Operations Management

School of Engineering
The University of the Thai
Chamber of Commerce

Operations Management UTCC Page 1

 Forecasting

School of Engineering
The University of the Thai Chamber of Commerce

Operations Management UTCC Page 2

 Agenda
• What is forecast?
• Elements of good forecasts
• The necessary steps in preparing a forecast
• Basic forecasting techniques
• How to monitor a forecast

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Operations Management UTCC Page 4
 จำาน วน ผ ล ผ ล ต สิ น ค้ าเก ษ ต ร ก ล ม ภ าค้ เห น อ ต อ น ล างที่ ได้ ปี 2547

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 Motto in OM class
• It’s an old story, but an instructive note: T w o shoe
salesmen arrive on a primitive island where no one
w ears shoes. O ne cables his head office saying “N o
business. S hoes not w orn”, the other sends a
different m essage “S end m ore shoes. N o
com petition.”

John F. Kenedy

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 1. Introduction
• Have you ever forecast??
• How much food and drink will I need for the party?
• Will I get the job?
• Which team will be a world champion in 2006?

To make these forecasts,

• One is current factors or conditions.
• The other is past experience in a similar situation.

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 1. Introduction
• Forecasting are the basis for budgeting and
planning for capacity, sales, production and
inventory, personnel, purchasing, and more.
• Forecast play an important role in the planning
process.
• Forecasts affect decisions and activities throughout
an organization, in accounting, finance, human
resources, marketing, MIS, as well as operations,
and other parts of an organization.

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 2.1 Uses of Forecasts
Accounting Cost/profit estimates

Finance Cash flow and funding

Human Resources Hiring/recruiting/training

Marketing Pricing, promotion, strategy

MIS IT/IS systems, services

Operations Schedules, MRP, workloads

Product/service design New products and services

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2. FORECAST:

• There are two methods for forecasting.

– Plan the system (involves long term plan
about the types of products and service to
offer).
– Plan to use the system (involves short and
intermediate term plan such as planning
inventory , workforce levels, planning
purchasing, budgeting and scheduling).

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Operations Management UTCC Page 11
 ก ารออก แบ บ ศู น ย์ ก ระจาย์ สิน ค้ าข องจงห วัด พิ ษ ณุ โลก

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 2.1 Features Common to all Forecasts

• Assumes causal system

past ==> future
• Forecasts rarely perfect because of
randomness
• Forecasts more accurate for
groups vs. individuals I see that you will
get an A this semester.
• Forecast accuracy decreases
as time horizon increases

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 Forecasting time horizons
- Short-range forecast (not more than one year;
Planning purchasing, Job scheduling, Workforce levels
and so on)

- Medium-range forecast ( 3 months to 3 years;

Production planning and budgeting, Cash budgeting)

- long-range forecast (more than 3 years; planning for

new products, Capital expenditures, Facility location
and R&D

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The influence of product life cycle (PLC)

1 Introduction
2 Growth
3 Maturity
4 Decline

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Operations Management UTCC Page 17
 3. Elements of a Good Forecast

Timely

Reliable Accurate

Written

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 4. Steps in the Forecasting Process

“T h e fo recast”

Step 7 Validate and Implement the results

Step 6 Monitor the forecast

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

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 5. Types of Forecasts

• Judgmental - uses subjective inputs

• Time series - uses historical data assuming the future
will be like the past
• Associative models or Casual Model – use equation
that consists of one or more explanatory variables to
predict the future. For example, demand for paint might
be related to variables such as the price per gallon and
the amount spent on advertising, as well as specific
characteristics of the paint.

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 6. Judgmental Forecasts

• Executive opinions
• Sales force opinions
• Consumer surveys
• Outside opinion
• Delphi method
– Opinions of managers and staffs
– Achieves a consensus forecast

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 7. Time Series Forecasts

• is a time-ordered sequence of observations taken at

regular intervals.
• The data may be measurements of demand, earnings,
profits, shipments, accidents, output and productivity.
• Trend - long-term movement in data
• Seasonality - short-term regular variations in data
• Cycle – w avelike variations of m ore than one year’s
duration
• Irregular variations - caused by unusual circumstances
• Random variations - caused by chance (Bird Flu)
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 7.1 Forecast Variations

Irregular
variation

Trend

Cycles

90
89
88
Seasonal variations

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 7.2 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

th e p reviou s p eriod ’s actu al valu e.

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 7.2 Naïve 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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 7.2 Uses for Naïve Forecasts

• Stable time series data

– F(t) = A(t-1)
• Seasonal variations
– F(t) = A(t-n)
• Data with trends
– F(t) = A(t-1) + (A(t-1) – A(t-2))

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 7.2 Naïve Methods
• Uses a single previous value of a time series as the basis
of a forecast

Period Actual Change from previous value Forecast

t-1 50
t 53 +3
t+1 53+3 = 56

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 7.3 Techniques for Averaging
• Generate forecasts that reflect recent values of a
time series.
• Work best when a series tends to vary around an
average
– Moving average
– Weighted moving average
– Exponential smoothing

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 7.3.1 Moving average
• Uses a number of the most recent actual data values in
generating a forecast. n

A i
Ft MA
n  i1
n
i = an index that corresponds to periods
n = number of periods in the moving average
Ai = actual value in period i
MA = Moving Average
Ft = Forecast for period t

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 Example 1
• Compute a three period Period Age Demand

moving average forecast 1 5 42

given demand for 2 4 40
shopping carts for the last 3 3 43
five periods. 4 2 40
5 1 41


43
4041
F
6 
41
.33
3
If actual demand in period 6 
40
4139
turns out to be 39. What is F7 ? F
7 
40
3

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 7.3.2 Weighted Moving Average
• A weighted average is similar to a moving average,
except that it assigns more weight to the most
recent values in a time series.
• For instance, the most recent value might be
assigned a weight of .40, the next most recent value
a weight of .30, the next after that a weight of .20,
and the next after that a weight of .10.
• That weights sum to 1.00, and that the heaviest
weights are assigned to the most recent values.

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 7.3.2 Weighted Moving Average
a) Compute weighted average forecast using a weight .4 for the most
recent period, .3 for the next most recent, .2 for the next, and .1 for
the next.
b) If the actual demand for period 6 is 39, forecast demand for period 7
using the same weights as in part a.

Period Demand
1 42
2 40
3 43
4 40
5 41

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 7.3.2 Weighted Moving Average

a
.
F6
.4
(
41
)
.
3(
40
)
.
2(
43
)
.
1(
40
)
41
.
0
b
.
F7
.4
(
39
)
.
3(
41
)
.
2(
40
)
.
1(
43
)
40
.
2

Note that if four weights are used, only the four most recent
demands are used to prepare the forecast.

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7.3.2 Weighted Moving Average
• The weighted average is more reflective of the most
recent occurrences.
• The choice of weights is somewhat arbitrary and
generally involves the use of trial and error to find a
suitable weighting scheme.

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 7.3.3 exponential smoothing
• Exponential smoothing is a sophisticated weighted
averaging method that is still relatively easy to use
and understand. Each new forecast is based on the
previous forecast plus a percentage of the
difference between that forecast and the actual
value of the series at that point.

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 7.3.3 Exponential Smoothing


Next
fore
Pre
for
(A
-
PF

t
F F1
t 
(A 1
t F
t
1)
α represents a percentage of the forecast error.
Therefore, each new forecast is equal to the previous forecast plus a
percentage of the previous error.
Suppose the previous forecast was 42 units, actual demand was 40
units, and α = .10. the new forecasts
F = 42 + .10(40-42) = 41.8
Then if the actual demand turns out to be 43, the next forecast would
be?? Ans. 41.92
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 7.3.3 Exponential Smoothing
• An alternate form of formula reveals the weighting of the
previous forecast and the latest actual demand:

t
F F1
t 
(A 1
t F
t
1)
t
F (
1
)F1
t 
At
1

• For example:
t
F F
t
10
.10
(
A t
1F
t
1)
t
F (
0.9
)F
t
10
.1
At
1

F = 42 + .10(40-42) = (0.9)(42) + (.10)(40) = 41.8

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 Example 2
• The following table illustrates two series of forecasts
for a data set and the resulting error for each
period. One forecast uses α = .10 and one uses α =
.40. The following figure plots the actual data and
both sets of forecasts.

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Example 2 - Exponential Smoothing

P eriod A c t ual A lpha = 0. 1E rror A lpha = 0. 4E rror

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

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 Picking a Smoothing Constant

Actual
50
.4
 .1
Demand

45

40

35
1 2 3 4 5 6 7 8 9 10 11 12
Period

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 7.3.3 Exponential Smoothing
• The closer α is to zero, the slower the forecast will be to
adjust to forecast errors. (the greater the smoothing,
emphasis the previous data)

• The closer the value of α is to 1.00, the greater the




responsiveness and the less the smoothing. (emphasis
the present data )


F
t A

t
1
(
1A
)

t
2
(
1A
)A
...
(
1) 2

t
3
n

t
n

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 7.4 Techniques for trend
• Develop an equation that will suitably describe trend
• The trend component may be linear, or it may not.
• Two important techniques that can be used to
develop forecasts
– Trend equation
– Extension of exponential smoothing

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 7.4 Common Nonlinear Trends
Figure 3.5

Parabolic

Exponential

Growth

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7.5 Linear Trend Equation

Ft

Ft = a + bt

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

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 7.5 Trend equation
The coefficients of the line, a and b, can be computed from
historical data using these components.
ntyty
b
nt2 (t)2

a
ybt
or y-bt
n

n = number of periods
y = value of the time series

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 Linear Trend Equation Example

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

2
t = 15 
t = 55 y= 812 ty= 2499
2
(
t) = 225

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 Linear Trend Calculation

5 (2499) - 15(812) 12495-12180

b = = = 6.3
5(55) - 225 275 -225

812 - 6.3(15)
a = = 143.5
5

y = 143.5 + 6.3t

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 Example 3
Cell phone sales for a Week Unit Sales
California-based firm over the 1 700
last 10 weeks are shown in the 2 724
following table. Plot the data, 3 720
and visually check to see if a 4 728
linear trend line would be 5 740
appropriate. Then determine
6 742
the equation of the trend line,
7 758
and predict sales for weeks 11
8 750
and 12.
9 770
10 775

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 Example 3
a. A plot suggests that a linear trend line would be appropriate:
unit sales

800
780
760
740
sales

720
700
680
660
1 2 3 4 5 6 7 8 9 10
week

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 Example 3
Week (t) Unit Sales Ty b. ntyty
b
(y) nt2 (t)2
1 700 700
a
ybt
or y-bt
2 724 1448
n
3 720 2160
4 728 2912 10
(41
,358)(55
)(7
,407
) 6
,195
b  7
.51
10(
385 )55
(55) 825
5 740 3700
7
,4077.51(
55)
6 742 4452 a 699.40
10
7 758 5306
8 750 6000 Thus the trend line is
9 770 6930

t 
10 775 7750 y699
.40
7
.51
t
55 7407 41358

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 Example 3
c. Substituting values of t into this equation, the forecasts
for the next two periods are:

y
11699
.
40
7.
51(
11
) 782
.
01
y
12699
.
40
7.
51(
12
) 789
.
52

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 Example 3
d. For purposes of illustration, the original data, the trend line,
and the two projections (forecasts) are shown on the following
graph. unit sales

800
780
760
740
sales

720
700
680
660
1 2 3 4 5 6 7 8 9 10
week
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 7.6 Associative Forecasting
• Associative techniques rely on identification of
related variables that can be used to predict
values of the variable of interest.
• 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

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 7.7 Linear Model Seems Reasonable
X Y Computed
7 1 5
relationship
2 1 0
6 1 3 50

4 1 5 40

1 4 2 5 30

1 5 2 7 20

10
1 6 2 4
0
1 2 2 0 0 5 10 15 20 25

1 4 2 7
2 0 4 4
1 5 3 4
7 1 7
A straight line is fitted to a set of sample points.

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 8. Forecast Accuracy

• Error = actual value - predicted value

• Mean Absolute Deviation (MAD)
– Average absolute error
• Mean Squared Error (MSE)
– Average of squared error
• Mean Absolute Percent Error (MAPE)
– Average absolute percent error

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 8.1 MAD, MSE, and MAPE

 Actual  forecast
MAD =
n
2
 ( Actual  forecast)
MSE =
n -1

 ( Actual  forecast / Actual*100)

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

MAD= 2.75
MSE= 10.86
MAPE= 1.28

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 Example 4: Solution
• MAD = 22/8 = 2.75
• MSE = 76/(8-1) = 10.86
• MAPE = 10.26%/8 = 1.28%

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 9. 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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9.1 Control Chart
• S = MSE • MSE = 2
• UCL : z MSE• S = MSE 1
.
41
• LCL : z MSE• UCL : zMSE
2
.
82
• LCL : zMSE
2
.
82

+2.82

-2.82

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 10. Sources of Forecast errors

• Model may be inadequate

• Irregular variations
• Incorrect use of forecasting technique

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 11. Tracking Signal or Control Chart

•Tracking signal
– Ratio of cumulative error to MAD

Tracking signal =
 (Actual-forecast)
MAD
Bias – Persistent tendency for forecasts to be
Greater or less than actual values.

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 12. 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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 13. Forecast factors, by range of forecast

Factor Short Range Intermediate Long Range

Range
1. Frequency Often Occasional Infrequent
2. Level of Aggregation Item Product family Total output, type of
product/service
3. Type of model Smoothing, Smoothing, Managerial
projection, projection, judgment
regression regression
4. Degree of management Low Moderate High
involvement
5. Cost per forecast Low Moderate high

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 Problem 1
1. The appropriate naïve Period Number of Complaints
approach
2. A three period moving 1 60
average and five period
3. A weighted average 2 65
using weights of .50
(most recent), .30, and 3 55
.20
4. Exponential smoothing 4 58
with a smoothing
constant of .40 5 64

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 Solution:
1. The values are stable. Therefore, the most recent
value of the series becomes the next forecast: 64
2. MA3 = (55+58+64)/3 = 59
MA5 = (60+65+55+58+64)/5 = 60.4
3. F = .20(55)+.30(58)+.50(64) = 60.4

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 Solution:
Period Number of Forecast calculations
complaints
1 60

2 65 60

3 55 62 60+.40(65-60) = 62

4 58 59.2 62+.40(55-62) = 59.2

5 64 58.72 59.2 + .40(58-59.2) = 58.72

6 60.83 58.72+.40(64-58.72) = 60.83

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 Problem 2:
• Plot the data on a graph, Period Demand
and verify visually that a 1 44
linear trend line is 2 52
appropriate. Develop a line
3 50
trend equation for the
following data. Then use 4 54
the equation to predict the 5 55
next two value of the 6 55
series 7 60
8 56
9 62
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 Solution 2:

70
60
50
Demand

40
30
20
10
0
0 2 4 6 8 10
Period

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 Solution 2:
Period (t) Demand (y) Ty
1 44 44
2 52 104
3 50 150
4 54 216
5 55 275
6 55 330
7 60 420
8 56 448
9 62 558
448 2545

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 Solution 2:
ntyty 9(2,545)(45
)(488)
b b 1.75
nt2 (t)2 9(285)45(45)

a
ybt
or y-bt a
488 1.75(45
)
45.47
n 9
Thus the trend line is

t
F 45 
.471.75
t
F
1045 
.471.75 )
(10 62
.97
F
1145 
.471.75 )
(11 64
.72

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 Problem 3
• The manager of a large manufacturer of industrial pumps must chose
between two alter active forecasting techniques. Both techniques have
been used to prepare forecasts for a six-month period. Using MAD as
a criterion, which technique has the better performance record?
Forecast
Month Demand Technique 1 Technique 2
1 492 488 495
2 470 484 482
3 485 480 478
4 493 490 488
5 498 497 492
6 492 493 493

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 Solution 3

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 Solution 3:
• Technique 1 is superior in this comparison because
its MAD is smaller, although six observations would
generally be too few on which to base a realistic
comparison.

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 Problem 4:
• Given the demand data that follow, prepare a naïve forecast
for periods 2 through 10. Then determine each forecast
error, and use those values to obtain 2s control limits. If
demand in the next two periods turns out to be 125 and 130,
can you conclude that the forecasts are in control?

Period 1 2 3 4 5 6 7 8 9 10

Demand 118 117 120 119 126 122 117 123 121 124

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 Solution 4:
Period Demand Forecast Error Error square
1 118 - - -
2 117 118 -1 1

3 120 117 3 9
4 119 120 -1 1
5 126 119 7 49
6 122 126 -4 16
7 117 122 -5 25
8 123 117 6 36
9 121 123 -2 4
10 124 121 3 9
6 150

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 Solution 4:

s
 150
2
error
33 n = Number of errors
4
.

n1 
91

The control limits are 2(4.33) = +/-8.66

The forecast for period 11 was 124. demand turned out to be 125, for an
error of 125-124 = 1. this is within the limits of +/-8.66. If the next demand
is 130 and the naïve forecast is 125, the error is +5. again, this is within
the limits, so you cannot conclude the forecast is not working properly.
With more values at least five or six you could plot the errors to see
whether you could detect any patterns suggesting the presence of non-
randomness.

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 Problem 5:
5. National mixer Inc. sell can Month Sales
openers. Monthly sales for (000 units)
a seven-month period Feb 19
were as follows: Mar 18

Apr 15
May 20
Jun 18
Jul 22
Aug 20

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 Problem 5
a. Plot the monthly data
b. Forecast September sales volume using each of the
following:
a. A linear trend equation.
b. A five-month moving average
c. Exponential smoothing with alpha = 0.20, assuming a March
forecast of 19(000).
d. The naïve approach
e. A weighted average using .60 for August, .30 for July, and .10
for June.
c. Which method seems least appropriate? Why?

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 Problem 6
6. Freight car loadings over a 12 year period at a busy port are

Week Ton Shipped Week Ton Shipped Week Ton Shipped

1 405 8 433 15 466
2 410 9 438 16 474

3 420 10 440 17 476

4 415 11 446 18 482
5 412 12 451
6 420 13 455
7 424 14 464

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 Problem 6:
a. Determine a linear trend line for freight car
loadings.
b. Use the trend equation to predict loadings for
weeks 20 and 21.
c. The manager intends to install new equipment
when the volume exceeds 800 loadings per week.
assuming the current trend continues, the loading
volume will reach that level in approximately what
week?

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 Problem 7:
7. Two different forecasting techniques were used to forecast
demand fore cases of bottled water. Actual demand and
the two sets of forecasts are as follows:
Forecast
Period Demand Technique 1 Technique 2
1 68 66 66
2 75 68 68
3 70 72 70
4 74 71 72
5 69 72 74
6 72 70 76
7 80 71 78
8 78 74 80

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 Problem 7:
a) Compute MAD for set of forecasts. Given your results,
which forecast appears to be more accurate? Explain
b) Compute the MSE for each set of forecasts. Given your
results, which forecast appears to be more accurate?
c) In practice, either MAD or MSE would be employed to
compute forecast errors. What factors might lead a
manager to choose one rather than the other?
d) Compute MAPE for each data set. Which forecast
appears to be more accurate?

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