Introduction to Management Science

8th Edition
by
Bernard W. Taylor III

Chapter 15
Forecasting

Chapter 15 - Forecasting 1
Chapter Topics

Forecasting Components
Time Series Methods
Forecast Accuracy
Regression Methods

Chapter 15 - Forecasting 2
Forecasting Components

A variety of forecasting methods are

available for use depending on the time
frame of the forecast and the existence of
patterns.
Time Frames:
Short-range (one to two months)
Medium-range (two months to one or two
years)
Long-range (more than one or two years)

Chapter 15 - Forecasting 3
Forecasting Components

Patterns:
Trend
Random variations
Cycles
Seasonal pattern

Chapter 15 - Forecasting 4
Forecasting Components
Patterns (1 of 2)
Trend - A long-term movement of the item being
forecast.
Random variations - movements that are not
predictable and follow no pattern.
Cycle - A movement, up or down, that repeats itself
over a lengthy time span.
Seasonal pattern - Oscillating movement in
demand that occurs periodically in the short run
and is repetitive.

Chapter 15 - Forecasting 5
Forecasting Components
Patterns (2 of 2)

Figure 15.1
Forms of Forecast Movement: (a) Trend, (b) Cycle, (c) Seasonal
Pattern, (d) Trend with Seasonal Pattern
Chapter 15 - Forecasting 6
Forecasting Components
Forecasting Methods
Times Series - Statistical techniques that
use historical data to predict future behavior.
Regression Methods - Regression (or causal
) methods that attempt to develop a
mathematical relationship between the item
being forecast and factors that cause it to
behave the way it does.
Qualitative Methods - Methods using
judgment, expertise and opinion to make
forecasts.
Chapter 15 - Forecasting 7
Forecasting Components
Qualitative Methods
Qualitative methods, the “jury of executive opinion,” is the
most common type of forecasting method for long-term
strategic planning.
Performed by individuals or groups within an organization,
sometimes assisted by consultants and other experts,
whose judgments and opinion are considered valid for the
forecasting issue.
Usually includes specialty functions such as marketing,
engineering, purchasing, etc. in which individuals have
experience and knowledge of the forecasted item.
Supporting techniques include the Delphi Method, market
research, surveys, etc.

Chapter 15 - Forecasting 8
Time Series Methods
Overview

Statistical techniques that make use of

historical data collected over a long
period of time.
Methods assume that what has
occurred in the past will continue to
occur in the future.
Forecasts based on only one factor -
time.
Chapter 15 - Forecasting 9
Time Series Methods
Moving Average (1 of 5)
Moving average uses values from the recent
past to develop forecasts.
This dampens or smoothes out random
increases and decreases.
Useful for forecasting relatively stable items
that do not display any trend or seasonal
pattern.

Chapter 15 - Forecasting 10
Time Series Methods
Moving Average (1 of 5)
Formula:
n
 Di
MAn = i=1n
where:
n = number of periods in the moving average
D = data in period i
i

Chapter 15 - Forecasting 11
Time Series Methods
Moving Average (2 of 5)
Example: Instant Paper Clip Supply Company forecast of
orders for the next month.
Three-month moving average:
3
 Di
MA = i=1 = 90 +110 +130 =110 orders
3 3 3

Five-month moving average:

5
 Di
MA = i=1 = 90 +110 +130 + 75 + 50 = 91 orders
5 5 5

Chapter 15 - Forecasting 12
Time Series Methods
Moving Average (3 of 5)

Figure 15.2
Three- and Five-Month Moving Averages

Chapter 15 - Forecasting 13
Time Series Methods
Moving Average (4 of 5)

Figure 15.2
Three- and Five-Month Moving Averages

Chapter 15 - Forecasting 14
Time Series Methods
Moving Average (5 of 5)
Longer-period moving averages react more slowly
to changes in demand than do shorter-period
moving averages.
The appropriate number of periods to use often
requires trial-and-error experimentation.
Moving average does not react well to changes
(trends, seasonal effects, etc.) but is easy to use
and inexpensive.
Good for short-term forecasting.

Chapter 15 - Forecasting 15
Time Series Methods
Weighted Moving Average (1 of 2)
In a weighted moving average, weights are assigned to the
most recent data.
Formula:
n
WMAn =  W D
i=1 i i

where W = the weight for period i, between 0% and 100%

i
Wi = 1.00
D = data in period i
i

Chapter 15 - Forecasting 16
 Time Series Methods
Weighted Moving Average (1 of 2)

Example : Paper clip company we ights 50% for October, 33%

for September, 17% for August :
3
WMA =  W D = (.50)(90) + (.33)(110) + (.17)(130) = 103.4 orders
3 i=1 i i

Chapter 15 - Forecasting 17
Time Series Methods
Weighted Moving Average (2 of 2)

Determining precise weights and

number of periods requires trial-and-
error experimentation.

Chapter 15 - Forecasting 18
Time Series Methods
Exponential Smoothing (1 of 11)
Exponential smoothing weights recent past data more
strongly than more distant data.
Two forms: simple exponential smoothing and adjusted
exponential smoothing.
Simple exponential smoothing:
Ft + 1 = Dt + (1 - )Ft
where: Ft + 1 = the forecast for the next period
Dt = actual demand in the present period
Ft = the previously determined forecast for the
present period
 = a weighting factor (smoothing constant).

Chapter 15 - Forecasting 19
Time Series Methods
Exponential Smoothing (2 of 11)

The most commonly used values of 

are between .10 and .50.
Determination of  is usually
judgmental and subjective and often
based on trial-and -error
experimentation.

Chapter 15 - Forecasting 20
Time Series Methods
Exponential Smoothing (4 of 11)

Table 15.4
Exponential Smoothing Forecasts,  = .30 and  = .50

Chapter 15 - Forecasting 21
Time Series Methods
Exponential Smoothing (3 of 11)
Example: PM Computer Services (see Table 15.4).
Exponential smoothing forecasts using smoothing
constant of .30.
Forecast for period 2 (February):
F2 =  D1 + (1- )F1 = (.30)(37) + (.70)(37)
= 37 units
Forecast for period 3 (March):
F3 =  D2 + (1- )F2 = (.30)(40) + (.70)(37)
= 37.9 units
Chapter 15 - Forecasting 22
Time Series Methods
Exponential Smoothing (4 of 11)

Table 15.4
Exponential Smoothing Forecasts,  = .30 and  = .50

Chapter 15 - Forecasting 23
Time Series Methods
Exponential Smoothing (5 of 11)
The forecast that uses the higher smoothing
constant (.50) reacts more strongly to changes in
demand than does the forecast with the lower
constant (.30).
Both forecasts lag behind actual demand.
Both forecasts tend to be consistently lower than
actual demand.
Low smoothing constants are appropriate for
stable data without trend; higher constants
appropriate for data with trends.

Chapter 15 - Forecasting 24
Time Series Methods
Exponential Smoothing (6 of 11)

Figure 15.3
Exponential Smoothing Forecasts

Chapter 15 - Forecasting 25
Time Series Methods
Exponential Smoothing (7 of 11)
Adjusted exponential smoothing: exponential smoothing
with a trend adjustment factor added.
Formula:
AFt + 1 = Ft + 1 + Tt+1
where: T = an exponentially smoothed trend factor

Tt + 1 = (Ft + 1 - Ft) + (1 - )Tt

Tt = the last period trend factor
 = smoothing constant for trend ( a value
between zero and one).
Reflects the weight given to the most recent trend data.
Determined subjectively.
Chapter 15 - Forecasting 26
Time Series Methods
Exponential Smoothing (9 of 11)

From the previous

calculation given
 is 0.5, Solve for
the trend (Tt + 1) and
the Adjusted
Forecast
(AFt + 1 )

Table 15.5
Adjusted Exponentially Smoothed Forecast Values

Chapter 15 - Forecasting 27
Time Series Methods
Exponential Smoothing (8 of 11)
Example: PM Computer Services exponential
smoothed forecasts with  = .50 and  = .30 (see
Table 15.5).
Adjusted forecast for period 3:
T3 = (F3 - F2) + (1 - )T2
= (.30)(38.5 - 37.0) + (.70)(0) = 0.45
AF3 = F3 + T3 = 38.5 + 0.45 = 38.95

Chapter 15 - Forecasting 28
Time Series Methods
Exponential Smoothing (9 of 11)

Table 15.5
Adjusted Exponentially Smoothed Forecast Values

Chapter 15 - Forecasting 29
Time Series Methods
Exponential Smoothing (10 of 11)

Adjusted forecast is consistently higher

than the simple exponentially smoothed
forecast.
It is more reflective of the generally
increasing trend of the data.

Chapter 15 - Forecasting 30
Time Series Methods
Exponential Smoothing (11 of 11)

Figure 15.4
Adjusted Exponentially Smoothed Forecast

Chapter 15 - Forecasting 31
Seatwork
A computer software firm has experienced the following
demand for its Personal Finance software package:

PERIOD UNITS

1 56
Develop an exponential
2 61 smoothing forecast, using
3 55 α=0.40 and an adjusted
4 70 exponential smoothing
5 66
forecast using α=0.40 and
 = 0.20.
6 65
7 72
8 75

Chapter 15 - Forecasting 32