Machine Learning In Demand Forecasting For Retail
Liudmyla Taranenko, Data Science Engineer at MobiDev
My university professor once asked me: "Who would agree with the statement that the only thing math can't calculate… is human behavior?" I don't remember what his scientific answer was. What I know for sure now is that human behavior could be predicted with data science and machine learning. In demand forecasting, we take a look at human behavior—not from a human perspective, but from sales data.
What Is Demand Forecasting in Machine Learning?
In this article, I want to show how machine learning approaches can help with customer demand forecasting. Since I have experience in building forecasting models for retail field products, I'll use a retail business as an example.
What Is Demand Forecasting in Machine Learning?
Machine learning techniques allow predicting the amount of products/services to be purchased during a defined future period. In this case, a software system can learn from data for improved analysis. Compared to traditional demand forecasting methods, machine learning:
• Accelerates data processing speed
• Provides the more accurate forecast
• Automates forecast updates based on the recent data
• Analyzes more data
• Identifies hidden patterns in data
• Creates robust system
• Increases adaptability to changes
With the arrival of artificial intelligence and machine learning, most businesses are looking to automate processes and use big data to implement AI. A 2019 report by Research and Markets' report says, in 2018 AI in retail was $720.0 million and is predicted to reach a CAGR of 35.4% during 2019-2024.
As for technology trends in retail sphere, demand forecasting is often aimed to improve the following processes:
• Supplier relationship management. By having the prediction of customer demand in numbers, it's possible to calculate how many products to order, making it easy for you to decide whether you need new supply chains or to reduce the number of suppliers.
• Customer relationship management. Customers planning to buy something expect the products they want to be available immediately. Demand forecasting allows you to predict which categories of products need to be purchased in the next period from a specific store location. This improves customer satisfaction and commitment to your brand.
• Order fulfillment and logistics. Demand forecasting features optimize supply chains. This means that at the time of order, the product will be more likely to be in stock, and unsold goods won't occupy prime retail space.
• Marketing campaigns. Forecasting is often used to adjust ads and marketing campaigns and can influence the number of sales. Sophisticated machine learning forecasting models can take marketing data into account as well.
• Manufacturing flow management. Being part of the ERP, time series-based demand forecasting predicts production needs based on how many goods will eventually be sold.
Design Algorithm for ML-Based Demand Forecasting Solutions
When initiating the demand forecasting feature development, it's recommended to understand the workflow of ML modeling. This offers a data-driven roadmap on how to optimize the development process.
Let's review the process of how we approach ML demand forecasting tasks.
Step 1. Brief Data Review
The first task when initiating the demand forecasting project is to provide the client with meaningful insights. The process includes the following steps:
1. Gather available data
3. Run a few data tests and pilots
In my experience, a few days is enough to understand the current situation and outline possible solutions.
Step 2. Setting Business Goals and Success Metrics
This stage establishes the client's highlights of business aims and additional conditions to be taken into account. Our team provides data science consulting to combine it with the client's business vision. The goal is to achieve something similar to:
"I want to integrate the demand forecasting feature so to forecast sales and plan marketing campaigns."
Success metrics offer a clear definition of what is "valuable" within demand forecasting. A typical message might state:
"I need such machine learning solution that predicts demand for [...] products, for the next [week/month/a half-a-year/year], with [...]% accuracy."
These points will help you to identify what your success metrics look like. You will want to consider the following:
What types of products/product categories will you forecast? Different products/services have different demand forecasting outputs. For example, the demand forecast for perishable products and subscription services coming at the same time each month will likely be different.
What is the length of time for the demand forecast?
Short-term forecasts are commonly done for less than 12 months - 1 week/1 month/6 month. These forecasts may have the following purposes:
• Uninterrupted supply of products/services
• Sales target setting and evaluating sales performance
• Optimization of prices according to the market fluctuations and inflation
• Finance maintenance
• Hiring of required specialists
Long-term forecasts are completed for periods longer than a year. The purpose of long-term forecasts may include the following:
• Long-term financial planning and funds acquisition
• Decision making regarding the expansion of business
• Annual strategic planning
What is the minimum required percentage of demand forecast accuracy for making informed decisions? Implementing retail software development projects, we were able to reach an average accuracy level of 95.96% for positions with enough data. The minimum required forecast accuracy level is set depending on your business goals.
Step 3. Data Preparation & Understanding
Regardless of what we'd like to predict, data quality is a critical component of an accurate demand forecast. This following data could be used for building forecasting models:
Source: IBF (Institute of Business Forecasting and Planning )
Data Quality Parameters
When building a forecasting model, the data is evaluated according to the following parameters:
In reality, the data collected by companies often isn't ideal. This data usually needs to be cleaned, analyzed for gaps and anomalies, checked for relevance, and restored. When developing POS application for our retail clients, we use data preparation techniques that allow us to achieve higher data quality.
Once the data was cleaned, generated, and checked for relevance, we structure it into a comprehensive form. Below, you can see an example of the minimum required processed data set for demand forecasting:
Data understanding is the next task once preparation and structuring are completed. It's not modeling yet but an excellent way to understand data by visualization. Below you can see how we visualized the data understanding process:
Step 4. Machine Learning Models Development
There are no "one-size-fits-all" forecasting algorithms. Often, demand forecasting features consist of several machine learning approaches. The choice of machine learning models depends on several factors, such as business goal, data type, data amount and quality, forecasting period, etc.
Here I describe those machine learning approaches when applied to our retail clients. But if you have already read some articles about demand forecasting, you might discover that these approaches work for most demand forecasting cases.
• Time Series
• Linear Regression
• Feature Engineering
• Random Forest
Time Series Approach
This involves processed data points that occur over a specific time that are used to predict the future. Time series is a sequence of data points taken at successive, equally-spaced points in time. The major components to analyze are: trends, seasonality, irregularity, cyclicity.
The analysis algorithm involves the use of historical data to forecast future demand. That historical data includes trends, cyclical fluctuations, seasonality, and behavior patterns.
In the retail field, the most applicable time series models are the following:
1. ARIMA (auto-regressive integrated moving average) models aim to describe the auto-correlations in the time series data. When planning short-term forecasts, ARIMA can make accurate predictions. By providing forecasted values for user-specified periods, it clearly shows results for demand, sales, planning, and production.
2. SARIMA (Seasonal Autoregressive Integrated Moving Average) models are the extension of the ARIMA model that supports uni-variate time series data involving backshifts of the seasonal period.
3. Exponential Smoothing models generate forecasts by using weighted averages of past observations to predict new values. The essence of these models is in combining Error, Trend, and Seasonal components into a smooth calculation.
Related article: Optical Character Recognition Based on Machine Learning Technology
Let's say you want to forecast demand for vegetables in the next month. For a time series approach, you require historical sale transaction data for at least the previous three months. If you have historical data about seasonal products - vegetables in our case - the best choice will be the SARIMA model. The forecast error, in that case, may be around 10-15%.
Linear Regression Approach
Linear regression is a statistical method for predicting future values from past values. It can help determine underlying trends and deal with cases involving overstated prices.
This regression type allows you to:
• Predict trends and future values through data point estimates.
• Forecast impacts of changes and identify the strength of the effects by analyzing dependent and independent variables.
Let's say you want to calculate the demand for tomatoes based on their cost. Assuming that tomatoes grow in the summer and the price is lower because of high tomato quantity, the demand indicator will increase by July and decrease by December.
The information required for such type forecasting is historical transaction data, additional information about specific products (tomatoes in our case), discounts, average market cost, the amount in stock, etc. The forecast error may be 5-15%.
Feature engineering is the use of domain knowledge data and the creation of features that make machine learning models predict more accurately. It enables a deeper understanding of data and more valuable insights.
Since feature engineering is creating new features according to business goals, this approach is applicable in any situation where standard methods fail to add value. In custom ML modeling, a data scientist builds new features from existing ones to achieve higher forecast accuracy or to get new data.
The basic idea behind the random forest model is a decision tree. The decision tree approach is a data mining technique used for data forecasting and classification. The decision tree method itself does not have any conceptual understanding of the problem. It learns from the data we provide it.
Random forest is the more advanced approach that makes multiple decision trees and merges them together. By taking an average of all individual decision tree estimates, the random forest model results in more reliable forecasts.
Random forest can be used for both classification and regression tasks, but it also has limitations. The model may be too slow for real-time predictions when analyzing a large number of trees.
If you have no information other than the quantity data about product sales, this method may not be as valuable. In such cases, the time series approach is superior.
Step 5. Training & Deployment
Once the forecasting models are developed, it's time to start the training process. When training forecasting models, data scientists usually use historical data. By processing this data, algorithms provide ready-to-use trained model(s).
This step requires the optimization of the forecasting model parameters to achieve high performance. By using a cross-validation tuning method where the training dataset is split into ten equal parts, data scientists train forecasting models with different sets of hyper-parameters. The goal of this method is to figure out which model has the most accurate forecast.
When researching the best business solutions, data scientists usually develop several machine learning models. Since models show different levels of accuracy, the scientists choose the ones that cover their business needs the best.
The improvement step involves the optimization of analytic results. For example, using model ensemble techniques, it's possible to reach a more accurate forecast. In that case, the accuracy is calculated by combining the results of multiple forecasting models.
This stage assumes the forecasting model(s) integration into production use. We also recommend setting a pipeline to aggregate new data to use for your next AI features. This can save you a lot of data preparation work in future projects. Doing this also increases the accuracy and variety of what you could be able to forecast.
So, what did we learn? Machine learning is not limited to demand forecasting. The future potential of this technology depends on how well we take advantage of it.
As a 17-year-old student, I never knew that math and statistics applied to so many complex solutions. Today, I work on demand forecasting technology and understand what added value it can deliver to modern businesses.