Operations Management

Forecasting
Models & Their Applications
 Forecasting: Models and Applications

Lecture Outline

 Definitions of forecasting
 Roles of Forecasting and applications
 Components of Forecasting Demand
 List the elements of a good forecast
 The steps in the forecasting process
Operations Management

 Compare and contrast qualitative and

quantitative approaches to forecasting
 Advantages and disadvantages of each
 Time Series Methods
 Forecast Accuracy
 Time Series Forecasting Using Excel (if possible)
 Regression Methods
 Forecasting: Models and Applications

Forecasting ?

Forecasting
• Predicting the future based on the historical data.

• A statement about the future value of a variable of interest

such as demand.

• Forecasting is used to make informed decisions.

Operations Management

- Long-range

- Short-range

 It is the basis for budgeting, planning capacity, sales,

production and inventory, personnel, purchasing, and more.
Forecasts play an important role in the planning process to
anticipate the future plan accordingly.
 Forecasting: Models and Applications

Types of Forecasting

Two main methods:

Qualitative forecast methods
- subjective
Quantitative forecast methods
- based on mathematical formulas
Another distinction consists of:
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Data based - expecting that history repeats itself in a certain

way; usually given in the form of a time series, a
chronological sequence of observed data with respect to a
certain variable.

Theory based - where the external factors determine events.

 Forecasting: Models and Applications

Uses of Forecasting

Decisions and activities throughout an organization

Accounting Cost/profit estimates

Finance Cash flow and funding

Human Resources Hiring/recruiting/training

Operations Management

Marketing Pricing, promotion, strategy

MIS IT/IS systems, services

Operations Schedules, MRP, workloads

Product/service design New products and services

 Forecasting: Models and Applications

Features of Forecasting

• Assumes causal system

Past => Present => Future

• Forecasts rarely perfect because of randomness

• Forecasts more accurate for groups vs. individuals

Operations Management

• Forecast accuracy decreases as time horizon increases

Elements of a
Good Forecast I see that you will
Timely get an A this semester.

Reliable Accurate

Written
 Forecasting: Models and Applications

Types of Forecasting Methods

Depend on
• time frame
• demand behavior
• causes of behavior

Time Frame
Operations Management

Indicates how far into the future is forecast

• Short- to mid-range forecast

• typically encompasses the immediate future

• daily up to two years

• Long-range forecast

• usually encompasses a period of time longer

than two years
 Forecasting: Models and Applications

Types of Forecasting Methods

Demand Behavior
 Trend

• a gradual, long-term up or down movement of

demand

 Random variations
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• movements in demand that do not follow a pattern

 Cycle

• an up-and-down repetitive movement in demand

 Seasonal pattern

• an up-and-down repetitive movement in demand

occurring periodically
 Forecasting: Models and Applications

Types of Forecasting Methods

Demand Behavior

Demand
Demand

Random
movement
Operations Management

Time Time
(a) Trend (b) Cycle

Demand
Demand

Time Time
(c) Seasonal pattern (d) Trend with seasonal pattern
 Forecasting: Models and Applications

Types of Forecasting Methods

Regular Behavior
 Time series

• statistical techniques that use historical demand

data to predict future demand

 Regression methods
Operations Management

• attempt to develop a mathematical relationship

between demand and factors that cause its behavior

 Qualitative

• use management judgment, expertise, and opinion

to predict future demand
 Forecasting: Models and Applications

Steps of Forecasting Technique

“The forecast”
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Step 6 Monitor the forecast

Step 5 Make the forecast
Step 4 Obtain, clean and analyze data
Step 3 Select a forecasting technique

Step 2 Establish a time horizon

Step 1 Determine purpose of forecast
 Forecasting: Models and Applications

Steps of Forecasting Technique

1. Identify the 2. Collect 3. Plot data and

purpose of forecast historical data identify patterns

6. Check forecast 5. Develop/compute 4. Select a forecast

accuracy with one forecast for period model that seems
or more measures of historical data appropriate for data
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7.
Is accuracy No 8b. Select new
of forecast
forecast model or
acceptable?
adjust parameters
of existing model

Yes
9. Adjust forecast
based on additional 10. Monitor results
8a. Forecast over
qualitative information and measure
planning horizon
and insight forecast accuracy

Copyright 2011 John Wiley & Sons, Inc.

 Forecasting: Models and Applications

Forecasting Techniques

 Judgmental

- uses subjective inputs for qualitative methods

 Time series

- uses historical data assuming the future will be like

Operations Management

the past or present data

 Associative models

- uses explanatory variables to predict the future

 Forecasting: Models and Applications

Forecasting Techniques

Opinion and Judgmental Methods

Forecasts are largely intuitive, whereas others integrate data

and perhaps even mathematical or statistical techniques.

Judgmental forecasts consist of:

 forecasts by experts in the same field,
Operations Management

 forecasts by individual sales people,

 forecasts by division or product-line managers,
 consumer surveys,
 outside/ external experts or technical reports

Historical analogy relies on comparisons; Delphi method

o Opinions of managers and staff
o Achieves a consensus forecast
 Forecasting: Models and Applications

Forecasting Techniques

Time series Analysis

 A time series is a set of observations of a variable at
regular intervals over time.
 Assume that what has occurred in the past will continue
to occur in the future.
 Components of a time series are generally classified as
Operations Management

trend T, cyclical C, seasonal S, and random or irregular R.

 Time series analysis includes:
• moving average
• exponential smoothing
• linear trend line
 Data are tabulated or graphed to show the nature of the
time dependence.
 Forecasting: Models and Applications

Forecasting Techniques

Time series forecasting procedure

Following are the steps in time series forecasting:

1. Plot historical data to confirm relationship (e.g.,

linear, exponential, logarithmic etc).
2. Develop a trend equation (T ) to describe the data.
Operations Management

3. Develop a seasonal index (e.g., monthly index values).

4. Project trend into the future (e.g., monthly trend values).
5. Multiply trend values by corresponding seasonal
index values.
6. Modify projected values by any knowledge of:
• Cyclical business conditions (C) ,
• Anticipated irregular effects (R) .
 Forecasting: Models and Applications

Forecasting Techniques

Naïve Forecasts

 The forecast for any period equals the previous period’s

actual value.
 Demand in current period is used as next period’s
forecast
Uh, give me a minute....
Operations Management

Why Naïve Forecasts ? We sold 250 wheels last week....

Now, next week we should
 Simple to use sell.... 250???
 Virtually no cost
 Quick and easy to prepare
 Data analysis is nonexistent
 Easily understandable
 Cannot provide high accuracy
 Can be a standard for accuracy
 Forecasting: Models and Applications

Forecasting Techniques

Naïve Forecasts ORDERS

Month Per Month Forecast
Mathematical formula
Jan 120 -
used in Naïve:
Feb 90 120
Mar 100 90
• Stable time series
data Apr 75 100
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F (t ) = A (t -1) May 110 75

June 50 110
July 75 50
• Seasonal variations
F (t ) = A (t – n ) Aug 130 75
Sept 110 130

• Data with trends Oct 90 110

F (t ) = A ( t - 1) + Nov - ?? 90
(A (t -1) – A(t – 2 ))
 Forecasting: Models and Applications

Forecasting Techniques

Trend Technique

Three methods for describing trend are:

1. Moving average,
2. Hand fitting, and
3. Least squares.
Operations Management

Moving Average Method:

A centered moving average is obtained by summing and
averaging the values from a given number of periods
repetitively, each time deleting the oldest value and adding
a new value.
Moving averages can smooth out fluctuations in any data,
while preserving the general pattern of the.
 Forecasting: Models and Applications

Forecasting Techniques
Moving Average Method Cont…

The generalized formula for moving average method is:

𝒙
𝑴𝑨 =
Number of Period

Techniques for Averaging

Operations Management

 Moving average / simple moving average

 Weighted moving average

 Exponential smoothing
– Averaging method
– Weights most recent data more strongly
– Reacts more to recent changes
– Widely used, accurate method
 Forecasting: Models and Applications

Forecasting Techniques

Simple Moving average

A technique that averages a number of recent actual

values, updated as new values become available.

n where

Di n = number of periods
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i=1
in the moving
MAn = average
n
Di = demand in period i

Or,
At-n + … At-2 + At-1
Ft = MAn=
n
 Forecasting: Models and Applications

Forecasting Techniques

3-month Simple Moving Average

Orders Moving
Month Per Month Average 3
 Di
Jan 120 – i=1
Feb 90 – MA3 =
3
Operations Management

Mar 100 –
Apr 75 103.3
May 110 88.3 90 + 110 + 130
=
June 50 95.0 3
July 75 78.3
Aug 130 78.3 = 110 orders for Nov
Sept 110 85.0
Oct 90 105.0
Nov - 110.0
 Forecasting: Models and Applications

Forecasting Techniques

5-month Simple Moving Average

Orders Moving
Month Per Month Average 5
 Di
Jan 120 –
– MA5 = i = 1
Feb 90 5
Mar 100 –
Operations Management

Apr 75 – 90 + 110 + 130+75+50

=
May 110 – 5
June 50 99.0
85.0 = 91 orders for Nov
July 75
Aug 130 82.0
Sept 110 88.0
Oct 90 95.0
Nov - 91.0
 Forecasting: Models and Applications

Forecasting Techniques

Effect of 3-month and 5-month moving average

150 –

125 – 5-month

100 –
Orders
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75 –

50 – 3-month

Actual
25 –

0– | | | | | | | | | | |
Jan Feb Mar Apr May June July Aug Sept Oct Nov
Month
 Forecasting: Models and Applications

Forecasting Techniques

Weighted Moving Average

 More recent values in a series are given more weight in
computing the forecast.
 Adjusts moving average method to more closely reflect
data fluctuations
Operations Management

n
WMAn =  Wi Di Ft = WMAn=
i=1
wnAt-n + … wn-1At-2 + w1At-1
where
n
Wi = the weight for period i,
between 0 and 100 %
 Wi = 1.00
 Forecasting: Models and Applications

Forecasting Techniques

Example: Weighted Moving Average

MONTH WEIGHT DATA

August 17% 130

September 33% 110
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October 50% 90

3
November Forecast WMA3 = 
i=1
W D i i

= (0.50)(90) + (0.33)(110) + (0.17)(130)

= 103.4 orders
 Forecasting: Models and Applications

Forecasting Techniques

Example: Weighted Moving Average

Shipments (in tons) of welded tube by an aluminum producer
are shown below:
Operations Management

a) Graph the data, and comment on the relationship.

b) Compute a 3-year moving average, plot it as a dotted
line, and use it to forecast shipments in year 12.
c) Using a weight of 3 for the most recent data, 2 for
the next, and 1 for the oldest, forecast shipments in
year 12.

Ref. Operations management, A. Kumar and N. Suresh, New Age, pp. 108-109
 Forecasting: Models and Applications

Forecasting Techniques
The data are plotted as shown:
Example: WMA Cont…

Solution:
Year Shipments 3-y moving
average
1 2 -
2 3 3.7
3 6 6.3
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4 10 8.0
5 8 8.3 The MA forecast for year 12 would be
that of the latest average, 17.0 tons.
6 7 9.0
7 12 11.0 Moving average:
8 14 13.3
9 14 15.3
10 18 17.0
11 19 - = 17.8 tons
 Forecasting: Models and Applications

Forecasting Techniques
Exponential Smoothing
The equation used for forecast for next period is:
𝑭𝒕+𝟏 = 𝜶𝑫𝒕 + 𝟏 − 𝜶 𝑭𝒕
where:
Ft +1 = forecast for next period
Dt = actual demand for present period
Ft = previously determined forecast for present period
Operations Management

𝜶 = weighting factor, smoothing constant

Effect of Smoothing Constant

0.0  1.0

If = 0.20, then Ft +1 = 0.20 Dt + 0.80 Ft If = 0, then Ft +1 = 0 Dt + 1 Ft = Ft
Forecast does not reflect recent data

If = 1, then Ft +1 = 1 Dt + 0 Ft = Dt ; Forecast based only on most recent data

 Forecasting: Models and Applications

Forecasting Techniques
Example: Exponential Smoothing

Period Month Demand Letting,  =0.30

1 Jan 37 F2 = D1 + (1 - )F1
2 Feb 40
= (0.30)(37) + (0.70)(37)
3 Mar 41
= 37
4 Apr 37
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5 May 45 F3 = D2 + (1 - )F2

6 Jun 50 = (0.30)(40) + (0.70)(37)
7 Jul 43 = 37.9
8 Aug 47 and so on. Similarly …
9 Sep 56
10 Oct 52 F13 = D12 + (1 - )F12
11 Nov 55 = (0.30)(54) + (0.70)(50.84)
12 Dec 54 = 51.79
 Forecasting: Models and Applications

Forecasting Techniques
Example: Exponential Smoothing
Forecast, Ft + 1
Period Month Demand ( = 0.3) ( = 0.5)
1 Jan 37 – –
2 Feb 40 37.00 37.00
3 Mar 41 37.90 38.50
4 Apr 37 38.83 39.75
Operations Management

5 May 45 38.28 38.37

6 Jun 50 40.29 41.68
7 Jul 43 43.20 45.84
8 Aug 47 43.14 44.42
9 Sep 56 44.30 45.71
10 Oct 52 47.81 50.85
11 Nov 55 49.06 51.42
12 Dec 54 50.84 53.21
13 Jan – 51.79 53.61
 Forecasting: Models and Applications

Forecasting Techniques

70 –

60 – Actual  = 0.50

50 –

40 –
Operations Management

Orders

 = 0.30
30 –

20 –

10 –

0– | | | | | | | | | | | | |
1 2 3 4 5 6 7 8 9 10 11 12 13
Month
 Forecasting: Models and Applications

Forecasting Techniques

Common Nonlinear Trends

Parabolic
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Exponential

Growth
 Forecasting: Models and Applications

Forecasting Techniques
Linear Trend Line

The generalized equation

𝒙𝒚 − 𝒏. 𝒙. 𝒚
𝒃=
𝒙𝟐 − 𝒏𝒙𝟐
y = a + bx

Where, 𝒂 = 𝒚 − 𝒃𝒙
Operations Management

a = intercept where
n = number of periods
b = slope of the line 𝒙
𝒙= = mean of the x values
x = time period 𝒏
𝒚
y = forecast for 𝒚= = mean of the y values
𝒏
demand for period x
 Forecasting: Models and Applications

Forecasting Techniques 𝟓𝟓𝟕

𝟕𝟖
𝒙= = 𝟔. 𝟓 𝒚= = 𝟒𝟔. 𝟒𝟐
Example: Linear Trend Line 𝟏𝟐 𝟏𝟐
x(Period) y(Demand) xy x2 𝒙𝒚−𝒏.𝒙.𝒚
𝒃= = 1.72
1 73 37 1 𝒙𝟐 −𝒏𝒙𝟐
2 40 80 4 𝒂 = 𝒚 − 𝒃𝒙
3 41 123 9 = 𝟒𝟔. 𝟒𝟐 − 𝟏. 𝟕𝟐 × 𝟔. 𝟓 = 𝟑𝟓. 𝟐

4 37 148 16 Linear trend line y = 35.2 + 1.72x

5 45 225 25
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Forecast for period 13, y = 57.56 units

6 50 300 36
7 43 301 49
8 47 376 64
9 56 504 81
10 52 520 100
11 55 605 121
12 54 648 144
78 557 3867 650
 Forecasting: Models and Applications

Forecasting Techniques
Regression Method

 Linear regression
• mathematical technique that relates a dependent
variable to an independent variable in the form of a
linear equation

 Correlation
Operations Management

• a measure of the strength of the relationship between

independent and dependent variables

Linear Regression
The generalized equation, y = a + bx
Where, a = intercept, b = slope of the line, x = time
period, and y = forecast for demand for period x
𝒙𝒚 − 𝒏. 𝒙. 𝒚
𝒂 = 𝒚 − 𝒃𝒙 𝒃= n = number of periods
𝒙𝟐 − 𝒏𝒙𝟐
 Forecasting: Models and Applications

Forecasting Techniques
Example: Linear Regression

X Y xy x2 From data,
wins attendance 𝒙 = 𝟔. 𝟏𝟐𝟓 𝒚 = 𝟒𝟑. 𝟑𝟔
4 36.3 145.2 16 𝒂 = 𝟏𝟖. 𝟒𝟔
𝒃 = 𝟒. 𝟎𝟔
6 40.1 240.6 36
Operations Management

6 41.2 247.2 36

8 53.0 424.0 64

6 44.0 264.0 36

7 45.6 319.2 49

5 39.0 195.0 25

7 47.5 332.5 49

49 346.7 2167.7 311

 Forecasting: Models and Applications

Forecasting Techniques

Correlation

 Correlation, r

• Measure of strength of relationship

• Varies between -1.00 and +1.00

 Coefficient of determination, r2
Operations Management

• Percentage of variation in dependent variable resulting

from changes in the independent variable

Computing coefficient of correlation:

n xy -  x y
r=
[n x2 - ( x)2] [n y2 - ( y)2]

(8)(2,167.7) - (49)(346.9)
r= =0.947
[(8)(311) - (49)2] [(8)(15,224.7) - (346.9)2]
 Forecasting: Models and Applications

Forecasting Techniques

Multiple Regression
Study the relationship of demand to two or more independent
variables

The relationship is expressed as:

y = 0 + 1x1 + 2x2 … + kxk

Operations Management

where
0 = the intercept
1, … , k = parameters for the independent variables
x1, … , xk = independent variables
 Forecasting: Models and Applications

Forecasting Techniques

Multiple Regression
Operations Management

r2, the coefficient

of determination

Regression equation y = 19,094.42 + 3560.99 x1 + .0368 x2

coefficients for x1 and x2 y = 19,094.42 + 3560.99 (7) + .0368 (60,000)
= 46,229.35
 Forecasting: Models and Applications

Forecasting Techniques
Seasonal Adjustments
• Repetitive increase/ decrease in demand
• Use seasonal factor to adjust forecast
21.9
Di 𝑆3 = = 0.15
Seasonal factor = Si = 148.7
D
55.3
𝑆4 = = 0.37
Operations Management

148.7
year Demand ( in 1000 units)
1 2 3 4 For 2005
y = 40.97 + 4.30x =
2002 12.686 6.3 17.5 45.0
40.97 + 4.30(4) = 58.17
2003 14.110 7.5 18.2 50.1
SF1 = (S1) (F5) = (0.28)(58.17) = 16.28
2004 15.31 8.1 19.6 53.6
Total 42.029 21.9 55.3 148.7 SF2 = (S2) (F5) = (0.20)(58.17) = 11.63
SF3 = (S3) (F5) = (0.15)(58.17) = 8.73
𝐷1 42.029
𝑆1 = = = 0.28 𝑆2 = 0.20 SF4 = (S4) (F5) = (0.37)(58.17) = 21.53
𝐷 148.7
 Forecasting: Models and Applications

Forecasting Techniques
Exponentially Smoothing using Excel

=B5*(C11-C10)+
(1-B5)*D10

=C10+D10
Operations Management

=ABS(B10-E10)

=SUM(F10:F20)

=G22/11
 Forecasting: Models and Applications

Forecasting Techniques

Click on “Insert” then “Line”

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 Forecasting: Models and Applications

Forecasting Techniques

=INTERCEPT(B5:B12,A5:A12)
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=SUM(B5:B12) =CORREL(B5:B12,A5:A12)
 Forecasting: Models and Applications

Forecasting Techniques
Operations Management
 Forecasting: Models and Applications

Choosing Forecasting Tech

 No single technique works in every situation
 Two most important factors
o Cost and Accuracy
 Other factors include the availability of:
 Historical data
 Computers
 Time needed to gather and analyze the data
Operations Management

 Forecast horizon
 Forecasts are the basis for many decisions
 Work to improve short-term forecasts
 Accurate short-term forecasts improve
• Profits
• Lower inventory levels
• Reduce inventory shortages
• Improve customer service levels
• Enhance forecasting credibility
 Forecasting: Models and Applications

Effect of Bad Forecasting

Operations Management