number of competitors. They have a lot of options to choose from. On the other hand marketers have limited options. They have to cater to the demands of the consumers otherwise the consumer have a basket of options to choose from. Thus the question arises that how do they cater to the demand of the consumers. Companies need to ahead of time and predict what the consumers needs might be or rather more specifically how much the consumers will want to buy in the near future. To quantify that how much the consumers will buy is a difficult proposition. This is where the need of demand forecasting arises. A lot of research has gone into understanding the consumer’s pattern of consumption. Consumer behaviour helps us to know that why do consumers at time buy more or what are the factors that drive them to buy more or less. Demand forecasting helps to quantify the consumer needs. However demand forecasting has a lot of errors because there are no well defined parameters that can help us to understand the consumer’s pattern. The question still remains that why do companies need to predict the future demand. A company’s main aim is to maximise profits. In order to maximise profits they can adjust two variables that is by lowering the costs and maximising the sales. That brings us to the next question that how much do they produce to maximize sales. A decade ago the answer would have been to produce to the maximum capacity. But producing to the maximum capacity does not solve the problem of maximising sales. If the company is producing more than what the demand is then the problem for the company would be to store the products in the form of inventory. Inventory cost can harm the company’s profit margins as it is a cost for the company. On the other hand if the company is producing less then it would loose out on sales and in turn on revenues. Thus production is a double edged sword that can prove to be beneficial but if not used properly it can prove to be harmful as well. Thus a very fine balance has to be struck between the producing the optimum quantity, where demand forecasting can play a vital role. Forecasting the demand has an important role to play in supply chain management. Demand forecasting mainly focuses on customer activity. The main objective of demand forecast is to ensure that there is a smooth supply of goods among each channels exists so that the customer receive their goods in time. Demand forecasting is different from that of demand creation which is often used by marketers for increasing sales (Sekhri, et.al., 2006). Demand forecasting is a part of demand management. Demand management acts as an interface between the manufacturing process and the market. Sometimes it is very easy to forecast demand. In case of a baker, it is possible for him to find out historical data and predict what the demand would be in the coming week or so. It is not so easy all the times. In case of a complex environment where there are a number of variables involved like the competitors, distributors suppliers, and government, forecasting becomes complex. Thus while forecasting in such an environment all the variables should be taken into consideration for an accurate forecast (Armstrong & Green, 2006). Principle of Forecasting Forecasting is not accurate every time, so while forecasting the demand forecasting error should be mentioned so that the while using the data for manufacturing the error is accounted for. It should be kept in mind that long term forecast is more accurate than short term forecast. To increase the level of forecasting accuracy a greater degree of association is required. Types of forecasting Forecasting can be broadly categorised into three types. The short term forecasting is significant for inventory management and scheduling. Short term focusing varies from few days to 3months. The medium term forecasting is for production planning, distribution and purchase. It ranges from three to 2 years. Whereas the long term forecasting takes a broader perspective like the strategic planning and capacity planning. The time frame of this is more than two years. Thus depending upon the type of forecasting required the adequate methods can be adopted. For example, for short term such a method has to be used which is cheap and easy to install and that which can be adjusted according to the situation. For medium type forecasting a slightly expensive and more specific kind of a method should be adopted. Whereas for long term, methods that would be used would be less accurate and would require subjective inputs from managers (Sarin, 2007). Methods of Forecasting Broadly methods of forecasting are of two types. Qualitative and quantitative. Qualitative method is subjective in nature and more dependent on human judgement and perception. Whereas quantitative method is more of an analytical approach which uses historical data mathematical models and variables to reach a prediction. Qualitative methods These methods are mainly used for long term forecasting. It is more subjective and includes opinion of knowledgeable people and expert analysis. They can be of the following types Opinion of a group of executives, where high level mangers come together and give their views about the forecast. Opinion of the sales force. Members of the sales team comes together and estimates the amount of sales in a territory. Market research method. It gathers data from customers regarding their future plans. Delphi technique. Over here questionnaires are distributed through which a survey is conducted among a dispersed respondents and their opinion are taken into considerations. Quantitative Methods Mathematical derivations and data are used in this method to forecast demand. They are time series methods, casual methods and simulation method. Time series method. This method uses the historical data and extrapolates it to future using statistical tools like moving averages, exponential moving average and time series decomposition. They are suited for stable environments. Casual method. The basic assumption of this method is that demand is highly correlated with environmental factors. It uses correlation, regression and econometric models for calculations. Simulation method works on the principle of imitating consumer choice and arriving to demand forecast. Reference Armstrong, J. S. & Green, K.C., 2006. Demand Forecasting: Evidence-based Methods. University of Pennsylvania. [pdf] Avaliable at: http://marketing.wharton.upenn.edu/ideas/pdf/Armstrong/DemandForcasting.pdf [Accessed on 8 July 2009]. Ashram, H. No Date. Economic Order Quantity and Economic Production Quantity Models for Inventory Management. University of Baltimore. [Online] Available at: http://home.ubalt.edu/ntsbarsh/Business-stat/otherapplets/Inventory.htm [Accessed on 8 July 2009]. Sekhri, N. et.al., 2006. PRINCIPLES FOR FORECASTING DEMAND FOR GLOBAL HEALTH PRODUCTS. Centre for global development. [pdf] Avaliable at: http://www.cgdev.org/doc/ghprn/Demand_Forecasting_Principles,Sept-06.pdf [Accessed on 8 July 2009]. Sarin, B., 2007. MODERN PRODUCTION / OPERATIONS MANAGEMENT. 8th Ed. Wiley-India. Loerch, A. G., No Date. Management Science. George Mason University. [Pdf] Available at: http://classweb.gmu.edu/aloerch/DemandForec.pdf [Accessed on 8 July 2009]. Bibliography Armstrong, J. S., 2001. Standard and Practices of Forecasting. The Wharton School, University of Pennsylvania. [pdf] Avaliable at: http://www.forecastingprinciples.com/files/standardshort.pdf [Accessed on 8 July 2009]. Armstrong, J. S., 2001. Principles of forecasting: a handbook for researchers and practitioners. Springer. Read More