Forecasting

August 29, Wednesday

Course
Structure

Introduction

Operations Strategy & Competitivenes

Quality Management
Strategic Decisions (some)
Design
Process Selection
Capacity and
of and Design
Facility Decisions
Forecastin
Produc
ts g
and
Servic

Forecasting

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, ?

Forecasting

Predict the next number in the pattern:

a) 3.7,

3.7,

3.7,

3.7,

3.7, 3.7

b) 2.5,

4.5,

6.5,

8.5,

10.5, 12.5

c) 5.0, 7.5, 6.0, 4.5, 7.0, 9.5, 8.0, 6.5, 9.0

Outline

What is forecasting?

Types of forecasts
Time-Series forecasting

Nave

Moving Average

Exponential Smoothing

Regression

Good forecasts

What is Forecasting?

Process of predicting a future event

based on historical data

Educated Guessing

Underlying basis of
all business decisions

Production
Inventory
Personnel
Facilities

Why do we need to forecast?

In general, forecasts are almost always wrong. So,
Throughout the day we forecast very different
things such as weather, traffic, stock market, state
of our company from different perspectives.
Virtually every business attempt is based on
forecasting. Not all of them are derived from
sophisticated methods. However, Best" educated
guesses about future are more valuable for
purpose of Planning than no forecasts and hence
no planning.

Importance of Forecasting in OM
Departments throughout the organization depend on
forecasts to formulate and execute their plans.
Finance needs forecasts to project cash flows and
capital requirements.
Human resources need forecasts to anticipate hiring
needs.
Production needs forecasts to plan production
levels, workforce, material requirements,
inventories, etc.

Importance of Forecasting in OM
Demand is not the only variable of interest to
forecasters.
Manufacturers also forecast worker
absenteeism, machine availability, material
costs, transportation and production lead
times, etc.
Besides demand, service providers are also
interested in forecasts of population, of other
demographic variables, of weather, etc.

Types of Forecasts by Time Horizon

Short-range forecast

Usually < 3 months

Job scheduling, worker assignments

Medium-range forecast

Detailed
use of
system

3 months to 2 years

Quantitative
methods

Sales/production planning

Long-range forecast

> 2 years

New product planning

Design
of system
Qualitative
Methods

Forecasting During the Life Cycle

Introduction

Growth

Qualitative models
- Executive judgment
- Market research
-Survey of sales force
-Delphi method
Sales

Maturity

Quantitative models
- Time series analysis
- Regression analysis

Time

Decline

Qualitative Forecasting Methods

Qualitative
Forecasting

Executive
Judgement

Sales
Force
Composite

Market
Research/
Survey
Smoothing

Models
Delphi
Method

Qualitative Methods
Briefly, the qualitative methods are:
Executive Judgment: Opinion of a group of high level
experts or managers is pooled

Sales Force Composite: Each regional salesperson

provides his/her sales estimates. Those forecasts are then
reviewed to make sure they are realistic. All regional
forecasts are then pooled at the district and national levels
to obtain an overall forecast.
Market Research/Survey: Solicits input from customers
pertaining to their future purchasing plans. It involves the
use of questionnaires, consumer panels and tests of new
products and services.

Qualitative Methods
Delphi Method: As opposed to regular panels where the individuals
involved are in direct communication, this method eliminates the
effects of group potential dominance of the most vocal members. The
group involves individuals from inside as well as outside the
organization.
Typically, the procedure consists of the following steps:
Each expert in the group makes his/her own forecasts in form of
statements
The coordinator collects all group statements and
summarizes them
The coordinator provides this summary and gives another set
of questions to each
group member including feedback as to the input of other
experts.
The above steps are repeated until a consensus is reached.
.

Quantitative Forecasting Methods

Quantitative
Forecasting
Regression
Models

Time Series
Models

1. Naive

2. Moving
Average
a) simple
b) weighted

3. Exponential
Smoothing
a) level
b) trend
c) seasonality

Quantitative Forecasting Methods

Quantitative
Forecasting
Regression
Models

Time Series
Models

1. Naive

2. Moving
Average
a) simple
b) weighted

3. Exponential
Smoothing
a) level
b) trend
c) seasonality

Time Series Models

Try to predict the future based on past

data

Assume that factors influencing the past will

continue to influence the future

Time Series Models: Components

Random

Trend

Seasonal

Composite

Demand for product or service

Product Demand over Time

Year
1

Year
2

Year
3

Year
4

Product Demand over Time

Trend component
Demand for product or service

Seasonal peaks

Actual
demand line

Random
variation
Year
1

Year
2

Year
3

Year
4

Now lets look at some time series approaches to forecasting

Borrowed from Heizer/Render - Principles of Operations Management, 5e, and Operations Management, 7e

Quantitative Forecasting Methods

Quantitative
Time Series
Models
Models
1. Naive

2. Moving
Average
a) simple
b) weighted

3. Exponential
Smoothing
a) level
b) trend
c) seasonality

1. Naive Approach

Demand in next period is the same as

demand in most recent period

June
= 48
May sales
= forecast
48

Usually not good

2a. Simple Moving Average

Assumes an average is a good estimator of

future behavior

Used if little or no trend

Used for smoothing

AAt t ++AAt -t1-1++AAt -t 2-2 ++...
++AAt -t n-n11
...
FFt t 11 ==
nn
Ft+1
n

= Forecast for the upcoming period, t+1

= Number of periods to be averaged
At
= Actual occurrence in period t

2a. Simple Moving Average

AAt ++AAt -1 ++AAt -2 ++......++AAt -n 1

t -1
t -2
t - n 1
FFt 1 == t
t 1
nn

Youre manager in Amazons electronics

department. You want to forecast ipod sales for
months 4-6 using a 3-period moving average.

Month
1
2
3
4
5
6

Sales
(000)
4
6
5
?
?
?

2a. Simple Moving Average

AAt ++AAt -1 ++AAt -2 ++......++AAt -n 1

t -1
t -2
t - n 1
FFt 1 == t
t 1
nn

Youre manager in Amazons electronics

department. You want to forecast ipod sales for
months 4-6 using a 3-period moving average.

Month
1
2
3
4
5
6

Sales
(000)
4
6
5
?
?
?

Moving Average
(n=3)
NA
NA
NA
(4+6+5)/3=5

2a. Simple Moving Average

What if ipod sales were actually 3 in month 4

Month
1
2
3
4
5
6

Sales
(000)
4
6
5
3?
?
?

Moving Average
(n=3)
NA
NA
NA
5

2a. Simple Moving Average

Forecast for Month 5?

Month
1
2
3
4
5
6

Sales
(000)
4
6
5
3
?
?

Moving Average
(n=3)
NA
NA
NA
5
(6+5+3)/3=4.667

2a. Simple Moving Average

Actual Demand for Month 5 = 7

Month
1
2
3
4
5
6

Sales
(000)
4
6
5
3
?7
?

Moving Average
(n=3)
NA
NA
NA
5
4.667

2a. Simple Moving Average

Forecast for Month 6?

Month
1
2
3
4
5
6

Sales
(000)
4
6
5
3
7
?

Moving Average
(n=3)
NA
NA
NA
5
4.667
(5+3+7)/3=5

2b. Weighted Moving Average

Gives more emphasis to recent data

FFtt11 == w
w11A
Att ++ w
w22A
Att-1-1 ++w
w33A
Att--22 ++...
...++w
wnnA
Att--nn11

Weights

decrease for older data

sum to 1.0

Simple
Simple moving
moving
average
average models
models
weight
weight all
all previous
previous
periods
periods equally
equally

FFt t 11 ==ww11AAt t ++ww22AAt -t1-1++ww33AAt -t2-2++......++wwnnAAt -tn-n11

2b. Weighted Moving Average: 3/6, 2/6, 1/6

Month
1
2
3
4
5
6

Sales
(000)
4
6
5
?
?
?

Weighted
Moving
Average
NA
NA
NA
31/6 = 5.167

FFt t 11 ==ww11AAt t ++ww22AAt -t1-1++ww33AAt -t2-2++......++wwnnAAt -tn-n11

2b. Weighted Moving Average: 3/6, 2/6, 1/6

Month
1
2
3
4
5
6

Sales
(000)
4
6
5
3
7

Weighted
Moving
Average
NA
NA
NA
31/6 = 5.167
25/6 = 4.167
32/6 = 5.333

3a. Exponential Smoothing

Assumes the most recent observations have

the highest predictive value

gives more weight to recent time periods

FFt+1
=
F
+
(A
F
)
=
F
+
(A
F
t
t
t
t+1
t
t
t)
et

Ft+1
At

Need
initia
Need
initia
= Forecast value for time t+1
= Actual value at time t forecast F
forecast F
= Smoothing constant

to
to start.
start.

3a. Exponential Smoothing Example 1

FFt+1
=
F
+
(A
F
)
=
F
+
(A
F
t
t
t
t+1
t
t
t)
i

Ai

Given
Given the
the weekly
weekly demand
demand
data
data what
what are
are the
the exponential
exponential
smoothing
smoothing forecasts
forecasts for
for
periods
periods 2-10
2-10 using
using =0.10?
=0.10?
Assume
Assume FF11=D
=D11

3a. Exponential Smoothing Example 1

FFt+1
=
F
+
(A
F
)
=
F
+
(A
F
t
t
t
t+1
t
t
t)
i

Ai

Fi

F2 = F1+ (A1F1) =820+(820820)

=820

3a. Exponential Smoothing Example 1

FFt+1
=
F
+
(A
F
)
=
F
+
(A
F
t
t
t
t+1
t
t
t)
i

Ai

Fi

F3 = F2+ (A2F2) =820+(775820)

=815.5

3a. Exponential Smoothing Example 1

FFt+1
=
F
+
(A
F
)
=
F
+
(A
F
t
t
t
t+1
t
t
t)
i

Ai

Fi

This process
continues
through week
10

3a. Exponential Smoothing Example 1

FFt+1
=
F
+
(A
F
)
=
F
+
(A
F
t
t
t
t+1
t
t
t)
i

Ai

Fi

What if the
constant
equals 0.6

3a. Exponential Smoothing Example 2

FFt+1
=
F
+
(A
F
)
=
F
+
(A
F
t
t
t
t+1
t
t
t)
i

Ai

Fi

What if the
constant
equals 0.6

3a. Exponential Smoothing Example 3

Company
Company A,
A, aa personal
personal computer
computer producer
producer
purchases
purchases generic
generic parts
parts and
and assembles
assembles them
them to
to
final
final product.
product. Even
Even though
though most
most of
of the
the orders
orders
require
require customization,
customization, they
they have
have many
many common
common
components.
components. Thus,
Thus, managers
managers of
of Company
Company A
Aneed
need
aa good
good forecast
forecast of
of demand
demand so
so that
that they
they can
can
purchase
purchase computer
computer parts
parts accordingly
accordingly to
to minimize
minimize
inventory
inventory cost
cost while
while meeting
meeting acceptable
acceptable service
service
level.
level. Demand
Demand data
data for
for its
its computers
computers for
for the
the past
past 55
months
months isis given
given in
in the
the following
following table
table..

3a. Exponential Smoothing Example 3

FFt+1
=
F
+
(A
F
)
=
F
+
(A
F
t
t
t
t+1
t
t
t)
i

Ai

Fi

What if the
constant
equals 0.5

3a. Exponential Smoothing

How to choose

depends on the emphasis you want to place

on the most recent data

Increasing makes forecast more

sensitive to recent data

Forecast Effects of
Smoothing Constant
or

Ft+1

Ft+1 = Ft + (At - Ft)

= At + (1- ) At - 1 + (1- )2At - 2 + ...
w1

w2

w3

Weights
=

= 0.10
= 0.90

Prior Period

2 periods ago 3 periods ago

(1 - )

(1 - )2

10%

9%

8.1%

90%

9%

0.9%

To Use a Forecasting Method

Collect historical data

Select a model

Moving average methods

Exponential smoothing

Select n (number of periods)

For weighted moving average: select weights
Select

Selections should produce a good forecast

but what is a good forecast?

A Good Forecast
Has a small error
Error = Demand - Forecast

Measures of Forecast Error

a.

b.

c.

MAD = Mean Absolute Deviation

MSE = Mean Squared Error

et
nn

MAD
MAD==

AA --FF
t=1
t=1

tt

tt

nn

nn

22

A
F

At t - Ft t

t=
t =11
MSE
=
MSE =

nn

RMSE = Root Mean Squared Error RMSE

RMSE == MSE
MSE

Ideal values =0 (i.e., no forecasting error)

nn

MAD Example

MAD
MAD==

AA --FF
t=1
t=1

tt

tt

nn

What
What isis the
the MAD
MAD value
value given
given the
the
forecast
forecast values
values in
in the
the table
table below?
below?
At

Month
1
2
3
4
5

Ft

Sales Forecast
220
n/a
250
255
210
205
300
320
325
315

|At Ft|
5
5
20
10
= 40

= 40 =10
4

nn

MSE/RMSE Example

22

A
F

At t - Ft t

t =t =11
MSE
=
MSE =

What
What isis the
the MSE
MSE value?
value?

nn

= 550 =137.5
4

RMSE = 137.5

=11.73
At

Month
1
2
3
4
5

Ft

Sales Forecast
220
n/a
250
255
210
205
300
320
325
315

|At Ft| (At Ft)2

5
5
20
10

25
25
400
100
= 550

Measures of Error1.
t

At

Ft

et

|et|

et2

Jan

120

100

20

20

400

Feb

90

106

-16

16

256

Mar

101

102

-1

April

91

101

Mean
Absolute
Deviation
84 = 14
2a. Mean
(MAD) 6
Squared
Error
2b.
e Root
1,446
MSE
= 241
n
(MSE)
Mean
6
Squared
RMSE MSE
Error
= SQRT(241)
=15.52
(RMSE)
n

MAD

-10

10

100

May

115

98

17

17

289

June

83

103

-20

20

400

-10

84

1,446

An accurate forecasting system will have small MAD,

MSE and RMSE; ideally equal to zero. A large error may
indicate that either the forecasting method used or the

used in the method are wrong.

parameters such as

et

Forecast Bias

How can we tell if a forecast has a positive or

negative bias?

TS = Tracking Signal
Good tracking signal has low values

(actual

forecast t )

RSFE
TS =
= t
MAD Mean absolute
deviation
MAD
30

Quantitative Forecasting Methods

Quantitative
Forecasting
Regression
Models

Time Series
Models

1. Naive

2. Moving
Average
a) simple
b) weighted

3. Exponential
Smoothing
a) level
b) trend
c) seasonality

Exponential Smoothing (continued)

We looked at using exponential

smoothing to forecast demand with
only random variations
Ft+1 = Ft + (At - Ft)
Ft+1 = Ft + At Ft
Ft+1 = At + (1-) Ft

Exponential Smoothing (continued)

We looked at using exponential

smoothing to forecast demand with
only random variations
What if demand varies due to
randomness and trend?
What if we have trend and seasonality
in the data?

Regression Analysis as a Method for

Forecasting
Regression analysis takes advantage
of the relationship between two
variables. Demand is then
forecasted based on the
knowledge of this relationship and
for the given value of the related
variable.
Ex: Sale of Tires (Y), Sale of Autos (X)
are obviously related
If we analyze the past data of these
two variables and establish a
relationship between them, we may
use that relationship to forecast the
sales of tires given the sales of
automobiles.
The simplest form of the relationship
is, of course, linear, hence it is
referred to as a regression line.

Sales of Autos (100,000)

Formulas
y

where,
x

xy n x y

b
x nx
2

x
y

a y bx

Regression Example

yy == aa++ bb X
X

xy n x y

b
x nx
2

a y bx

General Guiding Principles for

Forecasting
1. Forecasts are more accurate for larger groups of items.
2. Forecasts are more accurate for shorter periods of time.
3. Every forecast should include an estimate of error.
4. Before applying any forecasting method, the total system
should be understood.
5. Before applying any forecasting method, the method
should be tested and evaluated.
6. Be aware of people; they can prove you wrong very easily
in forecasting

FOR JULY 2nd MONDAY

READ THE CHAPTERS ON

Forecasting
Product and service design