Management II

Part 2: Forecasting
Time horizon of forecasts
• Short-term (days or weeks)
» used for day-to-day planning of production plans, shift scheduling, etc.
• Intermediate term (weeks or months)
» used for mid-term planning of resource requirements, sales patterns for
product families, requirements and availabilities of workers, resource
requirements, etc.
• Long-term (months or years)
» used for planning long-term capacity needs and performing strategic
investment decisions like building new plants or retrofitting facilities with
new technologies

2
Characteristics of forecasts
• They are usually wrong
»A planning system should be sufficiently robust to be able to react
to unanticipated forecast errors
“640K ought to be enough for anybody.”, Bill Gates, 1981
“The phonograph has no commercial value at all.”, Thomas A. Edison, 1880
“I think there is a world market for maybe five computers.”, Thomas J. Watson, 1948
“There is no reason for any individual to have a computer in his home.”, Ken Olsen, 1977

• A good forecast gives information on the anticipated error

»Could be a range or the variance of the distribution of the error

3
Characteristics of forecasts
• Aggregate forecasts are more accurate
» The variance of the average of a collection of independent identically
distributed random variables is lower than the variance of each of the
random variables
• A longer forecast horizon causes a less accurate forecast
» Tomorrow’s demand can be predicted more accurately than next year’s
demand
• Should not be used to the exclusion of known information
» If additional information that has an influence on the forecasted value is
available, this information has to be manually factored into the forecast
and may not be ignored (e.g., a planned special promotion).

4
Forecasting methods
• Subjective forecasting methods
» Methods that measure either individual or group opinion.
» Used if no historical data is available or cannot be used
» Also used to adapt results from objective methods to one-time effects
• Objective forecasting methods
» Make forecasts based on past history
» Time series forecasting uses only the past history of the series itself to
find predictable and repeatable patterns in past data
» Regression models often use the past history of other series for the
forecast. One phenomenon is predicted based on the evolution of one or
more other phenomenon.

5
Subjective forecasting methods
Subjective forecasting methods

7
Sales force composites
• Sales force members submit estimates for products and
services they will sell in the next year (either individual
numbers or best/likely/worst estimates) and an estimated
probability for these sales
• Sales manager aggregates individual estimates to get an
overall forecast for each geographic region or product group

8
Sales force composites
• Advantages
»Sales force has direct consumer contact and sees preference
changes early
»For short-term or mid-term planning of existing products
• Disadvantages
»Underestimation if compensation is based on meeting a quota
»Under-/overestimation based on individual character (optimist vs.
pessimist)
»Sales force may not have all necessary information for new
products (e.g. new features)

9
Example: Sales force composite
Project Project volume Probability Estimated value
(million Euros) (percent) (million Euros)
Product Development VAG 1.2 30 0.36
Supply Chain Management WAG 0.8 10 0.08
Optimizing sourcing XAG 1.0 100 1.00
Reducing make span YAG 2.4 50 1.20
Turnaround operations ZAG 2.0 30 0.60
3.24

10
Customer surveys
• Essentially, the customers decide on the demand
• A representative sample of customers gets a questionnaire
• The questionnaire is then evaluated and the forecast is
performed based on the given answers

11
Customer surveys
• Advantages
» Systematic and fact based method
» Well suited for existing products and services for short-term and mid-
term planning
» Can signal future trends and shifting preference patterns
• Disadvantages
» Surveys and sampling plans must be carefully designed to guarantee
unbiased results
» High efforts and costs
» Low return rates can invalidate results

12
Jury of executive opinion
• Executives have good knowledge on new developments and
the introduction of future products
• Personnel in the functional areas of marketing, finance, and
operations should be solicited
• Either executives are questioned individually to create a
forecast or the group is asked to meet and come to a
conclusion together

13
Jury of executive opinion
• Advantages
» Knowledge from different functional areas is combined
» Personnel with knowledge about future developments also does the
forecast
» Well suited for new products or services and mid-term to long-term
planning
• Disadvantages
» No single person is responsible
» Risk that single groups are dominating others
» Binding expensive and scarce personnel

14
The Delphi method
• Based on soliciting the opinion of experts without risking
negative effects of group dynamics
• Individuals opinions expressed in questionnaire are
summarized by a moderator, with special attention to
opinions that are different from group average.
• Experts can reconsider their opinion based on the summary
iteratively until (ideally) an overall group consensus is
reached

15
The Delphi method
• Advantages
» Knowledge from different functional areas is combined
» Personnel with knowledge about future developments also does the
forecast
» Well suited for new products or services and mid-term to long-term
planning
» Avoids effects of group dynamics
• Disadvantages
» Slow process and sometimes no consensus is reached
» No single person is responsible
» Very sensitive to formulation of the questionnaire (no discussion
possible)

16
Objective forecasting methods
Objective forecasting methods

18
Objective forecasting methods – causal models

19
Causal models – basic idea
• Causal models use data from sources other than the series
being predicted.
• Example: predict the demand for taxi services based on the
number of inhabitants of a city.
• The function defining how demand is related to the
predicting factor can be linear or non-linear.

20
Causal models
• Let
»𝑦𝑦 be the phenomenon we wish to forecast
»𝑦𝑦1 , 𝑦𝑦2 , … , 𝑦𝑦𝑚𝑚 a set of 𝑀𝑀 known values for this phenomenon
»𝑥𝑥1 , 𝑥𝑥2 , … , 𝑥𝑥𝑛𝑛 a set of 𝑁𝑁 variables the we believe to be related to 𝑌𝑌
»𝑥𝑥𝑛𝑛𝑛 , 𝑥𝑥𝑛𝑛𝑛 , … , 𝑥𝑥𝑛𝑛𝑛𝑛 a set of 𝑀𝑀 known values for variable 𝑥𝑥𝑛𝑛
• The forecast is a function of these variables, e.g., a linear
one:
𝑦𝑦� 𝑥𝑥1 , 𝑥𝑥2 , … , 𝑥𝑥𝑛𝑛 = 𝛼𝛼0 + 𝛼𝛼1 𝑥𝑥1 + 𝛼𝛼2 𝑥𝑥2 + ⋯ + 𝛼𝛼𝑛𝑛 𝑥𝑥𝑛𝑛

21
Causal models
• Most commonly the coefficients 𝛼𝛼0 , 𝛼𝛼1 , … , 𝛼𝛼𝑛𝑛 are determined to
minimize the mean squared error (MSE)
𝑀𝑀
1 2
𝑀𝑀𝑀𝑀𝑀𝑀 𝛼𝛼0 , 𝛼𝛼1 , … , 𝛼𝛼𝑛𝑛 = � 𝜖𝜖𝑚𝑚
𝑀𝑀
𝑚𝑚=1
𝑀𝑀
1 2
= � 𝑦𝑦� 𝑥𝑥1𝑚𝑚 , 𝑥𝑥2𝑚𝑚 , … , 𝑥𝑥𝑛𝑛𝑛𝑛 − 𝑦𝑦𝑚𝑚
𝑀𝑀
𝑚𝑚=1
𝑀𝑀
1 2
= � 𝛼𝛼0 + 𝛼𝛼1 𝑥𝑥1𝑚𝑚 + 𝛼𝛼2 𝑥𝑥2𝑚𝑚 + ⋯ + 𝛼𝛼𝑛𝑛 𝑥𝑥𝑛𝑛𝑚𝑚 − 𝑦𝑦𝑚𝑚
𝑀𝑀
𝑚𝑚=1

22
Causal models
• In the special case with only one known variable this reduces to
𝑦𝑦� 𝑥𝑥 = 𝛼𝛼0 + 𝛼𝛼1 𝑥𝑥

𝑀𝑀
1 2
𝑀𝑀𝑀𝑀𝑀𝑀 𝛼𝛼0 , 𝛼𝛼1 = � 𝛼𝛼0 + 𝛼𝛼1 𝑥𝑥𝑚𝑚 − 𝑦𝑦𝑚𝑚
𝑀𝑀
𝑚𝑚=1
• The optimal solution for 𝛼𝛼0 and 𝛼𝛼1 can be found using

∑𝑀𝑀 2 𝑀𝑀 𝑀𝑀 𝑀𝑀
𝑚𝑚=1 𝑥𝑥𝑚𝑚 ∑𝑚𝑚=1 𝑦𝑦𝑚𝑚 − ∑𝑚𝑚=1 𝑥𝑥𝑚𝑚 ∑𝑚𝑚=1 𝑥𝑥𝑚𝑚 𝑦𝑦𝑚𝑚
𝛼𝛼0 =
𝑀𝑀 ∑𝑀𝑀 2 𝑀𝑀
𝑚𝑚=1 𝑥𝑥𝑚𝑚 − ∑𝑚𝑚=1 𝑥𝑥𝑚𝑚
2

𝑀𝑀 ∑𝑀𝑀 𝑀𝑀 𝑀𝑀
𝑚𝑚=1 𝑥𝑥𝑚𝑚 𝑦𝑦𝑚𝑚 − ∑𝑚𝑚=1 𝑥𝑥𝑚𝑚 ∑𝑚𝑚=1 𝑦𝑦𝑚𝑚
𝛼𝛼1 =
𝑀𝑀 ∑𝑀𝑀 2 𝑀𝑀
𝑚𝑚=1 𝑥𝑥𝑚𝑚 − ∑𝑚𝑚=1 𝑥𝑥𝑚𝑚
2

23
Causal models - Example
• Predict the amount of required service in man-years based
on number of servers:
Data point Servers Required service
𝒎𝒎 𝒙𝒙𝒎𝒎 𝒚𝒚𝒎𝒎
1 36 3.15
2 270 6.30
3 504 7.70
4 612 8.40
5 756 8.75
6 972 9.45
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Causal models - Example

Data point Servers Required service 𝒙𝒙𝟐𝟐𝒎𝒎 𝒙𝒙𝒎𝒎 𝒚𝒚𝒎𝒎

𝒎𝒎 𝒙𝒙𝒎𝒎 𝒚𝒚𝒎𝒎
1 36 3.15 1,296 113
2 270 6.30 72,900 1,701
3 504 7.70 254,016 3,881
4 612 8.40 374,544 5,141
5 756 8.75 571,536 6,615
6 972 9.45 944,784 9,185
Σ 3,150 43.75 2,219,076 26,636

25
Causal models - Example
2,219,076 � 43.75 − 3,150 � 26,636
𝛼𝛼0 = 2
= 3.89
6 � 2,219,076 − 3,150

6 � 26,636 − 3,150 � 43.75

𝛼𝛼1 = 2
= 0.0065
6 � 2,219,076 − 3,150

𝑦𝑦� 𝑥𝑥 = 3.89 + 0.0065𝑥𝑥

26
 Causal models - Example

x2 15

10
slope 𝛼𝛼1 𝜖𝜖𝑛𝑛

7.14 𝑦𝑦� 𝑥𝑥 = 𝛼𝛼0 + 𝛼𝛼1 𝑥𝑥 = 3.89 + 0.0065𝑥𝑥

5

y-intercept
𝛼𝛼0
0
0 200 400 500 600 800 1000

x1
Observations
27
Causal models - Example
• What would the demand for service be in a region with 200
installed servers?
𝑦𝑦� 200 = 3.89 + 0.0065 � 200 = 5.19
• By how much would the demand rise if the number of
servers increases by 100?
0.0065 � 100 = 0.65 man-years

28
Objective forecasting methods – time series methods

29
Time series methods – basic idea
• Require no information other than the past values of the
variable being predicted. Therefore also called naive
methods.
• The idea is that information can be inferred from the pattern
of past observations and can be used to forecast future
values of the series.
• Depending on the pattern exhibited by the time series,
different methods can be used for forecasting.

30
Time series methods – stationary series

31
Time series methods – stationary series
• Moving average method
»The forecast value equals the average value of a specific number of
past time periods
• Simple exponential smoothing method
»The forecast value equals an exponentially weighted average of all
previous periods

32
Moving average
• Forecast values are based on values of the last 𝑇𝑇 periods
𝑡𝑡−1
1
𝑦𝑦�𝑡𝑡 = � 𝑦𝑦𝜏𝜏
𝑇𝑇
𝜏𝜏=𝑡𝑡−𝑇𝑇
• 𝑇𝑇 has to be selected carefully
» very small values lead to highly fluctuating forecasts and ignore demand
information included in past data
» very large values ignore changes in demand almost completely and
weight very old data exactly the same as new data
» 𝑇𝑇 is often selected based on the MSE observed for different 𝑇𝑇-values

33
Moving average – Example with T=3

Week Demand 1
𝑦𝑦�4 = 12 + 15 + 12 = 13
𝒕𝒕 𝒚𝒚𝒕𝒕 3
1 12 1
𝑦𝑦�5 = 15 + 12 + 15 = 14
3
2 15
1
3 12 𝑦𝑦�6 = 12 + 15 + 12 = 13
3
4 15
5 12
6 17

34
Moving average – Example with T=3
Week Demand Forecast Forecast Squared
𝒕𝒕 𝒚𝒚𝒕𝒕 �𝒎𝒎
𝒚𝒚 error forecast
𝝐𝝐𝒕𝒕 error
𝝐𝝐𝟐𝟐𝒕𝒕
1 12
2 15
3 12
4 15 13 -2 4
1
5 12 14 2 4 𝑀𝑀𝑀𝑀𝑀𝑀 = 4 + 4 + 16 = 8
3
6 17 13 -4 16

35
Simple exponential smoothing
• The forecast for next period is based on the current period‘s
observation value and forecast weighted by a factor 𝛼𝛼:

𝑦𝑦�𝑡𝑡+1 = 𝛼𝛼𝑦𝑦𝑡𝑡 + 1 − 𝛼𝛼 𝑦𝑦�𝑡𝑡

• 𝛼𝛼 has to be selected carefully

» very small values ignore changes in demand almost completely and
weight very old data extremely high
» very large values lead to highly fluctuating forecasts and ignore demand
information included in past data
» 𝛼𝛼 is often selected based on the MSE observed for different 𝛼𝛼-values

36
Simple exponential smoothing – Example with α=0.2
𝒕𝒕 𝒚𝒚𝒕𝒕 �𝒕𝒕
𝒚𝒚 𝝐𝝐𝒕𝒕 𝝐𝝐𝟐𝟐𝒕𝒕 𝑀𝑀𝑀𝑀𝑀𝑀 = 234.13
0 134.5 -
x2 200
1 106.8 134.5 27.7 767.29
2 129.2 129.0 -0.2 0.06
150
3 153.0 129.0 -24.0 575.62
4 149.1 133.8 -15.3 233.89
5 158.3 136.9 -21.4 459.45 100

6 132.9 141.2 8.3 68.10

7 149.8 139.5 -10.3 106.06 50
8 140.3 141.6 1.3 1.59
9 138.3 141.3 3.0 9.05
0
10 152.2 140.7 -11.5 132.08 0 1 2 3 4 5 6 7 8 9 10 11 12

11 128.1 143.0 14.9 222.18 x1

12 140.0 Observations Forecasts 37
Simple exponential smoothing – Example with α=0.2
𝒕𝒕 𝒚𝒚𝒕𝒕 �𝒕𝒕
𝒚𝒚 𝝐𝝐𝒕𝒕 𝝐𝝐𝟐𝟐𝒕𝒕 There was no forecast for period 1, so we start with
0 134.5 - 𝑦𝑦�1 = 𝑦𝑦0 = 134.5
1 106.8 134.5 27.7 767.29 Forecast for period 2 based on values known in t=1:
2 129.2 129.0 -0.2 0.06 𝑦𝑦� = 𝛼𝛼𝑦𝑦 + 1 − 𝛼𝛼 𝑦𝑦� = 0.2 � 106.8 + 0.8 � 134.5 = 129.0
2 1 1
3 153.0 129.0 -24.0 575.62
4 149.1 133.8 -15.3 233.89 Forecast for period 3 based on values known in t=2:
5 158.3 136.9 -21.4 459.45 𝑦𝑦�3 = 𝛼𝛼𝑦𝑦2 + 1 − 𝛼𝛼 𝑦𝑦�2 = 0.2 � 129.2 + 0.8 � 129.0 = 129.0
6 132.9 141.2 8.3
68.10 Forecast for period 4 based on values known in t=3:
7 149.8 139.5 -10.3 106.06 𝑦𝑦� = 𝛼𝛼𝑦𝑦 + 1 − 𝛼𝛼 𝑦𝑦� = 0.2 � 153.0 + 0.8 � 129.0 = 133.8
4 3 3
8 140.3 141.6 1.3 1.59
9 138.3 141.3 3.0 9.05
10 152.2 140.7 -11.5 132.08
11 128.1 143.0 14.9 222.18
12 140.0 38
Time series methods - trend

39
Simple exponential smoothing on series with trend

x2 200 • For positive trends,

demand is tendentially
150 underestimated
• For negative trends,
100
demand is tendentially
50
overestimated
• This is denoted as
0 structural forecast error
0 1 2 3 4 5 6 7 8 9 10 11 12

x1
Observations Simple exponential smoothing 𝛼𝛼=0.2
40
Linear regression on time series with trend
• The concept is equivalent to that of general purpose linear regression.
Instead of using an independent variable for predicting a phenomenon,
historical observations are used.
• The formulas here are:
𝑦𝑦�𝑡𝑡,𝑡𝑡+𝜏𝜏 = 𝑎𝑎𝑡𝑡 + 𝑏𝑏𝑡𝑡 𝑡𝑡 + 𝜏𝜏

12 ∑𝑡𝑡𝜏𝜏=1 𝜏𝜏𝑦𝑦𝜏𝜏 − 6 𝑡𝑡 + 1 ∑𝑡𝑡𝜏𝜏=1 𝑦𝑦𝜏𝜏

𝑏𝑏𝑡𝑡 =
𝑡𝑡 𝑡𝑡 2 − 1
𝑡𝑡
1 1
𝑎𝑎𝑡𝑡 = � 𝑦𝑦𝜏𝜏 − 𝑏𝑏𝑡𝑡 𝑡𝑡 + 1
𝑡𝑡 2
𝜏𝜏=1

41
Linear regression on time series with trend - Example
𝒕𝒕 𝒚𝒚𝒕𝒕 𝒃𝒃𝒕𝒕 𝒂𝒂𝒕𝒕 �𝒕𝒕−𝟏𝟏,𝒕𝒕
𝒚𝒚
1 26.8
x2 200
2 39.2 12.40 14.40
3 72.3 22.75 0.60 51.6
150
4 71.3 16.66 10.75 91.6
5 83.2 14.49 15.09 94.0
6 92.9 13.19 18.13 102.0 100

7 121.9 14.41 14.86 110.4

8 112.1 12.91 19.38 130.2 50
9 115.8 11.59 23.76 135.6
10 154.2 12.38 20.86 139.7
0
11 175.2 13.21 17.57 157.1 0 1 2 3 4 5 6 7 8 9 10 11 12

12 176.1 x1
Observations Forecasts 42
 Linear regression on time series with trend - Example
𝒕𝒕 𝒚𝒚𝒕𝒕 𝒃𝒃𝒕𝒕 𝒂𝒂𝒕𝒕 �𝒕𝒕−𝟏𝟏,𝒕𝒕
𝒚𝒚 Forecast for period 3 based on values known in t=2:
1 26.8 12 1�26.8+2�39.2 −6(2+1)(26.8+39.2)
𝑏𝑏2 = = 12.40
2 22 −1
2 39.2 12.40 14.40 1 1
𝑎𝑎2 = 26.8 + 39.2 − 12.40 2 + 1 = 14.40
3 72.3 22.75 0.60 51.6 2 2
𝑦𝑦�2,3 = 𝑎𝑎2 + 𝑏𝑏2 2 + 1 = 14.40 + 12.40 � 3 = 51.6
4 71.3 16.66 10.75 91.6
5 83.2 14.49 15.09 94.0 Forecast for period 4 based on values known in t=3:
6 92.9 12 1�26.8+2�39.2+3�72.3 −6(3+1)(26.8+39.2+72.3)
13.19 18.13 102.0 𝑏𝑏3 = = 22.75
3 32 −1
7 121.9 14.41 14.86 110.4 1 1
𝑎𝑎3 = 26.8 + 39.2 + 72.3 − 22.75 3 + 1 = 0.60
8 112.1 12.91 19.38 130.2 3 2
𝑦𝑦�3,4 = 𝑎𝑎3 + 𝑏𝑏3 3 + 1 = 0.60 + 22.75 � 4 = 91.6
9 115.8 11.59 23.76 135.6
10 154.2 12.38 20.86 139.7 Forecast for period 4 or 12 based on values known in t=2:
11 175.2 13.21 17.57 157.1 𝑦𝑦�2,4 = 𝑎𝑎2 + 𝑏𝑏2 2 + 2 = 14.40 + 12.40 � 4 = 64.0
12 176.1 𝑦𝑦�2,12 = 𝑎𝑎2 + 𝑏𝑏2 2 + 10 = 14.40 + 12.40 � 12 = 138.4
43
Linear regression on time series with trend
• Difficulties with this method:
»Complex formula
»Equal weight for each period
»Expensive re-calculation

44
Double exponential smoothing (Holt’s method)
• Used for time series with linear trend
• Uses two smoothing constants 𝛼𝛼 and 𝛽𝛽 and two smoothing
equations:
𝑆𝑆𝑡𝑡 = 𝛼𝛼𝑦𝑦𝑡𝑡 + 1 − 𝛼𝛼 𝑆𝑆𝑡𝑡−1 + 𝐺𝐺𝑡𝑡−1
𝐺𝐺𝑡𝑡 = 𝛽𝛽 𝑆𝑆𝑡𝑡 − 𝑆𝑆𝑡𝑡−1 + 1 − 𝛽𝛽 𝐺𝐺𝑡𝑡−1
• The value 𝑆𝑆𝑡𝑡 can be interpreted as the intercept at time 𝑡𝑡 and
𝐺𝐺𝑡𝑡 as the value of the slope at time 𝑡𝑡.

45
Double exponential smoothing (Holt’s method)
• The formula 𝑆𝑆𝑡𝑡 = 𝛼𝛼𝑦𝑦𝑡𝑡 + 1 − 𝛼𝛼 𝑆𝑆𝑡𝑡−1 + 𝐺𝐺𝑡𝑡−1 can be
interpreted as averaging the current demand observation 𝑦𝑦𝑡𝑡
with the previous demand forecast which is the sum of the
intercept and one times the slope.
• The formula 𝐺𝐺𝑡𝑡 = 𝛽𝛽 𝑆𝑆𝑡𝑡 − 𝑆𝑆𝑡𝑡−1 + 1 − 𝛽𝛽 𝐺𝐺𝑡𝑡−1 can be
interpreted as revising the slope due to changing the
intercept. The new estimate for the slope 𝑆𝑆𝑡𝑡 − 𝑆𝑆𝑡𝑡−1 is
weighted against the previous estimate for the slope 𝐺𝐺𝑡𝑡−1 .

46
Double exponential smoothing (Holt’s method)
• The same value could be used for both smoothing constants,
but for most applications more stability is given to the slope
estimate 𝛽𝛽 ≤ 𝛼𝛼 .
• The 𝜏𝜏 step ahead forecast made in period 𝑡𝑡 is given by
𝑦𝑦�𝑡𝑡,𝑡𝑡+𝜏𝜏 = 𝑆𝑆𝑡𝑡 + 𝜏𝜏𝐺𝐺𝑡𝑡
• The intial values 𝑆𝑆0 and 𝐺𝐺0 need to be estimated manually –
a regression analysis on a set of initial periods would be ideal
for this purpose

47
Double exponential smoothing – Example (α=β=0.1)
𝒕𝒕 𝒚𝒚𝒕𝒕 𝑺𝑺𝒕𝒕 𝑮𝑮𝒕𝒕 �𝒕𝒕−𝟏𝟏,𝒕𝒕
𝒚𝒚
1 26.8
x2 200
2 39.2 14.40 12.40
3 72.3 31.35 12.86 26.80
150
4 71.3 46.91 13.13 44.21
5 83.2 62.36 13.36 60.04
6 92.9 77.43 13.53 75.71 100

7 121.9 94.06 13.84 90.96

8 112.1 108.32 13.88 107.89 50
9 115.8 121.56 13.82 122.20
10 154.2 137.26 14.01 135.37
0
11 175.2 153.65 14.24 151.26 0 1 2 3 4 5 6 7 8 9 10 11 12

12 151.11 12.57 167.90 x1

Observations Forecasts 48
 Double exponential smoothing – Example (α=β=0.1)
𝒕𝒕 𝒚𝒚𝒕𝒕 𝑺𝑺𝒕𝒕 𝑮𝑮𝒕𝒕 �𝒕𝒕−𝟏𝟏,𝒕𝒕
𝒚𝒚 Values 𝑆𝑆2 and 𝐺𝐺2 are from linear regression.
1 26.8
Forecast for period 3 based on values known in t=2:
2 39.2 14.40 12.40
𝑦𝑦�2,3 = 𝑆𝑆2 + 𝜏𝜏𝐺𝐺2 = 14.4 + 1 � 12.4 = 26.8
3 72.3 31.35 12.86 26.80
4 71.3 Forecast for period 4 based on values known in t=3:
46.91 13.13 44.21
𝑆𝑆3 = 𝛼𝛼𝑦𝑦3 + 1 − 𝛼𝛼 𝑆𝑆2 + 𝐺𝐺2 = 0.1 � 72.3 + 0.9 � 26.8 = 31.35
5 83.2 62.36 13.36 60.04
𝐺𝐺3 = 𝛽𝛽 𝑆𝑆3 − 𝑆𝑆2 + 1 − 𝛽𝛽 𝐺𝐺2 = 0.1 � 16.95 + 0.9 � 12.4 = 12.86
6 92.9 77.43 13.53 75.71 𝑦𝑦� = 𝑆𝑆 + 𝜏𝜏𝐺𝐺 = 31.35 + 1 � 12.86 = 44.21
3,4 3 3
7 121.9 94.06 13.84 90.96 Forecast for period 5 or 12 based on values known in t=3:
8 112.1 108.32 13.88 107.89 𝑦𝑦� = 𝑆𝑆 + 𝜏𝜏𝐺𝐺 = 31.35 + 2 � 12.86 = 57.07
3,5 3 3
9 115.8 121.56 13.82 122.20 𝑦𝑦� = 𝑆𝑆 + 𝜏𝜏𝐺𝐺 = 31.35 + 9 � 12.86 = 147.09
3,12 3 3
10 154.2 137.26 14.01 135.37
11 175.2 153.65 14.24 151.26
12 151.11 12.57 167.90
49
Evaluating forecasts
• Two common measures are
»the mean squared error (MSE)
𝑁𝑁
1
𝑀𝑀𝑀𝑀𝑀𝑀 = � 𝜖𝜖𝑛𝑛2
𝑁𝑁
𝑛𝑛=1
»the mean absolute deviation (MAD)
𝑁𝑁
1
𝑀𝑀𝐴𝐴𝐴𝐴 = � 𝜖𝜖𝑛𝑛
𝑁𝑁
𝑛𝑛=1

50
Evaluating forecasts
• The MSE
»is similar to the variance of a random sample and is often used in
operations management
»has good theoretical properties
• The MAD
»is more intuitive to interpret (e.g. 50 units vs. 2,500 units²)
»does not require squaring and is thus faster to calculate
• Other methods (e.g., the mean absolute percentage error)
exist, but are less comonly used

51