Forecasting

भारतीय प्रबंधन संस्थान शिलांग

Indian Institute of Management Shillong
Forecasting
➢ What is forecasting?

➢ Why forecasting is needed?

➢ What kind of strategic role play the forecasting in

supply chain management?

➢ Which forecasting method is best suited for various

type of organization?

➢ How much accurate is the given forecast?

भारतीय प्रबंधन संस्थान शिलांग

3 October
2022
Continues…
Forecast is a prediction of what will occur in the future.
Hopefully, the forecast will reduce uncertainty about the future
as much as possible, but it will never eliminate uncertainty.
A forecast of product demand is the basis for most important
planning decisions.
Planning decisions regarding—
• scheduling,
• inventory,
• production,
• facility layout and design,
• workforce,
• distribution,
• purchasing, etc.

भारतीय प्रबंधन संस्थान शिलांग

3 October
2022
Why forecasting is important?
• Forecasts serve as a basis for
planning
• Enable managers to anticipate
the future to plan the system
and plan the use of that system
• Forecasting is more than
predicting demand
• It is not an exact science; one
must blend experience,
judgment, and technical
expertise

भारतीय प्रबंधन संस्थान शिलांग

3 October
2022
Strategic role of forecasting
In today’s global business environment, strategic planning and design
tend to focus on supply chain management and quality management.
Supply chain management
• Forecasts of product demand determine how much inventory is
needed, how much product to make, and how much material to
purchase from suppliers to meet forecasted customer needs.
• The distortion of information (bullwhip effect) about product
demand (including forecasts) as it is transmitted up the supply chain
back toward suppliers is serious problem with respect to demand
forecast.
• Ideally, a single forecast of demand for the final customer in the
supply chain would drive the development of subsequent forecasts
for each supply chain member back up through the supply chain.
• One trend in supply chain design is continuous replenishment,
wherein continuous updating of data is shared between suppliers
and customers.

भारतीय प्रबंधन संस्थान शिलांग

3 October
2022
Continues…
Total Quality Management
• An inaccurate forecast causes service to break down, resulting
in poor quality.
• For manufacturing operations, especially for suppliers,
customers expect parts to be provided when demanded.
• Accurately forecasting customer demand is a crucial part of
providing the high-quality service.
• Example: When customers walk into a McDonald’s to order a
meal, they do not expect to wait long to place orders.

भारतीय प्रबंधन संस्थान शिलांग

3 October
2022
Types of Forecasting
Depend on

➢ time frame

➢ demand behavior

भारतीय प्रबंधन संस्थान शिलांग

3 October
2022
Time Frame

Indicates how far into the future is

forecast
▪ Short- to mid-range forecast
• typically encompasses the
immediate future
• daily up to some months
▪ Long-range forecast
• usually encompasses a
period of time longer in
years

भारतीय प्रबंधन संस्थान शिलांग

3 October
2022
Demand Behavior
Trend
• a gradual, long-term up or down
movement of demand
Random variations
• 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

भारतीय प्रबंधन संस्थान शिलांग

3 October
2022
Common features for All forecasts
• Errors occur-- actual differs from predicted; presence of
randomness
• Assumption that past continues into future
• Forecasts of group of items (aggregate) tends to be more
accurate than individual items
• Forecast accuracy decreases as time horizon increases

भारतीय प्रबंधन संस्थान शिलांग

3 October
2022
Characteristics of a Good Forecast
• Timely

• Reliable

• Accurate

• Meaningful units

• Easy to use

भारतीय प्रबंधन संस्थान शिलांग

3 October
2022
Forecasting Process
1. Identify the purpose 2. Collect historical data 3. Plot data and identify
of forecast patterns

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

accuracy with one or forecast for period of model that seems
more measures historical data appropriate for data

7.
Is accuracy of No 8b. Select new forecast
forecast model or adjust
acceptable? parameters of existing
model
Yes
9. Adjust forecast based 10. Monitor results and
8a. Forecast over
on additional qualitative measure forecast
planning horizon
information and insight accuracy

भारतीय प्रबंधन संस्थान शिलांग

3 October
2022
Forecasting Methods
Forecasting methods are classified into two groups:
Qualitative methods Quantitative methods

Characteristics Based on human judgement, opinions; Based on mathematical formulas

subjective in nature

Strengths Can incorporate latest changes in the Consistent and objective; able to
business environment and “inside consider much information and data at
information” one time

Weaknesses Can bias the forecast and reduce forecast Often quantifiable data are not available.
accuracy Only as the data on which they are based

भारतीय प्रबंधन संस्थान शिलांग

3 October
2022
Qualitative methods
• Executive opinions
• Sales-force opinions Decision Makers
• Consumer surveys (Evaluate
responses and
• Delphy method make decisions)

Staff
(Administering
survey)

Respondents
(People who can
make valuable
judgments)
भारतीय प्रबंधन संस्थान शिलांग
3 October
2022
Quantitative Methods
Time Series Models:
❑ Assumes information needed to generate a forecast is
contained in a time series of data
❑ Relate the forecast to only one factor - time
➢Naive method
➢Simple moving average
➢Weighted moving average
➢exponential smoothing
➢linear trend line
Causal Models or Associative Models
❑ Explores cause-and-effect relationships
➢Regression Methods
➢Correlation

भारतीय प्रबंधन संस्थान शिलांग

3 October
2022
Naive method
Demand in current period is used as next period’s forecast

ORDERS
MONTH PER MONTH FORECAST
Jan 120 -
Feb 90 120
Mar 100 90
Apr 75 100
May 110 75
June 50 110
July 75 50
Aug 130 75
Sept 110 130
Oct 90 110
Nov - 90

भारतीय प्रबंधन संस्थान शिलांग

3 October
2022
Simple Moving Average
▪ uses average demand for a fixed sequence of periods
▪ stable demand with no pronounced behavioral patterns

n

i=1
Di
MAn =
n
where

n = number of periods in the

moving average
Di = demand in period i

भारतीय प्रबंधन संस्थान शिलांग

3 October
2022
3-month Simple Moving Average

ORDERS MOVING
MONTH PER MONTH AVERAGE 3

Jan 120 – 
i=1
Di
Feb 90 – MA3 =
Mar 100 – 3
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

भारतीय प्रबंधन संस्थान शिलांग

3 October
2022
5-month Simple Moving Average

ORDERS MOVING
MONTH PER MONTH AVERAGE 5

Jan 120 – 
i=1
Di
Feb 90 – MA5 =
Mar 100 – 5
Apr 75 –
May 110 – 90 + 110 + 130+75+50
= 5
June 50 99.0
July 75 85.0
Aug 130 82.0 = 91 orders for Nov
Sept 110 88.0
Oct 90 95.0
Nov - 91.0

भारतीय प्रबंधन संस्थान शिलांग

3 October
2022
Smoothing Effects
150 –

125 – 5-month

100 –
Orders

75 –

50 – 3-month

Actual
25 –

0– | | | | | | | | | | |
Jan Feb Mar Apr May June July Aug Sept Oct Nov
Month

भारतीय प्रबंधन संस्थान शिलांग

3 October
2022
Weighted Moving Average
Adjusts moving average method to more closely reflect data
fluctuations
n
WMAn =  Wi Di
i=1
where
Wi = the weight for period i,
between 0 and 100 percent
 Wi = 1.00

भारतीय प्रबंधन संस्थान शिलांग

3 October
2022
Continues…

MONTH WEIGHT DATA

August 17% 130
September 33% 110
October 50% 90
3
November Forecast WMA3 =  Wi Di
i=1

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

= 103.4 orders

भारतीय प्रबंधन संस्थान शिलांग

3 October
2022
Exponential Smoothing
• Weights most recent data more strongly
• Reacts more to recent changes
• Widely used, accurate method
Ft +1 =  Dt + (1 - )Ft
where:
Ft +1 = forecast for next period
Dt = actual demand for present period
Ft = previously determined forecast for
present period
= weighting factor, smoothing constant

भारतीय प्रबंधन संस्थान शिलांग

3 October
2022
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

भारतीय प्रबंधन संस्थान शिलांग

3 October
2022
Exponential smoothing (α=0.30)

PERIOD MONTH DEMAND F2 = D1 + (1 - )F1

1 Jan 37 = (0.30)(37) + (0.70)(37)
2 Feb 40 = 37
3 Mar 41
4 Apr 37 F3 = D2 + (1 - )F2
5 May 45 = (0.30)(40) + (0.70)(37)
6 Jun 50
= 37.9
7 Jul 43
8 Aug 47 F13 = D12 + (1 - )F12
9 Sep 56
= (0.30)(54) + (0.70)(50.84)
10 Oct 52
11 Nov 55 = 51.79
12 Dec 54

भारतीय प्रबंधन संस्थान शिलांग

3 October
2022
Continues…
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
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

भारतीय प्रबंधन संस्थान शिलांग

3 October
2022
Continues…

70 –

60 – Actual  = 0.50

50 –

40 –
Orders

 = 0.30
30 –

20 –

10 –

0– | | | | | | | | | | | | |
1 2 3 4 5 6 7 8 9 10 11 12 13
Month

भारतीय प्रबंधन संस्थान शिलांग

3 October
2022
Adjusted Exponential Smoothing

AFt +1 = Ft +1 + Tt +1
where
T = an exponentially smoothed trend factor

Tt +1 = (Ft +1 - Ft) + (1 - ) Tt
where
Tt = the last period trend factor
 = a smoothing constant for trend
0≤≤1

भारतीय प्रबंधन संस्थान शिलांग

3 October
2022
Adjusted Exponential Smoothing (β=0.30)

T3 = (F3 - F2) + (1 - ) T2
PERIOD MONTH DEMAND
= (0.30)(38.5 - 37.0) + (0.70)(0)
1 Jan 37
= 0.45
2 Feb 40
3 Mar 41 AF3 = F3 + T3 = 38.5 + 0.45
4 Apr 37 = 38.95
5 May 45
6 Jun 50 T13 = (F13 - F12) + (1 - ) T12
7 Jul 43
= (0.30)(53.61 - 53.21) + (0.70)(1.77)
8 Aug 47
9 Sep 56 = 1.36
10 Oct 52
11 Nov 55
12 Dec 54 AF13 = F13 + T13 = 53.61 + 1.36 = 54.97

भारतीय प्रबंधन संस्थान शिलांग

3 October
2022
Continues…

FORECAST TREND ADJUSTED

PERIOD MONTH DEMAND Ft +1 Tt +1 FORECAST AFt +1

1 Jan 37 37.00 – –
2 Feb 40 37.00 0.00 37.00
3 Mar 41 38.50 0.45 38.95
4 Apr 37 39.75 0.69 40.44
5 May 45 38.37 0.07 38.44
6 Jun 50 38.37 0.07 38.44
7 Jul 43 45.84 1.97 47.82
8 Aug 47 44.42 0.95 45.37
9 Sep 56 45.71 1.05 46.76
10 Oct 52 50.85 2.28 58.13
11 Nov 55 51.42 1.76 53.19
12 Dec 54 53.21 1.77 54.98
13 Jan – 53.61 1.36 54.96

भारतीय प्रबंधन संस्थान शिलांग

3 October
2022
Continues…
70 –
Adjusted forecast ( = 0.30)
60 –
Actual
50 –

40 –
Demand

30 – Forecast ( = 0.50)

20 –

10 –

0– | | | | | | | | | | | | |
1 2 3 4 5 6 7 8 9 10 11 12 13
Period

भारतीय प्रबंधन संस्थान शिलांग

3 October
2022
Linear Trend Line

 xy - nxy
y = a + bx b =
 x2 - nx2
where a = y-bx
a = intercept
where
b = slope of the line
n = number of periods
x = time period
y = forecast for x
x = = mean of the x values
demand for period x n
y
y = n = mean of the y values

भारतीय प्रबंधन संस्थान शिलांग

3 October
2022
Least Squares Example
x(PERIOD) y(DEMAND) xy x2
1 37 37 1
78
x2 = = 6.540 80 4
3 12 41 123 9
4 37 148 16
y5 = 557 = 46.42
45 225 25
12
6 50 300 36
b7 = xy - nxy43 3867 - (12)(6.5)(46.42)
= 301 49 =1.72
8 x2 - nx47
2 376 650 - 12(6.5)
64 2
9 56 504 81
10
a = y - bx 52 520 100
11 55
= 46.42 - (1.72)(6.5) 605
= 35.2 121
12 54 648 144
78 557 3867 650

भारतीय प्रबंधन संस्थान शिलांग

3 October
2022
Continues…
70 –
Linear trend line y = 35.2 + 1.72x
Forecast for period 13 y = 35.2 + 1.72(13) = 57.56 units
60 –
Actual

50 –
Demand

40 –
Linear trend line
30 –

20 –

10 – | | | | | | | | | | | | |
1 2 3 4 5 6 7 8 9 10 11 12 13
Period

भारतीय प्रबंधन संस्थान शिलांग

3 October
2022
Seasonal Adjustments
• Repetitive increase/ decrease in demand
• Use seasonal factor to adjust forecast

Di
Seasonal factor = Si = D

भारतीय प्रबंधन संस्थान शिलांग

3 October
2022
Continues…

DEMAND (1000’S PER QUARTER)

YEAR 1 2 3 4 Total

2008 12.6 8.6 6.3 17.5 45.0

2009 14.1 10.3 7.5 18.2 50.1
2010 15.3 10.6 8.1 19.6 53.6
Total 42.0 29.5 21.9 55.3 148.7

D1 42.0 D3 21.9
S1 = = = 0.28 S3 = = = 0.15
D 148.7 D 148.7
D2 29.5 D4 55.3
S2 = = = 0.20 S4 = = = 0.37
D 148.7 D 148.7

3 October 2022 भारतीय प्रबंधन संस्थान शिलांग

Continues…

For 2011

y = 40.97 + 4.30x = 40.97 + 4.30(4) = 58.17

SF1 = (S1) (F5) = (0.28)(58.17) = 16.28

SF2 = (S2) (F5) = (0.20)(58.17) = 11.63
SF3 = (S3) (F5) = (0.15)(58.17) = 8.73
SF4 = (S4) (F5) = (0.37)(58.17) = 21.53

भारतीय प्रबंधन संस्थान शिलांग

3 October
2022
Forecasting accuracy
A forecast is never completely accurate; forecasts will always
deviate from the actual demand.
This difference between the forecast and the actual is the
forecast error.
A large degree of error may indicate that either the forecasting
technique is the wrong one or it needs to be adjusted by
changing its parameters (for example, α in the exponential
smoothing forecast).
There are different measures of forecast error. Like—
• Mean absolute deviation (MAD),
• Mean absolute percent deviation (MAPD),
• Cumulative error, and
• Average error or bias (Ē)

भारतीय प्रबंधन संस्थान शिलांग

3 October
2022
Mean absolute deviation (MAD)
MAD is an average of the difference between the forecast and
actual demand, as computed by the following formula:

 Dt - Ft 
MAD = n

Where,
t = the period number
Dt = demand in period t
Ft = the forecast for period t
n = the total number of periods
 = the absolute value

भारतीय प्रबंधन संस्थान शिलांग

3 October
2022
MAD Example
PERIOD DEMAND, Dt Ft ( =0.3) (Dt - Ft) |Dt - Ft|
1 37 37.00 – –
2 40 37.00 3.00 3.00
3 41 37.90 3.10 3.10
4 37 38.83 Dt-1.83
- Ft  1.83
5 45 MAD38.28
= n6.72 6.72
6 50 40.29 9.69 9.69
7 43 43.20 53.39
-0.20 0.20
8 47 =
43.14 11 3.86 3.86
9 56 44.30 11.70 11.70
10 52 47.81
= 4.854.19 4.19
11 55 49.06 5.94 5.94
12 54 50.84 3.15 3.15
557 49.31 53.39

भारतीय प्रबंधन संस्थान

3 October
2022
Mean absolute percent deviation (MAPD)
The mean absolute percent deviation (MAPD) measures the
absolute error as a percentage of demand rather than per
period.
As a result, it eliminates the problem of interpreting the measure
of accuracy relative to the magnitude of the demand and
forecast values, as MAD does.
The mean absolute percent deviation is computed according to
the following formula:

|Dt - Ft|
MAPD =
Dt

भारतीय प्रबंधन संस्थान शिलांग

3 October
2022
Cumulative error
Cumulative error is computed simply by summing the forecast
errors, as shown in the following formula.

✓ Cumulative error
E = et
= 49.31
A large positive value indicates that the forecast is
probably consistently lower than the actual demand, or
is biased low.
✓ Average error
et
E=
n
भारतीय प्रबंधन संस्थान शिलांग
3 October
2022
Comparison of errors

FORECAST MAD MAPD E (E)

Exponential smoothing ( = 0.30) 4.85 9.6% 49.31 4.48
Exponential smoothing ( = 0.50) 4.04 8.5% 33.21 3.02
Adjusted exponential smoothing 3.81 8.1% 21.14 1.92
( = 0.50,  = 0.30)
Linear trend line 2.29 4.9% – –

भारतीय प्रबंधन संस्थान शिलांग

3 October
2022
Forecast control
There are several ways to monitor forecast error over time to
make sure that the forecast is performing correctly—that is, the
forecast is in control.
✓ Reasons for out-of-control forecasts
✓ Change in trend
✓ Appearance of cycle
✓ Weather changes
✓ Promotions
✓ Competition
✓ Politics

भारतीय प्रबंधन संस्थान शिलांग

3 October
2022
Continues…
A tracking signal indicates if the forecast is consistently biased
high or low. It is computed by dividing the cumulative error by
MAD, according to the formula—
✓ Compute each period
✓ Compare to control limits
✓ Forecast is in control if within limits

(Dt - Ft) E
Tracking signal = =
MAD MAD
Use control limits of +/- 2 to +/- 5 MAD

भारतीय प्रबंधन संस्थान शिलांग

3 October
2022
Example
DEMAND FORECAST, ERROR E = TRACKING
PERIOD Dt Ft Dt - Ft (Dt - Ft) MAD SIGNAL

1 37 37.00 – – – –
2 40 37.00 3.00 3.00 3.00 1.00
3 41 37.90 3.10 6.10 3.05 2.00
4 37 38.83 -1.83 4.27 2.64 1.62
5 45 38.28 signal6.72
Tracking for period10.99
3 3.66 3.00
6 50 40.29 9.69 20.68 4.87 4.25
7 43 43.20 -0.20
6.10 20.48 4.09 5.01
8 47 TS3 =
43.14 3.86
3.05 = 2.00
24.34 4.06 6.00
9 56 44.30 11.70 36.04 5.01 7.19
10 52 47.81 4.19 40.23 4.92 8.18
11 55 49.06 5.94 46.17 5.02 9.20
12 54 50.84 3.15 49.32 4.85 10.17

भारतीय प्रबंधन संस्थान शिलांग

3 October
2022
Tracking Signal Plot

3 –

2 –
Exponential smoothing ( = 0.30)
Tracking signal (MAD)

1 –

0 –

-1 –

-2 – Linear trend line

-3 –
| | | | | | | | | | | | |
0 1 2 3 4 5 6 7 8 9 10 11 12
Period

भारतीय प्रबंधन संस्थान शिलांग

3 October
2022
Regression methods
Regression is used for forecasting by establishing a mathematical
relationship between two or more variables.
For example, there is a relationship between increased demand
in new housing and lower interest rates.
There are two basic regression methods—
• Linear regression method
• Multiple regression method

भारतीय प्रबंधन संस्थान शिलांग

3 October
2022
Linear regression method
Linear regression is a mathematical technique that relates one
variable, called an independent variable, to another, the
dependent variable, in the form of an equation for a straight line.
A linear equation has the following general form:

y = a + bx

भारतीय प्रबंधन संस्थान शिलांग

3 October
2022
Continues…

a = y-bx

b =  xy - nxy
 x2 - nx2
where
a = intercept (at period 0)
b = slope of the line
x
x = = mean of the x data
n

y = y = mean of the y data

n

भारतीय प्रबंधन संस्थान शिलांग

3 October
2022
Linear regression example
The State University athletic department wants to develop its budget for
the coming year using a forecast for football attendance. Football
attendance accounts for the largest portion of its revenues, and the
athletic director believes attendance is directly related to the number of
wins by the team. The business manager has accumulated total annual
average attendance figures for the past eight years.

Given the number of returning starters and the strength of the schedule,
the athletic director believes the team will win at least seven games next
year. Develop a simple regression equation for this data to forecast
attendance for this level of success.
भारतीय प्रबंधन संस्थान शिलांग
3 October
2022
Continues…

भारतीय प्रबंधन संस्थान शिलांग

3 October
2022
Correlation
Correlation in a linear regression equation is a measure of the
strength of the relationship between the independent and
dependent variables. The formula for the correlation coefficient
is

भारतीय प्रबंधन संस्थान शिलांग

3 October
2022
Correlation example

This value for the correlation coefficient is very close to 1.00,

indicating a strong linear relationship between the number of
wins and home attendance.
Another measure of the strength of the relationship between
the variables in a linear regression equation is the coefficient
of determination.
It is computed by squaring the value of r.

This value for the coefficient of determination means that 89.7% of the
amount of variation in attendance can be attributed to the number of wins by
the team

भारतीय प्रबंधन संस्थान शिलांग

3 October
2022
Thank You

भारतीय प्रबंधन संस्थान शिलांग

3 October
2022