Chapter 3

Forecasting

A
Forecasting Framework
Forecasting is the art and science of predicting future events
Focus on the forecasting of demand for output from the
operations

function

(Demand

may

differ

from

sales,

forecasting may serve for developing operating planning)

Demand management is coordinating and controlling all

source of demand so the production system can be used
efficiently and product be delivered on time

Demand can be:

Dependent: demand for a product caused by the demand

for other product (a product linked to demand of other)

Independent: occurs independently of demand from any

other product (can not be derived directly from that of other
product)

A Forecasting Framework
Difference between forecasting and planning
Forecasting: what we think will happen
Planning: what we think should happen

Forecasting is an input to all business planning and

control
Marketing uses for planning product, promotion and pricing
Finance uses for financial planning
Forecasting for operation decision

Forecasting application in various decision areas of operations

(capacity planning, inventory management, others)

Forecasting and
on most recent
operationInformation
system
demand and production
Demand forecast
for operations

Planning the system

(design)
Product design
Process design
Equipment investment
and replacement
Capacity planning

Scheduling the

system

Aggregate
production planning

Operation
scheduling

Output of goods
and services

Controlling the
system
Production control
Inventory control
Labor control
Cost control

Characteristics of demand
over
time
Time series
analysis

Plot the demand data on a time scale, study the plot

and look for consistent shape or pattern. The time
series of demand might have the following pattern
Constant
Trends
Seasonal(cyclical) pattern
Random variation (cause by chance of event)
Some combinations of these patterns
Conditions
Low noise: most the points lies around /very close
to the pattern
High noise: many points lies relatively far away
from the pattern

Useful Forecasting Model

Techniques
Qualitative and judgment method: based on

estimates and opinions

Naive (time series)quantitative/Extrapolative

model: based on data related to past demand can

be used to predict future demand
Causal relationship (quantitative) or Explanatory

model: -using linear regression techniques

Simulation
7

Qualitative Forecasting
Based upon managerial judgment when there is a lack
Methods
of data or the data were not reliable or relevant. No
specific model is used but qualitative.
When new product is introduced

Major methods:
Grass root
Builds the forecast by adding successively from the

bottom, the assumption is that the person closest

to the customer or end user of the product knows
its future need best (front line operators data)
8

Qualitative Forecasting
Delphi Technique
Methods

It is a panel of group of experts with different level

of expertise (variety of knowledgeable people) and

answer questionnaires and summarized given back
to the entire group with new set of questions
Delphi
conceals the identity of individuals
participating in the study
Market Surveys (research)
panel, questionnaire, market test
Life-cycles (historical) Analogy
In forecasting new products, where an existing
product or generic product could be used as a model
Informed Judgment (group of individuals on
experience, facts)

Time-Series Forecasting

Try to predict the future based on the past data

To select forecasting model: Time horizon, Data availability,

Accuracy required, size of forecasting budget, qualified

personnel
Components of time-series data:
Trendgeneral direction (up or down)
Seasonalityshort term recurring cycles
Cyclelong term business cycle
Error (random or irregular component)
Decomposition of time-series
Data are broken into the four components
Simple Average
Weighted Moving Averages
Exponential Smoothing
Regression Analysis
9

Simple Moving Average

Assumes

no

trend,

seasonal

or

cyclical

components.
Simple Moving Average: combines demand data

from several of the most recent periods;

their

average being the forecast for next period.

As general rule: the longer the averaging period,

the slower response to demand change

1
1

Simple Moving Average

Forecast Ft is average of n previous observations

or actuals Dt
1:

Ft 1

( Dt Dt 1 Dt 1 n )

n
t
1
Note
the n past
Ftthat
Diobservations are equally

1
weighted. n i t 1 n
Issues with moving average forecasts:
All n past observations treated equally;
Observations older than n are not included at

all;
Requires that n past observations be retained;

Simple Moving Average

Include n most recent observations
Weight equally
Ignore older observations
weight
1/n

n
13

...

today

Simple Moving Average

Compute three period moving average (number of periods is
the decision of the forecaster)
Period

Actual Demand

10

18

29

Forecast

19

(10+18+29)/3 = 19
Period 5 will be (18+29+actual for period 4)/3
11-14

Simple Moving Average

Example
Month
January
February
March
April
May
June
July

Actual
Shed Sales
10
12
13
16
19
23
26

3-Month
Moving Average

(10 + 12 + 13)/3
13 = 11 2/3
(12 + 13 + 16)/3 = 13 2/3
(13 + 16 + 19)/3 = 16
(16 + 19 + 23)/3 = 19 1/3

Weighted Moving Average

Weighted Moving Average: wants to use the

moving average but does not want to have all

n periods equally weighted. This makes
responsive:

16

Weights Applied
Period
Exampl
3
Last month
2
Two months ago
Average
e Weighted Moving
1
Three months ago
6

Sum of weights

Month

Actual
Shed Sales

3-Month Weighted
Moving Average

January
February
March
April
May
June
July

10
12
13
16
19
23
26

[(3 x 13)
= 121/6
13 + (2 x 12)
12 + (10)]/6
10
[(3 x 16) + (2 x 13) + (12)]/6 = 141/3
[(3 x 19) + (2 x 16) + (13)]/6 = 17
[(3 x 23) + (2 x 19) + (16)]/6 = 201/2

Exponential Smoothing:
Concept

Include all past observations

Weight recent observations much more heavily

than very old observations:

0 1

weight

(1 )

Decreasing weight given

to older observations

(1 ) 2
(1 )
today
18

Simple Exponential
The forecast:
Smoothing

F=forecast of demand (both this period and next)

D = actual demand (this period)
t = time period
The value of the smoothing constant () is a choice. It
determines how much the calculation smoothes out the
random variations. Its value can be set between zero (0)
and one (1). Normally it is in the 0.1 to 0.3 range.
11-19

Exponential Smoothingcalculation
If Ft+1 is to be very responsive to recent demand,
choose the large value of
the most recent occurrences are more indicative
of the future than in the more distant past
Facts:
September forecast for sales was 15
September actual sales were 13
Alpha ( ) is 0.2
What is the forecast for October?

Calculation
October Forecast = September forecast + (September

actual-September forecast)
=15+0.2(13-15)=15+0.2(-2)=15-0.4=14.6
11-20

Exponential Smoothing
Example
Predicted demand (t-1)= 142 Ford Mustangs
Actual demand = (t-1)153
Smoothing constant = .20
New forecast (t) = 142 + .2(153 142)

Exponential Smoothing Example

Predicted demand = 142 Ford Mustangs
Actual demand = 153
Smoothing constant = .20
New forecast

= 142 + .2(153 142)

= 142 + 2.2
= 144.2 144 cars

Forecast Errors
Error Estimation might be used
To monitor erratic demand observations

and outliers (Perhaps may be rejected from

data)
To set safety stock or safety capacity and

ensure against stock out

23

Forecast Errors
Cumulative Sum of Forecast Error (CFE)

and Mean Forecast Error (MFE)

Mean Square Error (MSE)
Mean Absolute Deviation (MAD)measure

of deviation in units.
Mean Absolute Percentage Error (MAPE)
Tracking Signal (TS)relative measure of

bias

et
et=Actual demand (Dt)- Forecast (Ft)

Forecast error for Period t is

11-24

Forecasting Performance
How good is the forecast?
Mean Forecast Error (MFE or Bias):

25

Measures average deviation of forecast

from actuals.
Mean
Absolute Deviation (MAD):
Measures average absolute deviation of
forecast from actuals.
Mean Absolute Percentage Error (MAPE):
Measures absolute error as a
percentage of the forecast.
Standard
Squared
Error
(MSE):
Measures variance of forecast error

Mean Absolute Deviation

(MAD)
1 n
MAD

D F

n
t 1

Measures absolute error

Positive and negative errors thus do not

cancel out (as with MFE)

Want MAD to be as small as possible

26

Forecast Errors: Formulas

n

CFE = et
i=1
n

Mean Square Error

Mean Absolute
Deviation

11-27

MSE =

2
t

i=1

Mean Absolute
Percentage Error

MAPE =

Tracking Signal

MAD =

i=1

TS =

i=1

MAD
n

i=1

n
|e |

et

| D

Mean Error

ME =

i=1

| 100

Tracking Signal
A tracking signal monitors any forecasts that have
been made in comparison with actuals, and warns when
there are unexpected departures of the outcomes from
. the forecasts.
Analogous to control charts in quality control, viz. if
there is no bias, its values should fluctuate around zero.

11-28

Example
Period

Forecast

11

13.5

-2.5

2.5

13

-4.0

4.0

10

10

0.0

9.5

-1.5

1.5

14

5.0

5.0

12

11

1.0

1.0

MFE = -2/6 = -0.33

MAD = 14/6 = 2.33

Error

Absolute
Error

Demand

n = 6 observations

Ideal value = 0;
MFE > 0, model tends to under-forecast
MFE < 0, model tends to over-forecast

Conclusion: Model tends to slightly over-forecast, with an average absolute error of

2.33 units.

29

Time Series vs. Causal

Models
Time series compares data being forecast

over

time, i.e. Time is the independent variable or xaxis or X-variable.

Causal

models compare data being forecast

against some other data set which the forecaster

may think is a cause of the forecasted data,
e.g. population size causes newspaper sales.

11-30

Causal Forecasting Models

The general regression model:(Least

Squares Method)

The Values of a and b

11-31

Values of Dependent Variable

Least Squares Method

Actual observation
(y-value)

Deviation7

Deviation5

Deviation6

Deviation3
Deviation4
Deviation1
(error)

Deviation2

Trend line, y ^= a + bx

Time period

Figure 4.4

Values of Dependent Variable

Least Squares Method

Actual observation
(y-value)

Deviation7

Deviation5
Deviation3

Deviation6

Least squares method minimizes the sum

of the squared errors (deviations)
Deviation4

Deviation1
(error)

Deviation2

Trend line, y ^= a + bx

Time period

Figure 4.4

Least Squares Method

Equations to calculate the regression variables
^

y = a + bx
xy - nxy
b=
x2 - nx2
a = y - bx

Least Squares Example

Year
2006
2007
2008
2009
2010
2011
2012

Time
Electrical Power
Period (x) Demand (megawatt)

x2

xy

1
2
3
4
5
6
7

74
79
80
90
105
142
122

1
4
9
16
25
36
49

74
158
240
360
525
852
854

x = 28
x=4

y = 692
y = 98.86

x2 = 140

xy = 3,063

3,063 - (7)(4)(98.86)
xy - nxy
b=
= 140 - (7)(42)
x2 - nx2
a = y - bx = 98.86 - 10.54(4) = 56.70

= 10.54

Least Squares Example

Year

Time
Period (x)

2003
2004
2005The
2006
2007
2008
2009

1
2
trend
3 line is
4
^
y =5 56.70 +
6
7

x = 28
x=4

Electrical Power
Demand

x2

xy

1
4
9
16
25
36
49

74
158
240
360
525
852
854

x2 = 140

xy = 3,063

74
79
80
90
105
10.54x
142
122

y = 692
y = 98.86

3,063 - (7)(4)(98.86)
xy - nxy
b=
= 140 - (7)(42)
= 10.54
x2 - nx2
a = y - bx = 98.86 - 10.54(4) = 56.70

Power demand

Least Squares Example

160
150
140
130
120
110
100
90
80
70
60
50

Trend line,
y^= 56.70 + 10.54x

|
2006

|
2007

|
2008

|
2009

|
2010
Year

|
2011

|
2012

|
2013

|
2014

2011 Pearson Education, Inc.

publishing as Prentice Hall

Example of Time Series Model

Yt = a + b(t)
Dt = actual sales
Ft = forecasted sales
t = time period (e.g. year)

F7 = 117.87 + 1.66 (7) = 129.47 = sales forecast for next year

11-38

Selecting A Forecasting
Methods
User and Systems Sophistication:

People reluctant to use what they dont

understand
How sophisticated are the managers
Inside and outside operations
Who is expecting to use the forecasting results

Time and resource available

When is forecast needed?
What is value of forecast?

39

Selecting A Forecasting
Methods
Use and decision characteristics
Accuracy required, Time horizon
Pricing decision require highly accurate short

ranged forecasts for large number of item

40

Data availability and quality

Data pattern affects the type of forecasting
If the time series is flat, A first order method can
be used, where as if the data shows trend or
seasonal pattern some advance method will be
used
If the data is unstable over time, a qualitative
method may be selected
Dont force the data to fit the model!

Forecast Horizons and Forecast

Accuracy
The longer the forecast horizon, the less

accurate the forecast

Long lead times require long forecast
horizons
Lean, responsive companies have the goal
of decreasing lead times so they are
shorter than the forecast horizon

41

End

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