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Forecasting
Dr.Kavita K.M
Professor AMSIMR
What is Forecasting?
FORECAST:
• A statement about the future value of a variable of interest such
as demand.
• Forecasts affect decisions and activities throughout an
organization
• Accounting, finance
• Human resources
• Marketing
• MIS
• Operations
• Product / service design
Uses of Forecasts
Timely
Reliable Accurate
e
f ul us
i ng Written y
to
an s
M
e Ea
Steps in the Forecasting Process
“The forecast”
• Consumer surveys
• Outside opinion
Time Series Forecasts
Irregular
variation
Trend
Cycles
90
89
88
Seasonal variations
Naive Forecasts
• Easily understandable
∑ A i
• MA = i=1
The demand for tiresnin a tire store in the past 5 weeks were as
n
follows. Compute a three-period moving average forecast for
demand in week 6.
83 80 85 90 94
Moving average & Actual demand
Moving Averages
• Weighted moving average – More recent values in a
series are given more weight in computing the
forecast.
Example:
• For the previous demand data, compute a weighted
average forecast using a weight of .40 for the most
recent period, .30 for the next most recent, .20 for the
next and .10 for the next.
• If the actual demand for week 6 is 91, forecast demand
for week 7 using the same weights.
Exponential Smoothing
Exponential Smoothing
Actual Alpha=0.10 Alpha=0.40
100
95
90
Demand
85
80
75
70
2 3 4 5 6 7 8 9 10 11
Period
Problem 1
• National Mixer Inc. sells can openers.
Monthly sales for a seven-month period
were as follows: Month Sales
• Forecast September sales volume using (1000)
each of the following: Feb 19
• A five-month moving average Mar 18
• Apr 15
Exponential smoothing with a smoothing
constant equal to .20, assuming a March May 20
forecast of 19. Jun 18
• The naive approach Jul 22
• Aug 20
A weighted average using .60 for August,
.30 for July, and .10 for June.
Problem 2
• A dry cleaner uses exponential smoothing to
forecast equipment usage at its main plant. August
usage was forecast to be 88% of capacity. Actual
usage was 89.6%. A smoothing constant of 0.1 is
used.
• Prepare a forecast for September
• Assuming actual September usage of 92%, prepare
a forecast of October usage
Problem 3
•An electrical contractor’s records during the last five
weeks indicate the number of job requests:
Week: 1 2 3 4 5
Requests: 20 22 18 21 22
• Averaging
• Moving average
• Weighted moving average
• Exponential smoothing
Techniques for Trend
Parabolic
Exponential
Growth
Linear Trend Equation
Ft
Ft = a + bt
Week: 1 2 3 4 5
Sales: 150 157 162 166 177
Sales
180
175
170
165
160
Sales
Sales
155
150
145
140
135
1 2 3 4 5
Week
Calculating a and b
n ∑ (ty) - ∑ t ∑ y
b =
n∑ t 2 - ( ∑ t) 2
∑ y - b∑ t
a =
n
Linear Trend Equation Example
t y
2
W e e k t S a le s t y
1 1 1 5 0 1 5 0
2 4 1 5 7 3 1 4
3 9 1 6 2 4 8 6
4 1 6 1 6 6 6 6 4
5 2 5 1 7 7 8 8 5
2
Σ t = 1 Σ 5t = 5 Σ 5y = 8 Σ 1t y 2 = 2 4 9
2
(Σ t ) = 2 2 5
Linear Trend Calculation
812 - 6.3(15)
a = = 143.5
5
y = 143.5 + 6.3t
Linear Trend plot
180
175
170
165
160
155
150
145
140
135
1 2 3 4 5
Recall: Problem 1
• National Mixer Inc. sells can openers.
Monthly sales for a seven-month period
were as follows: Month Sales
(1000)
• Feb 19
Plot the monthly data
Mar 18
• Forecast September sales volume using Apr 15
a line trend equation May 20
• Which method of forecast seems least Jun 18
appropriate? Jul 22
• What does use of the term sales rather Aug 20
than demand presume?
Line chart
Sales
20
0
F M A M J
J Month A S
Problem 4
• A cosmetics manufacturer’s marketing department has
developed a linear trend equation that can be used to predict
annual sales of its popular Hand & Foot Cream:
Ft = 80 + 15t
where
Ft = Annual sales (1000 bottles)
t = 0 corresponds to 1990
Ft = 124 + 7.5t
• Quarter relatives are
• What forecasts are appropriate for the last quarter of this year and the
first quarter of next year?
Problem
• A manager of store that sells and installs hot tubs
wants to prepare a forecast for January, February
and March of 2007. Her forecasts are a
combination of trend and seasonality. She uses the
following equation to estimate the trend component
of monthly demand:
Ft = 70 + 5t
Where t=0 is June of 2005. Seasonal relatives are
1.10 for Jan, 1.02 for Feb, and .95 for March. What
demands should she predict?
Computing seasonal relatives
120
100
80
60
40
20
0
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21
If your data appears to have seasonality, how do you compute the
seasonal relatives?
Computing seasonal relatives
• Calculate centered moving average for each
period.
• Obtain the ratio of the actual value of the period
over the centered moving average.
• Number of periods needed in a centered moving
average = Number of seasons involved:
• Monthly data: a 12-period moving average
• Quarterly data: a 4-period moving average
Example
• The manager of a parking lot has computed the
number of cars per day in the lot for three weeks.
Using a seven-period centered moving average,
calculate the seasonal relatives.
Year: 1 2 3 4
Quarter: 1 2 3 4 1 2 3 4 1 2 3 4 1
Demand: 14 18 35 46 28 36 60 71 45 54 84 88 58
Problem
160
140
120
($Millions)
100
Sales
80
60
40
20
0
0 0.5 1 1.5 2 2.5
Advertising Expenditures ($Millions)
n∑ xy − ∑ x ∑ y
r=
[n(∑ x ) − (∑ x) ][n(∑ y ) − (∑ y ) ]
2 2 2 2
Simple Linear Regression
y = a + bx
where:
y = Value of the dependent variable
x = Value of the independent variable
a = Population’s y-intercept
b = Slope of the population regression line
Simple Linear Regression
n∑ xy − ∑ x ∑ y
b=
n∑ x − (∑ x )
2 2
a=
∑ y − b∑ x
or n
a = y − bx
Problem 7
Sold (y) Price (x)
• The manager of a seafood restaurant was
asked to establish a pricing policy on 200 6.00
lobster dinners. Experimenting with 190 6.50
prices produced the following data: 188 6.75
180 7.00
• Create the scatter plot and determine if a 170 7.25
linear relationship is appropriate.
162 7.50
160 8.00
• Determine the correlation coefficient
and interpret it 155 8.25
156 8.50
• Obtain the regression line and interpret 148 8.75
its coefficients. 140 9.00
133 9.25
Forecast Accuracy
• Source of forecast errors:
• Model may be inadequate
• Irregular variations
• Incorrect use of forecasting technique
• Random variation
∑ Actual − forecast
MAD =
n
2
∑ ( Actual − forecast)
MSE =
n -1
Actual − Forecast
∑ Actual
× 100
MAPE =
n
Example
MAD= 2.75
MSE= 10.86
MAPE= 1.28
Controlling the Forecast
• Control chart
• A visual tool for monitoring forecast errors
2 s = 6.59 1.41
Period 1 2 3 4 5 6 7 8 9 10
Demand 118 117 120 119 126 122 117 123 121 124
Choosing a Forecasting Technique
• No single technique works in every situation
• Two most important factors
• Cost
• Accuracy
• Forecast horizon