4

Forecasting
Demand

PowerPoint presentation to accompany

Heizer and Render
Operations Management, Global Edition, Eleventh Edition
Principles of Operations Management, Global Edition, Ninth Edition

PowerPoint slides by Jeff Heyl

© 2014 Pearson
© 2014 Education
Pearson Education 4-1
 Outline
▶ Global Company Profile:
Walt Disney Parks &
Resorts
▶ What Is Forecasting?
▶ The Strategic Importance
of Forecasting
▶ Seven Steps in the Forecasting
System
▶ Forecasting Approaches
© 2014 Pearson Education 4-2
 Outline - Continued
▶ Time-Series Forecasting
▶ Associative Forecasting Methods:
Regression and Correlation
Analysis
▶ Monitoring and Controlling Forecasts
▶ Forecasting in the Service Sector
 Learning Objectives
When you complete this chapter you
should be able to :
1. Understand the three time horizons and
which models apply for each use
2. Explain when to use each of the four
qualitative models
3. Apply the naive, moving average,
exponential smoothing, and trend
methods
When you complete this chapter you
should be able to :
4. Compute three measures of forecast
accuracy
5. Develop seasonal indices
6. Conduct a regression and correlation
analysis
7. Use a tracking signal
 Forecasting Provides a
Competitive Advantage for Disney

► Global portfolio includes parks in Hong

Kong, Paris, Tokyo, Orlando, and Anaheim
► Revenues are derived from people –
how many visitors and how they spend
their money
► Daily management report contains only
the forecast and actual attendance at each
park
© 2014 Pearson
© 2014 Education
Pearson Education 4-6
 Forecasting Provides a
Competitive Advantage for Disney

► Disney generates daily, weekly,

monthly, annual, and 5-year forecasts
► Forecast used by labor management,
maintenance, operations, finance, and park
scheduling
► Forecast used to adjust opening times,
rides, shows, staffing levels, and guests
admitted
© 2014 Pearson
© 2014 Education
Pearson Education 4-7
 Forecasting Provides a
Competitive Advantage for Disney

► 20% of customers come from outside

the USA
► Economic model includes gross domestic
product, cross-exchange rates, arrivals into
the USA
► A staff of 35 analysts and 70 field people
survey 1 million park guests, employees, and
travel professionals each year

© 2014 Pearson
© 2014 Education
Pearson Education 4-8
 Forecasting Provides a
Competitive Advantage for Disney

► Inputs to the forecasting model include

airline specials, Federal Reserve policies,
Wall Street trends, vacation/holiday
schedules for 3,000 school districts around
the world
► Average forecast error for the 5-year
forecast is 5%
► Average forecast error for annual forecasts
is between 0% and 3%
© 2014 Pearson
© 2014 Education
Pearson Education 4-9
 What is Forecasting?
► Process of predicting
a future event
Underlying basis
►

of all business ??
decisions
► Production
► Inventory
► Personnel
► Facilities
© 2014 Pearson Education 4 - 10
 Forecasting Time Horizons
1. Short-range forecast
► Up to 1 year, generally less than 3 months
► Purchasing, job scheduling, workforce levels,
job assignments, production levels
2. Medium-range forecast
► 3 months to 3 years
► Sales and production planning, budgeting
3. Long-range forecast
► 3+ years
► New product planning, facility location,
research and development
© 2014 Pearson Education 4-
111
 Distinguishing Differences
1. Medium/long range forecasts deal with more
comprehensive issues and support
management decisions regarding planning
and products, plants and processes
2. Short-term forecasting usually employs
different methodologies than longer-term
forecasting
3. Short-term forecasts tend to be more
accurate than longer-term forecasts

© 2014 Pearson Education 4 - 12

 Influence of Product Life
Cycle
Introduction – Growth – Maturity – Decline

► Introduction and growth require

longer forecasts than maturity and
decline
► As product passes through life
cycle, forecasts are useful in
projecting
► Staffing levels
► Inventory levels
© 2014 Pearson Education 4 - 13
 ► Factory capacity

© 2014 Pearson Education 4 - 14

 Product Life Cycle
Introduction Growth Maturity Decline

Best period to Practical to change Poor time to Cost control

increase market price or quality change image, critical
share image price, or quality
Company Strategy/Issues

R&D engineering is Strengthen niche Competitive costs

critical become critical
Defend market
position Drive-through
Internet search restaurants
engines
DVDs
Xbox 360
iPods
Boeing 787

Sales
3D printers

3-D game Analog

players Electric vehicles TVs
Figure 2.5
© 2014 Pearson Education 4 - 14
 Introduction Growth Maturity Decline
Product design Forecasting critical Standardization Little product
and development differentiation
critical Product and Fewer product
process reliability changes, more Cost
Frequent product minor changes minimization
and process Competitive
OM Strategy/Issues

design changes product Optimum capacity Overcapacity in

improvements and Increasing stability the industry
Short production options
runs of process Prune line to
Increase capacity eliminate items
High production Long production not returning
costs Shift toward runs good margin
product focus
Limited models Product Reduce
Enhance improvement and capacity
Attention to quality distribution cost cutting
 Types of Forecasts
1. Economic forecasts
► Address business cycle – inflation rate, money
supply, housing starts, etc.
2. Technological forecasts
► Predict rate of technological progress
► Impacts development of new products
3. Demand forecasts
► Predict sales of existing products and services

© 2014 Pearson Education 4 - 16

 Strategic Importance of
Forecasting
► Supply-Chain Management – Good
supplier relations, advantages in product
innovation, cost and speed to market
► Human Resources – Hiring, training,
laying off workers
► Capacity – Capacity shortages can result
in undependable delivery, loss of
customers, loss of market share

© 2014 Pearson Education 4 - 17

 Seven Steps in Forecasting
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 model(s)
5. Gather the data needed to make the
forecast
6. Make the forecast
7. Validate and implement results
© 2014 Pearson Education 4 - 18
 The Realities!
► Forecasts are seldom perfect,
unpredictable outside factors may
impact the forecast
► Most techniques assume an
underlying stability in the
system
► Product family and aggregated
forecasts are more accurate than
individual product forecasts
© 2014 Pearson Education 4 - 19
 Forecasting
Approaches
Qualitative Methods

► Used when situation is vague

and little data exist
► New products
► New technology
► Involves intuition, experience
► e.g., forecasting sales on Internet
Quantitative Methods

► Used when situation is ‘stable’

and historical data exist
► Existing products
► Current technology
► Involves mathematical techniques
► e.g., forecasting sales of color
televisions
Overview of Qualitative Methods

1. Jury of executive opinion

► Pool opinions of high-level experts,
sometimes augment by statistical
models
2. Delphi method
► Panel of experts, queried iteratively
3. Sales force composite
► Estimates from individual salespersons
are reviewed for reasonableness, then
aggregated
4. Market Survey
► Ask the customer
 Jury of Executive Opinion
► Involves small group of high-level experts
and managers
► Group estimates demand by working
together
► Combines managerial experience with
statistical models
► Relatively quick
► ‘Group-think’
disadvantage

© 2014 Pearson Education 4 - 24

 Delphi Method
► Iterative group
process, Decision Makers

continues u s
n u
ti s
l i
c r
o a
n c
s h
e e
n
© 2014 Pearson Education 4 - 25
 (Evaluate
d responses
and make
e
decisions) n
t
► 3 St
s R
aff
types (A e
s
of d
mi p
partici nis o
ter n
pants in d
g e
su n
rv t
ey s
) (
P
► Decisio ► Staff e
n ► Respond o
makers p
© 2014 Pearson Education 4 - 26
 le who can
make
valuable
judgments)

© 2014 Pearson Education 4 - 27

 Sales Force Composite

► Each salesperson projects his or

her sales
► Combined at district and
national levels
► Sales reps know customers’ wants
► May be overly optimistic

© 2014 Pearson Education 4 - 26

 Market Survey
► Ask customers about
purchasing plans
► Useful for demand and
product design and planning
► What consumers say, and what
they actually do may be different
► May be overly optimistic

© 2014 Pearson Education 4 - 27

 Overview of Quantitative
Approaches
1. Naive approach
2. Moving averages
3. Exponential Time-series
smoothing models
4. Trend projection
5. Linear regression Associative
model
 Time-Series Forecasting

► Set of evenly spaced numerical data

► Obtained by observing response
variable at regular time periods
► Forecast based only on past values,
no other variables important
► Assumes that factors influencing past
and present will continue influence in
future
Time-Series Components

Trend Cyclical

Seasonal Random
 Components of Demand
Trend
component
Demand for product or service

Seasonal peaks

Actual demand
line

Average demand
over 4 years

Random variation
| | | |
1 2 3 4
Time (years)
Figure 4.1
 Trend Component
► Persistent, overall upward
or downward pattern
► Changes due to
population, technology, age,
culture, etc.
► Typically several years duration
 Seasonal Component
► Regular pattern of up and
down fluctuations
► Due to weather, customs, etc.
► Occurs within a single year
PERIOD LENGTH “SEASON” LENGTH NUMBER OF “SEASONS” IN PATTERN
Week Day 7
Month Week 4 – 4.5
Month Day 28 – 31
Year Quarter 4
Year Month 12
Year Week 52
 Cyclical Component
► Repeating up and down movements
► Affected by business cycle,
political, and economic factors
► Multiple years duration
► Often causal
or associative
relationships

0 5 10 15 20
 Random Component
► Erratic, unsystematic,
‘residual’ fluctuations
► Due to random variation or
unforeseen events
► Short duration
and
nonrepeating
 Random Component
M T W T
© 2014 Pearson Education
F 4 - 35
 Naive
Approach
► Assumes demand in next
period is the same as
demand in most recent
period
► e.g., If January sales were 68, then
February sales will be 68
► Sometimes cost effective
and efficient
► Can be good starting point
© 2014 Pearson Education 4 - 36
 Moving Average
Method
► MA is a series of arithmetic means
► Used if little or no trend
► Used often for smoothing
► Provides overall impression of data
over time

Moving average   demand in previous n periods

n
 Moving Average
Example
MONTH ACTUAL SHED SALES 3-MONTH MOVING AVERAGE
January 1100
February 1122
March 1133
April 16 (10 + 12 + 13)/3 = 11 2/3
May 19 (12 + 13 + 16)/3 = 13 2/3
June 23 (13 + 16 + 19)/3 = 16
July 26 (16 + 19 + 23)/3 = 19 1/3
August 30 (19 + 23 + 26)/3 = 22 2/3
September 28 (23 + 26 + 30)/3 = 26 1/3
October 18 (29 + 30 + 28)/3 = 28
November 16 (30 + 28 + 18)/3 = 25 1/3
December 14 (28 + 18 + 16)/3 = 20 2/3
 Weighted Moving
Average
► Used when some trend might
be present
► Older data usually less important
► Weights based on experience
and intuition

Weighted
moving  
average
Weight for period nDemand in period n
Weights
MONTH ACTUAL SHED SALES 3- MONTH WEIGHTED MOVING AVERAGE
January 1100
February 1122
March 1133
April 16 [(3 x 13) + (2 x 12) + (10)]/6 = 12 1/6
May 19
June WEIGHTS PERIOD
July APPLIED
23 Last month
August 26 3
Two months ago
September 30 2
Three months ago
October 28 1
Sum of the weights
November 18 6
Forecast for
14this month =
16
December 3 x Sales last mo. + 2 x Sales 2 mos. ago + 1 x Sales 3 mos. ago
S
u
m

o
f
t
h
e

w
e
i
g
h
t
s
MONTH ACTUAL SHED SALES 3-MONTH WEIGHTED MOVING AVERAGE
January 1100
February 1122
March 1133
April 16 [(3 x 13) + (2 x 12) + (10)]/6 = 12 1/6
May 19 [(3 x 16) + (2 x 13) + (12)]/6 = 14 1/3
June 23 [(3 x 19) + (2 x 16) + (13)]/6 = 17
July 26 [(3 x 23) + (2 x 19) + (16)]/6 = 20 1/2
August 30 [(3 x 26) + (2 x 23) + (19)]/6 = 23 5/6
September 28 [(3 x 30) + (2 x 26) + (23)]/6 = 27 1/2
October 18 [(3 x 28) + (2 x 30) + (26)]/6 = 28 1/3
November 16 [(3 x 18) + (2 x 28) + (30)]/6 = 23 1/3
December 14 [(3 x 16) + (2 x 18) + (28)]/6 = 18 2/3
 Potential Problems With
Moving Average
► Increasing n smooths the forecast but
makes it less sensitive to changes
► Does not forecast trends well

► Requires extensive historical data

© 2014 Pearson Education 4 - 42

 Graph of Moving Averages
Weighted moving average
30 –

25 –
Sales demand

20 –

15 – Actual sales

10 – Moving average

5–
| | | | | | | | | | | |

J F M A M J J A S O N D
Figure 4.2 Month

© 2014 Pearson Education 4 - 43

 Exponential Smoothing
► Form of weighted moving average
► Weights decline exponentially
► Most recent data weighted most
► Requires smoothing constant ()
► Ranges from 0 to 1
► Subjectively chosen
► Involves little record keeping of
past data
New forecast = Last period’s forecast
+  (Last period’s actual demand
– Last period’s forecast)

Ft = Ft – 1 + (At – 1 - Ft – 1)

where Ft = new forecast

Ft – 1 = previous period’s forecast
 = smoothing (or weighting) constant (0 ≤  ≤ 1)
At – 1 = previous period’s actual demand
 Exponential Smoothing
Example
Predicted demand = 142 Ford Mustangs
Actual demand = 153
Smoothing constant  = .20
Predicted demand = 142 Ford Mustangs
Actual demand = 153
Smoothing constant  = .20

New forecast = 142 + .2(153 – 142)

Predicted demand = 142 Ford Mustangs
Actual demand = 153
Smoothing constant  = .20

New forecast = 142 + .2(153 – 142)

= 142 + 2.2
= 144.2 ≈ 144 cars
 Effect of
Smoothing Constants
▶ Smoothing constant generally .05 ≤  ≤ .50
▶ As  increases, older values become
less significant

WEIGHT ASSIGNED TO
MOST 2ND MOST 3RD MOST 4th MOST 5th MOST
RECENT RECENT RECENT RECENT RECENT
SMOOTHING PERIOD PERIOD PERIOD PERIOD PERIOD
CONSTANT () (1 – ) (1 – )2 (1 – )3 (1 – )4
 = .1 .1 .09 .081 .073 .066

 = .5 .5 .25 .125 .063 .031

 Impact of Different

225 –

Actual demand  = .5
200 –
Demand

175 –

 = .1
||
150 – | | | | | | |
1 2 3 4 5 6 7 8 9
Quarter
 225 –

► Actual of 
Chose high values  = .5
demand
when
200 – underlying average
d
an is likely to change
m
e
Choose
D ► 175 –
low values of 
when underlying average
is stable  = .1
| | |
150 – | | | | | |
1 2 3 4 5 6 7 8 9
Quarter
 Choosing

The objective is to obtain the most
accurate forecast no matter the
technique
We generally do this by selecting the
model that gives us the lowest forecast
error
Forecast error = Actual demand – Forecast value
= At – Ft
Common Measures of Error

Mean Absolute Deviation (MAD)

MAD 
 Actual - Forecast
n
 Determining the MAD
ACTUAL
TONNAGE FORECAST WITH
QUARTER UNLOADED FORECAST WITH  = .10  = .50
1 180 175 175

2 168 175.50 = 175.00 + .10(180 – 175) 177.50

3 159 174.75 = 175.50 + .10(168 – 175.50) 172.75

4 175 173.18 = 174.75 + .10(159 – 174.75) 165.88

5 190 173.36 = 173.18 + .10(175 – 173.18) 170.44

6 205 175.02 = 173.36 + .10(190 – 173.36) 180.22

7 180 178.02 = 175.02 + .10(205 – 175.02) 192.61

8 182 178.22 = 178.02 + .10(180 – 178.02) 186.30

9 ? 178.59 = 178.22 + .10(182 – 178.22) 184.15

 ACTUAL FORECAST ABSOLUTE FORECAST ABSOLUTE
TONNAGE WITH DEVIATION WITH DEVIATION
QUARTER UNLOADED  = .10 FOR a = .10  = .50 FOR a = .50
1 180 175 5.00 175 5.00

2 168 175.50 7.50 177.50 9.50

3 159 174.75 15.75 172.75 13.75

4 175 173.18 1.82 165.88 9.12

5 190 173.36 16.64 170.44 19.56

6 205 175.02 29.98 180.22 24.78

7 180 178.02 1.98 192.61 12.61

8 182 178.22 3.78 186.30 4.30

Sum of absolute deviations: 82.45 98.62

Σ|Deviations|
MAD = 10.31 12.33
n
Common Measures of Error

Mean Squared Error (MSE)

Forecast errors 2

MSE 
n
 Determining the MSE
ACTUAL
TONNAGE FORECAST FOR
QUARTER UNLOADED  = .10 (ERROR)2
1 180 175 52 = 25
2 168 175.50 (–7.5)2 = 56.25
3 159 174.75 (–15.75)2 = 248.06
4 175 173.18 (1.82)2 = 3.31
5 190 173.36 (16.64)2 = 276.89
6 205 175.02 (29.98)2 = 898.80
7 180 178.02 (1.98)2 = 3.92
8 182 178.22 (3.78)2 = 14.29
Sum of errors squared = 1,526.52

MSE Forecast errors 2

 1,526.52 / 8  190.8
 n
Common Measures of Error

Mean Absolute Percent Error (MAPE)

n

100 Actual Forecast

i i
/ Actuali
MAPE i1

 n
 Determining the MAPE
ACTUAL
TONNAGE FORECAST FOR ABSOLUTE PERCENT ERROR
QUARTER UNLOADED  = .10 100(ERROR/ACTUAL)
1 180 175.00 100(5/180) = 2.78%
2 168 175.50 100(7.5/168) = 4.46%
3 159 174.75 100(15.75/159) = 9.90%
4 175 173.18 100(1.82/175) = 1.05%
5 190 173.36 100(16.64/190) = 8.76%
6 205 175.02 100(29.98/205) = 14.62%
7 180 178.02 100(1.98/180) = 1.10%
8 182 178.22 100(3.78/182) = 2.08%
Sum of % errors = 44.75%

MAPE absolute percent error 44.75%  5.59%

 8
 n
 Comparison of Forecast Error
Rounded Absolute Rounded Absolute
Actual Forecast Deviation Forecast Deviation
Tonnag with for with for
Quarter Unloaded
e  = .10  = .10  = .50  = .50
1 180 175 5.00 175 5.00
2 168 175.5 7.50 177.50 9.50
3 159 174.75 15.75 172.75 13.75
4 175 173.18 1.82 165.88 9.12
5 190 173.36 16.64 170.44 19.56
6 205 175.02 29.98 180.22 24.78
7 180 178.02 1.98 192.61 12.61
8 182 178.22 3.78 186.30 4.30
82.45 98.62

© 2014 Pearson Education 4 - 60

 Comparison of Forecast Error
∑ |deviations|
Rounded Absolute Rounded Absolute
Actual Forecast Deviation Forecast Deviation
MAD =
Tonnage with for with for
Quarter Unloaded
n
a = .10 a = .10  = .50  = .50
1 For  180
= .10 175 5.00 175 5.00
2 168 175.5 7.50 177.50 9.50
3 159 = 82.45/8
174.75 = 10.31
15.75 172.75 13.75
4 175 173.18 1.82 165.88 9.12
5 For  190
= .50 173.36 16.64 170.44 19.56
6 205 = 98.62/8
175.02 = 29.98
12.33 180.22 24.78
7 180 178.02 1.98 192.61 12.61
8 182 178.22 3.78 186.30 4.30
82.45 98.62

© 2014 Pearson Education 4 - 61

 Comparison of Forecast Error
2
∑ (forecast
Rounded errors)
Absolute Rounded Absolute
MSE Actual Forecast Deviation Forecast Deviation
Tonnage n
with for with for
=
Quarter Unloaded a = .10 a = .10  = .50  = .50
1 For  180
= .10 175 5.00 175 5.00
2 168 175.5 7.50 177.50 9.50
3 = 1,526.54/8
159 174.75 = 190.82
15.75 172.75 13.75
4 175 173.18 1.82 165.88 9.12
For  5= .50 190 173.36 16.64 170.44 19.56
6 = 1,561.91/8
205 175.02 = 195.24
29.98 180.22 24.78
7 180 178.02 1.98 192.61 12.61
8 182 178.22 3.78 186.30 4.30
82.45 98.62
MAD 10.31 12.33

© 2014 Pearson Education 4 - 62

Comparison
n
of Forecast Error
∑100|
Rounded
Absolute Rounded Absolute
MAPE Actual
= Forecast Deviation Forecast Deviation
deviation
Tonnage with |/actualfor
i i .10
with
Quarter Unloaded
i=1 a = .10 a = a = .5
for
1 180 175 n 5.00 175
0 = .50
2 168 175.5 7.50 177.5

3 159 174.75 15.75 172.7
4 For 
175= .10 173.18 1.82 165.8 5.00
5 190 173.36 16.64 170.4 0 9.50
6 205 = 44.75/8
175.02 =29.98
5.59% 180.2 5 13.75
192.6 8 9.12
For  78= .5
180
182
178.02
0 178.22
1.98
3.78 186.3 4 19.56
= 54.05/8 =82.45
6.76% 2 24.78
98.62
MAD 10.31 1 12.61
12.33
MSE 190.82 0 4.30
195.24

© 2014 Pearson Education 4 - 63

Comparison of Forecast Error
Rounded Absolute Rounded Absolute
Actual Forecast Deviation Forecast Deviation
Tonnage with for with for
Quarter Unloaded  = .10  = .10  = .50  = .50
1 180 175 5.00 175 5.00
2 168 175.5 7.50 177.50 9.50
3 159 174.75 15.75 172.75 13.75
4 175 173.18 1.82 165.88 9.12
5 190 173.36 16.64 170.44 19.56
6 205 175.02 29.98 180.22 24.78
7 180 178.02 1.98 192.61 12.61
8 182 178.22 3.78 186.30 4.30
82.45 98.62
MAD 10.31 12.33
MSE 190.82 195.24
MAPE 5.59% 6.76%
© 2014 Pearson Education 4 - 64
 Exponential Smoothing with
Trend Adjustment
When a trend is present, exponential
smoothing must be modified
MONTH ACTUAL DEMAND FORECAST (Ft) FOR MONTHS 1 – 5

1 100 Ft = 100 (given)

2 200 Ft = F1 + (A1 – F1) = 100 + .4(100 – 100) = 100

3 300 Ft = F2 + (A2 – F2) = 100 + .4(200 – 100) = 140

4 400 Ft = F3 + (A3 – F3) = 140 + .4(300 – 140) = 204

5 500 Ft = F4 + (A4 – F4) = 204 + .4(400 – 204) = 282

© 2014 Pearson Education 4 - 65

Forecast Exponentially Exponentially
including (FITt) = smoothed (Ft) + smoothed (Tt)
trend forecast trend

Ft = (At - 1) + (1 - )(Ft - 1 + Tt - 1)

Tt = (Ft - Ft - 1) + (1 - )Tt - 1

where Ft = exponentially smoothed forecast average

Tt = exponentially smoothed trend
At = actual demand
 = smoothing constant for average (0 ≤  ≤ 1)
 = smoothing constant for trend (0 ≤  ≤ 1)
Step 1: Compute Ft
Step 2: Compute Tt
Step 3: Calculate the forecast FITt = Ft + Tt
Exponential Smoothing with
Trend Adjustment Example
MONTH (t) ACTUAL DEMAND (At) MONTH (t) ACTUAL DEMAND (At)

1 12 6 21

2 17 7 31

3 20 8 28

4 19 9 36

5 24 10 ?

 = .2  = .4
TABLE 4.1 Forecast with  - .2 and  = .4
SMOOTHED FORECAST
FORECAST SMOOTHED INCLUDING TREND,
MONTH ACTUAL DEMAND AVERAGE, TREND, Tt FITt
Ft
1 12 11 2 13.00
2 17 12.80
3 20
4 19
Step 1: Average for Month 2
5 24
6 21
F2 = A1 + (1 – )(F1 + T1)
7 31
8 28 F2 = (.2)(12) + (1 – .2)(11 + 2)
9 36
10 —
= 2.4 + (.8)(13) = 2.4 + 10.4
= 12.8 units
TABLE 4.1 Forecast with  - .2 and  = .4
SMOOTHED FORECAST
FORECAST SMOOTHED INCLUDING TREND,
MONTH ACTUAL DEMAND AVERAGE, TREND, Tt FITt
Ft
1 12 11 2 13.00
2 17 12.80 1.92
3 20
4 19
5 24 Step 2: Trend for Month 2
6 21
7 31 T2 = (F2 - F1) + (1 - b)T1
8 28
9 36
T2 = (.4)(12.8 - 11) + (1 - .4)(2)
10 — = .72 + 1.2 = 1.92 units
TABLE 4.1 Forecast with  - .2 and  = .4
SMOOTHED FORECAST
FORECAST SMOOTHED INCLUDING TREND,
MONTH ACTUAL DEMAND AVERAGE, TREND, Tt FITt
Ft
1 12 11 2 13.00
2 17 12.80 1.92 14.72
3 20
4 19
5 24 Step 3: Calculate FIT for Month 2
6 21
7 31 FIT2 = F2 + T2
8 28
9 36 FIT2 = 12.8 + 1.92
10 — = 14.72 units
TABLE 4.1 Forecast with  - .2 and  = .4
SMOOTHED FORECAST
FORECAST SMOOTHED INCLUDING TREND,
MONTH ACTUAL DEMAND AVERAGE, TREND, Tt FITt
Ft
1 12 11 2 13.00
2 17 12.80 1.92 14.72
3 20 15.18 2.10 17.28
4 19 17.82 2.32 20.14
5 24 19.91 2.23 22.14
6 21 22.51 2.38 24.89
7 31 24.11 2.07 26.18
8 28 27.14 2.45 29.59
9 36 29.28 2.32 31.60
10 — 32.48 2.68 35.16
 40 – Figure 4.3
35 –
Actual demand (At)
30 –
Product demand

25 –
20 –
15 –
10 – Forecast including trend (FITt)
5 – with  = .2 and  = .4
0 –
| | | | | | | | |
1 2 3 4 5 6 7 8 9
Ti
m
e
(
m
o
nt
h
s)
 Trend Projections
Fitting a trend line to historical data points to
project into the medium to long-range
Linear trends can be found using the least
squares technique
^
y = a + bx
where y^ = computed value of the variable to be predicted
(dependent variable)
a = y-axis intercept
b = slope of the regression line
x = the independent variable

© 2014 Pearson Education 4 - 74

Values of Dependent Variable (y-values) Least Squares Method
Actual observation (y-value) Deviation7

Deviation5 Deviation6

Deviation3 Least squares method minimizes the

sum of the squared errors (deviations)
Deviation4

Deviation1
(error) Deviation2
Trend line, y^ = a + bx

| | | | | | |
1 2 3 4 5 6 T
7
 Least Squares Method
Figure 4.4
Equations to calculate the regression variables

yˆ  a  bx

b
 xy  nxy

 x  nx
2 2

a  y  bx
 Least Squares Example

ELECTRICAL ELECTRICAL
YEAR POWER DEMAND YEAR POWER DEMAND
1 74 5 105
2 79 6 142
3 80 7 122
4 90
 ELECTRICAL POWER
YEAR (x) DEMAND (y) x2 xy
1 74 1 74
2 79 4 158
3 80 9 240
4 90 16 360
5 105 25 525
6 142 36 852
7 122 49 854
Σx = 28 Σy = 692 Σx2 = 140 Σxy = 3,063

x
x    28
y   692  98.86
y
n 4
7 n 7
 Least Squares Example
xy  nxy 3,063 7498.86 295
b   POWER   10.54

ELECTRICAL
    x 28
2 2
Y EAR (x) x  nx
DEMAND (y) 140  7 4 2 2
xy
1 74 1 74
2 79

4 158
3
a  y  bx  98.868010.54 4  56.70 9 240
4 90 16 360
5 Thus,105 yˆ  56.70 10.54x
25 525
6 142 36 852
7 122 49 854
Σx = 28 Σy = 692 Σx2 = 140 Σxy = 3,063

 x in28year 8 = 56.70
Demand  y+ 10.54(8)
692
x  4 y  
98.86 = 141.02, or 141 megawatts
n 7 n 7
© 2014 Pearson Education 4 - 79
 Least Squares Example
Trend line,
160 –
y^ = 56.70 + 10.54x
150 –
Power demand (megawatts)

140 –
130 –
120 –
110 –
100 –
90 –
80 –
70 –
60 –
50 –
| | | | | | | | |
1 2 3 4 5 6 7 8 9
Year Figure 4.5
© 2014 Pearson Education 4 - 80
Least Squares Requirements

1. We always plot the data to insure

a linear relationship
2. We do not predict time periods
far beyond the database
3. Deviations around the least
squares line are assumed to be
random
Seasonal Variations In Data

The multiplicative
seasonal model can
adjust trend data for
seasonal variations
in demand
Steps in the process for monthly seasons:

1. Find average historical demand for each month

2. Compute the average demand over all months
3. Compute a seasonal index for each month
4. Estimate next year’s total demand
5. Divide this estimate of total demand by
the number of months, then multiply it by
the seasonal index for that month
 Seasonal Index Example
DEMAND
AVERAGE AVERAGE
YEARLY MONTHL SEASONAL
MONTH YEAR 1 YEAR 2 YEAR 3 DEMAND Y INDEX
DEMAND
Jan 80 85 105 90
Feb 70 85 85 80
Mar 80 93 82 85
Apr 90 95 115 100
May 113 125 131 123
June 110 115 120 115
July 100 102 113 105
Aug 88 102 110 100
Sept 85 90 95 90
Oct 77 78 85 80
Nov 75 82 83 80
Dec 82 78 80 80
Total average annual demand = 1,128
 DEMAND

AVERAGE AVERAG
YEARLY E SEASONAL
MONTH YEAR 1 YEAR 2 YEAR DEMAND MONTHLY INDEX
3 DEMAND
Jan 80 85 105 90 94
Fe 70 85 85 80 94
b Average
80 93 82 85 94
Mar 90 95 115 10
Apr 113 125 131 12
monthly 1,128 0 94
May 110 =115 120 = 94
12 months 113 94
June demand
5 94
July De 100 82 102
Aug c 88 102
Sept 85 90
Oct 77 78
Nov 75 82
78 113 85 105 90 94
110 83 80 94
100
95 80 80 94
80 94
Total average annual demand = 1,128
 DEMAND
AVERAGE AVERAGE
YEARLY MONTHLY SEASONAL
MONTH YEAR 1 YEAR 2 YEAR 3 DEMAND DEMAND INDEX
Jan 80 85 105 90 94 .957( = 90/94)
Feb 70 85 85 80 94
Mar 80 93 82 85 94
Apr 90 95 115 100 94

May 113 125 131 123 94

Seasonal110
June Average
115 monthly
120 demand
115 for past 3 94
years
July
index 100= 102
Average
113
monthly
105
demand 94
Aug 88 102 110 100 94
Sept 85 90 95 90 94
Oct 77 78 85 80 94
Nov 75 82 83 80 94
Dec 82 78 80 80 94
Total average annual demand = 1,128
 DEMAND
AVERAGE AVERAGE
YEARLY MONTHL SEASONAL
MONTH YEAR 1 YEAR 2 YEAR 3 DEMAND Y INDEX
DEMAND
Jan 80 85 105 90 94 .957( = 90/94)
Feb 70 85 85 80 94 .851( = 80/94)
Mar 80 93 82 85 94 .904( = 85/94)
Apr 90 95 115 100 94 1.064( = 100/94)
May 113 125 131 123 94 1.309( = 123/94)
June 110 115 120 115 94 1.223( = 115/94)
July 100 102 113 105 94 1.117( = 105/94)
Aug 88 102 110 100 94 1.064( = 100/94)
Sept 85 90 95 90 94 .957( = 90/94)
Oct 77 78 85 80 94 .851( = 80/94)
Nov 75 82 83 80 94 .851( = 80/94)
Dec 82 78 80 80 94 .851( = 80/94)
Total average annual demand = 1,128
Seasonal forecast for Year 4
MONTH DEMAND MONTH DEMAND

Jan 1,200 July 1,200

x .957 = 96 x 1.117 = 112
12 12
Feb 1,200 Aug 1,200
x .851 = 85 x 1.064 = 106
12 12
Mar 1,200 Sept 1,200
x .904 = 90 x .957 = 96
12 12
Apr 1,200 Oct 1,200
x 1.064 = 106 x .851 = 85
12 12
May 1,200 Nov 1,200
x 1.309 = 131 x .851 = 85
12 12
June 1,200 Dec 1,200
x 1.223 = 122 x .851 = 85
12 12
 Year 4 Forecast
140 – Year 3 Demand
130 – Year 2 Demand
Year 1 Demand
120 –
Demand

110 –
100 –
90 –
80 –
70 –
| | | | | | | | | | | |
J F M A M J J A S O N D
Time
 San Diego Hospital
Trend Data Figure 4.6

10,200 –

10,000 –
Inpatient Days

9,800 – 9745
9659 9702
9573 9616 9766
9,600 – 9530 9724
9680
9594 9637
9,400 – 9551

9,200 –

9,000 – | | | | | | | | | | | |
Jan Feb Mar Apr May June July Aug Sept Oct Nov Dec
67 68 69 70 71 72 73 74 75 76 77 78
Month
 Seasonality Indices for Adult Inpatient Days at San Diego Hospital

MONTH SEASONALITY INDEX MONTH SEASONALITY INDEX

January 1.04 July 1.03

February 0.97 August 1.04

March 1.02 September 0.97

April 1.01 October 1.00

May 0.99 November 0.96

June 0.99 December 0.98

 Seasonal Indices Figure 4.7

1.06 –
1.04
1.04 – 1.04
Index for Inpatient Days

1.03
1.02
1.02 – 1.01
1.00
1.00 – 0.99
0.98
0.98 – 0.99
0.96 – 0.97
0.97
0.94 – 0.96

0.92 – | | | | | | | | | | | |
Jan Feb Mar Apr May June July Aug Sept Oct Nov Dec
67 68 69 70 71 72 73 74 75 76 77 78
Month
Period 67 68 69 70 71 72

Month Jan Feb Mar Apr May June

Forecast with 9,911 9,265 9,164 9,691 9,520 9,542

Trend &
Seasonality
Period 73 74 75 76 77 78

Month July Aug Sept Oct Nov Dec

Forecast with 9,949 10,068 9,411 9,724 9,355 9,572

Trend &
Seasonality
 Combined Trend and Seasonal Forecast Figure 4.8

10,200 –
10068
10,000 – 9911 9949
–
Inpatient Days

9,800 9764 9724

9691
9,600 – 9572

9,400 – 9520 9542

9411
9265 9355
9,200 –

9,000 – | | | | | | | | | | | |
Jan Feb Mar Apr May June July Aug Sept Oct Nov Dec
67 68 69 70 71 72 73 74 75 76 77 78
Month
 Adjusting Trend Data

yˆ seasonal  Index yˆ
trend forecast


Quarter I: yˆI  (1.30)($100,000) 

Quarter II: $130,000 yˆ  (.90)($120,000) 
II
Quarter III:
$108,000 yˆIII  (.70)($140,000)
Quarter IV:
 $98,000 yˆIV  (1.10)
 Adjusting Trend Data
($160,000
)
$176,000
 Associative Forecasting

Used when changes in one or more independent

variables can be used to predict the changes in
the dependent variable

Most common technique is linear

regression analysis

We apply this technique just as we did

in the time-series example
Forecasting an outcome based on predictor
variables using the least squares technique

y^ = a + bx

where y^ = value of the dependent variable (in our example,

sales)
a = y-axis intercept
b = slope of the regression line
x = the independent variable
 Associative Forecasting
Example
NODEL’S SALES AREA PAYROLL NODEL’S SALES AREA PAYROLL
(IN $ MILLIONS), (IN $ BILLIONS), (IN $ MILLIONS), (IN $ BILLIONS),
y x y x
2.0 1 2.0 2
3.0 3 2.0 1
2.5 4 3.5 7

4.0 –
Nodel’s sales (in$ millions)

3.0 –

2.0 –

1.0 –

© 2014 Pearson Education | |

| |
|

0 1 2
 Associative Forecasting
4 5 6 7
Example
Area payroll
(in $ billions)

4 - 98
 SALES, y PAYROLL, x x2 xy
2.0 1 1 2.0
3.0 3 9 9.0
2.5 4 16 10.0
2.0 2 4 4.0
2.0 1 1 2.0
3.5 7 49 24.5
Σy = 15.0 Σx = 18 Σx2 = 80 Σxy = 51.5

 x  18 
x y  
15
 2.5
6 6 3 y 6

b
xy    51.5  (6)(3)
. a  y  bx  2.5  (.25)(3) 
 x  nx
2 (2.5)
2
25 1.75
80  (6)(3 )
© 2014 Pearson Education 4 - 99
SALES, y PAYROLL, x x2 xy
2.0 1 1 2.0
3.0 3 9 9.0
yˆ  1.75 .25x
2.5 4 16 10.0
2.0 2 Sales
4  1.75 4.0
2.0 1 .25(payroll)
1 2.0
3.5 7 49 24.5
Σy = 15.0 Σx = 18 Σx2 = 80 Σxy = 51.5
 S ALES, y PAYROLL, x x2 xy
2.0 1 1 2.0
3.0 4.0 –
3
yˆ 91.75 .25x 9.0
Nodel’s sales (in$ millions)

2.5 3.0 – 4 16 10.0

2.0 2 Sales  1.75
4 ll)
4.0
.25(payro
2.0 – 1 1 2.0
2.0 1.0 –
4.5
1.5
Σy 3.5 7 49 2
|||||||
= 15.0 Σx = 18 Σx2 = 80 Σxy = 5
01234567
x  y 15
18Area payroll (in $ billions)
x  3 y   2.5
b
xy    51.5  (6)(3)  . a  y  bx  2.5  (.25)(3) 
 x  nx
2 (2.5)
2
25 1.75
80  (6)(3 )
© 2014 Pearson Education 4 - 101
 If payroll next year is estimated to be $6 billion,
then:

Sales (in $ millions) = 1.75 + .25(6)

= 1.75 + 1.5 = 3.25

Sales = $3,250,000

© 2014 Pearson Education 4 - 102

If payroll4.0
next
– year is estimated to be $6 ,
thbillion 3.25
(in$ millions) Nodel’s sales

3.0 –
en:
2.0 –

1.0 –
Sales (in$ millions) = 1.75 + .25(6)
| | |= 1.75
| +| 1.5| = 3.25
|
0 1 2 3 4 5 6 7
Area payroll (in $ billions)
Sales = $3,250,000
Standard Error of the Estimate
► A forecast is just a point estimate of
a future value
► This point is
actually the
mean of a 4.0 –
3.25
probability (in$ millions) Nodel’s sales
3.0 –
Regression line,
distribution 2.0 – yˆ  1.75 .25x

1.0 –

| | | | | | |
0 1 2 3 4 5 6 7
Figure 4.9 Area payroll (in $ billions)
 S y,x 
 ( y  y)
c
2

n2

where y = y-value of each data point

yc = computed value of the dependent variable,
from the regression equation
n = number of data points
Computationally, this equation is
considerably easier to use

S y,x


y 2  a y  bxy n  2

We use the standard error to set up

prediction intervals around the point
estimate
Sy,x 

y 2  a y  bxy n  2 39.5 1.75(15.0) .25(51.5)

62
 .09375
 .306 (in $ millions)
4.0 –
Nodel’s sales (in$ millions) 3.25
3.0 –

The standard error 2.0 –

of the estimate is
1.0 –
$306,000 in sales
| | | | | | |
0 1 2 3 4 5 6 7
Area payroll (in $ billions)
 Correlation
► How strong is the linear relationship
between the variables?
► Correlation does not necessarily imply
causality!
► Coefficient of correlation, r,
measures degree of association
► Values range from -1 to +1
 Correlation Coefficient

  
n x  
    
 y 
2 2
2
x n y
2


nxy   x  y
r

 Figure 4.10
y y

x x
(a) P (e) Perfect positive
erfect negative
correlation correlation
y
y

y
x x
(b) Negative correlation (d) Positive
correlation

x
(c) No correlation

Hig Moderate Low Low Moderate High

| h | | | | | | | |

–1.0 –0.8 –0.6 –0.4 –0.2 0 0.2 0.4 0.6 0.8 1.0
© 2014 Pearson Education 4 - 110
 Correlation coefficient values

© 2014 Pearson Education 4 - 111

 y x x2 xy y2
2.0 1 1 2.0 4.0
3.0 3 9 9.0 9.0
2.5 4 16 10.0 6.25
2.0 2 4 4.0 4.0
2.0 1 1 2.0 4.0
3.5 7 49 24.5 12.25
Σy = 15.0 Σx = 18 Σx2 = 80 Σxy = 51.5 Σy2 = 39.5

(6)(51.5)
2 – (18)(15.0)
r  (6)(80) – (18) (16)(39.5) – (15.0) 
 2

  

309  39 39  .901
 
(156)(12) 1,872  43.3
270
 Correlation
► Coefficient of Determination, r2,
measures the percent of change in
y predicted by the change in x
► Values range from 0 to 1
► Easy to interpret

For the Nodel Construction example:

r = .901
r2 = .81
© 2014 Pearson Education 4 - 112
 Multiple-Regression
Analysis
If more than one independent variable is to be
used in the model, linear regression can be
extended to multiple regression to accommodate
several independent variables

yˆ  a  b1x1  b2 x2

Computationally, this is quite

complex and generally done on the
computer
In the Nodel example, including interest rates in the
model gives the new equation:

yˆ  1.80 .30x1  5.0x2

An improved correlation coefficient of r = .96 suggests

this model does a better job of predicting the change
in construction sales

Sales = 1.80 + .30(6) - 5.0(.12) = 3.00

Sales = $3,000,000
 Monitoring and Controlling
Forecasts
Tracking Signal
► Measures how well the forecast is predicting
actual values
► Ratio of cumulative forecast errors to mean
absolute deviation (MAD)
► Good tracking signal has low values
► If forecasts are continually high or low, the
forecast has a bias error
 Tracking
= Cumulative error
signal
MAD

(Actual demand in period i Forecast demand in period i)


 ActualForecast
n
 Tracking Signal
Figure 4.11
Signal exceeding limit
Tracking signal
Upper control limit
+

0 MADs Acceptable
range

–
Lower control limit

Time

© 2014 Pearson Education 4 - 117

 Tracking Signal Example
ABSOLUTE CUM ABS TRACKING
ACTUAL FORECAST CUM FORECAST FORECAST SIGNAL (CUM
QTR DEMAND DEMAND ERROR ERROR ERROR ERROR MAD ERROR/MAD)
1 90 100 –10 –10 10 10 10.0 –10/10 = –1

2 95 100 –5 –15 5 15 7.5 –15/7.5 = –2

3 115 100 +15 0 15 30 10. 0/10 = 0

4 100 110 –10 –10 10 40 10. 10/10 = –1

5 125 110 +15 +5 15 55 11.0 +5/11 = +0.5

6 140 110 +30 +35 30 85 14.2 +35/14.2 = +2.5

At the end of quarter 6, MAD  Forecast

n
errors 85  14.2
 6

Cumulative M D
Tracking
error signal  A
© 2014 Pearson Education 4 - 118
 35
 14.2  2.5
MAD
s

© 2014 Pearson Education 4 - 119

 Adaptive Smoothing
► It’s possible to use the computer to
continually monitor forecast error
and adjust the values of the  and 
coefficients used in exponential
smoothing to continually minimize
forecast error
► This technique is called
adaptive smoothing

© 2014 Pearson Education 4 - 119

 Focus Forecasting
► Developed at American Hardware Supply,
based on two principles:
1. Sophisticated forecasting models are not
always better than simple ones
2. There is no single technique that should be
used for all products or services

► Uses historical data to test multiple

forecasting models for individual items
► Forecasting model with the lowest error used
to forecast the next demand

© 2014 Pearson Education 4 - 120

 Forecasting in the Service
Sector
► Presents unusual challenges
► Special need for short term records
► Needs differ greatly as function
of industry and product
► Holidays and other calendar events
► Unusual events

© 2014 Pearson Education 4 - 121

 Fast Food Restaurant Forecast
20% –
Percentage of sales by hour of day

Figure 4.12

15% –

10% –

5% –

11-12 1-2 3-4 5-6 7-8 9-10

12-1 2-3 4-5 6-7 8-9 10-11
(Lunchtime) (Dinnertime)
Hour of day
© 2014 Pearson Education 4 - 122
 FedEx Call Center Forecast
12% – Figure 4.12

10% –

8% –

6% –

4% –

2% –

0% –
2 4 6 8
10 12 2 4 6 8 10 12
A.M.
P.M.
Hour of day
© 2014 Pearson Education 4 - 123
All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or
transmitted, in any form or by any means, electronic, mechanical, photocopying, recording, or
otherwise, without the prior written permission of the publisher.
Printed in the United States of America.

© 2014 Pearson Education 4 - 124