Chp3 Part 2 Updated

Chapter 3
part2
Forecasting
Dr. Masoumeh
Mahdieh
McGraw-Hill/Irwin
Copyright 2012 by The McGraw-Hill Companies, Inc. All rights reserved.
MGT2110/MGT2220 Operations
Management
Dr. Masoumeh Mahdieh
Review of Forecasting part 1
3-2
Management
Forecast
Forecast a statement about the future value
of a variable of interest or Process of

predicting a future event
We make forecasts about such things as
weather, demand, and resource availability
Forecasts are an important element in making
informed decisions
3-3
Management
Steps in the Forecasting Process

1. Determine the purpose of the forecast
2. Establish a time horizon
3. Obtain, clean, and analyze appropriate data
4. Select a forecasting technique
5. Make the forecast
6. Monitor the forecast accuracy over time
3-4
Management
Forecast Accuracy
Due to the complex nature of most real-world
variables,
It is nearly impossible to correctly forecast real-
world variable values on a regular basis

Forecast Error = Actual Forecast
et At Ft where t any given time period
If errors fall beyond acceptable bounds,
corrective action may be necessary

3-5
Forecast Error
Actual
Forecast
E t = A t Ft
+5
Management
Common Measures of Error

Mean Absolute Deviation (MAD) weights all
errors evenly Actual Forecast
t
t
MAD
Error
Mean Squared Error (MSE) weights errors

2
according to their
squared
values
Actual t Forecast t
MSE
n 1
Error
n 1
Mean Absolute Percent Error (MAPE) weights
errors according
relative
error
Actual t to
Forecast
t
100
Actual t
MAPE
Error t
Actual
n
100
t
3-7
Management
Forecast Error Calculation

Perio
d
Actu
al
(A)
Foreca
st
(F)
Error
(A-F)
|
Error|
Error2
(|Error|/Actual)
100
107
110
-3
(3/107)100 =
2.80%
125
121
4
3
16
9
(4/125)100 =
(3/115)x100=2.61%
3.20%
115
112
-3
(2/118)x100=1.69%
118
120
(1/108)x100=0.93%
108
109
39
11.23%
Example 1
2
1
Sum
13
5
n=
13/5
MAD
==
2.6
n-1 =
39/4
==
MSE
9.7
5
5
n=
11.23/5 =
MAPE
=
2.25%
3-8
Management
Forecasting Approaches
Qualitative Methods
Used when situation is

vague & little data exist
New products
New technology
Involves intuition,
experience
e.g., forecasting sales on
Internet
Quantitative Methods
Used when situation is

stable & historical
data exist
Existing products
Current technology
Involves mathematical
techniques
e.g., forecasting sales of
color televisions
3-9
Management
Overview of Qualitative Methods

Executive Opinions
Pool opinions of high-level experts
Salesforce Opinions
Estimates from individual salespersons are
reviewed for reasonableness, then aggregated

Consumer Surveys
Ask the customer
Delphi method
Panel of experts, queried iteratively
3-10
Management
Overview of Quantitative Methods

Naive approach
Moving averages
Time-Series Models
Exponential smoothing
Trend projection
Linear regression
Associative Models
3-11
Management
Time Series Components

Trend
Cyclical
Seasonal
Random
3-12
Components of Demand
Trend
component
Demand for product or service
Seasonal peaks
Actual
demand
Average demand
over four years
Random
variation
|
1
|
2
|
3
Year
|
4
Figure 4.1
Management
Time-Series Forecasting - Averaging

Averaging techniques smooth fluctuations in
the data
Offset the individual highs and lows by
combining them into an average.

Work best when a series tends to vary about an
average.
Used if little or no trend
Techniques
1. Moving average
2. Weighted moving average
3. Exponential smoothing
3-14
Management
Moving Average
Average a number of the most recent actual
values in generating a forecast

n
Ft MA n
t i
i 1
At n At ( n 1) At 2 At 1
n
where
Ft Forecast for time period t
MA n n period moving average
At Actual value in period t
n Number of periods in the moving average
3-15
Moving Average
Month
January
February
March
April
May
June
July
Example 2
Actual
Shed Sales
10
12
13
16
19
23
26
3-Month
Moving Average
(10 + 12 + 13)/3 = 11.67

(12 + 13 + 16)/3 = 13.67
(13 + 16 + 19)/3 = 16
(16 + 19 + 23)/3 = 19.33
Management
Weighted Moving Average

The most recent values in a time series are
given more weight in computing a forecast

Weights can be given either as fractions:
n
Ft wt i At i wt n At n wt 1 At 1
i 1
where
wt weight for period t
At the actual value for period t
Or as whole numbers:
3-17
Weighted Moving Average (weights as

fractions)
Month
Actual
Shed Sales
January
February
March
April
May
June
July
10
12
13
16
19
23
26
Example 3
3-Month weighted
Moving Average
(0.1 x 10) + (0.3 x 12) + (0.6 x 13) = 12.4

(0.1 x 12) + (0.3 x 13) + (0.6 x 16) = 14.7
(0.1 x 13) + (0.3 x 16) + (0.6 x 19) = 17.5
(0.1 x 16) + (0.3 x 19) + (0.6 x 23) = 21.1
Weights Applied
Periods
0.1
Three months ago
0.3
Two months ago
0.6
Last month
Weighted Moving Average (weights as whole

numbers)
Month
Actual
Shed Sales
January
February
March
April
May
June
July
10
12
13
16
19
23
26
Example 3
3-Month weighted
Moving Average
[(1 x 10) + (3 x 12) + (6 x 13)]/10 = 12.4

[(1 x 12) + (3 x 13) + (6 x 16)]/10 = 14.7
[(1 x 13) + (3 x 16) + (6 x 19)]/10 = 17.5
[(1 x 16) + (3 x 19) + (6 x 23)]/10 = 21.1
Weights Applied
Periods
Three months ago
Two months ago
Last month
Management
part 2
Chapter 3 Forecasting
3-20
Management
Exponential Smoothing
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
3-21
Management
Next forecast = Previous forecast + (Actual Previous forecast)
Ft = Ft 1 + (At 1 - Ft 1)
where
Ft = new forecast
Ft 1 = previous forecast
= smoothing (or weighting)
constant (0 1)
3-22
Exponential Smoothing Example 1

Predicted demand = 142 cars
Actual demand = 153
Smoothing constant = 0.2
Forecast for next period = ?
Ft = Ft 1 + (At 1 - Ft 1)
New forecast = 142 + 0.2(153 142) =
144.2 144 cars
Management
Exponential Smoothing example 2

Compute F3, F4 and F5 using exponential smoothing
with =0.1
Period
Demand
Forecast
42
40
42
43
41.8
40
41.92
41
41.73
F3 F2 A2 F2
42 0.1 40 42 41.8
F4 F3 A3 F3
41.8 0.1 43 41.8 41.92
F5 F4 A4 F4
41.92 0.1 40 41.92 41.73
3-24
Management
Impact of smoothing constant (0 1)
The closer is to 1.00, the greater
responsiveness and the less the

smoothing.
3-25
Impact of Different
225
Demand
200
= .5
Actual
demand
175
150
|
1
|
2
|
3
|
4
|
5
Quarter
|
6
= .1
|
7
|
8
|
9
Impact of Different
225
Demand
200
= .5
Actual
Chose high values
of when
demand
underlying average is likely

175
to change
Choose low values of when
150
underlying
average is stable
|
1
|
2
|
3
|
4
|
5
Quarter
|
6
= .1
|
7
|
8
|
9
Choosing by Comparison of
Forecast Error
Quarter
1
2
3
4
5
6
7
8
Actual
180
168
159
175
190
205
180
182
MAD
MSE
MAPE
Forecast
= .10
175
175.5
174.75
173.18
173.36
175.02
178.02
178.22
|Error|
= .10
5.00
7.50
15.75
1.82
16.64
29.98
1.98
3.78
82.45
82.45/8=10.31
218.08
5.59%
Forecast
= .50
175
177.50
172.75
165.88
170.44
180.22
192.61
186.30
|Error|
= .50
5.00
9.50
13.75
9.12
19.56
24.78
12.61
4.30
98.62
98.62/8=12.33
223.13
6.76%
Management
Exponential Smoothing with Trend

Adjustment
When a trend is present, exponential smoothing
must be modified
The trend adjusted forecast consists of two
components
Smoothing factor
Trend factor
Forecast
Exponentially
including (TAFt+1) = smoothed (St) +
trend
forecast
Exponentially
(Tt) smoothed
trend
3-29
Management
Trend-Adjusted Exponential Smoothing

TAF t +1 S t Tt
where
S t Previous forecast plus smoothed error
(Exponenti ally smoothed forecast)
Tt Current tr end estimate
(Exponenti ally smoothed trend)
and
St TAF t + At TAF t
Tt Tt 1 TAF t TAF t 1 Tt 1
where
smoothing constant for average 0 1

smoothing constant for trend 0 1
3-30
Management

Example
Use trend-adjusted exponential smoothing to obtain
forecasts for period 6 through 11 with =0.4 and
=0.3
Starting period = 5
Smoothe
d
Smoothed
Forecast
Period Actual Forecast trend
(At)
(TAFt)
(Tt)
(St)
1
700
724
737.33
9.33
Initial Trend :
If it is not given use Trend

for period 5 =
T5
A4 A1 728 700
9.33
3
3
720
728
740
Forecast for period 5 = TAF5,
742
758
750
770
If it is not given only for this

period use
TAF5 = A4 + T5
=728+9.33=737.33
10
775
3-31
Management

Example
Smoothe
d
Smoothed
Forecast
(At)
(TAFt)
(Tt)
(St)
1
700
724
720
728
740
742
758
750
770
10
775
11
737.33
747.73
9.33
=0.4
Smoothed Forecast for Period 5
S5 = TAF5 + (A5 - TAF5)
=737.33 + 0.4(740 - 737.33)
=738.40
738.40
Forecast for Period 6

TAF6 = S5 + T5
= 738.40+9.33 = 747.73
3-32
Management

Example
=0.4
Smoothe
d
Smoothed
Forecast
(At)
(TAFt)
(Tt)
(St)
1
700
724
720
728
740
742
758
750
770
10
775
11
737.33
747.73
755.09
9.33
9.65
738.40
745.44
Smoothed Forecast for Period 6

S6 = TAF6 + (A6 - TAF6)
=747.73 + 0.4(742 747.73)
=745.44
=0.3
Smoothed Trend for Period 6
T6 = T5 + (TAF6 TAF5 T5)
=9.33 + 0.3(747.73 737.33
9.33)
=9.65
Forecast for Period 7: TAF7 = S6 + T6
3-33
= 745.44+9.65 = 755.09
3-33
Management

Example
Smoothe
d
Smoothed
Forecast
(At)
(TAFt)
(Tt)
(St)
1
2
3
4
5
6
7
8
9
10
11
700
724
720
728
740
742
758
750
770
775
737.33
747.73
755.09
765.22
768.44
776.55
783.60
9.33
9.65
8.96
9.31
7.49
7.67
738.40
745.44
756.25
759.13
769.07
775.93
3-34
Management
End of part 2
Chapter 3 Forecasting
3-35

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Chapter 3

Copyright 2012 by The McGraw-Hill Companies, Inc. All rights reserved.

Dr. Masoumeh Mahdieh

Review of Forecasting part 1

Dr. Masoumeh Mahdieh

of a variable of interest or Process of

Dr. Masoumeh Mahdieh

Steps in the Forecasting Process

Dr. Masoumeh Mahdieh

world variable values on a regular basis

corrective action may be necessary

Dr. Masoumeh Mahdieh

Common Measures of Error

errors evenly Actual Forecast

Mean Squared Error (MSE) weights errors

Mean Absolute Percent Error (MAPE) weights

Dr. Masoumeh Mahdieh

Forecast Error Calculation

Dr. Masoumeh Mahdieh

Used when situation is

Used when situation is

Dr. Masoumeh Mahdieh

Overview of Qualitative Methods

reviewed for reasonableness, then aggregated

Dr. Masoumeh Mahdieh

Overview of Quantitative Methods

Dr. Masoumeh Mahdieh

Time Series Components

Dr. Masoumeh Mahdieh

Time-Series Forecasting - Averaging

Offset the individual highs and lows by

combining them into an average.

Dr. Masoumeh Mahdieh

values in generating a forecast

(10 + 12 + 13)/3 = 11.67

Dr. Masoumeh Mahdieh

Weighted Moving Average

given more weight in computing a forecast

Weighted Moving Average (weights as

(0.1 x 10) + (0.3 x 12) + (0.6 x 13) = 12.4

Three months ago

Two months ago

Weighted Moving Average (weights as whole

[(1 x 10) + (3 x 12) + (6 x 13)]/10 = 12.4

Three months ago

Two months ago

Dr. Masoumeh Mahdieh

Dr. Masoumeh Mahdieh

Requires smoothing constant ()

Involves little record keeping of past

Dr. Masoumeh Mahdieh

Next forecast = Previous forecast + (Actual Previous forecast)

Exponential Smoothing Example 1

Dr. Masoumeh Mahdieh

Exponential Smoothing example 2

41.8 0.1 43 41.8 41.92

41.92 0.1 40 41.92 41.73

Dr. Masoumeh Mahdieh

responsiveness and the less the

underlying average is likely

Dr. Masoumeh Mahdieh

Exponential Smoothing with Trend

When a trend is present, exponential smoothing

The trend adjusted forecast consists of two