1. Forecasting and Logistics
John H. Vande Vate
Fall, 2002 1

2. Fundamental Rules
The farther in the future we must forecast, the worse the forecast
The longer we have to do something the cheaper it is to do it.
Balance these two
Long plans mean bad forecasts
Short plans mean high operational costs 2

3. Balancing Risk News vendor problem A single shot at a fashion market
Guess how much to order
If you order too much, you can only salvage the excess (perhaps at a loss) (s-c = net salvage value)
If you order too little, you lose the opportunity to sell (r = revenue)
Question: What value do you choose? 3

4. The Idea Balance the risks Look at the last item
What did it promise?
What risk did it pose?
If Promise is greater than the risk?
If the Risk is greater than the promise? 4

5. Measuring Risk and Return
Profit from the last item
$p if the Outcome is greater,$0 otherwise
Expected Profit
$p*Probability Outcome is greater than our choice
Risk posed by last item
$r if the Outcome is smaller, $0 otherwise
Expected Risk
$r*Probability Outcome is smaller than our choice
Example: r = Cost – Salvage Value
What if r < 0?
What if Salvage Value > Cost? 5

6. Balancing Risk and Reward
Expected Profit
$p*Probability Outcome is greater than our choice
Expected Risk
$r*Probability Outcome is smaller than our choice
How are probabilities Related? 6

7. Risk & Reward How are they related? Prob. Outcome is smaller
Our choice
How are they related?
Prob. Outcome is larger 7

8. Balance Expected Revenue Expected Risk Set these equal p*(1-P) = r*P
$p*(1- Probability Outcome is smaller than our choice)
Expected Risk
$r*Probability Outcome is smaller than our choice
Set these equal
p*(1-P) = r*P
p = (r+p)*P
p/(r + p) = P = Probability Outcome is smaller than our choice 8

9. Making the Choice p/(r+p) Cumulative Probability
Prob. Outcome is smaller
Our choice
Cumulative Probability
p/(r+p) 9

10. How does this Apply? Source in Asia Source in Mexico
Cost is Low, Lead time is high (add 2 wks)
Source in Mexico
Cost is higher, lead time is lower
Place your first order far in advance in Asia. Asia has capacity
Place subsequent order in Mexico when you know more
What do you order from Asia?
What do you order from Mexico? 10

11. What Matters? Ordering from Asia Ordering from Mexico Anything Else?
Expected Demand from?
Variance in Demand from?
Ordering from Mexico
What you ordered from Asia
Expected Demand
Variance in Demand
Anything Else? 11

12. What Else! How much you can learn from waiting!
If the forecast is bad before and bad after you might as well order early
If the forecast is bad before but good after, you gain by waiting.
But, how to know…. 12

13. Example: Common Variance
Order x(k) of product k
Products differ only in mean demand
Can’t order more than 5,000 from Asia
Express x(k) = (k) + z*
Probability Demand < x(k)?
Normal (x(k) - (k))/) = Normal(z)
So?
Use News Vendor to find z 13

14. Only Means Matter x(k) = (k) + z* S x(k) = S ((k) + z*) = 5,000
n*z* = 5,000 - S (k)
z = (5,000 - S (k))/(n*)
Then find x(k) from z. 14

15. Sourcing Decisions What matters: And Now: Piece price Quality Freight
Packaging
Pipeline inventory
Etc
And Now:
Leadtime impacts on forecast accuracy and
Forecast accuracy impacts on supply chain costs! 15

16. Where Else? Where else do these ideas apply?
What if we are the manufacturer?
The longer it takes us to make a product, the farther forward we must forecast
What can we do to reduce this? 16