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Ch. 5: Forecasting

POM - J. Galvn

Learning Objectives

POM - J. Galvn

What is Forecasting?

Process of predicting a future event Underlying basis of all business decisions

Production Inventory Personnel Facilities

POM - J. Galvn 3

ShortShort-range forecast

Up

3

MediumMedium-range forecast

months to 3 years Sales & production planning, budgeting

LongLong-range forecast

3+

POM - J. Galvn 4

Medium/long range forecasts deal with more comprehensive issues and support management decisions regarding planning and products, plants and processes. ShortShort-term forecasting usually employs different methodologies than longerlongerterm forecasting ShortShort-term forecasts tend to be more accurate than longer-term forecasts. longerPOM - J. Galvn 5

Stages of introduction & growth require longer forecasts than maturity and decline Forecasts useful in projecting

staffing levels, inventory levels, and factory capacity

POM - J. Galvn 6

Types of Forecasts

Economic forecasts

Address

Technological forecasts

Predict

Demand forecasts

Predict

POM - J. Galvn 7

Determine the use of the forecast Select the items to be forecast Determine the time horizon of the forecast Select the forecasting model(s) Gather the data Make the forecast Validate and implement results

POM - J. Galvn 8

Realities of Forecasting

Forecasts are seldom perfect Most forecasting methods assume that there is some underlying stability in the system Both product family and aggregated product forecasts are more accurate than individual product forecasts

POM - J. Galvn 9

Forecasting Approaches

Qualitative Methods Quantitative Methods

Used when situation is Used when situation vague & little data is stable & historical exist data exist New products Existing products New technology Current technology Involves intuition, Involves mathematical experience techniques e.g., forecasting sales e.g., forecasting sales on Internet of color televisions

POM - J. Galvn 10

Jury of executive opinion Pool opinions of high-level executives, sometimes highaugment by statistical models Sales force composite estimates from individual salespersons are reviewed for reasonableness, then aggregated Delphi method Panel of experts, queried iteratively Consumer Market Survey Ask the customer

POM - J. Galvn

11

Involves small group of high-level managers

Combines managerial experience with statistical models Relatively quick Group-think disadvantage

POM - J. Galvn 12

Each salesperson projects their sales Combined at district & national levels Sales reps know customers wants Tends to be overly optimistic

POM - J. Galvn

Sales

13

Delphi Method

Decision Staff Respondents

Decision Makers

(Sales?) (Sales will be 50!)

be? survey)

Reduces groupgroupthink

POM - J. Galvn

Respondents

(Sales will be 45, 50, 55)

14

Ask customers about purchasing plans What consumers say, and what they actually do are often different Sometimes difficult to answer

How many hours will you use the Internet next week?

POM - J. Galvn

15

Nave approach Moving averages Exponential smoothing Trend projection Linear regression

POM - J. Galvn

Time-series Models

Causal models

16

5-22

(Non(Non-Naive)

Quantitative Forecasting Time Series Models Causal Models

Moving Average

Exponential Smoothing

Trend Projection

Linear Regression

POM - J. Galvn

17

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, present, & future will continue Example Year: 1993 1994 1995 1996 1997 Sales: 78.7 63.5 89.7 93.2 92.1

POM - J. Galvn

18

Trend

Cyclical

Seasonal

POM - J. Galvn

Random

19

Trend Component

Persistent, overall upward or downward pattern Due to population, technology etc. Several years duration

Response

POM - J. Galvn

Cyclical Component

Repeating up & down movements Due to interactions of factors influencing economy Usually 2-10 years duration 2Cycle Response

POM - J. Galvn 21

Seasonal Component

Regular pattern of up & down fluctuations Due to weather, customs etc. Occurs within 1 year

Summer Response

1984-1994 T/Maker Co.

22

Random Component

strike Tornado

Union

POM - J. Galvn 23

Any observed value in a time series is the product (or sum) of time series components Multiplicative model Yi = Ti Si Ci Ri (if quarterly or mo. data) Additive model Yi = Ti + Si + Ci + Ri (if quarterly or mo. data)

POM - J. Galvn

24

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 & efficient

1995 Corel Corp.

POM - J. Galvn 25

MA is a series of arithmetic means Used if little or no trend Used often for smoothing

POM - J. Galvn 26

Sales 8 6 4 2 0 93

Actual

Forecast

94

95 96 Year

POM - J. Galvn

97

98

27

Increasing n makes forecast less sensitive to changes Do not forecast trend well Require much historical data

1984-1994 T/Maker Co.

POM - J. Galvn

28

Used for forecasting linear trend line Assumes relationship between response variable, Y, and time, X, is a linear function Yi ! a bX i Estimated by least squares method

POM - J. Galvn 29

Y

a b<0 a Time, X

POM - J. Galvn 30

b>0

Scatter Diagram

Sales 4 3 2 1 0 92

Sales vs. Time

93

94

95

96

Time

POM - J. Galvn 31

Equation:

Yi ! a bx i

n

Slope:

b ! i ! n x i n x

i !

x i y i nx y

Y-Intercept:

a ! y bx

POM - J. Galvn 32

Find average historical demand for each season by summing the demand for that season in each year, and dividing by the number of years for which you have data. Compute the average demand over all seasons by dividing the total average annual demand by the number of seasons. Compute a seasonal index by dividing that seasons historical demand (from step 1) by the average demand over all seasons. Estimate next years total demand Divide this estimate of total demand by the number of seasons then multiply it by the seasonal index for that season. This provides the seasonal forecast. 33 forecast. POM - J. Galvn

Example:

Slope

Y-intercept

^ Yi = a + b X i

Dependent (response) variable

POM - J. Galvn

34

Y

Yi = a + b X i + Error

Error Regression line

^ =a +b X Yi i

X

Observed value

POM - J. Galvn 35

Equation:

Yi ! a bx i

n

Slope:

b ! i ! n x i n x

i !

x i y i nx y

Y-Intercept:

a ! y bx

POM - J. Galvn 36

Interpretation of Coefficients

Slope (b) (b

Estimated

If

b = 2, then sales (Y) is expected to (Y increase by 2 for each 1 unit increase in advertising (X) (X

Y-intercept (a) (a

Average

If

value of Y when X = 0

POM - J. Galvn 37

Correlation

Answers: how strong is the linear how relationship between the variables? Coefficient of correlation Sample correlation coefficient denoted r

POM - J. Galvn 38

Perfect Negative Correlation No Correlation Perfect Positive Correlation

-1.0

-.5

+.5

+1.0

POM - J. Galvn

39

Y

r=1

^ Yi = a + b Xi X

r = -1

^ Yi = a + b Xi X

r = .89

^ Yi = a + b Xi X

r=0

^ Yi = a + b Xi X

40

POM - J. Galvn

No

Error

Smallest

Mean

POM - J. Galvn

41

Trend Not Fully Accounted for Error 0 Time (Years) Error 0 Time (Years)

Desired Pattern

POM - J. Galvn

42

Tracking Signal

Measures how well forecast is predicting actual values Ratio of running sum of forecast errors (RSFE) to mean absolute deviation (MAD)

Good

POM - J. Galvn 43

3 2 1 TS 0 -1 -2 -3

1 2 3 4 5 6

44

Time

POM - J. Galvn

need for short term records needs differ greatly as function of industry and product issues of holidays and calendar unusual events

special

POM - J. Galvn

45

Forecasting example

SALES DURING LAST YEAR

LAST YEAR Spring Summer Fall Winter TOTAL ANNUAL SALES ESTIMATION: Real sales 200 350 300 150 1000 Annual increase of sales 10,00%

What are the estimated seasonal sales amount for next year?

POM - J. Galvn 46

LAST YEAR Past sales Average sales for each season Total past annual sales/ n of seasons Spring Summer Fall Winter TOTAL ANNUAL SALES 200 350 300 150 250 250 250 250 Seasonal factor Past sales/ Avg. Sales 0,8 1,4 1,2 0,6

1000

POM - J. Galvn

1000

47

NEXT YEAR NEXT YEAR SALES 1100 Average sales for each season Total estimated annual sales/n of seasons Spring Summer Fall Winter TOTAL ANNUAL SALES ? ? ? ? 1100 275 275 275 275 1100

POM - J. Galvn

(10% increase) Seasonal factor As calculated 0,8 1,4 1,2 0,6 Next year's seasonal forecast Avg.sales* Factor 220 385 330 165 1100

48

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