Operations and Quality Management

Session 3

Demand forecasting and Production Planning

Session outline

First part: Forecasting Demand

Second Part: Capacity Planning

Third part: Strategy Investment

What is Forecasting?

• Forecasting – the art and science of predicting the future events.

• Forecasting may involve taking historical data and projecting them into the future with some sort of mathematical model.

• An increasingly complex world economy makes forecasting challenging

Forecasting Time Horizons

• Short range forecast – spans up to one year, but generally less than three months (purchasing planning, job scheduling, job assignments and production levels);

• Medium range forecast (intermediate) – spans from three months to three years (sales/production planning, budgeting);

• Long range forecast – for more then three years (new product planning, capital expenditures, R&D)

Distinctive Features

Short Range

• Employs different methodologies including some of mathematical techniques;

• Tend to be more accurate;

Intermediate and long-run

• Deal with more comprehensive issues supporting management decisions regarding planning and processes;

Types of Forecasts

• Economic – predicting inflation rates, money supplies, housing starts and etc.;

• Technological – rates of progress, which can result in the birth of exciting new product

• Demand – projections for demand for a company’s product and/or services, also called sales forecast, driving company’s production, capacity and scheduling system.

Strategic Importance

The forecast is the only estimate of demand until actual becomes known.

• Human resources;

• Capacity;

• Supply-chain management

HRM

• Hiring, training and laying off workers all depend on anticipated demand.

• If the human resources department must hire additional workers without warning, the amount of training declines and the quality of the workforce suffers.

Capacity

• When capacity is inadequate, the resulting shortages can lead to loss of customers and market share.

Supply-Chain Management

• Good supplier relations and the ensuing price advantages for materials and parts depend on accurate forecasts.

Forecasting System Steps

1. Determine the use of the forecast.

2. Select the items to be forecasted.

3. Determine the time horizon of the forecast.

4. Select the forecasting models.

5. Gather the data needed to make the forecast.

6. Make the forecast.

7. Validate and implement the results.

Forecasting Approaches

• Quantitative forecasts – that employ mathematical modeling to forecast demand

• Qualitative forecasts – that incorporate such factors as the decision maker’s intuition, emotions, personal experience and value system

Qualitative Method

• Jury of executive opinion – uses the opinion of a small group of high-level managers

• Delphi method – uses a group process that allows experts to make forecast (decision makers, staff personnel and respondents)

• Sales force composite – based on salesperson’s estimates of expected sales

• Consumer market survey – solicits input from customers or potential customers regarding future purchasing plans

Quantitative Method

Five quantitative forecasting methods all of which use historical data. 1. Naive approach

2. Moving averages

3. Exponential smoothing

4. Trend projection

5. Linear regression

Time-series models

Associative model

Overview of Quantitative Methods

Time series – a technique that uses a series of past data points to make a forecast.

• Time series models predict on the assumption that the future is a function of the past.

• Associative models incorporate the variables or factors that might influence the quantity being forecast.

Time-Series Forecasting

Future values are predicted only from past values and based on a sequence of evenly spaced data points.

Decomposition of a Time Series:• Trend• Seasonality• Cycles• Random variations

Time-Series Forecasting

1. Naive Approach – a technique which assumes that demand in the next period is equal to demand in the most recent period.

Time-Series Forecasting

2. Moving-average – uses a number of historical actual data values to generate forecast. Used if we can assume that market demands will stay fairly steady over time.

Moving average =

Weighted Moving Average =

n (number of periods)Σ demand in previous n periods

Σ (Weight for period n)(Demand in period n) Σ Weights

Time-Series Forecasting

3. Exponential Smoothing is a sophisticated weighted-moving-average forecasting method which involves very little record keeping of past data.

New forecast = Last period’s forecast

+ α (Last period’s actual demand – Last period’s forecast)

Smoothing Constant α – the weighting factor used in an exponential smoothing forecast, a number between 0 and 1, chosen by forecaster

Time-Series Forecasting

4. Trend Projection – fits a trend line to a series of historical data points and then projects the line into the future for forecast

• Seasonal variations – regular upward or downward movements in a time series that tie to recurring events

• Cyclical variations – patterns in the data that occur every several years

Associative Forecasting

5. Regression analysis – a straight-line mathematical model to describe the functional relationships between independent and dependent variables

The manager’s job is to develop the best statistical relationship between dependent and independent variable

Monitoring and Controlling

• Tracking signal – a measurement of how well a forecast is predicting actual values

• Bias – a forecast that is consistently higher or lower than actual values of a time series

Summarizing Forecasting

• Forecasts are critical part of operations manager’s functions, driving a firm’s production, capacity, scheduling systems and affecting the financial, marketing and personnel functions

Forecasting Techniques

Qualitative

• Employ judgment, experience, intuition, and a host of other factors that are difficult to quantify

Quantitative

• Uses historical data and causal or associative relations to project future demands

Capacity

• The “throughput” or number of units a facility can hold, receive, store or produce in a period of time

• Too little capacity loses customers and too much capacity is expensive

• Capacity determines the rate of output of a process or the speed at which the firm can pull completed work out of the process

Capacity Planning

• The purpose – to ensure the right quantity of goods or services at the right time and with the best use of available resources.

1. What will be done at the facility?

2. How much capacity is needed?

3. When should capacity be changed?

Design and Effective Capacity

• Design capacity – the theoretical maximum output of a system in a given period under ideal condition

• Effective capacity – the capacity a firm can expect to achieve, given its product mix, methods of scheduling, maintenance and standards of quality

System Performance Measures

Utilization

• Actual output as a percent of design capacity

Utilization =

Efficiency

• Actual output as a percent of effective capacity

Efficiency =

Actual output Design capacity

Actual output Effective capacity

Capacity and Strategy

• Sustained profits are coming from building competitive advantage

• Capacity decisions must be integrated into organization’s mission and strategy

Capacity Decisions

• Facilities and capacity decisions generally are very expensive and irreversible. Thus, when making such a decisions in a dynamic environment, the organization must make a throughout assessment of the future scenarios that might evolve

• Both the size and timing of facility and capacity decisions depend on the growth (or decline) of demand for products and services as characterized by the product life cycle.

Capacity Considerations

1. Forecast Demand accurately

2. Understand the technology and capacity increments

3. Optimum operating size (volume)

4. Build for change

Managing Demand

1. Demand exceeds capacity:o Raising priceso Scheduling long lead times

2. Capacity exceeds demands:o Price reductiono Aggressive marketing

3. Adjusting to seasonal demands:o Product with complementary demand patterns

Managing Demand

• Managers calculate theoretical values for maximization and effective capacity to guide their production plans

• Maximum capacity cannot be increased unless the facility or the labor force is expanded or modified

Matching Capacity to Demand

1. Making stuffing changes

2. Adjusting equipment

3. Improving processes to increase throughput

4. Redesigning products

5. Adding process flexibility

6. Closing facilities

Service Sector

Demand Management

• Appointments, reservations or first-come, first-served rule

Capacity Management

• When managing demand is not feasible

• Changes in full-time, temporary or part-time staff

Bottleneck Analysis

• Capacity analysis – a means of determining throughput capacity of workstations or an entire production system

• Bottleneck – the limiting factor or constraint in a system

Process Times

• Process time of a station – the time to produce units at a single workshop

• Process time of a system – the time of a longest (slowest) process, the bottleneck

• Process cycle time – the time it takes for a product to go through the production process with no waiting

Theory of Constraints

• Theory of Constraints (TOC) – a body of knowledge that deals with anything that limits an organization ability to achieve its goals

The Basis of TOC

1. Identify the constraints

2. Develop a plan for overcoming the identified constraints

3. Focus resources

4. Reduce the effects of the constraints

5. Identify new constraint

Bottleneck Management

A crucial constraint in any system is the bottleneck, and managers must focus significant attention on it

1. Release work orders to the system at the pace set by the bottleneck’s capacity – the concept of drum, buffer and rope:• Drum – the beat of the system • The buffer – the source (inventory)• The rope – communication

Bottleneck Management

2. Lost time at the bottleneck represents lost capacity for the whole system

3. Increasing the capacity of a non-bottleneck station is a mirage

4. Increasing the capacity of the bottleneck increases capacity for the whole system

Break-Even Analysis

• A means of finding the point, in dollars and units, at which costs equal revenues

Strategy Investments

• Net Present Value – a means of determining the discounted value of series of future cash receipts

F = P(1 + i)n P =

where: F – future value

P – present value

I – interest rate

N – number of years

F(1 + i)n

End of Session

Questions and Discussions