Operations Management: Chapter 4 - Forecasting

Operations
Management
Chapter 4 Forecasting
PowerPoint presentation to accompany
Heizer/Render
Principles of Operations Management, 6e
Operations Management, 8e
2006
Prentice
Hall, Inc. Hall, Inc.
2006
Prentice
41
Outline
Global Company Profile:
Tupperware Corporation
What Is Forecasting?
Forecasting Time Horizons
The Influence of Product Life Cycle
Types Of Forecasts
2006 Prentice Hall, Inc.
42
Outline Continued
The Strategic Importance Of
Forecasting
Human Resources
Capacity
Supply-Chain Management
Seven Steps In The Forecasting

System
43
Outline Continued
Forecasting Approaches
Overview of Qualitative Methods
Overview of Quantitative Methods
44
Outline Continued
Time-series Forecasting
Decomposition of a Time Series
Nave Approach
Moving Averages
Exponential Smoothing
Exponential Smoothing with Trend
Adjustment
Trend Projections
Seasonal Variations in Data
Cyclical Variations in Data
45
Outline Continued
Associative Forecasting Methods:
Regression And Correlation
Analysis
Using Regression Analysis to
Forecast
Standard Error of the Estimate
Correlation Coefficients for
Regression Lines
Multiple-Regression Analysis
46
Outline Continued
Monitoring And Controlling
Forecasts
Adaptive Smoothing
Focus Forecasting
Forecasting In The Service Sector
47
Learning Objectives
When you complete this chapter, you
should be able to :
Identify or Define:
Forecasting
Types of forecasts
Time horizons
Approaches to forecasts
48
Learning Objectives
When you complete this chapter, you
should be able to :
Describe or Explain:
Moving averages
Exponential smoothing
Trend projections
Regression and correlation analysis
Measures of forecast accuracy
49
Forecasting at Tupperware
Each of 50 profit centers around the
world is responsible for
computerized monthly, quarterly,
and 12-month sales projections
These projections are aggregated by
region, then globally, at
Tupperwares World Headquarters
Tupperware uses all techniques
discussed in text
4 10
Tupperwares
Process
4 11
Three Key Factors for

Tupperware
The number of registered
consultants or sales
representatives
The percentage of currently active
dealers (this number changes each
week and month)
Sales per active dealer, on a weekly
basis
4 12
Forecast by Consensus
Although inputs come from sales,
marketing, finance, and production,
final forecasts are the consensus of
all participating managers
The final step is Tupperwares
version of the jury of executive
opinion
4 13
What is Forecasting?
Process of
predicting a future
event
Underlying basis of
all business
decisions
??
Production
Inventory
Personnel
Facilities
4 14
Forecasting Time Horizons

Short-range forecast
Up to 1 year, generally less than 3 months
Purchasing, job scheduling, workforce levels,
job assignments, production levels
Medium-range forecast
3 months to 3 years
Sales and production planning, budgeting
Long-range forecast
3+ years
New product planning, facility location,
research and development
4 15
Distinguishing Differences
Medium/long range forecasts deal with
more comprehensive issues and support
management decisions regarding
planning and products, plants and
processes
Short-term forecasting usually employs
different methodologies than longer-term
forecasting
Short-term forecasts tend to be more
accurate than longer-term forecasts
4 16
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
4 17
Product Life Cycle

Company Strategy/Issues
Introduction
Growth
Maturity
Best period to
increase market
share
Practical to change
price or quality
image
Poor time to
change image,
price, or quality
R&D engineering is
critical
Strengthen niche
Competitive costs
become critical
Defend market
position
CD-ROM
Internet
Sales
Decline
Cost control
critical
Fax machines
Drive-through
restaurants
Color printers
Flat-screen
monitors
DVD
3 1/2
Floppy
disks
Figure 2.5
4 18
OM Strategy/Issues
Product Life Cycle

Introduction
Growth
Maturity
Decline
Product design
and
development
critical
Frequent
product and
process design
changes
Short production
runs
High production
costs
Limited models
Forecasting
critical
Product and
process
reliability
Competitive
product
improvements
and options
Increase capacity
Standardization
Less rapid
product changes
more minor
changes
Optimum
capacity
Increasing
stability of
process
Long production
runs
Product
improvement and
cost cutting
Little product
differentiation
Cost
minimization
Overcapacity
in the
industry
Prune line to
eliminate
items not
returning
good margin
Reduce
capacity
Attention to
quality
Shift toward
product focus
Enhance
distribution
Figure 2.5
4 19
Types of Forecasts
Economic forecasts
Address business cycle inflation rate,
money supply, housing starts, etc.
Technological forecasts
Predict rate of technological progress
Impacts development of new products
Demand forecasts
Predict sales of existing product
4 20
Strategic Importance of
Forecasting
Human Resources Hiring, training,
laying off workers
Capacity Capacity shortages can
result in undependable delivery, loss
of customers, loss of market share
Supply-Chain Management Good
supplier relations and price advance
4 21
Seven Steps in Forecasting

Determine the use of the forecast
Select the items to be forecasted
Determine the time horizon of the
forecast
Select the forecasting model(s)
Gather the data
Make the forecast
Validate and implement results
4 22
The Realities!
Forecasts are seldom perfect
Most techniques assume an
underlying stability in the system
Product family and aggregated
forecasts are more accurate than
individual product forecasts
4 23
Qualitative Methods
Used when situation is vague
and little data exist
New products
New technology
Involves intuition, experience

e.g., forecasting sales on Internet
4 24
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
4 25
Overview of Qualitative
Methods
Jury of executive opinion
Pool opinions of high-level
executives, sometimes augment by
statistical models
Delphi method
Panel of experts, queried iteratively
4 26
Overview of Qualitative
Methods
Sales force composite
Estimates from individual
salespersons are reviewed for
reasonableness, then aggregated
Consumer Market Survey

Ask the customer
4 27
Jury of Executive Opinion

Involves small group of high-level
managers
Group estimates demand by working
together
Combines managerial experience with
statistical models
Relatively quick
Group-think
disadvantage
4 28
Sales Force Composite

Each salesperson projects his or
her sales
Combined at district and national
levels
Sales reps know customers wants
Tends to be overly optimistic
4 29
Delphi Method
Iterative group
process,
continues until
consensus is
reached
Staff
(Administering
3 types of
survey)
participants
Decision makers
Staff
Respondents
Decision Makers
(Evaluate
responses and
make decisions)
Respondents
(People who can
make valuable
judgments)
4 30
Consumer Market Survey

Ask customers about purchasing
plans
What consumers say, and what
they actually do are often different
Sometimes difficult to answer
4 31
Overview of Quantitative
Approaches
1. Naive approach
2. Moving averages
3. Exponential
smoothing
Time-Series
Models
4. Trend projection
5. Linear regression
Associative
Model
4 32
Time Series Forecasting

Set of evenly spaced numerical
data
Obtained by observing response
variable at regular time periods
Forecast based only on past

values
Assumes that factors influencing
past and present will continue
influence in future
4 33
Time Series Components

Trend
Cyclical
Seasonal
Random
4 34
Demand for product or service
Components of Demand
Trend
component
Seasonal peaks
Actual
demand
Random
variation
|
1
|
2
|
3
Year
Average
demand over
four years
|
4
Figure 4.1
4 35
Trend Component
Persistent, overall upward or
downward pattern
Changes due to population,
technology, age, culture, etc.
Typically several years
duration
4 36
Seasonal Component
Regular pattern of up and
down fluctuations
Due to weather, customs, etc.
Occurs within a single year
Period
Length
Number of
Seasons
Week
Month
Month
Year
Year
Year
Day
Week
Day
Quarter
Month
Week
7
4-4.5
28-31
4
12
52
4 37
Cyclical Component
Repeating up and down movements
Affected by business cycle,
political, and economic factors
Multiple years duration
Often causal or
associative
relationships
0
10
15
20
4 38
Random Component
Erratic, unsystematic, residual
fluctuations
Due to random variation or
unforeseen events
Short duration and
nonrepeating
M
F
4 39
Naive Approach
Assumes demand in next period is
the same as demand in most
recent period
e.g., If May sales were 48, then June
sales will be 48
Sometimes cost effective and

efficient
4 40
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
demand in previous n periods
Moving average =
n
4 41
Moving Average Example

Month
January
February
March
April
May
June
July
Actual
Shed Sales
10
12
13
16
19
23
26
3-Month
Moving Average
(10 + 12 + 13)/3 = 11 2/3

(12 + 13 + 16)/3 = 13 2/3
(13 + 16 + 19)/3 = 16
(16 + 19 + 23)/3 = 19 1/3
4 42
Shed Sales
Graph of Moving Average

30
28
26
24
22
20
18
16
14
12
10
Moving
Average
Forecast
Actual
Sales
|
J
|
F
|
M
|
A
|
M
|
J
|
J
|
A
|
S
|
O
|
N
|
D
4 43
Weighted Moving Average

Used when trend is present
Older data usually less important
Weights based on experience and

intuition
Weighted
=
moving average
(weight for period n)

x (demand in period n)
weights
4 44
Weights Applied
Period
3
Last
month
Weighted Moving
Average
2
1
6
Month
Actual
Shed Sales
January
February
March
April
May
June
July
10
12
13
16
19
23
26
Two months ago

Three months ago
Sum of weights
3-Month Weighted
Moving Average
[(3 x 13) + (2 x 12) + (10)]/6 = 121/6

[(3 x 16) + (2 x 13) + (12)]/6 = 141/3
[(3 x 19) + (2 x 16) + (13)]/6 = 17
[(3 x 23) + (2 x 19) + (16)]/6 = 201/2
4 45
Potential Problems With

Moving Average
Increasing n smooths the forecast
but makes it less sensitive to
changes
Do not forecast trends well
Require extensive historical data
4 46
Moving Average And

Weighted Moving Average
Weighted
moving
average
30
Sales demand
25
20
Actual
sales
15
Moving
average
10
5
|
Figure 4.2
|
F
|
M
|
A
|
M
|
J
|
J
|
A
|
S
|
O
|
N
|
D
4 47
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
4 48
New forecast = last periods forecast
+ (last periods actual demand
last periods forecast)
Ft = Ft 1 + (At 1 - Ft 1)
where
Ft = new forecast
Ft 1 = previous forecast
= smoothing (or weighting)
constant (0 1)
4 49
Example
Predicted demand = 142 Ford Mustangs
Actual demand = 153
Smoothing constant = .20
4 50
Example
Actual demand = 153
New forecast = 142 + .2(153 142)
4 51
Example
Actual demand = 153
New forecast = 142 + .2(153 142)
= 142 + 2.2
= 144.2 144 cars
4 52
Effect of
Smoothing Constants
Weight Assigned to
Smoothing
Constant
Most
Recent
Period
( )
2nd Most 3rd Most 4th Most 5th Most

Recent
Recent
Recent
Recent
Period
Period
Period
Period
2
3
(1 - ) (1 - )
(1 - )
(1 - )4
= .1
.1
.09
.081
.073
.066
= .5
.5
.25
.125
.063
.031
4 53
Impact of Different
225
Demand
= .5
Actual
demand
200
175
150
|
1
|
2
|
3
|
4
|
5
|
6
= .1
|
7
|
8
|
9
Quarter
4 54
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
4 55
Common Measures of Error

Mean Absolute Deviation (MAD)
|actual - forecast|
MAD =
n
Mean Squared Error (MSE)

(forecast errors)2
MSE =
n
4 56
Common Measures of Error

Mean Absolute Percent Error (MAPE)
n
100 |actuali - forecasti|/actuali

MAPE =
i=1
4 57
Comparison of Forecast
Error
Quarter
Actual
Tonnage
Unloaded
Rounded
Forecast
with
= .10
Absolute
Deviation
for
= .10
Rounded
Forecast
with
= .50
1
2
3
4
5
6
7
8
180
168
159
175
190
205
180
182
175
176
175
173
173
175
178
178
5
8
16
2
17
30
2
4
84
175
178
173
166
170
180
193
186
Absolute
Deviation
for
= .50
5
10
14
9
20
25
13
4
100
4 58
Error
|deviations|
MADActual
=
Quarter
Tonage
Unloaded
Rounded
Forecast
n
with
= .10
Absolute
Deviation
for
= .10
For
=
.10
1
180
175
2
168 = 84/8
176
= 10.50
3
4 For
5
6
7
8
159
175
175
= .50 173
190
173
205 = 100/8
175 =
180
178
182
178
5
8
16
2
17
12.5030
2
4
84
Rounded
Forecast
with
= .50
175
178
173
166
170
180
193
186
Absolute
Deviation
for
= .50
5
10
14
9
20
25
13
4
100
4 59
Error
(forecast errors)
2
MSE = Actual
Quarter
Tonage
Unloaded
Rounded
Forecast
n
with
= .10
Absolute
Deviation
for
= .10
For
=
.10
1
180
175
5
2
168
176
= 1,558/8
= 194.758
3
4 For
5
6
7
8
159
175
175
= .50 173
190
173
= 1,612/8
=
205
175
180
178
182
178
16
2
17
201.50
30
2
4
84
MAD
10.50
Rounded
Forecast
with
= .50
175
178
173
166
170
180
193
186
Absolute
Deviation
for
= .50
5
10
14
9
20
25
13
4
100
12.50
4 60
n
Error|/actual
100 |deviation
i
i =Rounded
1
Absolute
MAPE =Actual
Forecast n Deviation
Tonage
with
for
Quarter Unloaded
= .10
= .10
1
2
3
4
5
6
7
8
For 180
= .10 175
5
168
176
8
= 45.62/8
= 5.70%
159
For 175
=
190
205
180
182
175
.50 173
173
= 54.8/8
175
178
178
MAD
MSE
16
2
17
= 6.85%
30
2
4
84
10.50
194.75
Rounded
Forecast
with
= .50
175
178
173
166
170
180
193
186
Absolute
Deviation
for
= .50
5
10
14
9
20
25
13
4
100
12.50
201.50
4 61
Error
Quarter
Actual
Tonnage
Unloaded
Rounded
Forecast
with
= .10
1
2
3
4
5
6
7
8
180
168
159
175
190
205
180
182
175
176
175
173
173
175
178
178
MAD
MSE
MAPE
Absolute
Deviation
for
= .10
5
8
16
2
17
30
2
4
84
10.50
194.75
5.70%
Rounded
Forecast
with
= .50
175
178
173
166
170
180
193
186
Absolute
Deviation
for
= .50
5
10
14
9
20
25
13
4
100
12.50
201.50
6.85%
4 62
Exponential Smoothing with

Trend Adjustment
When a trend is present, exponential
smoothing must be modified
Forecast
including (FITt) =
trend
exponentially
smoothed (Ft) + (Tt)
forecast
exponentially
smoothed
trend
4 63

Trend Adjustment
Ft = (At - 1) + (1 - )(Ft - 1 + Tt - 1)
Tt = (Ft - Ft - 1) + (1 - )Tt - 1
Step 1: Compute Ft
Step 2: Compute Tt
Step 3: Calculate the forecast FITt = Ft + Tt
4 64

Trend Adjustment Example
Month(t)
1
2
3
4
5
6
7
8
9
10
Actual
Demand (At)
Smoothed
Forecast, Ft
Smoothed
Trend, Tt
Forecast
Including
Trend, FITt
12
17
20
19
24
21
31
28
36
11
13.00
Table 4.1
4 65

Month(t)
1
2
3
4
5
6
7
8
9
10
Actual
Demand (At)
Smoothed
Forecast, Ft
Smoothed
Trend, Tt
Forecast
Including
Trend, FITt
12
17
20
19
24
21
31
28
36
11
13.00
Step 1: Forecast for Month 2

F2 = A1 + (1 - )(F1 + T1)
F2 = (.2)(12) + (1 - .2)(11 + 2)
= 2.4 + 10.4 = 12.8 units
Table 4.1
4 66

Month(t)
1
2
3
4
5
6
7
8
9
10
Actual
Demand (At)
Smoothed
Forecast, Ft
Smoothed
Trend, Tt
Forecast
Including
Trend, FITt
12
17
20
19
24
21
31
28
36
11
12.80
13.00
Step 2: Trend for Month 2

T2 = (F2 - F1) + (1 - )T1
T2 = (.4)(12.8 - 11) + (1 - .4)(2)
= .72 + 1.2 = 1.92 units
Table 4.1
4 67

Month(t)
1
2
3
4
5
6
7
8
9
10
Actual
Demand (At)
Smoothed
Forecast, Ft
Smoothed
Trend, Tt
12
17
20
19
24
21
31
28
36
11
12.80
2
1.92
Forecast
Including
Trend, FITt
13.00
Step 3: Calculate FIT for Month 2

FIT2 = F2 + T1
FIT2 = 12.8 + 1.92
= 14.72 units
Table 4.1
4 68

Month(t)
1
2
3
4
5
6
7
8
9
10
Actual
Demand (At)
Smoothed
Forecast, Ft
Smoothed
Trend, Tt
Forecast
Including
Trend, FITt
12
17
20
19
24
21
31
28
36
11
12.80
15.18
17.82
19.91
22.51
24.11
27.14
29.28
32.48
2
1.92
2.10
2.32
2.23
2.38
2.07
2.45
2.32
2.68
13.00
14.72
17.28
20.14
22.14
24.89
26.18
29.59
31.60
35.16
Table 4.1
4 69

35
Product demand
30
Actual demand (At)
25
20
15
10
Forecast including trend (FITt)
5
0
|
1
|
2
|
3
|
4
|
5
|
6
Time (month)
|
7
|
8
|
9
Figure 4.3
4 70
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
4 71
Values of Dependent Variable
Least Squares Method

Actual observation
(y value)
Deviation7
Deviation5
Deviation3
Deviation4
Deviation1
Deviation2
Trend line, y^ = a + bx
Time period
Deviation6
Figure 4.4
4 72
Values of Dependent Variable

Actual observation
(y value)
Deviation7
Deviation5
Deviation3
Least squares method

minimizes the sum of the
Deviation
squared errors (deviations)
4
Deviation1
Deviation2
Trend line, y^ = a + bx
Time period
Deviation6
Figure 4.4
4 73

Equations to calculate the regression variables
y^ = a + bx
xy - nxy
b=
x2 - nx2
a = y - bx
4 74
Least Squares Example

Year
1999
2000
2001
2002
2003
2004
2005
Time
Period (x)
1
2
3
4
5
6
7
x = 28
x=4
Electrical Power
Demand
74
79
80
90
105
142
122
y = 692
y = 98.86
x2
xy
1
4
9
16
25
36
49
x2 = 140
74
158
240
360
525
852
854
xy = 3,063
3,063 - (7)(4)(98.86)
xy - nxy
b=
=
= 10.54
140 - (7)(42)
x2 - nx2
a = y - bx = 98.86 - 10.54(4) = 56.70
4 75

Year
Time
Period (x)
Electrical Power
Demand
x2
xy
1999
1
74
1
2000
2
79
4
line is 80
2001The trend
3
9
2002
4
90
16
2003
105
25
y^ 5= 56.70 + 10.54x
2004
6
142
36
2005
7
122
49
x = 28
y = 692
x2 = 140
x=4
y = 98.86
74
158
240
360
525
852
854
xy = 3,063
3,063 - (7)(4)(98.86)
xy - nxy
b = x2 - nx2 =
= 10.54
140 - (7)(42)
a = y - bx = 98.86 - 10.54(4) = 56.70
4 76
Power demand

160
150
140
130
120
110
100
90
80
70
60
50
Trend line,
y^ = 56.70 + 10.54x
|
1999
|
2000
|
2001
|
2002
|
2003
Year
|
2004
|
2005
|
2006
|
2007
4 77
Seasonal Variations In Data

The multiplicative seasonal model can
modify trend data to accommodate
seasonal variations in demand
1. Find average historical demand for each season
2. Compute the average demand over all seasons
3. Compute a seasonal index for each season
4. Estimate next years total demand
5. Divide this estimate of total demand by the
number of seasons, then multiply it by the
seasonal index for that season
4 79
Seasonal Index Example

Month
Jan
Feb
Mar
Apr
May
Jun
Jul
Aug
Sept
Oct
Nov
Dec
Demand
2003 2004 2005
80
70
80
90
113
110
100
88
85
77
75
82
85
85
93
95
125
115
102
102
90
78
72
78
105
85
82
115
131
120
113
110
95
85
83
80
Average
2003-2005
Average
Monthly
90
80
85
100
123
115
105
100
90
80
80
80
94
94
94
94
94
94
94
94
94
94
94
94
Seasonal
Index
4 80

Month
Demand
2003 2004 2005
Average
2003-2005
Average
Monthly
Jan
80
85 105
90
94
Feb
70
85
85
80
94
2003-2005
Mar
80
93 average
82
85 monthly demand
94
Seasonal index =
demand
Apr
90
95 115 average monthly
100
94
May
113 125= 90/94
131 = .957 123
94
Jun
110 115 120
115
94
Jul
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
72
83
80
94
Dec
82
78
80
80
94
Seasonal
Index
0.957
4 81

Month
Jan
Feb
Mar
Apr
May
Jun
Jul
Aug
Sept
Oct
Nov
Dec
Demand
2003 2004 2005
80
70
80
90
113
110
100
88
85
77
75
82
85
85
93
95
125
115
102
102
90
78
72
78
105
85
82
115
131
120
113
110
95
85
83
80
Average
2003-2005
Average
Monthly
Seasonal
Index
90
80
85
100
123
115
105
100
90
80
80
80
94
94
94
94
94
94
94
94
94
94
94
94
0.957
0.851
0.904
1.064
1.309
1.223
1.117
1.064
0.957
0.851
0.851
0.851
4 82

Month
Jan
Feb
Mar
Apr
May
Jun
Jul
Aug
Sept
Oct
Nov
Dec
Demand
2003 2004 2005
Average
2003-2005
Average
Monthly
80
85 105
90
94
for802006
70
85 Forecast
85
94
80
93
82
85
94
annual demand
= 1,200
90Expected
95 115
100
94
113 125 131
123
94
110 115 120 1,200 115
94
Jan
x .957 = 96
100 102 113 12
105
94
88 102 110 1,200 100
94
85
90
Feb 95
x90
.851 = 85 94
12
77
78
85
80
94
75
72
83
80
94
82
78
80
80
94
Seasonal
Index
0.957
0.851
0.904
1.064
1.309
1.223
1.117
1.064
0.957
0.851
0.851
0.851
4 83

2006 Forecast
2005 Demand
2004 Demand
2003 Demand
140
130
Demand
120
110
100
90
80
70
|
J
|
F
|
M
|
A
|
M
|
J
|
J
|
A
|
S
|
O
|
N
|
D
Time
4 84
San Diego Hospital

Trend Data
10,200
Inpatient Days
10,000
9,800
9,600
9,400
9573
9530
9551
9659
9616
9594
9637
9745
9702
9680
9723
9766
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
Figure 4.6
4 85
San Diego Hospital

Seasonal Indices
Index for Inpatient Days
1.06
1.04 1.04
1.02
1.02
1.00
0.94
0.92
1.01
1.00
0.99
0.98
0.96
1.03
1.04
0.98
0.99
0.97
0.97
0.96
|
|
|
|
|
|
|
|
|
|
|
|
67 68 69 70 71 72 73 74 75 76 77 78
Month
Figure 4.7
4 86
San Diego Hospital

Combined Trend and Seasonal Forecast
10,200
Inpatient Days
10,000
9,800
10068
9949
9911
9764
9,600
9572
9,400
9,200
9,000
9724
9691
9520 9542
9265
9411
9355
|
|
|
|
|
|
|
|
|
|
|
|
67 68 69 70 71 72 73 74 75 76 77 78
Month
Figure 4.8
4 87
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
4 88
Forecasting an outcome based on predictor
variables 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
though to predict the value of the
dependent variable
4 89
Example
Local Payroll
($000,000,000), x
1
3
4
4.0
2
3.0
1
7
2.0
Sales
Sales
($000,000), y
2.0
3.0
2.5
2.0
2.0
3.5
1.0
|
1
|
2
|
|
|
|
3 4
5 6
Area payroll
|
7
4 90
Example
Sales, y
2.0
3.0
2.5
2.0
2.0
3.5
y = 15.0
Payroll, x
x2
1
1
3
9
4
16
2
4
1
1
7
49
x = 18
x2 = 80
x = x/6 = 18/6 = 3
y = y/6 = 15/6 = 2.5
b=
xy - nxy
x2 - nx2
xy
2.0
9.0
10.0
4.0
2.0
24.5
xy = 51.5
51.5 - (6)(3)(2.5)
80 - (6)(32)
= .25
a = y - bx = 2.5 - (.25)(3) = 1.75

4 91
Example
If payroll next year

is estimated to be
$600 million, then:
Sales = 1.75 + .25(6)
Sales = $325,000
Sales = 1.75 + .25(payroll)

4.0
3.25
3.0
Sales
y^ = 1.75 + .25x
2.0
1.0
0
|
1
|
2
|
|
|
|
3 4
5 6
Area payroll
|
7
4 92
Standard Error of the

Estimate
Sales
A forecast is just a point estimate of a

future value
This point is
4.0
actually the
3.25
3.0
mean of a
2.0
probability
1.0
distribution
0
Figure 4.9
|
1
|
2
|
|
|
|
3 4
5 6
Area payroll
|
7
4 93

Estimate
Sy,x =
where
y
=
point
(y - yc)2
n-2
y-value of each data
yc
=
computed value of
the dependent variable, from the
regression equation
n
=
points
number of data
4 94

Estimate
Computationally, this equation is
considerably easier to use
Sy,x =
y2 - ay - bxy
n-2
We use the standard error to set up

prediction intervals around the
point estimate
4 95

Estimate
Sy,x =
39.5 - 1.75(15) - .25(51.5)

6-2
y2 - ay - bxy
=
n-2
Sy,x = .306
4.0
The standard error

of the estimate is
$30,600 in sales
Sales
3.25
3.0
2.0
1.0
0
|
1
|
2
|
|
|
|
3 4
5 6
Area payroll
|
7
4 96
Correlation
How strong is the linear
relationship between the
variables?
Correlation does not necessarily
imply causality!
Coefficient of correlation, r,
measures degree of association
Values range from -1 to +1
4 97
Correlation Coefficient
r=
n xy - x y
[n x2 - ( x)2][n y2 - ( y)2]
4 98
Correlation Coefficient
y
r=
nxy - xy
[nx2 - (x)2][ny2 - (y)2]
(a) Perfect positive x

correlation:
r = +1
(b) Positive
correlation:
0<r<1
(c) No correlation:
r=0
(d) Perfect negative x

correlation:
r = -1
4 99
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
4 100
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
y^ = a + b1x1 + b2x2
Computationally, this is quite

complex and generally done on the
computer
4 101
Multiple Regression
Analysis
In the Nodel example, including interest rates in
the model gives the new equation:
y^ = 1.80 + .30x1 - 5.0x2

An improved correlation coefficient of r = .96
means this model does a better job of predicting
the change in construction sales
Sales = 1.80 + .30(6) - 5.0(.12) = 3.00
Sales = $300,000
4 102
Monitoring and Controlling

Forecasts
Tracking Signal
Measures how well the forecast is
predicting actual values
Ratio of running sum of forecast errors
(RSFE) to mean absolute deviation (MAD)
Good tracking signal has low values
If forecasts are continually high or low, the
forecast has a bias error
4 103
Monitoring and Controlling

Forecasts
Tracking = RSFE
signal
MAD
(actual demand in
period i forecast demand
in period i)
Tracking =
signal
|actual - forecast|/n)
4 104
Tracking Signal
Signal exceeding limit
Tracking signal
+
Upper control limit
0 MADs
Acceptable
range
Lower control limit

Time
4 105
Tracking Signal Example

Actual
Qtr Demand
1
2
3
4
5
6
90
95
115
100
125
140
Forecast
Demand
Error
RSFE
Absolute
Forecast
Error
100
100
100
110
110
110
-10
-5
+15
-10
+15
+30
-10
-15
0
-10
+5
+35
10
5
15
10
15
30
Cumulative
Absolute
Forecast
Error
MAD
10
15
30
40
55
85
10.0
7.5
10.0
10.0
11.0
14.2
4 106
Tracking Signal Example

Qtr
1
2
3
4
5
6
Tracking
Actual Signal
Forecast
Demand
Demand Error
(RSFE/MAD)
RSFE
Absolute
Forecast
Error
90-10/10
100= -1 -10
95
-15/7.5
100= -2 -5
115 0/10
100
= 0 +15
100-10/10
110= -1 -10
125
+5/11110
= +0.5+15
140
+35/14.2
110= +2.5
+30
-10
-15
0
-10
+5
+35
10
5
15
10
15
30
Cumulative
Absolute
Forecast
Error
MAD
10
15
30
40
55
85
10.0
7.5
10.0
10.0
11.0
14.2
The variation of the tracking signal

between -2.0 and +2.5 is within acceptable
limits
4 107
Adaptive Forecasting
Its possible to use the computer to
continually monitor forecast error and
adjust the values of the and
coefficients used in exponential
smoothing to continually minimize
forecast error
This technique is called adaptive
smoothing
4 108
Focus Forecasting
Developed at American Hardware Supply,
focus forecasting is based on two principles:
1. Sophisticated forecasting models are not
always better than simple models
2. There is no single techniques that should
be used for all products or services
This approach uses historical data to test
multiple forecasting models for individual items
The forecasting model with the lowest error is
then used to forecast the next demand
4 109
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
4 110
Fast Food Restaurant

Forecast
Percentage of sales
20%
15%
10%
5%
11-12
1-2
12-1
(Lunchtime)
2-3
3-4
4-5
5-6
7-8
6-7
(Dinnertime)
Hour of day
8-9
9-10
10-11
Figure 4.12
4 111

Operations Management: Chapter 4 - Forecasting

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Operations

2006 Prentice Hall, Inc.

Seven Steps In The Forecasting

2006 Prentice Hall, Inc.

2006 Prentice Hall, Inc.

2006 Prentice Hall, Inc.

Forecasting In The Service Sector

2006 Prentice Hall, Inc.

2006 Prentice Hall, Inc.

2006 Prentice Hall, Inc.

Three Key Factors for

2006 Prentice Hall, Inc.

Forecasting Time Horizons

Influence of Product Life

Product Life Cycle

2006 Prentice Hall, Inc.

Product Life Cycle

2006 Prentice Hall, Inc.

2006 Prentice Hall, Inc.

Seven Steps in Forecasting

2006 Prentice Hall, Inc.

Involves intuition, experience

Involves mathematical techniques

2006 Prentice Hall, Inc.

Consumer Market Survey

2006 Prentice Hall, Inc.

Jury of Executive Opinion

Sales Force Composite

2006 Prentice Hall, Inc.

Consumer Market Survey

2006 Prentice Hall, Inc.

Time Series Forecasting

Forecast based only on past

Time Series Components

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Demand for product or service

2006 Prentice Hall, Inc.

2006 Prentice Hall, Inc.

2006 Prentice Hall, Inc.

Sometimes cost effective and

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Moving Average Method

Moving Average Example

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(10 + 12 + 13)/3 = 11 2/3

Graph of Moving Average

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Weighted Moving Average

Weights based on experience and

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(weight for period n)

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Two months ago

[(3 x 13) + (2 x 12) + (10)]/6 = 121/6

Potential Problems With

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Moving Average And

Requires smoothing constant ( )

Involves little record keeping of past

2006 Prentice Hall, Inc.

2006 Prentice Hall, Inc.

2006 Prentice Hall, Inc.

2006 Prentice Hall, Inc.