2.0 Topic 2 - Forecasting 140914

Operations
Management
Topic 2 Forecasting
UiTM Shah Alam
Lecturer: Pn. Ahsana Aqilah Ahmad
T1-A14-2C
05/14/17 NY- MEM 575: Courtesy of Mc Graw 1

Hill and Pearson-Prentice Hall
Learning outcomes
At the end of this lesson students should be
able to :
1.Discuss the overview of forecasting techniques
2.Compare and contrast qualitative and quantitative
approaches to forecasting
3.Apply the naive, moving averages, weighted moving
averages and exponential smoothing methods.
4.Compute and analyze three measures of forecast
accuracy; MAD, MSE and MAPE
NY- MEM 575: Courtesy of Mc Graw Hill and Pearson-

05/14/17 Prentice Hall 2
What is Forecasting?
1. Process of
predicting a future Hmm. you
event are going to

get an A for
this subject.
2. Underlying basis But!!!
of
all business
decisions
Production
Inventory
PersonnelNY- MEM 575: Courtesy of Mc Graw
05/14/17 3
Forecasting Time Horizons
1. Short-range forecast
Up to 1 year, generally less than 3 months
Purchasing, job scheduling, workforce
levels, job assignments, production levels
2. Medium-range forecast
3 months to 3 years
Sales and production planning, budgeting
3. Long-range forecast
3+ years
New product planning, facility location,
research and development
NY- MEM 575: Courtesy of Mc Graw

05/14/17 4
Seven Steps in Forecasting
1. Determine the use of the forecast
2. Select the items to be forecasted
3. Determine the time horizon of the
forecast
4. Select the forecasting model(s)
5. Gather the data
6. Make the forecast
7. Validate and implement results
05/14/17 5
Types of Forecasts
1. Economic forecasts
Address business cycle inflation rate,
money supply, housing starts, etc.
2. Technological forecasts
Predict rate of technological progress
Impacts development of new products
3. Demand forecasts
Predict sales of existing products and
services

05/14/17 6
Strategic Importance of
Forecasting
1. Human Resources Hiring, training,

laying off workers
2. Capacity Capacity shortages can
result in undependable delivery, loss
of customers, loss of market share
3. Supply Chain Management Good
supplier relations and price
advantages
05/14/17 7
The Realities!
1. Forecasts are seldom perfect

2. Most techniques assume an underlying
stability in the system
3. Product family and aggregated forecasts
are more accurate than individual product
forecasts

05/14/17 8
Forecasting Methods
Generally there are two types of
forecasting methods; Qualitative and
Quantitative Methods
1. Qualitative methods are based on:
judgment
opinion
past experience
best guesses
2. Quantitative methods are based on:

mathematical methods
two traditional types; time series and regression

05/14/17 9
Forecasting Approaches
Qualitative Methods
Used when situation is vague
and little data exist
New products
New technology
Involves intuition, experience
e.g., forecasting sales on
Internet
05/14/17 10
Forecasting Approaches
Quantitative Methods
Used when situation is stable
and historical data exist
Existing products
Current technology
Involves mathematical
techniques
e.g., forecasting sales of color
05/14/17 televisions
11
Overview of Quantitative
Approaches
1. Naive approach
2. Moving averages
3. Weighted Moving Time-Series
Averages Models
4. Exponential smoothing
5. Trend projection
Associative
6. Linear regression Model

05/14/17 12
Time Series Forecasting
Set of evenly spaced numerical data
Obtained by observing response
variable at regular time periods
Forecast based only on past values,
no other variables important
Assumes that factors influencing past
and present will continue influence in
future

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Time Series Components
Trend Cyclical
Seasonal Random

05/14/17 14
Components of Demand
Trend
component
Demand for product or service
Seasonal peaks
Actual
demand
Average
demand over
Random four years
variation
| | | |
1 2 3 4
Year Figure 4.1
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Trend Component
1. Persistent, overall upward or
downward pattern
2. Changes due to population,
technology, age, culture, etc.
3. Typically several years
duration

05/14/17 16
Seasonal Component
1. Regular pattern of up and
down fluctuations
2. Due to weather, customs, etc.
3. Occurs within a single year
Number of
Period Length Seasons
Week Day 7
Month Week 4-4.5
Month Day 28-31
Year Quarter 4
Year Month 12
05/14/17
Year
NY- Week
MEM 575: Courtesy of Mc Graw 52 17
Cyclical Component
1. Repeating up and down movements
2. Affected by business cycle, political,
and economic factors
3. Multiple years duration
4. Often causal or
associative
relationships
0 5 10 15 20
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Random Component
1. Erratic, unsystematic, residual
fluctuations
2. Due to random variation or
unforeseen events
3. Short duration and
non-repeating
M T W T F
05/14/17 19
Naive Approach
Assumes demand in next
period is the same as
demand in most recent period
e.g., If January sales were 68,
then February sales will be 68
Sometimes cost effective and
efficient
Can be good starting point
05/14/17 20
Techniques for Averaging
1. Moving average
2. Weighted moving average
3. Exponential smoothing

05/14/17 21
Moving Average Method
1. MA is a series of arithmetic means
2. Used if little or no trend
3. Used often for smoothing
Provides overall impression of data
over time
demand in previous n periods

Moving average =
n
05/14/17 22
Moving Average Example
Actual 3-Month
Month Sales Moving Average
January 10
February 12
March 13
April 16 (10 + 12 + 13)/3 = 11 2/3
May 19 (12 + 13 + 16)/3 = 13 2/3
June 23 (13 + 16 + 19)/3 = 16
July 26 (16 + 19 + 23)/3 = 19 1/3

05/14/17 23
Graph of Moving Average
Moving
30 Average
28 Forecast
26 Actual
24 Sales
22
Sales
20
18
16
14
12
10
| | | | | | | | | | | |
J F M A M J J A S O N D
05/14/17 24
Weighted Moving Average
1. Used when trend is present
Older data usually less important
2. Weights based on experience
and intuition
(weight for period n)

Weighted x (demand in period n)
=
moving average weights

05/14/17 25
Weights Applied Period
Weighted Moving
3 Average
Last month
2 Two months ago
1 Three months ago
6 Sum of weights
Actual 3-Month Weighted

Month Sales Moving Average
January 10
February 12
March 13
April 16 [(3 x 13) + (2 x 12) + (10)]/6 = 121/6
May 19 [(3 x 16) + (2 x 13) + (12)]/6 = 141/3
June 23 [(3 x 19) + (2 x 16) + (13)]/6 = 17
July 26 [(3 x 23) + (2 x 19) + (16)]/6 = 201/2

05/14/17 26
Moving Average And
Weighted Moving Average
30 Weighted
moving
average
25
Sales demand
20
Actual
15 sales
10 Moving
average
5
| | | | | | | | | | | |
J F M A M J J A S O N D
Figure 4.2
05/14/17 27
Potential Problems With
Moving Average
1. Increasing n smoothens the forecast

but makes it less sensitive to
changes
2. Do not forecast trends well
3. Require extensive historical data

05/14/17 28
Exponential Smoothing
1. Form of weighted moving average
Weights decline exponentially
Most recent data weighted most
2. Requires smoothing constant ()
Ranges from 0 to 1
Subjectively chosen
3. Involves little record keeping of
past data
05/14/17 29
Remember This!!!!!!!!
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)
05/14/17 30
Choosing
The objective is to obtain the most accurate

forecast no matter the technique; lowest
forecast error indicates better accuracy.
Forecast error = Actual demand - Forecast value

= At - Ft

05/14/17 31
Forecast Accuracy
(Common Measures of Error)
MAD #1
Error: difference between actual value
and forecast value
1. Mean Absolute Deviation (MAD)
Average absolute error
{this value is computed by taking the sum of
the absolute values of the individual forecast
errors and dividing by the number of periods
of data (n)}
|Actual - Forecast|
MAD = n
NY- MEM 575: Courtesy of Mc Graw 32

05/14/17
Forecast Accuracy
(Common Measures of Error)-
MSE #2
2. Mean Squared Error (MSE)

Average of squared error;
{ 2nd method of measuring overall forecast
error; the average of the squared differences
between forecasted and observed values}.
(Actual - Forecast )2
MSE =
n

05/14/17
Forecast Accuracy
(Common Measures of Error)-
MAPE #3
3. Mean Absolute Percent Error

(MAPE)
Average absolute percent error
{ the average of the absolute value difference
betrween the forecasted and the actual
values; expressed
n in %}
100|Actuali - Forecasti|/Actuali
MAPE =
i=1 n

05/14/17
Common Measures of Error
or Forecast Accuracy
1) Mean Absolute Deviation (MAD)
|Actual - Forecast|
MAD = n
2) Mean Squared Error (MSE)
(Actual - Forecast )2
MSE =
n
3) Mean Absolute Percent Error (MAPE)
n
100|Actuali - Forecasti|/Actuali
MAPE =
i=1 n
05/14/17 35
Example
Predicted demand = 142 Ford Mustangs
Actual demand = 153
Smoothing constant = .20

05/14/17 36
Example
Actual demand = 153
New forecast = 142 + .2(153 142)

05/14/17 37
Example
Actual demand = 153
New forecast = 142 + .2(153 142)

= 142 + 2.2
= 144.2 144 cars

05/14/17 38
Example 2
Demand for the last four months
was:
Predict demand for July using each of these methods:

(A)
1) A 3-period moving average
2) exponential smoothing with alpha equal to .20 (use nave to
begin).
(B)
3) If the naive approach had been used to predict demand for April
through June, what would MAD have been for those months?

05/14/17 39
Example 2
A) 1. (8+10+8)/3 = 8.67 (July Forecast)
2. Use nave to begin
Month Deman Forecast
d
March 6 -
April 8 6
May 10 6 + 0.2(8 6) = 6.4
June 8 6.4 + 0.2(10 6.4) = 7.12
7.12 + 0.2(8 7.12) = 7.296
B)
Month March April May June
Demand 6 8 10 8
Nave - 6 8 10
Absolute - 2 2 2
Error
MAD = (2+2+2) /3 = 2
05/14/17 40
Other Examples
Moving Average
Weekly sales of ten-grain bread at the local organic food

market are in the table below. Based on this data,
forecast week 9 using a five-week moving average.
Wee 1 2 3 4 5 6 7 8
k
Sale 415 389 420 382 410 432 405 421
s
(382+410+432+405+421)/5 = 410.0

05/14/17 41
Other Examples
Exponential Smoothing & MAD
Jim's department at a local department store has tracked the sales of a product
over the last ten weeks. Forecast demand using exponential smoothing with
an alpha () of 0.4, and an initial forecast of 28.0. Calculate MAD, MSE and
MAPE.
Period Demand
1 24
2 23
3 26
4 36
5 26
6 30
7 32
8 26
05/14/17 9 25Hall
Hill and Pearson-Prentice
42
Other Examples
100*
100* At Ft / At
Demand At Ft ( At Ft)2
Period Forecast Error 100 (
( error
(Actual) error (error) 2
/actual)
1 24 28.00 -4 4 16 16.6 %
2 23 26.40 -3.40 3.40 11.56 14.78 %
3 26 25.04 0.96 0.96 0.92 3.69 %
4 36 25.42 10.58 10.58 111.94 29.39 %
5 26 29.65 -3.65 3.65 13.32 14.04%
6 30 28.19 1.81 1.81 3.28 6.03%
7 32 28.92 3.08 3.08 9.49 9.63 %
8 26 30.15 -4.15 4.15 17.22 15.96 %
9 25 28.49 -3.49 3.49 12.18 13.96%
10 28 27.09 0.91 0.91 0.83 3.25%
Total -1.36 36.03 196.74 127.33 %
Average -0.14 3.6 19.6 12.73 %
Bias MAD MSE MAPE

05/14/17 43
Lets Recap
1. Discuss the overview of forecasting techniques
2. Compare and contrast qualitative and
quantitative approaches to forecasting
3. Apply the naive, moving averages, weighted
moving averages and exponential smoothing
methods.
4. Compute and analyze three measures of forecast
accuracy; MAD, MSE and MAPE
NY- MEM 575: Courtesy of Mc Graw Hill and Pearson-

05/14/17 Prentice Hall 44
Class Exercise

05/14/17 45
05/14/17 46
05/14/17 47

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Operations

05/14/17 NY- MEM 575: Courtesy of Mc Graw 1

NY- MEM 575: Courtesy of Mc Graw Hill and Pearson-

event are going to

NY- MEM 575: Courtesy of Mc Graw

NY- MEM 575: Courtesy of Mc Graw

1. Human Resources Hiring, training,

1. Forecasts are seldom perfect

NY- MEM 575: Courtesy of Mc Graw

2. Quantitative methods are based on:

NY- MEM 575: Courtesy of Mc Graw

NY- MEM 575: Courtesy of Mc Graw

NY- MEM 575: Courtesy of Mc Graw

NY- MEM 575: Courtesy of Mc Graw

NY- MEM 575: Courtesy of Mc Graw

NY- MEM 575: Courtesy of Mc Graw

demand in previous n periods

NY- MEM 575: Courtesy of Mc Graw

(weight for period n)

NY- MEM 575: Courtesy of Mc Graw

Actual 3-Month Weighted

NY- MEM 575: Courtesy of Mc Graw

1. Increasing n smoothens the forecast

NY- MEM 575: Courtesy of Mc Graw

where Ft = new forecast

The objective is to obtain the most accurate

Forecast error = Actual demand - Forecast value

NY- MEM 575: Courtesy of Mc Graw

NY- MEM 575: Courtesy of Mc Graw 32

2. Mean Squared Error (MSE)

NY- MEM 575: Courtesy of Mc Graw 33

3. Mean Absolute Percent Error

NY- MEM 575: Courtesy of Mc Graw 34

NY- MEM 575: Courtesy of Mc Graw

New forecast = 142 + .2(153 142)

NY- MEM 575: Courtesy of Mc Graw

New forecast = 142 + .2(153 142)

NY- MEM 575: Courtesy of Mc Graw

Predict demand for July using each of these methods:

NY- MEM 575: Courtesy of Mc Graw

Weekly sales of ten-grain bread at the local organic food

NY- MEM 575: Courtesy of Mc Graw

NY- MEM 575: Courtesy of Mc Graw

NY- MEM 575: Courtesy of Mc Graw Hill and Pearson-

NY- MEM 575: Courtesy of Mc Graw

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