6.10.

2018

2 Forecasting

4-1

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

4-2

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Forecasting in Production
Planning and Control?
 How do you decide what to produce
when you don’t know what your
customers will buy?

4-3

Functional Areas and Forecasting

Organization

Finance Operations Marketing

Determines the revenue Warehousing can plan staffing for Initiates the forecast in $ or
to be generated and the stocking/shipping units (typically)
operating costs
Production looks at demand and Manages the forecasting
associated with the
on-hand inventory to develop a process
schedules to produce a
schedule and determine capacity
financial P/(L) forecast
requirements to meet demand and
for stock holders,
maintain safety stock
bankers, and executive
management Purchasing can use the schedule
to notify suppliers of dates raw
materials are needed
4-4

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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
4-5

Types of Forecasts
 Economic forecasts
 Address business cycle – inflation rate,
money supply, housing starts, etc.
 Technological forecasts
 Predict rate of technological progress
 Impacts development of new products
 Demand forecasts
 Predict sales of existing products and
services

4-6

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Strategic Importance of
Forecasting
 Human Resources – Hiring, training,
laying off workers
 Capacity – Capacity shortages can
result in undependable delivery, loss
of customers, loss of market share
 Supply Chain Management – Good
supplier relations and price
advantages

4-7

Seven Steps in Forecasting

1. Determine the use of the forecast
2. Select the items to be forecasted
3. Determine the time horizon of the
forecast
4. Select the forecasting model(s)
5. Gather the data
6. Make the forecast
7. Validate and implement results

4-8

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A Flowchart of the Forecasting Process

Identify the purpose Collect historical Plot data and
of the forecast demand data identify patterns

Select a forecast Develop forecast for Check forecast

methodology period of historical data accuracy

Make adjustments to model …

chose new one if necessary
N

Is accuracy of forecast
acceptable?

Y
Monitor results and
Develop forecast for Adjust the forecast based measure forecast accuracy
the planning horizon on qualitative insights

4-9

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

4 - 10

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Forecasting Approaches
Qualitative Methods

 Used when situation is vague and little

data exist
 New products
 New technology
 Involves intuition, experience
 e.g., forecasting sales on Internet

4 - 11

Forecasting Approaches
Quantitative Methods
 Used when situation is ‘stable’ and
historical data exist
 Existing products
 Current technology
 Involves mathematical techniques
 e.g., forecasting sales of color
televisions
4 - 12

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Overview of 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

4 - 13

Overview of Qualitative
Methods
3. Sales force composite
 Estimates from individual
salespersons are reviewed for
reasonableness, then aggregated
4. Consumer Market Survey
 Ask the customer

4 - 14

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Jury of Executive Opinion

 Involves small group of high-level
experts and managers
 Group estimates demand by working
together
 Combines managerial experience with
statistical models
 Relatively quick
 ‘Group-think’
disadvantage

4 - 15

Jury of Executive Opinion

• Horizon: Long range, new product

introduction

• Method: High level managers usually meet

collectively to develop forecast projections

• Risk: Dominant personalities may influence

other’s input

4 - 16

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Sales Force Composite

 Each salesperson projects his or

her sales
 Combined at district and national
levels
 Sales reps know customers’ wants
 Tends to be overly optimistic

4 - 17

Sales Force Composite

Horizon: Intermediate
Method: Sales force input based on contact
with customer. The sales force should be
knowledgeable about future customer plans
(such as promotional events) that could
influence demand
Risk: Sales force may not be honest about
demand
4 - 18

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Delphi Method
 Iterative group
Decision Makers
process, (Evaluate
continues until responses and
consensus is make decisions)
reached
Staff
 3 types of (Administering
survey)
participants
 Decision makers
 Staff Respondents
(People who can
 Respondents make valuable
judgments)
4 - 19

Delphi Method
• Horizon: Intermediate, long range, new
product introduction
• Method: A series of anonymous
questionnaires where each successive
questionnaire builds on the results of the
previous one
• Risk: It can take a long time with many
rounds.

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Consumer Market Survey

 Ask customers about purchasing

plans
 What consumers say, and what
they actually do are often different
 Sometimes difficult to answer

4 - 21

Consumer Market Survey

Horizon: Intermediate, long range, new product

introduction
Method: Solicit customer input by using a
designed survey
Risk: May not get useful or accurate information
… will customer really do what they say

4 - 22

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Overview of Quantitative
Approaches
Causal Models: A causal model is one in which the forecast
for y is some function of the variables from X1 to Xn.

Time Series Methods: Time series methods are often called

naive methods, as they require no information other than the
past values of the variable being predicted. (Moving
averages, Exponential smoothing, Holt’s method, Trend
projection etc.)

4 - 23

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

4 - 25

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)

4 - 26

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Trend Component

 Persistent, overall upward or

downward pattern
 Changes due to population,
technology, age, culture, etc.
 Typically several years
duration

4 - 27

Demand Variation
Trend - an overall upward or
downward pattern

Linear Trend

Parabolic Trend

Growth Trend

Exponential Trend

4 - 28

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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

4 - 29

Demand Variation

Seasonal patterns - regular 98

97
pattern of up or down depending
96
on time of year (e.g. lawnmower
Seasonal Variations
sales)

Cyclical patterns - repeating up

and down movements usually
Cycles
Cycles driven by the economy

4 - 30

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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
4 - 31

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

M T W T F
4 - 32

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History … An Indicator Of The Future ???

Forecasting deals with making a statement about the future … Can
history be used to tell us something about the future?

Actual Historical Demand

Future Demand

Time

4 - 33

Forecast Notation
Time Actual Forecast t = time period
1 A1 F1 At  actual at time t
2 A2 F2
3 A3 F3 Ft  forecast at time t
4 A4 F4
5 A5 F5
6 A6 F6
7 A7 F7
8 A8 F8
9 A9 F9
10 A10 F10
4 - 34

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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

4 - 35

Forecast Notation
Time Actual Forecast If t=4 and n=3 what is the forecast for t when
using the following forecast methodology?
1 17 #N/A
2 21 #N/A At-1  At-2 ... At-n
3 19 #N/A Ft 
n
4 23 19.00
5 18
A4-1  A4-2  A4-3

6 16 3
7 20 A  A2  A1
 3
8 18 3
9 22 17  21  19
  19
10 20 3
4 - 36

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Forecast Notation
Time Actual Forecast Verify these forecasts are correct for the
following forecast methodology?
1 17 #N/A
2 21 #N/A At-1  At-2 ... At-n
3 19 #N/A Ft 
n
4 23 19.00
5 18 21.00
6 16 20.00 Why is the forecast #N/A for t = 1, 2, 3?
7 20 19.00
8 18 18.00
9 22 18.00
10 20 20.00
4 - 37

Moving Average 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

4 - 38

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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

4 - 39

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 Last month
2 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

4 - 41

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

4 - 42

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 6.10.2018

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
4 - 43

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
4 - 44

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Exponential Smoothing

Ft = At – 1 + (1-)Ft – 1

where Ft = new forecast

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

4 - 45

Exponential Smoothing
Example
Predicted demand = 142 Ford Mustangs
Actual demand = 153
Smoothing constant  = .20

4 - 46

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 6.10.2018

Exponential Smoothing
Example
Predicted demand = 142 Ford Mustangs
Actual demand = 153
Smoothing constant  = .20

4 - 47

Exponential Smoothing
Example
Predicted demand = 142 Ford Mustangs
Actual demand = 153
Smoothing constant  = .20

New forecast = 0.20 *153+0.80 *142

= 144.2 ≈ 144 cars

4 - 48

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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

© 2011 Pearson Education, Inc. publishing as Prentice Hall 4 - 49

Impact of Different 
225 –

Actual  = .5
200
Chose
– high values of 
demand
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

4 - 50

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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

4 - 51

Common Measures of Error

Mean Absolute Deviation (MAD)

∑ |Actual - Forecast|
MAD =
n

Mean Squared Error (MSE)

∑ (Forecast Errors)2
MSE =
n

4 - 52

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Common Measures of Error

Mean Absolute Percent Error (MAPE)

n
∑100|Actuali - Forecasti|/Actuali
MAPE = i=1
n

4 - 53

Comparison of Forecast
Error
Rounded Absolute Rounded Absolute
Actual Forecast Deviation Forecast Deviation
Tonnage with for with for
Quarter Unloaded  = .10  = .10  = .50  = .50
1 180 175 5.00 175 5.00
2 168 175.5 7.50 177.50 9.50
3 159 174.75 15.75 172.75 13.75
4 175 173.18 1.82 165.88 9.12
5 190 173.36 16.64 170.44 19.56
6 205 175.02 29.98 180.22 24.78
7 180 178.02 1.98 192.61 12.61
8 182 178.22 3.78 186.30 4.30
82.45 98.62

4 - 54

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Comparison of Forecast
Error
∑ |deviations|
Rounded Absolute Rounded Absolute
MADActual
= Forecast Deviation Forecast Deviation
Tonnage n
with for with for
Quarter Unloaded  = .10  = .10  = .50  = .50
1
For 180
= .10 175 5.00 175 5.00
2 168 = 82.45/8
175.5 = 10.31
7.50 177.50 9.50
3 159 174.75 15.75 172.75 13.75
4 For 175
= .50 173.18 1.82 165.88 9.12
5 190 173.36 16.64 170.44 19.56
6 205 = 98.62/8
175.02 = 12.33
29.98 180.22 24.78
7 180 178.02 1.98 192.61 12.61
8 182 178.22 3.78 186.30 4.30
82.45 98.62

4 - 55

Comparison of Forecast
Error2
∑ (forecast errors)
Rounded Absolute Rounded Absolute
MSE = Actual Forecast Deviation Forecast Deviation
Tonnage
n
with for with for
Quarter Unloaded  = .10  = .10  = .50  = .50
1
For 180
= .10 175 5.00 175 5.00
2 = 1,526.54/8 = 190.82
168 175.5 7.50 177.50 9.50
3 159 174.75 15.75 172.75 13.75
4 For  = .50 173.18
175 1.82 165.88 9.12
5 190 173.36 16.64 170.44 19.56
6 = 1,561.91/8
205 175.02 = 195.24
29.98 180.22 24.78
7 180 178.02 1.98 192.61 12.61
8 182 178.22 3.78 186.30 4.30
82.45 98.62
MAD 10.31 12.33

4 - 56

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Comparison of Forecast
n Error
∑100|deviationi|/actuali
Rounded Absolute Rounded Absolute
MAPE = i=1
Actual Forecast Deviation Forecast Deviation
Tonnage with n for with for
Quarter Unloaded  = .10  = .10  = .50  = .50
1
 = .10 175
For 180 5.00 175 5.00
2 168 = 44.75/8
175.5 = 7.50
5.59% 177.50 9.50
3 159 174.75 15.75 172.75 13.75
4  = .50 173.18
For 175 1.82 165.88 9.12
5 190 173.36 16.64 170.44 19.56
6 205 = 54.05/8
175.02 =29.98
6.76% 180.22 24.78
7 180 178.02 1.98 192.61 12.61
8 182 178.22 3.78 186.30 4.30
82.45 98.62
MAD 10.31 12.33
MSE 190.82 195.24
4 - 57

Comparison of Forecast
Error
Rounded Absolute Rounded Absolute
Actual Forecast Deviation Forecast Deviation
Tonnage with for with for
Quarter Unloaded  = .10  = .10  = .50  = .50
1 180 175 5.00 175 5.00
2 168 175.5 7.50 177.50 9.50
3 159 174.75 15.75 172.75 13.75
4 175 173.18 1.82 165.88 9.12
5 190 173.36 16.64 170.44 19.56
6 205 175.02 29.98 180.22 24.78
7 180 178.02 1.98 192.61 12.61
8 182 178.22 3.78 186.30 4.30
82.45 98.62
MAD 10.31 12.33
MSE 190.82 195.24
MAPE 5.59% 6.76%
4 - 58

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Exponential Smoothing with

Trend Adjustment
When a trend is present, exponential
smoothing must be modified

4 - 59

Exponential Smoothing with

Trend Adjustment
(Holt’s method)
St = Dt + (1 - )(St - 1 + Gt - 1)
Gt = b(St - St - 1) + (1 - b)Gt - 1

Step 1: Compute St
Step 2: Compute Gt
Step 3: Calculate the forecast Ft,t+x = St + xGt

4 - 60

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Exponential Smoothing with

Trend Adjustment Example
35 –

30 – Actual demand (At)

Product demand

25 –

20 –

15 –

10 – Forecast including trend (FITt)

with  = .2 and b = .4
5 –

0 – | | | | | | | | |
1 2 3 4 5 6 7 8 9
Figure 4.3
Time (month)
4 - 61

Trend Projections
Fitting a trend line to historical data points
to project into the medium to long-range
Linear trends can be found using the least
squares technique

y^ = a + bx
^ = computed value of the variable to
where y
be predicted (dependent variable)
a = y-axis intercept
b = slope of the regression line
x = the independent variable

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Least Squares Method

Values of Dependent Variable
Actual observation Deviation7
(y-value)

Deviation5 Deviation6

Deviation3

Deviation4

Deviation1
(error) Deviation2
Trend line, y^ = a + bx

Time period Figure 4.4

4 - 63

Least Squares Method

Values of Dependent Variable

Actual observation Deviation7

(y-value)

Deviation5 Deviation6

Deviation3 Least squares method

minimizes the sum of the
Deviation
squared errors (deviations)
4

Deviation1
(error) Deviation2
Trend line, y^ = a + bx

Time period Figure 4.4

4 - 64

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Least Squares Method

Equations to calculate the regression variables

y^ = a + bx

Sxy - nxy
b=
Sx2 - nx2

a = y - bx

4 - 65

Least Squares Example

Time Electrical Power
Year Period (x) Demand x2 xy
2003 1 74 1 74
2004 2 79 4 158
2005 3 80 9 240
2006 4 90 16 360
2007 5 105 25 525
2008 6 142 36 852
2009 7 122 49 854
∑x = 28 ∑y = 692 ∑x2 = 140 ∑xy = 3,063
x=4 y = 98.86

∑xy - nxy 3,063 - (7)(4)(98.86)

b= = = 10.54
∑x2 - nx2 140 - (7)(42)

a = y - bx = 98.86 - 10.54(4) = 56.70

4 - 66

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Least Squares Example

Time Electrical Power
Year Period (x) Demand x2 xy
2003 1 74 1 74
2004 2 79 4 158
2005The trend
3 line is 80 9 240
2006 4 90 16 360
2007 y^ 5= 56.70 + 10.54x
105 25 525
2008 6 142 36 852
2009 7 122 49 854
∑x = 28 ∑y = 692 ∑x2 = 140 ∑xy = 3,063
x=4 y = 98.86

∑xy - nxy 3,063 - (7)(4)(98.86)

b= = = 10.54
∑x2 - nx2 140 - (7)(42)

a = y - bx = 98.86 - 10.54(4) = 56.70

4 - 67

Least Squares Example

160 –
Trend line,
150 – y^ = 56.70 + 10.54x
140 –
Power demand

130 –
120 –
110 –
100 –
90 –
80 –
70 –
60 –
50 –
| | | | | | | | |
2003 2004 2005 2006 2007 2008 2009 2010 2011
Year
4 - 68

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Seasonal Variations In Data

The multiplicative
seasonal model
can adjust trend
data for seasonal
variations in
demand

4 - 70

Seasonal Variations In Data

Steps in the process:
1. Find average historical demand for each season
2. Compute the average demand over all seasons
3. Compute a seasonal index for each season
4. Estimate next year’s total demand
5. Divide this estimate of total demand by the
number of seasons, then multiply it by the
seasonal index for that season

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Seasonal Index Example

Demand Average Average Seasonal
Month 2007 2008 2009 2007-2009 Monthly Index
Jan 80 85 105 90 94
Feb 70 85 85 80 94
Mar 80 93 82 85 94
Apr 90 95 115 100 94
May 113 125 131 123 94
Jun 110 115 120 115 94
Jul 100 102 113 105 94
Aug 88 102 110 100 94
Sept 85 90 95 90 94
Oct 77 78 85 80 94
Nov 75 72 83 80 94
Dec 82 78 80 80 94
4 - 72

Seasonal Index Example

Demand Average Average Seasonal
Month 2007 2008 2009 2007-2009 Monthly Index
Jan 80 85 105 90 94 0.957
Feb 70 85 85 80 94
Mar 80 93 Average
82 85 monthly 94
2007-2009 demand
Seasonal
Apr 90index =
95 115 Average monthly
100 demand94
May 113 125 131 123 94
= 90/94 = .957
Jun 110 115 120 115 94
Jul 100 102 113 105 94
Aug 88 102 110 100 94
Sept 85 90 95 90 94
Oct 77 78 85 80 94
Nov 75 72 83 80 94
Dec 82 78 80 80 94
4 - 73

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Seasonal Index Example

Demand Average Average Seasonal
Month 2007 2008 2009 2007-2009 Monthly Index
Jan 80 85 105 90 94 0.957
Feb 70 85 85 80 94 0.851
Mar 80 93 82 85 94 0.904
Apr 90 95 115 100 94 1.064
May 113 125 131 123 94 1.309
Jun 110 115 120 115 94 1.223
Jul 100 102 113 105 94 1.117
Aug 88 102 110 100 94 1.064
Sept 85 90 95 90 94 0.957
Oct 77 78 85 80 94 0.851
Nov 75 72 83 80 94 0.851
Dec 82 78 80 80 94 0.851
4 - 74

Seasonal Index Example

Demand Average Average Seasonal
Month 2007 2008 2009 2007-2009 Monthly Index
Jan 80 85 105 90 94 0.957
Feb 70 85 Forecast
85 for802010 94 0.851
Mar 80 93 82 85 94 0.904
Apr 90Expected
95 115annual demand
100 = 1,200
94 1.064
May 113 125 131 123 94 1.309
Jun 110 115 120 1,200 115 94 1.223
Jul Jan
100 102 113 12 x .957
105 = 96 94 1.117
Aug 88 102 110 100 94 1.064
1,200
Sept 85 90
Feb 95 x90
.851 = 85 94 0.957
Oct 77 78 85 12 80 94 0.851
Nov 75 72 83 80 94 0.851
Dec 82 78 80 80 94 0.851
4 - 75

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Seasonal Index Example

2010 Forecast
140 – 2009 Demand
130 – 2008 Demand
2007 Demand
120 –
Demand

110 –
100 –
90 –
80 –
70 –
| | | | | | | | | | | |
J F M A M J J A S O N D
Time
4 - 76

San Diego Hospital

Trend Data
10,200 –

10,000 –
Inpatient Days

9,800 – 9745
9659
9702
9573 9616 9766
9,600 – 9530 9680 9724
9594 9637
9,400 – 9551

9,200 –

9,000 – | | | | | | | | | | | |
Jan Feb Mar Apr May June July Aug Sept Oct Nov Dec
67 68 69 70 71 72 73 74 75 76 77 78
Month
Figure 4.6
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San Diego Hospital

Seasonal Indices
1.06 –
1.04
Index for Inpatient Days

1.04
1.04 – 1.03
1.02
1.02 – 1.01
1.00
1.00 – 0.99
0.98
0.98 – 0.99
0.96 – 0.97 0.97
0.96
0.94 –
0.92 – | | | | | | | | | | | |
Jan Feb Mar Apr May June July Aug Sept Oct Nov Dec
67 68 69 70 71 72 73 74 75 76 77 78
Month
Figure 4.7
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San Diego Hospital

Combined Trend and Seasonal Forecast
10,200 –
10068
10,000 – 9911 9949
Inpatient Days

9,800 – 9764 9724

9691
9,600 – 9572

9,400 – 9520 9542

9411
9265 9355
9,200 –

9,000 – | | | | | | | | | | | |
Jan Feb Mar Apr May June July Aug Sept Oct Nov Dec
67 68 69 70 71 72 73 74 75 76 77 78
Month
Figure 4.8
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Associative Forecasting

Used when changes in one or more

independent variables can be used to predict
the changes in the dependent variable

Most common technique is linear

regression analysis

We apply this technique just as we did

in the time series example

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Associative Forecasting
Forecasting an outcome based on
predictor variables using the least squares
technique
y^ = a + bx
^
where y = computed value of the variable to
be predicted (dependent variable)
a = y-axis intercept
b = slope of the regression line
x = the independent variable thought to
predict the value of the dependent
variable
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Associative Forecasting
Example
Sales Area Payroll
($ millions), y ($ billions), x
2.0 1
3.0 3
2.5 4 4.0 –
2.0 2
2.0 1 3.0 –

Sales
3.5 7
2.0 –

1.0 –

| | | | | | |
0 1 2 3 4 5 6 7
Area payroll
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Associative Forecasting
Example
Sales, y Payroll, x x2 xy
2.0 1 1 2.0
3.0 3 9 9.0
2.5 4 16 10.0
2.0 2 4 4.0
2.0 1 1 2.0
3.5 7 49 24.5
∑y = 15.0 ∑x = 18 ∑x2 = 80 ∑xy = 51.5

∑xy - nxy 51.5 - (6)(3)(2.5)

x = ∑x/6 = 18/6 = 3 b=
∑x2 - nx2
= 80 - (6)(32)
= .25

y = ∑y/6 = 15/6 = 2.5 a = y - bx = 2.5 - (.25)(3) = 1.75

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Associative Forecasting
Example
y^ = 1.75 + .25x Sales = 1.75 + .25(payroll)

If payroll next year

4.0 –
is estimated to be
$6 billion, then: 3.25
3.0 –

Nodel’s sales
2.0 –
Sales = 1.75 + .25(6)
Sales = $3,250,000 1.0 –

| | | | | | |
0 1 2 3 4 5 6 7
Area payroll

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Standard Error of the

Estimate
 A forecast is just a point estimate of a
future value
 This point is 4.0 –
actually the 3.25
mean of a 3.0 –
Nodel’s sales

probability 2.0 –
distribution
1.0 –

| | | | | | |
0 1 2 3 4 5 6 7
Area payroll
Figure 4.9

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Standard Error of the

Estimate

∑(y - yc)2
Sy,x =
n-2

where y = y-value of each data point

yc = computed value of the dependent
variable, from the regression
equation
n = number of data points

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Standard Error of the

Estimate
Computationally, this equation is
considerably easier to use

∑y2 - a∑y - b∑xy

Sy,x =
n-2

We use the standard error to set up

prediction intervals around the
point estimate

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Standard Error of the

Estimate
∑y2 - a∑y - b∑xy 39.5 - 1.75(15) - .25(51.5)
Sy,x = =
n-2 6-2

Sy,x = .306 4.0 –

3.25
3.0 –

Nodel’s sales
The standard error
2.0 –
of the estimate is
$306,000 in sales 1.0 –

| | | | | | |
0 1 2 3 4 5 6 7
Area payroll

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Correlation
 How strong is the linear
relationship between the variables?
 Correlation does not necessarily
imply causality!
 Coefficient of correlation, r,
measures degree of association
 Values range from -1 to +1

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Correlation Coefficient
nSxy - SxSy
r=
[nSx2 - (Sx)2][nSy2 - (Sy)2]

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y y
Correlation Coefficient
nSxy - SxSy
r=
[nSx2 - (Sx)2][nSy2 - (Sy)2]
(a) Perfect positive x x
(b) Positive
correlation: correlation:
r = +1 0<r<1

y y

(c) No correlation: x (d) Perfect negative x

r=0 correlation:
r = -1 4 - 91

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Correlation
 Coefficient of Determination, r2,
measures the percent of change in
y predicted by the change in x
 Values range from 0 to 1
 Easy to interpret

For the Nodel Construction example:

r = .901
r2 = .81
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Multiple Regression
Analysis
If more than one independent variable is to be
used in the model, linear regression can be
extended to multiple regression to
accommodate several independent variables

y^ = a + b1x1 + b2x2 …

Computationally, this is quite

complex and generally done on the
computer
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REFERENCES
• Heizer j., & Render, B., Operations Management,
Pearson
• Stevenson, W.J., Operations Management,
McGraw-Hill.

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