Forecasting Demand for Services

● Predictions are made using historical data

○ Can be used in food industry
■ Ex. estimate how much food to prepare in advance of actual order
○ Underestimated
■ Lines
■ Slow service
○ Overestimated
■ Profits lost from waste

The Choice of Forecasting Method

● Forecasting allows us to translate information available from databases → strategies
● Three basic models:
○ Subjective
○ Casual
○ Time series
● Some services can use one or more models
● As we go from subjective → time series, forecast time horizon becomes shorter

Method Data Required Relative Cost Forecast Horizon Application

Subjective Models:

Delphi method Survey results High Long term Technological

forecasting

Cross-impact Correlations between High Long term Technological

analysis events forecasting

Historical analogy Several years of data High Medium to long Life cycle demand
for a similar situation term projection

Casual Models:

Regression All past data for all Moderate Medium term Demand
variables forecasting

Econometric All past data for all Moderate to Medium to long Economic
variables high term conditions

Time series models:

Moving average N most recent Very low Short term Demand

observations forecasting
Exponential Previous smoothed Very low Short term Demand
smoothing value & most recent forecasting
observation

Subjective Models (Qualitative)

● Most forecasting techniques rely on data with stable patterns = reasonably useful forecasts
● Cases w/ few or no data & not useful for long-range forecasts
○ Use methods that are subjective in nature

Delphi Method
● Based on expert opinion
○ People w/ expertise are asked questions
■ People can not interact w/ one another
○ Experts are asked to make estimates
○ Administrator tabulates results → quartiles
○ Experts are asked to reconsider after seeing new information
■ Opinions in the two outside quartiles are asked to justify
○ Information is tabulated & returned to experts
■ Opinions outside the middle two quartiles (ex. IQR) are asked to justify
● Very labor-intensive, expensive, time consuming
○ Only practical for long-term forecasting
○ Useful when quantifiable data is not available
● Example
○ 98 people agreed to participate in a study about nuclear power
○ Round 1
■ 37 questions | 11 about past evolution, 26 about future

■ Asked for open-ended comments

○ Round 2
■ From Round 1

■ 11 questions about past dropped & 11 new questions from open-ended comments
were added
■ Participants were invited to “defend” positions if opinions were out of the IQR
○ Round 3 | Final
■ Administrator supplied participants w/ feedback from round 2
■ Asked to “vote” on the same questions
 ○ How the voting shifted & consensus:

Cross-Impact Analysis
● Assumes that some future event is related to occurrence of earlier event
● Experts studies set of correlations between events in a matrix
○ Correlations form basis for estimating likelihood of future event
● Similar to Delphi method
○ Experts need to arrive at satisfactory matrix that can be used for forcasting
● Example
○ Event A - $5/g gasoline prices by 2020
○ Event B - doubling of ridership on mass transit by 2030
○ Initial consensus
■ Given A, conditional probability B is .7
■ Given B, conditional probability A is .6
○ Forecasted
■ Event A - .8
■ Event B - 1.0
■ Statistically inconsistent with the matrix
● Will be pointed out to experts
● Experts will revise estimates in series of iterations

Historical Analogy
● Assumes that introduction & growth pattern of new service will mimic pattern of a similar
concept IF data is available
● Used to forecast market penetration or life cycle of a new service
○ Product life cycle stages:
■ Introduction
■ Growth
■ Maturity
■ Decline
● It is difficult to find the appropriate analogy
○ Patterns of previous data has many interpretations
○ Credibility of using this method is often doubted
● Example
○ Prediction of market penetration by color TV based on b&w TV
○ Growth in housekeeping services based on child-care services
Casual Models
● Having a wealth of information
○ Forecasts made for next year or next decade
○ Information needs to be processed to find critical information
● Makes assumptions similar to time series model
○ Data follows identifiable pattern over time & relationship exists between info we
wish to forecast & other factors

Regression Models
● Relationship between factor being forecasted (dependent variable; Y) and factors that
determine value of Y (independent variable; Xi)
● If there are n independent variables, the relationship between Y and Xi

(1) 𝑌 = 𝑎₀ + 𝑎₁𝑋₁ + 𝑎₂𝑋₂ + ... + 𝑎ₙ𝑋ₙ

● Values a are coefficients determined by computer programs being used
○ Determined by regression equations if done by hand
● Example
○ Quality of service facility location analysis depends on assessment of geographic
demand for service
■ Requires:
● Geographic unit that partitions area
○ Ex. ZIP code, census tract
● Method for predicting demand
○ Ex. retailers asking customers for ZIP code
○ Locating a day care center
■ Target population: families w/ children < 5 y/o and at least 1 employable adult
■ Census tract is chosen for geographic unit
■ Yi = % of families from census tract i in need of day care
○ Statistical analysis from SAS results in regression model:

■ Yi is multiplied by both the # of families in census track & avg # of children <
5y/o
■ Result: estimate for # of children that require day care service from census tract
● Development of regression model requires extensive data collection
○ Requires a lot of time and expense
 ○ Requires expertise in selection of independent & dependent variables
○ Appropriate for medium - long term forecasts

Econometric Models
● Versions of regression models that involve a system of equations
○ Equations are related to each other
○ Coefficients determined in simpler regression models
● Consists of simultaneous equations
○ One dependent variable
○ Several different independent variables
● Requires extensive data collection & sophisticated analysis
○ Used for long-range forecasts

Time Series Models (Quantitative)

● Applicable for short-term forecasts when values occur in an identifiable pattern over time
● Time Series Models - Assumes that the future is a function of the past
○ Types
■ Moving averages
■ Exponential smoothing
■ Trend projection - getting the best line
■ Seasonal Indexing
○ Subjected to
■ Trend (T) - persistent, overall upward or downward pattern
■ Seasonality (S) - regular pattern of up & down fluctuation / recurring cycle
■ Cycle (C) - repeating up & down movement; tied to business cycle
■ Random variation (R) - erratic, unsystematic fluctuations; no pattern
● Associative models - finds explanatory factors
○ Linear regression
● Exponential smoothing models
○ Can be adapted to track components of a forecast
■ Ex. AVG, trend, seasonality
■ Average - estimate of underlying mean of a random variable
■ Trend - increasing or decreasing increment in each period
■ Seasonality - recurring cycle
○ Each of those components can change over time

N-period Moving Average

● Forecasting period
○ Important consideration
○ Based on the nature of the demand & ability to use that information
○ Need to always be experimenting & is unique to each set of data
 ● Can be used to smooth out random variations
○ Provides reliable estimate
○ Calculates moving average (MA) for period t on basis of selecting N of the most recent
actual observation Aₜ

𝐴ₜ + 𝐴ₜ₋₁ + 𝐴ₜ₋₂ + ... 𝐴ₜ₋ₙ₊₁

(2) 𝑀𝐴 = 𝑁
● Method is slow to react
○ Old data is given same weight (i.e 1/N) as new data
○ Recent data are better indicators
● Example
○ Forecast Saturday occupancy for a 100-room hotel in a college town
■ Saturday is chosen because each day of the week is influenced by different
forces

○ Hotel owner wants to discontinue discount rates if there is increase occupancy

○ Need to take out the “noise” in pattern
○ If N = 3
■ Can not begin calculation until period 3
● Ex. Aug 15
■ Get three-period MA for first three Saturdays
● August 1, 8, 15
● MA = [(83 + 84 + 79)/3] = 82
■ Use MA to forecast occupancy for following Saturday (Aug 22)
○ Every three period MA involves adding three most recent
■ For MA of Aug 22
● Aug 8, 15, 22

Weighted Moving Average

● Assigns different weights to previous actual demand values
● If more recent data are weighted more heavily, forecast will be more responsive to changes in
demand
Simple Exponential Smoothing
● Most frequently used for demand forecasting
● Smooths out blips in data but also:
○ Old data is not dropped or lost
○ Older data progressively gets less weight
○ Calculation is simple & requires only recent data
● Based on concept of feeding back forecast error
○ Sₜ = smoothed value for period t
○ Aₜ = actual observed value for period t
○ ⍺ = smoothing constant between 0.1 - 0.5
■ To make smoothed values less responsive to latest data, assign a smaller value
of ⍺
○ Aₜ₋₁ - Sₜ₋₁ = forecast error
■ Difference between actual observation & smoothed value
■ Fraction ⍺ is added to previous smoothed value
■ Self-correcting method

(3) 𝑆ₜ = 𝑆ₜ₋₁ + α(𝐴ₜ₋ٖ₁ − 𝑆ₜ₋ٖ₁)

● Assumes that pattern of data is distributed around constant mean
● Smoothed value calculated in period t is used as forecast for period (t+1):

(4) 𝐹ₜ₊₁ = 𝑆ₜ
● Basing data on smoothed data helps to prevent overreacting to extremes in observed values
● Equation (3) rewritten:

(5) 𝑆ₜ = α(𝐴ₜ) + (1 − α)𝑆ₜ₋₁

○ A is given weight ⍺ in determining Sₜ
○ Aₜ₋₁ is given weight of ⍺ (1 - ⍺)
■ Actual value Aₜ₋ₙ is given weight of ⍺ (1 - ⍺)ⁿ
● Older observations never disappear entirely from the calculation

● Example
○ Hotel information from earlier

○ S₁ = first smoothed value = August 1 = A₁ = 79.00

○ S₂ can be derived from actual value for Aug 2 (A₂) & previous smoothed value (S₁) using
(3)
■ Selected ⍺ = 0.5

○ Best estimate for Aug 15 occupancy: 81.50

○ Forecast error = 84 - 79 = 5
■ Underestimated demand by 5
■ ½ of error was added to previous smoothed value to increase new estimate
○ Relationship between ⍺ and smoothed values in terms of responsiveness to latest data
Forecast Error
● Expect unbiased forecast with respect to its tracking of actual mean
○ Sum of forecast errors = 0
■ Take both positive & negative differences
■ If yes, look for underlying trends or seasonality

𝑛
(6) Cumulative Forecast Error (CFE)= ∑ (𝐴ₜ − 𝐹ₜ)
𝑡=1
● Mean absolute deviation (MAD) - most commonly used
○ Gives equal weight to each error

𝑛
1
(7) Mean Absolute Deviation (MAD) = 𝑛
∑ |𝐴ₜ − 𝐹ₜ|
𝑡=1
● Mean squared error (MSE) - used if large errors are very serious

𝑛
1
(8) Mean Square Error (MSE) = 𝑛
∑ (𝐴ₜ − 𝐹ₜ)²
𝑡=1
● Mean absolute percentage error (MAPE) - when errors need to put into perspective
○ Ex. absolute error of 2 in forecast of 10 > error of 2 for forecast of 1,000

𝑛
1 |𝐴ₜ−𝐹ₜ|
(9) Mean Absolute Percentage Error (MAPE) = 𝑛
∑ 𝐴ₜ
(100)
𝑡=1
● ⍺ can change your MAD
○ Selecting an ⍺ to minimize MAD can be accomplished using Excel Solver
Relationship between ⍺ and N
● Selecting ⍺ is a matter of judgment
○ Between 0.1 - 0.5 is a trade-off between overreacting and detexting a change
○ Value of ⍺ is to minimize MAD
● Assume that moving average & exponential smoothing method are similar when average ages
of past data are equal:
○ Moving Average

○ Exponential smoothing

■ Average age for exponential smoothing is a geometric series with the sum equal

○ Exponential smoothing = Moving average

Exponential Smoothing with Trend Adjustment

● Trend - average rate at which observed values change from one period to the next over time
○ Changes can be treated using an extension of simple exponential smoothing
● Smoothed value Sₜ using a modified (5) equation with trend value Tₜ₋₁
○ Accounts for the rate of increase

(10) 𝑆ₜ = ⍺(𝐴ₜ) + (1 − ⍺)(𝑆ₜ₋₁ + 𝑇ₜ₋₁)

● To incorporate trend adjustment
○ Use β as a smoothing constant
■ Assigned a value of 0.1 - 0.5
■ Can be the same as or different from ⍺
○ Trend for given period t is defined by (Sₜ - Sₜ₋₁ )
 ■ Rate of change in smoothed value from one period to the next
■ I.e. slope of demand curve
○ Tₜ is calculated at period t using equation (11)
■ Modification of equation (5) with observed trend (Sₜ - Sₜ₋₁) instead of Aₜ

(11) 𝑇ₜ = β(𝑆ₜ − 𝑆ₜ₋₁) + (1 − β)𝑇ₜ₋₁

● Forecasts are calculated in a stepwise manner

(12) 𝐹ₜ₊₁ = 𝑆ₜ + 𝑇ₜ
● Example
○ Commuter airline shows a steady increase from week 1 - week 8

○ Smoothed value for week 2 using (10):

○ Trend for week 2 using (11):

○ Forecasting for week 3 using (12):

● Measure of forecast bias = sum of forecast errors

○ = 9 + 6 + 10 - 2 + 11 - 6 + 3 = 31
■ Note for negative #s, actual load factor decreases

Exponential Smoothing with Seasonal Adjustments

● Remove seasonality from data & smooth data → put back seasonality to determine a forecast
● Cycle L = length of one season
○ Can be any length of time
○ Frequently used: 12 months
● Need to have data for at least one full season in order to forecast
● Seasonality Index ( I ) -Used to deseasonalize data in a given cycle L
○ Estimated by calculating ratio of actual value for period t divided by average value

𝐴ₜ
(13) 𝐼ₜ =
𝐴
● Index is used to deseasonalize data for corresponding months using (14)
○ Minor modification to basic exponential smoothing equation (5)

𝐴ₜ
(14) 𝑆ₜ = α 𝐼ₜ₋ₗ
+ (1 − α)𝑆ₜ₋₁
● Forecast for period t + 1 is seasonalized using smoothed value for t - L + 1

(15) 𝐹ₜ₊₁ = (𝑆ₜ)(𝐼ₜ₋ₗ₊₁)

● If seasonality indices are stable → forecasts that are based on one cycle L are reliable
● If indices are not stable → can be adjusted & smoothed
○ γ is assigned a value between 0.1 - 0.5

𝐴ₜ
(16) 𝐼ₜ = γ 𝑆ₜ
+ (1 − γ)𝐼ₜ₋ₗ
● In practice, smoothed values, indices, forecasts are calculated month-to-month
● Example
○ L = 12 months
○ Ā = 1.971.83
○ Can not calculate new smoothed data until period 13 (Jan 2020)
■ Assume S₁₂ = A₁₂
■ ⍺ = .2
■ It-L = .837 = Index from 1st month

○ Forecast for Feb 2020 using Feb 2019

○ Use (16) to update seasonality indices for future use

Exponential Smoothing w/ Trend & Seasonal Adjustments
● Create even more accurate forecasts by adjusting both trend & seasonal adjustments

𝐴ₜ
(17) 𝑆ₜ = α 𝐼ₜ₋ₗ
+ (1 − α)(𝑆ₜ₋₁ + 𝑇ₜ₋₁)

(18) 𝑇ₜ = β(𝑆ₜ − 𝑆ₜ₋₁) + (1 − β)𝑇ₜ₋₁

𝐴ₜ
(19) 𝐼= γ 𝑆ₜ
+ (1 − γ)𝐼ₜ₋ₗ

(20) 𝐹ₜ₊₁ = (𝑆ₜ + 𝑇ₜ)𝐼ₜ₋ₗ₊₁

Excel Formulas

Summary
● Exponential smoothing is relatively easy & straightforward to make short-term forecasts
○ All past data are considered in smoothing process
○ Recent data is assigned more weight than older data
○ Only recent data needs an update
○ Model is easy to implement on personal computers
○ Smoothie constants allow us to alter rate at which model responds