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Forecasting
Learning Objectives
List the elements of a good forecast.
Outline the steps in the forecasting process.
Compare and contrast qualitative and quantitative
approaches to forecasting.
Briefly describe averaging techniques, trend and
seasonal techniques, and regression analysis,
and solve typical problems.
Describe measure(s) of forecast accuracy.
Describe evaluating and controlling forecasts.
3-2
FORECAST:
A statement about the future value of a
variable of interest such as demand.
Forecasting is used to make informed
decisions
Match supply to demand.
Two important aspects:
Level of demand
Degree of accuracy
Long-range – plan the system (strategic)
Short-range – plan to use the system (on-
going operations)
3-3
Forecasts
Forecasts affect decisions and activities
throughout an organization
Accounting Cost/profit estimates
3-5
Elements of a Good Forecast
Timely
Reliable Accurate
Written
Cost Effective
3-6
Steps in the Forecasting Process
“The forecast”
3-7
Forecasting Process
1. Identify the 2. Collect historical 3. Plot data and identify
purpose of forecast data patterns
7.
Is accuracy of No 8b. Select new
forecast forecast model or
acceptable? adjust parameters of
existing model
Yes
9. Adjust forecast based 10. Monitor results
8a. Forecast over
on additional qualitative and measure forecast
planning horizon
information and insight accuracy
12-8
Types of Forecasts
3-9
Judgmental Forecasts
Executive opinions
Sales force opinions
Consumer surveys
Outside opinion
Delphi method
Opinions of managers and staff
Achieves a consensus forecast
3-10
Time Series Forecasts
Trend - long-term movement in data
Seasonality - short-term regular
variations in data
Cycle – wavelike variations of more than
one year’s duration
Irregular variations - caused by unusual
circumstances
Random variations - caused by chance
3-11
Forecast Variations
Irregular
variation
Trend
Cycles
90
89
88
Seasonal variations
3-12
Naive Forecasts
Uh, give me a minute....
We sold 250 wheels last
week.... Now, next week
we should sell....
3-13
Naïve Forecasts
Simple to use
Virtually no cost
Quick and easy to prepare
Data analysis is nonexistent
Easily understandable
Cannot provide high accuracy
Can be a standard for accuracy
3-14
Techniques for Averaging
Moving average
Weighted moving average
Exponential smoothing
3-15
Moving Averages
Moving average – A technique that averages a
number of recent actual values, updated as
new values become available.
At-n + … At-2 + At-1
Ft = MAn=
n
Weighted moving average – More recent
values in a series are given more weight in
computing the forecast.
wnAt-n + … wn-1At-2 + w1At-1
Ft = WMAn=
n
3-16
Moving Average Example
Calculate a three-period moving average forecast for demand in period 6
If the actual demand in period 6 is 38, then the moving average forecast for
period 7 is:
3-17
Simple Moving Average
Actual
MA5
47
45
43
41
39
37 MA3
35
1 2 3 4 5 6 7 8 9 10 11 12
1 42
2 40 10%
3 43 20%
4 40 30%
5 41 40%
3-19
Exponential Smoothing
3-20
Exponential Smoothing Example
F3 F2 ( A2 F2 )
0.10, F3 42 0.10(40 42) 42 0.10 (2) 42 0.2 41.8
F4 F3 ( A3 F3 )
0.10, F4 41.8 0.10(43 41.8) 41.8 0.10 1.2 41.8 0.12 41.92
3-21
Picking a Smoothing Constant
Actual
50
.4
.1
Demand
45
40
35
1 2 3 4 5 6 7 8 9 10 11 12
Period
3-22
Common Nonlinear Trends
Parabolic
Exponential
Growth
3-23
Linear Trend Equation
Ft
Ft = a + bt
0 1 2 3 4 5 t
Ft = Forecast for period t
t = Specified number of time periods
a = Value of Ft at t = 0
b = Slope of the line
3-24
Calculating a and b
n (ty) - t y
b =
2
n t - ( t) 2
y - b t
a =
n
3-25
Linear Trend Equation Example
t y
2
Week t Sales ty
1 1 150 150
2 4 157 314
3 9 162 486
4 16 166 664
5 25 177 885
3-26
Linear Trend Calculation
5 (2499) - 15(812) 12495-12180
b = = = 6.3
5(55) - 225 275 -225
812 - 6.3(15)
a = = 143.5
5
y = 143.5 + 6.3t
3-27
Associative Forecasting
3-28
Regression Methods
Linear regression
mathematical technique that relates a
dependent variable to an independent
variable in the form of a linear equation
Primary method for Associative Forecasting
Correlation
a measure of the strength of the relationship
between independent and dependent
variables
12-29
Linear Regression Assumptions
Variations around the line are random
Deviations around the line normally
distributed
Predictions are being made only within the
range of observed values
For best results:
Always plot the data to verify linearity
Check for data being time-dependent
Small correlation may imply that other variables
are important
3-30
Linear Model Seems Reasonable
X Y Computed
7 15
relationship
2 10
6 13 50
4 15 40
14 25 30
15 27 20
10
16 24
0
12 20 0 5 10 15 20 25
14 27
20 44
15 34
7 17
A straight line is fitted to a set of sample points.
3-31
Linear Regression
y = a + bx a = y-bx
xy - nxy
b =
x2 - nx2
where
a = intercept
b = slope of the line
x
x = = mean of the x data
n
y
y = n = mean of the y data
12-32
Linear Regression Example
x y
(WINS) (ATTENDANCE) xy x2
4 36.3 145.2 16
6 40.1 240.6 36
6 41.2 247.2 36
8 53.0 424.0 64
6 44.0 264.0 36
7 45.6 319.2 49
5 39.0 195.0 25
7 47.5 332.5 49
49 346.7 2167.7 311
12-33
Linear Regression Example
49
x= = 6.125
8
346.9
y= = 43.36
8
xy - nxy
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
12-34
Linear Regression Example
60,000 –
50,000 –
40,000 –
Attendance, y
| | | | | | | | | | |
0 1 2 3 4 5 6 7 8 9 10
Wins, x
12-35
Correlation and Coefficient of
Determination
Correlation, r
Measure of strength of relationship between the
dependent variable (demand) and the independent
variable
Varies between -1.00 and +1.00
Coefficient of determination, r2
Percentage of variation in dependent variable
resulting from changes in the independent variable
12-36
Computing Correlation
n xy - x y
r=
[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
12-37
Forecast Accuracy
Error - difference between actual value and predicted value
Mean Absolute Deviation (MAD)
Average absolute error
Weights errors linearly.
Mean Squared Error (MSE)
Average of squared error
Gives more weight to larger errors, which typically cause more problems
Mean Absolute Percent Error (MAPE)
Average absolute percent error
MAPE should be used when there is a need to put errors in perspective. For
example, an error of 10 in a forecast of 15 is huge. Conversely, an error of 10 in
a forecast of 10,000 is insignificant. Hence, to put large errors in perspective,
MAPE would be used.
3-38
MAD, MSE, and MAPE
Actual forecast
MAD =
n
2
( Actual forecast)
MSE =
n -1
3-39
Forecast Accuracy Example
3-40
MAD, MSE, and MAPE
MAD – easiest to compute, but weighs
errors linearly.
MSE – Gives more weight to larger
errors; larger errors cause more
problems.
MAPE – Puts errors in perspective: e.g.,
error of 10 in a forecast of 15 is huge, but
error of 10 in a forecast of 10,000 is
perhaps negligible.
3-41
Controlling the Forecast
Control chart
A visual tool for monitoring forecast errors
Used to detect non-randomness in errors
Forecasting errors are in control if
All errors are within the control limits
No patterns, such as trends or cycles, are
present
3-42
Tracking Signal
•Tracking signal
–Ratio of cumulative error to MAD
Tracking signal =
(Actual-forecast)
MAD
Bias – Persistent tendency for forecasts to be
Greater or less than actual values.
3-43
Forecast Control
Tracking signal
monitors the forecast to see if it
is biased high or low
(Dt - Ft) E
Tracking signal = =
MAD MAD
1 MAD ≈ 0.8 б
Control limits of 2 to 5 MADs are
used most frequently
Tracking Signal Values
3-45
Tracking Signal Plot
3-46
Sources of Forecast errors
Model may be inadequate
Irregular variations
Incorrect use of forecasting technique
3-47
Choosing a Forecasting Technique
No single technique works in every
situation
Two most important factors
Cost
Accuracy
Other factors include the availability of:
Historical data
Computers
Time needed to gather and analyze the data
Forecast horizon
3-48
Operations Strategy
Forecasts are the basis for many decisions
Work to improve short-term forecasts
Accurate short-term forecasts improve
Profits
Lower inventory levels
Reduce inventory shortages
Improve customer service levels
Enhance forecasting credibility
3-49
Supply Chain Forecasts
Sharing forecasts with supply can
Improve forecast quality in the supply chain
Lower costs
Shorter lead times
3-50