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Forecasting

McGraw-Hill/Irwin

You should be able to:

List the elements of a good forecast Outline the steps in the forecasting process Describe qualitative forecasting techniques and their advantages and disadvantages 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 three measures of forecast accuracy Describe two ways of evaluating and controlling forecasts Identify the major factors to consider when choosing a forecasting technique

3-2

Forecast

Forecast a statement about the future value of a variable of interest

We make forecasts about such things as weather, demand, and resource availability Forecasts are an important element in making informed decisions

3-3

The primary goal operations and supply chain management is to match supply to demand

A demand forecast is essential for determining how much supply will be needed to match demand:

Budget preparation Capacity decisions (e.g., staff and equipment) Purchasing decisions

3-4

Forecast Uses

Plan the system

Generally involves long-range plans related to: Types of products and services to offer Facility and equipment levels Facility location

Generally involves short- and medium-range plans related to: Inventory management Workforce levels Purchasing Budgeting

3-5

The forecast should be timely should be accurate should be reliable should be expressed in meaningful units should be in writing technique should be simple to understand and use should be cost effective

3-6

1. 2. 3. 4. 5. 6. Determine the purpose of the forecast Establish a time horizon Select a forecasting technique Obtain, clean, and analyze appropriate data Make the forecast Monitor the forecast

3-7

Forecasting Approaches

Qualitative Forecasting Qualitative techniques permit the inclusion of soft information such as: Human factors Personal opinions Hunches These factors are difficult, or impossible, to quantify Quantitative Forecasting Quantitative techniques involve either the projection of historical data or the development of associative methods that attempt to use causal variables to make a forecast These techniques rely on hard data

3-8

Judgemental Forecasting

Executive opinions Sales force opinion Consumer surveys Other approaches Delphi method

3-9

Time-Series Behaviors

3-10

Uses of Forecasts

Accounting Finance Cost/profit estimates Cash flow and funding

Operations Product/service design

Schedules, MRP, workloads New products and services

3-11

Features of Forecasts

Assumes causal system past ==> future Forecasts rarely perfect because of randomness

Forecast accuracy decreases as time horizon increases

I see that you will get an A this semester.

3-12

Naive Forecasts

Uh, give me a minute.... We sold 250 wheels last week.... Now, next week we should sell....

The forecast for any period equals the previous periods actual value.

3-13

Nave Forecasts

Simple to use Quick and easy to prepare Easily understandable Cannot provide high accuracy

3-14

Stable time series data

F(t) = A(t-1)

Seasonal variations

F(t) = A(t-n)

F(t) = A(t-1) + (A(t-1) A(t-2))

3-15

Moving average Weighted moving average Exponential smoothing

3-16

Muffins 30 34 32

Cinemon buns 18 17 19

Cupcakes 45 26 27

34

35 30 34 36 29 31

19

22 23 23 25 24 26

23

22 48 29 20 14 18

35

31 37 34 33

27

28 29 31 33

47

26 27 24 22

3-17

Moving Averages

Moving average A technique that averages a number of recent actual values, updated as new values become available.

Ft = MAn=

Weighted moving average More recent values in a series are given more weight in computing the forecast.

Ft = WMAn=

n

3-18

Actual

47 45 43 41 39 37 35 1 2 3 4 5 6 7 8 9 10 11 12

MA5

MA3

Ft = MAn=

n

3-19

Exponential Smoothing

month Feb Mar Sales (000) 19 18 Apr 15 Premise--The most recent observations might have the highest predictive value. May 20

Therefore, we should give more weight to the more June 18 recent time periods when forecasting.

Jul aug 22 20

3-20

Exponential Smoothing

Weighted averaging method based on previous forecast plus a percentage of the forecast error A-F is the error term, is the % feedback

3-21

50

Demand

Actu al

.4

45 40 35 1 2 3 4 5 6 7 8

.1

9 10 11 12

Period

3-22

Ft

Ft = a + bt

Ft = Forecast for period t t = Specified number of time periods a = Value of Ft at t = 0 b = Slope of the line

0 1 2 3 4 5 t

3-23

Calculating a and b

n (ty) - t y b = 2 - ( t) 2 n t

y - b t a = n

3-24

t Week 1 2 3 4 5 t2 1 4 9 16 25 y Sales 150 157 162 166 177 ty 150 314 486 664 885

t = 15 t2 = 55 2 ( t) = 225

y = 812 ty = 2499

3-25

b = 5 (2499) - 15(812) 5(55) - 225 = 12495 -12180 275 -225 = 6.3

y = 143.5 + 6.3t

3-26

Seasonal variations

Regularly repeating movements in series values that can be tied to recurring events.

Seasonal relative

Percentage of average or trend

A moving average positioned at the center of the data that were used to compute it.

3-27

Associative Forecasting

Predictor variables - used to predict values of variable interest Regression - technique for fitting a line to a set of points Least squares line - minimizes sum of squared deviations around the line

3-28

X 7 2 6 4 14 15 16 12 14 20 15 7 Y 15 10 13 15 25 27 24 20 27 44 34 17

Computed relationship

50 40 30 20 10 0 0 5 10 15 20 25

3-29

Forecast Accuracy

Error - difference between actual value and predicted value

3-30

MAD = Actual forecast

n

MSE = ( Actual forecast)

2

n -1

( Actual forecast n

3-31

MAPE =

/ Actual*100)

MAD

Easy to compute Weights errors linearly

MSE

Squares error More weight to large errors

MAPE

Puts errors in perspective

3-32

Example 10

Period 1 2 3 4 5 6 7 8 Actual 217 213 216 210 213 219 216 212 Forecast 215 216 215 214 211 214 217 216 (A-F) 2 -3 1 -4 2 5 -1 -4 -2 |A-F| 2 3 1 4 2 5 1 4 22 (A-F)^2 4 9 1 16 4 25 1 16 76 (|A-F|/Actual)*100 0.92 1.41 0.46 1.90 0.94 2.28 0.46 1.89 10.26

3-33

Control chart

A visual tool for monitoring forecast errors Forecasting errors are in control if All errors are within the control limits No patterns, such as trends or cycles, are present

3-34

Model may be inadequate Irregular variations Incorrect use of forecasting technique

3-35

Tracking Signal

Tracking signal

Ratio of cumulative error to MAD

MAD

Bias Persistent tendency for forecasts to be Greater or less than actual values.

3-36

No single technique works in every situation Two most important factors

Cost Accuracy

Historical data Computers Time needed to gather and analyze the data Forecast horizon

3-37

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

3-38

Sharing forecasts with supply can

Improve forecast quality in the supply chain Lower costs Shorter lead times

3-39

Exponential Smoothing

3-40

3-41

3-42

These Techniques work best when a series tends to vary about an average

Averaging techniques smooth variations in the data They can handle step changes or gradual changes in the level of a series Techniques

Moving average Weighted moving average Exponential smoothing

3-43

Regression - a technique for fitting a line to a set of data points

Simple linear regression - the simplest form of regression that involves a linear relationship between two variables

The object of simple linear regression is to obtain an equation of a straight line that minimizes the sum of squared vertical deviations from the line (i.e., the least squares criterion)

3-44

Tracking forecast errors and analyzing them can provide useful insight into whether forecasts are performing satisfactorily Sources of forecast errors

The model may be inadequate Irregular variations may have occurred The forecasting technique has been incorrectly applied Random error

Control charts are useful for identifying the presence of nonrandom error in forecasts Tracking signals can be used to detect forecast bias

3-45

Factors to consider

Cost Accuracy Availability of historical data Availability of forecasting software Time needed to gather and analyze data and prepare a forecast Forecast horizon

3-46

Reactive approach

View forecasts as probable future demand React to meet that demand

Proactive approach

Seeks to actively influence demand Advertising Pricing Product/service modifications Generally requires either and explanatory model or a subjective assessment of the influence on demand

3-47

Operations Strategy

The better forecasts are, the more able organizations will be to take advantage of future opportunities and reduce potential risks

A worthwhile strategy is to work to improve short-term forecasts Accurate up-to-date information can have a significant effect on forecast accuracy:

Prices Demand Other important variables

Reduce the time horizon forecasts have to cover Sharing forecasts or demand data through the supply chain can improve forecast quality

3-48

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