Forecasting

11-1

Learning Objectives
Be able to:
Discuss the importance of forecasting and identify the most
appropriate type of forecasting approach, given different
forecasting situations.
Understand the role of forecasting for both an enterprise and
a supply chain.
Identify the components of a demand forecast.
Forecast demand in a supply chain given historical demand
data using time-series methodologies.
Calculate measures of forecasting accuracy and interpret
the results.

11-2

Forecasting
Forecast – An estimate of the future level of some
variable (here we focus on demand).
From “License to Wed”

“Forecasting is like driving a car

blindfolded
with help from someone looking
out of the rear window”
Anonymous

“It is far better to foresee even without certainty than not to

foresee at all”
Henry Poincare 11-3
 Forecasting

 Why Forecast?
 Important because many other business decisions
are based on forecast of the future
 How does having a good idea about next month’s
demand help you?

 How does it relate to capacity management?

– First step in many capacity management problems

11-4

Role of Forecasting in a Supply Chain

• The basis for all strategic and planning decisions

in a supply chain
• Used for both push and pull processes
• Examples:
– Production: MRP, workloads, scheduling, inventory,
capacity management
– Finance: plant/equipment investment, budgetary
planning
– Human resources: workforce planning, hiring, layoffs
• All of these decisions are interrelated
11-5

Uses of Forecasts

Accounting Cost/profit estimates

Finance Cash flow and funding

Human Resources Hiring/recruiting/training

Sales / Marketing Pricing, promotion, strategy, sales

force allocation, new production
introduction
MIS IT/IS systems, services

Operations Schedules, MRP, workloads

Product/service design New products and services

11-6
 Demand Management & Forecasting

• How do firms manage demand?

– The purpose of demand management is to coordinate
and control all sources of demand to better match it
with supply.
• Demand comes from mainly two sources:
– Independent demand: the demand for a product or
service that cannot be derived directly from that of other
products
– Dependent demand: the demand for a product or
service caused by the demand for other products or
services
• How could a Ford auto plant forecast its total tire requirement
in 2020?
– Ask dealers? Consumer surveys? Auto sales forecasts?
• Forecasts are no substitutes for calculated values
11-7

Supply-Demand Balancing Methods

• Some combinations of supply-demand balancing

methods are used, depending on
– the nature of the product, the cost of stocking out, and the
organization’s ability to properly forecast customer demand

11-8

Characteristics (Laws) of Forecasting

1. Forecasts are always wrong.
– Are there perfect forecasts?
• No, but even close estimates are useful

2. Long-term forecasts are less accurate than short-term

forecasts (forecast horizon is important)
– Forecasts for the near term tend to be more accurate
– Change is often gradual
– Price of gas in next month vs. Oct 2033?
3. Aggregate forecasts (forecasts for a group of products or
services) are more accurate than disaggregate forecasts
– next year’s total chair sales vs. light blue chair sales?
4. Forecasts are no substitutes for calculated values
– Buyers forecasting raw materials requirements rather than asking
operations about next week’s production plan!

11-9
 Basic Approach to Demand Forecasting

• Understand the objectives of forecasting

• Integrate demand planning and forecasting
• Identify major factors that influence the demand
forecast
• Understand and identify customer segments
• Determine the appropriate forecasting technique
• Establish performance and error measures for
the forecast

11-10

Forecasting
Types of Forecasts
1. Qualitative: Based on judgment, intuition or informed
opinion
• Preferred when limited or no data available
• Relationship between past and future events difficult to model
quantitatively
Market surveys, Panel consensus forecasting, Delphi method,
Life cycle analogy, build-up forecasting, sales force composite, jury
of executive opinion…
2. Quantitative: Use measurable data to generate forecasts
a. Time series analysis: Future level of a variable is seen as a
function of time
b. Causal relationships: Future level of a variable is seen as a
function of factors other than time
a. Biomarkers (Nature Communications)
11-11

Selecting a Forecasting Method

11-12
 Qualitative Forecasting Methods

• Jury of executive opinion—combining and averaging

the outlooks of top executives.
• Delphi technique—soliciting opinions from several
people and gathering input from outside experts.
• Sales force composite—forecasting based on internal
insights (sales agents in territories) concerning short-
term future sales.
• Survey of buyer intentions — gathering input to
determine the purchasing intentions of a representative
group of present and potential customers.
11-13

Life cycle analogy

• The technique is based on the fact that many products
have well-defined life cycle stages
• (Growth, Maturity, and Decline)

• How long will each life cycle

stage last? What are we basing
this on? (opinion, survey, etc.)
• In general, will demand levels be
higher or lower? What are we
basing this on? (opinion, survey,
etc.)
• Key point: Using life cycle data
from a similar product provides a
starting point and helps us focus
on the right questions
http://scm.ncsu.edu/scm-articles/article/qualitative-methods-measuring-forecast-accuracy-a-tutorial

11-14

Using Expert Judgment

Many important forecasts are not based on formal models.

For example, during the high-interest-rate period of 1980 and 1981, the
most influential forecasters of interest rates were Henry Kaufman of
Salomon Brothers and Albert Wojnilower of First Boston.

These gentlemen combined relevant factors such as the money supply

and unemployment, as well as results from quantitative models, in their
own intuitive way to produce forecasts that had widespread credibility
and impact on the financial community.

11-15
 The consensus panel
Bring the experts together in a room and let them discuss
an event until a consensus emerges.
However, due to group dynamics, one person with a
strong personality can have an enormous effect on the
forecast.

11-16

The Delphi Method

• Obtaining a combined forecast from a group of experts.

• Developed by the Rand Corporation to retain the strength of a joint

forecast, while removing the effects of group dynamics (as in panel
consensus).

• Iterative group process allows experts to make forecasts without

meeting face-to-face

• Participants are typically 5-10 experts who make the forecast

• Staff personnel assist by preparing, distributing, collecting, and

summarizing a series of questionnaires and survey results

• After three or four passes through this process, a consensus

forecast typically emerges.
11-17

Grassroots Forecasting
Asking those who are close to the eventual consumer, such
as salespeople, about what they are going to sell next
period, and added the forecasts to predict total demand.

• Requires an experienced stable work force that knows

the customer base. Not good at retail!
• Can be expensive. Takes sales people away from sales
effort. Results can be biased.

Forecasts may be adjusted on the basis of the historical

correlation between the salesperson’s forecasts and the
actual sales.

11-18
Consulting Customers (Market Research)

• Market research is a large and important topic which includes a

variety of techniques
• Consumer panels
• Consumer surveys
• Test marketing, etc.

• Goal: To make forecasts about the size/structure of the market for

specific goods and/or services.

• Forecasts are usually based on small samples and are qualitative

in the sense that the original data typically consist of subjective
evaluations of consumers.

• Important activity in most consumer product firms.

11-19

Discussion

• A large recording company wants to predict CD

sales for a new recording artist
• What kind(s) of forecasting might be used
– Life cycle analogy: Draw comparisons to similar
artists
– Market survey: Test the CD with focus groups
• Depend more on their opinion than hard data?

11-20

Quantitative Forecasting Methods

A. Time Series Analysis: Based on the idea

that data relating to past demand can be
used to predict future demand.
1. Moving Average
2. Weighted Moving Average
3. Exponential Smoothing
4. Linear Regression
5. Causal Relationship Forecasting

11-21
 Time Series Forecasting Process
Look at the data Forecast using one or Evaluate the technique
(Scatter Plot) more techniques and pick the best one.

Observations from the

Techniques to try Ways to evaluate
scatter Plot

 CFE (BIAS)
Heuristics - Averaging methods
Data is reasonably  MAD
 Naive
stationary  MAPE
 Moving Averages
(no trend or seasonality)  MSE
 Simple Exponential Smoothing
 Tracking signal
 CFE (BIAS)
Regression MAD
Data shows a consistent  Linear  MAPE
trend  Non-linear Regressions (not  MSE
covered in this course)  Tracking signal
 R-Squared
 CFE (BIAS)
Classical decomposition MAD
Data shows both a trend and  Find Seasonal Index  MAPE
a seasonal pattern  Use regression analyses to find  MSE
the trend component  Tracking signal
 R-Squared 11-22

Components of Demand

1. Trend  Gradual increase or decrease in demand over time for an

organization, long term movement up or down
2. Seasonal element Repeated patterns of spikes and drops in
certain times of the year
3. Random fluctuation  A development that cannot be anticipated
and is usually the cause to hold safety stocks to avoid stockouts.

11-23

Time Series Components

Trend
Demand

Random
movement

Time

Seasonal Trend with

pattern seasonal pattern

Time Time 11-24

Quantitative Forecasting Methods
0. Naïve Model – (last period model)

• The simplest time series forecasting model

• Idea: “what happened last time (last year, last
month, yesterday) will happen again this time”
• Naïve Model:
– Algebraic: Ft = Yt-1
• Yt-1 : actual value in period t-1
• Ft : forecast for period t

Excel: Select previous period, Copy down

11-25

Quantitative Forecasting Methods

1. Moving Average Model

 Moving Average Model – forecast by taking an

average of recent demand value.
n

D t 1i
Ft 1  i 1
n

11-26

Moving Average Model

Period Demand
1 12 n
2 15  Dt 1i
3 11 Ft 1  i 1
4
5
9
10
n
6 9
7 14 3-period moving average
forecast for Period 8:
8 ?
= (14 + 9 + 10) / 3
= 11

11-27
 Moving Average

• Useful when demand is neither growing nor

declining rapidly and does not have seasonal
characteristics
• Important to select the best ”n”
– Longer gives more smoothing
– Shorter reacts quicker to trends: fashion products?
– Example: Samsung uses past years sales to
forecast 2020
• Best n?
• 10?

11-28

Exercise: Moving average

Week Sales Forecast- Moving Forecast –

Average Moving Average
( 3 weeks) (4 weeks)
1 5
2 8
3 8
4 11
5 15
6 10
7 ??? ???

Excel: Use average function, copy down

11-29

2. Weighted Moving Average Model

• Weighted Moving Average Model – A form of

the moving average model that allows the actual
weights applied to past observations to differ.

11-30
 Weighted Moving Average

• The moving average formula implies an equal

weight being placed on each value that is
being averaged
• The weighted moving average permits an
unequal weighting on prior time periods
– All the weights must sum up to one

11-31

Weighted Moving Average Model

(weights: 0.5 (most recent), 0.3, 0.2)
Period Demand
1 12
2 15
3 11
4 9
5 10
6 9
7 14
3-period weighted moving
8 ? average forecast for Period 8

F(8) = (0.5  14) + (0.3  9) + (0.2  10)

= 11.7
11-32

Ex. Weighted average

(weights: 0.4 (most recent), 0.3, 0.2, 0.1)
Month Demand Compute a weighted average forecast using a
weight of 0.4 for the most recent period, 0.3 for
1 42 the next most recent, 0.2 for the next and 0.1
for the next.
2 40
3 43 Continuing with the data on the left
F(6) =0.40(41)+0.30(40)+0.20(43)+0.10(40)=?
4 40
5 41 The weighted average is more reflective of the
most recent occurrences.
6 ?

Excel: Use $ sign in weights while multiplying demand with weights

11-33
 Choosing Weights

• Experience and trial-and-error are the simplest

ways
• Generally, the most recent past is the best
indicator

11-34

3. Exponential Smoothing Model

 Exponential Smoothing Model – A form of the
moving average model in which the forecast for
the next period is calculated as the weighted
average of the current period’s actual value and
forecast.

11-35

Exponential Smoothing

• Concept is simple!
– Make a forecast, any forecast
• Rule of thumb: Use the historical average
– Compare it to the actual
– Next forecast is
• Previous forecast plus an adjustment
– Essentially
• Not really forecast as a function of time
• Instead, forecast as a function of previous actual and
forecasted value

11-36
 Exponential Smoothing (cont.)

• Most used of all forecasting techniques

• Integral part of all computerized forecasting
programs
• Widely accepted because…
1. Exponential models are surprisingly accurate
2. Formulating an exponential model is relatively easy
3. The user can understand how the model works
4. Little computation is required to use the model
5. Computer storage requirements are small (little record
keeping)

11-37

Exponential Smoothing (cont.)

– Larger , more responsive forecast;

Smaller , smoother forecast

– “best”  can be found by Solver

– Suitable for relatively stable time series

11-38

Exponential Smoothing Model

 = .3
Period Demand Forecast
1 50 40

2 46 .3 * 50 + (1-.3) * 40 = 43

3 52 .3 * 46 + (1-.3) * 43 = 43.9

4 48 .3 * 52 + (1-.3) * 43.9 = 46.33

5 47 .3 * 48 + (1-.3) * 46.33 = 46.83

6 .3 * 47 + (1-.3) * 46.83 = 46.88

11-39
 Exponential Smoothing Model
 = .2
Period Demand Forecast
1 50 40

2 46 ?

3 52 ?

4 48 ?

5 47 ?

6 ?

Excel: Use $ sign in alfa cell.

11-40

Forecast Accuracy

How do we know:
• If a forecast model is “best”?
• If a forecast model is still working?
• What types of errors a particular forecasting
model is prone to make?

Need measures of forecast accuracy

11-41

Measures of Forecast Accuracy

• Forecast Error: The difference between the actual value and the
forecast value (Error = Actual – Forecast)
• Measures of error
– Cumulative sum of forecast errors (CFE): Total forecast error,
sum of both negative and positive errors
– Mean of forecast errors (MFE): Mean forecast error, average of
both negative and positive errors
– Mean absolute deviation (MAD): Average absolute error
(weights all errors evenly)
– Mean absolute percent error (MAPE)
– Mean Squared Error (MSE) : Average of squared error (negative
and positive errors do not cancel each other out)
– Tracking signal (TS): Used to measure forecast error, especially
good at identifying if a “bias” exists in the forecast errors.
(BIAS=CFE/ MAD)
11-42
 Mean Absolute Deviation (MAD)

• The larger the MAD (Mean Absolute

Deviation), the less the accurate the
resulting model

MAPE = MAD / Average Demand

Divide the MAD by Average Actual Demand and you get the MAPE (Mean
Absolute Percent Error)
PS: Other formulations exist. Results won’t change.

11-43

Exercise: MAD and MAPE

Week Demand Forecast Absolute Deviation

1 820 820 0
2 775 820 45
3 680 811 131
4 655 785 130

Mean Absolute Deviation (MAD) = (130 + 131 + 45 + 0) /4 = 76.5

Mean demand : (820+775+680+655)/4 = 732.5
Mean Absolute Percentage Error (MAPE) = 76.5 / 732.5 = 10.44 %

11-44

Use for MAD & MAPE & MSE

• Compare the accuracy of alternative
– forecasting methods using MAD, MAPE and MSE.
– parameter (such as alpha) values used in
forecasting by using MAD, MAPE and MSE
• Determine which method yields the lowest
MAD/MAPE or MSE for a given set of data.

11-45
 Forecast BIAS and Tracking Signal
• Forecast BIAS is described as a tendency to either
– over-forecast (the forecast is more than the actual), or
– under-forecast (the forecast is less than the actual).
• BIAS = Forecast – Actual Demand
– If the forecast is greater than actual demand than the bias is positive (indicates over-
forecast).
– The inverse, of course, results in a negative bias (indicates under-forecast).

• Tracking Signal: CFE/ MAD

– Can be used as a quality control chart indicating when the model is
generating too much error in its forecasts.
– Rule of thumb: As long as TS is between –3 MAD and +3 MAD for all
periods, we can assume that the model is acceptable. To find this number
calculate TS for each period.
• TS = Running CFE/ MAD
A forecasting process with a bias will eventually get off-rails unless steps are taken to
correct the course from time to time. A better course of action is to measure and then
correct for the bias routinely. This is irrespective of which formula one decides to 11-46
use.

Controlling the quality of forecast

• Necessary to monitor forecast to ensure that the

forecast is performing adequately
• This is accomplished by comparing forecast errors
to predetermined values
• Errors that fall within the limits are considered
acceptable
• Errors outside either limit indicates that corrective
action is needed.

11-47

Choosing a forecasting technique (cont.)

• Moving Averages and Exponential

Smoothing are short range techniques.
They produce forecast for the next period

• Trend equations are used for much longer

time horizons.

• More than one forecasting techniques might

be used to increase confidence.
11-48
 Supplemental readings and videos

READ
• Weather Channel Now Also Forecasts What You’ll Buy (WSJ, August 13, 2013)
http://online.wsj.com/news/articles/SB10001424127887323639704579012674092402660
• Predicting oil prices and Google https://www.linkedin.com/pulse/google-acquire-logistics---2015-
adrian?trk=tod-home-art-list-small_1
• What is demand forecasting and how can it help your business?
https://www.tradegecko.com/blog/what-is-demand-forecasting-and-how-can-it-help-your-business
• Zara supply chain analysis - the secret behind Zara's retail success
https://www.tradegecko.com/blog/zara-supply-chain-its-secret-to-retail-success

WATCH
• Moving Average Forecast in Excel https://www.youtube.com/watch?v=f9qprdj1Er8
• Forecasting with Exponential Smoothing https://www.youtube.com/watch?v=aCIbhYTSxys
• Creating an Exponential Forecast in Excel, Including Error Statistics
https://www.youtube.com/watch?v=uHy5tG1Rdvg
• Watch to learn more about tracking signal https://www.youtube.com/watch?v=vNz0KL1oYBo

11-49

Conclusion

• Forecasting reduces uncertainty

• Qualitative tools might be more helpful when
there is no historical data

11-50