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CHAPTER 13

FORECASTING
Outline

Forecasting and Choice of a Forecasting Methods
Methods for Stationary Series:
Simple and Weighted Moving Average
Exponential smoothing
Trend-Based Methods
Regression
Double Exponential Smoothing: Holts Method
A Method for Seasonality and Trend
Forecasting
Decisions Based on Forecasts
Production
Aggregate planning,
inventory control,
scheduling
Marketing
New product
introduction, sales-
force allocation,
promotions
Finance
Plant/equipment
investment, budgetary
planning

Personnel
Workforce planning,
hiring, layoff
Characteristics of Forecasts
Forecasts are always
wrong; so consider
both expected value
and a measure of
forecast error
Long-term forecasts
are less accurate than
short-term forecasts
Aggregate forecasts
are more accurate than
disaggregate forecasts

Forecasting
Components of demand
Evaluation of forecasts
Time series: stationary series
Time series: trend
Linear regression
Double exponential smoothing
Time series: seasonality
Components of Demand
Average demand
Trend
Gradual shift in average demand
Seasonal pattern
Periodic oscillation in demand which repeats
Cycle
Similar to seasonal patterns, length and
magnitude of the cycle may vary
Random movements
Auto-correlation
Q
a
n
t
i
t
y

Time
(a) Average: Data cluster about a horizontal line.
Components of Demand
Q
u
a
n
t
i
t
y

Time
(b) Linear trend: Data consistently increase or decrease.
Components of Demand
Components of Demand
Q
u
a
n
t
i
t
y

| | | | | | | | | | | |
J F M A M J J A S O N D
Months
(c) Seasonal influence: Data consistently show
peaks and valleys.
Year 1
Components of Demand
Q
u
a
n
t
i
t
y

| | | | | | | | | | | |
J F M A M J J A S O N D
Months
(c) Seasonal influence: Data consistently show
peaks and valleys.
Year 1
Year 2
Components of Demand
Components of Demand
Q
u
a
n
t
i
t
y

| | | | | |
1 2 3 4 5 6
Years
(c) Cyclical movements: Gradual changes over
extended periods of time.
Components of Demand
D
e
m
a
n
d

Time
Trend
Random
movement
D
e
m
a
n
d

Time
Trend with
seasonal pattern
Components of Demand
Snow Skiing
Seasonal
Long term growth trend
Demand for skiing products increased
sharply after the Nagano Olympics
E|E
t
|
n
EE
t
2

n
RSFE = EE
t

MAD =
MSE =
MAPE =
o = MSE
E[ |E
t
| (100) ] / A
t

n
Measures of Forecast Error
E
t
= A
t
- F
t
Choosing a Method
Forecast Error
Absolute
Error Absolute Percent
Month, Demand, Forecast, Error, Squared, Error, Error,
t A
t
F
t
E
t
E
t
2
|E
t
| (|E
t
|/A
t
)(100)

1 200 225
2 240 220
3 300 285
4 270 290
5 230 250
6 260 240
7 210 250
8 275 240
-
Total
Choosing a Method
Forecast Error
MSE = =
Measures of Error
MAD = =
MAPE = =
RSFE =
Choosing a Method
Forecast Error
Choosing a Method
Forecast Error
Running Sum Mean Absolute
of Forecast Errors Deviation
Method (RSFE - bias) (MAD)
Simple moving average
Three-week (n = 3) 23.1 17.1
Six-week (n = 6) 69.8 15.5
Weighted moving average
0.70, 0.20, 0.10 14.0 18.4
Exponential smoothing
o = 0.1 65.6 14.8
o = 0.2 41.0 15.3
Choosing a Method
Tracking Signals
Tracking signal =
RSFE
MAD
+2.0
+1.5
+1.0
+0.5
0
- 0.5
- 1.0
- 1.5
| | | | |
0 5 10 15 20 25
Observation number
T
r
a
c
k
i
n
g

s
i
g
n
a
l

Control limit
Control limit
Choosing a Method
Tracking Signals
Tracking signal =
RSFE
MAD
+2.0
+1.5
+1.0
+0.5
0
- 0.5
- 1.0
- 1.5
| | | | |
0 5 10 15 20 25
Observation number
T
r
a
c
k
i
n
g

s
i
g
n
a
l

Control limit
Control limit
Out of control
Choosing a Method
Tracking Signals
Control Limit
Spread
(Number of
MAD)
Equivalent
Number of o
(o=1.25 MAD)
Percentage of
Area within
Control Limits
1.0 0.80 57.62
1.5 1.20 76.98
2.0 1.60 89.04
2.5 2.00 95.44
3.0 2.40 98.36
3.5 2.80 99.48
4.0 3.20 99.86
Problem 13-2: Historical demand for a product is:
Month Jan Feb Mar Apr May Jun
Demand 12 11 15 12 16 15
a. Using a weighted moving average with weights of 0.60,
0.30, and 0.10, find the July forecast.
b. Using a simple three-month moving average, find the July
forecast.
c. Using single exponential smoothing with o=0.20 and a June
forecast =13, find the July forecast.
d. Using simple regression analysis, calculate the regression
equation for the preceding demand data
e. Using regression equation in d, calculate the forecast in
July
Problem 13-15: In this problem, you are to test the validity of
your forecasting model. Here are the forecasts for a model
you have been using and the actual demands that
occurred:
Week 1 2 3 4 5 6
Forecast 800 850 950 950 1,000 975
Actual 900 1,000 1,050 900 900 1,100

Compute MAD and tracking signal. Then decide whether the
forecasting model you have been using is giving
reasonable results.
Methods for Stationary Series
Time Series Methods
Simple Moving Averages
Week
450
430
410
390
370
P
a
t
i
e
n
t

a
r
r
i
v
a
l
s

| | | | | |
0 5 10 15 20 25 30
Actual patient
arrivals
Time Series Methods
Simple Moving Averages
Actual patient
arrivals
450
430
410
390
370
P
a
t
i
e
n
t

a
r
r
i
v
a
l
s

Week
| | | | | |
0 5 10 15 20 25 30
Patient
Week Arrivals
1 400
2 380
3 411
Time Series Methods
Simple Moving Averages
Actual patient
arrivals
450
430
410
390
370
P
a
t
i
e
n
t

a
r
r
i
v
a
l
s

Week
| | | | | |
0 5 10 15 20 25 30
Patient
Week Arrivals
1 400
2 380
3 411
F
4
=
Time Series Methods
Simple Moving Averages
Actual patient
arrivals
450
430
410
390
370
P
a
t
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n
t

a
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r
i
v
a
l
s

Week
| | | | | |
0 5 10 15 20 25 30
Patient
Week Arrivals
2 380
3 411
4 415
F
5
=
Time Series Methods
Simple Moving Averages
450
430
410
390
370
P
a
t
i
e
n
t

a
r
r
i
v
a
l
s

Week
| | | | | |
0 5 10 15 20 25 30
Actual patient
arrivals
3-week MA
forecast
Time Series Methods
Simple Moving Averages
Week
450
430
410
390
370
P
a
t
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n
t

a
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s

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0 5 10 15 20 25 30
Actual patient
arrivals
3-week MA
forecast
6-week MA
forecast
Taco Bell determined that
the demand for each 15-
minute interval
can be estimated from a 6-
week simple moving
average of sales.

The forecast was used to
determine the number of
employees needed.
Time Series Methods
Weighted Moving Average
450
430
410
390
370
P
a
t
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n
t

a
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v
a
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s

Week
| | | | | |
0 5 10 15 20 25 30
Actual patient
arrivals
3-week MA
forecast
Weighted Moving Average
Assigned weights
t-1 0.70
t-2 0.20
t-3 0.10
F
4
=
Time Series Methods
Weighted Moving Average
450
430
410
390
370
P
a
t
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n
t

a
r
r
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v
a
l
s

Week
| | | | | |
0 5 10 15 20 25 30
Actual patient
arrivals
3-week MA
forecast
Weighted Moving Average
Assigned weights
t-1 0.70
t-2 0.20
t-3 0.10
F
5
=
Time Series Methods
Exponential Smoothing
450
430
410
390
370
P
a
t
i
e
n
t

a
r
r
i
v
a
l
s

Week
| | | | | |
0 5 10 15 20 25 30
Exponential Smoothing
o = 0.10
F
t
= o A
t-1
+ (1 - o)F
t - 1
Time Series Methods
Exponential Smoothing
450
430
410
390
370
P
a
t
i
e
n
t

a
r
r
i
v
a
l
s

Week
| | | | | |
0 5 10 15 20 25 30
Exponential Smoothing
o = 0.10
F
t
= o A
t-1
+ (1 - o)F
t - 1
F
3
= (400 + 380)/2=390
A
3
= 411
Time Series Methods
Exponential Smoothing
450
430
410
390
370
P
a
t
i
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n
t

a
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r
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v
a
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s

Week
| | | | | |
0 5 10 15 20 25 30
F
4
=
Exponential Smoothing
o = 0.10
F
t
= o A
t-1
+ (1 - o)F
t - 1
F
3
= (400 + 380)/2=390
A
3
= 411
Time Series Methods
Exponential Smoothing
Week
450
430
410
390
370
P
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n
t

a
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s

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0 5 10 15 20 25 30
F
4
=
A
4
= 415
Exponential Smoothing
o = 0.10
F
t
= o A
t
+ (1 - o)F
t - 1
F
5
=
Time Series Methods
Exponential Smoothing
450
430
410
390
370
P
a
t
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e
n
t

a
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r
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v
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s

Week
| | | | | |
0 5 10 15 20 25 30
Comparison of Exponential
Smoothing and Simple Moving
Average
Both Methods
Are designed for stationary demand
Require a single parameter
Lag behind a trend, if one exists
Have the same distribution of forecast error if

) 1 /( 2 + = o N
Comparison of Exponential
Smoothing and Simple Moving
Average
Moving average uses only the last N periods
data, exponential smoothing uses all data
Exponential smoothing uses less memory and
requires fewer steps of computation; store only
the most recent forecast!
Problem 13-20: Your manager is trying to determine what
forecasting method to use. Based upon the following
historical data, calculate the following forecast and specify
what procedure you would utilize:
Month 1 2 3 4 5 6 7 8 9 10 11 12
Actual demand 62 65 67 68 71 73 76 78 78 80 84 85
a. Calculate the three-month SMA forecast for periods 4-12
b. Calculate the weighted three-month MA using weights of
0.50, 0.30, and 0.20 for periods 4-12.
c. Calculate the single exponential smoothing forecast for
periods 2-12 using an initial forecast, F
1
=61 and o=0.30
d. Calculate the exponential smoothing with trend component
forecast for periods 2-12 using T
1
=1.8,F
1
=60,o=0.30,o=0.30
e. Calculate MAD for the forecasts made by each technique in
periods 4-12. Which forecasting method do you prefer?
Trend-Based Methods
Turkeys have a long-term trend for increasing demand with a
seasonal pattern. Sales are highest during September to November
and sales are lowest during December and January.
Linear Regression
D
e
p
e
n
d
e
n
t

v
a
r
i
a
b
l
e

Independent variable
X
Y
Linear Regression
D
e
p
e
n
d
e
n
t

v
a
r
i
a
b
l
e

Independent variable
X
Y Regression
equation:
Y = a + bX
Linear Regression
D
e
p
e
n
d
e
n
t

v
a
r
i
a
b
l
e

Independent variable
X
Y
Actual
value
of Y
Value of X used
to estimate Y
Regression
equation:
Y = a + bX
Linear Regression
D
e
p
e
n
d
e
n
t

v
a
r
i
a
b
l
e

Independent variable
X
Y
Actual
value
of Y
Estimate of
Y from
regression
equation
Value of X used
to estimate Y
Regression
equation:
Y = a + bX
Linear Regression
D
e
p
e
n
d
e
n
t

v
a
r
i
a
b
l
e

Independent variable
X
Y
Actual
value
of Y
Estimate of
Y from
regression
equation
Value of X used
to estimate Y
Deviation,
or error
{
Regression
equation:
Y = a + bX
Linear Regression
Sales Advertising
Month (000 units) (000 $)

1 264 2.5
2 116 1.3
3 165 1.4
4 101 1.0
5 209 2.0
Linear Regression
Sales, y Advertising, x
Month (000 units) (000 $)

1 264 2.5
2 116 1.3
3 165 1.4
4 101 1.0
5 209 2.0
a = y - bx b =
Exy - nxy
Ex
2
- n(x

)
2
a = y - bx b =
Exy - nxy
Ex
2
- nx
2
Sales, y Advertising, x
Month (000 units) (000 $) xy x
2


1 264 2.5
2 116 1.3
3 165 1.4
4 101 1.0
5 209 2.0
Total
y= x =
Linear Regression
300
250
200
150
100
50
b = 109.229
Y =
S
a
l
e
s

(
0
0
0
s
)

| | | |
1.0 1.5 2.0 2.5
Linear Regression
Sales, y Advertising, x
Month (000 units) (000 $) xy x
2
y
2


1 264 2.5 660.0 6.25
2 116 1.3 150.8 1.69
3 165 1.4 231.0 1.96
4 101 1.0 101.0 1.00
5 209 2.0 418.0 4.00
Total 855 8.2 1560.8 14.90
y = 171 x = 1.64
nExy - Ex Ey
[nEx
2
-(Ex)
2
][nEy
2
- (Ey)
2
]
r =
Linear Regression
Sales, y Advertising, x
Month (000 units) (000 $) xy x
2
y
2


1 264 2.5 660.0 6.25 69,696
2 116 1.3 150.8 1.69 13,456
3 165 1.4 231.0 1.96 27,225
4 101 1.0 101.0 1.00 10,201
5 209 2.0 418.0 4.00 43,681
Total 855 8.2 1560.8 14.90 164,259
y= 171 x = 1.64
r = 0.98 r
2
= 0.96
Linear Regression
Forecast for Month 6:

Advertising expenditure = $1750

Y =
Time Series Methods
Linear Regression Analysis
| | | | | | | | | | | | | | |
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15
80
70
60
50
40
30
P
a
t
i
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n
t

a
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r
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v
a
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s

Week
Y
n
= a + bX
n


where

X
n
= Week
n
Time Series Methods
Linear Regression Analysis
| | | | | | | | | | | | | | |
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15
80
70
60
50
40
30
P
a
t
i
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n
t

a
r
r
i
v
a
l
s

Week
Y
n
= a + bX
n


where

X
n
= Week
n
Time Series Methods
Linear Regression Analysis
Standard error of estimate is computed as
follows:






2
) (
1
2

=

=
n
Y y
S
n
i
i i
yx
Time Series Methods
Linear Regression Analysis
An use of the standard error of estimate:
Suppose that a manager forecasts that the demand
for a product is 500 units and S
yx
is 20. If the
manager wants to accept a stockout only 2% time,
how many additional units should be held in the
inventory?
The method uses two smoothing constants o
and o
Time Series Methods
Double Exponential Smoothing
t t t
t t t t
t t t
T F
T F F T
A F
+ =
+ =
+ =


FIT
FIT
1 1
1 1
) 1 ( ) (
) 1 (
o o
o o
A Comparison of Methods
60
65
70
75
80
85
90
0 5 10 15
Months
D
e
m
a
n
d

Actual
3-Mo MA
3-Mo WMA
Exp Sm
Double Exp Sm
Methods for Seasonal Series
Quarter Year 1 Year 2 Year 3 Year 4
1 45 70 100 100
2 335 370 585 725
3 520 590 830 1160
4 100 170 285 215
Total 1000 1200 1800 2200
Average 250 300 450 550
Time Series Methods
Seasonal I nfluences
Quarter Year 1 Year 2 Year 3 Year 4
1 45 70 100 100
2 335 370 585 725
3 520 590 830 1160
4 100 170 285 215
Total 1000 1200 1800 2200
Average 250 300 450 550
Seasonal Index =
Actual Demand
Average Demand
Time Series Methods
Seasonal I nfluences
Quarter Year 1 Year 2 Year 3 Year 4
1 45 70 100 100
2 335 370 585 725
3 520 590 830 1160
4 100 170 285 215
Total 1000 1200 1800 2200
Average 250 300 450 550
Seasonal Index = =

Time Series Methods
Seasonal I nfluences
Quarter Year 1 Year 2 Year 3 Year 4
1 45/250 = 70 100 100
2 335 370 585 725
3 520 590 830 1160
4 100 170 285 215
Total 1000 1200 1800 2200
Average 250 300 450 550
Seasonal Index = =
Time Series Methods
Seasonal I nfluences
Quarter Year 1 Year 2 Year 3 Year 4
1 45/250 = 0.18 70/300 = 0.23 100/450 = 0.22 100/550 = 0.18
2 335/250 = 1.34 370/300 = 1.23 585/450 = 1.30 725/550 = 1.32
3 520/250 = 2.08 590/300 = 1.97 830/450 = 1.84 1160/550 = 2.11
4 100/250 = 0.40 170/300 = 0.57 285/450 = 0.63 215/550 = 0.39
Time Series Methods
Seasonal I nfluences
Quarter Year 1 Year 2 Year 3 Year 4
1 45/250 = 0.18 70/300 = 0.23 100/450 = 0.22 100/550 = 0.18
2 335/250 = 1.34 370/300 = 1.23 585/450 = 1.30 725/550 = 1.32
3 520/250 = 2.08 590/300 = 1.97 830/450 = 1.84 1160/550 = 2.11
4 100/250 = 0.40 170/300 = 0.57 285/450 = 0.63 215/550 = 0.39
Quarter Average Seasonal Index
1 (0.18 + 0.23 + 0.22 + 0.18)/4 = 0.20
2
3
4
Time Series Methods
Seasonal I nfluences
Quarter Average Seasonal Index Forecast
1 (0.18 + 0.23 + 0.22 + 0.18)/4 = 0.20
2
3
4
Projected Annual Demand = 2600
Average Quarterly Demand = 2600/4 = 650
Time Series Methods
Seasonal I nfluences
Seasonal I nfluences
Period
D
e
m
a
n
d

(a) Multiplicative influence
| | | | | | | | | | | | | | | |
0 2 4 5 8 10 12 14 16
Seasonal I nfluences
Period
| | | | | | | | | | | | | | | |
0 2 4 5 8 10 12 14 16
D
e
m
a
n
d

(b) Additive influence
Time Series Methods
Seasonal I nfluences with Trend
Step 1: Determine seasonal factors
Example: if the demands are quarterly, divide the average demand in
Quarter 1 by the average quarterly demand
Step 2: Deseasonalize the original data
Divide the original data by the seasonal factors
Step 3: Develop a regression line on deaseasonalized data
Find parameters a and b in Y=a+bX
Where
y
i
= deseasonalized data (not the original data)
x
i
= time; 1, 2, 3, , n
n = Number of periods
Time Series Methods
Seasonal I nfluences with Trend
Step 4: Make projection using regression line
For each i = n+1, n+2, , compute y
i
by substituting a, b and x
i
in
the regression equation y
i
= a+bx
i

Step 5: Reseasonalize projection using seasonal factors
Multiply the projected values by the seasonal factors
Problem 13-21: Use regression analysis on deseasonalized
demand to forecast demand in summer 2006, given the
following historical demand data:
Year Season Actual Demand
2004 Spring 205
Summer 140
Fall 375
Winter 575
2005 Spring 475
Summer 275
Fall 685
Winter 965
Reading and Exercises
Chapter 13 pp. 518-539
Problems 1, 7, 13, 14,16

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