Chapter 3

FORECASTING
FORECAST:
 A statement about the future

 Used to help managers

 Plan the system

 Plan the use of the system

 Forecast Uses
 Plan the system
 Generally involves long-range plans related to:
 Types of products and services to offer
 Facility and equipment levels
 Facility location
 Plan the use of the system
 Generally involves short- and medium-range plans related
to:
 Inventory management
 Workforce levels
 Purchasing
 Budgeting
 Common Features

 Assumes causal system

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

Timely

Reliable Accurate

Written
Steps in the Forecasting Process

“The forecast”

Step 6 Monitor the forecast

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

 Judgmental - uses subjective inputs (qualitative)

 Time series - uses historical data assuming the

future will be like the past (quantitative)
 Associative models - uses explanatory variables to
predict the future
 Judgmental Forecasts
(Qualitative)

Consumer surveys
Delphi method
Executive opinions
 Opinions of managers and staff

Sales force.
 Time Series Forecasts
(Quantitative)

 Trend - long-term movement in data

 Seasonality - short-term regular variations in data
 Irregular variations - caused by unusual
circumstances
 Random variations - caused by chance

 CYCLE- wave like variations lasting more than one

year
 The Forecast of Forecasts
 Naïve
 Simple Moving Average
 Weighted Moving Average
 Exponential Smoothing
 ES with Trend and Seasonality
 Naïve Forecast
 Simple to use
 Virtually no cost
 Data analysis is nonexistent
 Easily understandable
 Cannot provide high accuracy
 Techniques for Averaging

 Moving average

 Weighted moving average

 Exponential smoothing
 Simple Moving Average
 Smoothes out randomness by averaging positive
and negative random elements over several periods
 n - number of periods (this example uses 4)

Period 1 2 3 4 5 6 7
Demand 74 90 100 60 80 90
Forecast 81 82.5 82.5
 Points to Know on Moving Averages

 Pro: Easy to compute and understand

 Con: All data points were created equal….

…. Weighted Moving Average

 Weighted Moving Average
 Similar to a moving average methods except that it
assigns more weight to the most recent values in a
time series.
 n -- number of periods
ai – weight applied to period t-i+1

t
Ft +1 =  a t − i +1 A i 1 2 3
i = t − n +1 Alpha 0.6 0.3 0.1

Period 1 2 3 4 5 6 7 8 Average
Demand 46 48 47 23 40
Forecast 32.70 35.60
 Exponential Smoothing
 Simpler equation, equivalent to WMA
a – exponential smoothing parameter (0< a<1)

 Ft = Ft −1 + a ( At −1 − Ft −1 )
a 0.1

Period 1 2 3 4 5 6 7 8 Average
Demand 74 90 100 60
Forecast 72 72.2 73.98
 Exponential Smoothing (α=0.30)
Ft = Ft −1 + a ( At −1 − Ft −1 )
PERIOD MONTH DEMAND F2 37 + (0.30)(37-37)
=
1 Jan 37 = 37
2 Feb 40
3 Mar 41
4 Apr 37
F3 =37+ (0.30)(40-37)
5 May 45
6 Jun 50 = 37.9
7 Jul 43
8 Aug 47
9 Sep 56
10 Oct 52
11 Nov 55
12 Dec 54
Exponential Smoothing (cont.)
FORECAST, Ft + 1
PERIOD MONTH DEMAND (a = 0.3) (a = 0.5)
1 Jan 37 – –
2 Feb 40 37.00 37.00
3 Mar 41 37.90 38.50
4 Apr 37 38.83 39.75
5 May 45 38.28 38.37
6 Jun 50 40.29 41.68
7 Jul 43 43.20 45.84
8 Aug 47 43.14 44.42
9 Sep 56 44.30 45.71
10 Oct 52 47.81 50.85
11 Nov 55 49.06 51.42
12 Dec 54 50.84 53.21
13 Jan – 51.79 53.61
Adjusted Exponential Smoothing
AFt +1 = Ft +1 + Tt +1
where
T = an exponentially smoothed trend factor

Tt +1 = (Ft +1 - Ft) + (1 - ) Tt
where
Tt = the last period trend factor
 = a smoothing constant for trend
 Adjusted Exponential
Smoothing (β=0.30)
PERIOD MONTH DEMAND T3 = (F3 - F2) + (1 - ) T2
1 Jan 37 = (0.30)(38.5 - 37.0) + (0.70)(0)
2 Feb 40 = 0.45
3 Mar 41
4 Apr 37 AF3 = F3 + T3 = 38.5 + 0.45
5 May 45 = 38.95
6 Jun 50
7 Jul 43 T13 = (F13 - F12) + (1 - ) T12
8 Aug 47 = (0.30)(53.61 - 53.21) + (0.70)(1.77)
9 Sep 56
= 1.36
10 Oct 52
11 Nov 55
12 Dec 54 AF13 = F13 + T13 = 53.61 + 1.36 = 54.96
 Adjusted Exponential Smoothing:
Example
FORECAST TREND ADJUSTED
PERIOD MONTH DEMAND Ft +1 Tt +1 FORECAST AFt +1

1 Jan 37 37.00 – –
2 Feb 40 37.00 0.00 37.00
3 Mar 41 38.50 0.45 38.95
4 Apr 37 39.75 0.69 40.44
5 May 45 38.37 0.07 38.44
6 Jun 50 38.37 0.07 38.44
7 Jul 43 45.84 1.97 47.82
8 Aug 47 44.42 0.95 45.37
9 Sep 56 45.71 1.05 46.76
10 Oct 52 50.85 2.28 58.13
11 Nov 55 51.42 1.76 53.19
12 Dec 54 53.21 1.77 54.98
13 Jan – 53.61 1.36 54.96
 Linear Trend Equation

Yt = a + bt
a
0 1 2 3 4 5 t
 b is the line slope.
 Calculating a and b

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

 y - b t
a =
n

Yes… Linear Regression!!

 Linear Trend Equation Example

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

 t = 15  t2 = 55  y = 812  ty = 2499
( t)2 = 225
 Linear Trend Calculation

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

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

812 - 6.3(15)
a = = 143.5
5

y = 143.5 + 6.3t

Look on page 85
 Disadvantage of simple linear regression

1-apply only to linear relationship with an independent

variable.
2-one needs a considerable amount of data to establish
the relationship ( at least 20).
3-all observations are weighted equally
 Forecast Accuracy

 Forecast error
 difference between forecast and actual demand

 MAD
 mean absolute deviation
 MAPD
 mean absolute percent deviation
 Cumulative error
 Average error or bias
Mean Absolute Deviation (MAD)

 At - Ft 
MAD = n
where
t = period number
At = demand in period t
Ft = forecast for period t
n = total number of periods
  = absolute value
 MAD Example
PERIOD DEMAND, At Ft (a =0.3) (At - Ft) |At - Ft|
1 37 37.00 – –
2 40 37.00 3.00 3.00

 At38.83
- Ft 
3 41 37.90 3.10 3.10
4 37 -1.83 1.83
5 MAD
45 = n38.28 6.72 6.72
6 50 40.29 9.69 9.69
7 43 53.39
43.20 -0.20 0.20
=
8 47 1143.14 3.86 3.86
9 56 44.30 11.70 11.70
10 52 = 4.85 47.81 4.19 4.19
11 55 49.06 5.94 5.94
12 54 50.84 3.15 3.15
557 49.31 53.39
 Other Accuracy Measures

Mean absolute percent deviation (MAPD)

|At - Ft|
MAPD =
At
Cumulative error
E = et
Average error
et
(E )= n
 Comparison of Forecasts

FORECAST MAD MAPD E (E)

Exponential smoothing (a = 0.30) 4.85 9.6% 49.31 4.48
Exponential smoothing (a = 0.50) 4.04 8.5% 33.21 3.02
Adjusted exponential smoothing 3.81 7.5% 21.14 1.92
(a = 0.50,  = 0.30)
 Forecast Control

 Tracking signal
 monitors the forecast to see if it is biased high or low

(At - Ft) E
Tracking signal = =
MAD MAD
 Tracking Signal Values
DEMAND FORECAST, ERROR E = TRACKING
PERIOD At Ft At - Ft (At - Ft) MAD SIGNAL

1 37 37.00 – – – –
2 40 37.00 3.00 3.00 3.00 1.00
3 41 37.90 3.10 6.10 3.05 2.00
4 37 38.83 -1.83 4.27 2.64 1.62
5 45 38.28
Tracking 6.72 for period
signal 10.99 3 3.66 3.00
6 50 40.29 9.69 20.68 4.87 4.25
7 43 43.20 -0.20
6.10 20.48 4.09 5.01
8 47 43.14TS = 3.86 = 24.34
2.00 4.06 6.00
3
9 56 44.30 3.05 36.04
11.70 5.01 7.19
10 52 47.81 4.19 40.23 4.92 8.18
11 55 49.06 5.94 46.17 5.02 9.20
12 54 50.84 3.15 49.32 4.85 10.17
 Sources of forecast errors

 The model may be inadequate.

 Irregular variation may be occur.
 The forecasting technique may be used incorrectly or
the results misinterpreted.
 There are always random variation in the data.
 End Notes

 The two most important factors in choosing a

forecasting technique:
 Cost
 Accuracy
 Keep it SIMPLE!
 =FORECAST(70,{23,34,12},{67,76,56}) (if you
can…let the computer do it)