Stevenson

Forecasting
 Learning Objectives
 List the elements of a good forecast.
 Outline the steps in the forecasting process.
 Compare and contrast qualitative and quantitative
approaches to forecasting.
 Briefly describe averaging techniques, trend and
seasonal techniques, and regression analysis,
and solve typical problems.
 Describe measure(s) of forecast accuracy.
 Describe evaluating and controlling forecasts.

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FORECAST:
 A statement about the future value of a variable
of interest such as demand.
 Forecasting is used to make informed
decisions
 Match supply to demand.
 Two important aspects:
 Level of demand
 Degree of accuracy
 Long-range – plan the system (strategic)
 Short-range – plan to use the system (on-going
operations)

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 Forecasts
 Forecasts affect decisions and activities
throughout an organization
Accounting Cost/profit estimates

Finance Cash flow and funding

Human Resources Hiring/recruiting/training

Marketing Pricing, promotion, strategy

MIS IT/IS systems, services

Operations Schedules, workloads

Product/service design New products and services

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 Features of Forecasts
 Assumes causal system
past ==> future
 Forecasts are rarely perfect
 Forecast accuracy decreases
as time horizon increases
 Forecast accuracy increases as you
forecast larger group of items.

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Elements of a Good Forecast

Timely

Reliable Accurate

l s e
g fu u
i n Written to
n s y
a
M
e Ea

Cost Effective
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Steps in the Forecasting Process

“The forecast”

Step 6 Monitor the forecast

Step 5 Make the forecast
Step 4 Obtain, clean and analyze data
Step 3 Select a forecasting technique
Step 2 Establish a time horizon
Step 1 Determine purpose of forecast

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 Types of Forecasts

 Judgmental- uses subjective inputs

 Time series- uses historical data assuming

the future will be like the past

 Associative models- uses explanatory

variables to predict the future

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 Judgmental Forecasts
 Executive opinions

 Sales force opinions

 Consumer surveys

 Other Approaches
 Outside opinion
 Delphi Method
 Opinions of managers and staff
 Achieves a consensus forecast

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 Time Series Forecasts
 Trend- long-term movement in data

 Seasonality- short-term regular variations in data

 Cycle– wavelike variations of more than one year’s duration

 Irregular Variations- caused by unusual circumstances

 Random variations- caused by chance

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 Forecast Variations

Irregular
variation

Trend

Cycles

90
89
88
Seasonal variations

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Naive Forecasts
Uh, give me a minute....
We sold 250 wheels last
week.... Now, next week
we should sell....

The forecast for any period equals

the previous period’s actual value.

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 Features Naïve Forecasts
 Simple to use

 Virtually no cost

 Quick and easy to prepare

 Data analysis is nonexistent

 Easily understandable

 Cannot provide high accuracy

 Can be a standard for accuracy

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 Techniques for Averaging

 Moving average

 Weighted moving average

 Exponential smoothing

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 Moving Averages
 Moving average – A technique that averages a
number of recent actual values, updated as
new values become available.
At-n + … At-2 + At-1
Ft = MAn=
n
 Weighted moving average – More recent
values in a series are given more weight in
computing the forecast.
wnAt-n + … wn-1At-2 + w1At-1
Ft = WMAn=
n
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 Moving Average Example
Calculate a three-period moving average forecast for demand in period 6

If the actual demand in period 6 is 38, then the moving average forecast for
period 7 is:

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 Simple Moving Average
Actual
MA5

MA3

At-n + … At-2 + At-1

Ft = MAn=
n
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Weighted Moving Average Example
Period Demand Weight

1 42

2 40 10%

3 43 20%

4 40 30%

5 41 40%

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 Exponential Smoothing

Ft = Ft-1 + (At-1 - Ft-1)

• Premise--The most recent observations might have
the highest predictive value.
 Therefore, we should give more weight to the more
recent time periods when forecasting.
 Uses most recent period’s actual and forecast data
 Weighted averaging method based on previous
forecast plus a percentage of the forecast error
 A-F is the error term,  is the % feedback

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 Exponential Smoothing Example

F3  F2   ( A2  F2 )
  0.10, F3  42  0.10(40  42)  42  0.10  (2)  42  0.2  41.8

F4  F3   ( A3  F3 )
  0.10, F4  41.8  0.10(43  41.8)  41.8  0.10  1.2  41.8  0.12  41.92

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Picking a Smoothing Constant
Actual
50
.4
.1
45
Demand

40

35
1 2 3 4 5 6 7 8 9 10 11 12
Period

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Common Nonlinear Trends

Parabolic

Exponential

Growth

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 Linear Trend Equation
Ft

Ft = a + bt

0 1 2 3 4 5 t
 Ft = Forecast for period t
 t = Specified number of time periods
 a = Value of Ft at t = 0
 b = Slope of the line

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Calculating a and b

n  (ty) -  t  y
b =
n t 2 - (  t) 2

 y - b t
a =
n

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Linear Trend Equation Example
t y
2
W eek t S a le s ty
1 1 150 150
2 4 157 314
3 9 162 486
4 16 166 664
5 25 177 885

2
 t = 15  t = 55  y = 812  ty = 2 4 9 9
2
(  t) = 2 2 5

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 Linear Trend Calculation
5 (2499) - 15(812) 12495-12180
b = = = 6.3
5(55) - 225 275 -225

812 - 6.3(15)
a = = 143.5
5

y = 143.5 + 6.3t

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 Associative Forecasting

 Predictor variables- used to predict values of

variable interest

 Regression- technique for fitting a line to a set of

points

 Least squares line- minimizes sum of squared

deviations around the line

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 Regression Methods
 Linear regression
 mathematical technique that relates a
dependent variable to an independent variable
in the form of a linear equation
 Primary method for Associative Forecasting

 Correlation
 a measure of the strength of the relationship
between independent and dependent variables

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 Linear Regression Assumptions
 Variations around the line are random
 Deviations around the line normally
distributed
 Predictions are being made only within the
range of observed values
 For best results:
 Always plot the data to verify linearity
 Check for data being time-dependent
 Small correlation may imply that other variables
are important
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Linear Model Seems Reasonable
X Y Computed
7 15
relationship
2 10
6 13 50

4 15 40

14 25 30

15 27 20

16 24 10

0
12 20 0 5 10 15 20 25

14 27
20 44
15 34
7 17
A straight line is fitted to a set of sample points.

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 Linear Regression
y = a + bx a = y-bx
xy - nxy
b =
x2 - nx2
where
a = intercept
b = slope of the line
x
x = = mean of the x data
n
y
y = n = mean of the y data

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Linear Regression Example
x y
(WINS) (ATTENDANCE) xy x2
4 36.3 145.2 16
6 40.1 240.6 36
6 41.2 247.2 36
8 53.0 424.0 64
6 44.0 264.0 36
7 45.6 319.2 49
5 39.0 195.0 25
7 47.5 332.5 49
49 346.7 2167.7 311

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Linear Regression Example
49
x= = 6.125
8
346.9
y= = 43.36
8

xy - nxy
b=
x2 - nx2
(2,167.7) - (8)(6.125)(43.36)
=
(311) - (8)(6.125)2
= 4.06

a = y - bx
= 43.36 - (4.06)(6.125)
= 18.46

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 Linear Regression Example
60,000 –

50,000 –

40,000 –
Attendance, y

Linear regression line, y

30,000 – = 18.46 + 4.06x
Attendance forecast for 7 wins
20,000 –
y = 18.46 + 4.06(7)
= 46.88, or 46,880
10,000 –

| | | | | | | | | | |
0 1 2 3 4 5 6 7 8 9 10
Wins, x

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 Correlation and Coefficient of
Determination
 Correlation, r
 Measure of strength of relationship between the
dependent variable (demand) and the
independent variable
 Varies between -1.00 and +1.00

 Coefficient of determination, r2
 Percentage of variation in dependent variable
resulting from changes in the independent
variable

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 Computing Correlation
n xy -  x y
r=
[n x2 - ( x)2] [n y2 - ( y)2]

(8)(2,167.7) - (49)(346.9)
r=
[(8)(311) - (49)2] [(8)(15,224.7) - (346.9)2]

r = 0.947

Coefficient of determination
r2 = (0.947)2 = 0.897

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 Forecast Accuracy
 Error - difference between actual value and predicted value
 Mean Absolute Deviation (MAD)
 Average absolute error
 Weights errors linearly.
 Mean Squared Error (MSE)
 Average of squared error
 Gives more weight to larger errors, which typically cause more problems
 Mean Absolute Percent Error (MAPE)
 Average absolute percent error
 MAPE should be used when there is a need to put errors in perspective. For
example, an error of 10 in a forecast of 15 is huge. Conversely, an error of 10 in a
forecast of 10,000 is insignificant. Hence, to put large errors in perspective, MAPE
would be used.

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 MAD, MSE, and MAPE

 Actual  forecast
MAD =
n
2
 ( Actual  forecast)
MSE =
n -1

 Actual  forecast / Actual*100)

MAPE =
n

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Forecast Accuracy Example

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 MAD, MSE, and MAPE
 MAD – easiest to compute, but weighs
errors linearly.
 MSE – Gives more weight to larger
errors; larger errors cause more
problems.
 MAPE – Puts errors in perspective: e.g.,
error of 10 in a forecast of 15 is huge, but
error of 10 in a forecast of 10,000 is
perhaps negligible.

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 Controlling the Forecast
 Control chart
 A visual tool for monitoring forecast errors
 Used to detect non-randomness in errors
 Forecasting errors are in control if
 All errors are within the control limits
 No patterns, such as trends or cycles, are
present

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 Tracking Signal
•Tracking signal
–Ratio of cumulative error to MAD

Tracking signal =
(Actual-forecast)
MAD
Bias – Persistent tendency for forecasts to be
Greater or less than actual values.

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 Forecast Control

 Tracking signal
 monitors the forecast to see if it is
biased high or low
(Dt - Ft) E
Tracking signal = =
MAD MAD
 1 MAD ≈ 0.8 б
 Control limits of 2 to 5 MADs are
used most frequently
Tracking Signal Values

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Tracking Signal Plot

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 Sources of Forecast errors
 Model may be inadequate
 Irregular variations
 Incorrect use of forecasting technique

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Choosing a Forecasting Technique
 No single technique works in every
situation
 Two most important factors
 Cost
 Accuracy
 Other factors include the availability of:
 Historical data
 Computers
 Time needed to gather and analyze the data
 Forecast horizon
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 Operations Strategy
 Forecasts are the basis for many decisions
 Work to improve short-term forecasts
 Accurate short-term forecasts improve
 Profits
 Lower inventory levels
 Reduce inventory shortages
 Improve customer service levels
 Enhance forecasting credibility

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 Supply Chain Forecasts
 Sharing forecasts with supply can
 Improve forecast quality in the supply chain
 Lower costs
 Shorter lead times

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 REVIEW QUESTIONS
 Define
 Forecast, Delphi Method, Naïve Forecast, and
Forecast Error.

 Differentiate
 Judgmental Forecast vs. Time Series Forecast
 Long Range Forecast vs. Short Range Forecast

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 REVIEW QUESTIONS
 Short Questions
 What are the elements of a good forecast?
 Mention the steps of forecasting process.
 What are the common features of forecasts?
 Why is it important to communicate & share forecasted
information throughout the supply chain?
 What are the positive & negative features of Naïve Method?
 Describe all types of judgmental forecasts and tools.
 Describe all types of time-series forecasts and tools.
 What are the sources of forecasting errors?
 How to choose a forecasting technique?

 Pages for Special Topics: Topic number 3.2 to 3.6.

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 REVIEW QUESTIONS
 Math
 Averaging Techniques
 Moving Average, Weighted Moving Average, Exponential Smoothing

 Naïve Method
 Linear Trend Equation & Linear Regression
 Error Calculation: MAD, MSE, and MAPE

 Example 1, 2, 3, 4, and 5 (Avoid data plotting).

 Solved Problems 1 & 3.
 Practice Problems 1, 2, 3, 4, 5, 7, 8, 20, 21, and 22.

 Avoid any sort of data plotting, drawing graph, or anything else

except calculating forecasted quantity or error.
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