Overview of Quantitative

Approaches
1. Naive approach
2. Moving averages
Time-Series
3. Exponential Models
smoothing
4. Trend projection
Associative
5. Linear regression Model

© 2008 Prentice Hall, Inc. 4 – 32

 Comparison of Forecast
Error
Rounded Absolute Rounded Absolute
Actual Forecast Deviation Forecast Deviation
Tonnage with for with for
Quarter Unloaded α = .10 α = .10 α = .50 α = .50
1 180 175 5.00 175 5.00
2 168 175.5 7.50 177.50 9.50
3 159 174.75 15.75 172.75 13.75
4 175 173.18 1.82 165.88 9.12
5 190 173.36 16.64 170.44 19.56
6 205 175.02 29.98 180.22 24.78
7 180 178.02 1.98 192.61 12.61
8 182 178.22 3.78 186.30 4.30
82.45 98.62
MAD 10.31 12.33
MSE 190.82 195.24
MAPE 5.59% 6.76%
© 2008 Prentice Hall, Inc. 4 – 63
 Exponential Smoothing with
Trend Adjustment
When a trend is present, exponential
smoothing must be modified

Forecast Exponentially Exponentially

including (FITt) = smoothed (Ft) + (Tt) smoothed
trend forecast trend

© 2008 Prentice Hall, Inc. 4 – 64

 Exponential Smoothing with
Trend Adjustment

Ft = α (At - 1) + (1 - α )(Ft - 1 + Tt - 1)

Tt = β (Ft - Ft - 1) + (1 - β )Tt - 1

Step 1: Compute Ft
Step 2: Compute Tt
Step 3: Calculate the forecast FITt = Ft + Tt
© 2008 Prentice Hall, Inc. 4 – 65
 Exponential Smoothing with
Trend Adjustment Example
Forecast
Actual Smoothed Smoothed Including
Month(t) Demand (At) Forecast, Ft Trend, Tt Trend, FITt
1 12 11 2 13.00
2 17
3 20
4 19
5 24
6 21
7 31
8 28
9 36
10
Table 4.1
© 2008 Prentice Hall, Inc. 4 – 66
 Exponential Smoothing with
Trend Adjustment Example
Forecast
Actual Smoothed Smoothed Including
Month(t) Demand (At) Forecast, Ft Trend, Tt Trend, FITt
1 12 11 2 13.00
2 17
3 20
4 19
5 24 Step 1: Forecast for Month 2
6 21
7 31 F2 = αA1 + (1 - α)(F1 + T1)
8 28
9 36
F2 = (.2)(12) + (1 - .2)(11 + 2)
10 = 2.4 + 10.4 = 12.8 units
Table 4.1
© 2008 Prentice Hall, Inc. 4 – 67
 Exponential Smoothing with
Trend Adjustment Example
Forecast
Actual Smoothed Smoothed Including
Month(t) Demand (At) Forecast, Ft Trend, Tt Trend, FITt
1 12 11 2 13.00
2 17 12.80
3 20
4 19
5 24 Step 2: Trend for Month 2
6 21
7 31 T2 = β(F2 - F1) + (1 - β)T1
8 28
9 36
T2 = (.4)(12.8 - 11) + (1 - .4)(2)
10 = .72 + 1.2 = 1.92 units
Table 4.1
© 2008 Prentice Hall, Inc. 4 – 68
 Exponential Smoothing with
Trend Adjustment Example
Forecast
Actual Smoothed Smoothed Including
Month(t) Demand (At) Forecast, Ft Trend, Tt Trend, FITt
1 12 11 2 13.00
2 17 12.80 1.92
3 20
4 19
5 24 Step 3: Calculate FIT for Month 2
6 21
7 31 FIT2 = F2 + T1
8 28
FIT2 = 12.8 + 1.92
9 36
10 = 14.72 units
Table 4.1
© 2008 Prentice Hall, Inc. 4 – 69
 Exponential Smoothing with
Trend Adjustment Example
Forecast
Actual Smoothed Smoothed Including
Month(t) Demand (At) Forecast, Ft Trend, Tt Trend, FITt
1 12 11 2 13.00
2 17 12.80 1.92 14.72
3 20 15.18 2.10 17.28
4 19 17.82 2.32 20.14
5 24 19.91 2.23 22.14
6 21 22.51 2.38 24.89
7 31 24.11 2.07 26.18
8 28 27.14 2.45 29.59
9 36 29.28 2.32 31.60
10 32.48 2.68 35.16

Table 4.1
© 2008 Prentice Hall, Inc. 4 – 70
 Exponential Smoothing with
Trend Adjustment Example
35 –
Actual demand (At)
30 –
Product demand

25 –

20 –

15 –

10 –
Forecast including trend (FITt)
with α = .2 and β = .4
5 –

0 – | | | | | | | | |
1 2 3 4 5 6 7 8 9
Figure 4.3
Time (month)
© 2008 Prentice Hall, Inc. 4 – 71
 Trend Projections
Fitting a trend line to historical data points
to project into the medium to long-range
Linear trends can be found using the least
squares technique

y^ = a + bx
^ where y = computed value of
the variable to be predicted
(dependent variable)
a = y-axis intercept
b = slope of the regression line
© 2008 Prentice Hall, Inc. x = the independent variable 4 – 72
 Values of Dependent Variable
Least Squares Method

Actual observation Deviation7

(y value)

Deviation5 Deviation6

Deviation3 Least squares method

minimizes the sum of the
Deviation
squared errors (deviations)
4

Deviation1
Deviation2
Trend line, y^ = a + bx

Time period Figure 4.4

© 2008 Prentice Hall, Inc. 4 – 74
 Least Squares Method
Equations to calculate the regression variables

y^ = a + bx

Σ xy - nxy
b=
Σ x2 - nx2

a = y - bx

© 2008 Prentice Hall, Inc. 4 – 75

 Least Squares Example
Time Electrical Power
Year Period (x) Demand x2 xy
2001 1 74 1 74
2002 2 79 4 158
2003 3 80 9 240
2004 4 90 16 360
2005 5 105 25 525
2005 6 142 36 852
2007 7 122 49 854
∑x = 28 ∑y = 692 ∑x2 = 140 ∑xy = 3,063
x=4 y = 98.86

∑xy - nxy 3,063 - (7)(4)(98.86)

b= = = 10.54
∑x - nx
2 2 140 - (7)(4 )
2

a = y - bx = 98.86 - 10.54(4) = 56.70

© 2008 Prentice Hall, Inc. 4 – 76
 Least Squares Example
Time Electrical Power
Year Period (x) Demand x2 xy
1999 1 74 1 74
2000 2 79 4 158
2001The trend3 line is 80 9 240
2002 4 90 16 360
2003 y^ 5= 56.70 + 10.54x
105 25 525
2004 6 142 36 852
2005 7 122 49 854
Σ x = 28 Σ y = 692 Σ x2 = 140 Σ xy = 3,063
x=4 y = 98.86

Σ xy - nxy 3,063 - (7)(4)(98.86)

b= = = 10.54
Σ x - nx
2 2 140 - (7)(4 )
2

a = y - bx = 98.86 - 10.54(4) = 56.70

© 2008 Prentice Hall, Inc. 4 – 77
 Least Squares Example
Trend line,
160 –
150 –
y^ = 56.70 + 10.54x
140 –
Power demand

130 –
120 –
110 –
100 –
90 –
80 –
70 –
60 –
50 –
| | | | | | | | |
2001 2002 2003 2004 2005 2006 2007 2008 2009
Year
© 2008 Prentice Hall, Inc. 4 – 78
 Seasonal Variations In Data
Steps in the process:
1. Find average historical demand for each
season
2. Compute the average demand over all
seasons
3. Compute a seasonal index for each season
4. Estimate next year’s total demand
5. Divide this estimate of total demand by the
number of seasons, then multiply it by the
seasonal index for that season

© 2008 Prentice Hall, Inc. 4 – 81

 Seasonal Index Example
Demand Average Average Seasonal
Month 2005 2006 2007 2005-2007 Monthly Index
Jan 80 85 105 90 94
Feb 70 85 85 80 94
Mar 80 93 82 85 94
Apr 90 95 115 100 94
May 113 125 131 123 94
Jun 110 115 120 115 94
Jul 100 102 113 105 94
Aug 88 102 110 100 94
Sept 85 90 95 90 94
Oct 77 78 85 80 94
Nov 75 72 83 80 94
Dec 82 78 80 80 94
© 2008 Prentice Hall, Inc. 4 – 82
 Seasonal Index Example
Demand Average Average Seasonal
Month 2005 2006 2007 2005-2007 Monthly Index
Jan 80 85 105 90 94 0.957
Feb 70 85 85 80 94
Mar 80 93 average
82 85 monthly demand
2005-2007 94
Seasonal90index95= 115
Apr 100 94
average monthly demand
May 113 125 131 123 94
= 90/94 = .957
Jun 110 115 120 115 94
Jul 100 102 113 105 94
Aug 88 102 110 100 94
Sept 85 90 95 90 94
Oct 77 78 85 80 94
Nov 75 72 83 80 94
Dec 82 78 80 80 94
© 2008 Prentice Hall, Inc. 4 – 83
 Seasonal Index Example
Demand Average Average Seasonal
Month 2005 2006 2007 2005-2007 Monthly Index
Jan 80 85 105 90 94 0.957
Feb 70 85 85 80 94 0.851
Mar 80 93 82 85 94 0.904
Apr 90 95 115 100 94 1.064
May 113 125 131 123 94 1.309
Jun 110 115 120 115 94 1.223
Jul 100 102 113 105 94 1.117
Aug 88 102 110 100 94 1.064
Sept 85 90 95 90 94 0.957
Oct 77 78 85 80 94 0.851
Nov 75 72 83 80 94 0.851
Dec 82 78 80 80 94 0.851
© 2008 Prentice Hall, Inc. 4 – 84
 Seasonal Index Example
Demand Average Average Seasonal
Month 2005 2006 2007 2005-2007 Monthly Index
Jan 80 85 105 90 94 0.957
Feb 70 85 Forecast
85 for802008 94 0.851
Mar 80 93 82 85 94 0.904
Apr 90Expected
95 115annual demand
100 = 1,200
94 1.064
May 113 125 131 123 94 1.309
Jun 110 115 120 1,200 115 94 1.223
Jul
Jan
100 102 113 12
x .957 = 96 94
105 1.117
Aug 88 102 110 100 94 1.064
1,200
Sept 85 Feb
90 95 x90.851 = 85 94 0.957
Oct 77 78 85 12 80 94 0.851
Nov 75 72 83 80 94 0.851
Dec 82 78 80 80 94 0.851
© 2008 Prentice Hall, Inc. 4 – 85
 Seasonal Index Example
2008 Forecast
140 – 2007 Demand
130 – 2006 Demand
2005 Demand
120 –
Demand

110 –
100 –
90 –
80 –
70 –
| | | | | | | | | | | |
J F M A M J J A S O N D
Time
© 2008 Prentice Hall, Inc. 4 – 86
 Associative Forecasting
Used when changes in one or more
independent variables can be used to predict
the changes in the dependent variable

Most common technique is linear

regression analysis

We apply this technique just as we did

in the time series example

© 2008 Prentice Hall, Inc. 4 – 90

 Associative Forecasting
Forecasting an outcome based on predictor
variables using the least squares technique

y^ = a + bx
^ where y = computed value of
the variable to be predicted
(dependent variable)
a = y-axis intercept
b = slope of the regression line
x = the independent variable
though to predict the value of the
dependent variable
© 2008 Prentice Hall, Inc. 4 – 91
 Associative Forecasting
Example
Sales Local Payroll
($ millions), y ($ billions), x
2.0 1
3.0 3
2.5 4 4.0 –
2.0 2
2.0 1 3.0 –
3.5 7 Sales
2.0 –

1.0 –

| | | | | | |
0 1 2 3 4 5 6 7
Area payroll

© 2008 Prentice Hall, Inc. 4 – 92

 Associative Forecasting
Example
Sales, y Payroll, x x2 xy
2.0 1 1 2.0
3.0 3 9 9.0
2.5 4 16 10.0
2.0 2 4 4.0
2.0 1 1 2.0
3.5 7 49 24.5
∑y = 15.0 ∑x = 18 ∑x2 = 80 ∑xy = 51.5

∑xy - nxy 51.5 - (6)(3)(2.5)

x = ∑x/6 = 18/6 = 3 b= = = .25
∑x - nx
2 2 80 - (6)(32)

y = ∑y/6 = 15/6 = 2.5 a = y - bx = 2.5 - (.25)(3) = 1.75

© 2008 Prentice Hall, Inc. 4 – 93

 Associative Forecasting
Example
y^ = 1.75 + .25x Sales = 1.75 + .25(payroll)

If payroll next year

4.0 –
is estimated to be
$6 billion, then: 3.25
3.0 –
Sales
2.0 –
Sales = 1.75 + .25(6) 1.0 –
Sales = $3,250,000
| | | | | | |
0 1 2 3 4 5 6 7
Area payroll
© 2008 Prentice Hall, Inc. 4 – 94
 Correlation
 How strong is the linear
relationship between the
variables?
 Correlation does not necessarily
imply causality!
 Coefficient of correlation, r,
measures degree of association
 Values range from -1 to +1

© 2008 Prentice Hall, Inc. 4 – 99

 y
Correlation Coefficient y

nΣ xy - Σ xΣ y
r=
[
(a) Perfect positivenΣx x 2
- ( Σ x )2
][n Σ y Σ
(b) Positive ]
2
- ( y ) 2
x
correlation: correlation:
r = +1 0<r<1

y y

(c) No correlation: x (d) Perfect negative x

r=0 correlation:
r = -1
© 2008 Prentice Hall, Inc. 4 – 101
 Correlation
 Coefficient of Determination, r2,
measures the percent of change in
y predicted by the change in x
 Values range from 0 to 1
 Easy to interpret

For the Nodel Construction example:

r = .901
r2 = .81
© 2008 Prentice Hall, Inc. 4 – 102