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PRODUCTION AND
OPERATIONS MANAGEMENT
MGT-303

Week : 4 & 5

Forecasting
The outline of the session
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 What is Forecasting?
 Types of Forecasts
 The Strategic Importance of Forecasting
 Seven Steps in Forecasting System
 An Overview of Forecasting Techniques
 Qualitative Methods of Forecasting
 Quantitative Methods of Forecasting
 A Case Study: The Computer Club Warehouse Problem
 Applying Time-Series Forecasting to the Case Study
 Causal Forecasting with Linear Regression
 Judgmental Forecasting Methods
Learning objectives
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At the end of forecasting session, you should be able to


1. Describe some important types of forecasting applications.
2. Identify two common measures of the accuracy of forecasting
methods.
3. Adjust forecasting data to consider seasonal patterns.
4. Describe several forecasting methods that use the pattern of
historical data to forecast a future value.
5. Apply these methods with the Excel software.
6. Compare these methods to identify the conditions when each is
particularly suitable.
7. Describe and apply an approach to forecasting that relates the
quantity of interest to one or more other quantities.
8. Describe several forecasting methods that use expert judgment.
What is Forecasting?
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 Forecasting is a process of estimating the


unknown.

 Forecasting Time Horizons


• Short-range forecast
• Medium-range forecast
• Long-range forecast
Types of Forecasts
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1. Economic forecasts address the business cycle. They


predict housing starts, inflation rates, money supplies, and
other indicators.
2. Technological forecasts monitor rates of technological
progress. This keeps organizations abreast of trends and can
result in exciting new products. New products may require new
facilities and equipment, which must be planned for in the
appropriate time frame.
3. Demand forecasts deal with the company's products and
estimate consumer demand. These are also referred to as sales
forecasts, which have multiple purposes. In addition to driving
scheduling, production, and capacity, they are also inputs to
financial, personnel, and marketing future plans.
Strategic Importance of Forecasts
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 Operations managers have two tools in their hand


by which to make decisions: actual data and
forecasts.

 Human Resources
 Capacity
 Supply-Chain Management
Forecasting System
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1. Determine what the forecast is for.


2. Select the items for the forecast.
3. Select the time horizon.
4. Select the forecast model type.
5. Gather data to be input into the model.
6. Make the forecast.
7. Verify and implement the results.
Approaches to Forecasting
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Forecasting
Methods

Quantitative Qualitative

Time-series
Models Associative
Model Personal Assessment
Panel consensus
Delphi method
Last-value Method Sales Force composite
Linear
Moving Averages Regression Market Research
Exponential Smoothing
Trend Projection
Forecasting Methods Currently in Use
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 Qualitative Methods
• Personal Assessment
• Panel Consensus
• Delphi Method
• Sales Force Composite
• Market Research
Forecasting Methods Currently in Use
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 Quantitative Methods
- There are three subcategories:

-Time Series Methods: seek to identify historical patterns


(using time as reference) and the forecast using a time-
based extrapolation of those patterns.
- Explanatory (Causal) Methods: seek to identify the
relationships that led to (caused) observed outcomes in the
past and then forecast by applying those relationships to the
future.
An overview of Quantitative
Forecasting Techniques
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Time Series Forecasting Methods

Casual Forecasting Methods/Associative


model
Example: Forecasting at Fastchips
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 Fastchips is a leading producer of microprocessors.


 Six months ago, it launched the sales of its latest
microprocessor.
 Month-by-month sales (in thousands) over the initial six
months have been

17 25 24 26 30 28

Question: What is the forecast for next month’s sales?


The Last-Value Forecasting Method
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The last-value forecasting method ignores all


data points in a time series except the last one.
Forecast = Last value

Fastchips: Month-by-month sales (in thousands)


over the initial six months:
17 25 24 26 30 28
Forecast = 28
The Averaging Forecasting Method
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The averaging forecasting method uses all the


data points in the time series and simply
averages these points.
Forecast = Average of all data to date

Fastchips: Month-by-month sales (in thousands)


over the initial six months:
17 25 24 26 30 28
Forecast = (17+25+24+26+30+28) / 6 = 25
The Moving-Average Forecasting
Method
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The moving-average forecasting method averages the data for


only the most recent time periods.

n = Number of recent periods to consider as relevant for


forecasting
Forecast = Average of last n values

Fastchips: Month-by-month sales (in thousands) over the initial


six months:
17 25 24 26 30 28

Forecast (n=3) = (26+30+28) / 3 = 28


The Exponential Smoothing
Forecasting Method
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 The exponential smoothing forecasting method


provides a more sophisticated version of the
moving-average method.
 It gives the greatest weight to the last month and
then progressively smaller weights to the older
months.
 Exponential smoothing with trend adjusts
exponential smoothing by also directly considering
any current upward or downward trend in sales
Linear Regression
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 Linear regression uses a two-dimensional graph


with sales measured along the vertical axis and
time measured along the horizontal axis.
 After plotting the sales data, this method finds a
line passing through the midst of the data as
closely as possible.
 The extension of the line into future months
provides the forecast of sales in these future
months.
Measuring the Forecast (error)
Accuracy
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 The mean absolute deviation (called MAD) measures


the average forecasting error.
MAD = (Sum of forecasting errors) / (Number of forecasts)

 The mean square error (often abbreviated MSE)


measures the average of the square of the forecasting
error.
MSE = (Sum of square of forecasting errors) / (Number of forecasts).

 The MSE increases the weight of large errors relative to


the weight of small errors.
A Case Study: The Computer Club
Warehouse (CCW)
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 The Computer Club Warehouse (CCW) sells computer products


at bargain prices by taking telephone orders (as well as
website and fax orders) directly from customers.
 Products include computers, peripherals, supplies, software,
and computer furniture.
 The CCW call center is never closed. It is staffed by dozens of
agents to take and process customer orders.
 A large number of telephone trunks are provided for incoming
calls. If an agent is not free when a call arrives, it is placed on
hold. If all the trunks are in use (called saturation), the call
receives a busy signal.
 An accurate forecast of the demand for agents is needed.
Question: How should the demand for agents be forecasted?
Average Daily Call Volume (3 Years
of Data)
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A B C D E
1 CCW's Average Daily Call Volume
2
3 Year Quarter Call Volume
4 1 1 6,809
5 1 2 6,465
6 1 3 6,569
7 1 4 8,266
8 2 1 7,257
9 2 2 7,064
10 2 3 7,784
11 2 4 8,724
12 3 1 6,992
13 3 2 6,822
14 3 3 7,949
15 3 4 9,650
Applying Time based (time-series)
Forecasting Models to the Case Study
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Data collected over a period of time is usually called a time-


series.
Components of a Time Series:
- Seasonal Component: these are regular fluctuations within a
complete time period (a day, a week, a month etc.).
- Trend Component: is the underlying movement in the data – it
may be upward, downward or stationary.
- Cyclical Component: are long term fluctuations in the data
and are similar to seasonal factors. They can be difficult to identify
unless long series of data is available.
- Irregular Component: are random or residual factors, like
unpredictable element to the data. Something like unusual weather
conditions affecting holiday sales.
Considering Seasonal Effects
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 When there are seasonal patterns in the data, they can be


addressed by forecasting methods that use seasonal factors.

 The seasonal factor for any period of a year (a quarter, a


month, etc.) measures how that period compares to the overall
average for an entire year.
Seasonal factor = (Average for the period) / (Overall average)

 It is easier to analyze data and detect new trends if the data


are first adjusted to remove the seasonal patterns.
Seasonally adjusted data = (Actual call volume) / (Seasonal
factor)
Calculation of Seasonal Factors for
CCW
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Excel Template for Calculating
Seasonal Factors
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A B C D E F G
1 Estimating Seasonal Factors for CCW
2
3 True
4 Year Quarter Value Type of Seasonality
5 1 1 6,809 Quarterly
6 1 2 6,465
7 1 3 6,569
8 1 4 8,266 Estimate for
9 2 1 7,257 Quarter Seasonal Factor
10 2 2 7,064 1 0.9323
11 2 3 7,784 2 0.9010
12 2 4 8,724 3 0.9873
13 3 1 6,992 4 1.1794
14 3 2 6,822
15 3 3 7,949
16 3 4 9,650
Seasonally Adjusted Time Series for
CCW
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A B C D E F
1 Seasonally Adjusted Time Series for CCW
2
3 Seasonal Actual Seasonally Adjusted
4 Year Quarter Factor Call Volume Call Volume
5 1 1 0.93 6,809 7,322
6 1 2 0.90 6,465 7,183
7 1 3 0.99 6,569 6,635
8 1 4 1.18 8,266 7,005
9 2 1 0.93 7,257 7,803
10 2 2 0.90 7,064 7,849
11 2 3 0.99 7,784 7,863
12 2 4 1.18 8,724 7,393
13 3 1 0.93 6,992 7,518
14 3 2 0.90 6,822 7,580
15 3 3 0.99 7,949 8,029
16 3 4 1.18 9,650 8,178
Outline for Forecasting Call Volume
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1. Select a time-series forecasting method.

2. Apply this method to the seasonally adjusted


time series to obtain a forecast of the seasonally
adjusted call volume for the next time period.

3. Multiply this forecast by the corresponding


seasonal factor to obtain a forecast of the actual
call volume (without seasonal adjustment).
The Last-Value Forecasting Method
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 The last-value forecasting method ignores all


data points in a time series except the last one.

Forecast = Last value


 The last-value forecasting method is sometimes called
the naïve method, because statisticians consider it
naïve to use just a sample size of one when other data
are available.
 However, when conditions are changing rapidly, it
may be that the last value is the only relevant data
point.
The Last-Value Method Applied to
CCW’s Problem
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A B C D E F G H I J K
1 Last-Value Forecasting Method with Seasonality for CCW
2
3 Seasonally Seasonally
4 True Adjusted Adjusted Actual Forecasting
5 Year Quarter Value Value Forecast Forecast Error Type of Seasonality
6 1 1 6,809 7,322 Quarterly
7 1 2 6,465 7,183 7,322 6,589 124
8 1 3 6,569 6,635 7,183 7,112 543 Quarter Seasonal Factor
9 1 4 8,266 7,005 6,635 7,830 436 1 0.93
10 2 1 7,257 7,803 7,005 6,515 742 2 0.90
11 2 2 7,064 7,849 7,803 7,023 41 3 0.99
12 2 3 7,784 7,863 7,849 7,770 14 4 1.18
13 2 4 8,724 7,393 7,863 9,278 554
14 3 1 6,992 7,518 7,393 6,876 116
15 3 2 6,822 7,580 7,518 6,766 56
16 3 3 7,949 8,029 7,580 7,504 445
17 3 4 9,650 8,178 8,029 9,475 175
18 4 1 8,178 7,606
19 4 2
20 4 3
21 4 4
22 5 1 Mean Absolute Deviation
23 5 2 MAD = 295
24 5 3
25 5 4 Mean Square Error
26 6 1 MSE = 145,909
Measuring the Forecast Accuracy (error)
for Last-Value Method with Seasonality
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 The mean absolute deviation (MAD)


MAD = (Sum of forecasting errors) / (Number of
forecasts)
= 3246/11 = 295

 The mean square error (MSE)


MSE = (Sum of square of forecasting errors) / (Number
of forecasts).
= (124)2+(543)2+ … +(175)2/11
= 145909
The Averaging Forecasting Method
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 The averaging forecasting method uses all the data


points in the time series and simply averages these
points.
Forecast = Average of all data to date

 The averaging forecasting method is a good one to use


when conditions are very stable.

 However, the averaging method is very slow to respond


to changing conditions. It places the same weight on all
the data, even though the older values may be less
representative of current conditions than the last value
observed.
The Averaging Method Applied to
CCW’s Problem
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A B C D E F G H I J K
1 Averaging Forecasting Method with Seasonality for CCW
2
3 Seasonally Seasonally
4 True Adjusted Adjusted Actual Forecasting
5 Year Quarter Value Value Forecast Forecast Error Type of Seasonality
6 1 1 6,809 7,322 Quarterly
7 1 2 6,465 7,183 7,322 6,589 124
8 1 3 6,569 6,635 7,252 7,180 611 Quarter Seasonal Factor
9 1 4 8,266 7,005 7,047 8,315 49 1 0.93
10 2 1 7,257 7,803 7,036 6,544 713 2 0.90
11 2 2 7,064 7,849 7,190 6,471 593 3 0.99
12 2 3 7,784 7,863 7,300 7,227 557 4 1.18
13 2 4 8,724 7,393 7,380 8,708 16
14 3 1 6,992 7,518 7,382 6,865 127
15 3 2 6,822 7,580 7,397 6,657 165
16 3 3 7,949 8,029 7,415 7,341 608
17 3 4 9,650 8,178 7,471 8,816 834
18 4 1 7,530 7,003
19 4 2
20 4 3
21 4 4
22 5 1 Mean Absolute Deviation
23 5 2 MAD = 400
24 5 3
25 5 4 Mean Square Error
26 6 1 MSE = 242,876
The Moving-Average Forecasting
Method
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 The moving-average forecasting method averages the data for only the
most recent time periods.
n = Number of recent periods to consider as relevant for
forecasting
Forecast = Average of last n values

 The moving-average forecasting method is a good one to use when


conditions don’t change much over the number of time periods included in
the average.

 However, the moving-average method is slow to respond to changing


conditions. It places the same weight on each of the last n values even
though the older values may be less representative of current conditions
than the last value observed.
The Moving-Average Method Applied
to CCW
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A B C D E F G H I J K
1 Moving Average Forecasting Method with Seasonality for CCW
2
3 Seasonally Seasonally
4 True Adjusted Adjusted Actual Forecasting Number of previous
5 Year Quarter Value Value Forecast Forecast Error periods to consider
6 1 1 6,809 7,322 n= 4
7 1 2 6,465 7,183
8 1 3 6,569 6,635 Type of Seasonality
9 1 4 8,266 7,005 Quarterly
10 2 1 7,257 7,803 7,036 6,544 713
11 2 2 7,064 7,849 7,157 6,441 623 Quarter Seasonal Factor
12 2 3 7,784 7,863 7,323 7,250 534 1 0.93
13 2 4 8,724 7,393 7,630 9,003 279 2 0.90
14 3 1 6,992 7,518 7,727 7,186 194 3 0.99
15 3 2 6,822 7,580 7,656 6,890 68 4 1.18
16 3 3 7,949 8,029 7,589 7,513 436
17 3 4 9,650 8,178 7,630 9,004 646
18 4 1 7,826 7,279
19 4 2
20 4 3
21 4 4
22 5 1
23 5 2
24 5 3
25 5 4 Mean Absolute Deviation
26 6 1 MAD = 437
27 6 2
28 6 3 Mean Square Error
29 6 4 MSE = 238,816

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