Demand Forecasting

Types of Products and Demand

• Consumer Products: Used by end consumer

• Demand for these products are called as

autonomous demand

• Producer Products: Used in further

production

• Demand for these products are called as

derived demand
 What is Forecasting?
 Process of predicting a
future event
 Underlying basis of
all business decisions
 Production
 Inventory
 Personnel
 Facilities
 Forecasting Time Horizons
 Short-range forecast
 Up to 1 year, generally less than 3 months
 Purchasing, job scheduling, workforce levels, job
assignments, production levels
 Medium-range forecast
 3 months to 3 years
 Sales and production planning, budgeting
 Long-range forecast
 3+ years
 New product planning, facility location, research and
development
 Distinguishing Differences
Medium/long range forecasts deal with more
comprehensive issues and support management
decisions regarding planning and products, plants
and processes
Short-term forecasting usually employs different
methodologies than longer-term forecasting
Short-term forecasts tend to be more accurate
than longer-term forecasts
 Influence of Product Life Cycle

Introduction – Growth – Maturity – Decline

 Introduction and growth require longer forecasts
than maturity and decline
 As product passes through life cycle, forecasts
are useful in projecting
 Staffing levels
 Inventory levels
 Factory capacity
 Product Life Cycle
Introduction Growth Maturity Decline
Best period to Practical to change Poor time to change Cost control critical
increase market share price or quality image image, price, or quality
Company Strategy/Issues

R&D engineering is Strengthen niche Competitive costs

critical become critical
Defend market
position

CD-ROM Fax machines

Internet

Color printers
Sales
3 1/2”
Floppy
Flat-screen disks
monitors DVD

Figure 2.5
 Types of Forecasts
 Economic forecasts
 Address business cycle – inflation rate, money
supply, housing stats, etc.
 Technological forecasts
 Predict rate of technological progress
 Impacts development of new products
 Demand forecasts
 Predict sales of existing product
 Strategic Importance of
Forecasting
 Human Resources – Hiring, training, laying off
workers
 Capacity – Capacity shortages can result in
undependable delivery, loss of customers,
loss of market share
 Supply-Chain Management – Good supplier
relations and price advance
 Seven Steps in Forecasting
 Determine the use of the forecast
 Select the items to be forecasted
 Determine the time horizon of the forecast
 Select the forecasting model(s)
 Gather the data
 Make the forecast
 Validate and implement results
 The Realities!

 Forecasts are seldom perfect

 Most techniques assume an underlying
stability in the system
 Product family and aggregated forecasts
are more accurate than individual product
forecasts. For e.g. forecasts of portfolio
betas are more accurate than individual
company beta.
 Forecasting Approaches
Qualitative Methods
 Used when situation is vague and
little data exist
 New products
 New technology
 Involves intuition, experience
 e.g., forecasting sales on Internet
 Forecasting Approaches
Quantitative Methods
 Used when situation is ‘stable’ and
historical data exist
 Existing products
 Current technology
 Involves mathematical techniques
 e.g., forecasting sales of color televisions
Overview of Qualitative Approaches
 Executive Opinion
 Involves small group of high-level managers
 Group estimates demand by working together
 Combines managerial experience with statistical
models
 Relatively quick
 ‘Group-think’
disadvantage
 Sales Force Composite
 Each salesperson projects his or her sales
 Combined at district, state and national
levels
 Sales reps know customers’ wants
 Tends to be overly optimistic
The Delphi method is a structured
communication technique or method, originally
developed as a systematic, interactive
forecasting method which relies on a panel of
experts. The experts answer questionnaires in
two or more rounds.
 Delphi Method
 Iterative group Decision Makers
(Evaluate responses and
process, continues make decisions)

until consensus is
reached
 3 types of Staff
(Administering survey)
participants
 Decision makers
 Staff
 Respondents
Respondents
(People who can make
valuable judgments)
 Consumer Market Survey

 Ask customers about purchasing plans

 What consumers say, and what they
actually do are often different
 Sometimes difficult to answer
 Suitable for very short term
 Data Types and Models
Data Types:
• Time Series Data
• Cross Section Data
• Panel Data
Models:
• Theoretical Models- Let the data speak for
itself
• Structural Models/ econometric models
 Time Series Forecasting
 Set of evenly spaced numerical data
 Obtained by observing response variable
at regular time periods
 Forecast based only on past values
 Assumes that factors influencing past
and present will continue to influence in
future
 Time Series Components

Trend Cyclical

Seasonal Random
 Components of Demand
Trend
component
Seasonal peaks
Demand for product or service

Actual
demand

Average demand
over four years
Random
variation
| | | |
1 2 3 4
Year
 Trend Component
 Persistent, overall upward or
downward pattern
 Changes due to population,
technology, age, etc.
 Typically several years duration
 Seasonal Component
 Regular pattern of up and down
fluctuations
 Due to weather, customs, etc.
 Occurs within a single year
Number of
Period Length Seasons
Week Day 7
Month Week 4-4.5
Month Day 28-31
Year Quarter 4
Year Month 12
Year Week 52
 Seasonality in financial assets

• Seasonality in stock prices

1. Day of the week effect

2. January effect

3. Expiration day effect

 Cyclical Component
 Repeating up and down movements
 Affected by business cycle, political, and
economic factors
 Multiple years duration
 Often causal or
associative
relationships

0 5 10 15 20
 Random Component
 Erratic, unsystematic, ‘residual’
fluctuations
 Due to random variation or unforeseen
events
 Short duration and
nonrepeating

M T W T F
 Overview of Quantitative
Approaches
1. Naive approach
2. Moving averages
Time-Series
3. Exponential Models
smoothing
4. Trend projection
5. Linear regression Associative
Model
Overview of Quantitative
Approaches
 Naive Approach
 Assumes demand in next period is the
same as demand in most recent period
 e.g., If May sales were 48, then June sales
will be 48
 Sometimes cost effective and efficient
 Moving Average Method
 MA is a series of arithmetic means
 Used if little or no trend
 Used often for smoothing
 Provides overall impression of data over
time

∑ demand in previous n periods

Moving average = n
 Moving Average Example
Actual 3-Month
Month Shed Sales Moving Average

January 10
February 12
March 13
April 16 (10 + 12 + 13)/3 = 11 2/3
May 19 (12 + 13 + 16)/3 = 13 2/3
June 23 (13 + 16 + 19)/3 = 16
July 26 (16 + 19 + 23)/3 = 19 1/3
 Graph of Moving Average
Moving Average
Forecast
30 –
28 –
Actual Sales
26 –
24 –
22 –
Shed Sales

20 –
18 –
16 –
14 –
12 –
10 –
| | | | | | | | | | | |
J F M A M J J A S O N D
 Weighted Moving Average

 Used when trend is present

 Older data usually less important
 Weights based on experience and
intuition
∑ (weight for period n)
x (demand in period n)
Weighted
moving average =
∑ weights
 Weights Applied Period

Weighted Moving Average

3
2
Last month
Two months ago
1 Three months ago
6 Sum of weights

Actual 3-Month Weighted

Month Shed Sales Moving Average

January 10
February 12
March 13
April 16 [(3 x 13) + (2 x 12) + (10)]/6 = 121/6
May 19 [(3 x 16) + (2 x 13) + (12)]/6 = 141/3
June 23 [(3 x 19) + (2 x 16) + (13)]/6 = 17
July 26 [(3 x 23) + (2 x 19) + (16)]/6 = 201/2
 Potential Problems With
Moving Average
 Increasing ‘n’ smooths the forecast but
makes it less sensitive to changes
 Do not forecast trends well
 Require extensive historical data
 Moving Average And
Weighted Moving Average
Weighted
30 – moving
average
25 –
Sales demand

20 – Actual
sales
15 –
Moving
10 – average

5 –
| | | | | | | | | | | |
J F M A M J J A S O N D
Figure 4.2
 Exponential Smoothing
 Form of weighted moving average
 Weights decline exponentially
 Most recent data weighted most
 Requires smoothing constant ()
 Ranges from 0 to 1
 Subjectively chosen
 Involves little record keeping of past data
 Exponential Smoothing

New forecast = last period’s forecast

+  (last period’s actual demand
– last period’s forecast)

Ft = Ft – 1 + (At – 1 - Ft – 1)
where Ft = new forecast
Ft – 1 = previous forecast
 = smoothing (or weighting)
constant (0    1)
Exponential Smoothing Example

Predicted demand = 142 Cars

Actual demand = 153
Smoothing constant  = .20
Exponential Smoothing Example

Predicted demand = 142 Cars

Actual demand = 153
Smoothing constant  = .20

New forecast = 142 + .2(153 – 142)

Exponential Smoothing Example

Predicted demand = 142 Cars

Actual demand = 153
Smoothing constant  = .20

New forecast = 142 + .2(153 – 142)

= 142 + 2.2
= 144.2 ≈ 144 cars
 Effect of
Smoothing Constants

Weight Assigned to
Most 2nd Most 3rd Most 4th Most 5th Most
Recent Recent Recent Recent Recent
Smoothing Period Period Period Period Period
Constant () (1 - ) (1 - )2 (1 - )3 (1 - )4

 = .1 .1 .09 .081 .073 .066

 = .5 .5 .25 .125 .063 .031

 Impact of Different 
225 –

Actual  = .5
demand
200 –
Demand

175 –

 = .1

150 – | | | | | | | | |
1 2 3 4 5 6 7 8 9
Quarter
 Choosing 
The objective is to obtain the most
accurate forecast no matter the technique

We generally do this by selecting the model that

gives us the lowest forecast error

Forecast error = Actual demand - Forecast value

= At - Ft
Common Measures of Error

Mean Absolute Deviation (MAD)

∑ |actual - forecast|
MAD =
n

Mean Squared Error (MSE)

∑ (forecast errors)2
MSE =
n
 Common Measures of Error

Mean Absolute Percent Error (MAPE)

n
100 ∑ |actuali - forecasti|/actuali
MAPE = i=1
n
 Comparison of Forecast Error
Rounded Absolute Rounded Absolute
Actual Forecast Deviation Forecast Deviation
Tonnage with for with for
Quarter Unloaded  = .10  = .10  = .50  = .50
1 180 175 5 175 5
2 168 176 8 178 10
3 159 175 16 173 14
4 175 173 2 166 9
5 190 173 17 170 20
6 205 175 30 180 25
7 180 178 2 193 13
8 182 178 4 186 4
84 100
 Comparison of Forecast Error
∑ |deviations|
Rounded Absolute Rounded Absolute
MADActual
= Forecast Deviation Forecast Deviation
Tonage n
with for with for
Quarter Unloaded  = .10  = .10  = .50  = .50
1
For  =180
.10 175 5 175 5
2 168 = 84/8176
= 10.50 8 178 10
3 159 175 16 173 14
4 For  =175
.50 173 2 166 9
5 190 173 17 170 20
6 205 = 100/8
175= 12.50 30 180 25
7 180 178 2 193 13
8 182 178 4 186 4
84 100
 Comparison of Forecast Error
∑ (forecast errors)2
Rounded Absolute Rounded Absolute
MSE = Actual Forecast Deviation Forecast Deviation
Tonage
n
with for with for
Quarter Unloaded  = .10  = .10  = .50  = .50
1
For  =180
.10 175 5 175 5
2 = 1,558/8176
168 = 194.75 8 178 10
3 159 175 16 173 14
4 For  =175
.50 173 2 166 9
5 190 173 17 170 20
6 = 1,612/8175
205 = 201.50 30 180 25
7 180 178 2 193 13
8 182 178 4 186 4
84 100
MAD 10.50 12.50
 Comparison
n
of Forecast Error
100 ∑ |deviationi|/actuali
MAPE = Actual i = Rounded
1 Absolute Rounded Absolute
Forecast Deviation Forecast Deviation
Tonage with n for with for
Quarter Unloaded  = .10  = .10  = .50  = .50
1
For 180
= .10 175 5 175 5
2 168 = 45.62/8
176 = 5.70%
8 178 10
3 159 175 16 173 14
4 For 175
= .50 173 2 166 9
5 190 173 17 170 20
6 205 = 54.8/8
175 = 6.85%30 180 25
7 180 178 2 193 13
8 182 178 4 186 4
84 100
MAD 10.50 12.50
MSE 194.75 201.50
 Comparison of Forecast Error
Rounded Absolute Rounded Absolute
Actual Forecast Deviation Forecast Deviation
Tonnage with for with for
Quarter Unloaded  = .10  = .10  = .50  = .50
1 180 175 5 175 5
2 168 176 8 178 10
3 159 175 16 173 14
4 175 173 2 166 9
5 190 173 17 170 20
6 205 175 30 180 25
7 180 178 2 193 13
8 182 178 4 186 4
84 100
MAD 10.50 12.50
MSE 194.75 201.50
MAPE 5.70% 6.85%
 Exponential Smoothing with Trend
Adjustment
When a trend is present, exponential smoothing
must be modified

Forecast exponentially exponentially

including (FITt) = smoothed (Ft) + (Tt) smoothed
trend forecast trend
Exponential Smoothing with Trend
Adjustment

Ft = (At - 1) + (1 - )(Ft - 1 + Tt - 1)

Tt = b(Ft - Ft - 1) + (1 - b)Tt - 1

Step 1: Compute Ft
Step 2: Compute Tt
Step 3: Calculate the forecast FITt = Ft + Tt
 Exponential Smoothing with Trend
Adjustment Example
Forecast
Actual Smoothed Smoothed Including
Month(t) Demand (At) Forecast, Ft Trend, Tt Trend, FITt
1 12 11 2 13.00
2 17
3 20
4 19
5 24
6 21
7 31
8 28
9 36
10

Table 4.1
 Exponential Smoothing with Trend
Adjustment Example
Forecast
Actual Smoothed Smoothed Including
Month(t) Demand (At) Forecast, Ft Trend, Tt Trend, FITt
1 12 11 2 13.00
2 17
3 20
4 19
5 24 Step 1: Forecast for Month 2
6 21
F2 = A1 + (1 - )(F1 + T1)
7 31
8 28 F2 = (.2)(12) + (1 - .2)(11 + 2)
9 36 = 2.4 + 10.4 = 12.8 units
10

Table 4.1
 Exponential Smoothing with Trend
Adjustment Example
Forecast
Actual Smoothed Smoothed Including
Month(t) Demand (At) Forecast, Ft Trend, Tt Trend, FITt
1 12 11 2 13.00
2 17 12.80
3 20
4 19
5 24 Step 2: Trend for Month 2
6 21
T2 = b(F2 - F1) + (1 - b)T1
7 31
8 28 T2 = (.4)(12.8 - 11) + (1 - .4)(2)
9 36 = .72 + 1.2 = 1.92 units
10

Table 4.1
 Exponential Smoothing with Trend
Adjustment Example
Forecast
Actual Smoothed Smoothed Including
Month(t) Demand (At) Forecast, Ft Trend, Tt Trend, FITt
1 12 11 2 13.00
2 17 12.80 1.92
3 20
4 19
5 24 Step 3: Calculate FIT for Month 2
6 21
FIT2 = F 2 + T1
7 31
FIT2 = 12.8 + 1.92
8 28
9 36 = 14.72 units
10

Table 4.1
 Exponential Smoothing with Trend
Adjustment Example
Forecast
Actual Smoothed Smoothed Including
Month(t) Demand (At) Forecast, Ft Trend, Tt Trend, FITt
1 12 11 2 13.00
2 17 12.80 1.92 14.72
3 20 15.18 2.10 17.28
4 19 17.82 2.32 20.14
5 24 19.91 2.23 22.14
6 21 22.51 2.38 24.89
7 31 24.11 2.07 26.18
8 28 27.14 2.45 29.59
9 36 29.28 2.32 31.60
10 32.48 2.68 35.16

Table 4.1
Exponential Smoothing with Trend
Adjustment Example
35 –

30 – Actual demand (At)

25 –
Product demand

20 –

15 –

10 – Forecast including trend (FITt)

5 –

0 – | | | | | | | | |
1 2 3 4 5 6 7 8 9
Figure 4.3
Time (month)
 Trend Projections
Fitting a trend line to historical data points to
project into the medium-to-long-range
Linear trends can be found using the least squares
technique
^
y = a + bx
where^y = computed value of the variable to be predicted
(dependent variable)
a = y-axis intercept
b = slope of the regression line
x = the independent variable
 Least Squares Method

Actual observation Deviation7

(y value)
Values of Dependent Variable

Deviation5 Deviation6

Deviation3

Deviation4

Deviation1
Deviation2
Trend line, y =^ a + bx

Time period Figure 4.4

 Least Squares Method

Actual observation Deviation7

(y value)
Values of Dependent Variable

Deviation5 Deviation6

Deviation3
Least squares method minimizes the sum
of the squared errors (deviations)
Deviation4

Deviation1
Deviation2
Trend line, y =^ a + bx

Time period Figure 4.4

 Least Squares Method
Equations to calculate the regression variables

^
y = a + bx

Sxy - nxy
b=
Sx2 - nx2

a = y - bx
 Least Squares Example
Time Electrical Power
Year Period (x) Demand x2 xy
1999 1 74 1 74
2000 2 79 4 158
2001 3 80 9 240
2002 4 90 16 360
2003 5 105 25 525
2004 6 142 36 852
2005 7 122 49 854
∑x = 28 ∑y = 692 ∑x2 = 140 ∑xy = 3,063
x=4 y = 98.86

∑xy - nxy 3,063 - (7)(4)(98.86)

b= = = 10.54
2
∑x - nx 2 140 - (7)(42)

a = y - bx = 98.86 - 10.54(4) = 56.70

 Least Squares Example
Time Electrical Power
Year Period (x) Demand x2 xy
1999 1 74 1 74
2000 2 79 4 158
2001The trend3 line is 80 9 240
2002 4 90 16 360
^
2003 y =5 56.70 + 10.54x
105 25 525
2004 6 142 36 852
2005 7 122 49 854
Sx = 28 Sy = 692 Sx2 = 140 Sxy = 3,063
x=4 y = 98.86

Sxy - nxy 3,063 - (7)(4)(98.86)

b= = = 10.54
Sx - nx
2 2 140 - (7)(42)

a = y - bx = 98.86 - 10.54(4) = 56.70

 Least Squares Example
Trend line,
160 – y^= 56.70 + 10.54x
150 –
140 –
130 –
Power demand

120 –
110 –
100 –
90 –
80 –
70 –
60 –
50 –
| | | | | | | | |
1999 2000 2001 2002 2003 2004 2005 2006 2007
Year
 Seasonal Variations In Data
The multiplicative seasonal model can modify
trend data to accommodate seasonal variations in
demand
1. Find average historical demand for each season
2. Compute the average demand over all seasons
3. Compute a seasonal index for each season
4. Estimate next year’s total demand
5. Divide this estimate of total demand by the number of seasons, then
multiply it by the seasonal index for that season
 Seasonal Index Example
Demand Average Average Seasonal
Month 2003 2004 2005 2003-2005 Monthly Index
Jan 80 85 105 90 94
Feb 70 85 85 80 94
Mar 80 93 82 85 94
Apr 90 95 115 100 94
May 113 125 131 123 94
Jun 110 115 120 115 94
Jul 100 102 113 105 94
Aug 88 102 110 100 94
Sept 85 90 95 90 94
Oct 77 78 85 80 94
Nov 75 72 83 80 94
Dec 82 78 80 80 94
 Seasonal Index Example
Demand Average Average Seasonal
Month 2003 2004 2005 2003-2005 Monthly Index
Jan 80 85 105 90 94 0.957
Feb 70 85 85 80 94
Mar 80 93 82
average 85 monthly demand
2003-2005 94
Seasonal index
Apr 90 = 95 115 average monthly
100 demand94
May 113 125 131 123 94
= 90/94 = .957
Jun 110 115 120 115 94
Jul 100 102 113 105 94
Aug 88 102 110 100 94
Sept 85 90 95 90 94
Oct 77 78 85 80 94
Nov 75 72 83 80 94
Dec 82 78 80 80 94
 Seasonal Index Example
Demand Average Average Seasonal
Month 2003 2004 2005 2003-2005 Monthly Index
Jan 80 85 105 90 94 0.957
Feb 70 85 85 80 94 0.851
Mar 80 93 82 85 94 0.904
Apr 90 95 115 100 94 1.064
May 113 125 131 123 94 1.309
Jun 110 115 120 115 94 1.223
Jul 100 102 113 105 94 1.117
Aug 88 102 110 100 94 1.064
Sept 85 90 95 90 94 0.957
Oct 77 78 85 80 94 0.851
Nov 75 72 83 80 94 0.851
Dec 82 78 80 80 94 0.851
 Seasonal Index Example
Demand Average Average Seasonal
Month 2003 2004 2005 2003-2005 Monthly Index
Jan 80 85 105 90 94 0.957
Feb 70 85 Forecast
85 for 2006 80 94 0.851
Mar 80 93 82 85 94 0.904
Apr 90Expected
95 annual
115demand = 1,200
100 94 1.064
May 113 125 131 123 94 1.309
Jun 110 115 120 1,200 115 94 1.223
Jan 12 x .957 = 96
Jul 100 102 113 105 94 1.117
Aug 88 102 110 1,200 100 94 1.064
Sept 85 90
Feb 95 12 90 = 85
x .851 94 0.957
Oct 77 78 85 80 94 0.851
Nov 75 72 83 80 94 0.851
Dec 82 78 80 80 94 0.851
 Seasonal Index Example
2006 Forecast
140 – 2005 Demand
130 – 2004 Demand
2003 Demand
120 –
Demand

110 –
100 –
90 –
80 –
70 –
| | | | | | | | | | | |
J F M A M J J A S O N D
Time
 Associative Forecasting
Used when changes in one or more independent
variables can be used to predict the changes in the
dependent variable

Most common technique is linear

regression analysis

We apply this technique just as we did in the

time series example
 Associative Forecasting
Forecasting an outcome based on predictor
variables using the least squares technique

^
y = a + bx

where^y = computed value of the variable to be predicted

(dependent variable)
a = y-axis intercept
b = slope of the regression line
x = the independent variable though to predict the value of
the dependent variable
 Associative Forecasting Example
Sales Local Payroll
($000,000), y ($000,000,000), x
2.0 1
3.0 3
2.5 4 4.0 –
2.0 2
2.0 1 3.0 –
3.5 7 Sales
2.0 –

1.0 –

| | | | | | |
0 1 2 3 4 5 6 7
Area payroll
 Associative Forecasting Example
Sales, y Payroll, x x2 xy
2.0 1 1 2.0
3.0 3 9 9.0
2.5 4 16 10.0
2.0 2 4 4.0
2.0 1 1 2.0
3.5 7 49 24.5
∑y = 15.0 ∑x = 18 ∑x2 = 80 ∑xy = 51.5

∑xy - nxy 51.5 - (6)(3)(2.5)

x = ∑x/6 = 18/6 = 3 b= = = .25
∑x2 - nx2 80 - (6)(32)

y = ∑y/6 = 15/6 = 2.5 a = y - bx = 2.5 - (.25)(3) = 1.75

 Associative Forecasting Example
^
y = 1.75 + .25x Sales = 1.75 + .25(payroll)

If payroll next year is

estimated to be $600 million, 4.0 –
then:
3.25
3.0 –
Sales

Sales = 1.75 + .25(6) 2.0 –

Sales = $325,000
1.0 –

| | | | | | |
0 1 2 3 4 5 6 7
Area payroll
 Standard Error of the Estimate
 A forecast is just a point estimate of a future
value
 This point is 4.0 –
actually the 3.25
mean of a 3.0 –
Sales
probability 2.0 –
distribution
1.0 –

| | | | | | |
0 1 2 3 4 5 6 7
Area payroll
Figure 4.9
Standard Error of the Estimate

∑(y - yc)2
Sy,x =
n-2

where y = y-value of each data point

yc = computed value of the dependent variable, from the
regression equation
n = number of data points
 Standard Error of the Estimate
Computationally, this equation is
considerably easier to use

∑y2 - a∑y - b∑xy

Sy,x =
n-2

We use the standard error to set up

prediction intervals around the point
estimate
 Standard Error of the Estimate
∑y2 - a∑y - b∑xy 39.5 - 1.75(15) - .25(51.5)
Sy,x = =
n-2 6-2

Sy,x = .306 4.0 –

The standard error of the 3.25
estimate is $30,600 in sales 3.0 –
Sales

2.0 –
The standard error of the
estimate is a measure of the
1.0 –
accuracy of predictions made
with a regression line. | | | | | | |
0 1 2 3 4 5 6 7
Area payroll
 Correlation
 How strong is the linear relationship
between the variables?
 Correlation does not necessarily imply
causality!
 Coefficient of correlation, r, measures
degree of association
 Values range from -1 to +1
Correlation Coefficient
nSxy - SxSy
r=
[nSx2 - (Sx)2][nSy2 - (Sy)2]
y y
Correlation Coefficient
n∑xy - ∑x∑y
r=
[n∑x 2 - (∑x)2][n∑y2 - (∑y)2]
(a) Perfect positive x (b) Positive x
correlation: correlation:
r = +1 0<r<1

y y

(c) No correlation: x (d) Perfect negative x

r=0 correlation:
r = -1
 Correlation
 Coefficient of Determination, r2,
measures the percent of change in y
predicted by the change in x
 Values range from 0 to 1
 Easy to interpret
 Multiple Regression Analysis

If more than one independent variable is to be used

in the model, linear regression can be extended to
multiple regression to accommodate several
independent variables

y^ = a + b1x1 + b2x2 …

Computationally, this is quite complex and

generally done on the computer
 Monitoring and Controlling
Forecasts
Tracking Signal
 Measures how well the forecast is predicting
actual values
 Ratio of running sum of forecast errors (RSFE) to
mean absolute deviation (MAD)
 Good tracking signal has low values
 If forecasts are continually high or low, the forecast
has a bias error
 Monitoring and Controlling
Forecasts

Tracking RSFE
signal =
MAD

∑(actual demand in
period i -
forecast demand
Tracking in period i)
=
signal (∑|actual - forecast|/n)
 Tracking Signal
Signal exceeding limit
Tracking signal
Upper control limit
+

0 MADs Acceptable
range

–
Lower control limit

Time
 Tracking Signal Example
Cumulative
Absolute Absolute
Actual Forecast Forecast Forecast
Qtr Demand Demand Error RSFE Error Error MAD
1 90 100 -10 -10 10 10 10.0
2 95 100 -5 -15 5 15 7.5
3 115 100 +15 0 15 30 10.0
4 100 110 -10 -10 10 40 10.0
5 125 110 +15 +5 15 55 11.0
6 140 110 +30 +35 30 85 14.2
 Tracking Signal Example
Tracking Cumulative
Absolute Absolute
Actual Signal
Forecast Forecast Forecast
Qtr Demand(RSFE/MAD)
Demand Error RSFE Error Error MAD
1 90 -10/10100
= -1 -10 -10 10 10 10.0
2 95 -15/7.5
100
= -2 -5 -15 5 15 7.5
3 115 0/10100=0 +15 0 15 30 10.0
4 100 -10/10110
= -1 -10 -10 10 40 10.0
5 125 +5/11 110
= +0.5 +15 +5 15 55 11.0
6 140+35/14.2
110
= +2.5 +30 +35 30 85 14.2

The variation of the tracking signal between -2.0 and +2.5 is within
acceptable limits
 Adaptive Forecasting
It’s possible to use the computer to
continually monitor forecast error and adjust
the values of the  and b coefficients used in
exponential smoothing to continually
minimize forecast error
This technique is called adaptive smoothing
 Focus Forecasting
Developed at American Hardware Supply, focus
forecasting is based on two principles:
1. Sophisticated forecasting models are not always better than simple
models
2. There is no single techniques that should be used for all products
or services

This approach uses historical data to test multiple forecasting models for
individual items
The forecasting model with the lowest error is then used to forecast the next
demand
Forecasting in the Service Sector

 Presents unusual challenges

 Special need for short term records
 Needs differ greatly as function of industry
and product
 Holidays and other calendar events
 Unusual events
 Fast Food Restaurant Forecast
20% –
Percentage of sales

15% –

10% –

5% –

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

12-1 2-3 4-5 6-7 8-9 10-11
(Lunchtime) (Dinnertime)
Hour of day Figure 4.12