05 Forecasting

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Chapter 5
Forecasting
To accompany Quantitative Analysis for Management, Tenth Edition, by Render, Stair, and Hanna Power Point slides created by Jeff Heyl
2008 Prentice-Hall, Inc. 2009 Prentice-Hall, Inc.
Introduction
!! Managers are always trying to reduce
uncertainty and make better estimates of what will happen in the future !! This is the main purpose of forecasting !! Some firms use subjective methods !! Seat-of-the pants methods, intuition, experience !! There are also several quantitative techniques !! Moving averages, exponential smoothing, trend projections, least squares regression analysis
2009 Prentice-Hall, Inc.
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Introduction
!! Eight steps to forecasting :
1.! Determine the use of the forecastwhat objective are we trying to obtain? 2.! Select the items or quantities that are to be forecasted 3.! Determine the time horizon of the forecast 4.! Select the forecasting model or models 5.! Gather the data needed to make the forecast 6.! Validate the forecasting model 7.! Make the forecast 8.! Implement the results
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Introduction
!! These steps are a systematic way of initiating,
!!
!! !! !!
designing, and implementing a forecasting system When used regularly over time, data is collected routinely and calculations performed automatically There is seldom one superior forecasting system Different organizations may use different techniques Whatever tool works best for a firm is the one they should use
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Forecasting Models
Forecasting Techniques Qualitative Models Delphi Methods Jury of Executive Opinion Sales Force Composite Consumer Market Survey Time-Series Methods Moving Average Exponential Smoothing Trend Projections Figure 5.1 Decomposition
Causal Methods Regression Analysis Multiple Regression
Time-Series Models
!! Time-series models attempt to predict the
future based on the past !! Common time-series models are

!! Nave
!! Simple moving average and weighted moving
average !! Exponential smoothing !! Trend projections !! Decomposition
!! Regression analysis is used in trend
projections and one type of decomposition model

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Causal Models
!! Causal models use variables or factors
that might influence the quantity being forecasted !! The objective is to build a model with the best statistical relationship between the variable being forecast and the independent variables !! Regression analysis is the most common technique used in causal modeling
Qualitative Models
!! Qualitative models incorporate judgmental
or subjective factors !! Useful when subjective factors are thought to be important or when accurate quantitative data is difficult to obtain !! Common qualitative techniques are
!! Delphi method !! Jury of executive opinion !! Sales force composite !! Consumer market surveys
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Qualitative Models
!! Delphi Method an iterative group process where
(possibly geographically dispersed) respondents provide input to decision makers !! Jury of Executive Opinion collects opinions of a small group of high-level managers, possibly using statistical models for analysis !! Sales Force Composite individual salespersons estimate the sales in their region and the data is compiled at a district or national level !! Consumer Market Survey input is solicited from customers or potential customers regarding their purchasing plans
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Scatter Diagrams
Scatter diagrams are helpful when forecasting time-series data because they depict the relationship between variables.
450 400 350 300 250 200 150 100 50 0 0 2 4
Radios
Annual Sales
Televisions
t Discs Compac
6 Time (Years) 8 10 12
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Scatter Diagrams
!! Wacker Distributors wants to forecast sales for
three different products

TELEVISION SETS 250 250 250 250 250 250 250 250 250 250
YEAR 1 2 3 4 5 6 7 8 9 10
Table 5.1
RADIOS 300 310 320 330 340 350 360 370 380 390
COMPACT DISC PLAYERS 110 100 120 140 170 150 160 190 200 190
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Scatter Diagrams
(a)
Annual Sales of Televisions 330 250 " " " " " " " " " " 200 150 100 50
| | | | | | | | | |
!! Sales appear to be
constant over time Sales = 250 !! A good estimate of sales in year 11 is 250 televisions
0 1 2 3 4 5 6 7 8 9 10
Time (Years)
Figure 5.2
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Scatter Diagrams
(b)
Annual Sales of Radios 420 400 380 360 340 320 300 " 280
|
!! Sales appear to be
" " "
"
"
"
"
"
"
0 1 2 3 4 5 6 7 8 9 10
increasing at a constant rate of 10 radios per year Sales = 290 + 10(Year) !! A reasonable estimate of sales in year 11 is 400 televisions
Time (Years)
Figure 5.2
Scatter Diagrams
Annual Sales of CD Players
(c)
!! This trend line may

200 180 160 140 120 100 "
|
" " " " "

| | | | | | |
" "
"
"
0 1 2 3 4 5 6 7 8 9 10
not be perfectly accurate because of variation from year to year !! Sales appear to be increasing !! A forecast would probably be a larger figure each year
Time (Years)
Figure 5.2
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Measures of Forecast Accuracy

!! We compare forecasted values with actual values
to see how well one model works or to compare models Forecast error = Actual value Forecast value
!! One measure of accuracy is the mean absolute
deviation (MAD)
MAD =
! forecast error
n
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!! Using a nave forecasting model
YEAR 1 2 3 4 5 6 7 8 9 10 11 ACTUAL SALES OF CD PLAYERS 110 100 120 140 170 150 160 190 200 190 FORECAST SALES 110 100 120 140 170 150 160 190 200 190 ABSOLUTE VALUE OF ERRORS (DEVIATION), (ACTUAL FORECAST) |100 110| = 10 |120 110| = 20 |140 120| = 20 |170 140| = 30 |150 170| = 20 |160 150| = 10 |190 160| = 30 |200 190| = 10 |190 200| = 10 Sum of |errors| = 160 MAD = 160/9 = 17.8
Table 5.2
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!! Using a nave forecasting model
YEAR 1 2 3 5 MAD = 6 7 8 9 10 11 4 ACTUAL SALES OF CD PLAYERS 110 100 120 FORECAST SALES 110 100 ABSOLUTE VALUE OF ERRORS (DEVIATION), (ACTUAL FORECAST) |100 110| = 10 |120 110| = 20 |140 120| = 20 |170 140| = 30 |150 170| = 20 |160 150| = 10 |190 160| = 30 |200 190| = 10 |190 200| = 10 Sum of |errors| = 160 MAD = 160/9 = 17.8
! forecast error
140 170 150 160 190 200 190
160 = 17.8 170 9

120 140 150 160 190 200 190
Table 5.2
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!! There are other popular measures of forecast
accuracy !! The mean squared error
MSE =
! (error )
n
!! The mean absolute percent error
MAPE =
! actual
n
error
100%
!! And bias is the average error and tells whether the
forecast tends to be too high or too low and by how much. Thus, it can be negative or positive.
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Year 1 2 3 4 5 6 7 8 9 10 11 Actual CD Sales 110 100 120 140 170 150 160 190 200 190 110 100 120 140 170 150 160 190 200 190 10 20 20 30 20 10 30 10 10 Forecast Sales |Actual -Forecast|
Sum of |errors| MAD
160 17.8
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Hospital Days Forecast Error Example

Ms. Smith forecasted total hospital inpatient days last year. Now that the actual data are known, she is reevaluating her forecasting model. Compute the MAD, MSE, and MAPE for her forecast.
Month JAN FEB MAR APR MAY JUN JUL AUG SEP OCT NOV DEC Forecast 250 320 275 260 250 275 300 325 320 350 365 380 Actual 243 315 286 256 241 298 292 333 326 378 382 396
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Hospital Days Forecast Error Example

JAN FEB MAR APR MAY JUN JUL AUG SEP OCT NOV DEC AVERAGE Forecast 250 320 275 260 250 275 300 325 320 350 365 380 Actual 243 315 286 256 241 298 292 333 326 378 382 396 MAD= 11.83 |error| 7 5 11 4 9 23 8 8 6 28 17 16 MSE= 192.83 error2 49 25 121 16 81 529 64 64 36 784 289 256 MAPE= .0381*100 = 3.81
|error/actual| 0.03 0.02 0.04 0.02 0.04 0.08 0.03 0.02 0.02 0.07 0.04 0.04
Time-Series Forecasting Models

!! A time series is a sequence of evenly
spaced events (weekly, monthly, quarterly, etc.) !! Time-series forecasts predict the future based solely of the past values of the variable !! Other variables, no matter how potentially valuable, are ignored
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Decomposition of a Time-Series
!! A time series typically has four components
1.!Trend (T) is the gradual upward or downward movement of the data over time 2.!Seasonality (S) is a pattern of demand fluctuations above or below trend line that repeats at regular intervals 3.!Cycles (C) are patterns in annual data that occur every several years 4.!Random variations (R) are blips in the data caused by chance and unusual situations
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Demand for Product or Service Trend Component Seasonal Peaks Actual Demand Line Average Demand over 4 Years
Year 1 Figure 5.3
Year 2
Time
Year 3
Year 4
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!! There are two general forms of time-series
models !! The multiplicative model

!! The additive model
Demand = T x S x C x R
Demand = T + S + C + R
!! Models may be combinations of these two
forms !! Forecasters often assume errors are normally distributed with a mean of zero
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Nave Forecast *
!! Nave forecast is the simplest technique. It
uses the actual demand for the past period as the forecasted demand for the next period !! This makes the theory that the past will repeat. !! Also assumes that any time series components are either reflected in the previous periods demand or do not exist. Nave forecast, Ft+1 = Yt
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Nave Forecast *
Period 1 2 3 4 5 6 Actual Demand 35 40 55 65 60 35 40 55 65 60 Forecast
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Moving Averages
!! Moving averages can be used when demand is
relatively steady over time !! The next forecast is the average of the most recent n data values from the time series !! The most recent period of data is added and the oldest is dropped
irregularities in the data series
!!This methods tends to smooth out short-term
Moving average forecast =
Sum of demands in previous n periods n

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Moving Averages
!! Mathematically
Ft +1 =
where
Yt + Yt !1 + ... + Yt ! n+1 n
Ft +1 = forecast for time period t + 1 Yt = actual value in time period t n = number of periods to average
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Wallace Garden Supply Example

!! Wallace Garden Supply wants to
forecast demand for its Storage Shed !! They have collected data for the past year !! They are using a three-month moving average to forecast demand (n = 3)
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MONTH January February March April May June July August September October November December January Table 5.3
ACTUAL SHED SALES 10 12 13 16 19 23 26 30 28 18 16 14
THREE-MONTH MOVING AVERAGE
(10 + 12 + 13)/3 = 11.67 (12 + 13 + 16)/3 = 13.67 (13 + 16 + 19)/3 = 16.00 (16 + 19 + 23)/3 = 19.33 (19 + 23 + 26)/3 = 22.67 (23 + 26 + 30)/3 = 26.33 (26 + 30 + 28)/3 = 28.00 (30 + 28 + 18)/3 = 25.33 (28 + 18 + 16)/3 = 20.67 (18 + 16 + 14)/3 = 16.00
Weighted Moving Averages

!! Weighted moving averages use weights to put
more emphasis on recent periods !! Often used when a trend or other pattern is emerging
Ft +1 =
! ( Weight in period i )( Actual value in period) ! ( Weights)

Ft +1 = w1Yt + w2Yt !1 + ... + w nYt ! n +1 w1 + w2 + ... + w n
!! Mathematically
where wi = weight for the ith observation

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Weighted Moving Averages

!! Both simple and weighted averages are
effective in smoothing out fluctuations in the demand pattern in order to provide stable estimates !! Problems
!!Increasing the size of n smoothes out
fluctuations better, but makes the method less sensitive to real changes in the data !!Moving averages can not pick up trends very well they will always stay within past levels and not predict a change to a higher or lower level

!! Wallace Garden Supply decides to try a
weighted moving average model to forecast demand for its Storage Shed !! They decide on the following weighting scheme
WEIGHTS APPLIED 3 2 1 6 Sum of the weights
PERIOD Last month Two months ago Three months ago
3 x Sales last month + 2 x Sales two months ago + 1 X Sales three months ago
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MONTH January February March April May June July August September October November December January Table 5.4
ACTUAL SHED SALES 10 12 13 16 19 23 26 30 28 18 16 14
THREE-MONTH WEIGHTED MOVING AVERAGE
[(3 X 13) + (2 X 12) + (10)]/6 = 12.17 [(3 X 16) + (2 X 13) + (12)]/6 = 14.33 [(3 X 19) + (2 X 16) + (13)]/6 = 17.00 [(3 X 23) + (2 X 19) + (16)]/6 = 20.50 [(3 X 26) + (2 X 23) + (19)]/6 = 23.83 [(3 X 30) + (2 X 26) + (23)]/6 = 27.50 [(3 X 28) + (2 X 30) + (26)]/6 = 28.33 [(3 X 18) + (2 X 28) + (30)]/6 = 23.33 [(3 X 16) + (2 X 18) + (28)]/6 = 18.67 [(3 X 14) + (2 X 16) + (18)]/6 = 15.33
Program 5.1A
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Program 5.1B
Exponential Smoothing
!! Exponential smoothing is easy to use and
requires little record keeping of data !! It is a type of moving average
New forecast = Last periods forecast + !(Last periods actual demand Last periods forecast) Where ! is a weight (or smoothing constant) with a value between 0 and 1 inclusive A larger ! gives more importance to recent data while a smaller value gives more importance to past data 2009 Prentice-Hall, Inc.
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Exponential Smoothing
!! Mathematically
Ft +1 = Ft + " (Yt ! Ft )
where Ft+1 = new forecast (for time period t + 1) Ft = previous forecast (for time period t) ! = smoothing constant (0 ! ! ! 1) Yt = previous periods actual demand
!! The idea is simple the new estimate is the
old estimate plus some fraction of the error in the last period
Exponential Smoothing Example

!! In January, Februarys demand for a certain
car model was predicted to be 142 !! Actual February demand was 153 autos !! Using a smoothing constant of ! = 0.20, what is the forecast for March?
New forecast (for March demand) = 142 + 0.2(153 142) = 144.2 or 144 autos
!! If actual demand in March was 136 autos, the
April forecast would be
New forecast (for April demand) = 144.2 + 0.2(136 144.2) = 142.6 or 143 autos
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Selecting the Smoothing Constant

!! Selecting the appropriate value for
! is key to obtaining a good forecast !! The objective is always to generate an accurate forecast !! The general approach is to develop trial forecasts with different values of ! and select the ! that results in the lowest MAD
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Port of Baltimore Example

!! Exponential smoothing forecast for two values of
ACTUAL TONNAGE UNLOADED 180 168 159 175 190 205 180 182 ? 175 175.5 = 175.00 + 0.10(180 175) 174.75 = 175.50 + 0.10(168 175.50) 173.18 = 174.75 + 0.10(159 174.75) 173.36 = 173.18 + 0.10(175 173.18) 175.02 = 173.36 + 0.10(190 173.36) 178.02 = 175.02 + 0.10(205 175.02) 178.22 = 178.02 + 0.10(180 178.02) 178.60 = 178.22 + 0.10(182 178.22) FORECAST USING ! =0.10
QUARTER 1 2 3 4 5 6 7 8 9 Table 5.5
FORECAST USING ! =0.50 175 177.5 172.75 165.88 170.44 180.22 192.61 186.30 184.15
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Selecting the Best Value of !

QUARTER 1 2 3 4 5 6 7 8 ACTUAL TONNAGE UNLOADED 180 168 159 175 190 205 180 182 Best choice FORECAST WITH ! = 0.10 175 175.5 174.75 173.18 173.36 175.02 178.02 178.22 ABSOLUTE DEVIATIONS FOR ! = 0.10 5".. 7.5.. 15.75 1.82 16.64 29.98 1.98 3.78 82.45 !|deviations| n = 10.31 MAD = FORECAST WITH ! = 0.50 175 177.5 172.75 165.88 170.44 180.22 192.61 186.30 ABSOLUTE DEVIATIONS FOR ! = 0.50 5". 9.5.. 13.75 9.12 19.56 24.78 12.61 4.3.. 98.63
Sum of absolute deviations
Table 5.6
MAD =
12.33
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Program 5.2A
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Program 5.2B
PM Computer: Moving Average Example

!! PM Computer assembles customized personal
computers from generic parts
!! The owners purchase generic computer parts in volume at a discount from a variety of sources whenever they see a good deal.
!! It is important that they develop a good
forecast of demand for their computers so they can purchase component parts efficiently.
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PM Computers: Data
Period Month Actual Demand 1 Jan 37 2 Feb 40 3 Mar 41 4 Apr 37 5 May 45 6 June 50 7 July 43 8 Aug 47 9 Sept 56 !! Compute a 2-month moving average
!! !! !!
Compute a 3-month weighted average using weights of 4,2,1 for the past three months of data Compute an exponential smoothing forecast using ! = 0.7, previous forecast of 40 Using MAD, what forecast is most accurate? 2009 Prentice-Hall, Inc.
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PM Computers: Moving Average Solution

2 month MA Abs. Dev 3 month WMA Abs. Dev Exp.Sm. 37.00 37.00 38.50 40.50 39.00 41.00 47.50 46.50 45.00 51.50 5.29 2.50 3.50 6.00 9.00 4.50 0.50 11.00 40.14 38.57 42.14 46.71 45.29 46.29 51.57 5.43 3.14 6.43 7.86 3.71 1.71 9.71 39.10 40.43 38.03 42.91 47.87 44.46 46.24 53.07 4.95 3.00 1.90 3.43 6.97 7.09 4.87 2.54 9.76 Abs. Dev
Exponential smoothing resulted in the lowest MAD.

MAD
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Exponential Smoothing with Trend Adjustment

!! Like all averaging techniques, exponential
smoothing does not respond to trends !! A more complex model can be used that adjusts for trends !! The basic approach is to develop an exponential smoothing forecast then adjust it for the trend Forecast including trend (FITt) = New forecast (Ft) + Trend correction (Tt)
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Exponential Smoothing with Trend Adjustment

!! The equation for the trend correction uses a
new smoothing constant " !! Tt is computed by
Tt +1 = (1 ! " )Tt + " ( Ft +1 ! Ft )

where Tt+1 = smoothed trend for period t + 1 Tt = smoothed trend for preceding period " = trend smooth constant that we select Ft+1 = simple exponential smoothed forecast for period t + 1 Ft = forecast for pervious period
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Selecting a Smoothing Constant

!! As with exponential smoothing, a high value of
!! !!
!! !!
" makes the forecast more responsive to changes in trend A low value of " gives less weight to the recent trend and tends to smooth out the trend Values are generally selected using a trial-anderror approach based on the value of the MAD for different values of " Simple exponential smoothing is often referred to as first-order smoothing Trend-adjusted smoothing is called second-order, double smoothing, or Holts method
Trend Projection
!! Trend projection fits a trend line to a
series of historical data points !! The line is projected into the future for medium- to long-range forecasts !! Several trend equations can be developed based on exponential or quadratic models !! The simplest is a linear model developed using regression analysis
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Trend Projection
!! Trend projections are used to forecast time-
series data that exhibit a linear trend.
!! A trend line is simply a linear regression
equation in which the independent variable (X) is the time period !! Least squares may be used to determine a trend projection for future forecasts.
!! Least squares determines the trend line forecast by
minimizing the mean squared error between the trend line forecasts and the actual observed values.
!! The independent variable is the time period and
the dependent variable is the actual observed value in the time series.
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Trend Projection
!! The mathematical form is: 0 Where: = predicted value Y b0 = intercept b1 = slope of the line X = time period (i.e., X = 1, 2, 3, ", n)
= b + b1 X Y
b1 = #xy nx y ------------#x2 nx 2
b0 = y b1 x
Where: #= summation sign for n data points x = values of independent variables y= values of dependent variables n = number of data points or observations x = average of the values of the xs y = average of the values of the ys
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Trend Projection
Dist7
Value of Dependent Variable
*
Dist1
Dist5 Dist3
Dist6
Dist2
Dist4
Time
Figure 5.4
Midwestern Manufacturing Company Example

!! Midwestern Manufacturing Company has
experienced the following demand for its electrical generators over the period of 2001 2007
YEAR 2001 2002 2003 2004 2005 2006 2007 ELECTRICAL GENERATORS SOLD 74 79 80 90 105 142 122
Table 5.7
Determine the forecast for 2008 and 2009, and plot a time series.
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Notice code instead of actual years
Program 5.3A
r2 says model predicts about 80% of the variability in demand Significance level for F-test indicates a definite relationship
Program 5.3B
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!! The forecast equation is
= 56.71+ 10.54 X Y
!! To project demand for 2008, we use the coding
system to define X = 8
(sales in 2008) = 56.71 + 10.54(8) = 141.03, or 141 generators

!! Likewise for X = 9
(sales in 2009) = 56.71 + 10.54(9) = 151.57, or 152 generators


160 150 140 Generator Demand 130 120 110 100 90 80 70 60 50
| | | | | | | | |
" " " " " " " "

Actual Demand Line Trend Line = 56.71+ 10.54 X Y
Figure 5.5
2001 2002 2003 2004 2005 2006 2007 2008 2009 Year
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Program 5.4A
Program 5.4B
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Seasonal Variations
!! Recurring variations over time may
indicate the need for seasonal adjustments in the trend line !! A seasonal index indicates how a particular season compares with an average season !! When no trend is present, the seasonal index can be found by dividing the average value for a particular season by the average of all the data
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Seasonal Variations
!! Eichler Supplies sells telephone
answering machines !! Data has been collected for the past two years sales of one particular model !! They want to create a forecast that includes seasonality
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Seasonal Variations
SALES DEMAND MONTH January February March April May June July August September October November December YEAR 1 80 85 80 110 115 120 100 110 85 75 85 80 YEAR 2 100 75 90 90 131 110 110 90 95 85 75 80 AVERAGE TWO- YEAR DEMAND 90 80 85 100 123 115 105 100 90 80 80 80 MONTHLY DEMAND 94 94 94 94 94 94 94 94 94 94 94 94 AVERAGE 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
Total average demand = 1,128
Average monthly demand =
1,128 = 94 12 months
Seasonal index =
Average two-year demand Average monthly demand

Table 5.8
Seasonal Variations
!! The calculations for the seasonal indices are
Jan. Feb. Mar. Apr. May June
1,200 ! 0.957 = 96 12
July Aug. Sept. Oct. Nov. Dec.
1,200 ! 1.117 = 112 12
1,200 ! 0.851 = 85 12
1,200 ! 0.904 = 90 12 1,200 ! 1.064 = 106 12 1,200 ! 1.309 = 131 12 1,200 ! 1.223 = 122 12
1,200 ! 1.064 = 106 12

1,200 ! 0.957 = 96 12 1,200 ! 0.851 = 85 12 1,200 ! 0.851 = 85 12 1,200 ! 0.851 = 85 12
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Seasonal Variations with Trends

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CHAPTER 5 FORECASTING
!! When both trend and seasonal components

TABLE 5.11 Centered Moving Averages and Seasonal Ratios for Turner Industries
YEAR 1 QUARTER 1 2 3 4 2 3 4 2 3 SALES ($1,000,000s) 108 125 150 141 134 159 152 142 168
CMA
SEASONAL RATIO
are present in a time series, a change from one month to the next could be due to a trend, to a seasonal variation, or simply to random fluctuations. !! To help with this problem, the seasonal indices should be computed using centered moving average approach whenever trend is present. !! Using this approach prevents a variation due to trend from being incorrectly interpreted as a variation due to the season.
132.000 134.125 138.875 141.125 143.000 147.875 2 1 116 136.375 3 1 123 145.125 4 165
1.136 1.051 0.851 0.965 1.127 1.063 0.848 0.960
we take quarters 2, 3, and 4 of year 1, plus one-half of quarter 1 for year 1 and one-half of quarter 1 for year 2. The average will be CMA 1quarter 3 of year 12 = 0.511082 + 125 + 150 + 141 + 0.511162 4 = 132.00
We compare the actual sales in this quarter to the CMA and we have the following seasonal ratio: Seasonal ratio = Sales in quarter 3 150 = = 1.136 CMA 132.00
Thus, sales in quarter 3 of year 1 are about 13.6% higher than an average quarter at this time. 2009 Inc. 5 67 All of the CMAs and the seasonal ratios arePrentice-Hall, shown in Table 5.11. Since there are two seasonal ratios for each quarter, we average these to get the seasonal index. Thus, Index for quarter 1 = I1 = 10.851 + 0.8482> 2 = 0.85 Index for quarter 4 = I4 = 11.051 + 1.0632> 2 = 1.06 Index for quarter 2 = I2 = 10.965 + 0.9602> 2 = 0.96 Index for quarter 3 = I3 = 11.136 + 1.1272> 2 = 1.13
Steps Used to Compute Seasonal Indices based on CMAs

1. 2. 3. 4.
The sum of these indices should be the number of seasons (4) since an average season should have an index of 1. In this example, the sum is 4. If the sum were not 4, an adjustment would be made. We would multiply each index by 4 and divide this by the sum of the indices. Steps Used to Compute Seasonal Indices Based on CMAs Compute a CMA for each observation (where possible). Compute seasonal ratio = Observation/CMA for that observation. Average seasonal ratios to get seasonal indices. If seasonal indices do not add to the number of seasons, multiply each index by (Number of seasons)/(Sum of the indices).
1.! Compute a CMA for each observation (where Figure 5.5 provides a scatterplot of the Turner Industries data and the CMAs. Notice that
the plot of the CMAs is much smoother than the original data. A definite trend is apparent in the possible) data. 2.! Compute seasonal ratio = Observation/CMA for that observation. 3.! Average seasonal ratios to get seasonal indices. (This eliminates as much randomness as possible.) 4.! If seasonal indices do not add to the number of seasons, multiply each index by (Number of seasons)/(Sum of the indices).
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Turner Industries Example

174
TABLE 5.11 Centered Moving Averages and Seasonal Ratios for Turner Industries
YEAR 1
QUARTER 1 2 3 4
SALES ($1,000,000s) 108 125 150 141 116 134 159 152 123 142 168 165
CMA
SEASONAL RATIO
132.000 134.125 136.375 138.875 141.125 143.000 145.125 147.875
1.136 1.051 0.851 0.965 1.127 1.063 0.848 0.960
1 2 3 4
1 2 3 4
Thus, sales in quarter 3 of year 1 are about 13.6% higher than an average quarter at this time. All of the CMAs and the seasonal ratios are shown in Table 5.11. 2009 Prentice-Hall, Inc. 5 69 Since there are two seasonal ratios for each quarter, we average these to get the seasonal index. Thus, Index for quarter 1 = I1 = 10.851 + 0.8482> 2 = 0.85 Index for quarter 4 = I4 = 11.051 + 1.0632> 2 = 1.06 Index for quarter 2 = I2 = 10.965 + 0.9602> 2 = 0.96 Index for quarter 3 = I3 = 11.136 + 1.1272> 2 = 1.13
The sum of these indices should be the number of seasons (4) since an average season should have an index of 1. In this example, the sum is 4. If the sum were not 4, an adjustment would be made. We would multiply each index by 4 and divide this by the sum of the indices.
Turner Industries Example

1. 2. 3. 4.
Steps Used to Compute Seasonal Indices Based on CMAs Compute a CMA for each observation (where possible). Compute seasonal ratio = Observation/CMA for that observation. Average seasonal ratios to get seasonal indices. If seasonal indices do not add to the number of seasons, multiply each index by (Number of seasons)/(Sum of the indices).
Figure 5.5 provides a scatterplot of the Turner Industries data and the CMAs. Notice that the plot of the CMAs is much smoother than the original data. A definite trend is apparent in the data.
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Scatter Plot of Turner Industries Sales and CMA
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The Decomposition Method with Trend and Seasonal Components

!! Decomposition is the process of isolating linear
trend and seasonal factors to develop more accurate forecasts !! The first step is to compute seasonal indices for each season, then the data are deseasonalized by dividing each number by its seasonal index !! A trend line is then found using the deseasonalized data.
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CMA 1quarter 3 of year 12 =
0.511082 + 125 + 150 + 141 + 0.511162 4
= 132.00
Thus, sales in quarter 3 of year 1 are about 13.6% higher than an average quarter at this time. All of the CMAs and the seasonal ratios are shown in Table 5.11. Since there are two seasonal ratios for each quarter, we average these to get the seasonal index. Thus, Index for quarter 1 = I1 = 10.851 + 0.8482> 2 = 0.85 Index for quarter 4 = I4 = 11.051 + 1.0632> 2 = 1.06 Index for quarter 2 = I2 = 10.965 + 0.9602> 2 = 0.96 Index for quarter 3 = I3 = 11.136 + 1.1272> 2 = 1.13
12/16/13
Steps to Develop a Forecast Using the Decomposition Method

1. 2. 3. 4.
174
TABLE 5.11 1.! Compute seasonal indices using CMAs. YEAR QUARTER SALES ($1,000,000s) CMA SEASONAL RATIO Figure 5.5 provides a scatterplot of the Turner Industries data and the CMAs. Notice that Centered Moving Turner Industries
1 1 108
the plot of the CMAs is much smoother than the original data. A definite trend is apparent in the Averages and 2.! Deseasonalize the data each number data. Seasonal Ratios forby dividing 2 125
by its seasonal index. 3.! Find the equation of a trend line using the deseasonalized data. 4.! Forecast the future periods using the trend line. 5.! Multiply the trend line forecast by the appropriate seasonal index
3 4 2 3 4 2 3 150 141 134 159 152 142 168 2 1 116 3 1 123 4 165
132.000 134.125 136.375 138.875 141.125 143.000 145.125 147.875
1.136 1.051 0.851 0.965 1.127 1.063 0.848 0.960
Thus, sales in quarter 3 of year 1 are about 13.6% higher than an average quarter at this time. 2009 Inc. 5 73 All of the CMAs and the seasonal ratios arePrentice-Hall, shown in Table 5.11. Since there are two seasonal ratios for each quarter, we average these to get the seasonal index. Thus, Index for quarter 1 = I1 = 10.851 + 0.8482> 2 = 0.85 Index for quarter 4 = I4 = 11.051 + 1.0632> 2 = 1.06 Index for quarter 2 = I2 = 10.965 + 0.9602> 2 = 0.96 Index for quarter 3 = I3 = 11.136 + 1.1272> 2 = 1.13
Deseasonalized Data for Turner Industries

1. 2. 3. 4.
Figure 5.5 provides a scatterplot of the Turner Industries data and the CMAs. Notice that the plot of the CMAs is much smoother than the original data. A definite trend is apparent in the data.
5 74
37
CMA 1quarter 3 of year 12 =
0.511082 + 125 + 150 + 141 + 0.511162 4
= 132.00
Thus, sales in quarter 3 of year 1 are about 13.6% higher than an average quarter at this time. All of the CMAs and the seasonal ratios are shown in Table 5.11. Since there are two seasonal ratios for each quarter, we average these to get the seasonal index. Thus, Index for quarter 1 = I1 = 10.851 + 0.8482> 2 = 0.85 Index for quarter 4 = I4 = 11.051 + 1.0632> 2 = 1.06 Index for quarter 2 = I2 = 10.965 + 0.9602> 2 = 0.96 Index for quarter 3 = I3 = 11.136 + 1.1272> 2 = 1.13
12/16/13
Finding the Trend Line of Deseasonalized Data

1. 2. 3. 4.
b1 = 2.34, b0 = 124.78 Figure 5.5 provides a scatterplot of the Turner Industries data and the CMAs. Notice that the plot of the CMAs is much smoother than the original data. A definite trend is apparent in the Y = 124.78 + 2.34X where X = time data.
This equation is used to develop the forecast based on trend, and the result is multiplied by the appropriate seasonal index to make a seasonal adjustment. The forecast for the first quarter of year 4 (time period = 13 and seasonal index I1 = 0.85) Y = 124.78 + 2.34X = 124.78 + 2.34(13) = 155.2 (forecast before adjustment for seasonality) Multiply this by the seasonal index for quarter 1: Y x I1 = 155.2 x 0.85 = 131.92 Find the forecast for quarters 2, 3 and 4 of the next year.
Regression with Trend and Seasonal Components

!! Multiple regression can be used to forecast both
trend and seasonal components in a time series

!! One independent variable is time
!! Dummy independent variables are used to represent the
seasons
!! The model is an additive decomposition model
= a + b1 X 1 + b2 X 2 + b3 X 3 + b4 X 4 Y
where X1 X2 X3 X4 = time period = 1 if quarter 2, 0 otherwise = 1 if quarter 3, 0 otherwise = 1 if quarter 4, 0 otherwise
38
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Program 5.6A
Program 5.6B (partial)

39
12/16/13

!! The resulting regression equation is
= 104.1 + 2.3 X 1 + 15.7 X 2 + 38.7 X 3 + 30.1X 4 Y

!! Using the model to forecast sales for the first two
quarters of next year
= 104.1+ 2.3(13) + 15.7(0) + 38.7(0) + 30.1(0) = 134 Y = 104.1+ 2.3(14) + 15.7(1) + 38.7(0) + 30.1(0) = 152 Y
!! These are different from the results obtained
using the multiplicative decomposition method !! Use MAD and MSE to determine the best model

!! American Airlines original spare parts inventory
system used only time-series methods to forecast the demand for spare parts
!! This method was slow to responds to even moderate
changes in aircraft utilization let alone major fleet expansions
!! They developed a PC-based system named RAPS
which uses linear regression to establish a relationship between monthly part removals and various functions of monthly flying hours
!! The computation now takes only one hour instead of
the days the old system needed
!! Using RAPS provided a one time savings of $7 million
and a recurring annual savings of nearly $1 million
5 80
40
12/16/13
Monitoring and Controlling Forecasts

!! Tracking signals can be used to monitor
the performance of a forecast !! Tracking signals are computed using the following equation
Tracking signal =
where
RSFE MAD
MAD =
! forecast error
n
5 81

Signal Tripped + 0 MADs Upper Control Limit Tracking Signal Acceptable Range
Lower Control Limit
Time
Figure 5.7
41
12/16/13

!! Positive tracking signals indicate demand is !! !!
!! !! !!
greater than forecast Negative tracking signals indicate demand is less than forecast Some variation is expected, but a good forecast will have about as much positive error as negative error Problems are indicated when the signal trips either the upper or lower predetermined limits This indicates there has been an unacceptable amount of variation Limits should be reasonable and may vary from item to item

!! How do you decide on the upper and lower limits?
!! Too small a value will trip the signal too often and
too large will cause a bad forecast
!! Plossl & Wight use maximums of 4 MADs for
high volume stock items and 8 MADs for lower volume items
!! One MAD is equivalent to approximately 0.8
standard deviation so that 4 MADs =3.2 s.d.
!! For a forecast to be in control, 89% of the errors
are expected to fall within 2 MADs, 98% with 3 MADs or 99.9% within 4 MADs whenever the errors are approximately normally distributed
5 84
42
12/16/13
Kimballs Bakery Example

!! Tracking signal for quarterly sales of croissants
TIME PERIOD FORECAST DEMAND ACTUAL DEMAND ERROR RSFE |FORECAST | | ERROR | CUMULATIVE ERROR MAD TRACKING SIGNAL
1 2 3 4 5 6
100 100 100 110 110 110
90 95 115 100 125 140
10 5 +15 10 +15 +30
10 15 0 10 +5 +35
10 5 15 10 15 30
10 15 30 40 55 85
10.0 7.5 10.0 10.0 11.0 14.2
1 2 0 1 +0.5 +2.5
n RSFE 35 Tracking signal = = = 2.5MADs MAD 14.2

MAD =
! forecast error
85 = 14.2 6
Forecasting at Disney
!! The Disney chairman receives a daily
report from his main theme parks that contains only two numbers the forecast of yesterdays attendance at the parks and the actual attendance
!! An error close to zero (using MAPE as the
measure) is expected
!! The annual forecast of total volume
conducted in 1999 for the year 2000 resulted in a MAPE of 0
5 86
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12/16/13
Using The Computer to Forecast

!! Spreadsheets can be used by small and
medium-sized forecasting problems !! More advanced programs (SAS, SPSS, Minitab) handle time-series and causal models !! May automatically select best model parameters !! Dedicated forecasting packages may be fully automatic !! May be integrated with inventory planning and control
44

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2008 Prentice-Hall, Inc. 2009 Prentice-Hall, Inc.

2009 Prentice-Hall, Inc.

Causal Methods Regression Analysis Multiple Regression

future based on the past !! Common time-series models are

!! Simple moving average and weighted moving

average !! Exponential smoothing !! Trend projections !! Decomposition

!! Regression analysis is used in trend

projections and one type of decomposition model

2009 Prentice-Hall, Inc.

2009 Prentice-Hall, Inc.

2009 Prentice-Hall, Inc.

three different products

!! This trend line may

" " " " "

Measures of Forecast Accuracy

!! One measure of accuracy is the mean absolute

2009 Prentice-Hall, Inc.

Measures of Forecast Accuracy

2009 Prentice-Hall, Inc.

Measures of Forecast Accuracy

160 = 17.8 170 9

2009 Prentice-Hall, Inc.

Measures of Forecast Accuracy

accuracy !! The mean squared error

!! The mean absolute percent error

!! And bias is the average error and tells whether the

2009 Prentice-Hall, Inc.

Measures of Forecast Accuracy

Sum of |errors| MAD

2009 Prentice-Hall, Inc.

Hospital Days Forecast Error Example

2009 Prentice-Hall, Inc.

Hospital Days Forecast Error Example

Time-Series Forecasting Models

2009 Prentice-Hall, Inc.

2009 Prentice-Hall, Inc.

Year 1 Figure 5.3

2009 Prentice-Hall, Inc.

models !! The multiplicative model

2009 Prentice-Hall, Inc.

2009 Prentice-Hall, Inc.

2009 Prentice-Hall, Inc.

!!This methods tends to smooth out short-term

Moving average forecast =

Sum of demands in previous n periods n

2009 Prentice-Hall, Inc.

Wallace Garden Supply Example

2009 Prentice-Hall, Inc.

Wallace Garden Supply Example

ACTUAL SHED SALES 10 12 13 16 19 23 26 30 28 18 16 14

THREE-MONTH MOVING AVERAGE

Weighted Moving Averages

! ( Weight in period i )( Actual value in period) ! ( Weights)

where wi = weight for the ith observation

Weighted Moving Averages

Wallace Garden Supply Example

PERIOD Last month Two months ago Three months ago

Wallace Garden Supply Example

ACTUAL SHED SALES 10 12 13 16 19 23 26 30 28 18 16 14

THREE-MONTH WEIGHTED MOVING AVERAGE

Wallace Garden Supply Example

Wallace Garden Supply Example