Operations

Management
Forecasting
Chapter 4

4-1
 Outline
 Global Company Profile: Tupperware
 What is Forecasting?
 Forecasting Time Horizons
 The Influence of Product Life Cycle

 Types of Forecasts
 The Strategic Importance of Forecasting
 Human Resources
 Capacity
 Supply-Chain Management

 Seven Steps in the Forecasting System

4-2
 Outline - Continued
 Forecasting Approaches
 Overview of Qualitative Methods
 Overview of Quantitative Methods
 Time-Series Forecasting
 Decomposition of Time Series
 Naïve Approach
 Moving Averages
 Exponential Smoothing
 Exponential Smoothing with Trend Adjustment
 Trend Projections
 Seasonal Variations in Data
 Cyclic Variations in Data

4-3
 Outline - Continued
Associative Forecasting Methods:
Regression and Correlation Analysis
 Using Regression Analysis to Forecast
 Standard Error of the Estimate
 Correlation Coefficients for Regression Lines
 Multiple-Regression Analysis
Monitoring and Controlling Forecasts
 Adaptive Smoothing
 Focus Forecasting
Forecasting in the Service Sector
4-4
 Learning Objectives

When you complete this chapter, you should be

able to :
Identify or Define:
 Forecasting
 Types of forecasts
 Time horizons
 Approaches to forecasts

4-5
 Learning Objectives - continued
When you complete this chapter, you should
be able to :
Describe or Explain:
 Moving averages
 Exponential smoothing
 Trend projections
 Regression and correlation analysis
 Measures of forecast accuracy

4-6
 Forecasting at Tupperware
Each of 50 profit centers around the world is
responsible for computerized monthly,
quarterly, and 12-month sales projections
These projections are aggregated by region,
then globally, at Tupperware’s World
Headquarters
Tupperware uses all techniques discussed in
text

4-7
Three Key Factors for Tupperware
The number of registered “consultants” or
sales representatives

The percentage of currently “active” dealers

(this number changes each week and month)

Sales per active dealer, on a weekly basis

4-8
 Tupperware - Forecast by
Consensus

Although inputs come from sales, marketing,

finance, and production, final forecasts are
the consensus of all participating managers.
The final step is Tupperware’s version of the
“jury of executive opinion”

4-9
 What is Forecasting?

 Process of predicting a Sales will

future event be $200
Million!
 Underlying basis of
all business decisions
 Production
 Inventory
 Personnel
 Facilities

4-10
 Types of Forecasts by Time
Horizon
Short-range forecast
 Up to 1 year; usually less than 3 months
 Job scheduling, worker assignments

Medium-range forecast
 3 months to 3 years
 Sales & production planning, budgeting

Long-range forecast
 3+ years
 New product planning, facility location

4-11
Short--term vs. Longer-
Short Longer-term Forecasting
Medium/long range forecasts deal with more
comprehensive issues and support
management decisions regarding planning
and products, plants and processes.
Short-term forecasting usually employs
different methodologies than longer-term
forecasting
Short-term forecasts tend to be more
accurate than longer-term forecasts.
4-12
 Influence of Product Life Cycle

Stages of introduction and growth require

longer forecasts than maturity and decline
Forecasts useful in projecting
 staffing levels,
 inventory levels, and
 factory capacity

as product passes through life cycle stages

4-13
 Strategy and Issues During a
Product’s Life
Introduction Growth Maturity Decline
Best period to Practical to change Poor time to change Cost control
increase market price or quality image image, price, or quality critical
share
Strengthen niche Competitive costs become
R&D product critical
Company Strategy/Issues

engineering critical
Defend market position
Drive-thru restaurants Fax machines
3 1/2”
CD-ROM Floppy
disks
Sales
Station
Internet wagons
Color copiers

HDTV

Product design and Forecasting critical Standardization Little product

development critical Product and process differentiation
Less rapid product
Frequent product and reliability changes - more minor Cost minimization
OM Strategy/Issues

process design changes Competitive product changes

Short production runs
High production costs
Limited models
Attention to quality
improvements and options
Optimum capacity
Increase capacity Increasing stability of
Shift toward product process
focused
Long production runs
Enhance distribution
Product improvement and
cost cutting
Over capacity in the
industry
Prune line to eliminate
items not returning good
margin
Reduce capacity

4-14
 Types of Forecasts
Economic forecasts
 Address business cycle, e.g., inflation rate, money
supply etc.
Technological forecasts
 Predict technological change
 Predict new product sales

Demand forecasts
 Predict existing product sales

4-15
 Seven Steps in Forecasting
Determine the use of the forecast
Select the items to be forecast
Determine the time horizon of the forecast
Select the forecasting model(s)
Gather the data
Make the forecast
Validate and implement results

4-16
 Product Demand Charted over 4
Years with Trend and Seasonality
Seasonal peaks Trend component
Demand for product or service

Actual
demand line

Average demand
over four years
Random
variation
Year Year Year Year
1 2 3 4
4-17
Actual Demand, Moving Average,
Weighted Moving Average
35 Weighted moving average
30
Actual sales
25
Sales Demand

20
15
10
Moving average
5

0
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec
Month

4-18
 Realities of Forecasting

Forecasts are seldom perfect

Most forecasting methods assume that there
is some underlying stability in the system
Both product family and aggregated product
forecasts are more accurate than individual
product forecasts

4-19
 Forecasting Approaches
Qualitative Methods Quantitative Methods
 Used when situation is  Used when situation is
vague & little data exist ‘stable’ & historical
 New products data exist
 New technology  Existing products
 Involves intuition,  Current technology

experience  Involves mathematical

 e.g., forecasting sales on techniques
Internet  e.g., forecasting sales of
color televisions

4-20
 Overview of Qualitative Methods
Jury of executive opinion
 Pool opinions of high-level executives, sometimes
augment by statistical models
Sales force composite
 Estimates from individual salespersons are
reviewed for reasonableness, then aggregated
Delphi method
 Panel of experts, queried iteratively
Consumer Market Survey
 Ask the customer
4-21
 Jury of Executive Opinion
 Involves small group of high-level managers
 Group estimates demand by working together
 Combines managerial experience with
statistical models
 Relatively quick
 ‘Group-think’
disadvantage

4-22
© 1995 Corel Corp.
 Sales Force Composite

 Each salesperson
Sales
projects their sales
 Combined at district &
national levels
 Sales rep’s know
customers’ wants
 Tends to be overly
optimistic
© 1995 Corel Corp.

4-23
 Delphi Method
Iterative group
process Decision Makers
(Sales?)
3 types of people (Sales will be 50!)
Staff
 Decision makers
(What will
 Staff sales be?
 Respondents survey)

Reduces ‘group-
think’ Respondents
(Sales will be 45, 50, 55)

4-24
 Consumer Market Survey
How many hours will
 Ask customers you use the Internet
about purchasing next week?
plans
 What consumers
say, and what they
actually do are
often different
 Sometimes difficult
© 1995 Corel
to answer Corp.

4-25
Overview of Quantitative Approaches

Naïve approach
Moving averages Time-series
Exponential smoothing Models

Trend projection

Associative
Linear regression models

4-26
Quantitative Forecasting Methods
(Non--Naive)
(Non
Quantitative
Forecasting

Time Series Associative

Models Models

Moving Exponential Trend Linear

Average Smoothing Projection Regression

4-27
 What is a Time Series?
 Set of evenly spaced numerical data
 Obtained by observing response variable at regular
time periods
 Forecast based only on past values
 Assumes that factors influencing past and present
will continue influence in future
 Example
Year: 1993 1994 1995 1996 1997
Sales: 78.7 63.5 89.7 93.2 92.1

4-28
 Time Series Components

Trend Cyclical

Seasonal Random

4-29
 Trend Component
Persistent, overall upward or downward
pattern
Due to population, technology etc.
Several years duration

Response

Mo., Qtr., Yr. © 1984-1994 T/Maker Co.

4-30
 Seasonal Component

Regular pattern of up & down fluctuations

Due to weather, customs etc.
Occurs within 1 year

Summer
Response
© 1984-1994 T/Maker Co.

Mo., Qtr.

4-31
 Cyclical Component
Repeating up & down movements
Due to interactions of factors influencing
economy
Usually 2-10 years duration

Cycle
Response


Mo., Qtr., Yr.
4-32
 Random Component

Erratic, unsystematic, ‘residual’ fluctuations

Due to random variation or unforeseen
events © 1984-1994 T/Maker Co.

 Union strike
 Tornado

Short duration &

nonrepeating

4-33
 General Time Series Models

Any observed value in a time series is the

product (or sum) of time series components

Multiplicative model
 Yi = Ti · Si · Ci · Ri (if quarterly or mo. data)

Additive model
 Yi = Ti + Si + Ci + Ri (if quarterly or mo. data)

4-34
 Naive Approach

 Assumes demand in next

period is the same as
demand in most recent
period
 e.g., If May sales were 48, then
June sales will be 48
 Sometimes cost effective &
efficient
© 1995 Corel Corp.

4-35
 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
 Equation

MA   Demand in Previous n Periods

n

4-36
 Moving Average Example
You’re manager of a museum store that sells
historical replicas. You want to forecast
sales (000) for 1998 using a 3-period moving
average.
1993 4
1994 6
1995 5
1996 3
1997 7
© 1995 Corel Corp.

4-37
 Moving Average Solution
Time Response Moving Moving
Yi Total Average
(n=3) (n=3)
1995 4 NA NA
1996 6 NA NA
1997 5 NA NA
1998 3 4+6+5=15 15/3 = 5
1999 7
2000 NA

4-38
 Moving Average Solution
Time Response Moving Moving
Yi Total Average
(n=3) (n=3)
1995 4 NA NA
1996 6 NA NA
1997 5 NA NA
1998 3 4+6+5=15 15/3 = 5
1999 7 6+5+3=14 14/3=4 2/3
2000 NA

4-39
 Moving Average Solution
Time Response Moving Moving
Yi Total Average
(n=3) (n=3)
1995 4 NA NA
1996 6 NA NA
1997 5 NA NA
1998 3 4+6+5=15 15/3=5.0
1999 7 6+5+3=14 14/3=4.7
2000 NA 5+3+7=15 15/3=5.0

4-40
 Moving Average Graph

Sales
8 Actual
6
Forecast
4
2
95 96 97 98 99 00
Year
4-41
Weighted Moving Average Method

Used when trend is present

 Older data usually less important
Weights based on intuition
 Often lay between 0 & 1, & sum to 1.0
Equation
Σ(Weight for period n) (Demand in period n)
WMA =
ΣWeights

4-42
Actual Demand, Moving Average,
Weighted Moving Average
35 Weighted moving average
30
Actual sales
25
Sales Demand

20
15
10
Moving average
5

0
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec
Month

4-43
 Disadvantages of
Moving Average Methods

Increasing n makes forecast less

sensitive to changes
Do not forecast trend well
Require much historical
data © 1984-1994 T/Maker Co.

4-44
 Exponential Smoothing Method

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

4-45
Exponential Smoothing Equations

 Ft = At - 1 + (1-)At - 2 + (1- )2·At - 3

+ (1- )3At - 4 + ... + (1- )t-1·A0
 Ft = Forecast value
 At = Actual value
  = Smoothing constant

 Ft = Ft-1 + (At-1 - Ft-1)

 Use for computing forecast

4-46
 Exponential Smoothing Example
You’re organizing a Kwanza meeting. You
want to forecast attendance for 2000 using
exponential smoothing
( = .10). The1995 forecast was 175.
1995 180
1996 168
1997 159
1996 175
1999 190
© 1995 Corel Corp.

4-47
Exponential Smoothing Solution
Ft = Ft-1 + 
·
(At-1 - Ft-1)
Forecast, F t
Time Actual
α = .10
(α .10))
1995 180 175.00 (Given)
1996 168 175.00 +
1997 159
1998 175
1999 190
2000 NA

4-48
Exponential Smoothing Solution
Ft = Ft-1 + 
·
(At-1 - Ft-1)
Forecast, Ft
Time Actual
(α= .10
.10))
1995 180 175.00 (Given)
1996 168 175.00 + .10
.10(180
(180 - 175.00
175.00)) = 175.50
1997 159
1998 175
1999 190
2000 NA

4-49
Exponential Smoothing Solution
Ft = Ft-1 + 
·
(At-1 - Ft-1)
Forecast, F t
Time Actual
(α = .10)
1995 180 175.00 (Given)
1996 168 175.00 + .10(180 - 175.00) = 175.50
1997 159 175.50 + .10(168 - 175.50) = 174.75
1998 175 174.75 + .10(159 - 174.75) = 173.18
1999 190 173.18 + .10(175 - 173.18) = 173.36
2000 NA 173.36 + .10
.10(190
(190 - 173.36
173.36)) = 175.02

4-50
Exponential Smoothing Graph

Sales
190 Actual
180
170 Forecast
160
150
140
93 94 95 96 97 98
Year
4-51
 Multiplicative Seasonal Model
 Find average historical demand for each “season” by
summing the demand for that season in each year, and
dividing by the number of years for which you have data.
 Compute the average demand over all seasons by dividing
the total average annual demand by the number of seasons.
 Compute a seasonal index by dividing that season’s
historical demand (from step 1) by the average demand
over all seasons.
 Estimate next year’s total demand
 Divide this estimate of total demand by the number of
seasons, then multiply it by the seasonal index for that
season. This provides the seasonal forecast.
4-52
 Linear Regression Model

Shows linear relationship between dependent

& explanatory variables
 Example: Sales & advertising (not time)

Y-intercept Slope

^
Y i = a b X i

Dependent Independent (explanatory)

(response) variable variable

4-53
 Linear Regression Model
Y Y i = a b X i Error

Error
Regression line

Y^i = a b X i
X
Observed value

4-54
 Interpretation of Coefficients

Slope (b)
 Estimated Y changes by b for each 1 unit increase
in X
 If b = 2, then sales (Y) is expected to increase by 2 for each
1 unit increase in advertising (X)
Y-intercept (a)
 Average value of Y when X = 0
 If a = 4, then average sales (Y) is expected to be 4 when
advertising (X) is 0

4-55
 Random Error Variation

Variation of actual Y from predicted Y

Measured by standard error of estimate
 Sample standard deviation of errors
 Denoted SY,X

Affects several factors

 Parameter significance
 Prediction accuracy

4-56
 Least Squares Assumptions
Relationship is assumed to be linear. Plot
the data first - if curve appears to be present,
use curvilinear analysis.
Relationship is assumed to hold only within
or slightly outside data range. Do not
attempt to predict time periods far beyond
the range of the data base.
Deviations around least squares line are
assumed to be random.
4-57
 Standard Error of the Estimate

n
 yi  ŷi 
S y,x  i  Text uses symbol Yc
n

n  n n
 yi a  yi  b  x i yi
 i  i  i 
n

4-58
 Correlation

Answers: ‘how strong is the linear relationship

between the variables?’
Coefficient of correlation Sample correlation
coefficient denoted r
 Values range from -1 to +1
 Measures degree of association

Used mainly for understanding

4-59
Sample Coefficient of Correlation

n n n
n  x i yi   x i  yi
r i  i  i 
 n   n   n   n  
n  x i    x i   n  yi    yi  
 i   i     i   i   

4-60
 Coefficient of Correlation Values
Perfect Perfect
Negative No Correlation Positive
Correlation Correlation

-1.0 -.5 0 +.5 +1.0

Increasing degree of Increasing degree of

negative correlation positive correlation

4-61
 Guidelines for Selecting
Forecasting Model
You want to achieve:
 No pattern or direction in forecast error
^
 Error = (Y - Y ) = (Actual - Forecast)
i i
 Seen in plots of errors over time

 Smallest forecast error

 Mean square error (MSE)
 Mean absolute deviation (MAD)

4-62
 Pattern of Forecast Error

Trend Not Fully

Accounted for Desired Pattern
Error Error

0 0

Time (Years) Time (Years)

4-63