Forecasting

© 2014
© 2014
Pearson
Pearson
Education,
Education,
Inc.Inc. 4-1
 Outline

▶ Global Company Profile: Disney World

▶ What Is Forecasting?
▶ The Strategic Importance of
Forecasting
▶ Seven Steps in the Forecasting
System
▶ Forecasting Approaches

© 2014 Pearson Education, Inc. 4-2

 Outline - Continued
▶ Time-Series Forecasting
▶ Associative Forecasting Methods:
Regression and Correlation Analysis
▶ Monitoring and Controlling Forecasts
▶ Forecasting in the Service Sector

© 2014 Pearson Education, Inc. 4-3

 Forecasting at Disney World
 Global portfolio includes parks in Shanghai,
Hong Kong, Paris, Tokyo, Orlando, and
California
 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 Education, Inc. 4-4

 Forecasting at Disney World
 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 Education, Inc. 4-5

 Forecasting at Disney World
 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 Education, Inc. 4-6

 Forecasting at Disney World
 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 Education, Inc. 4-7

 What is Forecasting?
► Process of predicting a
future event
► Underlying basis
of all business
??
decisions
► Production
► Inventory
► Personnel
► Facilities
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 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
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 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, Inc. 4 - 10

 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
► Factory capacity
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 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

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 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
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 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, Inc. 4 - 14

 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

© 2014 Pearson Education, Inc. 4 - 15

 Forecasting Approaches
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
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 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

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 Overview of Qualitative
Methods
3. Sales force composite
► Estimates from individual salespersons
are reviewed for reasonableness, then
aggregated
4. Market Survey
► Ask the customer

© 2014 Pearson Education, Inc. 4 - 18

 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

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 Delphi Method
► Iterative group
process, continues Decision Makers
(Evaluate responses
until consensus is and make decisions)
reached
► 3 types of Staff
(Administering
participants survey)
► Decision makers
► Staff
► Respondents Respondents
(People who can make
valuable judgments)
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 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, Inc. 4 - 21

 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, Inc. 4 - 22

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

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 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

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 Time-Series Components

Trend Cyclical

Seasonal Random

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 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

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 Trend Component
► Persistent, overall upward or
downward pattern
► Changes due to population,

technology, age, culture, etc.

► Typically several years duration

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 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

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 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
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 Random Component
► Erratic, unsystematic, ‘residual’
fluctuations
► Due to random variation or unforeseen
events
► Short duration
and nonrepeating

M T W T
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 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

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 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

© 2014 Pearson Education, Inc. 4 - 32

 Moving Average Example
MONTH ACTUAL SHED SALES 3-MONTH MOVING AVERAGE
January 10
February 12
12
March 13
13
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
November 16 (29 + 30 + 28)/3 = 28

December 14 (30 + 28 + 18)/3 = 25 1/3

(28 + 18 + 16)/3 = 20 2/3

© 2014 Pearson Education, Inc. 4 - 33

 Weighted Moving Average
► Used when some trend might be
present
► Older data usually less important
► Weights based on experience and
intuition

Weighted
moving
average

© 2014 Pearson Education, Inc. 4 - 34

 Weighted Moving Average
MONTH ACTUAL SHED SALES 3-MONTH WEIGHTED MOVING AVERAGE
January 10
February 12
12
March 13
13
April 16 [(3 x 13) + (2 x 12) + (10)]/6 = 12 1/6
May 19
June WEIGHTS
23 APPLIED PERIOD
July 26 3 Last month
August 30 2 Two months ago
September 28 1 Three months ago
October 18 6 Sum of the weights
November Forecast for
16this month =
December 3 x 14
Sales last mo. + 2 x Sales 2 mos. ago + 1 x Sales 3 mos. ago
Sum of the weights

© 2014 Pearson Education, Inc. 4 - 35

 Weighted Moving Average
MONTH ACTUAL SHED SALES 3-MONTH WEIGHTED MOVING AVERAGE
January 10
February 12
12
March 13
13
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
November 16 [(3 x 28) + (2 x 30) + (26)]/6 = 28 1/3
December 14 [(3 x 18) + (2 x 28) + (30)]/6 = 23 1/3
[(3 x 16) + (2 x 18) + (28)]/6 = 18 2/3

© 2014 Pearson Education, Inc. 4 - 36

 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, Inc. 4 - 37

 Graph of Moving Averages
Weighted moving average

30 –

25 –
Sales demand

20 –
Actual sales
15 –

Moving average
10 –

5–
| | | | | | | | | | | |

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

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 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
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 Exponential Smoothing
New forecast = Last period’s forecast
+ a (Last period’s actual demand
– Last period’s forecast)

Ft = Ft – 1 + a(At – 1 - Ft – 1)

where Ft = new forecast

Ft – 1 = previous period’s forecast
a = smoothing (or weighting) constant (0 ≤ a ≤ 1)
At – 1 = previous period’s actual demand

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 Exponential Smoothing Example

Predicted demand = 142 Ford Mustangs

Actual demand = 153
Smoothing constant a = .20

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 Exponential Smoothing Example

Predicted demand = 142 Ford Mustangs

Actual demand = 153
Smoothing constant a = .20

New forecast = 142 + .2(153 – 142)

© 2014 Pearson Education, Inc. 4 - 42

 Exponential Smoothing Example

Predicted demand = 142 Ford Mustangs

Actual demand = 153
Smoothing constant a = .20

New forecast = 142 + .2(153 – 142)

= 142 + 2.2
= 144.2 ≈ 144 cars

© 2014 Pearson Education, Inc. 4 - 43

 Impact of Different 

225 –
Actual a = .5
demand
200 –
Demand

175 –
a = .1
| | | | | | | | |
150 –
1 2 3 4 5 6 7 8 9
Quarter
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 Impact of Different 

225 –
Actual a = .5
► Choose high of  values
demand
when
200 – underlying average
Demand

is likely to change
► Choose low values of 
175 –
when underlying average a = .1
is stable
| | | | | | | | |
150 –
1 2 3 4 5 6 7 8 9
Quarter
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 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

© 2014 Pearson Education, Inc. 4 - 46

 Common Measures of Error

Mean Absolute Deviation (MAD)

© 2014 Pearson Education, Inc. 4 - 47

 Determining the MAD
ACTUAL
TONNAGE FORECAST WITH
QUARTER UNLOADED FORECAST WITH a = .10 a = .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

© 2014 Pearson Education, Inc. 4 - 48

 Determining the MAD
ACTUAL FORECAST ABSOLUTE FORECAST ABSOLUTE
TONNAGE WITH DEVIATION WITH DEVIATION
QUARTER UNLOADED a = .10 FOR a = .10 a = .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

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 Common Measures of Error

Mean Squared Error (MSE)

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 Determining the MSE
ACTUAL
TONNAGE FORECAST FOR
QUARTER UNLOADED a = .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

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 Common Measures of Error

Mean Absolute Percent Error (MAPE)

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 Determining the MAPE
ACTUAL
TONNAGE FORECAST FOR ABSOLUTE PERCENT ERROR
QUARTER UNLOADED a = .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%

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 Comparison of Forecast Error
Rounded Absolute Rounded Absolute
Actual Forecast Deviation Forecast Deviation
Tonnage with for with for
Quarter Unloaded a = .10 a = .10 a = .50 a = .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

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 Comparison of Forecast Error
∑
Actual
|deviations|
Rounded
Forecast
Absolute
Deviation
Rounded
Forecast
Absolute
Deviation
MADTonnage
= with for with for
Quarter Unloaded n
a = .10 a = .10 a = .50 a = .50
1 For a180
= .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 a190
= .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

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 Comparison of Forecast Error
∑ (forecast errors)
Rounded 2
Absolute Rounded Absolute
MSE = Tonnage
Actual Forecast Deviation Forecast Deviation

Quarter Unloaded
n
with
a = .10
for
a = .10
with
a = .50
for
a = .50
1 For a180
= .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
5 For a190
= .50 173.36 16.64 170.44 19.56
6 205 175.02
= 1,561.91/8 = 29.98
195.24 180.22 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, Inc. 4 - 56

 Comparison of Forecast Error
n
∑
Actual
100|deviation
Rounded
Forecast i |/actual
Absolute
Deviation i
Rounded
Forecast
Absolute
Deviation
MAPE = i=1
Tonnage with for with for
Quarter Unloaded a = .10 n a = .10 a = .50 a = .50
1 a = .10 175
For 180 5.00 175 5.00
2 168 175.5 7.50 177.50 9.50
3 159 = 44.75/8
174.75 =15.75
5.59% 172.75 13.75
4 175 173.18 1.82 165.88 9.12
5 For a=
190 .50 173.36 16.64 170.44 19.56
6 205 175.02
= 54.05/8 =29.98
6.76% 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

© 2014 Pearson Education, Inc. 4 - 57

 Comparison of Forecast Error
Rounded Absolute Rounded Absolute
Actual Forecast Deviation Forecast Deviation
Tonnage with for with for
Quarter Unloaded a = .10 a = .10 a = .50 a = .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%
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 Exponential Smoothing with
Trend Adjustment

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 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

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

Deviation5 Deviation6

Deviation3
Least squares method minimizes the
sum of Deviation
the squared
4
errors (deviations)

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

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

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 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

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

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 Least Squares Example
ELECTRICAL POWER
YEAR (x) DEMAND (y) x2 xy
74 1 74
1
79 4 158
2
80 9 240
3
90 16 360
4
105 25 525
5
142 36 852
6
Demand in year 8 = 56.70 + 10.54(8)
122 49 854
7 = 141.02, or 141 megawatts
Σx = 28 Σy = 692 Σx2 = 140 Σxy = 3,063

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 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
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 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

© 2014 Pearson Education, Inc. 4 - 74

 Problem
The number of disk drives (in millions) made at a plant in
Taiwan during the past 5 years follows:

a) Forecast the number of disk drives to be made next

year, using linear regression.
b) b) Compute the mean squared error (MSE) when using
linear regression.
c) Compute the mean absolute percent error (MAPE).
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 Seasonal Variations In Data

The multiplicative
seasonal model can
adjust trend data for
seasonal variations
in demand

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 Seasonal Variations In Data
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

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 Seasonal Index Example
DEMAND
AVERAGE AVERAGE
YEARLY MONTHLY SEASONAL
MONTH YEAR 1 YEAR 2 YEAR 3 DEMAND DEMAND INDEX
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
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 Seasonal Index Example
DEMAND
AVERAGE AVERAGE
YEARLY MONTHLY SEASONAL
MONTH YEAR 1 YEAR 2 YEAR 3 DEMAND DEMAND INDEX
Jan 80 85 105 90 94
Feb 70 85 85 80 94
Mar 80 93 82 85 94
Apr
Average
90 95 115 100 94
May
monthly
113 125 131 123 94
June
demand
110 115 120 115 94
July 100 102 113 105 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
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 Seasonal Index Example
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 115 120 115 94
July index 100 102 113 105 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
© 2014 Pearson Education, Inc. 4 - 80
 Seasonal Index Example
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 .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
© 2014 Pearson Education, Inc. 4 - 81
 Seasonal Index Example
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

© 2014 Pearson Education, Inc. 4 - 82

 Seasonal Index Example
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
© 2014 Pearson Education, Inc. 4 - 83
 Problem
George Kyparisis owns a company that manufactures sailboats. Actual
demand for George’s sailboats during each of the past four seasons was
as follows:

George has forecasted that annual demand for his sailboats in year 5 will
equal 5,600 sailboats. Based on this data and the multiplicative seasonal
model, what will the demand level be for George’s sailboats in the spring of
year 5?

© 2014 Pearson Education, Inc. 4 - 84

 San Diego Hospital
Trend Data Figure 4.6

10,200 –

10,000 –
Inpatient Days

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

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
© 2014 Pearson Education, Inc. 4 - 85
 San Diego Hospital
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

© 2014 Pearson Education, Inc. 4 - 86

 San Diego Hospital
Seasonal Indices Figure 4.7

1.06 –
1.04 1.04
Index for Inpatient Days

1.04 – 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
0.96
0.94 –
| | | | | | | | | | | |
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
© 2014 Pearson Education, Inc. 4 - 87
 San Diego Hospital
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

© 2014 Pearson Education, Inc. 4 - 88

 San Diego Hospital
Combined Trend and Seasonal Forecast Figure 4.8

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

9764 9724
9,800 – 9691
9572
9,600 –
9520 9542
9,400 –
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
© 2014 Pearson Education, Inc. 4 - 89
 Adjusting Trend Data

Quarter I:
Quarter II:
Quarter III:
Quarter IV:

© 2014 Pearson Education, Inc. 4 - 90

 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

© 2014 Pearson Education, Inc. 4 - 91

 Associative Forecasting
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

© 2014 Pearson Education, Inc. 4 - 92

 Associative Forecasting
Example
NODEL’S SALES AREA PAYROLL NODEL’S SALES AREA PAYROLL
(IN $ MILLIONS), y (IN $ BILLIONS), x (IN $ MILLIONS), y (IN $ BILLIONS), 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 –

| | | | | | |

0 1 2 3 4 5 6 7
Area payroll (in $ billions)
© 2014 Pearson Education, Inc. 4 - 93
 Associative Forecasting
Example
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

© 2014 Pearson Education, Inc. 4 - 94

 Associative Forecasting
Example
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

© 2014 Pearson Education, Inc. 4 - 95

 Associative Forecasting
Example
SALES, y PAYROLL, x x2 xy
2.0 1 1 2.0
3.0 4.0 – 3 9 9.0
Nodel’s sales

2.5 4 16 10.0
(in$ millions)

3.0 –
2.0 2 4 4.0
2.0 2.0 – 1 1 2.0
3.5 7 49 24.5
1.0 –
Σy = 15.0 Σx = 18 Σx2 = 80 Σxy = 51.5
| | | | | | |
0 1 2 3 4 5 6 7
Area payroll (in $ billions)

© 2014 Pearson Education, Inc. 4 - 96

 Associative Forecasting
Example

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, Inc. 4 - 97

 Problem
Mark Gershon, owner of a musical instrument distributorship, thinks that demand
for guitars may be related to the number of television appearances by the popular
group Maroon 5 during the previous month. Mark has collected the data shown in
the following table:

a) Graph these data to see whether a linear equation might describe the
relationship between the group’s television shows
and guitar sales.

b) Use the least-squares regression method to derive a forecasting equation.

c) What is your estimate for guitar sales if Maroon 5 performed on TV nine

times last month?

d) What are the correlation coefficient ( r ) and the coefficient of determination

( r 2 ) for this model, and what do they mean
© 2014 Pearson Education, Inc. 4 - 98
 Associative Forecasting
Example

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

3.0 –

2.0 –
Sales (in$ millions) = 1.75 + .25(6)
1.0 –
= 1.75 + 1.5 = 3.25
| | | | | | |
0 1 2 3 4 5 6 7
Sales = $3,250,000
Area payroll (in $ billions)

© 2014 Pearson Education, Inc. 4 - 99

 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
Nodel’s sales
(in$ millions)3.0 –
Regression line,
distribution 2.0 –

1.0 –

| | | | | | |
0 1 2 3 4 5 6 7
Figure 4.9 Area payroll (in $ billions)

© 2014 Pearson Education, Inc. 4 - 100

 Standard Error of the Estimate

where y = y-value of each data point

yc = computed value of the dependent
variable, from the regression equation
n = number of data points

© 2014 Pearson Education, Inc. 4 - 101

 Standard Error of the Estimate
Computationally, this equation is
considerably easier to use

We use the standard error to set up

prediction intervals around the point
estimate
© 2014 Pearson Education, Inc. 4 - 102
 Standard Error of the Estimate

S y,x 
y 2
 a  y  b xy

39.5  1.75(15.0)  .25(51.5)
n2 62
 .09375
 .306 (in $ millions)

4.0 –
Nodel’s sales3.25
(in$ millions)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)

© 2014 Pearson Education, Inc. 4 - 103

 Correlation
► How strong is the linear relationship
between the variables?
► Coefficient of correlation, r, measures
degree of association
► Values range from -1 to +1

© 2014 Pearson Education, Inc. 4 - 104

 Correlation Coefficient

© 2014 Pearson Education, Inc. 4 - 105

 Correlation Coefficient
Figure 4.10
y y

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

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

x
(c) No correlation

High Moderate Low Low Moderate High

| | | | | | | | |

–1.0 –0.8 –0.6 –0.4 –0.2 0 0.2 0.4 0.6 0.8 1.0
Correlation coefficient values

© 2014 Pearson Education, Inc. 4 - 106

 Correlation Coefficient
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

© 2014 Pearson Education, Inc. 4 - 107

 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, Inc. 4 - 108
 Problem
▶ Bus and subway ridership for the summer months in London, England, is
believed to be tied heavily to the number of tourists visiting the city. During
the past 12 years, the data given below have been obtained:

a)Plot these data and decide if a linear model is reasonable.

b) Develop a regression relationship.
c) What is expected ridership if 10 million tourists visit London in a year?
d) Explain the predicted ridership if there are no tourists at all.
e) What is the standard error of the estimate?
f) What is the model’s correlation coefficient and coefficient of determination?
© 2014 Pearson Education, Inc. 4 - 109
 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

Computationally, this is quite

complex and generally done on the
computer
© 2014 Pearson Education, Inc. 4 - 110
 Multiple-Regression Analysis
In the Nodel example, including interest rates in the
model gives the new equation:

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

© 2014 Pearson Education, Inc. 4 - 111

 Problem
The number of auto accidents in Athens, Ohio, is related to the regional
number of registered automobiles in thousands ( X 1 ), alcoholic beverage
sales in $10,000s ( X 2 ), and rainfall in inches ( X 3 ). Furthermore, the
regression formula has been calculated as:

Calculate the expected number of automobile accidents under conditions a, b,

and c:

© 2014 Pearson Education, Inc. 4 - 112

 Problem
Accountants at the Tucson firm, Larry Youdelman, CPAs, believed that
several traveling executives were submitting unusually high travel vouchers
when they returned from business trips. First, they took a sample of 200
vouchers submitted from the past year. Then they developed the following
multiple-regression equation relating expected travel cost to number of days
on the road ( x1 ) and distance traveled ( x2 ) in miles:

The coefficient of correlation computed was .68.

a) If Donna Battista returns from a 300-mile trip that took her out of
town for 5 days, what is the expected amount she should claim as
expenses?
b) Battista submitted a reimbursement request for $685. What should
the accountant do?
c) Should any other variables be included? Which ones? Why?

© 2014 Pearson Education, Inc. 4 - 113

 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

© 2014 Pearson Education, Inc. 4 - 114

 Monitoring and Controlling
Forecasts

Tracking Cumulative error

signal =
MAD

© 2014 Pearson Education, Inc. 4 - 115

 Tracking Signal
Figure 4.11
Signal exceeding limit
Tracking signal
Upper control limit
+

Acceptable
0 MADs range

– Lower control limit

Time

© 2014 Pearson Education, Inc. 4 - 116

 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,

© 2014 Pearson Education, Inc. 4 - 117

 Problem
▶ The following are monthly actual and forecast demand
levels for May through December for units of a product
manufactured by the D. Bishop Company in Des Moines:

▶ What is the value of the tracking signal as of the end of

December?

© 2014 Pearson Education, Inc. 4 - 118

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

© 2014 Pearson Education, Inc. 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, Inc. 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, Inc. 4 - 121

 Fast Food Restaurant Forecast
Percentage of sales by hour of day

20% – 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, Inc. 4 - 122
 FedEx Call Center Forecast
Figure 4.12
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, Inc. 4 - 123

 Problem
▶ Thirteen students entered the business program at
Sante Fe College 2 years ago. The following table
indicates what each student scored on the high school
SAT math exam and their grade-point averages (GPAs)
after students were in the Sante Fe program for 2 years:

▶ a) Is there a meaningful relationship between SAT math

scores and grades?
▶ b) If a student scores a 350, what do you think his or her
GPA will be?
▶ c) What about a student who scores 800?
© 2014 Pearson Education, Inc. 4 - 124