D1

Forecasting
Predicting the Future
Qualitative forecast methods

subjective

Quantitative forecast methods

based on mathematical formulas

Slide 1
D1

DELL, 2/16/2012

Forecasting and Supply Chain

Management
Accurate forecasting determines how much
inventory a company must keep at various points
along its supply chain
Continuous replenishment

supplier and customer share continuously updated data

typically managed by the supplier
reduces inventory for the company
speeds customer delivery

Variations of continuous replenishment

quick response
JIT (just(just-in
in--time)
VMI (vendor(vendor-managed inventory)
stockless inventory

Forecasting and TQM

Accurate forecasting customer demand is a
key to providing good quality service
Continuous replenishment and JIT
complement TQM

eliminates the need for buffer inventory, which, in

turn, reduces both waste and inventory costs, a
primary goal of TQM
smoothes process flow with no defective items
meets expectations about on-time delivery, which is
perceived as good-quality service

Types of Forecasting Methods

Depend on

time frame
demand behavior
causes of behavior

Time Frame
Indicates how far into the future is
forecast

Short-- to midShort
mid-range forecast
typically encompasses the immediate future
daily up to two years

Long--range forecast
Long

usually encompasses a period of time longer

than two years

Demand Behavior
Trend

a gradual, longlong-term up or down movement of

demand

Random variations

movements in demand that do not follow a pattern

Cycle

an upup-and
and--down repetitive movement in demand

Seasonal pattern

an upup-and
and--down repetitive movement in demand
occurring periodically

Demand

Demand

Forms of Forecast Movement

Random
movement
Time
(b) Cycle

Demand

Demand

Time
(a) Trend

Time
(c) Seasonal pattern

Time
(d) Trend with seasonal pattern

Forecasting Methods
Qualitative

use management judgment, expertise, and opinion to

predict future demand

Time series

statistical techniques that use historical demand data

to predict future demand

Regression methods

attempt to develop a mathematical relationship

between demand and factors that cause its behavior

Qualitative Methods
Management, marketing, purchasing,
and engineering are sources for internal
qualitative forecasts
Delphi method

involves soliciting forecasts about

technological advances from experts

Forecasting Process
1. Identify the
purpose of forecast

2. Collect historical
data

3. Plot data and identify

patterns

6. Check forecast
accuracy with one or
more measures

5. Develop/compute
forecast for period of
historical data

4. Select a forecast
model that seems
appropriate for data

7.
Is accuracy of
forecast
acceptable?

No

8b. Select new

forecast model or
adjust parameters of
existing model

Yes
8a. Forecast over
planning horizon

9. Adjust forecast based

on additional qualitative
information and insight

10. Monitor results

and measure forecast
accuracy

Time Series
Assume that what has occurred in the past will
continue to occur in the future
Relate the forecast to only one factor - time
Include

moving average
exponential smoothing
linear trend line

Moving Average
Naive forecast

demand of the current period is used as

next periods forecast

Simple moving average

stable demand with no pronounced

behavioral patterns

Weighted moving average

weights are assigned to most recent data

Moving Average:
Nave Approach
MONTH
Jan
Feb
Mar
Apr
May
June
July
Aug
Sept
Oct
Nov

ORDERS
PER MONTH
120
90
100
75
110
50
75
130
110
90
-

FORECAST
120
90
100
75
110
50
75
130
110
90

Simple Moving Average

n

Di

i=1
MAn =

where
n = number of periods in
the moving average
Di = demand in period i

3-month Simple Moving Average

3

MONTH
Jan
Feb
Mar
Apr
May
June
July
Aug
Sept
Oct
Nov

ORDERS
PER MONTH
120
90
100
75
110
50
75
130
110
90
-

MOVING
AVERAGE

103.3
88.3
95.0
78.3
78.3
85.0
105.0
110.0

Di

i=1
MA3 =

3
90 + 110 + 130
3

= 110 orders
for Nov

5-month Simple Moving Average

MONTH
Jan
Feb
Mar
Apr
May
June
July
Aug
Sept
Oct
Nov

ORDERS
PER MONTH
120
90
100
75
110
50
75
130
110
90
-

MOVING
AVERAGE

99.0
85.0
82.0
88.0
95.0
91.0

Di

i=1
MA5 =

90 + 110 + 130+75+50
5
= 91 orders
for Nov

Smoothing Effects
150
5-month

125

Orders

100
75
3-month

50
Actual

25
0

|
Jan

|
Feb

|
Mar

|
|
Apr May

|
|
June July

Month

|
|
Aug Sept

|
Oct

|
Nov

Weighted Moving Average

Adjusts
moving
average
method to
more closely
reflect data
fluctuations

WMAn =

Wi Di

i=1

where

Wi = the weight for period i,

between 0 and 100
percent

Wi = 1.00

Weighted Moving Average Example

MONTH

WEIGHT

DATA

17%
33%
50%

130
110
90

August
September
October

November Forecast

WMA3 =

Wi Di

i=1

= (0.50)(90) + (0.33)(110) + (0.17)(130)

= 103.4 orders

Exponential Smoothing

Averaging method
Weights most recent data more strongly
Reacts more to recent changes
Widely used, accurate method

Exponential Smoothing (cont.)

Ft +1 =
D
Dt + (1 - )Ft
where:
Ft +1 = forecast for next period
Dt = actual demand for present period
Ft = previously determined forecast for
present period
=

weighting factor, smoothing constant

Effect of Smoothing Constant

0.0

1.0
If
=
= 0.20, then Ft +1 = 0.20
0.20Dt + 0.80 Ft
If
=
= 0, then Ft +1 = 0
0Dt + 1 Ft 0 = Ft
Forecast does not reflect recent data

If
=
= 1, then Ft +1 = 1
1Dt + 0 Ft =Dt
Forecast based only on most recent data

Exponential Smoothing (
(=0.30)
PERIOD

MONTH

DEMAND

1
2
3
4
5
6
7
8
9
10
11
12

Jan
Feb
Mar
Apr
May
Jun
Jul
Aug
Sep
Oct
Nov
Dec

37
40
41
37
45
50
43
47
56
52
55
54

F2 = D1 + (1 - )F1
= (0.30)(37) + (0.70)(37)
= 37
F3 = D2 + (1 - )F2
= (0.30)(40) + (0.70)(37)
= 37.9
F13 = D12 + (1 - )F12
= (0.30)(54) + (0.70)(50.84)
= 51.79

Exponential Smoothing
(cont.)
PERIOD

MONTH

DEMAND

1
2
3
4
5
6
7
8
9
10
11
12
13

Jan
Feb
Mar
Apr
May
Jun
Jul
Aug
Sep
Oct
Nov
Dec
Jan

37
40
41
37
45
50
43
47
56
52
55
54

FORECAST, Ft + 1
( = 0.3)
( = 0.5)

37.00
37.90
38.83
38.28
40.29
43.20
43.14
44.30
47.81
49.06
50.84
51.79

37.00
38.50
39.75
38.37
41.68
45.84
44.42
45.71
50.85
51.42
53.21
53.61

Exponential Smoothing (cont.)

70
Actual

60

= 0.50

Orders

50
40
= 0.30
30
20
10
0

|
1

|
2

|
3

|
4

|
5

|
6
Month

|
7

|
8

|
9

|
10

|
11

|
12

|
13

Adjusted Exponential Smoothing

AFt +1 = Ft +1 + Tt +1
where
T = an exponentially smoothed trend factor
Tt +1 = (Ft +1 - Ft) + (1 - ) Tt
where
Tt = the last period trend factor
=

= a smoothing constant for trend

Adjusted Exponential
Smoothing (
(=0.30)
PERIOD

MONTH

DEMAND

1
2
3
4
5
6
7
8
9
10
11
12

Jan
Feb
Mar
Apr
May
Jun
Jul
Aug
Sep
Oct
Nov
Dec

37
40
41
37
45
50
43
47
56
52
55
54

T3

= (F3 - F2) + (1 - ) T2
= (0.30)(38.5 - 37.0) + (0.70)(0)
= 0.45

AF3 = F3 + T3 = 38.5 + 0.45

= 38.95
T13 = (F13 - F12) + (1 - ) T12
= (0.30)(53.61 - 53.21) + (0.70)(1.77)
= 1.36
AF13 = F13 + T13 = 53.61 + 1.36 = 54.96

Adjusted Exponential Smoothing:

Example
PERIOD

MONTH

DEMAND

FORECAST
Ft +1

1
2
3
4
5
6
7
8
9
10
11
12
13

Jan
Feb
Mar
Apr
May
Jun
Jul
Aug
Sep
Oct
Nov
Dec
Jan

37
40
41
37
45
50
43
47
56
52
55
54

37.00
37.00
38.50
39.75
38.37
38.37
45.84
44.42
45.71
50.85
51.42
53.21
53.61

TREND
Tt +1

ADJUSTED
FORECAST AFt +1

0.00
0.45
0.69
0.07
0.07
1.97
0.95
1.05
2.28
1.76
1.77
1.36

37.00
38.95
40.44
38.44
38.44
47.82
45.37
46.76
58.13
53.19
54.98
54.96

Adjusted Exponential Smoothing

Forecasts
70
Adjusted forecast (
( = 0.30)

60

Actual

Demand

50
40
Forecast (
( = 0.50)

30
20
10
0

|
1

|
2

|
3

|
4

|
5

|
|
6
7
Period

|
8

|
9

|
10

|
11

|
12

|
13

Forecast Accuracy
Forecast error

difference between forecast and actual demand

MAD

MAPD

mean absolute deviation

mean absolute percent deviation

Cumulative error
Average error or bias

Mean Absolute Deviation

(MAD)
Dt - Ft
MAD =
n
where
t = period number
Dt = demand in period t
Ft = forecast for period t
n = total number of periods
= absolute value

MAD Example
PERIOD
1
2
3
4
5
6
7
8
9
10
11
12

DEMAND, Dt
37
40
41
37
MAD
45
50
43
47
56
52
55
54
557

=
=
=

Ft ( =0.3)

37.00
37.00
37.90
D38.83
t - Ft
n38.28
40.29
53.39
43.20
1143.14
44.30
4.8547.81
49.06
50.84

(Dt - Ft)

|Dt - Ft|

3.00
3.10
-1.83
6.72
9.69
-0.20
3.86
11.70
4.19
5.94
3.15

3.00
3.10
1.83
6.72
9.69
0.20
3.86
11.70
4.19
5.94
3.15

49.31

53.39

Other Accuracy Measures

Mean absolute percent deviation (MAPD)

|Dt - Ft|
MAPD =
Dt
Cumulative error
E = et
Average error

et
E= n

Comparison of Forecasts

FORECAST

MAD

MAPD

(E)

Exponential smoothing (
(=
= 0.30)
Exponential smoothing (
(=
= 0.50)
Adjusted exponential smoothing
(
=
= 0.50,
=
= 0.30)
Linear trend line

4.85
4.04
3.81

9.6%
8.5%
7.5%

49.31
33.21
21.14

4.48
3.02
1.92

2.29

4.9%

Regression Methods
Linear regression

a mathematical technique that relates a

dependent variable to an independent
variable in the form of a linear equation

Correlation

a measure of the strength of the relationship

between independent and dependent
variables

Linear Regression
y = a + bx

a = y-bx
xy

xy - nxy
b =
xx2 - nx2

where
a = intercept
b = slope of the line
x
x
= mean of the x data
n
yy

y = n = mean of the y data

x =

xy - nxy
b =
x2 - nx2
a = y-bx
where
n = number of periods
x
x =
= mean of the x values
n
y
y = n = mean of the y values

Linear Regression Example

x

y
(Sales)

xy

x2

4
6
6
8
6
7
5
7

36.3
40.1
41.2
53.0
44.0
45.6
39.0
47.5

145.2
240.6
247.2
424.0
264.0
319.2
195.0
332.5

16
36
36
64
36
49
25
49

49

346.7

2167.7

311

(Money spent on R & D)

Linear Regression Example (cont.)

49
= 6.125
8
346.9
y=
= 43.36
8
x=

xy - nxy2
b=
x2 - nx2
(2,167.7) - (8)(6.125)(43.36)
=
(311) - (8)(6.125)2
= 4.06
a = y - bx
= 43.36 - (4.06)(6.125)
= 18.46

Linear Regression Example (cont.)

Regression equation

forecast for x = 7

y = 18.46 + 4.06x

y = 18.46 + 4.06(7)
= 46.88, or 46,880

60,000

Attendance, y

50,000
40,000
30,000

Linear regression line,

y = 18.46 + 4.06x
4.06x

20,000
10,000
|
0

|
1

|
2

|
3

|
4

|
5
Wins, x

|
6

|
7

|
8

|
9

|
10

Correlation and Coefficient of

Determination
Correlation, r
Measure of strength of relationship
Varies between -1.00 and +1.00

Coefficient of determination, r2
Percentage of variation in dependent
variable resulting from changes in the
independent variable

Computing Correlation
r=

n xy - x y
[n x2 - ( x)2] [n
[n y2 - ( y)2]
(8)(2,167.7) - (49)(346.9)

r=

[(8)(311) - (49)2] [(8)(15,224.7) - (346.9)2]

r = 0.947
Coefficient of determination
r2 = (0.947)2 = 0.897

 Environ Inc. produces and installs solar panels. During the past
ten years, the sales revenue has increased from Rs. 25000000/25000000/to Rs. 65000000/65000000/ Calculate the companys growth rate in sales using the constant
growth model with annual compounding. You can use the
following formula for the constant growth model with annual
compounding:
St = S0(1+g)t, where
St = Sales at time t; S0 = Initial sales; g = growth rate.
Derive a fivefive-year and tenten-year sales forecast.