LECTURE 10

Forecasting

Forecasting
Predicting the future
Qualitative forecast methods
subjective

Quantitative forecast methods

based on mathematical formulas

2014 John Wiley & Sons, Inc. - Russell and Taylor 8e

12-2

The Effect of Inaccurate Forecasting

2014 John Wiley & Sons, Inc. - Russell and Taylor 8e

12-3

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

2014 John Wiley & Sons, Inc. - Russell and Taylor 8e

12-4

Components of Forecasting Demand

Time frame
Demand behavior
Causes of behavior

2014 John Wiley & Sons, Inc. - Russell and Taylor 8e

12-5

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

2014 John Wiley & Sons, Inc. - Russell and Taylor 8e

12-6

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

2014 John Wiley & Sons, Inc. - Russell and Taylor 8e

12-7

Forms of Forecast Movement

2014 John Wiley & Sons, Inc. - Russell and Taylor 8e

12-8

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

2014 John Wiley & Sons, Inc. - Russell and Taylor 8e

12-9

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

2014 John Wiley & Sons, Inc. - Russell and Taylor 8e

12-10

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

2014 John Wiley & Sons, Inc. - Russell and Taylor 8e

9. Adjust forecast based

on additional qualitative
information and insight

10. Monitor results

and measure forecast
accuracy

12-11

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

nave forecast
moving average
exponential smoothing
linear trend line

2014 John Wiley & Sons, Inc. - Russell and Taylor 8e

12-12

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

good for stable demand with no pronounced
behavioral patterns

Weighted moving average

weights are assigned to most recent data

2014 John Wiley & Sons, Inc. - Russell and Taylor 8e

12-13

 2014 John Wiley & Sons, Inc. - Russell and Taylor 8e

12-14

Moving Average: Nave Approach

MONTH

ORDERS
PER MONTH

Jan

120

Feb

90

Mar

100

Apr

75

May

110

Nov
June

-50

July

75

Aug

130

2014 John Wiley & Sons, Inc. - Russell and Taylor 8e

FORECAST

12-15

Moving Average: Nave Approach

MONTH

ORDERS
PER MONTH

Jan

120

Feb

90

Mar

100

Apr

75

May

110

Nov
June

-50

July

75

Aug

130

2014 John Wiley & Sons, Inc. - Russell and Taylor 8e

FORECAST
120
90
100
75
110
50
75
130
110
90

12-16

Simple Moving Average

n

i = 1 Di

MAn =

where
n
Di

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

2014 John Wiley & Sons, Inc. - Russell and Taylor 8e

12-17

3-month Simple Moving Average

ORDERS
MONTH
Jan
MONTH

PER

i = 1 Di

120

Feb

90

Mar

100

Apr

75

May

110

June

50

July

75

Aug

130

2014 John Wiley & Sons, Inc. - Russell and Taylor 8e

Sept

MOVING
AVERAGE

110

MA3 =

12-18

3-month Simple Moving Average

ORDERS
MONTH
Jan
MONTH

PER

120

Feb

90

Mar

100

Apr

75

May

110

June

50

July

75

Aug

130

2014 John Wiley & Sons, Inc. - Russell and Taylor 8e

Sept

110

MOVING
AVERAGE

103.3
88.3
95.0
78.3
78.3
85.0
105.0
110.0

i = 1 Di

MA3 =
=

3
90 + 110 + 130
3

= 110 orders for Nov

12-19

5-month Simple Moving Average

ORDERS
MONTH
Jan
MONTH

PER

i = 1 Di

120

Feb

90

Mar

100

Apr

75

May

110

June

50

July

75

Aug

130

2014 John Wiley & Sons, Inc. - Russell and Taylor 8e

Sept

MOVING
AVERAGE

110

MA5 =

12-20

5-month Simple Moving Average

ORDERS
MONTH
Jan
MONTH

PER

120

Feb

90

Mar

100

Apr

75

May

110

June

50

July

75

Aug

130

2014 John Wiley & Sons, Inc. - Russell and Taylor 8e

Sept

110

MOVING
AVERAGE

99.0
85.0
82.0
88.0
95.0
91.0

i = 1 Di

MA5 =
=

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

12-21

Smoothing Effects

2014 John Wiley & Sons, Inc. - Russell and Taylor 8e

12-22

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

2014 John Wiley & Sons, Inc. - Russell and Taylor 8e

12-23

 2014 John Wiley & Sons, Inc. - Russell and Taylor 8e

12-24

Weighted Moving Average Example

MONTH
August
September
October
November Forecast

2014 John Wiley & Sons, Inc. - Russell and Taylor 8e

WEIGHT

DATA

17%
33%
50%

130
110
390

= 1W D
WMA3 = i
i
i

12-25

Weighted Moving Average Example

MONTH
August
September
October
November Forecast

WEIGHT

DATA

17%
33%
50%

130
110
390

= 1W D
WMA3 = i
i
i

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

= 103.4 orders

2014 John Wiley & Sons, Inc. - Russell and Taylor 8e

12-26

Exponential Smoothing

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

2014 John Wiley & Sons, Inc. - Russell and Taylor 8e

12-27

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

2014 John Wiley & Sons, Inc. - Russell and Taylor 8e

12-28

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

2014 John Wiley & Sons, Inc. - Russell and Taylor 8e

12-29

 2014 John Wiley & Sons, Inc. - Russell and Taylor 8e

12-30

Exponential Smoothing (=0.30)

F2 = D1 + (1 - )F1

PERIOD
DEMAND
1

MONTH
Jan

37

Feb

40

Mar

41

Apr

37

May

45

Jun

50

Jul

43

Aug

47

2014 John Wiley & Sons, Inc. - Russell and Taylor 8e

F3 = D2 + (1 - )F2

F13 = D12 + (1 - )F12

12-31

Exponential Smoothing (=0.30)

F2 = D1 + (1 - )F1

PERIOD
DEMAND
1

MONTH
Jan

37

Feb

40

Mar

41

Apr

37

May

45

Jun

50

Jul

43

Aug

47

2014 John Wiley & Sons, Inc. - Russell and Taylor 8e

= (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

12-32

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

2014 John Wiley & Sons, Inc. - Russell and Taylor 8e

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

12-33

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

2014 John Wiley & Sons, Inc. - Russell and Taylor 8e

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

12-34

Exponential Smoothing

2014 John Wiley & Sons, Inc. - Russell and Taylor 8e

12-35

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

2014 John Wiley & Sons, Inc. - Russell and Taylor 8e

12-36

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

2014 John Wiley & Sons, Inc. - Russell and Taylor 8e

12-37

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

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

2014 John Wiley & Sons, Inc. - Russell and Taylor 8e

Ft ( =0.3)
37.00
37.00
37.90
38.83
38.28
40.29
43.20
43.14
44.30
47.81
49.06
50.84

(Dt - Ft)

|Dt - Ft|

12-38

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

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

2014 John Wiley & Sons, Inc. - Russell and Taylor 8e

Ft ( =0.3)

(Dt - Ft)

|Dt - Ft|

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

12-39

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

2014 John Wiley & Sons, Inc. - Russell and Taylor 8e

12-40

Other Accuracy Measures

Mean absolute percent deviation (MAPD)
MAPD =

|Dt - Ft|
Dt

Cumulative error
E = et
Average error

et

E= n
2014 John Wiley & Sons, Inc. - Russell and Taylor 8e

12-41

Comparison of Forecasts
FORECAST

MAD

MAPD

(E)

Exponential smoothing (= 0.30)

4.85

9.6%

49.31

4.48

Exponential smoothing (= 0.50)

4.04

8.5%

33.21

3.02

Based on the table, the company

should choose 5-month forecast
because the smaller MAD indicates a
more accurate forecast
2014 John Wiley & Sons, Inc. - Russell and Taylor 8e

12-42