Forecasting LEARNING OBJECTIVES After completing this chapter, students will be able to: 4 Understand and know when to use various families 4. Understand Delphi and other qualitative decision- of forecasting models. making approaches. 2. Compare moving averages, exponential smoothing, 5. Compute a variety of error measures. land other time-series models, 3. Seasonally adjust data, Cede a 5.4 Introduction 5.4 Measures of Forecast Accuracy 5.2 Types of Forecasts 5.5. Time-Series Forecasting Models 5.3. Scatter Diagrams and Time Series 5.6 Monitoring and Controlling Forecasts Summary * Glossary + Key Equations + Solved Problems + Self-Test + Discussion Questions and Problems + Internet Homework Problems + Case Study: Forecasting Attendance at SWU. Sales + Intemet Case Study + Bibliography Appendix 5.1: Forecasting with QM for Windows football Games + Case Study: Forecasting Monthly 153154 CHAPTERS + FORECASTING 5.1 Introduction [No single method is superior. Whatever works best should Be used. 5.2 _ Types of Forecasts Every day, managers make decisions without knowing what will happen in the future. Inventory is ordered though no one knows what sales will be, new equipment is purchased though no one knows the demand for products, and investments are made though no one knows what profits will be. Managers are always trying to reduce this uncertainty and to make better estimates of what will happen in the future, Accomplishing this is the main purpose of forecasting ‘There are many ways to forecast the future. In numerous firms (especially smaller ones), the entize process is subjective, involving seat-of-the-pants methods, intuition, and years of ex- perience. There are also many quantitative forecasting models, such as moving averages, expo- nential smoothing, trend projections, and least squares regression analysis. ‘The following steps can help in the development of a forecasting system. While steps 5 and 66 may not be as relevant if a qualitative model is selected in step 4, data are certainly necessary for the quantitative forecasting models presented in this chapter. Eight Steps to Forecasting 1. Determine the use of the forecast—what objective are we trying to obtain? 2, Select the items or quantities that are to be forecasted. 3. Determine the time horizon of the forecast—is it | to 30 days (short term), 1 month (0 1 year (medium term), or more than I year (long term)? Select the forecasting model or models. Gather the data or information needed to make the forecast. ‘Validate the forecasting model, Make the forecast Implement the results. ‘These steps present a systematic way of initiating, designing, and implementing a forecast- ing system. When the forecasting system is to be used to generate forecasts regularly over time, data must be collected routinely, and the actual computations or procedures used to make the forecast can be done automatically, ‘There is scldom a single superior forecasting method. One organization may find regression effective, another firm may use several approaches, and a third may combine both quantitative and subjective techniques. Whatever tool works best fora firm is the one that should be used, The three categories of models are time series, causal, and qualitative. In this chapter we consider forecasting models that can be classified into one of three categories: time-series models, causal models, and qualitative models (see Figute 5.1) Time-Series Models ‘Time-series models attempt to predict the future by using historical data, These models make the assumption that what happens in the futur is a function of what has happened in the past. In other words, time-series models look at what has happened over a period of time and use a se- ries of past data to make a forecast. Thus, if we are forecasting weekly sales for lawn mowers, wwe use the past weekly sales for lawn mowers in making the forecast ‘The time-series models we examine inthis chapter are moving average, exponential smooth- ing, trend projections, and decomposition. Regression analysis can be used in trend projections and in one type of decomposition model. The primary emphasis ofthis chapter is time series forecasting, Causal Models ‘Causal models incorporate the variables or factors that might influence the quantity being fore- casted into the forecasting model. For example, daily sales of a cola drink might depend on the season, the average temperature, the average humidity, whether itis a weekend or a weekday, and so on, Thus, @ causal model would attempt to include factors for temperature, humidity, season, day of the week, and so on, Causal models may also include past sales data as time- series models do, but they include other factors as wel.FIGURE 5.1 Forecasting Models Overview of four qualitative or Judgmental approaches: Delphi Jury of executive opinion, sales ‘force composite, and consumer market survey 5.2 TYPESOFFORECASTS 155 Forecasting ‘Techniques Quaitaive Time-Series causal Mocs Methods Methods Delph Moving Regression ethos ‘Averages ‘Analysis Jury of Executive Exponential Munple Opinion Smoothing Regression Sales Force Trend Compastio Projections Consumer oe Decomposition Our job as quantitative analysts is to develop the best statistical relationship between sales or the variable being forecast and the set of independent variables, The most common quantita- tive causal model is regression analysis, which was presented in Chapter 4, The examples in Sections 4.8 and 4.9 illustrate how a regression model can be used in forecasting. Specifically, they demonstrate how to predict the selling price of a house based on characteristics such as size, age, and condition of the house, Other causal models do exist, and many of them are based fon regression analysis. Qualitative Models ‘Whereas time-series and causal models rely on quantitative data, qualitative models attempt to incorporate judgmental or subjective factors into the forecasting model. Opinions by experts, in- dividual experiences and judgments, and other subjective factors may be considered. Qualitative ‘models are especially useful wen subjective factors are expected to be very important or when, accurate quantitative data are difficult to obtain. Here is a brief overview of four different qualitative forecasting techniques: 1, Delphi method. This iterative group process allows experts, who may be located in differ- ent places, to make forecasts. There are three different types of participants in the Delphi process: decision makers, staff personnel, and respondents. The decision making group usually consists of 5 to 10 experts who will be making the actual forecast. The stall person- nel assis the decision makers by preparing, distributing, collecting, and summarizing a series of questionnaires and survey resulls. The respondents are a group of people whose judgments are valued and are being sought. This group provides inputs to the decision makers before the forecast is made, In the Delphi method, when the results of the first questionnaire are obtained, the results are summarized and the questionnaite is modified. Both the summary of the results and the new questionnaire are then sent to the same respondents for a new round of responses. The respondents, upon seeing the results from the first questionnaire, may view things differently and may modify their original responses. This process is repeated with the hope that a consensus is reached 2. Jury of executive opinion. This method takes the opinions of a small group of high-level man- agers, often in combination with statistical models, and results in a group estimate of demand, 43. Sales force composite. In this approach, each salesperson estimates what sales will bein his of her region; these forecasts ate reviewed to ensure that they are realistic and age then combined at the dstzict and national levels to reach an overall forecast, 4, Consumer market survey. This method solicits input from customers or potential customers regarding their future purchasing plans. It can help not only in preparing a forecast but also in improving product design and planning for new products156 CHAPTER 5 + FORECASTING Scents the natonat Huron Crier (MH) of he Na Tat Went sere fave the sey afc ob of pret Mier hve fa huriane wl Nt and Acta eats trey enportont fo coal busheses nd resets wh tect teres forest or phos een erat They me Sho mpuran to el goverrent ofc Iw evrcaet agenda and eer emergency sponds who il poe he Rev sims psd Ove te jase NaC hs ene thay nore feast sche (sued by ath fhscte Seaton MAD) pedng te acta anda ec ton frhacanes at organ he Alone Ocean Te ie pees occa pecs unt whee he hurtin eyeolf ona Suc bl aon eto ae map(in 450 400 - , 350 300 7 e 250 Miles 200 150 100 50 ° 1989 19941999 Year Hurricane Landfall Location Forecasts and LUNE LON the Mean Absolute Deviation recorded when a hurricane is 72 hours, 48 hours, 36 hours, 24 hours, and 12 hours away from actually reaching land. Once the hurricane has come ashore, these forecasts are compared to the actual landfall location, and the error (in miles) is recorded. [At the end of the hurricane season, the errs for all the huricanes in that year are used to cakulate the MAD for each type of fore- cast (12 hours away, 24 hour away, etc}. The graph below shows how the landfall location forecast has improved since 1989, Our ing the early 1990s, tne lanaall forecast when the hurricane was 48 hours away had an MAD close to 200 miles; 2008, ths num- ber was down to about 75 miles. Clearly, there has been vast improvement in forecast accuracy, anc this vend is continuing ‘Source: Bad on National Hsicane Cen, p/w be oa, s) of Hurricane Landfall Location Forecast 1989-2009 -*-12hours out + 24hours out 36 hours out + ABhours out + 72hours out 2004 5.3 Scatter Diagrams and Time Series A scatter diagram helps obtain ‘ideas about a relationship. As with regression models, seatter diagrams are very helpful when forecasting time series. A scat- ter diagram fora time series may be plotted on a wo-dimensional graph withthe horizontal axis representing the time period. The vasiable to be forecast (such as sales) is placed on the vertical axis, Letus consider the example ofa frm that needs to forecast sales fr three different products, Wacker Distributors notes that annual sales for three of its products—television sets, radios, and compact dise players—over the past 10 years are as shown in Table 5.1. One sim- pple way to examine these historical data, and perhaps to use them to establish a forecast, is to raw a scatter diagram for each product (Figure 5.2). This picture, showing the relationship be- tween sales of a product and time, is useful in spotting trends or eycles. An exact mathematical ‘mode! that describes the situation can then be developed if it appears reasonable to do so,TABLE 5.1 Annual Sales of Three Products FIGURE 5.2 Scatter Diagram for Sales = () ‘Annual Sales of CD Players ‘Anns Sales of Televisions Annual Sales of Racios 8 250 200 150 100 50 420 400 ao 360 40 320 300 280 200 180 160 140 120 100 012345678910 ‘Time (Years) 012345678910 Time (Yeats) 012345678910 ‘Time (Years) 5.3. SCATTER DIAGRAMS AND TIME SERIES 157 x0 10 30 v0 x0 190 sso a0 Sales appear to be constant overtime. This honzonal ine could be described by the equation Sales = 250 ‘Thatis, no matter what year(t. 2.8, and 20 0n) we ince into tne equation, ealee wil not change. A good estimate of future ‘ales (in year 11) is 250 televisions! Sales appear tobe increasing ata ‘constant rate of 10 radi each year. Iv the lng is extended lef fo the vertical axis, we see that sales would be 290 in year 0, The equation Sales = 290 + 10(Year) ‘best describes tis relationship betwen sales and time. A reasonable estimate of radio sales in year 11 is 400, Inyear 12, 410 radios. This tend line may not be perfectly accurate because of variation each ‘year. But CD sales do appear to ‘have boon increasing over the past 10 years. If we had o forecast future sales, we would probably pick a Targer gure exch year.158 CHAPTERS + FORECASTING 5.4 Measures of Forecast Accuracy The naive forecast forthe next period isthe actual value ‘observed in the current period. TABLE 5.2 ‘Computing the Mean Absolute Deviation (map) We discuss several different forecasting models in this chapter. To see how well one model works, or to compare that model with other models, the forecasted values are compared with the actual or observed values. The forecast error (or deviation) is defined as follows: jecast error = Actual value — Forecast value ‘One measure of accuracy isthe mean absolute deviation (MAD). This is computed by tak- ing the sum of the absolute values of the individual forecast errors and dividing by the numbers of errors (7) MAD Zlforecast error] (54) Consider the Wacker Distributors sles of CD players shown in Table 5.1, Suppose that in the past. Wacker had forecast sales foreach yar tobe the sles that were actully achieved in the previous yea. This i sometimes called a nave model, Table 5.2 gives thse forecasts aswel as the absolute value ofthe eror. In forecasting forthe next time period (year 11, te forecast wold be 190, Novice tht there i no emer computed for year {since there was no forecast for this you, and there is no exer for yet I1 since te acto aloe of his isnot yet Kove, Ts, the aumber of erers (nis 9, rom this, we se te following sap = Dloeeatewerl 160g rn) This means that onthe average, each forecast missed the actual value by 178 units Other measures of the accuracy of historical ers in forecasting are sometimes used besides the MAD. One ofthe most common isthe mean squared error (MISE), which i the average ofthe squared eros Serre)? 62) ee Reet Vat ey PT SACO as i eee el 1 110 = — 2 100 10 lio - 110] = 10 3 120 00 [120 = 100] = 20 4 140 20 liso 120] = 20 s 170 40 1170 ~ 140] = 30 6 150 70 [150 — 170] = 20 7 160 50 liso ~ 150] = 10 5 130 160 lu90 ~ 150] = 30 9 200 90 [p00 = 190] = 10 0 190 200 [190 ~ 200) = 10 1 = 190 - Sum of ferrrs| = 160 MAD = 16019 = 17.8 “Inregression analysis, the MSE formula is usually adjusted to provide an unbiase estimator ofthe eo variance. Throughout this cepler we wil use the Forma provided bezMODELING IN THE REAL WORLD |Hisiebtsiehadinaaiiaaia Defining ‘the Problem | Developing Model | Acquiing Inpur Data | Developing a Solution Testing the Solution | Analyzing the Results | Implementing the Results 5.4 MEASURES OF FORECAST ACCURACY 159. Internat Defining the Problem To dive production at each of Tupperware’ 15 plans in the United States, Lain America, Africa, Europe, and Asia the frm needs accurate forecasts of demand for its products Developing a Model A variety of statistical models ae used, including moving averages, exponential smoothing, and regression analysis. Qualitative analysis is also employed in the process. Acquiring Input Data [At world headquarters in Orlando, Florida, huge databases are maintained that map the sales of each product, the test market results of each new product (since 20% af the firm's sales come from products less than 2 yeas old), and were each product fallin its own fe cycle Developing a Solution Each of Tuoperware’s 50 profit centers worldwide develops computerized monthly, quatterh, and ‘12-month sales projections, These are aggregated by region and then globally, ‘Testing the Solution Reviews of these forecasts take place in sales, marketing, finance, and production departments, Analyzing the Results Participating managers analyze forecasts with Tupperware's version of a “jury of executive opinion Implementing the Results Forecasts are used to schedule material, equipment, and personnel at each plant Source flervews hy the ashore with Toppers executes Three common measures of error are MAD, MSE, and MAPE. Bias gives the average error and ‘may be positive or negative ‘Besides the MAD and MSE, the mean absolute percent error (MAPE) is sometimes used, ‘The MAPE is the average of the absolute values of the errors expressed as percentages of the actual values. This is computed as follows: 63) ‘There is another common term associated with error in forecasting. Bias is the average er- ror and tells whether the forecast tends to be too high or too low and by how much. Thus, bias ‘may be negative or positive. It is not a good measure of the actual size ofthe errors because the negative errors can cancel out the positive errors,160 CHAPTERS + FORECASTING 5.5 _Time-Series Forecasting Models Four components ofa time series are trend, seasonality, cycles, and random variations FIGURE 5.3 Product Demand Charted cover 4 Years, with Trend and Seasonality Indicated A time series is based on a sequence of evenly spaced (weekly, monthly, quarterly, and so on) data points. Examples include weekly sales of HP personal computers, quarterly earnings te- ports of Microsoft Corporation, daily shipments of Eveready batteries, and annual U.S. con- sumer price indices. Forecasting time-series data implies that future values are predicted only from past values of that variable (such as we saw in Table 5.1) and that other variables, no mat- ter how potentially valuable, are ignored, Components of a Time Series Analyzing time series means breaking down past data into components and then projecting them forward. A time series typically ha four components 1. Trend (1) is the gradual upward or downward movement of the data overtime. 2 Seasonality (S) i a pattern of the demand fluctuation above ox below the tend line that repeats at regular intervals. 3. Cycles (C) axe pattems in annual data that oocur every several years. They axe usually tied into the business cycle 4 Random variations (R) are “blips” inthe data caused by chance and unusual situations; they follow no discernible pattern Figure 5.3 shows a time series and its components ‘There are two general forms of time-series models in statistics, The first is a multiplicative ‘model, which assumes that demand is the product of the four components. Cis stated as follows: Demand = TX SX CXR An additive model adds the components together to provide an estimate. Multiple regres- sion is often used to develop additive models. This additive relationship is stated as follows: Demand =T+S5+C+R ‘There are other models that may be a combination of these. For example, one of the components (uch as trend) might be additive while another (such as seasonality) could be multiplicative. Understanding the components of a time series will help in selecting an appropriate fore- casting technique to use. If all variations in a time series are due to random variations, with no trend, seasonal, or cyclical component, some type of averaging or smoothing model would be appropriate, The averaging techniques in this chapter are moving average, weighted moving average, and exponential smoothing. These methods will smooth out the forecasts and not be Trend Component Demand for Preduct or ServiceMoving averages smooth out variations when forecasting demands are fairly steady. Weights can be used to put more ‘emphasis on recent periods. TABLE 5.3 Wallace Garden Supply Shed Sales 55 TIME-SERIES FORECASTING MODELS 161 too heavily influenced by random variations. However, if there is a trend or seasonal pattern present in the data, then a technique which incorporates that particular component into the fore- ‘east should be used, Two such techniques are exponential smoothing with trend and trend pro- jections. If there is a seasonal pattern present in the data, then a seasonal index may be developed and used with any of the averaging methods. If both trend and seasonal components are present, then a method such as the decomposition method should be used, Moving Averages Moving averages are useful if we can assume that market demands wall stay fairly steady over time. For example, a four-month moving average is found simply by summing the demand dur- ing the past four months and dividing by 4. With each passing month, the most recent month's data are added to the sum of the previous three months’ data, and the earliest month is dropped. ‘This tends to smooth out short-term irregularities in the data series. ‘An mperiod moving average forecast, which serves as an estimate of the next period's demand, is expressed as follows Sum of demands in previous m periods Moving average foect = Susman inpreviousn prods ea ‘Mathematically, this is written as % Fae 65) where soy = forecast for time period r + 1 ¥, = actual value in time period + n = number of periods to average ‘A4-month moving average has n = 4; a S-month moving average has n = 5. WALLACE GARDEN SUPPLY EXAMPLE Storage shed sales at Wallace Garden Supply are shown in the middle column of Table 5.3. A 3-month moving average is indicated on the right. The forecast for the next January, using this technique, is 16. Were we simply asked to find a fore- cast for next January, we would only have to make this one calculation. The other forecasts are necessary only if we wish to compute the MAD or another measure of accuracy. WEIGHTED MOVING AVERAGE A simple moving average gives the same weight (1/n) to each of the past observations being used to develop the forecast. On the other hand, a weighted moving average allows different weights to be assigned to the previous observations. As the ont one Tanwary 10 February 2 March B + pal 16 (04124 138 = 1167 May 19 (24134 163 = 13.67 June 2 (13 + 16+ 19y8 = 16.00 July 2% (16 + 19423) = 19.33, August 30 (19 +23 4 26y3 = 22.67 September 28 (23+ 26+ 30) = 26.33, October 18 (26 +30+28)3 = 28.00 November 16 004284 19)3 = 25.33 December “ 8+ 18+ 163 = 2067 January - (18 + 16+ 14) = 16.00162 CHAPTERS + FORECASTING Moving averages have two problems: the larger number of periods may smooth out real ‘changes, and they don't pick up trend, weighted moving average method typically assigns greater weight to more recent observations, this forecast is more responsive to changes in the pattern ofthe data that occur. However, this is also a potential drawback to this method because the heavier weight would also respond just as guickly to random fluctuations. ‘A weighted moving average may be expressed as > (Weigh in period) (Actual value in period) Fos = y (5-6) Sowers) Mathematically, this is py Rata ho won - aes mw, + wy + ey en where 1; = weight for ith observation Wallace Garden Supply decides to use a 3-month weighted moving average forecast with weights of 3 for the most recent observation, 2 for the next observation, and I for the most dis- tant observation, This would be implemented as follows: fotuecd Ec ‘Last month 2 months ago 3 months ago © » Sates 3 months ago + Ox Sales? ments a80 O- O% Sates at mont * Sum of the weights “The results of the Wallace Garden Supply weighted average forecast are shown in Table 5.4. In this particular forecasting situation, you can see that weighting the latest month more heavily provides a much more accurate projection, and calculating the MAD for each of these would verity this. Choosing the weights obviously has an important impact on the forecasts. One way to choose weights is to try various combinations of weights, calculate the MAD for each, and select the set of weights that results in the lowest MAD, Some forecasting software has an op- tion to search for the best set of weights, and forecasts using these weights are then provided, ‘The best set of weights can also be found by using nonlinear programming, as will be seen in a later chapter, ‘Some software packages require that the weights add to 1, and this would simplify Equa- tion 5-7 because the denominator would be 1. Forcing the weights to sum to 1 is easily achieved by dividing each of the weights by the sum of the weights, In the Wallace Garden Supply exam- ple in Table 54, the weights are 3, 2, and 1, which add to 6. These weights could be revised to the new weights 3/6, 2/6, and 1/6, which add to 1. Using these weights gives the same forecasts shown in Table 5.4 Both simple and weighted moving averages are effective in smoothing out sudden fluctua- tions in the demand pattern in order to provide stable estimates. Moving averages do, however, ‘have two problems. Fust, increasing the size of n (the number of periods averaged) does smooth out fluctuations better, but it makes the method less sensitive to real changes in the data should they occur. Second, moving averages cannot pick up trends very well. Because they are aver- ages, they will always stay within past levels and will not predict a change to either a higher or a lower level USING EXCEL AND EXCEL QM IN FORECASTING Excel and spreadsheets in general are frequently used in forecasting. Many forecasting techniques are supported by buill-in Excel functions. You can also use Excel QM’s forecasting module, which has several components. To access ExcelTABLE 5.4 Weighted Moving Average Forecast for Wallace Garden Supply PROGRAM 5.18 Selecting the Forecasting Module in Excel QM 55 TIME-SERIES FORECASTING MODELS. 163 our nonnenn: Janvary 10 February 2 March 3 ——————_, Apa 16 (8x19 +@x12) + GOy6 May 19 18x 19) + x13) + ADV June 2 16X19) = 2x 169) + aH Jaly 26 (8x28) +@x 19) + A065 = August 30 18 x 26) + X23) + UY September 28 1G X30) + 2x26) + a3)H6 October 18 1 x 28) + @ x 30) + Q6)/6 = 28.33 November 16 (BX 18) + 2X28) + BOY'S December 4 16 x 16) + @ x18) + ANY Janvary = 16x14) +@x 16) + AB/6 ‘QM after it has been installed in Excel 2010 or Excel 2007 (see Appendix F for information about installing Excel QM), go to the Add-ins tab and select Excel OM and then select Forecasting. If you click on a technique such as Moving Average, Weighted Moving Average, of Exponential Smoothing, an input window will open. To use Excel QM forthe Wallace Garden Supply weighted moving average forecast, select Forecasting—Weighted Moving Average, as shown in Program 5.1A. Enter the number of past periods of data and the number of periods to be averaged. as shown in Program 5.1B. Click OK when finished, anda spreadsheet wil be in- tialized. Simply enter the past observations and any parameters, such as the number of periods tobe averaged, and the output will automatically appear because the formulas are automatically generated by Excel QM. Program 5.1C provides the results. To display the formulas in Excel, simply press Cull+ (grave accent) Pressing this again return the display to the values instead of the formulas Home inert PagelayeutFomulas Data Review View Pha Peterences HEE EET lo 7 © Gena pu wer se “Bel Qne AL sia exe Assignment hese ney TO 8 Aaestab, select Excel OM, Forecasting +) teovina average Sur) aigneea Woung Avera H r& Maced Integer Procraning Exponential smoating ines Markov chaine Regeenion rena Anlse Mate Requrements Planning Mutiple Regression Network Anas Decomposition ‘oject Management egresionfrojecor Dusky Conte ee Click on the method that appears onthe right ‘Smuation164 CHAPTERS + FORECASTING PROGRAM 5.18 Spreadsheet intalizaton Initialization Screen for Weighted Moving Average “Tite: Vielace Garden Supply Sheetname: Cons (FTracking Sonal Number of (past) peros of cata Name for perod Peed (Use A for A,B,C ..0r2 fora, b,c Number of perioes to average PROGRAM 5.1¢ ted Moving Average in Excel QM for 2 Wallace Garden Supply orecastina Weighted ‘The names of the petiods canbe changed ‘ 7 Data Forecasts ond Ericr Analysis, & Poicd” Denard "Wai Fovocast [enor — [Absolute [Squared [Abs Pal 8 wemsary 7 a 10 Famty ‘aj 1 11 Maren ‘3 3} 42 Apt i aa EE EA 13|May si peer] 21 77d — pa a ‘June Input the weight. Note that 1 e[ 36] 25.054) 15 uh the highest weigh is forthe [3] aes] a1 486 16 August rmestrecent obsen—ation. Eiss7| 38.0278] — 20-56% 47 September iB Os 0251 01754 18 (October ‘a Et fosssa| oe] —s7at4 48, November i ti Tass 53777 20 December 15.657 67] 217778 21 [raat 5 a0) 323-335 22 |The forecast forthe next period is here.) [S223 sauual 359058) ae fac fort nev pri sere), A 24 Se 67 2 Nentpenod BSS Exponential Smoothing Exponential smoothing is a forecasting method that is easy to use and is handled efficiently by computers. Although itis a type of moving average technique, it involves litle record keeping of past data, The basic exponential smoothing formula can be shown as follows: New forecast Last period's forecast 68) + a{Last period’s actual demand — Last period’s forecast) where « is a weight (or smoothing constant) that has a value between 0 and 1, inclusive,The smoothing constant, e, “allows managers to assign weight to recent data. 55 TIME-SERIES FORECASTING MODELS 165 Equation 5-8 can also be written mathematically as Fars F, + a(t — Fi) 69) where Foy = new forecast (for time period ¢ + 1) F, = previous forecast (for time period 1) = smoothing constant (0 = a = 1) Y, = previous period's actual demand ‘The concept here is not complex. The latest estimate of demand is equal to the old estimate adjusted by a fraction ofthe erzor (last period's actual demand minus the old estimate), ‘The smoothing constant, a, can be changed to give more weight to recent data when the value is high or more weight to past data when itis low. For example, when a = 0.5, it ean be shown mathematically that the new forecast is based almost entiely on demand in the past three periods. When a = 0.1, the forecast places little weight on any single period, even the most recent, and it takes many periods (about 19) of historic values into account." For example, in January, a demand for 142 of a certain car model for February was pre- dicted by a dealer. Actual February demand was 153 autos. Using a smoothing constant of ‘@ = 0.20, we can forecast the March demand using the exponential smoothing model. Substi- tuting into the formula, we obtain New forecast (for March demand) = 142 + 0.2(153 — 142) 144.2 ‘Thus, the demand forecast for the cars in March is 144 Suppose that actual demand for the cars in March was 136, A forecast for the demand in April, using the exponential smoothing model with a constant of « = 0.20, can be made New forecast (for April demand) = 144.2 + 0.2(136 — 144.2) 142.6, or 143 autos SELECTING THE SMOOTHING CONSTANT The exponential smoothing approach is easy to use and has been applied successfully by banks, manufacturing companies, wholesalers, and other organizations. The appropriate value of the smoothing constant, a, however, can make the difference between an accurate forecast and an inaccurate forecast, In picking a value for the smoothing constant, the objective is to obtain the most accurate forecast. Several values of the smoothing constant may be tried, and the one with the lowest MAD could be selected. This is analogous to how weights are selected for a weighted moving average forecast. Some forecasting software will automatically select the best smoothing constant. QM for Windows will display the MAD that would be obtained with values of a ranging from 0 to 1 in incre- ments of 0.01, PORT OF BALTIMORE EXAMPLE Let us apply this concept with a trial-and-error testing of two values of a in an example. The port of Baltimore has unloaded large quantities of grain from ships during the past eight quarters. The port's operations manager wants to test the use ‘of exponential smoothing to see how well the technique works in predicting tonnage unloaded. He assumes that the forecast of grain unloaded in the first quarter was 175 tons. Two values of « are examined: a = 0.10 and « = .50. Table 5.5 shows the derailed calculations for «= 0.10 only. “The term exponential smoothing is used because the weight of any on psiod’s demand in a forcast decreases expo sentaly over tine See an advanced forearting book fr sgebrie proc166 cHarrel TABLE 5.5 Port of Baltimore Exponential Smoothing Forecasts for a= 0.10 and a = 0.50 Two smoothing constants are used. TABLE 5.6 Absolute Deviations and MADs for the Port of Baltimore Example 5 + FORECASTING Teas 1 180) 175 175 2 6s 1955 = 175.00 + 0.10(180 ~ 175) ms 3 19 17495 = 175.50 + 0.10(168 ~ 175.50) rs 4 75 173.18 = 174.75 + 0.100159 — 174.75) 165.88 5 190 173.36 = 173.18 + 0.100075 ~ 173.18) 046 6 205 175.02 = 17336 +0.10490— 17336 18022 7 180) 178.02 = 17502 + 0.100205 ~ 175.02), 19261 5 182 178.22 = 178.02 + 0.10(180 ~ 178.02) 186.30 8 . 178.60 = 178.22 4 0.10082— 178.22) 18415 To evaluate the accuracy of each smoothing constant, we can compute the absolute devia tions and MADs (see Table 5.6). Based on this analysis, a smoothing constant of « = 0.10 is preferred to a = 0.50 because its MAD is smaller. USING EXCEL QM FOR EXPONENTIAL SMOOTHING Program 5.2 illustrates how Excel QM han- les exponential smoothing with the port of Baltimore example. EXPONENTIAL SMOOTHING WITH TREND ADJUSTMENT The averaging or smoothing forecast- ing techniques are useful when a time series has only a random component, but these techniques {ail wo respond to trends, If there is trend present in the data, a forecasting model that explicitly incorporates this into the forecast should be used, One such technique is the exponential smooth- ing with trend model. The idea is to develop an exponential smoothing forecast and then adjust this for tend, Two smoothing constants, « and Bare used in this model, and both of these val- vues must be between 0 and 1. The level of the forecast is adjusted by multiplying the first smoothing constant, «, by the most recent forecast error and adding it to the previous forecast. The tend is adjusted by multiplying the second smoothing constant, 8, by the most recent error fr excess amount in the tend. A higher value gives more weight to recent observations and thus responds more quickly to changes in the patterns As with simple exponential smoothing. the first time a forecast is developed, a previous forecast (F;,) must be given or estimated. If none is available, often the inital forecast is as- ACTUAL eens en RON ME oU ATC ONM e RETAILS CE OU A CeO ee Ri eo Pe) 1 180 115 5 115 5 2 168 uss 1s ms os 3 159 maT 1575 ints was 4 ns rma 12 165.48 on s 190 17336 165 7048 1955 6 205 w7s02 2998 8022 un 7 180 7802 198 10x61 R61 8 12. 17822 aa 18630 4a Sum of absolute deviations as 9863 Map = SHevatonl 56.31 MaDPROGRAM 5.2 Port of Baltimore Exponential Smoothing Example in Excel QM. Estimate or assume inital values fork, and, 55 TIME-SERIES FORECASTING MODELS 167 A 18 c 1 Port of Baltimore intial forecast i given, enter ithere, you do not want a to inclide the error fortis inital forecast, celle EIOHTO. 3 Forecasting Exponential smoothing 4 | Enleraipa (belveon and *), ent the past demandsinthedhaded column then niet StaringforecastF the staring forecasts not ne Mistpefédthen delete ie eter 2 analsistoralrows abovetie staring forecast. 7 Alpha 5 Data ts and Error Analysis 9 Period Demand Error_[Absolu SquareqAbs Pete 10 | Quarter 4 180) 475 3 5] 25] 0278%| 11 Quarter 2 168} 4755| __-75| 7.5] 5625| 04.40%! 12 Quarter3 159) 37475| 1575] 15.75] 248.06|09.97%| 43 Quarter 4 475] 473.175| 1.825| 1.825| 33300| 04.04% 4 Quarter 5 190) 773.358] 16.643] 16.643] 276.97| 05.70%| 45 Quarter 8 205) 475.022| 29.978| 29.978| 898 7|_ 14.82% 416 Quarter 7 180 478.02| 1.9804] 1.9804] 3.9221] 01 10%| 47 Quarter 182 778218| 3 7824| 37824] 14.206| 0.02078] 8 Total| 35.959| 82.459| 1526.5| 44.75%| 19 | The forecast for uarter 9ishere.|| Average) 4.4948| 10.907| 190.82| 06.69%] 2 Bias | MAD | MSE |MAPE 2 SE] 15.951 22 Next peri] 178.596] sumed to be perfect. In addition, a previous trend (7) must be given or estimated. This is often estimated using other past data, if available, or by using subjective means, or by calculating the increase (or decrease) observed during the fitst few time periods of the data available. Without such an estimate available, the trend is sometimes assumed to be 0 initially, although this may lead to poor forecasts ifthe trend is large and 8 is small. Once these initial conditions have been se, the exponential smoothing forecast including trend (FIT,) is developed using three steps Step 1. Compute the smoothed forecast (F,1) for time period ¢ + 1 using the equation Smoothed forecast ~ Previous forecast including tend + a(Last error) Frey = FIT, + @(¥, ~ FIT,) 10) Step 2. Update the trend (T;-) using the equation Previous tend + @(Error or excess in trend) 1, + B(Fy ~ FIT) Gay) Step 3, Calculate the tend-adjusted exponential smoothing forecast (FUT;,:) using the equation Forecast including trend (F/T,.;) = Smoothed forecast (F,-) + Smoothed wend (T+) Fifa = Fir +7 (42) where T,, = smoothed tend for time period 1 Fr smoothed forecast for time period + forecast including trend for time period 1 smoothing constant for forecasts 8 = smoothing constant for trend168 CHAPTERS + FORECASTING TABLE 5.7 Midwestern Manufacturing’ Demand 2004 1% 2005 Pp 2006 0 2007 90 2008 105 2009 142 2010 fred Consider the case of Midwestern Manufacturing Company, which has a demand for electti- cal generators over the period 2004 to 2010 as shown in Table 5.7. To use the trend-adjusted exponential smoothing method, first set initial conditions (previous values for F and 7) and choose a and B. Assuming that F; is perfect and 7; is 0, and picking 0.3 and 0.4 for the smooth- ing constants, we have Fi=74 Ty=0 @=03 B04 This results in FIT, = Fy +7; =14+0=74 Following the three steps to get the forecast for 2005 (time period 2), we have Step 1. Compute F; + using the equation Foy = FIT, = a, ~ FIT) Fy = FIT, + 03(¥, — FIT;) = 74 + 0.3(74 — 74) = 74 Step 2, Update the wend (7,1) using the equation Tis =T) + BUFrsa ~ FIT) T, + 04(F, — FIT;) = 0 + 0.4(74 — 74) = 0 step 3, Calculate the trend-adjusted exponential smoothing forecast (F/T;.;) using the equation FIT, = Fy +T,=74+0=74 For 2006 (time period 3) we have Step Fy = FIT, + 03(¥) ~ FIT:) = 74 + 0.3(79 — 74) = 755 Step 2. Ty =Tz + OA(Fs — FIT:) = 0 + 0.4(75.5 ~ 74) = 0.6 Step 3. FIT, = Fy + Ty = 155 +06 = 76.1 “The other results are shown in Table 5.8. The forecast for 2011 would be about 131.35.55 TIME-SERIES FORECASTING MODELS Using Excel QM for Trend-Adjusted Exponential Smoothing Program 5.3 shows how Excel QM can be used for the exponential smoothing with trend forecasts 169 TABLE 5.8 Midwestern Manufacturing Exponential Smoothing with Trend Forecasts DEMAND m4 ™ ° 200 Ha + 03474) 0 + 04(%4 ~ 14) 1” 3 55H 78 + 03(79 7H 0 + 04(755 ~ 18) 761 4% nave Lot mae = 161 + 03(80 ~ 751) = 06 + 047727 ~ 761) 5 Bs 21937 268 4305 = 19208 + 03490 ~ 78338) Lost + 08(81.837 ~ 78228) 6 sous 4952 95466 = 90514 + 4952 = 84305 +0305 ~ 8305) = 2468 + 04190514 ~ 84305) 7m 109.426 10536 lug.962 = 109496 + 10536 = 95456 + 03(182 ~ 95456) = 4952 + 04(108.426 ~ 95465 : nosts 10.780 Iaiass = 12nsra + 10.780 = 119,962 + 0,3(122 — 119.962) 10.536 + 0.4(120.573 — 119.962) PROGRAM 5.3 Fe YS ST FP TT Midwestern 4 Midwestern Manufacturing (5,2 values for the smoothing constants Manufacturing Trend- 2 Adjusted Exponential | Ree eae Smoothing in Excel QM | laiscunralsshansadntdesne tats z}Kme To Cu mey orev fo Fa sn Fence iter E or Seat sexe sori] 558 * Bar| Mab | MSE Ne a Gis at etree Nar | ws Attend line i a regression equation with time as the independent variable. Trend Projections Another method for forecasting time series with trend is called trend projection, This technique fits a trend line to a series of historical data points and then projects the line into the future for ‘medium. to long-range forecasts. There are several mathematical trend equations that can be170 CHAPTERS + FORECASTING PROGRAM 5.4A Excel Input Screen for Midwestern Manufacturing Trend Line developed (¢.g., exponential and quadratic), but in this section we look at linear (straight line) trends only. A trend line is simply a linear regression equation in which the independent vari- able (X) is the time period. The form of this is P= by + bX where F = predicted value by = intercept b; = slope of the line X = time period (ic., X = 1,2,3,....n) ‘The least squares regression method may be applied to find the coefficients that minimize the sum of the squared errors, thereby also minimizing the mean squared ertor (MSE). Chapter 4 provides detailed explanation of least squares regression, and formulas to calculate the coefli- cients by hand are in Section 4.3. In this section, we will rely on Excel and Excel QM to per- form the calculations. MIDWESTERN MANUFACTURING COMPANY EXAMPLE Let us consider the case of Midwestern Manufacturing Company, That firm’s demand for electrical generators over the period 2004-2010 was shown in Table 5.7. A trend line to predict demand (Y) based on the time pe- riod can be developed using a regression model, If we let 2004 be time period | (X = 1), then 2008 is time period 2 (X = 2), and so forth. The regression line can be developed using Excel 2010 (see Chapter 4 for details) by going to the Data tab and selecting Data Analysis—Regression and entering the information as shown in Program 5.4. The results ae shown in Program 5.4B, From this we get 5671 + 10.54x To project demand in 2011, we first denote the year 2011 in our new coding system as X=8: (sales in 2011) = 56.71 + 10.54(8) = 141.03, or 141 generators ‘We can estimate demand for 2012 by inserting X= 9 in the same equation: (sales in 2012) = 56.71 + 10.54(9) 151.57, or 152 generators a [4 2 | Tie 0) Daren) Be oe =) 2 ro zhao 63 3 | 8 vow irra ensano a5 We i até Dlesnaie2ne 9) 8 oo? Dleetimetent [EI i 4 ones [13] canta ia M4 Oven vaien B te sm ibet aa ig Lpesains (ei Hate [38h Tisteded seed Claw i [an tera Posy 21 Cinemas ousPROGRAM 5.48 Excel Output for Midwestern Manufacturing Trend Line FIGURE 5.4 Electrical Generators and ‘the Computed Trend 55 TIME-SERIES FORECASTING MODELS. 171 Te os E Fe STE Gestapo end ni 1054) =f bE t PE os 7S Seamer + Cs 7] 06 7 3108 eT 20 06H Trg 5 39908671 | Ta Sarda Ear Slat Paton oe 5 Uap oer 5 Oar BSR RESP PR ENS BSe5) Tuan) stray 37 — tote rou, wa ou 7 Time) | T0s3571| 234950) 44642400618) 48604 T657=29 486K 1657529 ‘Aplotof historical demand and the trend line is provided in Figure 5.4, In this case, we may ‘wish to be cautious and try to understand the 2009-2010 swings in demand. USING EXCEL QM IN TREND ANALYSIS Regression can also be performed in Excel QM, Go to the Add-Ins tab in Excel 2010 and select Excel QM—Forecasting—Regression/Trend Analysis, Enter the number of periods of data (7 in this example), enter a ttle and name for the time peri- ods (e.g., week, month, year) if desired, and then click OK. When the initialized spreadsheet appears, enter the past data and the time periods, as shown in Program 5.5. ‘Seasonal Variations ‘Time-series forecasting such as that in the example of Midwestern Manufacturing involves look- ing at the trend of data over a series of time observations. Sometimes, however, tecurting varia- tions at certain seasons of the year make a seasonal adjustment in the trend line forecast172 CHAPTERS + FORECASTING PROGRAM 5.5 Excel QM Trend Projection Model ‘An average season has an index oft AaB z Goal + Midwestern Manufacturing 2 5 Forecasting 4 pac 3 (input the past data andthe tine period, 7 2 baw ro 2 Peiod Carey PORE averse [ere Ascii Saures [REE 10 Yor! ey ez EPG ore asenas| —osrzs| Tyee? a Trier ava asa taras| — or 12 Yee 4 wwaztd| zal oazia| De.z40a| Too tvewe od Seaeri|——ssaeri|easri|-7eaaso| 090% ta Yee os. Fosseze| ——-13020|_—a3e70| te20Tal ot Teo is rinaaeel az rea) 20707 00] — Te “8 Yeu? (The intercept (by) and slope (b) ae found here )-2a043| 84045] 716443] U6 97H 7 ey eee 4326-14] 60.0714] 772.8214] 57.57%) 12 ere | 507109 Ii aonsrestsia-satel i003 18 Slope | AO3387H] (To obtain a forecast for a future period, enter the ine period here 21 Nextpenoc 141 NN 2 Cora THT necessary. Demand for coal and fuel oil, for example, usually peaks during cold winter months. Demand for golf clubs or suntan lotion may be highest in summer. Analyzing data in monthly or uarterly terms usually makes it easy to spot seasonal patterns. A seasonal index is often used in multiplicative time series forecasting models to make an adjustment in the forecast when a sea- sonal component exists. An alternative is to use an additive model such as a regression model that will be introduced in a later section. A seasonal index indicates how a particular season (¢.g., month or quarter) compares with an average season, When no trend is present, the index can be found by dividing the average value for a particular season by the average of all the data, Thus, an index of 1 means the season is average, For example, if the average sales in January were 120 and the average sales in all months were 200, the seasonal index for January would be 120/200 = 0.60, so January is be- low average. The next example illustrates how to compute seasonal indices from historical data and (o use these in forecasting future values Monthly sales of one brand of telephone answering machine at Kichler Supplies are shown, in Table 5.9, for the two most recent years. The average demand in each month is computed, and these values ate divided by the overall average (94) to find the seasonal index for each month, We then use the seasonal indices from Table 5.9 to adjust future forecasts. For example, suppose wwe expected the third year's annual demand for answering machines to be 1,200 units, which is 100 per month. We would not forecast each month fo have a demand of 100, but we would ad- just these based on the seasonal indices as follows: 1.200 Jan x 0957 = 96 July Feb, x 08st = 85 Aus 1,200 1.200 a, 1200 opt M 2 0904 = 90 sept. 42® x 0987 = 96 Ap 108 0. 1.200 May bi No Px osst June 4,200 ca 122 De SX 085TABLE 5.9 Answering Machine Sales and Seasonal Indices Centered moving averages are tused to compute seasonal indices when there is trend. TABLE 5.10 Quarterly sales (51,000,000) for Turner industries 55 TIME-SERIES FORECASTING MODELS 173 SSNS RCC CCUM Cr OE CS ‘may * 4 rm Pinay 5S w oa asi Much » ts 4 0908 aga uo ico sa oot My ust s o 1 Tone ‘0 iis ot 22s ily mt ies sa 1" Auge 1090 ‘0 o 104 Seuenbx 595 %” 4 0951 omer SS » sa oat Noemie 55 0 o asi Deemer 080 % 4 351 “otal average demand = 1128 \ Average 2 year demand pt = ot seasonal index = AYE? yea demand TE mone erage “average monthly demand = iy demand Seasonal Variations with Trend ‘When both trend and seasonal components are present in atime series, a change from one month. to the next could be due to a trend, to a seasonal variation, or simply to random fluctuations. To help with this problem, the seasonal indices should be computed using a centered moving. average (CMA) approach whenever trend is present. Using this approach prevents a variation due to tend from being incorrectly interpreted as a variation due to the season. Consider the fol- Towing example. Quarterly sales figures for Turner Industries are shown in Table 5.10. Notice that there is a definite wend as the total each year is increasing, and there is an increase for each quarter from ‘one year to the next as well. The seasonal component is obvious as there isa definite drop from the fourth quarter of one year (o the frst quarter of the next. A similar pattern is observed in ‘comparing the third quarters to the fourth quarters immediately following. Ifa seasonal index for quarter 1 were computed using the overall average, the index would bbe too low and misleading, since this quarter has less tend than any of the others in the sample. If the first quarter of year 1 were omitted and replaced by the first quarter of year 4 (if it were available), the average for quarter 1 (and consequently the seasonal index for quarter 1) would, bbe considerably higher. To derive an accurate seasonal index, we should use a CMA. Consider quarter 3 of year 1 for the Turner Industries example, The actual sales in that quar- ter were 150, To determine the magnitude of the seasonal variation, we should compare this with an average quarter centered at that time period. Thus, we should have a total of four quarters (1 year of data) with an equal number of quarters before and after quarter 3 so the trend i averaged ‘out. Thus, we need 1.5 quarters before quarter 3 and 1.5 quarters after it. To obtain the CMA, Rtas YEAR na 1 108 116 11567 2 125 14 2 13367 3 150 159 198 159,00 4 141 152 1 15267 Average 131.00 140.25 149.50 14025174 CHAPTERS + FORECASTING TABLE 5.11 Centered Moving Averages and Seasonal Ratios for Turner Industries Ste) 1 1 108 2 12s 3 150 132,000 1.136 4 14 134.25 1.051 1 1s 136.375 oss 2 1 138.875 0.965 3 159 1412s 1127 4 152 143.000 1.063 3 1 123 145.125 osts 2 142 14785 0.960 3 168 4 165 we take quarters 2, 3, and 4 of year 1, plus one-half of quarter 1 for year 1 and one-half of quar- ter I for year 2. The average will be 0.S(108) + 125 + 150 + 141 + 0.5(116) CMA (quarter 3 of year 1) =) 2.00 ‘We compare the actual sales inthis quarter to the CMA and we have the following seasonal ratio: Sales in quarter3__ 150 Seasonal ratio = 1136 CMA 132.00 Thus, sales in quarter 3 of year | are about 13,6% higher than an average quarter at this time. All of the CMAs and the seasonal ratios are shown in Table 5.11 Since there are two seasonal ratios for each quarter, we average these to get the seasonal index, Thus, Index for quarter 1 = J, = (0.851 + 0,848)/2 = 0.85 Index for quarter2 = 2 = (0.965 + 0.960}/2 = 0.96 Index for quarter’3 = fy = (1.136 + 1.127)/2 = 1.13 Index for quarter 4 = Jy = (1.051 + 1.063)/2 = 1.06 “The sum of these indices should be the number of seasons (4) since an average season should have an index of 1. In this example, the sum is 4 Ifthe sum were not 4, an adjustment would be made. We would multiply each index by 4 and divide this by the sum of the indices Steps Used to Compute Seasonal Indices Based on CMAs ‘Compute a CMA for each observation (where possible). ‘Compute seasonal ratio = Observation/CMA for that observation, Average seasonal ratios to get seasonal indices. If seasonal indices do not add to the number of seasons, multiply each index by (Number (of seasons)/(Sum of the indices). Figure 5.5 provides a scatterplot of the Turner Industries data and the CMAs. Notice that the plot of the CMAs is much smoother than the original data, A definite trend is appaent in the data,FIGURE 5.5 Scatterplot of Turner Industries Sales and Centered Moving Average TABLE 5.12 Deseasonalized Data for Turner Industries Sales and Seasonal Components 55 TIME-SERIES FORECASTING MODELS 75 ‘The process of isolating linear tend and seasonal factors to develop more accurate forecasts is called decomposition. The frst step is to compute seasonal indices for each season as we have lone with the Tumer Industries data. Then, the data are deseasonalized by dividing each mum- ber by its seasonal index, as shown in Table 5.12, ‘A trend line is then found using the deseasonalized data, Using computer software with Ais data, we have" ‘The trend equation is y where 124.78 + 234K x time ‘This equation is used to develop the forecast based on trend, and the result is multiplied by the appropriate seasonal index to make a seasonal adjustment. For the Tumer Industries data, 108, 125 150 1a 116 134 159 152 123 12 168 165 os 096 LB 06 os 096 13 1.06 127.059) 130.208 132.743 133.019 136471 139.585 140.708 143.396 144.106 147917 Mas.673 155.660 “IEyou d te calculations by hand, the numbers ay dir slighly fom these due to rounding176 CHAPTERS + FORECASTING TABLE 5.13 Seasonal Indices for Adult Inpatient Days at San Diego Hospital the forecast for the first quarter of year 4 (time period X ~ 13 and seasonal index J = 0.85) would be found as follows; = 12478 + 2.34x 124.78 + 2.34(13) 1552 (forecast hefore adjustment for seasonality) ‘We muliply this by the seasonal index for quarter 1 and we get # x 1 = 1952. 085 = 13192 Using this same procedure, we find the forecasts for quarters 2,3, and 4 of the next year to be 151.24, 180.66, and 171.95, respectively. Steps to Develop a Forecast Using the Decomposition Method 1. Compute seasonal indices using CMAs. 2. Deseasonalize the data by dividing each number by its seasonal index. 3. Find the equation of a trend line using the deseasonalized data. 4, Forecast for future periods using the trend line. 5. Multiply the rend line forecast by the appropriate seasonal index. Most forecasting software, including Excel QM and QM for Windows, includes the decomposi- tion method as one of the available techniques. This will automatically compute the CMAs, de~ seasonalize the data, develop the trend line, make the forecast using the trend equation, and adjust the final forecast for seasonality ‘The following example provides another application of this process, The seasonal indices and trend line have already been computed using the decomposition process. SAN DIEGO HOSPITAL EXAMPLE A San Diego hospital used 66 months of adult inpatient hospi- tal days to reach the following equation: = 8,091 + 215K where ¥ = forecast patient days X= time, in months Based on this model, the hospital forecasts patient days for the next month (period 67) to be Patient days = 8,091 + (21.5)(67) = 9,532 (trend only) ‘As well as this model recognized the slight upward tend line in the demand for inpatient serv- ices, it ignored the seasonality that the administration knew to be present. Table 5.13 provides seasonal indices based on the same 66 months. Such seasonal data, by the way, were found to be typical of hospitals nationwide. Note that January, March, July, and August seem to exhibit ROME eniens NON Crean? January 10436 sly 1.0302, February 0.9669 August 1.0805 March, 1.0208 September 0.9653 April 1.0087 October 10088, May 0.9935 November 0.9598 June 0.9906 December 0980s Source: W. E. Sterk and E. G. Shryock. “Modem Methods Improve Hospital Forecasting,” ‘Healthcare Financial Management (Match 1987): 97. Reprinted with permission of author.‘Multiple regression can be used to develop an additive decomposition model. PROGRAM 5.6A ion Screen for ‘the Decomposition Method in Excel QM 55 TIME-SERIES FORECASTING MODELS 177 significantly higher patient days on average, while February, September, November, and December experience lower patient days. To correct the time-series extrapolation for seasonality, the hospital multiplied the monthly forecast by the appropriate seasonality index. Thus, for period 67, which was a January, 9,532)(1.0436) = 9,948 (trend and seasonal) Using this method, patient days were forecasted for January through June (periods 67 through. 72) as 9,948, 9,236, 9.768, 9,678, 9,554, and 9,547. This study led to better forecasts as well as to more accurate forecast budgets. Patient days USING EXCEL QM FOR DECOMPOSITION In Excel QM, to access the decomposition procedure, 20 to the Add-Ins tab and click Excel QM—Forecasting—Decomposition, and the initialization ‘window will open, Input the relevant information, as illustrated in Program 5.6A, and the spreadsheet will be initialized for the size of prablem specified. Enter the past periods of data, as shown in Program 5.6B, and the results will appear USING QM FOR WINDOWS FOR DECOMPOSITION QM for Windows can also be used for the de- ‘composition method of forecasting. See Appendix 5.1 for details. Using Regression with Trend and Seasonal Components Muipl regression may be used to forecast with both tend and seasonal components present in ‘time series. One independent variable is time, and other independent vasiables are dummy variables to indicat the season, If we forecast quarterly data there are four categories (quartets) s0 we would use three dummy variables. The basic model isan additive decomposition model and is expressed as follows; Fat bX, + Dake + OKs + BK where 1 if quarter 2 otherwise Lif quarter 3 = O otherwise X= Lifguarter + otherwise re Tarr idaes oe | a) Online | =F) @coneredroving averse — | Aunbor ef past py Nane fr pated vetage all data Nunber cf seasons f | (urea, 8.6 |178 CHAPTERS + FORECASTING PROGRAM 5.6B Turner industries Forecast Using the Decomposition Method in Excel QM “Tomer industries ) Fasting ute acompotn If Xz = Xs = Xz = 0, then the quarter would be quarter 1. Itis an arbitrary choice as to which of the quarters would not have a specific dummy variable associated with it, The forecasts will be the same regardless of which quarter does not have a specific dummy variable. Program 5.7 provides the Excel input, and Program 5.7B provides the Excel output for the Tomer Industries example. You can see how the data is input, and the regression equation (with coefficients rounded) is 1041 + 23K) + 15.7X) + 387X, + 01Xy TF this is used to forecast sles inthe ist quarter ofthe next yea, we get F = 1044 + 23(13) + 15.70) + 38:7(0) + 30.1(0) = 134 Forquarter2 of the next year, we get F = 1041 + 23(14) + 15:71) + 38.7(0) + 30.1(0) = 52 Notice these are not the same values we obtained using the multiplicative decomposition method, We could compare the MAD or MSE for each method and choose the one that is better. PROGRAM 5.7A Excel Input for the Turner Industries + a a Example Using Multiple =; 5 | hE ° o + Regression ft gee ee tina ‘ene a eee ee Bo EASES tiie fee = a es HiSeaienie Hien Line EES5.6 MONITORING AND CONTROLLING FORECASTS 179 PROGRAM 5.78 Ex a = Foss +) eer TimePeied Gr? Bors awe Excel Output for the 4% “ “| ° ° iB Turner Industries st z z : 8 Example Using Multiple 3 3 g 38 Regression 6] 4 5 o o o + é ‘ 8 a] 3 ; a ne) $1 ‘ é ¢ a4 ‘ot 5 f oo i z * ‘ o 8 231 3 2 a — 2 a e <4 48 sum ouput 4% 1 omer Ome J9iReqee | 988 BagonesR ove |2t|stancarae 1.93226, 2 owes 2 [2e)om Bee 2 Rogenaat 4 stes75 toons Somes ate o8 Brena’ 4a S38 2 ea Hi auses 2 50 ara Te ee ORI 3 ieee Tortoetau2 evar comm Ttosso Tare Tooss Tae Sajrteneba dat —agete teat goo! tanse aan" taaon ase Saar’ | sees tse ower towe—aezea_voats? teen) w9s7 Sibson Seren tao dsaeea tomo — daa Seen 2278 Sido some treaties tome seat suo 7a When ne ciseycraman receives a diy apo trm i main theme parks in ano, Fos, the report contains ony {ho mabe he forecast of esterday attendance at the parks (Mag Kingdom, Epc ort Were, Holywood Studs (or mnt MGM Studs), Animal Kingdom, yphoon Lagoon, and Btzrrd Beach) andthe atl aendance An orcs ozo {sng MAPE se measures expected. The chara aes forecasts vey ey “Tne forecasting team at ney Worl doesn’ st do a day orden, ower the chatman sot soc Bo proves day weet monty stn, and yet occas tose ber managerents matenance,opravons, trance and pated paras ees jdgrentl motes ono Incl, mong aeage model, and regtsson sal The teams annual forcast of otal vue, conducted In 1998 forthe yoo 2000, red h MAME of |) \eys fo Forecasting at Disney World With 20% of Disney Worle’s customers coming from out- side the United States, its econometric model includes such \varables as consumer confidence and the gross domestic prod- uct of seven countries. Disney also surveys one milion people ‘each year to examine their future travel plans and their experi- ‘ences atthe parks. This helos forecast not only attendance, but behavior at each ride thow long people will wait and how ‘many times they wil ride). Inputs to the monthly forecasting ‘model include airline specials, speeches by the chair ofthe Fed- eral reserve, and Wall Street trends. Disney even monitors 3,000 school districts inside and outside the United States for holidaytvacation schedules. Source: Based on J Newhk nd M, Haskl "Forcesing in the Service See tor pesation at th 12 Annual Mesing ofthe Porton and persons ‘Mangement Society Api 1, 2001, Orlando, 5.6 Monitoring and Controlling Forecasts ‘Afer a forecast has been completed, itis important that it not be forgotten. No manager wants to bbe reminded when his or her forecast is horribly inaccurate, bu a firm needs to determine why the actual demand (or whatever variable is being examined) differed significantly from that projected.” “te the forecaer is aevsrte, Neo he sally males sre ha everyone is sare of is rer lets. Very seldom does cone read aces in Fortine, Forbe, othe Wall See Journal, however, abou toy tanagers who aze conte fffby 25% in hele tock make ovecas180 CHAPTERS + FORECASTING A tracking signal measures how well predictions fit actual data Setting tracking limits isa matter of setting reasonable values for upper and lower limits FIGURE 5.6 Plot of Tracking Signals ‘One way to monitor forecasts to ensure that they are performing well is to employ a tracking signal, A tracking signal is a measurement of how well the forecast is predicting a tual values. As forecasts are updated every week, month, or quarter, the newly available demand data are compared to the forecast values. ‘The tacking signal is computed as the running sum of the forecast errors (RSFE) divided by the mean absolute deviation: RSFE MAD (Korecast error) MAD ‘Tracking signal = 13) where aap = Zila as seen eater in Equation 5-1 Positive tracking signals indicate that dena is greater than the forecast. Negative signals sean that demand is less than forecast. A good tacking sgnsl—that i, one with alow RSFE— bas abot ss much positive eror ait has negative eror. In other words, small devistons sre clay, but the positive and negative deviations should balance so thatthe trocking signal centers closely sroond zr0 ‘When tracking signals are calculated, they are compared with predetermined contol limits ‘When attacking sigoal excoods an upper or lower Kini a sigal a Gipped. This moans that here isa problem with he forecating method, and manageencot may want to reevluste the way it foeccasts demand. Figure 56 sows te graph ofa tracking sigoal tat is exceeding the renge of scceplable variation. Ifthe model being used is exponeatial smoothing, perhaps the smoothing Canttant needs tobe readjusted How do firms decide what the upper and lower trackiog limits should be? There is no single answer, but they ty to find reasonable values—in ether words, limits not so low as to be triggered with every smal frecast error and not so high a8 to allow bad forecasts to be regularly overlooked. George Plossl and Oliver Wight, (wo inventory control experts, suggested using maximums of 4 MADs for high-volume stock items and 8 MADs for Jower-volume items.” Other forecasters suggest slightly lower ranges. One MAD is equivalent to approximately 0.8 standard deviation, s0 that =2 MADs ~ 1.6 standard deviations, +3MADs ~ 24 sanded deviations, and 4 MADs = 3.2 standard deviations. This suggests that fora forecast o be “in ssa Tipe . type cana it Ne reso ei ° Range 7 ‘Lower Control Limit Tire "See G. W, Plossl and 0. W. Wight, Production and Imentory Conto. ppt Sale River, NI Prete Hall, 1967,SUMMARY 181 control.” 89% of the errors are expected to fall within 42 MADs, 98% within +3 MADs, or 99.9% within 4 MADs whenever the errors are approximately normally distributed.” KIMBALU'S BAKERY EXAMPLE Here is an example that shows how the tracking signal and RSFE can be computed. Kimball's Bakery’s quarterly sales of croissants (in thousands), as well as forecast demand and error computations, are in the following table. The objective is to compute the tracking signal and determine whether forecasts are performing adequately. En m = CCC SLI 1 100 30 =i 10 10 10 100 = 2 100 95 “3 ns 5 1s 18 2 3 100 ns “150 15 0 100 © 4 110 100 = -10 10 “0 100 5 110 125 a8 15 38 10 6 110 0 043s 30 ss M2 In period 6, the calculations are sap ~ Dltoecatenerl _g5 » 7 © =142 RSEE ‘Tracking signal = SEE = 2S5MADs ‘This tacking signal is within acceptable limits, We see that i drifted from —2.0 MADs to +2.5 MADs. ‘Adaptive Smoothing ‘Alot of research has been published on the subject of adaptive forecasting. This refers to com- puter monitoring of tracking signals and self-adjustment if a signal passes its preset limit, In exponential smoothing, the a and B coefficients are first selected based on values that minimize cerror forecasts and are then adjusted accordingly whenever the computer notes an errant track- ing signal. This is called adaptive smoothing Summary Forecasts are a critical part of a manager's function, Demand forecasts drive the production, capacity, and scheduling sys- tems ina firm and affect the financial, marketing, and person- nel planning functions In this chapter we introduced three types of forecasting ‘models: time series, causal, and qualitative. Moving averages, exponential smoothing, trend projection, and decomposition “To prove these thre percentages to yours, jst et up anormal eve for time-series models were developed. Regression and multiple regression models were recognized as causal models. Four qualitative models were briefly discussed. In addition, we explained the use of scatter diagrams and measures of forecast- ing accuracy. In future chapters you will see the usefulness of these techniques in determining values for the various decision-making models, 6 standard deviations (2 values). Using te oral table in Appendix A. you nd the area under tat he curve i 0.89. Tis cepesents 22 MADs, Simul, 43 MADs = standard deviations encompasses 98% ofthe ata, and so on fr 44 MAD182 CHAPTERS + FORECASTING As we leamed in this chapter, no forecasting method is perfect under all conditions. Even when management has ound a satisfactory approach, it must still monitor and control Glossary its forecasts to make sure that errors do not get out of hand, Forecasting can often be a very challenging but rewarding part of managing, Adaptive Smoothing The process of automatically monitor- ing and adjusting the smoothing constants in an exponential smoothing model Bias A technique for determining the accuracy of a forecast- ‘ing model by measuring the average error and its direction ‘Causal Models Models that forecast using variables and fac- tots in addition to time, Centered Moving Average An average of the values ‘centered at a particular point in time, This is used to ‘compute seasonal indices when trend is present. Decision-Making Group A group of experts in a Delphi technique that has the responsibility of making the forecast Decomposition A forecasting model that decomposes a time series into its seasonal and trend components, Delphi _A judgmental forecasting technique that uses decision makers, staff personnel, and respondents to deter- rine a forecast Deseasonalized Data Time series data in which each value has been divided by its seasonal index to remove the effect of the seasonal component, Deviation A term used in forecasting for error Error The difference between the actual value and the fore- cast value. Exponential Smoothing A forecasting method that isa ‘combination of the last forecast and the last observed value. Holt’s Method An exponential smoothing model that includes ‘a trend component. This is also called a double exponential smoothing model or a second-order smoothing model. Least Squares A procedure used in trend projection and regression analysis to minimize the squared distances between the estimated straight line and the observed valves, ‘Mean Absolute Deviation (MAD) A technique for ‘determining the accuracy of a forecasting model by taking the average of the absolute deviations. Key Equations Mean Absolute Percent Error (MAPE) _A technique for determining the accuracy ofa forecasting model by taking the average ofthe absolute erzors as a percentage of the ob- served values. Mean Squared Error (MSE) A technique for determining the accuracy of a forecasting model by taking the average ofthe squared error terms for a forecasting model. Moving Average A forecasting technique that averages past values in computing the forecast. Naive Model A time-series forecasting model in which the forecast for next period isthe actual value for the current period Qualitative Models Models that forecast using judgments, experience, and qualitative and subjective data Running Sum of Forecast Errors (RSFE) Used to develop a tracking signal for time-series forecasting models, this is a running total of the errors and may be positive or negative Scatter Diagrams Diagrams of the vaiable tobe forecasted, plotted against another variable, such as time Seasonal Index An index number that indicates how a par- ticular season compazes with an average time period (with an index of 1 indicating an average season). Smoothing Constant A value between 0 and 1 that is used ‘nan exponential smoothing forecast ‘Time-Series Models Models that forecast using only histori cal data Tracking Signal A measure of how well the forecast is pre- dicting actual values. Trend Projection The use of a trendline to forecast atime series with tend present A linear tend line isa regression line with time asthe independent variable. Weighted Moving Average A moving average forecasting method that places different weights on past values. [forecast error| A measure of overall forecast error called mean absolute deviation Diereer)? (6-1) MAD = (5-2) MSE = A measure of forecast accuracy called mean squared errr, > ectal 6-3) MAPE = —=""'oo% ‘A measure of forecast accuracy called mean absolute pereent error. ‘Sum of demands in previ (gt) Moving jous n periods average forecast 7 An equation for computing 8 moving average forecast.phe th, ‘A mathematical expression for a moving average forecast, 5-5) Fret = _ &(Weightin period /)(Actual value in period’) D(Weighis) ‘An equation for computing a weighted moving average forecast 6-8) Feat wie + waren to + we mnt wy wy FF Wy ‘A mathematical expression for a weighted moving aver- age forecast SD Fray (5-8) New forecast = Last period’s forecast + a(Last period's actual demand — Last period's forecast) ‘An equation for computing an exponential smoothing forecast 5-9) Fri = Fy + a, > Fi) Equation 5-8 rewritten mathematically Solved Problems SOLVED PROBLEMS 183 (5-10) Fy.y = FIT, + af¥, ~ FIT,) Equation to update the smoothed forecast (F,-1) used in the tend adjusted exponential smoothing model. SADT = 7, + BUF ~ FIT) Equation to update the smoothed trend value (T;,1) used in the trend adjusted exponential smoothing model (S12) FIT 1 = Fest + Tos Equation to develop forecast including trend (FIT) in the trend adjusted exponential smoothing model RSFE 5-13) Tracking signal = (6-13) Tracking signal = 555 E (Forecast error) ~~ MAD ‘An equation for monitoring forecasts with a wacking signal. Solved Problem 5-1 Demand for patient surgery at Washington General Hospital has increased steadily inthe past few years as seen in the following table: ieee 45 50 2 56 5s ‘The director of medical services predicted six years ago that demand in year 1 would be 42 surger- ies. Using exponential smoothing with a weight of a 20, develop forecasts for years 2 through 6 What she MAD? Solution Se er Ea 1 % ° 3 5 2 ‘0 26-12-4025) 74 1 : 2 4419426 +020- 26) 19 3 ‘ 6 57-441 0262-40) 1103 103 5 = 498-417 0258-417 a a map = ered 389 7g 29184 Solved Problem 5-2 Self-Test Before taking the self CHAPTER 5 + FORECASTING ‘Quarterly demand for Jaguar XJ8’s at a New York auto dealership is forecast with the equation ¥=10+3x where X = time period (quarter): quarter 1 of last year = 0 quarter 2of last year quarter 3 of last year quarter 4 of last year quarter of this year = 4, and soon and ¥ = predicted quarterly demand ‘The demand for luxury sedans is seasonal, andthe indices for quarters 1, 2, 3, and 4 are 0.80, 1.00, 1.30, ‘and 0.90, respectively. Using the trend equation, forecast the demand for each quarter of next year. Then ‘adjust each forecast to adjust for seasonal (quarterly) variations. Solution ‘Quarter 2 of this year is coded X = 5; quarter 3 of this year, X = 6; and quarter 4 of this year, X Hence, quarter 1 of next year is coded X ~ 8; quarter 2, X ~ 9; and so on. F (next yearquarter1) = 10 + (3)(8) = 34 Adjusted forecast = (0.80)(34) = 27.2 P (next year quarter2) = 10 + (3)(9) = 37 Adjusted forecast = (1.00)(37) = 37 F (next year quarter 3) = 10 + (3)(10) = 40 Adjusted forecast = (1.30)(40) = 52 F (next year quarter 4) = 10 + (3)(11) = 43 Adjusted forecast = (0.90)(43) = 38.7 Aes, refer to the learning objectives at the beginning of the chapter, the notes in the margins, and the glossary at the end of the chapter. © Use the key at the back of the book to correct your answers. © Restudy pages that correspond to any questions that you answered incorrectly or material you feel uncertain about. ‘Qualitative forecasting models include 4. Which of the following is atime series model? 4 regression analysis, a. the Delphi model b, Delphi, bi, regression analysis c. time-series models ¢. exponential smoothing trend lines. 4. multiple regression ‘A forecasting model that only uses historical data for the _S._ Which of the following is not a component of a time Variable being forecast is called a series? ‘a. time-series model a. seasonality ’, causal model '. causal variations . Delphi model. o. tend 4. variable model. d. random variations ‘One example of a causal model is 6. Which of the following may be negative? ‘a. exponential smoothing. a. MAD. », wend projections. ». bias cc, moving averages. ©, MAPE, dd. regression analysis, 4. MSE7. When comparing several forecasting models to determine which one best fits @ particular set of data, the mode! that should be selected is the one 1. with the highest MSE, ». with the MAD closest to 1. c, with a bias of 0 <. with the lowest MAD. 8. In exponential smoothing, if you wish to give a significant weight to the most recent observations, then the smoothing constant should be a, close 10 0. b. close to L «, close 10 05. 4. less than the error. 9. A tend equation is a regression equation in which. a. there are multiple independent variables '. the intercept and the slope are the same «the dependent variable is time. 4. the independent variable is time. 10. Sales for a company are typically higher in the summer ‘months than in the winter months. This variation would be called a a, trend. », seasonal factor. c. random factor. 4. eyclical factor. 11. Annaive forecast for monthly sales is equivalent to a, aone-month moving average model », an exponential smoothing model with « = 0. «, a seasonal model in which the seasonal index is 1 4. none of the above. Discussion Questions and Problems DISCUSSION QUESTIONS AND PROBLEMS 185 12, If the seasonal index for Tanuary is 0.80, then ‘a January sales tend to be 80% higher than an average ‘month, >, January sales tend to be 20% higher than an average month, «January sales tend to be 80% lower than an average month, 4 January sales tend to be 20% lower than an average month, 13, Ieboth tend and seasonal components are present in a time-series, then the seasonal indices ‘a, should be computed based on an overall average. », should be computed based on CMAS. c. will all be greater than 1 , should be ignored in developing the forecast 14, Which of the following is used to alert the user ofa fore~ ‘casting model that a significant error occurred in one of the periods? 1a seasonal index ». a smoothing constant . atracking signal a regression coefficient 15. Ifthe multiplicative decomposition model is used to fore- cast daily sales fora retail store, how many seasons will there be? ad b7 o12 365 Discussion Questions 5-1. Describe briefly the steps used to develop a forecast. ing system. 5.2. What isa time-series forecasting model? 5-3. What is the difference between a causal model and a time-series model? 5-4 What isa qualitative forecasting model, and when is it appropriate? 5-5. What are some of the problems and drawbacks of the moving average forecasting model? 5-6 What effect docs the value of the smoothing con- stant have on the weight given to the past forecast and the past observed value? 5.7 Describe briefly the Delphi technique 5:8 What is MAD, and why i it important in the selec- tion and use of forecasting models? Note © rant probly bere with QM for Windows: ea seta the pole may be soled with QM for Window nor Exel QM. sone mh Bxcel QM and 5.9 Explain how the number of season is determined ‘when forecasting with a seasonal component. ‘A seasonal index may be less than one, equal to one, ‘or greater than one. Explain what each of these val- ‘ues would mean 5-11 Explain what would happen if the smoothing con- stant in an exponential smoothing model was equal to zero, Explain what would happen if the smooth- ing constant was equal to one. 5-12. Explain when a CMA (father than an overall aver= age) should be used in computing a seasonal index. Explain why this is necessary. Problems 2-518 Dovetopfourmont moving erage frcs fr Wallace Garden Supply and compute the MAD. problem may be186 Gu 2515) CHAPTER 5 + FORECASTING AA three-month moving average forecast was devel- ‘oped in the section on moving averages in Table 5.3, Using MAD, determine whether the forecast in Problem 5-13 or the forecast in the section concern- ing Wallace Garden Supply is more accurate, Data collected on the yearly demand for 50-pound bags of fertilizer at Wallace Garden Supply are shown in the following table. Develop a 3-year mov- ing average to forecast sales. Then estimate demand again with a weighted moving average in which sales in the most recent year are given a weight of 2 ‘and sales inthe other 2 years are each given a weight ‘of 1. Which method do you think is best? DEMAND FOR FERTILIZER YEAR (4.0008 OF BAGS) 1 4 2 6 3 4 4 5 5 0 6 8 1 7 8 ° ° 2 10 Qs 2847 QE5.18 Q:5.19 n Develop a trend line for the demand for fertilizer in Problem 5-15, using any computer software, In Problems 5-15 and 5-16, tree different forecasts ‘were developed for the demand for fertilizer. These three forecasts are a 3-year moving average, a ‘weighted moving average, and a trend line. Which ‘one would you use? Explain your answer. Use exponential smoothing with a smoothing con- stant of 0.3 (o forecast the demand for fertilizer ‘given in Problem 5-15, Assume that last period's forecast for year 1 is 5,000 bags to begin the proce- dure. Would you prefer to use the exponential smoothing model or the weighted average model de- ‘veloped in Problem 5-15? Explain your answer, Sales of Cool-Man air conditioners have grown steadily during the past 5 years: YEAR SALES 450 495 sis S63 ssa Q.s20 28.21 + 5.24 SALES The sales manager had predicted, before the busi- ness started, that year I's sales would be 410 air con- ditioners. Using exponential smoothing with a weight of « = 0.30, develop forecasts for years 2 through 6, Using smoothing constants of 0.6 and 0.9, develop forecasts for the sales of Cool-Man air conditioners (see Problem 5-19), What effect did the smoothing constant have on the forecast for Cool-Man air conditioners? (See Prob- Jems 5-19 and 5-20.) Which smoothing constant ives the most accurate forecast? ‘Use a three-year moving average forecasting model to forecast the sales of Cool-Man air conditioners (see Problem 5-19), Using the trend projection method, develop a fore casting model for the sales of Cool-Man air condi toners (see Problem 5-19), Would you use exponential smoothing with a smoothing constant of 0.3, a 3-year moving average, ‘or a trend to predict the sales of Cool-Man air condi- toners? Refer to Problems 5-19, 5-22, and 5-23 Sales of industrial vacuum cleaners at R. Lowenthal ‘Supply Co. over the past 13 months are as follows: ($1,000) MONTH [SALES ($1,003) _ MONTH. 1 January 4 ‘August 4 February 0 September 16 March res October 10 Apil 4 November 18 May 16 December 7 June n January a July (2) Using a moving average with three periods, de- ‘termine the demand for vacuum cleaners for next February. (b) Using a weighted moving average with three pe~ rods, determine the demand for vacuum clean- ers for February. Use 3, 2, and 1 for the weights of the most recent, second most recent, and third ‘most recent periods, respectively. For example, if you were forecasting the demand for February, November would have a weight of 1, December would have a weight of 2, and January would have a weight of 3. (©) Evaluate the accuracy of each of these methods. (@) What other factors might R. Lowenthal consider forecasting sales?2:58 WEEK 1 2 3 4 5 6 Passenger miles flown on Northeast Airlines, acom- moter firm serving the Boston hub, are as follows for the past 12 weeks: ACTUAL PASSENGER ‘ACTUAL PASSENGER MILES (1.0008) | WEEK MILES (,0008) 7 7 20 a 5 1s 19 ° 2 2 0 20 Is a 1s 16 2 n (@ Assuming an initial forecast for week 1 of 17,000 miles, use exponential smoothing to compute miles for weeks 2 through 12. Use a =02, (b) What is the MAD for this model? (©) Compute the RSFE and tacking signals. Are they within acceptable limits? Emergency calls to Winter Park, Florida’s 911 sys~ tem, forthe past 24 weeks are as follows: wax cats | wank canis | wax catts 1.) es > > os | oo) ww sos fa os | ws s 0 | 2 0 | » © s os fa os | nos 6 os fw os | mx > ow] 3 (0) Comput the exponential smoothed forecast of falls for cach neck, Asse anna neest SO alin the fist week and use «=O. Wt isthe eect forte 25th week? (b) Retreat each eto using = 06, (©) Actal calls dting the 25th week were 85 ‘Which smoctingeonsant provides «spear forces? (Q:5:28 Using the 911 call ata in Problem $27, forecast tals for weeks 2 though 25 singe» 09, Which i best (Again, assume tht atl alsin week 25 tere 85 and wv an inital foreast of 0 cals) 25:29. Conaling income at Kate Walh Asocats forthe period February-July has been as follows: DISCUSSION QUESTIONS AND PROBLEMS 187 MONTH INCOME ($1,0008) February 700 March 685 Aprit was May m7 June 13 say ns ‘Use exponential smoothing to forecast August’s in- ‘come. Assume thatthe initial forecast for February is $65,000. The smoothing constant selected is a=01 Resolve Problem 5-29 with « = 0.3, Using MAD, “which smoothing constant provides a better forecast? A major source of revenue in Texas is a state sales tax on certain types of goods and services. Data are compiled and the state comptroller uses them to project future revenues for the state budget. One par- ticular category of goods is classified as Retail ‘Trade. Four years of quarterly data (in Smillions) for ‘one particular arca of southeast Texas follow QUARTER YEARI YEAR? YEAR3 YEARS 1 218 25 24 250 2 247 2s 265 283 3 24s 255 268 289 4 202 299 327 356 Biss Qis3 (a) Compute seasonal indices for each quarter based. ona CMA. (b) Deseasonalize the data and develop a tend line ‘on the deseasonalized data, (©) Use the tend line to forecast the sales for each quarter of year 5 (4) Use the seasonal indices to adjust the forecasts found in part (c) to obtain the final forecasts, Using the data in Problem S-31, develop a multiple regression model to predict sales (both wend and seasonal components), using dummy variables to in- ‘corporate the seasonal factor into the model. Use this model to predict sales for each quarter of the next year, Comment on the accuracy of this model ‘Trevor Harty, an avid mountain biker, always wanted to start a business selling top-of-the-line mountain bikes and other outdoor supplies. A litle over 6 years ago, he and a silent partner opened a store called Hale and Harty Trail Bikes and Supplies. Growth was rapid in the first 2 years, but since that188 CHAPTERS + FORECASTING time, growth in sales has slowed a bit, as expected, ‘The quarterly sales (in $1,000s) for the past 4 years are shown in the table below: YEAR| YEAR? YEARS YEAR 4 QUARTERT 274 22 282 296 (QUARTER 2 v8, 182 210 QUARTER3 130 B68 134 138 QUARTERS 162 158 170 182 (a) Develop a trend line using the data in the table. Use this to forecast sales for each quarter of year 5. What does the slope of this lin indicate? (b) Use the multiplicative decomposition model to incorporate both trend and seasonal components into the forecast, What does the slope of this line indicate? (©) Compare the slope of the trend line in part a to the slope in the tend line for the decomposition ‘model that was based on the deseasonalized sales figures. Discuss why these are so different and explain which one is best to use 5-34 The unemployment rates in the United States during a 10-year period are given in the following table. ‘Use exponential smoothing to find the best forecast for next year. Use smoothing constants of 0.2, 0.4, 046, and 0.8. Which one had the lowest MAD? Unemployment 72 70 62 55 53 55 67 74 68 61 rate (%) 35. Management of Davis's Department Store has used time-series extrapolation (o forecast retail sales for the next four quarters. The sales estimates are '$100,000, $120,000, $140,000, and $160,000 for the respective quarters before adjusting for season- ality, Seasonal indices for the four quarters have been found to be 1.30, 0.90, 0.70, and 1.10, respec tively. Compute a seasonalized or adjusted sales forecast 5-36. In the past, Judy Holmes's tie dealership sold an av- ‘erage of 1,000 radials each year. In the past two ‘years, 200 and 250, respectively, were sold in fall, 350 and 300 in winter, 150 and 165 in spring, and 300 and 285 in summer. With a major expansion planned, Judy projects sales next year to increase to 1,200 radials. What will the demand be each season? 5-37 The following table provides the Dow Jones Indus- trial Average (DJTA) opening index value on the first working day of 1991-2010: Develop a trend line and use it to predict the open- ing DJIA index value for years 2011, 2012, and 2013, Find the MSE for this model. YEAR DUA YEAR2__DIIA zoo toast ——2000=—=~—«L S02 20098772899 9213 2008 13,262——1998, 7908 2007 12,460 1997 644s 2006 107181996 sul7 2005 10,788 995 3834 2004 104531994 3.784 200383421993 3.301 2002 10022199, 3,169 200110779199 2634 5-38 Using the DITA data in Problem 5-37, use exponen- tial smooth with trend adjustment to forecast the opening DITA value for 2011. Use @ = 0.8 and 8 = 0.2. Compare the MSE for this technique with the MSE for the tend line 5-39 Refer to the DJIA data in Problem 5-37. (@) Use an exponential smoothing model with a smoothing constant of 0.4 to predict the opening [DITA index value for 2011, Find the MSE for this. (@) Use QM for Windows or Excel and find the smoothing constant that would provide the low- ‘est MSE, 5-40 The following table gives the average monthly ex- change rate between the U.S. dollar and the euro for 2009. It shows that 1 euro was equivalent to 1.324 U.S, dollars in January 2009, Develop a trené line that could be used to predict the exchange rate for 2010. Use this model to predict the exchange rate for January 2010 and February 2010. MONTH EXCHANGE RATE, January 1324 February 1278 March 1.305 April 1320 May 1363 June 1402 July 1.409 August Lao September 1456 October Las November 14g December 1461 5-41. For the data in Problem 5-40, develop an exponen- tial smoothing model with a smoothing constant of 0.3, Using the MSE, compare this with the model in Problem 5-40,w problems, Problems 5-42 to 5-50. Case Study €SeF Internet Homework Problems cASESTUDY 189 See our Internet home page, at www-pearsonhighered.com/render, for additional homework Forecasting Attendance at SWU Football Games Southwestern University (SWU), a large state college in Stephenville, Texas, 30 miles southwest of the Dallas/Fort ‘Worth metroplex, enrolls close to 20,000 students. Ina typical town-gown relationship, the school is a dominant force in the small city, with more students during fall and spring than per- ‘manent residents, ‘A longtime football powerhouse, SWU is a member of the Big Eleven conference and is usually in the top 20 in college football rankings. To bolster its chances of reaching the elusive and long-desized number-one ranking, in 2005 SWU hited the legendary Bo Pitterno as its head coach. Although the umber- fone ranking remained out of reach, attendance atthe five Satur- day home games each year increased. Prior to Pitterno’s arival, attendance generally averaged 25,000 to 29,000 per game. Sea- son ticket sales bumped up by 10,000 just with the announce ‘ment of the new coach's arrival, Stephenville and SWU were ready to move to the big time! ‘The immediate issue facing SWU, however, was not NCAA ranking. It was capacity. The existing SWU stadium, built in 1953, has seating for $4,000 fans. The following table indicates attendance at each game forthe past six years, One of Pitterno's demands upon joining SWU had been a stadium expansion, or possibly even a new stadium. With atten- dance increasing, SWU administrators began to face the issue head-on. Pitterno had wanted dormitories solely for his athletes in the stadium as an additional feature of any expansion. ‘SWU’s president, Dr. Marty Starr, decided it was time for his vice president of development to forecast when the existing stadium would "max out." He also sought a revenue projection, assuming an average ticket price of $20 in 2011 and a 5% in- crease each year in future prices. Discussion Questions 1. Develop a forecasting model, justify its selection over other techniques, and project attendance through 2012. 2. What revenues are to be expected in 2011 and 20127 3. Discuss the schoo!’s options. Southwestern University Football Game Attendance, 2005-2010 Pr pry MELEE Lt NIL Nc Coa 1 34,200 Baylor 36,100 Oklahoma 35,900 2 39,800 Texas 40,200 Nebraska 45.500 ‘Tenas Tech, 3 38,200 Lsv 38,100 43,100 Alaska a 26,900 Arkansas 5,300 27,900 Arizona 5 35,100 use 36,200 39,200 Rice Pry Poy ENTREE NNN EN ONES 1 41,900 Arkansas 42,500 Indiana 45000 LSU 2 46,100 Missouri 48,200 North Texas 50,100 Texas 3 43,900 Florida 44,200 Texas A&M, 45.900 Prarie View A&M + 30,00 Miami 33,900 Southern 36300 Montana 5 40,500 Duke 47,800 Okdaboma 49,900 Atizona State ‘Homecoming games “*Daring the fouth week of ech ato, Stephenville hosed a hugely pope southwest crafts festival. This event brought tens of thousands of touts tothe tow, especialy on weskend, and bad an obvious negative tpt on game mtendance, Source: J. Heuer nd 8. Render Operations Management, ch ed Upper Sadle River, NJ: Prentice Hal 2001, . 126.190 CHAPTERS + FORECASTING Case Study Forecasting Monthly Sales For years The Glass Slipper restaurant has operated in a resort ‘community near a popular ski area of New Mexico, The restau rant is busiest during the first 3 months of the year, when the ski slopes are crowded and tourists flock to the area ‘When James and Deena Weltee built The Glass Slipper, they had a vision of the ultimate dining experience. As the view ‘of surrounding mountains was breathtaking, a high priority was placed on having large windows and providing a spectacular view from anywhere inside the restaurant, Special attention was also given to the lighting, colors, and overall ambiance, result- ing in a tuly magnificent experience for all who came to enjoy ‘gourmet dining. Since its opening, The Glass Slipper has devel- ‘oped and maintained a reputation as one of the “must visit” places in that region of New Mexico. ‘While James loves to ski and truly appreciates the moun- tains and all that they have to offer, he also shares Deena’s dream of retiring to a tropical paradise and enjoying a more relaxed lifestyle on the beach, After some careful analysis of their financial condition, they knew that retirement was many years away. Nevertheless, they were hatching a plan to bring them closer to their dream, They decided to sell The Glass Slipper and open a bed and breakfast on a beautiful beach in ‘Mexico. While this would mean that work was still in their future, they could wake up in the morning to the sight of the palm ees blowing in the wind and the waves lapping at the shore. They also knew that hiring the right manager would al- Tow James and Deena the time to begin a semi-retirement in a comner of paradise ‘To make this happen, Tames and Deena would have to sell ‘The Glass Slipper for the right price. The price of the business ‘would be based on the value of the property and equipment, as well as projections of future income. A forecast of sales for the next year is needed to help in the determination of the value of the restaurant, Monthly sales for each of the past 3 years are provided in Table 5.14 Discussion Questions 1, Prepare a graph of the data. On this same graph, plot a 12-month moving average forecast. Discuss any apparent tuend and seasonal patterns, 2, Use regression to develop a trend line that could be used, to forecast monthly sales for the next year. Is the slope of this line consistent with what you observed in question 1? fnot, discuss a possible explanation. 3, Use the multiplicative decomposition model on these data, Use this model to forecast sales for each month of the next year. Discuss why the slope of the tend equation ‘with this model isso different from that ofthe trend equa- ‘ion in question 2 vanessa ES eT (in $1,000s) January 438 4h 450 Fomay 23a Mach rr ne May ee er ee i moss Amst 216 Selenber oko cor November 7180 Deember 915 a8 oS Internet Case Study See our Internet home page, at yw'v:pearsonhighered.com/rendler, for the additional case study ‘on Akron Zoological Park, This case involves forecasting attendance at Akron's 200.Bibliography APPENDIX'.1. FORECASTING WITH QM FOR WINDOWS 191 Berenson, Mak I, David M. Levine, an Timothy. Kricie, Barnent Sttsnes: Concepts and Applications 1th ed, Upper Sade Rive, NI: Prentice Hall, 2008. Billa, Bak, Maxell, King Ralph D. Snyder, and Anne B. Koehler. "Expo ‘sel Smoothing Model Selection fot Forecasting” Interational Jour tal of Forecetng 72, 2, (Apmi-Tone 20065 239-287, Black, Ken. Busnee Staritice: For Contemporary Decision Mating, he Joba Wiley & Sons, se, 2009 Dishol FX. Elemente ofForecarting, 2a ed Cncinnat South-Western College Publishing, 2001 ‘Gurdce, Everette 1c "Exponential Smoothing: The State of the Art—Past I" International Journal of Forecarting 2,4 (Oetobs 2006) 637-666. (Granger, Clive W, and J. M. Hashem Pesaran. “Eeooomic and Saisial ‘Measutes of Forecast Accusay Journal of Forecasting 19,7 (Decen- ber 2000); 537-560, Hanke 1. and. W, Wicker. Business Forecasting, M8, Upper Saale River, NF: Pestice Hal, 2009, izes, and B. Render Operations Management the, Upper Sade ‘River, Ni: Peace Hal, 2008 ‘Hyndman, Rob J. “The nteraton Between Teend and Seasonal.” Interational Journal of Forecasting 20, # October-December 2008) S616, ‘ypdnas, Reb J, and Anse B. Kohler. “Another Look at Measures of Fore ‘east Ascracy” Intemational Journal of Forecasting 22 (October 2006) 679-688 14, X."An fllignt Business Forecaster for Strateie Business Plasing: ouonal of Forecasting 18,3 (May 1989) 181-205, “Mead, igs. "Evidence forthe Selection of Forecasting Methods” Journal of Forecasting 19,6 (November 2000} 515-535 ‘Syd, Ralph D, and Roland G, Shami, “Exponential Smoothing of Sesonal ‘Das: A Comparison. Journal of Forecasting 20. (Ape 2001) 17-202, ‘Yukiowie, 1. “Forecasting Sofware Sarvey” OR/MS Today 35, August. 2008) 563, Appendix 5.1 Forecasting with QM for Windows In this section, we look at our other forecasting software package, QM for Windows, QM for Windows can project moving averages (both simple and weighted), do simple and trend- adjusted exponential smoothing, handle least squares trend projection, solve regression prob- lems, and use the decomposition method, ‘To develop forecasts in QM for Windows, select Module on the toolbar and select Forecasting. ‘Then either click the new document icon or click File—New—Time Series Analysis to enter a new time series problem. Specify the number of past observations and enter a tlle, if desired. ‘To illustrate QM for Windows, we will use the Port of Baltimore data from Table 5.5. The number of past observations was eight in that example, When you enter those data, the screen showa in Program 5.8A opens and allows for data input, Once the data is entered, click the PROGRAM 5.8A Be GR Yew thale oat Koos a Qi for Windows 1 G1 S| cick the arrow in the Method window to select the desired methods Forecasting Methods can = w= Port of Baltimore Past period 1 Demand) 180 Past period 2 168 Past period 3 159 Past period 4 pus peiods = Past period 6 205) Past period7 180 Past period § 162192 CHAPTERS + FORECASTING PROGRAM 5.88 Exponential Smoothing in the Port of Baltimore Example with QM for Windows: arrow on the message box to sec all the options and select the one desired, In selecting exponen tial smoothing for this example, a box appears where a (alpha) may be entered and a column where any previous forecasts (if available) may be entered, as shown in Program 5.8B. With other forecasting methods, other types of input boxes may appear. Click the Solve button, and the Forecasting Results screen appeats, as shown in Program 5.8C. If you want to try a different value for a, click Edit to return to the input screen, where you can change a. Note that you can enter an initial forecast if desited, but the error analysis will begin with the fist forecast gener- ated by the computer. Any forecasts entered by the user are ignored in the error analysis. Notice that additional output, including detailed results of the procedure and a graph, are available [rom the Window option in the toolbar once the problem has been solved. With expo- ential smoothing, one output is called Errors as a function of alpha. This will display the MAD and MSE for all values of « from 0 to I, in increments of 0.01. You can simply scroll dawn this screen to find the value for « that minimizes the MAD or MSE, For another example, we will use the decomposition method on the Tamer Industries exam- ple from Table 5.10, Enter a time-series problem with 12 past periods of data and select ‘Mulsiplicative Decomposition undet Method. When this is done, additional input is needed, so indicate that there are four seasons, select Centered Moving Average as the basis for smoothing, and specify thatthe seasonal factors should not be rescaled, as shown in Program 5.9. This out- put screen provides both the unadjusted forecasts found using the trend equation on the desea- sonalized data and the final or adjusted forecasts, which are found by muliplying the unadjusted forecast by the seasonal factor or index. Additional details can be seen by selecting Details and Error Analysis undex Window: [ete ie Yow ae erate ioe ae eB eT joa aie 2B tA oe we Ti ipa ferent al cig ns] Shain Por of Balimore ‘ter exponential smoothing elected, Inowthedestedvoke OteropionsDePandl)| Forecast appear for the forecasting methods 180 ° Past period 2 168 ° Past period 3 15 ° Past period 4 You can input he inal forecast, 175 ° Past period 5) ee eee we 190) ° Past period 6 actual valve (18D inthis example) 205 ° Past petiod7 180 ° Past period 8 182 °PROGRAM 5.8C Exponential Smoothing in the Port of Baltimore Output with QM for Windows PROGRAM 5.9 QM for Windows Decomposition Output for the Turner Industries Example APPENDIX 5.1 FORECASTING WITH QM FOR WINDOWS SSretcreea si ‘Watch for notes such as this one, which species that the error Analysis begins with the frst period With a forecast that was nat ‘A graph is available feral 1235) imeeries methods 2985 The forecast forthe next period is here wore ]MADteon Absolie Devintion) vse meen sauared eer) standard ra (denomen 208) ars (ean caine parce Err) rest period ‘When data were input, 4, Centered Moving Average, and Rezcale were all specified. If ‘Additional ouput, including a Teele cnaroyiervacee) i oe or the Wi de deen none, PR ae I 7 ‘Seasonal indies ae found here, The Unadjusted forecast is multiplied by ‘he appropriate seasonal index to get the adjusted ffnal forecast. 193