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Chapter 12

Forecasting

Lecture Outline
Strategic Role of Forecasting in Supply Chain
Management
Components of Forecasting Demand
Time Series Methods
Forecast Accuracy
Time Series Forecasting Using Excel
Regression Methods

Copyright 2011 John Wiley & Sons, Inc.

12-2

Forecasting
Predicting the future
Qualitative forecast methods
subjective

Quantitative forecast methods


based on mathematical formulas

Copyright 2011 John Wiley & Sons, Inc.

12-3

Supply Chain Management


Accurate forecasting determines inventory levels
in the supply chain
Continuous replenishment

supplier & 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-in-time)
VMI (vendor-managed inventory)
stockless inventory

Copyright 2011 John Wiley & Sons, Inc.

12-4

The Effect of Inaccurate Forecasting

Copyright 2011 John Wiley & Sons, Inc.

12-5

Forecasting
Quality Management
Accurately forecasting customer demand is a key to
providing good quality service

Strategic Planning
Successful strategic planning requires accurate
forecasts of future products and markets

Copyright 2011 John Wiley & Sons, Inc.

12-6

Types of Forecasting Methods


Depend on
time frame
demand behavior
causes of behavior

Copyright 2011 John Wiley & Sons, Inc.

12-7

Time Frame
Indicates how far into the future is forecast
Short- to mid-range forecast
typically encompasses the immediate future
daily up to two years
Long-range forecast
usually encompasses a period of time longer than
two years

Copyright 2011 John Wiley & Sons, Inc.

12-8

Demand Behavior
Trend
a gradual, long-term up or down movement of demand

Random variations
movements in demand that do not follow a pattern

Cycle
an up-and-down repetitive movement in demand

Seasonal pattern
an up-and-down repetitive movement in demand
occurring periodically
12-9

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
12-10

Forecasting Methods
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
use management judgment, expertise, and opinion to predict
future demand

12-11

Qualitative Methods
Management, marketing, purchasing, and
engineering are sources for internal qualitative
forecasts
Delphi method
involves soliciting forecasts about technological
advances from experts

12-12

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

12-13

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

12-14

Moving Average
Naive forecast
demand in current period is used as next periods
forecast

Simple moving average


uses average demand for a fixed sequence of periods
stable demand with no pronounced behavioral
patterns

Weighted moving average


weights are assigned to most recent data

Copyright 2011 John Wiley & Sons, Inc.

12-15

Naive forecasts
We sold 250 wheels last
week.... Now, next week we
should sell.

250 wheels

F(t+1) = At
At : Actual demand in period t
F(t+1) : Forecast of demand for period t+1

Moving Average: Nave Approach


MONTH

ORDERS
PER MONTH

Jan

120

Feb

90

Mar

100

Apr

75

May

110

June

50

July

75

Aug

130

Sept

110

Oct

90

Nov

Copyright 2011 John Wiley & Sons, Inc.

FORECAST
120
90
100
75
110
50
75
130
110
90

12-17

Simple Moving Average


n

i = 1 Di

MAn =

where
n
Di

Copyright 2011 John Wiley & Sons, Inc.

= number of periods in
the moving average
= demand in period i

12-18

3-month Simple Moving Average


MONTH

ORDERS
PER MONTH

Jan

120

Feb

90

Mar

100

Apr

75

May

110

June

50

July

75

Aug

130

Sept

110

Oct
Nov

90
-

Copyright 2011 John Wiley & Sons, Inc.

MOVING
AVERAGE

103.3
88.3
95.0
78.3
78.3
85.0
105.0
110.0

i=1

MA3 =

Di

3
=

90 + 110 + 130
3

= 110 orders for Nov

12-19

5-month Simple Moving Average


ORDERS
MONTH

PER MONTH

Jan

120

Feb

90

Mar

100

Apr

75

May

110

June

50

July

75

Aug

130

Sept

110

Oct
Nov

90
-

Copyright 2011 John Wiley & Sons, Inc.

MOVING
AVERAGE

99.0
85.0
82.0
88.0
95.0
91.0

i=1

MA5 =
=

Di

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

12-20

Smoothing Effects
150
125

5-month

Orders

100
75
50
3-month

25
Actual

0
|
Jan

|
Feb

|
Mar

|
Apr

|
May

|
|
June July

|
|
Aug Sept

|
Oct

|
Nov

Month
Copyright 2011 John Wiley & Sons, Inc.

12-21

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

W = 1.00
i

Copyright 2011 John Wiley & Sons, Inc.

12-22

Weighted Moving Average Example


MONTH
August
September
October
November Forecast

WEIGHT

DATA

17%
33%
50%

130
110
90

WMA3 = i
= 1 Wi Di

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


= 103.4 orders

Copyright 2011 John Wiley & Sons, Inc.

12-23

Exponential Smoothing

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

Copyright 2011 John Wiley & Sons, Inc.

12-24

Exponential Smoothing
Ft +1 = 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

Copyright 2011 John Wiley & Sons, Inc.

12-25

Effect of Smoothing Constant


0.0 1.0
If = 0.20, then Ft +1 = 0.20Dt + 0.80 Ft
If = 0, then Ft +1 = 0Dt + 1 Ft = Ft
Forecast does not reflect recent data

If = 1, then Ft +1 = 1Dt + 0 Ft =Dt


Forecast based only on most recent data

Copyright 2011 John Wiley & Sons, Inc.

12-26

Exponential Smoothing (=0.30)


PERIOD

MONTH

DEMAND

F2 = D1 + (1 - )F1
1

Jan

37

Feb

40

Mar

41

Apr

37

May

45

Jun

50

Jul

43

Aug

47

Sep

56

10

Oct

52

11

Nov

55

12

Dec

54

Copyright 2011 John Wiley & Sons, Inc.

= (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

12-27

Exponential Smoothing
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

Copyright 2011 John Wiley & Sons, Inc.

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

12-28

Exponential Smoothing
70
60

= 0.50

Actual

50

Orders

40
30

= 0.30

20
10
0
|
1

|
2

|
3

|
4

|
5

|
6

|
7

|
8

|
9

|
10

|
11

|
12

|
13

Month
Copyright 2011 John Wiley & Sons, Inc.

12-29

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
0

Copyright 2011 John Wiley & Sons, Inc.

12-30

Adjusted Exponential Smoothing (=0.30)


PERIOD

MONTH

DEMAND

Jan

37

Feb

40

Mar

41

Apr

37

May

45

Jun

50

Jul

43

Aug

47

Sep

56

10

Oct

52

11

Nov

55

12

Dec

54

Copyright 2011 John Wiley & Sons, Inc.

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 = 54.97

12-31

Adjusted Exponential Smoothing


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

Copyright 2011 John Wiley & Sons, Inc.

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
12-32

Adjusted Exponential Smoothing


Forecasts
70
Adjusted forecast ( = 0.30)

60

Actual

50

Demand

40
30
Forecast ( = 0.50)

20
10
0
|
1

|
2

|
3

Copyright 2011 John Wiley & Sons, Inc.

|
4

|
5

|
|
6
7
Period

|
8

|
9

|
10

|
11

|
12

|
13
12-33

Linear Trend Line


y = a + bx
where
a = intercept
b = slope of the line
x = time period
y = forecast for
demand for period x

Copyright 2011 John Wiley & Sons, Inc.

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

12-34

Least Squares Example


x(PERIOD)

y(DEMAND)

xy

x2

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

73
40
41
37
45
50
43
47
56
52
55
54

37
80
123
148
225
300
301
376
504
520
605
648

1
4
9
16
25
36
49
64
81
100
121
144

78

557

3867

650

Copyright 2011 John Wiley & Sons, Inc.

12-35

Least Squares Example


x = 78 = 6.5
12
y = 557 = 46.42
12
b = xy - nxy = 3867 - (12)(6.5)(46.42) =1.72
x2 - nx2
650 - 12(6.5)2
a = y - bx
= 46.42 - (1.72)(6.5) = 35.2

Copyright 2011 John Wiley & Sons, Inc.

12-36

Linear trend line y = 35.2 + 1.72x


Forecast for period 13 y = 35.2 + 1.72(13) = 57.56 units
70
60
Actual

Demand

50
40
30

Linear trend line

20
10
|
1

|
2

|
3

Copyright 2011 John Wiley & Sons, Inc.

|
4

|
5

|
|
6
7
Period

|
8

|
9

|
10

|
11

|
12

|
13

12-37

Seasonal Adjustments
Repetitive increase and decrease in demand
Use seasonal factor to adjust forecast
Holiday season: toys, sport equipments,
clothing, wine, fruit, etc.

Seasonal factor = Si =

Di
D

12-38

Seasonal Adjustment
YEAR
2002
2003
2004
Total

DEMAND (1000S PER QUARTER)


1
2
3
4
Total
12.6
14.1
15.3
42.0

8.6
10.3
10.6
29.5

D1

42.0
S1 =
=
= 0.28
D 148.7
D2

29.5
S2 =
=
= 0.20
148.7
D

Copyright 2011 John Wiley & Sons, Inc.

6.3
7.5
8.1
21.9

17.5
18.2
19.6
55.3

45.0
50.1
53.6
148.7

D3

21.9
S3 =
=
= 0.15
D 148.7
D4

55.3
S4 =
=
= 0.37
148.7
D

12-39

Seasonal Adjustment
For 2005
y = 40.97 + 4.30x = 40.97 + 4.30(4) = 58.17
SF1 = (S1) (F5) = (0.28)(58.17) = 16.28
SF2 = (S2) (F5) = (0.20)(58.17) = 11.63
SF3 = (S3) (F5) = (0.15)(58.17) = 8.73
SF4 = (S4) (F5) = (0.37)(58.17) = 21.53

Copyright 2011 John Wiley & Sons, Inc.

12-40

Forecast Accuracy
Forecast error
difference between forecast and actual demand

MAD
mean absolute deviation

MAPD
mean absolute percent deviation

Cumulative error
Average error or bias

Copyright 2011 John Wiley & Sons, Inc.

12-41

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

Copyright 2011 John Wiley & Sons, Inc.

12-42

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

DEMAND, Dt

Ft ( =0.3)

(Dt - Ft)

|Dt - Ft|

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

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

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

557

Copyright 2011 John Wiley & Sons, Inc.

12-43

MAD Calculation
Dt - Ft
MAD =
n
53.39
=
11
= 4.85

Copyright 2011 John Wiley & Sons, Inc.

12-44

Other Accuracy Measures


Mean absolute percent deviation (MAPD)
MAPD =

|Dt - Ft|
Dt

Cumulative error
E = et
Average error

et

E= n
Copyright 2011 John Wiley & Sons, Inc.

12-45

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%

Copyright 2011 John Wiley & Sons, Inc.

12-46

Forecast Control
Tracking signal
monitors the forecast to see if it is biased high or low
1 MAD 0.8
Control limits of 2 to 5 MADs are used most
frequently

Tracking signal =

Copyright 2011 John Wiley & Sons, Inc.

(Dt - Ft)
MAD

E
= MAD

12-47

Tracking Signal Values


PERIOD

DEMAND
Dt

FORECAST,
Ft

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

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

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

TS3 =
Copyright 2011 John Wiley & Sons, Inc.

ERROR
Dt - Ft

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

E =
(Dt - Ft)

MAD

3.00
6.10
4.27
10.99
20.68
20.48
24.34
36.04
40.23
46.17
49.32

3.00
3.05
2.64
3.66
4.87
4.09
4.06
5.01
4.92
5.02
4.85

TRACKING
SIGNAL

1.00
2.00
1.62
3.00
4.25
5.01
6.00
7.19
8.18
9.20
10.17

6.10
= 2.00
3.05
12-48

Tracking Signal Plot

Tracking signal (MAD)

3
2

Exponential smoothing ( = 0.30)

1
0
-1
-2
-3

|
0

Linear trend line

|
1

|
2

|
3

Copyright 2011 John Wiley & Sons, Inc.

|
4

|
5

|
6
Period

|
7

|
8

|
9

|
10

|
11

|
12

12-49

Statistical Control Charts

(Dt - Ft)2
n-1

Using we can calculate statistical


control limits for the forecast error
Control limits are typically set at 3

Copyright 2011 John Wiley & Sons, Inc.

12-50

Statistical Control Charts


18.39
12.24

UCL = +3

Errors

6.12
0
-6.12

-12.24
-18.39
LCL = -3
|
0

|
1

|
2

|
3

Copyright 2011 John Wiley & Sons, Inc.

|
4

|
5

|
6
Period

|
7

|
8

|
9

|
10

|
11

|
12

12-51

Time Series Forecasting Using Excel


Excel can be used to develop forecasts:

Moving average
Exponential smoothing
Adjusted exponential smoothing
Linear trend line

Copyright 2011 John Wiley & Sons, Inc.

12-52

Exponentially Smoothed and Adjusted


Exponentially Smoothed Forecasts
=B5*(C11-C10)+
(1-B5)*D10

=C10+D10
=ABS(B10-E10)

=SUM(F10:F20)

=G22/11
Copyright 2011 John Wiley & Sons, Inc.

12-53

Demand and Exponentially Smoothed


Forecast
Click on Insert then Line

Copyright 2011 John Wiley & Sons, Inc.

12-54

Data Analysis Option

Copyright 2011 John Wiley & Sons, Inc.

12-55

Forecasting With Seasonal Adjustment

Copyright 2011 John Wiley & Sons, Inc.

12-56

Forecasting With OM Tools

Copyright 2011 John Wiley & Sons, Inc.

12-57

Regression Methods
Linear regression
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

Copyright 2011 John Wiley & Sons, Inc.

12-58

Linear Regression
y = a + bx

a = y-bx
xy - nxy
b = x2 - nx2
where
a = intercept
b = slope of the line
x
x = n = mean of the x data
y
y = n = mean of the y data

Copyright 2011 John Wiley & Sons, Inc.

12-59

Linear Regression Example


x
(WINS)

y
(ATTENDANCE)

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

Copyright 2011 John Wiley & Sons, Inc.

12-60

Linear Regression Example


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
Copyright 2011 John Wiley & Sons, Inc.

12-61

Linear Regression Example


60,000
50,000

Attendance, y

40,000
30,000

Linear regression line, y


= 18.46 + 4.06x
Attendance forecast for 7 wins

20,000
10,000

|
0

y = 18.46 + 4.06(7)
= 46.88, or 46,880
|
1

|
2

|
3

|
4

|
5

|
6

|
7

|
8

|
9

|
10

Wins, x
Copyright 2011 John Wiley & Sons, Inc.

12-62

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

Copyright 2011 John Wiley & Sons, Inc.

12-63

Computing Correlation
r=

n xy - x y
[n x2 - ( x)2] [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

Copyright 2011 John Wiley & Sons, Inc.

12-64

Regression Analysis With Excel

=INTERCEPT(B5:B12,A5:A12)

=SUM(B5:B12)

Copyright 2011 John Wiley & Sons, Inc.

=CORREL(B5:B12,A5:A12)
12-65

Regression Analysis with Excel

Copyright 2011 John Wiley & Sons, Inc.

12-66

Regression Analysis With Excel

Copyright 2011 John Wiley & Sons, Inc.

12-67

Multiple Regression
Study the relationship of demand to two or more
independent variables
y = 0 + 1x1 + 2x2 + kxk
where
0
= the intercept
1, , k = parameters for the
independent variables
x1, , xk = independent variables
Copyright 2011 John Wiley & Sons, Inc.

12-68

Multiple Regression With Excel

r2, the coefficient


of determination

Copyright 2011 John Wiley & Sons, Inc.

Regression equation
coefficients for x1 and x2

12-69

Multiple Regression Example


y = 19,094.42 + 3560.99 x1 + .0368 x2

y = 19,094.42 + 3560.99 (7) + .0368 (60,000)


= 46,229.35

Copyright 2011 John Wiley & Sons, Inc.

12-70

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Copyright 2011 John Wiley & Sons, Inc.

12-71

Auto sales at Carmens Chevrolet are


shown below.
Develop a 3-week moving average.
Auto Sales

Week
1

10

11

10

13

demand in previous n periods

Moving average =
n

Week Auto
Sales

Three-Week Moving
Average

10

11

(8 + 9 + 10) / 3 = 9

10

(10 + 9 + 11) / 3 = 10

13

(9 + 11 + 10) / 3 = 10

(11 + 10 + 13) / 3 = 11 1/3

Carmens decides to forecast auto


sales by weighting the three weeks as
follows:
Weights Period
Applied
3

Last week

Two weeks ago

Three weeks ago

Total

(weight for period n)(demand in period n)

Weighted moving average =


weights

Week

Auto
Sales

Three-Week Moving Average

10

11

[(3*9) + (2*10) + (1*8)] / 6 = 9 1/6

10

[(3*11) + (2*9) + (1*10)] / 6 = 10 1/6

13

[(3*10) + (2*11) + (1*9)] / 6 = 10 1/6

[(3*13) + (2*10) + (1*11)] / 6 = 11 2/3

Exponential smoothing

Smoothing constant

.2

.05

Example 1

Ft Ft 1 ( A t 1 Ft 1 ) 500 0.1( 450 500) 495 units

Example 2

Month

Actual
Battery Sales

Forecast

January

20

22

February

21

March

15

April

14

May

13

June

16

Example 3
Given the forecast demand and actual
demand for 10-foot fishing boats, compute
the tracking signal and MAD.
Year

Forecast Demand

Actual Demand

78

71

75

80

83

101

84

84

88

60

85

73

Forecast errors

MAD =
n

70

11.7
6