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Forecasting

Operations Management

William J. Stevenson

8th edition

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Forecasting

FORECAST:

A statement about the future value of a variable of interest such as demand. Forecasts affect decisions and activities throughout an organization It involve taking historical data and projecting them into the future with some sorts of mathematical model. It may be subjective or institutive prediction It may involve combination of mathematical model adjusted by a managers good judgment. There is seldom single superior method

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Forecasting

Uses of Forecasts
Cost/profit estimates Cash flow and funding

Accounting Finance

Human Resources Marketing


MIS Operations Product/service design

Hiring/recruiting/training Pricing, promotion, strategy


IT/IS systems, services Schedules, MRP, workloads New products and services

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Forecasting

Features common to all forecasts

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

Forecasts more accurate for groups vs. individuals


Forecast accuracy decreases as time horizon increases

I see that you will get an A this semester.

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Forecasting

FORECASTING TIME HORIZONS

It can be classified by the future time horizon that it covers. Time horizons fall into three categories:-

Short range forecast: 3 months to 1year


Planning purchasing, job scheduling, workforce levels, job assignments, and production levels

Medium Range forecast: 3 months to 3years


For sales planning, production planning, cash budgeting and analyzing various operating plans

Large Range forecast: 3year or more


Planning for new products, capitial expenditures, facility location, or expansion, and R&D

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Forecasting

Elements of a Good Forecast

Timely

Reliable

Accurate

Written

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Forecasting

TYPES OF FORECASTS

Economics Forecast addresses the business cycle by predicting inflation rates, money supplies housing states and other planning indicators.

Technological Forecast are concerned with rates of technological program which can result in the birth of new exciting products, requiring new plants and equipments.
Demand Forecasts are projections of demand for a companys products or services. These forecasts are also called sales forecasts drives a company production capacity and scheduling system.

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The strategic importance of forecasts


Lets look at the impact of product forecast on three activities

Forecasting

Human Resources: Hiring firing training of workers all depend on anticipated demand.
Capacity: if you capacity without proper demand and forecast would result in higher cost of production Supply Chain Management: Good supplier relations and the ensuring price advantages for materials and parts depend on accurate forecasts.

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Forecasting

Steps in the Forecasting Process

The forecast

Step 6 Monitor the forecast

Step 5 Prepare the forecast Step 4 Gather and analyze data Step 3 Select a forecasting technique
Step 2 Establish a time horizon Step 1 Determine purpose of forecast

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Types of Forecasts

Judgmental - uses subjective inputs Time series - uses historical data assuming the future will be like the past Associative models - uses explanatory variables to predict the future

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Judgmental Forecasts

Executive opinions
Sales force opinions Consumer surveys Outside opinion method

Delphi

Opinions of managers and staff


Achieves a consensus forecast

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Time Series Forecasts

Trend - long-term movement in data Seasonality - short-term regular variations in data Cycle wavelike variations of more than one years duration Irregular variations - caused by unusual circumstances Random variations - caused by chance

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Forecast Variations
Irregular variatio n

Figure 3.1

Trend

Cycles
90 89 88 Seasonal variations

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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.

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Nave 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

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Uses for Nave Forecasts

Stable time series data

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

Seasonal variations

Data with trends

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Techniques for Averaging

Moving average Weighted moving average Exponential smoothing

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Moving Averages

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

MAn =

Ai i=1 n

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

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Simple Moving Average


Actual

MA5

47 45 43 41 39 37 35 1 2 3 4 5 6 7
n

MA3
8 9 10 11 12

MAn =

Ai i=1 n

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Exponential Smoothing

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


Premise--The most recent observations might have the highest predictive value.

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

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Exponential Smoothing

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

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

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Example 3 - Exponential Smoothing


Period 1 2 3 4 5 6 7 8 9 10 11 12 Actual 42 40 43 40 41 39 46 44 45 38 40 Alpha = 0.1 Error 42 41.8 41.92 41.73 41.66 41.39 41.85 42.07 42.36 41.92 41.73 -2.00 1.20 -1.92 -0.73 -2.66 4.61 2.15 2.93 -4.36 -1.92 Alpha = 0.4 Error 42 41.2 41.92 41.15 41.09 40.25 42.55 43.13 43.88 41.53 40.92 -2 1.8 -1.92 -0.15 -2.09 5.75 1.45 1.87 -5.88 -1.53

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Picking a Smoothing Constant


Actual

50
Demand

.4

45 40 35 1 2 3 4 5 6 7 8

.1

9 10 11 12

Period

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Trend adjusting Exponential Smoothing

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Common Nonlinear Trends

Figure 3.5

Parabolic

Exponential

Growth

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Linear Trend Equation


Ft

Ft = a + bt


0 1 2 Ft = Forecast for period t t = Specified number of time periods a = Value of Ft at t = 0 b = Slope of the line 3 4 5 t

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Calculating a and b
n (ty) - t y b = 2 2 n t - ( t)

y - b t a = n

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Linear Trend Equation Example


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

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Linear Trend Calculation


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

b =

812 - 6.3(15) a = = 143.5 5

y = 143.5 + 6.3t

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SEASONALITY EFFECT

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Summarizing Forecast Accuracy

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Linear Model Seems Reasonable


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

A straight line is fitted to a set of sample points.

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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

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Sources of Forecast errors

Model may be inadequate Irregular variations Incorrect use of forecasting technique

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Choosing a Forecasting Technique

Many different forecasting techniques are available, and no single technique works best in every situation. When selecting a technique for a given situation, the manager or analyst must take a number of factors into consideration. The two most important factors are:

Cost and Accuracy

How much money is budgeted for generating the forecast? What are the possible costs of error? What are the benefits that might accrue from an accurate forecast?

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Choosing a Forecasting Technique

Generally speaking, the higher the accuracy, the higher the cost, so it is important to weigh cost-accuracy trade-offs carefully. The time needed to gatherer and analyze data, and prepare the forecast. Time horizon are also important:- MA & Exp smoothing are short range techniques since they produce forecast for the next period. Trend equations can be used to project over much long range forecast. Delphi method & executive opinion methods are often used for long range planning.

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Choosing a Forecasting Technique

New products and services lack historical data, so forecast, for them must be based on subjective estimates. In some instances, a manager might use more than one forecasting technique to obtain independent forecasts. If different techniques produced approximately the same predictions, that would give increased confidence in the results; disagreement among the forecast would indicate that additional analysis may be needed.

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Tracking Signal

Tracking signal
Ratio of cumulative error to MAD

(Actual-forecast) Tracking signal = MAD


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

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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

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Exponential Smoothing

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Linear Trend Equation

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Simple Linear Regression

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