4 Forecasting

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 Outline
 What Is Forecasting?
 Forecasting Time Horizons
 The Strategic Importance of Forecasting
 Forecasting Approaches
Qualitative Methods
Quantitative Methods

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 Outline – Continued
 Time-Series Forecasting
 Decomposition of a Time Series
 Naive Approach
 Moving Averages
 Exponential Smoothing
 Exponential Smoothing with Trend Adjustment
 Trend Projections
 Seasonal Variations in Data
 Cyclical Variations in Data

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 Outline – Continued
 Associative Forecasting Methods: Regression
and Correlation Analysis
 Monitoring and Controlling Forecasts
 Adaptive Smoothing
 Focus Forecasting
 Forecasting in the Service Sector

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 What is Forecasting?
 Process of predicting
a future event
 Underlying basis
of all business
??
decisions
 Production
 Inventory
 Personnel
 Facilities

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 The Realities!

 Forecasts are seldom perfect

 Most techniques assume an
underlying stability in the system
 Product family and aggregated
forecasts are more accurate than
individual product forecasts

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 Forecasting Time Horizons
 Short-range forecast
 Up to 1 year, generally less than 3 months
 Purchasing, job scheduling, workforce levels, job
assignments, production levels
 Medium-range forecast
 3 months to 3 years
 Sales and production planning, budgeting
 Long-range forecast
 3+ years
 New product planning, facility location, research
and development

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 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

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 Product Life Cycle
Introduction Growth Maturity Decline
Product design Forecasting Standardization Little product
and critical Fewer product differentiation
OM Strategy/Issues development Product and changes, more Cost
critical process minor changes minimization
Frequent reliability Optimum Overcapacity
product and Competitive capacity in the
process design product industry
changes Increasing
improvements stability of Prune line to
Short production and options process eliminate
runs Increase capacity Long production items not
High production Shift toward runs returning
costs product focus good margin
Product
Limited models Enhance improvement Reduce
Attention to distribution and cost cutting capacity
quality

Figure 2.5
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 Forecasting Approaches
Qualitative Methods
 Used when little data exist
 New products
 New technology
 Involves intuition, experience
 e.g., forecasting sales on
Internet

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 Qualitative Methods

1. Jury of executive opinion (Pool opinions of high-level

experts, sometimes augment by statistical models)
2. Delphi method (Panel of experts, queried iteratively
until consensus is reached)
3. Sales force composite (Estimates from individual
salespersons are reviewed for reasonableness, then
aggregated)
4. Consumer Market Survey (Ask the customer)

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 Quantitative Approaches
 Used when situation is ‘stable’ and
historical data exist
 Existing products
 Current technology
 Involves mathematical techniques
 e.g., forecasting sales of LCD
televisions

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 Quantitative Approaches

1. Naive approach
2. Moving averages
3. Exponential smoothing time-series
4. Trend projection models
5. Linear regression

associative
model

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 Time Series Forecasting

 Set of evenly spaced numerical data

 Obtained by observing response variable at regular
time periods
 Forecast based only on past values, no other
variables important
 Assumes that factors influencing past and present
will continue influence in future

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 Time Series Components

Trend Cyclical

Seasonal Random

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 Components of Demand
Trend
component
Demand for product or service
Seasonal peaks

Actual demand
line

Average demand
over 4 years

Random variation
| | | |
1 2 3 4
Time (years)
Figure 4.1
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 Trend Component
 Persistent, overall upward or downward
pattern
 Changes due to population, technology,
age, culture, etc.
 Typically several years duration

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 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
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 Cyclical Component
 Repeating up and down movements
 Affected by business cycle, political, and
economic factors
 Multiple years duration

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

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 Naive Approach
 Assumes demand in next
period is the same as
demand in most recent period
 e.g., If January sales were 68, then
February sales will be 68
 Sometimes cost effective and
efficient
 Can be good starting point

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 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

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 Moving Average Example

Actual 3-Month
Month Shed Sales Moving Average
January 10
10
12
February 12
13
March 13 (10 + 12 + 13)/3 = 11 2/3
April 16
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

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Graph of Moving Average
Moving
30 –
Average
28 –
Forecast
26 – Actual
24 – Sales
Shed Sales

22 –
20 –
18 –
16 –
14 –
12 –
10 –
| | | | | | | | | | | |
J F M A M J J A S O N D

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 Weighted Moving Average
 Used when some trend might be 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

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 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

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 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

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 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
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 Exponential Smoothing
 Form of weighted moving average
 Weights decline exponentially
 Most recent data weighted most
 Requires smoothing constant ()
 Ranges from 0 to 1
 Subjectively chosen
 Involves little record keeping of past data

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 Exponential Smoothing
New forecast = Last period’s forecast
+  (Last period’s actual demand
– Last period’s forecast)

Ft = Ft – 1 + (At – 1 - Ft – 1)

where Ft = new forecast

Ft – 1 = previous forecast
 = smoothing (or weighting)
constant (0 ≤  ≤ 1)

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Exponential Smoothing Example

Predicted demand(t-1) = 142 Ford Mustangs

Actual demand (t-1)= 153
Smoothing constant  = .20

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Exponential Smoothing Example

Predicted demand (t-1)= 142 Ford Mustangs

Actual demand = (t-1)153
Smoothing constant  = .20

New forecast (t) = 142 + .2(153 – 142)

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Exponential Smoothing Example

Predicted demand = 142 Ford Mustangs

Actual demand = 153
Smoothing constant  = .20

New forecast = 142 + .2(153 – 142)

= 142 + 2.2
= 144.2 ≈ 144 cars

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 Impact of Different 
225 –

Actual  = .5
200 – demand
Demand

175 –

 = .1
150 – | | | | | | | | |
1 2 3 4 5 6 7 8 9
Quarter
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 Impact of Different 
225 –

Actual  = .5
200
Chose
– high values
demandof 
Demand

when underlying average

is likely to change
–
175
Choose low values of 
when underlying average  = .1
is stable|
150 – | | | | | | | |
1 2 3 4 5 6 7 8 9
Quarter
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