The Sum and Its Parts: Judgmental Hierarchical Forecasting

Posted: 17 Aug 2012 Last revised: 30 Mar 2016

Mirko Kremer

Pennsylvania State University

Enno Siemsen

University of Wisconsin-Madison

Douglas J. Thomas

Pennsylvania State University - Department of Supply Chain & Information Systems

Date Written: August 16, 2012

Abstract

Firms require demand forecasts at different levels of aggregation to support a variety of resource allocation decisions. For example, a retailer needs store-level forecasts for a particular item to manage inventory at the store but also requires a regionally-aggregated forecast for managing inventory at a distribution center. In generating an aggregate forecast, a firm can choose to make the forecast directly based on the aggregated data or indirectly by summing lower-level forecasts (i.e., bottom-up). Our study investigates the relative performance of such hierarchical forecasting processes through a behavioral lens. We identify two judgment biases that affect the relative performance of direct and indirect forecasting approaches: a propensity for random judgment errors, and a failure to benefit from the informational value that is embedded in the correlation structure between lower-level demands. Based on these biases we characterize demand environments where one hierarchical process results in more accurate forecasts than the other. Further, using field data, we demonstrate how to estimate the relevant correlation structure of lower-level demands.

Keywords: forecasting process, exponential smoothing, covariation detection, behavioral operations, sales and operations planning

Suggested Citation

Kremer, Mirko and Siemsen, Enno and Thomas, Douglas J., The Sum and Its Parts: Judgmental Hierarchical Forecasting (August 16, 2012). Available at SSRN: https://ssrn.com/abstract=2130708 or http://dx.doi.org/10.2139/ssrn.2130708

Mirko Kremer

Pennsylvania State University ( email )

University Park
State College, PA 16802
United States

Enno Siemsen (Contact Author)

University of Wisconsin-Madison ( email )

975 University Avenue
Madison, WI 53706
United States

Douglas J. Thomas

Pennsylvania State University - Department of Supply Chain & Information Systems ( email )

Dept. of Supply Chain & Information Systems
University Park, PA 16802-3306
United States

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