SCM – 302

OPERATIONS
MANAGEMENT
Forecasting
 SCM 302 - Forecasting

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Forecasting
• How much product do we need to make?
1. Why is effective forecasting important? Examples.
2. Distinguish three time horizons for forecasting and methods for each.
3. Compare qualitative vs. quantitative forecasting, their methods and
uses.
4. Describe four types of variation in time series data.
5. Compute the following time-series forecasts:
• Naïve, Moving Avg., Weighted Moving Avg., Exponential Smoothing
6. Interpret associative models and use of regression in forecasting
7. Compute prediction given slope, intercept.
8. Interpret correlation and 𝑅2 .
9. Compute measures of forecast accuracy
• MFE, MAD, MSE, MAPE
10. Compute a tracking signal to monitor forecast quality
11. Describe responsiveness vs. stability tradeoff. Examples.
12. Forecasting Insights
 SCM 302 - Forecasting

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Forecasting at Walt Disney World

 SCM 302 - Forecasting

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Walt Disney World

• What needs to be forecasted?
• What factors need to be considered
in developing a forecast for WDW?
• What decisions are made on the
basis of the forecasts?

If you are forecasting tomorrow’s attendance at the Magic Kingdom,

what one piece of information would you want?
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Forecasting Provides Competitive Advantage for WDW

• Parks in Orlando & Anaheim – Hong Kong, Paris, Tokyo
• Revenues: how many visitors and how they spend their money

• Reports:
• Forecasted and actual attendance at each park
• Daily, weekly, monthly, annual, and 5-year forecasts
• Average forecast error: 5% (5-year); 0% to 3% (annual)

• How are forecasts used?

• Labor management, maintenance, operations, finance,
and park scheduling
• Adjust opening times, rides, shows, staffing levels,
and guests admitted

• What variables are included in the models?

• 20% customers from outside US
• GDP, exchange rates, Fed. Reserve policies, Wall Street trends
• Airline specials, school district schedules
• 35 analysts, 70 field employees survey 1 million guests, employees,
and travel professionals each year
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Forecasting 101
What is forecasting?
• Process of predicting a future event
• Most techniques assume an underlying
stability in the system
• The only certain thing about a
forecast is that it will be wrong!
• As the forecast horizon increases, forecast
accuracy decreases.
• Product family and aggregated forecasts
are more accurate than individual
product forecasts
Capacity
Why forecast?
• Underlying basis of all business
decisions. Coordinates activities
• Production, Inventory, Personnel,
Facilities
• Common forecast allows decisions to be
mutually supportive across functions.
• Limiting forecast error leads to
productivity improvements
• As more data comes in  Review and
update forecasts
Inventory

Forecasting
Planning Staffing

Scheduling
 SCM 302 - Forecasting

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Poor Forecasting Costs Money

Excerpts from Wall Street Journal
• Cisco… reported more than $3.4 billion in
one-time charges last year, including a $2.2
billion write-down for excess inventory.
The inventory charge, primarily reflecting
a huge store of components Cisco
accumulated in response to a parts
shortage in the previous year.
• Liz Claiborne said… earnings decline is
consequence of [unanticipated] excess
inventories.
• …Ford's Big Batch Of Rare Metal
[palladium] Led To $1 Billion Write-Off.
• IBM sells out new Aptiva PC. Shortage
may cost millions.
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Forecasting Time Horizons

Forecasting Forecasting Methodologies

Introduction – Growth – Maturity – Decline

Comprehensive -----------------Specific

Time Horizon Application

Short-Range Purchasing, Moving average,
(0-3 months) job scheduling, exponential
workforce levels, smoothing

Product Life Cycle

job assignments,
production levels
Decisions

Medium-Range Sales and production Regression,

(3 months – 3 yrs) planning, budgeting time series analysis
Long-Range New product Economic
(3 years or more) planning, projections,
facility location, executive opinion,
research and Delphi method,
development market survey

Steps in Forecasting:
1) For what will we use the forecast? 2) What item needs to be forecasted?
3) What time horizon will we use? 4) How do we collect the appropriate data?
5) Which method will we use? 6) How accurate are our forecasts?
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Qualitative vs. Quantitative Forecasts

Qualitative Quantitative
• Subjective • Objective
Characteristics
• Use opinions, intuition, experience, values • Use numeric data, math modeling
• Can incorporate expertise that is hard to • Consistency
Strengths codify. • Can consider large amounts of data
• Handle new products, vague situations • Stable situation
Weaknesses • Opinions can dominate or bias forecast • Must have reliable data

• Jury of executive opinion • Time Series Models: Past data is best

• Pool opinions of high-level experts predictor of future
• Delphi method • Look for patterns in the previously
• Panel of experts, queried iteratively observed values
• Sales force composite • Naïve, Moving Average, Exponential
Methods • Estimates from individual salespersons Smoothing, Trend projection
are reviewed for reasonableness, then • Observe response variable at regular
aggregated time periods
• Market Survey • Associative Models: Forecast based on
• Ask the customer relationships to other variables
• Regression approaches

Long Term Short Term

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Forecasting Demand
Demand

250

200

150

100

50

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20
Week

What Would Be Your Forecast of Demand in Week 11 ?

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Previous Example Was Unrealistic

Demand is Almost Never Constant
Trend
component
Demand for product or service

Seasonal peaks

Actual demand
line

Average demand
over 4 years

Random variation
| | | |
1 2 3 4
Time (years)
Figure 4.1

4 Types of Time Series Variation
Trend
• Persistent upward or
downward pattern
• Due to population, technology,
age, culture, etc.
• Several years duration
Cyclicality
• Business cycle, political &
economic factors
• Unknown length, multiple years
• Causal or associative
relationships
SCM 302 - Forecasting
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Seasonality
• Regular up and down
fluctuations
• Due to weather, customs, etc.
• Occurs within single year
• Weekly, monthly, quarterly, etc.
Random Variation
• Erratic, unsystematic, ‘residual’
fluctuation
• Unforeseen events
• Short duration, nonrepeating
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Basic Time Series

Fluctuates About a Constant Mean

Fluctuates About A Constant Demand = Mean + Random Fluctuation

Mean
+
Demand
(1) Fluctuation Can be Positive or Negative
250 (2) Average Fluctuation = 0

200 Forecast = Current Estimate of the Mean

150

100 The Challenge is to Estimate the Mean level

of Demand
50

Notation
1 2 3 4 5 6 7 8 9 10 11 • At = Demand observed in period t
Week
• Ft+1 = Forecast (made in period t) for period t+1
• i.e. forecast of next period’s demand
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What approaches can you think of?

Period Demand (At) Forecast (Ft)

1 130

2 155

3 145

4 160

5 151

6 143

7
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Naïve Method,
Ft+1=At, Simplest Approach to Forecasting
Assume demand next
Period Demand Forecast period is the same the
most recent period
• If January sales were
Forecast of Demand 68, then February
in Period 2 1 130 - sales will be 68
(Forecast made after • Sometimes cost
seeing Demand in effective and efficient
Period 1) 2 155 130 • Good starting point
or reference point

3 145 155
Forecast of Demand
in Period 5 4 160 145
(This forecast made
after seeing
Demand in Period 5 151 160
4)

6 143 151

7 143
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The Moving Average Forecast

• A Simple Average forecast uses
ALL THE HISTORY of demands to generate the
forecast for the next period

• The (Simple) Moving Average forecast (order n) uses

ONLY THE n MOST RECENT period demands to
generate the forecast for the next period

• Used if little or no trend

• Used often for smoothing
• Provides overall impression of data over time
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Moving Average Forecast

Ft+1=(At-n+1+… +At-2+ At-1+At)/n
Period Demand Forecast Using
n=3
Forecast of
Demand in Period 1 130 -
2
(This forecast
made after seeing 2 155 - Not enough history

Demand in Period
1)
3 145 - Not enough history

Forecast of 4 160 143.33 (130+155+145)/3 = 143.33

Demand in Period
5
(This forecast 5 151 153.33 (155+145+160)/3 = 153.33

made after seeing

Demand in Period
4) 6 143 152.00 (145+160+151)/3 = 152.00

7 151.33 (160+151+143) /3 = 151.33

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The Weighted Moving Average Forecast

• The Simple Moving Average forecast (order n)
treats each of the n most recent demands
EQUALLY in generating the forecast for the next
period.

• The Weighted Moving Average forecast (order n)

weights each of the n most recent demands
(possibly) DIFFERENTLY in generating the
forecast for the next period.
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Weighted Moving Average Forecast

Ft+1= wt-n+1 At-n+1+… +wt-2 At-2+ wt-1 At-1+wtAt
n=3:
Period Demand Forecast wt=0.5, wt-1=0.3,
Forecast of wt-2=0.2
Demand in Period 1 130 -
2
(This forecast
made after seeing 2 155 - Not enough history

Demand in Period
1)
3 145 - Not enough history

0.2(130)+0.3(155)+0.5(145) =
Forecast of 4 160 145.00 145.00
Demand in Period
5
0.2(155)+0.3(145)+0.5(160) =
(This forecast 5 151 154.50 154.50
made after seeing
Demand in Period 0.2(145)+0.3(160)+0.5(151) =
4) 6 143 152.20 152.50

0.2(160)+0.3(151)+0.5(143) =
7 148.80 148.80
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Exponential Smoothing Forecast

Consider a weighted moving
Exponential Smoothing like
average forecast with the following
weighted average
weights

wt i   1    Ft 1   At  1    Ft
i

 [0,1] Is the same as ……

t 1
Ft 1   wt i At i
i 0

wt i   1   
i
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Exponential Smoothing Forecast

Ft+1=αAt + (1- α)Ft = Ft+α(At-Ft)

Period Demand Forecast α=0.2

Forecast of
Demand in 1 130 -
Period 2
(This forecast
2 F2=αA1 + (1- α)F1
made after
seeing Demand
in Period 1)
F2=(0.2)130 + (1- 0.2)F1
Problem!
Didn’t have a forecast for period 1 so how can we start the
exponential smoothing method
Options
(1) Use Naïve Forecast for Period 2 and then do exponential smoothing for periods 3,4,5,6,……
(2) Choose an initial forecast for period 1 (in some manner) and then do exponential
smoothing for periods 2,3,4,5,6,……
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Exponential Smoothing Forecast

Using Naïve Method for Period 2
Period Demand Forecast
α=0.2
Forecast of
Demand in 1 130 -
Period 2
(This forecast
made after 2 155 130 Using Naive

seeing Demand
in Period 1)
3 145 135.00 0.2(155)+(1-0.2)(130)=135.00

Forecast of 4 160 137.00 0.2(145)+(1-0.2)(135)=137.00

Demand in
Period 5
(This forecast 5 151 141.60 0.2(160)+(1-0.2)(137)=141.60

made after
seeing Demand 0.2(151) +
in Period 4) 6 143 143.48 (1-0.2)(141.60) =143.48

0.2(143) +
7 143.38 (1-0.2)(143.48) = 143.38
 SCM 302 - Forecasting

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Exponential Smoothing Forecast

Forecast for Period 1 Obtained in Some Manner
Period Demand Forecast
α=0.2
Forecast of
Demand in 1 130 140
Period 2
(This forecast
made after 2 155 138 0.2(130)+(1-0.2)(140)=138.00

seeing Demand
in Period 1)
3 145 141.40 0.2(155)+(1-0.2)(138)=141.40

0.2(145) +
Forecast of 4 160 142.12 (1-0.2)(141.40) = 142.12
Demand in
Period 5
0.2(160) +
(This forecast 5 151 145.70 (1-0.2)(142.12) = 145.70
made after
seeing Demand 0.2(151) +
in Period 4) 6 143 146.76 (1-0.2)(145.70) =146.76

0.2(143) +
7 146.00 (1-0.2)(146.76) = 146.00
 SCM 302 - Forecasting

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Question
If at the end of period 6,

I asked you to forecast the demand in periods 8, 9,

10 etc., what would your answer be?

Ft=146.00 is the best estimate for t>=8

If we don’t have more info that is all we can say with our current data.
 SCM 302 - Forecasting

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Exponential Smoothing - motivation

• Weighted moving averages
•Simple to calculate
BUT
•Need to carry some amount of data history along
•Need to determine n and the weights (wi)
Exponential Smoothing – a weighted moving average
•Simple to calculate
•Only need to carry two numbers
•All data history is retained but weighted appropriately
•Need to determine only one number – smoothing constant ()
 SCM 302 - Forecasting

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What If Mean Demand Level Shifts at

Some Point in Time ?
Change in Mean Demand Forecast reaction?
180 • How will the following
160 forecasts react
140 • Moving Average
120 • n=2
100 • n=7
80
• Exponential smoothing
60
• α =0.2
40
• α =0.9
20

0
1 3 5 7 9 11 13 15 17 19 21 23 25 27 29

Demand
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Forecast Parameter Influences

Responsiveness to Shift in Mean
Moving Average Exponential Smoothing
180 180

160 160

140 140

120 120

100 100

80 80

60 60

40 40

20 20

0 0
1 3 5 7 9 11 13 15 17 19 21 23 25 27 29 1 3 5 7 9 11 13 15 17 19 21 23 25 27 29

Demand MA 2 MA 7 Demand Exp 0.9 Exp 0.2

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Why Not Use An Extremely Responsive

Forecast?
No Change in Mean Demand Forecast reaction?

160 • How will the following

140
forecasts react
120
• Moving Average
• n=2
100
• n=7
80
• Exponential smoothing
60
• α=0.9
40
• α =0.2
20

0
1 3 5 7 9 11 13 15 17 19 21 23 25 27 29

Demand
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Stability vs. Responsiveness

Moving Average Exponential Smoothing

160 160

140 140

120 120

100 100

80 80

60 60

40 40

20 20

0 0
1 3 5 7 9 11 13 15 17 19 21 23 25 27 29 1 3 5 7 9 11 13 15 17 19 21 23 25 27 29

Demand MA 2 MA 7 Demand Exp 0.9 Exp 0.2

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Responsiveness vs. Stability

Responsiveness: Ability of forecast to respond quickly
to a true change in mean level demand

small n large α

Moving Average Exponential Smoothing

large n small α

Stability: Ability of forecast to ignore simple random

variations
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Summary of Basic Time Series Methods

Technique Decision Implicit assumption
•Naive •None •Only previous period is
important

•Simple Moving •Length (n) •Only last n periods are

Average important (equally).

•Weighted Moving •Length (n) •Not all recent periods equally

Average and weights important.

•Exponential •Smoothing •Importance of data declines

Smoothing constant, smoothly (in an exponential
alpha (α) fashion)
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Forecasting Exercise #1
Exponential
Weighted Moving
Naïve Simple Simple Moving Smoothing
Period Demand Average (n=2,
Forecast Average Average (n=2) Forecast (α=0.4)
wt=0.6, wt-1=0.4)

Average the Summation of weight α * Actual demand in

Forecast Actual Average of demand for the * actual demand for t
t+1 demand at t demand so far most recent n the most recent n + (1- α)* Forecast for t
periods periods

1 10

2 20

3 15

4 12
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Ratcliffe 33

Industry Question (IQ) #2

• You are a manager at Lego trying to forecast
demand for the new “Lego Friends” series of
building block for girls. You hire two outside
consulting companies to come up with their own
forecasts the demand.

• How would you decide which forecast is better?

• How good (of a forecast) is good enough?
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Which method is best?

• How should you choose between different forecast
methods?
• How should you choose parameter values for a
particular method?

• Objective: obtain most accurate forecast no matter the

technique
• General approach: select model that gives lowest
forecast error

• Forecast error = Actual value – Forecast value

= At – Ft
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Ratcliffe 35

Measuring Forecast Accuracy

• Absolute measures: do not consider underlying values (demand)
• MFE (Mean Forecast Error or Bias)
𝐴𝑐𝑡𝑢𝑎𝑙 − 𝐹𝑜𝑟𝑒𝑐𝑎𝑠𝑡
𝑀𝐹𝐸 =
𝑛

• MAD (Mean Absolute Deviation)

𝐴𝑐𝑡𝑢𝑎𝑙 − 𝐹𝑜𝑟𝑒𝑐𝑎𝑠𝑡
𝑀𝐴𝐷 =
𝑛

• MSE (Mean Square Error)

2
𝐴𝑐𝑡𝑢𝑎𝑙 − 𝐹𝑜𝑟𝑒𝑐𝑎𝑠𝑡
𝑀𝑆𝐸 =
𝑛

• Relative measures: account for magnitude of underlying values

• MAPE (Mean Absolute Percentage Error)
𝐴𝑐𝑡𝑢𝑎𝑙 − 𝐹𝑜𝑟𝑒𝑐𝑎𝑠𝑡
𝑀𝐴𝑃𝐸 = 𝐴𝑐𝑡𝑢𝑎𝑙
𝑛
 SCM 302 - Forecasting

Ratcliffe 36

Measuring Forecast Errors

Mean Forecast Error (MFE)

Period Demand Forecast Error

1 130 - -
2 155 130.00 25.00
3 145 155.00 -10.00 (25+(-10)+15+(-9)+(-8))/5
=
4 160 145.00 15.00 2.60

5 151 160.00 -9.00

6 143 151.00 -8.00

Mean Forecast
Error = 2.60
 SCM 302 - Forecasting

Ratcliffe 37

Measuring Forecast Errors

Mean Absolute Deviation (MAD)
Absolute
Period Demand Forecast Error Error
1 130 - - -
2 155 130.00 25.00 25.00
3 145 155.00 -10.00 10.00
4 160 145.00 15.00 15.00

5 151 160.00 -9.00 9.00

6 143 151.00 -8.00 8.00

MAD = 13.40
 SCM 302 - Forecasting

Ratcliffe 38

Measuring Forecast Errors

Mean Squared Error (MSE)
Squared
Period Demand Forecast Error Error
1 130 - - -
2 155 130.00 25.00 625.00 252=625

3 145 155.00 -10.00 100.00 (-10)2=100

4 160 145.00 15.00 225.00 152=225

5 151 160.00 -9.00 81.00 (-9)2=81

6 143 151.00 -8.00 64.00 82=64

MSE = 219.00
 SCM 302 - Forecasting

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Measuring Forecast Errors

Mean Absolute Percentage Error (MAPE)
Abs %
Period Demand Forecast Error % Error
Error
1 130 - - - -
2 155 130.00 25.00 =25/155=16.13% 16.13%
3 145 155.00 -10.00 =-10/145=-6.90% 6.9%
4 160 145.00 15.00 =15/160=9.38% 9.38%

5 151 160.00 -9.00 =-9/151=-5.96% 5.96%

6 143 151.00 -8.00 =-8/143=-5.59% 5.59%
MAPE 8.79%
 SCM 302 - Forecasting

Ratcliffe 40

Forecasting Exercise #2
Exponential Smoothing Absolute
Period Demand Error Squared Error Absolute % Error
Forecast (α=0.4) Deviation

Forecas α * Actual demand in t

t t+1 + (1- α)* Forecast for t

1 10

2 20

3 15

4 12

MAD = MSE = MAPE=

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Ratcliffe 41

Monitoring Forecasts Over Time

• It is important to continually monitor the quality of your forecasts
• Individual forecasts are almost always wrong
• Average forecast error should be close to zero
• If average forecast error is far from zero, bias in the forecast

• Tracking Signal
• Measures how well the forecast is predicting actual values
• Ratio of cumulative forecast errors to mean absolute deviation (MAD)
• Good forecast has low tracking signal
• Watch for TS beyond ± 4 for bias

𝑡
𝐶𝑢𝑚𝑢𝑙𝑎𝑡𝑖𝑣𝑒 𝐸𝑟𝑟𝑜𝑟 𝑖=1 𝐴𝑖 − 𝐹𝑖
Tracking Signal TS = = 𝑡
𝑀𝐴𝐷 𝑖=1 𝐴𝑖 − 𝐹𝑖
𝑡
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Ratcliffe 42

Tracking Signal Figure 4.11

Signal exceeding limit
Tracking signal
Upper control limit
+

0 MADs Acceptable
range

–
Lower control limit

Time

If TS falls outside a limit of about +/- 4 than the

forecast should be reviewed
 SCM 302 - Forecasting

Ratcliffe 43

What Happens When Tracking Signal

Falls Outside ±4 MADS?
 Your forecast is presenting a consistent bias!
16

14

12
Demand
10 Forecast

6
0 2 4 6 8 10 12

1 2 3 4 5 6 7 8 9 10
Demand 10 11 11 10 10 11 10 11 10 11

Tracking
1 2 3 2 1 0 -2 -4 -5 -7
Signal
 SCM 302 - Forecasting

Ratcliffe 44

Tracking Signal Example

ABSOLUTE CUM ABS TRACKING
ACTUAL FORECAST CUM FORECAST FORECAST SIGNAL (CUM
QTR DEMAND DEMAND ERROR ERROR ERROR ERROR MAD ERROR/MAD)
1 90 100 –10 –10 10 10 10.0 –10/10 = –1

2 95 100 –5 –15 5 15 7.5 –15/7.5 = –2

3 115 100 +15 0 15 30 10. 0/10 = 0

4 100 110 –10 –10 10 40 10. 10/10 = –1

5 125 110 +15 +5 15 55 11.0 +5/11 = +0.5

6 140 110 +30 +35 30 85 14.2 +35/14.2 = +2.5

At the end of quarter 6, MAD =

å Forecast errors 85
= = 14.2
n 6
Cumulative error 35
Tracking signal = = = 2.5 MADs
MAD 14.2
 SCM 302 - Forecasting

Ratcliffe 45

Time Series With Trends

Consider the following
What would happen if we
time series of sandwich
used the moving averages
demand
Sandwich Demand Sandwich Demand
140 140

130 130

120 120

110 110

100 100

90 90

80 80
1 3 5 7 9 11 13 15 17 19 21 1 3 5 7 9 11 13 15 17 19 21

Day Day
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Ratcliffe 46

Need to Account for Trend: 2 methods

• Double Exponential Smoothing: Exponential Forecast
Including Trend (𝐹𝐼𝑇𝑡 )*
1. Compute forecast of level
• 𝑆𝑡 = 𝛼𝐴𝑡 + 1 − 𝛼 𝑆𝑡−1 + 𝑇𝑡−1
2. Compute forecast of trend
• 𝑇𝑡 = 𝛽 𝑆𝑡 − 𝑆𝑡−1 + 1 − 𝛽 𝑇𝑡−1
3. Sum two together to get final forecast
• 𝐹𝐼𝑇𝑡+1 = 𝑆𝑡 + 𝑇𝑡

• Linear Regression
• Fit least-squares line to historical data
• Write forecast as 𝑦 = 𝑎 + 𝑏𝑥.
• Check linear regression assumptions:
• Plot the data to check for linear relationship
• Check that deviations around the line are random, Normally distributed
• Do not predict time periods far beyond the data

*different from text

 SCM 302 - Forecasting

Ratcliffe 48

Time Series With Trends

Single Exponential Smoothing Double Exponential Smoothing

Demand Demand
140 150

130 140

130
120
120
110
110
100
100

90 90

80 80
1 3 5 7 9 11 13 15 17 19 21 1 3 5 7 9 11 13 15 17 19 21

Day Day
 SCM 302 - Forecasting

Ratcliffe 49

Regression Method
Values of Dependent Variable (y-values)

Actual observation Deviation7

(y-value)

Deviation5 Deviation6

Deviation3
Least squares method minimizes the
sum ofDeviation
the squared
4
errors (deviations)

Deviation1
(error) Deviation2
Trend line, ^y = a + bx

| | | | | | |
1 2 3 4 5 6 7
Figure 4.4
Time period
 SCM 302 - Forecasting

Ratcliffe 50

Least Squares Example

ELECTRICAL
YEAR POWER
DEMAND
1 74
2 79 ELECTRICAL POWER DEMAND
3 80 160
4 90 140
5 105 120
6 142
Megawatts

100
7 122
80

60
y = 10.536x + 56.714
40 R² = 0.8009

20

0
0 1 2 3 4 5 6 7 8
Year
 SCM 302 - Forecasting

Ratcliffe 51

Seasonal Variations In Data

• One approach: use multiplicative
model to adjust for seasonality
1. Determine length of season
2. Perform linear regression to account for
trend
3. Compute unseasonalized regression
forecast
4. Calculate index = actual/forecast
5. Average indices by season
6. Compute regression predictions for
future periods
7. Multiply regression predictions by
average seasonal indices to get
seasonality-adjusted forecasts
 SCM 302 - Forecasting

Ratcliffe 52

Year Quarter Period t Demand At

Regression
Forecast Ft
At / Ft Seasonality Example
1000
1 Q1 1 227 263 0.86
Q2 2 306 307 1.00 800
Q3 3 522 350 1.49
Q4 4 412 394 1.05
600
2 Q1 5 297 437 0.68
Q2 6 425 481 0.88
400
Q3 7 603 524 1.15
Q4 8 534 568 0.94
3 Q1 9 521 612 0.85
200
Q2 10 615 655 0.94
Q3 11 822 699 1.18
0
Q4 12 748 742 1.01 1 2 3 4 5 6 7 8 9 10 11 12
Intercept: 219.48
Demand Regression Forecast
Slope: 43.57

Calculating Seasonal Indexes Forecast for Year 4

At / Ft Final forecast = Regression Forecast * Seasonal Index

Seasonal
Quarter
Index
Year 1 Year 2 Year 3 Year Quarter Period Regression Final Forecast

Q1 0.86 0.68 0.85 0.80 4 Q1 13 786 629

Q2 1.00 0.88 0.94 0.94 Q2 14 829 779
Q3 1.49 1.15 1.18 1.27 Q3 15 873 1109
Q4 1.05 0.94 1.01 1.00 Q4 16 917 917
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Let’s Look at The Forecasts

Attendance Forecast
accounting for
seasonality

Forecast
ignoring
seasonality
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Associative Forecasting
Response variable, Y, depends on
The relationship might be linear
explanatory variable, X

• Number of people at the beach 180

Sales $ (000)
depends on the temperature
170

• Gasoline price in US depends on 160

world oil production 150

140
• Sales depends on advertising
130

• Others? 120

110
Advertising $
• Use regression techniques as (000)
100
before 45 48 52 50 55 60
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Linear Regression Output from Excel

Regression Statistics
Multiple R 0.9644
R Square 0.9300
Adjusted R Square 0.9125
Standard Error 3.9537
Observations 6.0000

ANOVA
df SS MS F Significance F
Regression 1.0000 830.8050 830.8050 53.1475 0.0019
Residual 4.0000 62.5283 15.6321
Total 5.0000 893.3333

Coefficients Standard Error t Stat P-value Lower 95% Upper 95%

Intercept 24.0660 17.2585 1.3944 0.2356 -23.8514 71.9834
Adverstising 2.4245 0.3326 7.2902 0.0019 1.5012 3.3479

Y=intercept + slope*X…
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Linear Regression Analysis

• How accurate is our forecast?
• A forecast is a point estimate, could be high or low
• Use standard error describe distribution of forecast errors and come
up with prediction intervals.
• Wider intervals imply a less accurate forecast
• How strong is the relationship between the two
variables?
• Correlation does not necessarily imply causality!
• Coefficient of correlation, r, measures degree of association
• Values range from -1 to +1
• How much variation in the response variable is
explained by variation in the explanatory variable
• Coefficient of Determination, 𝑅 2 , measures percent of change in y
predicted by the change in x
• Values range from 0 to 1
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Correlation Coefficient
Figure 4.10
y y

x x
(a) Perfect negative (e) Perfect positive
correlation y y correlation

y
x x
(b) Negative correlation (d) Positive correlation

x
(c) No correlation

High Moderate Low Low Moderate High

| | | | | | | | |

–1.0 –0.8 –0.6 –0.4 –0.2 0 0.2 0.4 0.6 0.8 1.0
Correlation coefficient values
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Forecasting in the Service Sector

• Presents unusual challenges
• Special need for short term records
• Needs differ greatly as function of industry and product
• Holidays and other calendar events
• Unusual events
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M&M’s Forecasting Game

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1. Forecasting Demand for Families of Products is

Easier than Forecasting Demand for Members
• Example:
• Family: Top 5 colors for Benetton cardigans
• Say Benetton sells 100 of each color each week
Demands Absolute % Errors
Week Blue Black White Silver Green Family Blue Black White Silver Green Family
1 97 89 98 98 131 513 3.0% 11.0% 2.0% 2.0% 31.0% 2.6%
2 100 102 106 108 127 543 0.0% 2.0% 6.0% 8.0% 27.0% 8.6%
3 144 49 94 89 107 483 44.0% 51.0% 6.0% 11.0% 7.0% 3.4%
4 113 117 108 97 70 505 13.0% 17.0% 8.0% 3.0% 30.0% 1.0%
5 113 124 95 109 83 524 13.0% 24.0% 5.0% 9.0% 17.0% 4.8%
6 103 84 90 137 106 520 3.0% 16.0% 10.0% 37.0% 6.0% 4.0%
7 75 99 94 70 98 436 25.0% 1.0% 6.0% 30.0% 2.0% 12.8%
8 138 65 86 104 85 478 38.0% 35.0% 14.0% 4.0% 15.0% 4.4%
9 80 126 114 91 148 559 20.0% 26.0% 14.0% 9.0% 48.0% 11.8%
10 123 117 106 158 109 613 23.0% 17.0% 6.0% 58.0% 9.0% 22.6%
11 83 100 95 114 44 436 17.0% 0.0% 5.0% 14.0% 56.0% 12.8%
12 90 120 122 78 123 533 10.0% 20.0% 22.0% 22.0% 23.0% 6.6%
13 156 116 135 132 122 661 56.0% 16.0% 35.0% 32.0% 22.0% 32.2%
14 110 72 100 112 76 470 10.0% 28.0% 0.0% 12.0% 24.0% 6.0%
15 118 46 112 77 69 422 18.0% 54.0% 12.0% 23.0% 31.0% 15.6%
16 123 97 116 96 67 499 23.0% 3.0% 16.0% 4.0% 33.0% 0.2%
17 109 118 122 103 65 517 9.0% 18.0% 22.0% 3.0% 35.0% 3.4%
18 95 117 82 92 110 496 5.0% 17.0% 18.0% 8.0% 10.0% 0.8%
19 102 124 89 80 118 513 2.0% 24.0% 11.0% 20.0% 18.0% 2.6%
20 112 114 142 94 80 542 12.0% 14.0% 42.0% 6.0% 20.0% 8.4%
MAPE 17.2% 19.7% 13.0% 15.8% 23.2% 8.2%

Why is MAPE lower for the overall family than for individual colors?
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2. Forecasting Demand for a Month is More Accurate

than Forecasting Demand for a Week
Forecasting weekly Forecasting monthly
demand for the demand for the
most selling 5 colors most selling 5 colors
Weekly Forecasts for Family Monthly Forecasts for Family
Week Demand Abs % Error Weeks Demand Abs % Error
1 513 2.60% 1-4 2044 2.20%
2 543 8.60% 5-8 1958 2.10%
3 483 3.40% 9-12 2141 7.05%
4 505 1.00% 13-16 2052 2.60%
5 524 4.80% 17-20 2068 3.40%
6 520 4.00% MAPE 3.47%
7 436 12.80%
8 478 4.40%
9 559 11.80%
10 613 22.60%
11 436 12.80% Why is MAPE lower
12 533 6.60% for the monthly
13 661 32.20% forecasts than for
14 470 6.00%
15 422 15.60% weekly forecasts?
16 499 0.20%
17 517 3.40%
18 496 0.80%
19 513 2.60%
20 542 8.40%
MAPE 8.23%
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3. The further into the future you want to forecast

demand the less accurate you are likely to be
• The forecast for demand for cardigan in October
2009 will be more accurate than the forecast for
demand in October 2010
• Why?
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4. Danger of using Sales As Estimate of Demand

• Is the number of blue cardigans sold at a particular store

necessarily a good estimate of demand for blue cardigans
at that store?
• Why or why not?
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5. Beware of using Sales Targets as Forecasts

• Forecasts are often generated in different parts of
the company and for different reasons

• Sales sometime generate forecasts that are used as

targets or goals

• Dangerous to use a sales target as a forecast

• Why?