35A00210

Operations Management
Lecture 3
Forecasting
Importance of forecasts
Forecasting methods
Real world forecasting
Lecture 3
Forecasting
Importance of forecasts
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Companies forecast many things
Economic indicators
Advertising impact
Product development time
Competitor behaviour
Weather
Progress in productivity
Learning diffusion
Quality issues
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Raw material prices
Product cycles
Consumer behavior Technology developments
Price development
Values and social changes
Demand
Political environment
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It is hard to know what the future
holds
This telephone has too many shortcomings to be seriously
considered as a means of communication.
- Western Union internal memo, 1876.
Everything that can be invented has been invented
- Charles Duell, Commissioner, US Patent Office, 1899
Who the hell wants to hear actors TALK?
- Harry M. Warner, Warner Brothers, 1927
" Stocks have reached what looks like a permanently high plateau
- Irving Fisher, Professor of Economics, Yale University, 1929
I think there is a world market for maybe five computers.
- Thomas Watson, chairman of IBM, 1943
We dont like their sound, and guitar music is on the way out.
- Decca Records, 1962, from Beatles
There is no reason anyone would want a computer in their home
- Ken Olson, President, Chairman, and founder of DEC, 1977
In a computer, 640K ought to be enough for anybody.
- Bill Gates, 1981
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How valuable right information
would be? - case B-to-B marketplaces -
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Expectations were really high
- Forrester: $1.8 Trillion in 2003
- Goldman Sachs: $1.5 Trillion in 2004
- Yankee Group: $3.0 Trillion in 2004
- AMR Research: $5.7 Trillion in 2004
- Gartner Group: $7.3 Trillion in 2004
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Operations are based on forecasts
Forecasts often used in planning process,
decisi on making and resource all ocation
- long term: location, capacity, technology etc. questions
- short term: production planning, material management, hiring and
scheduling employees, allocating transportation etc.
Competiti on and speed of development
increased the importance lately
- wrong decisions cost more and more
Forecasti ng the future and success go pretty
much hand-in-hand
- good forecast is easy to use, reliable, accurate, timely and
meaningful
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Operations are based on forecasts
- case EuroDisney -
Fourth Disney-park in the world
- in Europe nothing equivalent
- forecasts had to be done based on US parks data
The park was buil d for larger number of visi tors
- Actual number of visitors 15-25% less than expected
Operati ons planned for different consumer
behavior
- park visitors used 10% less money than expected
Quick operati ons decision made to cover losses
- lower prices, cost cutting, targeted investments (shopping mall,
restaurants, congress facilities)
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Economic disaster
More loses (forecasts again too optimistic)
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Lecture 3
Forecasting
Forecasting methods
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Unofficial ones
Forecasting methods
Qualitative (Judgmental) Quantitative (Objective)
Time-series methods
- naive
- straight line
- moving average
- exponential smoothing
- classical decomposition
Causal methods
- regression and correlation
- econometrics
- leading indicators
Intuition, Gut feel
Guessing
Executive opinion
Expert opinion
Delphi-method
Build up -method
Market research
Customer panels
Test marketing
History analog
Life-cycle analog
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Time-series methods
In time-series, forecasts are based on a model
that fits the past data.
- basic assumption is that the future will be no different
- both structural and trend changes will cause problems
Various methods exi st/used.
- differ from each other on how many past periods are taken into
consideration and what are the relative weights of each period
In the real world used mostly for short term
forecasting
- simple and yields good enoughresults
- in practice, demands cycle component is quite hard to estimate due
to large data requirement and random variation of the data
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Time-series methods
- naive and straight line -
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In the naive forecast it is assumed
that the next periods demand is
same than currents one
- easy, cheap and fast method
- in some cases very efficient
- risks are naturally high
units
t
In the straight line forecasting it
is assumed that the trend in
demand will continue
lets budget 3% increase for next year too
Straight line works in stable
environment - case alcohol in Australia-
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Time-series methods
- moving average -
Moving average can be calculated for any number of periods!
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1999 2000 2001 2002 2003 2004
Sales 3y. without weights 3y. with weights
Time-series methods
- exponential smoothing -
The forecast is based on the latest periods
actual sales and the l atest peri ods forecast
- latest actual sales figures will be weighted with so called alfa()
- last forecasts weight will be 1-
Determi ning the correct alfa almost an art form
- large alfa emphasizes latest periods demand more
- same as naive forecast if =1
- typical values used for alfa between 0,1 - 0,3
- low alfa smooths the forecast
- often determined from past data (what fits the demand pattern)
Still wi dely used due to its simplicity
- no subjectivity needed as in giving weights to past periods demands
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Exponential smoothing example 1
Assumed if
not given
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Low alfa smooths the forecast
- theoretical example 2 -
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Determining alfa using historical data
- theoretical example 3 -
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Exponential smoothing example 4
Software company has sold its own platform-product for four years
(sales volumes can be found from the table below). What is the sales
forecast for year 2013 using exponential smoothing with 0,1 alfa?
Assumed when
2009 forecast not given
Forecast for 2013
=
alfa * Sales in 2012 + (1-alfa) * Forecast for 2012
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Exponential smoothing example 4
NOTICE!
Excel uses the term
damping factor
(1-alfa)
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Alfas impact on forecasts in
example 4
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Low alfa unsuitable for growth industries
0
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2009 2010 2011 2012 2013
Sales Forecast alpha 0,1 Forecast alpha 0,7
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Using a seasonal factor
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Problem
14-4
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Time-series methods
- classical decomposition -
Trend
Random
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Time
Cycle
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E.g. 5 years
Season
Year 1
Year 2 S
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Year
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Time
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Evaluating the quality of time-
series forecast
Methods goodness is measured with a forecasting
error
Must pay attention to longer than one periods errors
- different measurements emphasize error differently
forecast
actual
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Evaluating the quality of time-
series forecast
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3 month movi ng average seems to
forecast better than
4 month moving average
problem
14-2
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Causal methods
In causal models forecasts are based on historically
proven cause-effect relationship
- clearly the most developed method in forecasting
Regression models most often used causal models
- linear regression most widely known and used
- complex econometric models have also gained some popularity
Amount of data is not a substitute for quality
- leading indicator -variables most important (see the forest from the trees)
- time lags existence forgotten too often
- correlation and sample coefficient used as a goodness measurements
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problem14-15
Y =1121,2 -0,2819X
Qualitative methods
Judgmental, qualitative methods often used
because of time, knowledge and data problems
- Situations uniqueness not as common as often mentioned
Several different opinion methods used
- Executive opinion
- management knows best, groupthink the main common problem
- Expert opinion (guru-logic)
- validity sometimes questioned
- Delphi-method
- anonymity and justification should cut down the groupthink-effect
- slow and costly method
- Build up-method (sales force forecasts)
- forecast is aggregated from the organization one level at the time
- intentional falsification (both up and down) often noticed
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Qualitative methods
Qualitative data can also be based on tests
- Market research
- suffer a bit from overly optimistic consumption estimates and social bias
in answering
- Customer panels
- real motives, preferences and usage information better understood
- Test marketing
- tests products real demand and popularity
- Finland for example an EU test market for some high tech products
- History analogue
- e.g. new product demand pattern similar to earlier ones
- Life-cycle analogue
- e.g. growth in GSM-phone penetration follows Finlands case
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Lecture 3
Forecasting
Real world forecasting
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Simple forecasting process
1. Choose forecasted variables
2. Choose forecasted time horizon
3. What are results used for?
4. Choose methods to be used
5. Collect data (evaluate chosen methods)
6. Make a forecast
7. Analyze results and act accordingly
8. Evaluate forecasts accuracy
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Choosing the right forecasting
method
A. How accurate a forecast do you need
- adjusting to forecast errors is harder in short term so it is not a bad
idea to try improve forecasting methods
B. Amount of data available
- less data means more qualitative methods
C. Amount of time and resources available
- information technology has sped up the process and lowered the
costs (e.g. Delphi)
D. Economic risks of wrong forecast
- been recently highlighted
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Trade-off between cost and accuracy
Timeframe impacts chosen method
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Strategic forecasting
market entry (demand and price levels)
long-term capacity requirements
new product development
Operative forecasting
production planning and production
procurement and inventory levels
scheduling, maintenance
aggregate planning, employment needs
overtime, subcontracting
logistical solutions
5,000
patients
per year
Complex
mathematical
and subjective
models
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ER 1,000
Surgery 1,000
Other 3,00
Quite
complex
statistical
models
X-ray 500
Dialyse 100
Heart 20
Often
simple
methods
(e.g. ti me series)
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Fundamental
mi stake
Random
noise
Forecasts general truth
Forecasts al most always wrong
- based on historical data, system stability as an assumption
- i.e. do not trust blindly
Important to understand how much forecasts
were wrong and why
- right direction in many cases good enough
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Operative
How to improve the forecast?
standardize working methods
- systematic approach to used data and
methods as well as to who forecasts
- documenting clearly what has been done
use multiple methods
- both top-downand bottom-up
- group methods help against overly
optimistic forecasters
consider forecast incentives
- too much intentional errors
- can you separate forecaster and the user of
forecasts?
re-evaluate the forecasts
- too often forgotten
- tendency to repeat old mistakes!
- do not forget training
choose the correct forecasting unit
- you have to understand the business
understand the difference between
sales and demand
- systems tell only part of the story
- reduced prices, stock-outs, qualityproblems,
campaigns etc.
understand the cost of wrong
forecasts
- e.g. stock-outs consistently forgotten
use large forecasting units
- e.g. product familys demands variation
smaller than individual products
use early sales data
- try to forecast as close to the sales season
as possible and use early data
Process
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Information impacts the quality
Early sales data gives hints about how the sales will
develop
- even a couple days can improve forecast quality tremendously
Especially useful with short product lice-cycle products
- clothes, consumer electronics, books, movies, music, seminars etc.
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Forecast when 20%
of sal es is known
Forecast when 80% of
sales is known
Origi nal forecast
How to survive in fast paced
markets?
Fast paced decision making process?
- new kind attitude toward forecasting
- ABB: 7-3 formulaand pure intuition (wrong forecasts accepted)
- using new information technology in information management
- eases both information handling and sharing
- trusting test market data
- e.g. web pages customer feedback forms, softwares beta-versions
- Redesigning decision making process
- e.g. emphasizing decentralized decision making
Redesigning the whole operati ons?
- product design, improving production processes, flexibility in the
amount of capacity, flexibility of product assortment, decreasing set-
up times, location decisions, training personnel, focusing on value
added tasks, improved supplier relations etc.
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Forecasting doesnt have to be rocket
science - case asking the right questions -
Well do you think
it will be more than
last year?
Do you think that is
mostly servers or direct-
access storage devices?
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