QUANTITATIVE ANALYSIS (ISD

551) Dr. Emmanuel Quansah

Lecturer:
Department: Supply Chain and Information Systems - KSB
Office: SF 25, KSB Undergraduate Block
 Module 4:
BUSINESS
FORECASTING
Learning Objectives (1 of
2)
After completing this chapter, students will be able to:
1. Understand and know when to use various families of
forecasting models.
2. Compare moving averages, exponential smoothing,
and other time-series models.
3. Calculate measures of forecast accuracy.
4. Apply forecast models for random variations.
5. Manipulate data to account for seasonal variations.
Chapter
Outline
1. Types of Forecasting Models
2. Components of a Time Series
3. Measures of Forecast Accuracy
4. Forecasting Models – Random
Variations Only
5. Adjusting for Seasonal
Variations
Introduction…1
• Main purpose of forecasting
• Reduce uncertainty and make better estimates of what will
happen in the future
• Forecasting is essential for a number of planning
decisions and often provides a valuable input on which
future operations of the business enterprise depend.

• Subjective methods
• Seat-of-the pants methods, intuition, experience

• More formal quantitative and qualitative techniques

 Introduction…2
Some of the areas where forecasts of future product
demand would be useful are indicated below

(1) Specification of production targets as functions

of time.

(2) Planning equipment and manpower usage, as

wel as additional procurement .

(3) Budget allocation depending on the

level of
production and sales. 6
 Introduction…3
4) Determination of the best inventory policy.

5) Decisions on expansion and major

changes in production processes and
methods

6) Future trends of product

development, diversification, scrapping, etc.

7) Design of suitable pricing policy.

8) Planning
promotion. the methods of distribution and
7
 FORECASTING Vs
PREDICTION
FORECASTING
Forecasting generally refers to the scientific methodology that
often uses past data along with some well-defined
assumptions or ‗model‘ to come up with a ―forecast‖ of future
demand.

In that sense, forecasting is OBJECTIVE.

8
 FORECASTING Vs
PREDICTION
PREDICTION
A Prediction is a SUBJECTIVE estimate made
by an individual by using his intuitive ‗hunch‘
which may in fact come out true.

The fact that it is subjective (A’s prediction may be

different from B‘s and C‘s) and non-realizable as
a well-documented computer programme (which
would be used by anyone) deprives it of much
value.
9
Forecasting
Models
FIGURE 5.1 Forecasting Models
Qualitative Models (1 of
3)
• Incorporate judgmental or subjective
factors
–Useful when subjective factors are important or
accurate quantitative data is difficult to obtain
• Common qualitative techniques
1. Delphi method
2. Jury of executive opinion
3. Sales force composite
4. Consumer market surveys
Qualitative Models (2 of
3)
• Delphi Method
• Iterative group process
• Respondents provide input to decision makers
• Repeated until consensus is reached
• Jury of Executive Opinion
• Collects opinions of a small group of high-level
managers
• May use statistical models for analysis
Qualitative Models (3 of
3)
• Sales Force Composite
• Allows individual salespersons estimates
• Reviewed for reasonableness
• Data is compiled at a district or national level
• Consumer Market Survey
• Information on purchasing plans solicited from
customers or potential customers
• Used in forecasting, product design, new
product planning
 14

QUANTITATIVE
METHODS
Quantitative forecasting methods can be used when
(1) past information about the variable being

forecast is available,
(2) the information can be quantified, and

(3) a reasonable assumption is that the pattern of

the past will continue into the future.
In such cases, a forecast can be developed using a
TIME SERIES METHOD or a CAUSAL METHOD.
Time-Series
Models
• A time series is a set of observations of a variable
measured at successive points in time or over successive
periods of time.
• Based on a sequence of evenly spaced data points
(weekly, monthly, quarterly etc)
• Predict the future based on the past
• Uses only historical data on one variable
• Extrapolations of past values of a series
• Ignores factors such as
• Economy
• Competition
• Selling price
Components of a Time Series (1
of 4)
• Sequence of values recorded at successive
intervals of time
• Four possible components
• Trend (T)
• Seasonal (S)
• Cyclical (C)
• Random (R)
 TREN
• This refers to DUPWARD or DOWNWARD
the
movement that characterizes a time series over time.
• Thus trend reflects the long run growth or decline in

the time series.

• Trend movements can represent a variety of factors.

For example, long run movements in the sales of a

particular industry might be determined by changes
in consumer tastes, increase in total population, and
increases in per capita income.
 CYCL
E
• Refers to recurring UP-AND-DOWN movements around
trend levels.
• These fluctuations can last from 2 to 10 years or even

longer measured from peak to peak or trough to

trough. One of the most common cyclical series data
is the Business Cycle which is represented by
fluctuation in the time series caused by recurrent
periods of PROSPERITY and RECESSION.
 21

SEASONAL
• These VARIATIONS
are periodic patterns in a time series that
complete themselves within a calendar year or less
and are repeated on a regular basis.

• Often variations occur yearly.

seasonal drink sales and For hotel
example, soft are annually higher in the
occupancies room
summer
months, while department store sales are higher in
during Christmas holidays.
 SEASONAL
VARIATIONS
• Seasonal variations can also last less than one

year. For example daily restaurant patronage

might exhibit within week seasonal variations,
with daily patronage higher on Fridays and
Saturdays.
 RANDOM/
IRREGULAR
FLUCTUATIONS
• These are erratic time series movements that
follow no recognizable or regular pattern.

• Such movements represent what is ―left over‖ in

a time series after trend, cycle, and seasonal

variations have been accounted for.
Components of a Time Series (2
of 4)
FIGURE 5.2 Scatter Diagram for Four Time Series of
Quarterly Data
Components of a Time Series (3
of 4)
FIGURE 5.3 Scatter Diagram of a Time Series with
Cyclical and Random Components
 Components of a Time Series (4
of 4)
• Product Demand Charted over 4 Years, with Trend and Seasonality
Indicated
 Forecasting Time Horizons…
•1
The primary purpose of forecasting is to provide
valuable information for planning the design and
operation of the enterprise.
• Planning decisions may be classified as long term,

medium term and short term.

• Long term decisions include decisions like plant

expansion or new product introduction which may

require new technologies or a complete
transformation in social or moral fabric of society
 28

Forecasting Time Horizons…

2
• M edium term decisions involve such decisions as
.

planning the production levels in a manufacturing

plant over the next year, determination of manpower
requirements or inventory policy for the firm.
• Short term decisions include daily production
planning and scheduling decisions.
• For both medium and short term forecasting,

many methods and techniques exist.

Time-Series
Models
• Two basic forms
– Multiplicative

Demand = T × S × C ×
R
– Additive

Demand = T + S + C +
R
– Combinations are possible
Measures of Forecast Accuracy (1
of 5)
• Compare forecasted values with actual values
– See how well one model works
– To compare models

Forecast error = Actual value − Forecast

value

• Measure of accuracy
– Mean absolute deviation (MAD):

MAD 
 forecast error
n
Measures of Forecast Accuracy (2
of 5)
TABLE 5.1 Computing the Mean Absolute Deviation (MAD)
ACTUAL ABSOLUTE VALUE OF
SALES OF WIRELESS ERRORS (DEVIATION),
MONTH SPEAKERS FORECAST SALES (ACTUAL − FORECAST)
1 110 — —
2 100 110 |100 − 110| = 10
3 120 100 |120 − 100| = 20
4 140 120 |140 − 120| = 20
5 170 140 |170 − 140| = 30
6 150 170 |150 − 170| = 20
7 160 150 |160 − 150| = 10
8 190 160 |190 − 160| = 30
9 200 190 |200 − 190| = 10
10 190 200 |190 − 200| = 10
11 — 190 —
Sum of |errors| = 160
MAD = 160÷9 = 17.8
Measures of Forecast Accuracy (3
of 5)
TABLE 5.1 Computing the Mean Absolute Deviation (MAD)
ACTUAL ABSOLUTE VALUE OF
SALES OF WIRELESS ERRORS (DEVIATION),
MONTH SPEAKERS FORECAST SALES (ACTUAL − FORECAST)
1 110 —
2 100 110
3 120 100 • Forecast based on
4 140 120 naïve model
5 170 140
6 150 170 • No attempt to adjust
7 160 150 for time series
8 190 160 components
9 200 190
10 190 200
11 — 190
Measures of Forecast Accuracy (4 of
MAD 
 forecast error

160
 17.8
5) )
n
ACTUAL ABSOLUTE VALUE OF
TABLE SALES
5.1 Computing
OF WIRELESS the Mean AbsoluteERRORS
Deviation (MAD
(DEVIATION),
MONTH SPEAKERS FORECAST SALES (ACTUAL − FORECAST)
1 110 9 — —
2 100 110 |100 − 110| = 10
3 120 100 |120 − 100| = 20
4 140 120 |140 − 120| = 20
5 170 140 |170 − 140| = 30
6 150 170 |150 − 170| = 20
7 160 150 |160 − 150| = 10
8 190 160 |190 − 160| = 30
9 200 190 |200 − 190| = 10
10 190 200 |190 − 200| = 10
11 — 190 —
Sum of |errors| = 160
MAD = 160÷9 = 17.8
Measures of Forecast Accuracy (5
of 5)
• Other common measures
– Mean squared error
(MSE)
MSE   (error)2
n
– Mean absolute percent error (MAPE)
error

actual
MAPE  n 100%

– Bias is the average error

Forecasting Random
Variations
• No other components are present
• Averaging techniques smooth out forecasts
• Moving averages
• Weighted moving averages
• Exponential smoothing
Moving Averages (1 of
2)
• Used when demand is relatively steady over time
• The next forecast is the average of the most
recent n data values from the time series
• Smooths out short-term irregularities in the data
series

Sum of demands in previous n periods

Moving average forecast =
n
Moving Averages (2 of
2)
• Mathematically

Ft  Yt  Yt 1  ...  Yt
1 n
n 1

where
Ft+1 = forecast for time period t + 1
Yt = actual value in time period t
n = number of
periods to average
Wallace Garden Supply (1 of
4)
• Wallace Garden Supply wants to forecast demand for its
Storage Shed
• Collected data for the past year
• Use a three-month moving average (n = 3)
Wallace Garden Supply (2 of
4)
TABLE 5.2 Wallace Garden Supply Shed Sales
MONTH ACTUAL SHED SALES 3-MONTH MOVING AVERAGE

January 10
February 12

March 13
April 16 (10 + 12 + 13)÷3 = 11.67
May 19 (12 + 13 + 16)÷3 = 13.67
June 23 (13 + 16 + 19)÷3 = 16.00

July 26 (16 + 19 + 23)÷3 = 19.33

August 30 (19 + 23 + 26)÷3 = 22.67

September 28 (23 + 26 + 30)÷3 = 26.33
October 18 (26 + 30 + 28)÷3 = 28.00

November 16 (30 + 28 + 18)÷3 = 25.33

December 14 (28 + 18 + 16)÷3 = 20.67

January — (18 + 16 + 14)÷3 = 16.00
Weighted Moving
Averages
• Weighted moving averages use weights to put more
emphasis on previous periods
• Often used when a trend or other pattern is
emerging
Ft

 (Weight in period i )(Actual value in period
1
i) (Weights)
• Mathematically

Ft w1Yt  w 2Yt 1  ...  w nYt

 w1  w 2  ...  n
1

where
 n 1
w
wi = weight for the ith
observation
Wallace Garden Supply (3 of
4)
• Use a 3-month weighted moving average model to
forecast demand
• Weighting scheme

WEIGHT APPLIED PERIOD

3 Last month
2 2 months ago
1 3 months ago
3 × Sales last + 2 × Sales 2 months ago + 1 × Sales 3 months ago
month
6
Sum of the weights
Wallace Garden Supply (4 of
4)
TABLE 5.3 Weighted Moving Average Forecast for Wallace Garden Supply
MONTH ACTUAL SHED SALES 3-MONTH WEIGHTED MOVING AVERAGE

January 10
February 12

March 13
April 16 [(3 × 13) + (2 × 12) + (10)]÷6 = 12.17
May 19 [(3 × 16) + (2 × 13) + (12)]÷6 = 14.33
June 23 [(3 × 19) + (2 × 16) + (13)]÷6 = 17.00

July 26 [(3 × 23) + (2 × 19) + (16)]÷6 = 20.5

August 30 [(3 × 26) + (2 × 23) + (19)]÷6 = 23.83

September 28 [(3 × 30) + (2 × 26) + (23)]÷6 = 27.5
October 18 [(3 × 28) + (2 × 30) + (26)]÷6 = 28.33

November 16 [(3 × 18) + (2 × 28) + (30)]÷6 = 23.33

December 14 [(3 × 16) + (2 × 18) + (28)]÷6 = 18.67

January — [(3 × 14) + (2 × 16) + (18)]÷6 = 15.33
Exponential Smoothing (1 of
2)
• Exponential smoothing
• A type of moving average
• Easy to use
• Requires little record keeping of data

New forecast = Last period‘s forecast

+ α(Last period‘s actual demand
−Last period‘s forecast)

α is a weight (or smoothing constant) with a value 0 ≤ α ≤

1
Exponential Smoothing (2 of
2)
• Mathematically
  (Yt 
Ft 1  Ft
Ft )
where
= new forecast (for time period t + 1)
Ft+1
Ft = pervious forecast (for time period t)
α = smoothing constant (0 ≤ α ≤ 1)
Yt = pervious period‘s actual demand

The idea is simple – the new estimate is the old estimate

plus some fraction of the error in the last period
Exponential Smoothing Example (1 of
2)
• In January, February‘s demand for a certain car model
was predicted to be 142
• Actual February demand was 153 autos
• Using a smoothing constant of α = 0.20, what is the
forecast for March?
New forecast (for March demand) = 142
+ 0.2(153 −
142)
= 144.2 or 144
autos
• If actual March demand = 136
New forecast (for April demand) =
144.2 + 0.2(136
Exponential Smoothing Example (2 of
2)
• Selecting the appropriate value for α is key to
obtaining a good forecast
• The objective is always to generate an accurate
forecast
• The general approach is to develop trial forecasts
with different values of α and select the α that
results in the lowest MAD
Port of Baltimore Example (1
of 2)
TABLE 5.4 Port of Baltimore Exponential Smoothing
Forecasts for α = 0.10 and α = 0.50
ACTUAL FORECAST
TONNAGE FORECAST USING
QUARTER UNLOADED USING α = 0.10 α = 0.50
1 180 175 175
2 168 175.5 = 175.00 + 0.10(180 − 175) 177.5
3 159 174.75 = 175.50 + 0.10(168 − 175.50) 172.75
4 175 173.18 = 174.75 + 0.10(159 − 174.75) 165.88
5 190 173.36 = 173.18 + 0.10(175 − 173.18) 170.44
6 205 175.02 = 173.36 + 0.10(190 − 173.36) 180.22
7 180 178.02 = 175.02 + 0.10(205 − 175.02) 192.61
8 182 178.22 = 178.02 + 0.10(180 − 178.02) 186.30
9 ? 178.60 = 178.22 + 0.10(182 − 178.22) 184.15
Port of Baltimore Example (2
of 2)
TABLE 5.5 Absolute Deviations and MADs for the Port of Baltimore Example
ACTUAL ABSOLUTE ABSOLUTE
TONNAGE FORECAST DEVIATIONS FOR FORECAST DEVIATIONS
QUARTER UNLOADED WITH α = 0.10 α = 0.10 WITH α = 0.50 FOR α =
0.50
1 180 175 5 175 5
2 168 175.5 7.5 177.5 9.5
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 4.3
Sum of
absolute 82.45 98.63
deviations
Σ d MAD = 12.33
MAD = n

Best choice
Using Software (1 of
7)
PROGRAM 5.1A Selecting the Forecasting Model in
Wallace Garden Supply Problem
Using Software (2 of
7)
PROGRAM 5.1B Initializing Excel QM Spreadsheet for
Wallace Garden Supply Problem
Using Software (3 of
7)
PROGRAM 5.1C Excel QM Output for Wallace Garden
Supply Problem
Using Software (4 of
7)
PROGRAM 5.2A Selecting Time-Series Analysis in QM for
Windows in the Forecasting Module
Using Software (5 of
7)
PROGRAM 5.2B Entering Data for Port of Baltimore
Example in QM for Windows
Using Software (6 of
7)
PROGRAM 5.2C Selecting the Model and Entering Data
for Port of Baltimore Example in QM for Windows
Using Software (7 of
7)
PROGRAM 5.2D Output for Port of Baltimore Example in
QM for Windows
Trend Projections (1 of
2)
• Fits a trend line to a series of historical data points
• Projected into the future for medium- to long-range
forecasts
• Trend equations can be developed based on exponential
or quadratic models
• Linear model developed using regression analysis is
simplest
Trend Projections (2 of
2)
• Mathematical formula

Y ˆ  b 0  b1 X

where
Ŷ = predicted
value
b0 = intercept
b1 = slope of the
line
X = time period
(i.e., X = 1, 2, 3, …, n)
Midwestern Manufacturing (1 of
4)
• Based on least squares regression, the forecast equation is

Yˆ  56.71 10.54X

• Year 2014 is coded as X = 8

(sales in 2014) = 56.71 + 10.54(8)
= 141.03, or 141 generators
• For X = 9
(sales in 2015) = 56.71 + 10.54(9)
= 151.57, or 152 generators
Midwestern Manufacturing (2 of
4)
PROGRAM 5.4 Output from Excel QM in Excel 2016 for
Trend Line Example
Midwestern Manufacturing (3 of
4)
PROGRAM 5.5 Output from QM for Windows for Trend
Line Example
Midwestern Manufacturing (4 of
4)
FIGURE 5.4 Generator Demand and Projections for Next
Three Years Based on Trend Line
Seasonal
Variations
• Recurring variations over time may indicate the need for
seasonal adjustments in the trend line
• A seasonal index indicates how a particular season
compares with an average season
• An index of 1 indicates an average season
• An index > 1 indicates the season is higher than average
• An index < 1 indicates a season lower than average
 Seasonal
•Indices
Deseasonalized data is created by dividing each
observation by the appropriate seasonal index
• Once deseasonalized forecasts have been developed,
values are multiplied by the seasonal indices
• Computed in two ways
• Overall average
• Centered-moving-average approach
Seasonal Indices with No Trend (1
of 3)
• Divide average value for each season by the average of
all data
– Telephone answering machines at Eichler Supplies
– Sales data for the past two years for one model
– Create a forecast that includes seasonality
 Seasonal Indices with No Trend (2
of 3)
TABLE 5.8 Answering Machine Sales and Seasonal Indices
SALES DEMAND

MONTH YEAR 1 YEAR 2 AVERAGE 2- MONTHL AVERAGE

YEAR DEMAND Y SEASONAL INDEXb
DEMANDa
January 80 100 90 94 0.957
February 85 75 80 94 0.851
March 80 90 85 94 0.904
April 110 90 100 94 1.064
May 115 131 123 94 1.309
June 120 110 115 94 1.223
July 100 110 105 94 1.117
August 110 90 100 94 1.064
September 85 95 90 94 0.957
October 75 85 80 94 0.851
November 85 75 80 94 0.851
December 80 80 80 94 0.851
Total average demand = 1,128
1,12 Average 2-year demand
a
Average monthly demand = = 94 b
Seasonal index =
12 8months Average monthly demand
Seasonal Indices with No Trend (3
of 3)
• Calculations for the seasonal indices
July
Jan. 1,200  0.957 = 96 1,200
 1.117 = 112
12 12
Feb. 1,20  0.851 = 85 Aug.
1,20
0  1.064 = 106
0
12
12
Sept. 1,200
Mar. 1,20  0.904 = 90  0.957 = 96
0 12
12 1,200
 0.851 = 85
Apr. 1,20  1.064 = 106 Oct. 12
0 1,200
 0.851 = 85
12 12
May Nov.
1,20  1.309 = 131 1,200
0  0.851 = 85
12 12
12
June 1,20  1.223 = 122 Dec.
Questions???