Chapter Two

Forecasting
Planning
Forecast

Customer

Production Finished
Inputs Process Goods
Forecasting
Marketing: forecasts sales for new and
existing products.

Production: uses sales forecasts to plan

production and operations; sometimes
involved in generating sales forecasts.
Characteristics of Forecasts
They are usually wrong
A good forecast is usually more than a single
number
Aggregate forecast are more accurate
The longer the forecasting horizon, the less
accurate the forecasts will be
Forecasts should not be used to the exclusion of
known information
Forecasting Horizon
Short term
(inventory management, production plans..)
Intermediate term
(sales patterns for product families..)
Long term
(long term planning of capacity needs)
Forecasting Techniques
Forecasting
Technique

Judgmental Time Series

Models Causal Methods
Methods

Delphi Moving Regression

Method Average Analysis

Exponential
Smoothing

Seasonality
Models
Types of forecasting Methods

Subjective methods
Sales force composites
Customer survey
Jury of executive opinion
The Delphi method

Objective methods
Causal methods
Time series methods
Qualitative Methods
Dont have data
Dont have time to develop a forecast
Often used in practice
Close enough
Depend on expert opinions
Market surveys
More appropriate for long term forecasts
Delphi Technique
A method to obtain a consensus forecast
by using opinions from a group of
experts
expert opinion
consulting salespersons
consulting consumers
 Causal Methods
Causal methods use data from sources other than the
series being predicted.

If Y is the phenomenon to be forecast and X1 , X2 , . .., Xn

are the n variables we believe to be related to Y, then a
causal model is one in which the forecast for Y is some
function of these variables:

Y = f (X1 , X2 , . .., Xn )

Econometric models are causal models in which the

relationship between Y and (X1 , X2 , . .., Xn ) is linear.
That is
Y = ao + a1 X1 + a2 X2 + an Xn
for some constants a1 , a2 , . . . , an
Forecasting Steps for
Quantitative Methods
Collect data
Reduce/clean data
Build and evaluate model(s)
Forecast (model extrapolation)
Track the forecast
Identify the correct pattern
Collect data. Look for possible cause/effect
relationships
Determine which form can be used to
generate the pattern
Determine specific values of the parameters
 1600

Sales in thousands of cases 1400

1200

1000

800

600

400

200

Period
Building Models
Plot data over time. (remove outliers & get right scale).
Using part of the data, estimate model parameters.
Forecast the rest of the data with the model.
Evaluate accuracy of the model.
Use judgment to modify.
Keep track of model accuracy over time (redo, if needed).
Forecasting Stationary
Series
Time series Analysis
Patterns that arise most often

Trend
Seasonality
Cycles
Randomness
Fig. 2-2
Time Series Patterns
 Notation

Dt : Observed value of the demand during period t

time series we would like to predict

{Dt , t 1} :
forecast made for period t in period t-1
forecast made at the end of t-1 after having

Ft : observed , ,

Dt 1 Dt 2
Time Series Forecast

Ft an Dt n
n 0

For some set of weights

a0 , a1 ,....
Evaluating forecasts
Forecast error in period t

et Ft Dt

For multiple-step-ahead

et Ft Dt
Evaluating Forecasts
Mean Absolute Deviation
n

| e | i
MAD i 1
n
Mean Square Error
n

e 2
i
MSE i 1
n
Fig. 2-3

Forecast Errors Over Time

 TIME SERIES METHODS
Stationary Series
A stationary time series is represented by a
constant plus a random fluctuation:
Dt = + t
where is an unknown constant corresponding to
the mean of the series and t is a random error
with mean 0 and variance 2 .
The methods described for stationary series are:
MovingAverages
Exponential Smoothing
Methods of Forecasting
Stationary Series
Moving Averages
t 1

D i
Dt 1 Dt 2 ... Dt N
Ft i t N

N N
Exponential Smoothing

Ft Dt 1 (1 ) Ft 1
Moving Average

Dt 1 Dt 2 ... Dt N
Ft
N
Month Deliveries
Jan 120
Feb 90
Mar 100
Apr 75
May 110
Jun 50
Jul 75
Aug 130
Sep 110
Oct 90
Month Deliveries MA(3) MA(6)
Jan 120
Feb 90
Mar 100
Apr 75 103
May 110 88
Jun 50 95
Jul 75 78 91
Aug 130 78 83
Sep 110 85 90
Oct 90 105 92
110 94
Month Deliveries MA(3) MA(6)
1 2
2 4
3 6
4 8 4
5 10 6
6 12 8
7 14 10 7
8 16 12 9
9 18 14 11
10 20 16 13
11 22 18 15
12 24 20 17
22 19
Fig. 2-4

Moving-Average Forecasts
Lag Behind a Trend
 EXPONENTIAL SMOOTHING
Current forecast is a weighted average of the
last forecast and the current value of demand

New forecast = (current observation of demand)

+ (1- ) (last forecast)
Exponential Smoothing
Ft Dt 1 (1 ) Ft 1
Ft Ft 1 ( Ft 1 Dt 1 )
Ft Ft 1 et 1

Ft = Ft-1 (fraction of the observed forecast error in t-1)

If we forecast high in period t-1 error is positive adjustment
to decrease current forecast
If we forecast low in period t-1 error is negative adjustment
to increase current forecast
Ft Dt 1 (1 ) Ft 1
Ft 1 Dt 2 (1 ) Ft 2

Ft Dt 1 (1 ) Dt 2 (1 ) 2 Ft 2

Ft 1 Dt i 1
i

i o
Example

Quarter Failures Forecast

1 200 200
2 250 200
3 175 205
4 186 202
5 225 201
6 285 203
7 305 211
8 190 220
Fig. 2-5

Weights in Exponential
Smoothing
Fig. 2-6

Exponential Smoothing for

Different Values of Alpha
Smaller values of produce more stable forecasts,
whereas larger values of will produce forecasts
which react more quickly to changes in the demand
pattern.
Comparison
1 N ( N 1) N 1
(1 2 3 ... N )
N N 2

1
i 1
i 1

i 1

1 N 1

2
Similarities & Differences
Stationary series ES weighted average
Single parameter of all past data
Lag behind a trend MA only last N periods
When =2/(N+1)

Same distribution of MA : save past N data

forecast error ES : only last forecast
Multiple-Step-Ahead Forecasts
Same as one-step-ahead-forecast
Trend Based Methods
Regression Analysis

Ft a bt
Double Exponential
Smoothing

Ft ,t St Gt
Double Exponential Smoothing
Intercept at time t

St Dt (1 )( St 1 Gt 1 )
and slope at time t

Gt ( St St 1 ) (1 )Gt 1

Ft ,t St Gt