Chapter Two

Forecasting

 Meaning and use of forecasting

 Forecasting techniques
A forecast is a prediction of what will occur in the
future.
o Meteorologists ---weather,
o sportscasters--- the winners of football games, and
o companies---how much of their product will be
sold in the future.
Forecasting is an uncertain process.
Management hopes to forecast demand with as much
accuracy as possible,
o which is becoming increasingly difficult to do.
 Difficulties raise due to:
consumers have more product choices and more
information
demand receive greater product diversity, made
possible by rapid technological advances
• Consumers and markets have never been stationary
targets, but they are moving more rapidly now than they
ever have before.
??
 STRATEGIC ROLE OF FORECASTING IN SCM
 Today’s global business environment focus on SCM & QM
 Supply chain management(SCM)
 encompasses all of the facilities, functions, and activities
involved in producing a product or service from suppliers
(and their suppliers) to customers (and their customers).
 Supply chain functions include purchasing, inventory,
production, scheduling, facility location, transportation, and
distribution.
Fig. The Effect of Inaccurate Forecasting on the Supply Chain
 Importance of Forecasting in OM

Departments throughout the organization depend on forecasts

to formulate and execute their plans.

Finance needs forecasts to project cash flows and capital

requirements.

Human resources need forecasts to anticipate hiring needs.

Production needs forecasts to plan production levels, workforce,

material requirements, inventories, etc.
Importance of Forecasting in OM

Demand is not the only variable of interest to forecasters.

Manufacturers also forecast worker absenteeism, machine

availability, material costs, transportation and production
lead times, etc.

Besides demand, service providers are also interested in

forecasts of population, of other demographic variables,
of weather, etc.
Forecasting Time Horizons
 Short-range forecast
 Usually < 3 months Quantitative
methods
 Up to 1 year
E.g. Job scheduling, worker assignments
Detailed
 Medium-range forecast use of
system
 3 months to 3 years
 Sales/production planning, budgeting
 Long-range forecast
 > 3 years
Design
 New product planning, facility location, of system
Qualitative
research and development Methods
Medium/long range forecasts deal with more
comprehensive issues and support management
decisions regarding planning and products, plants
and processes
Short-term forecasting usually employs different
methodologies than longer-term forecasting
Short-term forecasts tend to be more accurate
than longer-term forecasts
 Influence of Product Life Cycle

Introduction – Growth – Maturity – Decline

 Introduction and growth require longer forecasts than

maturity and decline
 As product passes through life cycle, forecasts are
useful in projecting
 Staffing levels
 Inventory levels
 Factory capacity
Product Life Cycle
Introduction Growth Maturity Decline
Best period to Practical to change Poor time to change Cost control
Company Strategy/Issues

increase market price or quality image, price, or critical

share image quality
Competitive costs
R&D engineering is Strengthen niche become critical
critical Defend market
position

Figure
Product Life Cycle
Introduction Growth Maturity Decline
Product design and Forecasting critical Standardization Little product
development critical Product and process Less rapid product differentiation
Frequent product reliability changes – more Cost
and process design minor changes minimization
OM Strategy/Issues

Competitive product
changes improvements and Optimum capacity Overcapacity in
Short production options Increasing stability the industry
runs Increase capacity of process Prune line to
High production Shift toward product Long production eliminate items
costs focus runs not returning
Limited models good margin
Enhance distribution Product
Attention to quality improvement and Reduce capacity
cost cutting

Figure
 Forecasting Methods

Quantitative Qualitative
Methods Methods

- Time series analysis - Executive judgment

- Regression analysis - Market research
-Survey of sales force
-Delphi method
Qualitative forecasting methods:
Used when situation is vague and little data exist
 New products
 New technology
 Involves intuition, judgment, opinion, past
experience, or best guesses, to make forecasts.
 Qualitative Methods

Executive Judgment: Opinion of a group of high level

experts or managers is pooled
Sales Force Composite: Each regional salesperson provides
his/her sales estimates. Those forecasts are then reviewed to
make sure they are realistic. All regional forecasts are then
pooled at the district and national levels to obtain an overall
forecast.
Market Research/Survey: Solicits input from customers
pertaining to their future purchasing plans. It involves the use
of questionnaires, consumer panels and tests of new products
and services..
Qualitative Methods …con’d
Delphi Method: As opposed to regular panels where the
individuals involved are in direct communication, this method
eliminates the effects of group potential dominance of the
most vocal members. The group involves individuals from
inside as well as outside the organization.
Typically, the procedure consists of the following steps:
Each expert in the group makes his/her own forecasts in form of
statements
The coordinator collects all group statements and summarizes
them
The coordinator provides this summary and gives another set of
questions to each group member including feedback as to the input
of other experts.
The above steps are repeated until a consensus is reached.
 Quantitative Methods
Time Series Forecasting
 Set of evenly spaced numerical data
 Obtained by observing response variable at
regular time periods
 Forecast based only on past values
 Assumes that factors influencing past and present
will continue influence in future
Time Series Components

Trend Cyclical

Seasonal Random
Trend Component
 Persistent, overall upward or downward
pattern
 Changes due to population, technology, age,
culture, etc.
 Typically several years duration
 Seasonal Component
 Regular pattern of up and down
fluctuations
 Due to weather, customs, etc.
 Occurs within a single year

Number of
Period Length Seasons
Week Day 7
Month Week 4-4.5
Month Day 28-31
Year Quarter 4
Year Month 12
Year Week 52
 Cyclical Component
 Repeating up and down movements
 Affected by business cycle, political, and economic
factors
 Multiple years duration
 Often causal or associative relationships

0 5 10 15 20
 Random Component
 Erratic, unsystematic, ‘residual’
fluctuations
 Due to random variation or unforeseen
events
 Short duration and
nonrepeating

M T W T F
 1. Naive Approach

 Assumes demand in next period is the

same as demand in most recent period
 e.g., If May sales were 48, then June sales
will be 48
 Sometimes cost effective and efficient
 2. Moving Average Method
 MA is a series of arithmetic means
 Used if little or no trend
 Used often for smoothing
 Provides overall impression of data over time

∑ demand in previous n periods

Moving average = n
Example
Actual 3-Month
Month Shed Sales Moving Average
January 10
February 12
March 13
April 16 (10 + 12 + 13)/3 = 11 2/3
May 19 (12 + 13 + 16)/3 = 13 2/3
June 23 (13 + 16 + 19)/3 = 16
July 26 (16 + 19 + 23)/3 = 19 1/3
Graph of Moving Average
Moving
30 –
Average
28 –
Forecast
26 – Actual
24 – Sales
22 –
Shed Sales

20 –
18 –
16 –
14 –
12 –
10 –
| | | | | | | | | | | |
J F M A M J J A S O N D
Weighted Moving Average
 Used when trend is present
 Older data usually less important
 Weights based on experience and intuition

∑ (weight for period n)

Weighted x (demand in period n)
moving average =
∑ weights
 Weights Applied Period
Weighted Moving Average
3
2
Last month
Two months ago
1 Three months ago
6 Sum of weights

Actual 3-Month Weighted

Month Shed Sales Moving Average
January 10
February 12
March 13
April 16 [(3 x 13) + (2 x 12) + (10)]/6 = 121/6
May 19 [(3 x 16) + (2 x 13) + (12)]/6 = 141/3
June 23 [(3 x 19) + (2 x 16) + (13)]/6 = 17
July 26 [(3 x 23) + (2 x 19) + (16)]/6 = 201/2
 Potential Problems With
Moving Average
 Increasing n smooths the forecast but makes it less
sensitive to changes
 Do not forecast trends well
 Require extensive historical data
 Moving Average And
Weighted Moving Average
Weighted
30 – moving
average
25 –
Sales demand

20 – Actual
sales
15 –
Moving
10 – average

5 –
| | | | | | | | | | | |
J F M A M J J A S O N D
Figure 4.2
3. Exponential Smoothing
 Assumes the most recent observations have the
highest predictive value
 gives more weight to recent time periods

Ft+1 = Ft + a(At - Ft)

et

Ft+1 = Forecast value for time t+1 Need initial

At = Actual value at time t forecast Ft
a = Smoothing constant to start.
 Exponential Smoothing

New forecast = last period’s forecast

+ a (last period’s actual demand
– last period’s forecast)

Ft = Ft – 1 + a(At – 1 - Ft – 1)

where Ft = new forecast

Ft – 1 = previous forecast
a = smoothing (or weighting)
constant (0  a  1)
 Example 1

If:
Predicted demand = 142
Actual demand = 153
Smoothing constant a = .20
New forecast = 142 + .2(153 – 142)
= 142 + 2.2
= 144.2 ≈ 144
Example 2
Ft+1 = Ft + a(At - Ft)
i Ai

Week Demand
1 820 Given the weekly demand
2 775 data what are the exponential
3 680 smoothing forecasts for
4 655 periods 2-10 using a=0.10?
5 750
6 802 Assume F1=D1
7 798
8 689
9 775
10
 Example 2 ………con’d
Ft+1 = Ft + a(At - Ft)
i Ai Fi

Week Demand a = 0.1 0.6

1 820 820.00 820.00
2 775 820.00 820.00
F2 = F1+ a(A1–F1)
3 680 815.50 793.00=820+.1(820–820)
4 655 801.95 725.20=820
5 750 787.26 683.08
6 802 783.53 723.23
7 798 785.38 770.49
8 689 786.64 787.00
9 775 776.88 728.20
10 776.69 756.28
 Example 2 ………con’d
Ft+1 = Ft + a(At - Ft)
i Ai Fi

Week Demand a = 0.1 0.6

1 820 820.00 820.00
2 775 820.00 820.00
3 680 F3 =815.50
F2+ a(A2–F2) 793.00=820+.1(775–820)
4 655 801.95 725.20
=815.5
5 750 787.26 683.08
6 802 783.53 723.23
7 798 785.38 770.49
8 689 786.64 787.00
9 775 776.88 728.20
10 776.69 756.28
 Example 2 ………con’d
Ft+1 = Ft + a(At - Ft)
i Ai Fi

Week Demand a = 0.1 0.6

1 820 820.00 820.00
2 775 820.00 820.00
3 680 815.50 793.00
4 655 801.95 725.20
5 750 787.26 683.08
6 802 783.53 723.23 This process
7 798 785.38 770.49 continues
8 689 786.64 787.00through week 10
9 775 776.88 728.20
10 776.69 756.28
 Example 2 ………con’d
Ft+1 = Ft + a(At - Ft)
i Ai Fi

Week Demand a = 0.1 a = 0.6

1 820 820.00 820.00
2 775 820.00 820.00
3 680 815.50 793.00
4 655 801.95 725.20
5 750 787.26 683.08 What if the
6 802 783.53 723.23 a constant
7 798 785.38 770.49 equals 0.5
8 689 786.64 787.00
9 775 776.88 728.20
10 776.69 756.28
 Effect of Smoothing Constants

Weight Assigned to
Most 2nd Most 3rd Most 4th Most 5th Most
Recent Recent Recent Recent Recent
Smoothing Period Period Period Period Period
Constant (a) a(1 - a) a(1 - a)2 a(1 - a)3 a(1 - a)4

a = .1 .1 .09 .081 .073 .066

a = .5 .5 .25 .125 .063 .031

 Impact of Different 

225 –

Actual a = .5
200 – demand
Demand

175 –

a = .1
150 – | | | | | | | | |
1 2 3 4 5 6 7 8 9
Quarter
Choosing 
The objective is to obtain the most accurate
forecast no matter the technique

We generally do this by selecting the model that

gives us the lowest forecast error

Forecast error = Actual demand - Forecast value

= At - Ft
Common Measures of Error

Mean Absolute Deviation (MAD)

∑ |actual - forecast|
MAD =
n

Mean Squared Error (MSE)

∑ (forecast errors)2
MSE =
n
Common Measures of Error

Mean Absolute Percent Error (MAPE)

n
100 ∑ |actuali - forecasti|/actuali
MAPE = i=1
n
 Comparison of Forecast Error
Rounded Absolute Rounded Absolute
Actual Forecast Deviation Forecast Deviation
Tonnage with for with for
Quarter Unloaded a = .10 a = .10 a = .50 a = .50
1 180 175 5 175 5
2 168 176 8 178 10
3 159 175 16 173 14
4 175 173 2 166 9
5 190 173 17 170 20
6 205 175 30 180 25
7 180 178 2 193 13
8 182 178 4 186 4
84 100
 Comparison of Forecast Error
∑ |deviations|
Rounded Absolute Rounded Absolute
MADActual
= Forecast Deviation Forecast Deviation
Tonage n
with for with for
Quarter Unloaded a = .10 a = .10 a = .50 a = .50
1
For a = .10
180 175 5 175 5
2 168 = 84/8176
= 10.50 8 178 10
3 159 175 16 173 14
4 For a =175.50 173 2 166 9
5 190 173 17 170 20
6 205 = 100/8
175= 12.50 30 180 25
7 180 178 2 193 13
8 182 178 4 186 4
84 100
 Comparison of Forecast
2
Error
∑ (forecast errors)
MSE = Rounded Absolute Rounded Absolute
Actual Forecast
n Deviation Forecast Deviation
Tonage with for with for
Quarter Unloaded a = .10 a = .10 a = .50 a = .50
1
For a = .10
180 175 5 175 5
2 = 1,558/8176
168 = 194.75 8 178 10
3 159 175 16 173 14
4 For a =175.50 173 2 166 9
5 190 173 17 170 20
6 = 1,612/8175
205 = 201.50 30 180 25
7 180 178 2 193 13
8 182 178 4 186 4
84 100
MAD 10.50 12.50
 Comparisonn of Forecast Error
100 ∑ |deviationi|/actuali
MAPE = Actual i = Rounded
1 Absolute Rounded Absolute
Forecast Deviation Forecast Deviation
Tonage with n for with for
Quarter Unloaded a = .10 a = .10 a = .50 a = .50
1
For a180
= .10 175 5 175 5
2 168 = 45.62/8
176 = 5.70%
8 178 10
3 159 175 16 173 14
4 For a175
= .50 173 2 166 9
5 190 173 17 170 20
6 205 = 54.8/8
175 = 6.85%
30 180 25
7 180 178 2 193 13
8 182 178 4 186 4
84 100
MAD 10.50 12.50
MSE 194.75 201.50
 Comparison of Forecast Error
Rounded Absolute Rounded Absolute
Actual Forecast Deviation Forecast Deviation
Tonnage with for with for
Quarter Unloaded a = .10 a = .10 a = .50 a = .50
1 180 175 5 175 5
2 168 176 8 178 10
3 159 175 16 173 14
4 175 173 2 166 9
5 190 173 17 170 20
6 205 175 30 180 25
7 180 178 2 193 13
8 182 178 4 186 4
84 100
MAD 10.50 12.50
MSE 194.75 201.50
MAPE 5.70% 6.85%
A Good Forecast

 Has a small error

 Error = Demand - Forecast