Operations

Management
Forecasting
Chapter 4

4-1
 Examples
Predict the next number in the pattern:

a) 3.7, 3.7, 3.7, 3.7, 3.7, ?

b) 2.5, 4.5, 6.5, 8.5, 10.5, ?

c) 5.0, 7.5, 6.0, 4.5, 7.0, 9.5, 8.0, 6.5, ?

4-2
 Examples
Predict the next number in the pattern:

a) 3.7, 3.7, 3.7, 3.7, 3.7, y = 3.7

b) 2.5, 4.5, 6.5, 8.5, 10.5, y = 0.5 + 2x

c) 5.0, 7.5, 6.0, 4.5, 7.0, 9.5, 8.0, 6.5,

y = 4.5 + 0.5x + ci
c1 = 0; c2 = 2; c3 = 0; c4 = -2; etc
4-3
 Outline
Types of Forecasts.
Eight Steps in the Forecasting System.
Time-Series Forecasting:
Moving Averages.
Exponential Smoothing.
Trend Projection.
Associative Forecasting: Regression.
Monitoring and Controlling Forecasts.
Forecasting in the Service Sector.

4-4
 What is Forecasting?
Art and science of
predicting future events. Sales will
Underlying basis of be $200
Million!
all business decisions.
Production & Inventory.
Personnel & Facilities.

Focus on forecasting
demand.

4-5
Types of Forecasts by Time Horizon
Short-range forecast: Usually < 3 months.
Job scheduling, worker assignments.

Medium-range forecast: 3 months to 3 years.

Sales & production planning, budgeting.

Long-range forecast: > 3 years.

New product planning, facility location.

4-6
Short- vs. Long-term Forecasting
Medium & Long range forecasts:
Long range for design of system.
Deal with comprehensive issues.
Support management decisions regarding planning.

Short-term forecasts:
To plan detailed use of system.
Usually use quantitative techniques.
More accurate than longer-term forecasts.

4-7
Forecasting During the Life Cycle
Introduction Growth Maturity Decline

Hard to forecast - Forecasting Easier to Hard to forecast,

Often use critical, for future forecast. but forecasting
qualitative models. magnitude and Use quantitative is less important.
growth rate. models.
Need long-range
forecasts. Long-range
forecasts still
important.

Sales

Time
4-8
 Eight Steps in Forecasting
Determine the use of the forecast.
Select the item(s) to be forecast.
Determine the time horizon of the forecast.
Select the forecasting model(s).
Gather the data.
Make the forecast.
Validate and implement results.
Monitor forecasts and adjust when needed.
4-9
 Realities of Forecasting
Assumes future will be like the past (causal
factors will be the same).

Forecasts are imperfect.

Forecasts for groups of product are more

accurate than forecasts for individual products.

Accuracy decreases with length of forecast.

4-10
 Forecasting Approaches
Qualitative Methods Quantitative Methods
Used when little data or Used when situation is
time exist. stable & data exist.
New products & Existing products &
technology. current technology.
Long time horizon. Major changes not
Major changes expected. expected.
Involves intuition, Involves mathematical
experience. techniques.
Example: forecasting for Example: forecasting sales of
e-commerce sales. color televisions.

4-11
 Overview of Qualitative Methods
Jury of executive opinion.
Combine opinions from executives.
Sales force composite.
Aggregate estimates from salespersons.
Delphi method.
Query experts interatively.
Consumer market survey.
Survey current and potential customers.

4-12
 Jury of Executive Opinion
Seek opinions/estimates from small
group of high-level managers
working together.
Combines managerial experience
with statistical models.

+ Relatively quick.
- Group-think.
- Leader may dominate.
4-13
 Sales Force Composite
Each salesperson projects
their sales.
Aggregate projections at Sales
district & national levels.

+ Sales reps know customers.

- Must not reward inaccurate
forecasts.
May over- or under-forecast to
acquire more resources.
4-14
 Delphi Method
Iterative group process.
3 types of people: Decision Makers
Decision makers. (Make forecast)
Staff. Staff
Respondents. (Administer)

+ Reduces group-think.
- Takes time.
Respondents
(Provide input to decision makers)

4-15
 Consumer Market Survey
How many hours will
Ask customers about you use the Internet
purchasing plans. next week?

+ Relatively simple.
- What consumers say, and
what they actually do are
often different.

4-16
Quantitative Forecasting Methods

Quantitative
Forecasting

Time Series Associative

Models Models

Moving Exponential Trend Linear

Average Smoothing Projection Regression

4-17
 What is a Time Series?
Set of evenly spaced numerical data.
From observing response variable at regular time
periods.
Forecast based only on past values.
Assumes that factors influencing past will continue
influence in future.
Example:
Year: 1 2 3 4 5
Sales: 78.7 63.5 89.7 93.2 92.1

4-18
 Time Series Components

Trend Cyclical

Seasonal Random

4-19
Demand for product or service
Product Demand over 4 Years

Year Year Year Year

1 2 3 4
4-20
 Product Demand over 4 Years
Trend component
Seasonal peaks
Demand for product or service

Cyclic
component
Actual
Random demand line
variation
Year Year Year Year
1 2 3 4
4-21
 Trend Component
Persistent, overall upward or downward
pattern.
Due to population, technology etc.
Several years duration.

Time

4-22
 Seasonal Component
Regular pattern of up & down fluctuations.
Due to weather, customs etc.
Occurs within 1 year.
Quarterly, monthly, weekly, etc.
Summer
Demand

Time
4-23
 Cyclical Component
Repeating up & down movements.
Due to interactions of factors influencing
economy.
Usually 2-10 years duration.

Cycle
Demand

Year
4-24
 Random Component

Erratic, unsystematic, residual fluctuations.

Due to random variation or unforeseen events.
Union strike
Tornado
Short duration & non-repeating.

4-25
 General Time Series Models

Any value in a time series is a combination

of the trend, seasonal, cyclic, and random
components.
Multiplicative model: Yi = Ti Si Ci Ri

Additive model: Yi = Ti + Si + Ci + Ri

4-26
 Naive Approach
Demand in next period is the
same as demand in most recent
period.
e.g., If May sales were 48, then June
sales will be 48.

Sometimes cost effective &

efficient.
Usually not good.

4-27
 Moving Average Method
MA is a series of arithmetic means.
Used if little or no trend.
Used often for smoothing.

MA Demand in previous n periods

n

4-28
 Moving Average Example
Youre manager of a museum store that sells
historical replicas. You want to forecast
sales (in thousands) for months 4 and 5
using a 3-period moving average.

Month 1 4
Month 2 6
Month 3 5
Month 4 ?
Month 5 ?
4-29
 Moving Average Forecast

Sales Moving Average

Month (given) (n=3)
1 4 NA
2 6 NA
3 5 NA
4 ? (4+6+5)/3=5
5 ?
6 ?

4-30
 Moving Average Graph

Sales
Actual
6 Forecast
4

1 2 3 4 5 6
Month
4-31
 Actual Demand for Month 4 = 3

Sales Moving Average

Month (given) (n=3)
1 4 NA
2 6 NA
3 5 NA
4 3 5
5 ?
6 ?

4-32
 Moving Average Graph

Sales
Actual
6 Forecast
4

1 2 3 4 5 6
Month
4-33
 Forecast for Month 5

Sales Moving Average

Month (given) (n=3)
1 4 NA
2 6 NA
3 5 NA
4 3 5
5 ? (6+5+3)/3=4.667
6 ?

4-34
 Moving Average Graph

Sales
Actual
6 Forecast
4

1 2 3 4 5 6
Month
4-35
 Actual Demand for Month 5 = 7

Sales Moving Average

Month (given) (n=3)
1 4 NA
2 6 NA
3 5 NA
4 3 5
5 7 4.667
6 ?

4-36
 Moving Average Graph

Sales
Actual
6

4
Forecast
2

1 2 3 4 5 6
Month
4-37
 Forecast for Month 6

Sales Moving Average

Month (given) (n=3)
1 4 NA
2 6 NA
3 5 NA
4 3 5
5 7 4.667
6 ? (5+3+7)/3=5

4-38
 Moving Average Graph

Sales
Actual
6

4
Forecast
2

1 2 3 4 5 6
Month
4-39
Weighted Moving Average Method
Gives more emphasis to recent data.
Weights decrease for older data.
Weights sum to 1.0.
May be based on intuition.
Sum of digits weights: numerators are consecutive.
3/6, 2/6, 1/6
4/10, 3/10, 2/10, 1/10

[(Weight for period n) x (Demand in period n)]

WMA =
Weights
4-40
Weighted Moving Average: 3/6,
2/6, 1/6
Month Response Weighted
Yi Moving
Average
1 4 NA
2 6 NA
3 5 NA
4 ? 31/6 = 5.167
5 ?
6 ?
4-41
Weighted Moving Average: 3/6,
2/6, 1/6
Month Response Weighted
Yi Moving
Average
1 4 NA
2 6 NA
3 5 NA
4 3 31/6 = 5.167
5 7 25/6 = 4.167
6 ? 32/6 = 5.333
4-42
 Moving Average Methods
Increasing n makes forecast:
Less sensitive to changes.
Less sensitive to recent data.
Weights control emphasis on recent data.
Do not forecast trend well.
Require historical data.

4-43
 Moving Average Graph

Actual

Demand

Time
4-44
 Moving Average Graph

Actual
Large n

Small n
Demand

Time
4-45
 Weighted Moving Average Graph
Small weight
Actual on recent data

Large weight
Demand on recent data

Time
4-46
 Exponential Smoothing Method
Form of weighted moving average.
Weights decline exponentially.
Most recent data weighted most.
Requires smoothing constant ().
Usually ranges from 0.05 to 0.5
Should be chosen to give good forecast.
Involves little record keeping of past data.

4-47
 Exponential Smoothing Equation

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

Ft = Forecast value for time t
At-1 = Actual value at time t-1
= Smoothing constant

Need initial forecast Ft-1 to start.

Could be given or use moving average.

4-48
 Exponential Smoothing Example
You want to forecast product demand using
exponential smoothing with = .10. Suppose in the
most recent month (month 6) the forecast was 175
and the actual demand was 180.
Month 6 180
Month 7 ?
Month 8 ?
Month 9 ?
Month 10 ?

4-49
Exponential Smoothing - Month 7
Ft = Ft-1 + (At-1 - Ft-1)
Forecast, F t
Month Actual
( = .10)
6 180 175.00 (Given)
7 ? 175.00 + .10(180 - 175.00) = 175.50
8 ?
9 ?
10 ?
11 ?

4-50
Exponential Smoothing - Month 8
Ft = Ft-1 + (At-1 - Ft-1)
Forecast, F t
Month Actual
( = .10)
6 180 175.00 (Given)
7 168 175.00 + .10(180 - 175.00) = 175.50
8 ? 175.50 + .10(168 - 175.50) = 174.75
9 ?
10 ?
11 ?

4-51
 Exponential Smoothing Solution
Ft = Ft-1 + (At-1 - Ft-1)

Forecast, F t
Month Actual ( = .10)
6 180 175.00 (Given)
7 168 175.00 + .10(180 - 175.00) = 175.50
8 159 175.50 + .10(168 - 175.50) = 174.75
9 ? 174.75 + .10(159 - 174.75) = 173.18
10 ?
11 ?

4-52
 Exponential Smoothing Solution
Ft = Ft-1 + (At-1 - Ft-1)

Forecast, F t
Month Actual
( = .10)
6 180 175.00 (Given)
7 168 175.00 + .10(180 - 175.00) = 175.50
8 159 175.50 + .10(168 - 175.50) = 174.75
9 175 174.75 + .10(159 - 174.75) = 173.18
10 190 173.18 + .10(175 - 173.18) = 173.36
11 ? 173.36 + .10(190 - 173.36) = 175.02

4-53
Exponential Smoothing Graph

Sales
190 Actual

170
Forecast

150

6 7 8 9 10 11
Month
4-54
 Exponential Smoothing Methods
Increasing makes forecast:
More sensitive to changes.
More sensitive to recent data.

controls emphasis on recent data.

Do not forecast trend well.

Trend adjusted exponential smoothing - p. 90-93

4-55
 Exponential Smoothing Graph

Actual

Demand

Time
4-56
 Exponential Smoothing Graph

Actual
Small

Large
Demand

Time
4-57
 Forecast Effects of
Smoothing Constant

Ft = At - 1 + (1- )At - 2 + (1- )2At - 3 + ...

Weights
Prior Period 2 periods ago 3 periods ago
(1 - ) (1 - )2

= 0.10 10% 9% 8.1%

= 0.90 90% 9% 0.9%

4-58
 To Use a Forecasting Method
Collect historical data.
Moving Average methods:
Select n = number of periods.
For weighted moving average: Select weights.
Exponential Smoothing: Select .

Selections should produce a good forecast!

4-59
 A Good Forecast
A good method has a small error.

Error = Demand - Forecast

MAD = Mean Absolute Deviation:

Average of absolute values of errors.
MSE = Mean Squared Error:
Average of squared errors.
MAPE = Mean Absolute Percentage Error:
Average of absolute value of percentage errors.

4-60
 Forecast Error Equations
Mean Absolute Deviation (MAD)
n
| yi y i |
MAD i1

| forecast errors |
n n

Mean Squared Error (MSE)

n
(y i y i )2 2
MSE i1

forecast errors
n n

4-61
 Forecast Error Equations

Mean Absolute Percentage Error (MAPE)

| y i y i |
n
| forecast errors |

i1 yi Actual
MAPE
n n

4-62
 Forecast Error Example
Actual F1 F1 error F2 F2 error
20 19 1 18 2
10 15 -5 13 -3
24 22 2 21 3
20 21 -1 18 2

MAD F1 = 9/4 = 2.25 F2 = 10/4 = 2.5

MSE F1 = 31/4 = 7.75 F2 = 26/4 = 6.5

MAPE F1 = 0.171 = 17.1% F2 = 0.156 = 15.6%

4-63
 Which Forecast is Best?

MAD F1 = 9/4 = 2.25 F2 = 10/4 = 2.5

MSE F1 = 31/4 = 7.75 F2 = 26/4 = 6.5

MAPE F1 = 0.171 = 17.1% F2 = 0.156 = 15.6%

4-64