FORECASTING

Operations Management and

Total Quality Management
 LEARNING OUTCOMES
LO1: Distinguish the five basic patterns of most demand time series.
LO2: Evaluate the various measures of forecast errors.
LO3: Use regression to make forecasts with one or more
independent variables.
LO4: Develop forecasts using the most common approaches for
time-series analysis.
LO5: Create forecasts with seasonality.
LO6: Summarize a typical forecasting process used by businesses
 FORECASTS

• OM is mostly proactive not reactive

• It involves structured planning activities
• Planning requires data pertaining to the
feature
• Forecast: A statement about the future
• Not necessarily numerical
• Weather forecasts
 USE OF FORECASTS
Marketing
Accounting
Pricing, promotion, strategy
Cost/profit estimates

Finance Operations
Cash flow and Schedules, MRP, workloads
funding

HR Product Design
Hiring/ recruiting/ New products and services
training
 FORECASTS

• Assume a causal system

• Future resembles the past
• Forecasts rarely perfect because of
randomness
• Forecasts more accurate for groups vs.
individuals.
• Forecasting errors among items in a
group usually have a canceling effect.
 FORECASTS
• Extremes in a group cancel each other
• Ex. I can forecast the class average
from the midterm better than Mrs.
X’s individual grade.
• Forecast accuracy decreases as time
horizon for forecasts increases
• Ex. I can forecast this year’s class
average better than next year’s
class average
ELEMENTS OF GOOD FORECASTS

Timely Accurate Reliable

Meaningful Written Easy to

Use
STEPS IN THE FORECASTING
PROCESS

Determine Establish a Select a

purpose of time forecasting
forecast horizon technique

Step 1 Step 2 Step 3

STEPS IN THE FORECASTING
PROCESS

Gather and Prepare the Monitor the

analyze data forecast forecast

Step 4 Step 5 Step 6

 TYPES OF FORECASTS
Associative
Judgmental Time series
models
Subjective Analyzes historical data Objective
analysis of to reveal relationships analysis
subjective between (easily or in historical data
inputs advance) observable assuming the
quantities and forecast future will be like
quantities. Uses this the past
relationship to make
predictions
JUDGMENTAL FORECASTING
• When no historical data is available, only
judgmental forecasting is possible.
• The Delphi method consists of forecasting by
expert opinion by gathering judgments and
opinions of key personnel based on their
experience and knowledge of the situation.
JUDGMENTAL FORECASTING
• Another common approach to gathering data is
a survey. Sample sizes are usually much larger
than with Delphi, however, and the cost of such
surveys can be high.
• The major reasons for using judgmental methods
are:
 Greater accuracy
 Ability to incorporate unusual or one-
time events
 The difficultly of obtaining the data
necessary for quantitative techniques
JUDGEMENTAL FORECASTS
Consumer
Executive opinions survey
There are factors hard to
quantify The guy at the mall
who asks if you like
cherry flavor in your
shampoo
Outside opinion
Financial and consulting
gurus and companies Opinions of
managers and
staff
Sales force composite
Delphi method: A series
Retailer forecasts for the
of questionnaires
manufacturer
developed sequentially
 TIME SERIES
• Time-ordered sequence of observations
taken at regular intervals over a period of
time
• Future values of the series can be
estimated from past values.
 TIME SERIES
Irregular
Trend
Variations
long-term
movement in data caused by unusual
circumstances

Seasonality
short-term regular
variations in data Random
Variations
Cycles
Caused by chance
wavelike variations
of long-term
 TREND
The systematic
increase or
decrease in the
mean of the series
over time
SEASONAL
A repeatable
pattern of increases
or decreases in
demand, depending
on the time of day,
week, month, or
season.
 CYCLICAL
The less predictable
gradual increases or
decreases in demand
over longer periods
of time (years or
decades).
 NAÏVE FORECASTS
• Uses a single previous value of a time series as the basis of a
forecast.
• Virtually no cost
• Data analysis is nonexistent
• Easily understandable
• Cannot provide high accuracy
• If it were true, future will always be the same as the past

Some notation: Forecast at time t is F(t)

Actual observation at time t is D(t)
 USES OF NAÏVE FORECASTS
• Stable time series data
• Forecast is the same as the last actual observation
• F(t) = D(t-1)
• Seasonal variations
• Forecast is the same as the last actual observation when we were
in the same point in the cycle, where a cycle lasts n periods.
• F(t) = D(t-n)
• Data with trends
• There is constant trend, the change from (t-2) to (t-1) will be
exactly as the change from (t-1) to (t)
• F(t) = D(t-1) + (D(t-1) – D(t-2))
 NAÏVE FORECASTS

• Check if the resulting accuracy is acceptable

• The higher the accuracy, often the higher the
cost.
• Do we really need our forecast that accurate? Is
it worth the additional resources?
• Why do you need forecasts for? How critical they are
for operations?
 ILLUSTRATIVE PROBLEM 1
Using naïve forecasting method, what is the forecast for
Week 4?

The number of patient arrivals for the past

three weeks were as follows:
F(4) = D(3)

F(4) = 411
 Time Series Models: Variations
What is random and what is not?
• Historical data contain random variations or noise
• Random variations are caused by relatively unimportant
factors.
• What is random? Can we not study everything to negligible
detail? “God does not roll dices” –A.E.
• The objective is to remove all randomness and have real
variations.
• Minor variations are random and large ones are real.
TECHNIQUES FOR AVERAGING
Moving
Averages

Exponential
Smoothing
Weighted
Moving
Averages
 MOVING AVERAGES
• Involves calculating the average demand for the n most recent
time periods and using it as the forecast for future time periods
 ILLUSTRATIVE PROBLEM 2
Using the three-week forecasting method, what is the
forecast for Week 4?

The number of patient arrivals for the past

three weeks were as follows:
F(4) = [D(3)+D(2)+D(1)] / 3

F(4) = (400+380+411) / 3
F(4) = 397
 WEIGHTED MOVING AVERAGES
• Each historical demand in the average can have its own
weight
• The sum of the weights equals 1.0.
• For example, in a three-period weighted moving average
model, the most recent period might be assigned a weight of
0.50, the second most recent might be weighted 0.30, and the
third most recent might be weighted 0.20.
 ILLUSTRATIVE PROBLEM 3
The Polish General’s Pizza Parlor is a small restaurant catering to patrons with a
taste for European pizza. One of its specialties is Polish Prize pizza. The manager
must forecast weekly demand for these special pizzas so that he can order pizza
shells weekly. Recently, demand has been as follows:
F(@Jun23) = 0.5*52 +
0.3*65 + 0.2*50 = 55.5
F(@Jun30) = 0.5*56 +
Forecast June 23, 30 and July 7 by using
0.3*52 + 0.2*65 = 56.6
the weighted moving average method with
n = 3 and weights of 0.50, 0.30, and 0.20,
F(@Jul7) = 0.5*55 + 0.3*56
with 0.50 applying to the most recent + 0.2*52 = 54.7
demand.
 MA vs. WMA
Moving Weighted Moving
Averages Averages
Advantage: Advantage:
Easy to compute and easy Allows you to emphasize recent
to understand demand over earlier demand
Disadvantage: The forecast will be more
All values in the average responsive to changes in the
are weighted equally underlying average of the
demand series than the simple
moving average forecast.
 EXPONENTIAL SMOOTHING
• A sophisticated weighted moving average method that calculates the
average of a time series by implicitly giving recent demands more weight
than earlier demands, all the way back to the first period in the history file.
• Most frequently used formal forecasting method because of its simplicity
and the small amount of data needed to support it.
• Requires only three items of data: (1) the last period’s forecast; (2) the
actual demand for this period; and (3) a smoothing parameter, alpha (a),
which has a value between 0 and 1.0.
 ILLUSTRATIVE PROBLEM 4
Forecast using the exponential smoothing with a smoothing
constant value of 0.10, and forecast value for week 3 of 390
The number of patient arrivals for the past
three weeks were as follows:

F(4) = D(3)*0.10 + F(3)*0.90

F(4) = 411*0.10 + 390*0.90

= 392.1
 SEASONAL PATTERNS
• Regularly repeating upward or downward movements in demand
measured in periods of less than one year (hours, days, weeks, months, or
quarters).
• Multiplicative Seasonal Method is a method whereby seasonal factors are
multiplied by an estimate of average demand to arrive at a seasonal
forecast.
 MULTIPLICATIVE SEASONAL
METHOD
1. For each year, calculate the average demand per season by dividing annual
demand by the number of seasons per year.
2. For each year, divide the actual demand for a season by the average demand per
season. The result is a seasonal index for each season in the year, which indicates
the level of demand relative to the average demand.
3. Calculate the average seasonal index for each season, using the results from step
2. Add the seasonal indices for a season and divide by the number of years of data.
4. Calculate each season’s forecast for next year. Begin by forecasting next year’s
annual demand using the naïve method, moving averages, exponential smoothing,
or trend projection with regression. Then, divide annual demand by the number of
seasons per year to get the average demand per season. Finally, make the
seasonal forecast by multiplying the average demand per season by the
appropriate seasonal index found in step 3.
 ILLUSTRATIVE PROBLEM 5
The manager of the Stanley Steemer carpet cleaning company needs a quarterly
forecast of the number of customers expected next year. The carpet cleaning
business is seasonal, with a peak in the third quarter and a trough in the first
quarter. The manager wants to forecast customer demand for each quarter of
year 5, based on an estimate of total year 5 demand of 2,600 customers.
Year 1 Year 2 Year 3 Year 4
Qr Demand Demand Demand Demand
1 45 70 100 100
2 335 370 585 725
3 520 590 830 1160
4 100 170 285 215
 ILLUSTRATIVE PROBLEM 5
Year 1 Year 2 Year 3 Year 4

Q Demand Demand Demand Demand

1 45 0.18 70 0.233 100 0.222 100 0.182

2 335 1.34 370 1.233 585 1.30 725 1.318
3 520 2.08 590 1.967 830 1.844 1160 2.109
4 100 0.40 170 0.567 285 0.633 215 0.391
1,000 250 1,200 300 1,800 450 2,200 550
 ILLUSTRATIVE PROBLEM 5

Year 1 Year 2 Year 3 Year 4 Forecast

Qr SF SF SF SF Total Average 650
1 0.18 0.233 0.222 0.182 0.817 0.204 132.6
2 1.34 1.233 1.30 1.318 5.191 1.298 843.7
3 2.08 1.967 1.844 2.109 8 2 1,300
4 0.4 0.567 0.633 0.391 1.991 0.498 323.7

Forecast for year 5 = 2,600 2,600 / 4 quarters = 650 / quarter

ASSOCIATIVE FORECASTING
Based on identification of related variables that can
be used to predict values of the variable of interest.
a. Sales of mountain bikes in an area may be
related to the percentage of the young
population living in that area.
b. Sales of Harley-Davidson motorbikes is
related to mid-aged men population.
Average age of H-D owners is 46.
c. Ice cream sales can be related to
temperature
d. Increase in energy cost leads to price
increases in products and services
ASSOCIATIVE FORECASTING
1. Find an association between the predictor and the
predicted
2. Predictor variables - used to predict values of variable
interest, sometimes called independent variables
3. Predicted variable = Dependent variable
4. Regression - technique for fitting a line to a set of
points
5. Linear regression is the most widely used form of
regression
a. The objective is to obtain an equation of a straight line
that minimizes the sum of squared vertical deviations of
data points from the line.
 LINEAR REGRESSION

y = a + bx
Where
y = predicted (dependent) variable
x = predictor (independent) variable
b = slope of the line
a = value of y when x = 0 (the height of
line at the y intercept)
 LINEAR REGRESSION
• Correlation (r) between variables: The strength
and direction of relationships between two
variables
• 1.00 means changes in one variable are always
matched by changes in the other, vice versa.
• A correlation close to zero means little linear
relationship
• The square of the correlation coefficient provides
a measure of the percentage of variability in the
values of y that is explained by the independent
variable.(80% or more: the independent variable
is a good predictor of the values of dependent
variable)
 FORECAST ACCURACY
1. Measurement is the first step to improve
an activity
a. What value of smoothing constant is good?

2. Accuracy measurement is a vital aspect

of forecasting
3. Impossible to correctly predict future
values
4. Important to include an indication of
how big the forecast deviate from the
actual values
FORECAST ACCURACY
Mean squared
Error
difference between
error (MSE)
actual value and Average of squared error
predicted value (weights errors according
to their squared values)

Mean absolute Tracking

deviation (MAD) signal
Average absolute
Ratio of cumulative
error (weights all
error and MAD
errors evenly)
 FORECAST ACCURACY
Forecast error  Actual  Forecast
n

| A  F | t t
MAD  t 1
n
n n

(A  F )t t
2
(A  F ) t t
2

MSE  t 1
 t 1
n 1 n
n

A F t t
Tracking Signal  t 1
MAD
Estimate of (forecast error) standard deviation  s  MSE
Statistics says : MSE is the unbiased estimator for the variance of forecast error.
 ILLUSTRATIVE PROBLEM 5
The monthly demand for units
manufactured by the Acme Rocket Month Units
Company has been as follows. May 100
Use the exponential smoothing method to
Jun 80
forecast the number of units for June to
January. The initial forecast for May was Jul 110
105 units; a = 0.2. b. Calculate the Aug 115
absolute percentage error for each month
from June through December and the Sept 105
MAD and MAPE of forecast error as of the Oct 110
end of December. c. Calculate the tracking Nov 125
signal as of the end of December. What
can you say about the performance of Dec 120
your forecasting method?
 ILLUSTRATIVE PROBLEM 5
Month Actual Forecast Error AD SE %
May 100 105 A-F |E| E^2 E/A
Jun 80 100*0.2+105*0.8 104 -24 24 576 30%
Jul 110 80*0.2+104*0.8 99.2 10.8 10.8 116.64 9.8%
Aug 115 110*0.2+99.2*0.8 101.4 13.6 13.6 184.96 11.8%
Sept 105 115*0.2+101.4*0.8 104.1 0.9 0.9 0.81 0.9%
Oct 110 105*0.2+104.1*0.8 104.3 5.7 5.7 32.49 5.2%
Nov 125 110*0.2+104.3*0.8 105.4 19.6 19.6 384.16 15.7%
Dec 120 125*0.2+105.4*0.8 109.3 10.7 10.7 114.49 8.9%
37.3 85.3 1,409.55 82.3%
5.3 12.2 201.4 11.8%
 USE FOR MAD AND MSE

1. Compare the accuracy of alternative

a. forecasting methods using MAD and MSE.
b. parameter (such as alpha) values used in
forecasting by using MAD and MSE

2. Determine which method yields the

lowest MAD or MSE for a given set of
data.
CONTROLLING THE QUALITY
OF FORECAST
1. Necessary to monitor forecast to ensure that the forecast is
performing adequately
2. This is accomplished by comparing forecast errors to
predetermined values
3. Errors that fall within the limits are considered acceptable
4. Errors outside either limit indicates that corrective action is
needed.
5. Tracking signal values are compared to predetermined limits
(+4,-4) based on judgment and experience
6. Upper and lower limits for individual forecast errors are
calculated using control chart techniques. We will learn
about control charts in quality chapters.
 CHOOSING THE
FORECASTING TECHNIQUE
• No single technique works best in every situation
• The forecast horizon
• Forecasting frequency
• Forecasting is not free
• Consider cost and accuracy
• Weigh cost-accuracy trade-offs carefully
• Forecast detail, part / product level?
• Availability of
• historical data
• computers
• able users / decision makers
 CHOOSING THE
FORECASTING TECHNIQUE
• 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.
 SUMMARY
• We studied the steps of forecasting
• We examined three forecasting
techniques:
• Judgmental
• Associative
• Time Series
• We learned about seasonality, trend,
cyclical data
• Discussed monitoring forecast accuracy
THANKS! Do you have any
questions?
rosamaria.Castillo@ub.edu.ph

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