3-1 Forecasting

Forecasting

Operations Management, Eighth Edition, by William J. Stevenson

McGraw-Hill/Irwin Copyright © 2005 by The McGraw-Hill Companies, Inc. All rights reserved.
 3-2 Forecasting

FORECAST
• A statement about the future value of a variable of interest
such as demand.
• Forecasts affect decisions and activities throughout an
organization
• Accounting, finance
• Human resources
• Marketing
• MIS
• Operations
• Product / service design
3-3 Forecasting

Uses of Forecasts

Accounting Cost/profit estimates

Finance Cash flow and funding

Human Resources Hiring/recruiting/training

Marketing Pricing, promotion, strategy

MIS IT/IS systems, services

Operations Schedules, MRP, workloads

Product/service design New products and services

3-4 Forecasting

FORECAST
• Assumes causal system, past ==> future
• Forecasts rarely perfect because of randomness
• Forecasts more accurate for groups vs. individuals
• Forecast accuracy decreases I see that you will
as time horizon increases get an A this semester.
3-5 Forecasting

Elements of a Good Forecast

Timely

Reliable Accurate

Written
 3-6 Forecasting

Elements of a Good Forecast

• Timely: Usually, a certain amount of time is needed to respond to the
information contained in a forecast.
• Accurate: Degree of accuracy should be stated. This will enable users to
plan for possible errors and will provide a basis for comparing alternative
forecasts.
• Reliable: It should work consistently.
• Meaningful: Production planners need to know how many units will be
needed and schedulers need to know what machines and skills will be
required. The choice of units depends on user needs.
• Written: A written forecast will permit an objective basis for evaluating the
forecast once actual results are in.
• Ease of use: The forecasting technique should be simple to understand and
use.
3-7 Forecasting

Steps in the Forecasting Process

“The forecast”

Step 6 Monitor the forecast

Step 5 Prepare 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
3-8 Forecasting

Types of Forecasts

1. Judgmental - uses subjective inputs

2. Time series - uses historical data assuming the
future will be like the past
3. Associative models - uses explanatory variables to
predict the future
3-9 Forecasting

1. Judgmental Forecasts

• Executive opinions
• Sales force opinions
• Consumer surveys
• Outside opinion
• Delphi method
• Opinions of managers and staff
• Achieves a consensus forecast
3-10 Forecasting

2. Time Series Forecasts

• Trend - Long-term movement in data, e.g. demand
of IPS
• Seasonality - Short-term regular variations in data,
e.g. demand of winter cloths
• Cycle – Wavelike variations of more than one
year’s duration, e.g., demand of T.V. due to World
Cup
• Irregular variations - Caused by unusual
circumstances, e.g. demand of bread due to
earthquake
• Random variations - Caused by chance
3-11 Forecasting

Forecast Variations

Irregular
variatio
n
Trend

Cycles

90
89
88
Seasonal variations
3-12 Forecasting

3. Associative Forecasting

• Predictor variables - used to predict values of

variable interest
• Regression - technique for fitting a line to a set of
points
• Least squares line - minimizes sum of squared
deviations around the line
3-13 Forecasting

Naive Forecasts

Uh, give me a minute....

We sold 250 wheels last
week.... Now, next week
we should sell....

The forecast for any period equals

the previous period’s actual value.
3-14 Forecasting

Naïve Forecasts

• Simple to use
• Virtually no cost

• Quick and easy to prepare

• Data analysis is nonexistent

• Easily understandable

• Cannot provide high accuracy

• Can be a standard for accuracy

3-15 Forecasting

Techniques for Averaging

Averaging techniques smooth variations in the data.

This techniques generate forecasts that reflect
recent values of a time series (e.g. the average
value over the last several periods).
a. Moving average
b. Weighted moving average
c. Exponential smoothing
 3-16 Forecasting

Moving Averages
• Moving Average – A technique that averages a number of
recent actual values, updated as new values become
n
available.
∑ Di
MAn = i=1

n
[n = number of periods in the moving average, Di = Demand in Period i]
Weighted Moving Average – More recent values in a series
are given more weight in computing the forecast. [Wi = the
weight for period i, between 0 and 100 percent, ∑Wi = 1.00]

WMAn= ∑ WiDi
i=1
 3-17 Forecasting

Example – Moving Average

Month Orders Weight
January 120
February 90
March 100 0.2
April 75 0.3
May 110 0.5
Compute the forecast of orders for June
3-month moving average, MA3 = (110+75+100)/3 = 95
5-month moving average, MA5 = (110+75+100+90+120)/5 = 99
3-month Weighted Moving Average, WMA3 = (110*0.5 + 75*0.3 +
100*0.2) = 97.5
 3-18 Forecasting

Exponential Smoothing
• Exponential smoothing is a sophisticated weighted
averaging method that is still relatively easy to use
and understand.
• The most recent observations might have the highest predictive value.
• Therefore, we should give more weight to the more recent time
periods when forecasting.

Ft = Ft-1 + α(At-1 - Ft-1)

Ft = Forecast for period t
Ft-1 = Forecast for the previous period
A t-1 = Actual demand for the previous period
α = Smoothing Constant, it represents a percentage of the forecast
error
3-19 Forecasting

Exponential Smoothing

Ft = Ft-1 + α(At-1 - Ft-1)

Ft = Forecast for period t
Ft-1 = Forecast for the previous period
A t-1 = Actual demand for the previous period
α = Smoothing Constant, it represents a percentage of the
forecast error

• Weighted averaging method based on previous

forecast plus a percentage of the forecast error
• A-F is the error term, α is the % feedback
3-20 Forecasting

Example - Exponential Smoothing

Alpha = 0.1 Alpha = 0.4
Period Actual Forecast Error Forecast Error
1 42
2 40 42 -2.00 42 -2
3 43 41.8 1.20 41.2 1.8
4 40 41.92 -1.92 41.92 -1.92
5 41 41.73 -0.73 41.15 -0.15
6 39 41.66 -2.66 41.09 -2.09
7 46 41.39 4.61 40.25 5.75
8 44 41.85 2.15 42.55 1.45
9 45 42.07 2.93 43.13 1.87
10 38 42.36 -4.36 43.88 -5.88

(Alpha = 0.1) F3= F2 + 0.1(A2 – F2) = 42 + 0.1 (40-42) = 41.8

(Alpha = 0.4) F3 = F2 + 0.4 (A2 – F2) = 42 + 0.4 (40-42) = 41.2
(Alpha = 0.1) F5 = F4 + 0.1 (A4 – F4) = 41.92 + 0.1 (40-41.92) = 41.73
(Alpha = 0.4) F5 = F4 + 0.4 (A4 – F4) = 41.92 + 0.4 (40-41.92) = 41.15
3-21 Forecasting

Techniques for Trend

• Analysis of trend involves developing an equation
that will suitably describe trend.
• The trend component may be linear or it may not.
3-22 Forecasting

Common Nonlinear Trends

Parabolic

Exponential

Growth
3-23 Forecasting

Linear Trend Equation

Ft

Ft = a + bt

• Ft = Forecast for period t 0 1 2 3 4 5 t

• t = Specified number of time periods

• a = Value of Ft at t = 0
• b = Slope of the line
• y = a + bt
3-24 Forecasting

Calculating a and b

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

∑ y - b∑ t
a =
n
3-25 Forecasting

Linear Trend Equation Example

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

Σ t = 15 Σ t2 = 55 Σ y = 812 Σ ty = 2499
(Σ t)2 = 225
3-26 Forecasting

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
3-27 Forecasting

Forecast Accuracy

• Error - difference between actual value and predicted value

• Mean Absolute Deviation (MAD)
• Average absolute error
• Mean Squared Error (MSE)
• Average of squared error
• Mean Absolute Percent Error (MAPE)
• Average absolute percent error
3-28 Forecasting

MAD, MSE, and MAPE

∑ Actual − forecast
MAD =
n
2
∑ ( Actual − forecast)
MSE =
n -1

∑( Actual − forecast / Actual*100)

MAPE =
n
3-29 Forecasting

Example
Period Actual Forecast (A-F) |A-F| (A-F)^2 (|A-F|/Actual)*100
1 217 215 2 2 4 0.92
2 213 216 -3 3 9 1.41
3 216 215 1 1 1 0.46
4 210 214 -4 4 16 1.90
5 213 211 2 2 4 0.94
6 219 214 5 5 25 2.28
7 216 217 -1 1 1 0.46
8 212 216 -4 4 16 1.89
-2 22 76 10.26

MAD= 2.75
MSE= 10.86
MAPE= 1.28

MAD = 22/8 = 2.75

MSE = 76/ (8-1) = 10.86
MAPE = 10.26/8 = 1.28