NATIONAL ECONOMICS UNIVERSITY

OPERATIONS MANAGEMENT
FORECASTING
 CONTENT

1. DEFINITION
2. TYPES OF FORECASTING
3. IMPORTANCE OF FORECASTING
4. FORECASTING APPROACH
5. MONITORING AND CONTROLLING FORECAST
DEFINITION
WHAT IS FORECASTING?

 Process of predicting a
future event
??
 Underlying basis of
all business decisions
 Production
 Inventory
 Personnel
 Facilities
Forecasting

› Forecasting involves making predictions about events

that will happen in the future based on past data.
› Forecasting is both the art and science

5
INFLUENCE OF PRODUCT LIFE CYCLE
Introduction – Growth – Maturity – Decline

 Introduction and growth require longer forecasts

than maturity and decline
 As product passes through life cycle, forecasts are
useful in projecting
Staffing levels
Inventory levels
Factory capacity
INFLUENCE OF PRODUCT LIFE CYCLE

Introduction Growth Maturity Decline

Best period to Practical to change Poor time to Cost control
Company Strategy/Issues increase market price or quality change image, critical
share image price, or quality

R&D engineering is Strengthen niche Competitive costs

critical become critical
Defend market
position
CD-ROMs
Internet search engines
Analog TVs
Drive-through
LCD & plasma TVs restaurants

Sales iPods

3 1/2”
Xbox 360 Floppy
disks

Figure 2.5
THE REALITY

 Forecasts are seldom perfect

 Most techniques assume an underlying stability
in the system
 Product family and aggregated forecasts are
more accurate than individual product forecasts
TYPES OF FORECASTING
FORECASTING TIME HORIZONS
 Short-range forecast
Up to 1 year, generally less than 3 months
Purchasing, job scheduling, workforce levels, job assignments,
production levels
 Medium-range forecast
3 months to 3 years
Sales and production planning, budgeting
 Long-range forecast
3+ years
New product planning, facility location, research and
development
TYPES OF FORECASTING
 Economic forecasts
Address business cycle – inflation rate, money supply, housing
starts, etc.
 Technological forecasts
Predict rate of technological progress
Impacts development of new products
 Demand forecasts
Predict sales of existing products and services
IMPORTANCE OF
FORECASTING
Importance of Forecasts

› Helps plan all operation activities

› Reduce risk
› Take business opportunities
› Create a competitive advantage

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Importance of Forecasts

› Helps plan all operation activities

› Reduce risk
› Take business opportunities
› Create a competitive advantage

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STRATEGIC IMPORTANCE OF FORECASTING
 Human Resources – Hiring, training, laying off
workers
 Capacity – Capacity shortages can result in
undependable delivery, loss of customers, loss of
market share
 Supply Chain Management – Good supplier
relations and price advantages
Reasons for incorrect forecast
› The data is incomplete, discontinuous, the data scale is not
large enough;
› Using the incorrect method
› Fluctuating environment and changing conditions
› Uncontrolled forecast
› Choosing the incorrect expert

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Forecasting System
These seven steps can generate forecasts.
› 1. Determine what the forecast is for.
› 2. Select the items for the forecast.
› 3. Select the time horizon.
› 4. Select the forecast model type.
› 5. Gather data to be input into the model.
› 6. Make the forecast.
› 7. Verify and implement the results.

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FORECAST METHODS

Qualitative methods Quantitative methods

• Used when data is not available • Used when data is available

• Based on personal experience and • Based on mathematics, historical data

perception
What is Forecasting?

› https://www.youtube.com/watch?v=M8Kiwv9gDJU

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 Qualitative methods

› Get the opinion of the high level manager

› Sales force
› Consumer market survey
› Delphi method

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Get the opinion of the high level
manager
› This is based on the inputs and decisions of high-level
experts or management.
› Advantages:
- Very quick and easy to implement
- Leverage the experience and vision of the leader
› Disadvantages:
- Highly subjective
- Create passivity for employees
- The opinion of the leader almost becomes a commandment

21
Get the opinion of the Sales force
› Each sales person provides an individual estimate which is
reviewed for realism by management, and then combined
for a big picture view.
› Advantages:
- More objective
- Understand market fluctuations quickly
› Disadvantages:
- It takes a lot of time, effort and money.
- Processing the data

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Consumer market survey
› This is surveying the prospective customer base to
determine demand for existing products and can also be
used for new products.
› Advantages:
- High accuracy
› Disadvantages:
- It takes a lot of time, effort and money.
- Processing the data

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 Quantitative methods

Time Series Models Associative Model

predict by assuming the uses similar historical
future is a function of data inputs and then
the past includes other external
variables such as
advertising budget,
housing, competitor's
prices and more

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Quantitative methods

1. Naïve Method – Simple Average

2. Simple Moving Average
3. Weighted Moving Average Time
4. Trend Projection Series
Models
5. Exponential Smoothing
6. Regression

Associative
Model
1. Simple Average

• Formula:

σ𝑡−1
1 𝐴𝑖
𝐹𝑡 =
𝑛

• Where:
➢ Ft: Demand forecast for period t
➢ Ai : Actual demand observed in period i
➢ n: Number of periods

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 1. Simple Average

Example: Forecast for September using the simple average method.

Unit: 1000

Month Ai
:
1 40

2 42

3 38 σ81 𝐴𝑖
𝐹9 =
4 44
8

5 45 F9 = 45 products

6 49

7 48

8 50

v1.0012108210 27
2. Simple Moving Average

• Formula:
t −1

A i
Ft = i =t − n

n
• Where:
➢ Ft: Demand forecast for period t
➢ Ai : Actual demand observed in period i
➢ n: Number of periods

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 2. Simple Moving Average

Example: forecast for September using the simple 3-month moving average method

ĐVT: 1000 sp
Month Ai
1 40
8
2 42
A i
3 38 F9 = i =6

3
4 44
49 + 48 + 50
5 45
F9 =
3
6 49 = 49 Products
7 48
8 50
v1.0012108210 29
 3. Weighted Moving Average

• Formula:
t −1

 A xW i i
Ft = i =t − n

W i

• Where:
➢ Ft: Demand forecast for period t
➢ Ai : Actual demand observed in period i
➢ n: Number of periods
➢ Wi: Weight

v1.0012108210 30
 3. Weighted Moving Average
Example: Make a forecast for September using the 3-month moving average method with
the weights of 1, 2, and 3, respectively.

Unit: 1000
Month Ai
1 40
8

 A  Wi
2 42
i
3 38 F9 = i =6

4 44
Wi
49(1) + 48(2) + 50(3)
5 45 F9 =
1+ 2 + 3
6 49 = 49,166 products
7 48
8 50
v1.0012108210 31
 4. Mean Absolute Deviation (MAD)

n n

 AD  A − F i i
MAD = i =1
= i =1
n n
• MAD - Mean Absolute Deviation –
• Meaning: To choose the method with the smallest error (most accurate).

v1.0012108210 32
 |ADi| = Absolute value of actual demand minus forecast demand ( IAi - FiI)

Tháng At Ft ADi
1 40
2 42
3 38
4 44 = (40 + 42 + 38)/3 = 40 4
5 45 = (42 + 38 + 44)/3 = 41,3 3,7
6 49 = (38 + 44 + 45)/3 = 42,3 6,7
7 48 = (44 + 45 + 49)/3 = 46,0 2,0
8 50 = (45 + 49 + 48)/3 = 47,3 2,7

MAD = 19/5 = 3,8 Total = 19

v1.0012108210 33
 MAD - Weighted Moving Average Method

Tháng Ai Fi AD
1 40 - -
2 42 - -
3 38 - -
4 44 (401 + 422 + 383)/6 = 39,7 4,3
5 45 (421 + 382 + 443)/6 = 41,7 3,3
6 49 (381 + 442 + 453)/6 = 43,5 5,5
7 48 46,8 1,2
8 50 47,8 2,2

MAD = 16,5/5 =3,3 16,5

v1.0012108210 34
 5. LEAST SQUARES METHOD
y

Deviation n yt −  y t
Actual b=
demand Deviation n ti2 − ( ti ) 2

a=
 y − b t
n
Yˆ = a + bt

t
Point on the trend line
a - Y - intercept
b – slope of the trend line
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v1.0012108210 35
 Example Month Actual Demand Time period t*y t2
(y) (t)
1 40 1 40 1

2 42 2 84 4

3 38 3 114 9

4 44 4 176 16

5 45 5 225 25

6 49 6 294 36

7 48 7 336 49

8 50 8 400 64

Total 356 36 1669 204

nyt − yt
b= = 1,59; a = 37,32 F9 = 37,32 + 1,59(9) = 51630
nt i − (  t i )
2 2

v1.0012108210 36
 Seasonal Variations In Data

The multiplicative
seasonal model
can adjust trend
data for seasonal
variations in
demand
 Seasonal Variations In Data
Steps in the process:
1. Find average historical demand for each
season
2. Compute the average demand over all
seasons
3. Compute a seasonal index for each season
4. Estimate next year’s total demand
5. Divide this estimate of total demand by the
number of seasons, then multiply it by the
seasonal index for that season
 Seasonal Index Example
Demand Average Average Seasonal
Month 2005 2006 2007 2005-2007 Monthly Index
Jan 80 85 105 90 94
Feb 70 85 85 80 94
Mar 80 93 82 85 94
Apr 90 95 115 100 94
May 113 125 131 123 94
Jun 110 115 120 115 94
Jul 100 102 113 105 94
Aug 88 102 110 100 94
Sept 85 90 95 90 94
Oct 77 78 85 80 94
Nov 75 72 83 80 94
Dec 82 78 80 80 94
 Seasonal Index Example
Demand Average Average Seasonal
Month 2005 2006 2007 2005-2007 Monthly Index
Jan 80 85 105 90 94 0.957
Feb 70 85 85 80 94
Mar 80 93 average
82 85 monthly demand
2005-2007 94
Seasonal90index95= 115
Apr 100 94
average monthly demand
May 113 125 131 123 94
= 90/94 = .957
Jun 110 115 120 115 94
Jul 100 102 113 105 94
Aug 88 102 110 100 94
Sept 85 90 95 90 94
Oct 77 78 85 80 94
Nov 75 72 83 80 94
Dec 82 78 80 80 94
 Seasonal Index Example
Demand Average Average Seasonal
Month 2005 2006 2007 2005-2007 Monthly Index
Jan 80 85 105 90 94 0.957
Feb 70 85 85 80 94 0.851
Mar 80 93 82 85 94 0.904
Apr 90 95 115 100 94 1.064
May 113 125 131 123 94 1.309
Jun 110 115 120 115 94 1.223
Jul 100 102 113 105 94 1.117
Aug 88 102 110 100 94 1.064
Sept 85 90 95 90 94 0.957
Oct 77 78 85 80 94 0.851
Nov 75 72 83 80 94 0.851
Dec 82 78 80 80 94 0.851
 Seasonal Index Example
Demand Average Average Seasonal
Month 2005 2006 2007 2005-2007 Monthly Index
Jan 80 85 105 90 94 0.957
Feb 70 85 Forecast
85 for802008 94 0.851
Mar 80 93 82 85 94 0.904
Apr 90Expected
95 115annual demand
100 = 1,200
94 1.064
May 113 125 131 123 94 1.309
Jun 110 115 120 1,200 115 94 1.223
Jul Jan 113
100 102 x .957 = 96 94
105 1.117
12
Aug 88 102 110 100 94 1.064
1,200
Sept 85 90
Feb 95 x90.851 = 85 94 0.957
Oct 77 78 85 12 80 94 0.851
Nov 75 72 83 80 94 0.851
Dec 82 78 80 80 94 0.851
Seasonal Index Example
2008 Forecast
140 – 2007 Demand
130 – 2006 Demand
2005 Demand
120 –
Demand

110 –
100 –
90 –
80 –
70 –
| | | | | | | | | | | |
J F M A M J J A S O N D
Time
5. ASSOCIATIVE FORECASTING

Used when changes in one or more

independent variables can be used to predict
the changes in the dependent variable

Most common technique is linear

regression analysis

We apply this technique just as we did

in the time series example
Associative Forecasting
Forecasting an outcome based on
predictor variables using the least squares
technique
y^ = a + bx
^ = computed value of the variable to
where y
be predicted (dependent variable)
a = y-axis intercept
b = slope of the regression line
x = the independent variable though to
predict the value of the dependent
variable
Least Squares Method
Equations to calculate the regression variables

y^ = a + bx

xy - nxy
b=
x2 - nx2

a = y - bx
 Associative Forecasting Example
Sales Local Payroll
($ millions), y ($ billions), x
2.0 1
3.0 3
2.5 4 4.0 –
2.0 2
2.0 1 3.0 –

Sales
3.5 7
2.0 –

1.0 –

| | | | | | |
0 1 2 3 4 5 6 7
Area payroll
Associative Forecasting Example
Sales, y Payroll, x x2 xy
2.0 1 1 2.0
3.0 3 9 9.0
2.5 4 16 10.0
2.0 2 4 4.0
2.0 1 1 2.0
3.5 7 49 24.5
∑y = 15.0 ∑x = 18 ∑x2 = 80 ∑xy = 51.5

∑xy - nxy 51.5 - (6)(3)(2.5)

x = ∑x/6 = 18/6 = 3 b=
∑x2 - nx2
= 80 - (6)(32) = .25

y = ∑y/6 = 15/6 = 2.5 a = y - bx = 2.5 - (.25)(3) = 1.75

 Associative Forecasting Example

y^ = 1.75 + .25x Sales = 1.75 + .25(payroll)

If payroll next year

4.0 –
is estimated to be
$6 billion, then: 3.25
3.0 –

Sales
2.0 –
Sales = 1.75 + .25(6)
Sales = $3,250,000 1.0 –

| | | | | | |
0 1 2 3 4 5 6 7
Area payroll
Standard Error of the Estimate
 A forecast is just a point estimate of a
future value
 This point is 4.0 –
actually the 3.25
mean of a 3.0 –

Sales
probability 2.0 –
distribution
1.0 –

| | | | | | |
0 1 2 3 4 5 6 7
Area payroll
Figure 4.9
Standard Error of the Estimate
Computationally, this equation is
considerably easier to use

∑y2 - a∑y - b∑xy

Sy,x =
n-2

We use the standard error to set up

prediction intervals around the
point estimate
 Standard Error of the Estimate
∑y2 - a∑y - b∑xy 39.5 - 1.75(15) - .25(51.5)
Sy,x = = 6-2
n-2

Sy,x = .306 4.0 –

3.25
3.0 –

Sales
The standard error
2.0 –
of the estimate is
$306,000 in sales 1.0 –

| | | | | | |
0 1 2 3 4 5 6 7
Area payroll
Correlation
 How strong is the linear relationship between
the variables?
 Correlation does not necessarily imply
causality!
 Coefficient of correlation, r, measures degree
of association
 Values range from -1 to +1
Correlation Coefficient
nxy - xy
r=
[nx2 - (x)2][ny2 - (y)2]
Correlation Coefficient
nxy - xy
r=
[nx2 - (x)2][ny2 - (y)2]
Correlation
 Coefficient of Determination, r2, measures the
percent of change in y predicted by the change
in x
 Values range from 0 to 1
 Easy to interpret

For the Nodel Construction example:

r = .901
r2 = .81
Multiple Regression Analysis

If more than one independent variable is to be

used in the model, linear regression can be
extended to multiple regression to
accommodate several independent variables

y^ = a + b1x1 + b2x2 …

Computationally, this is quite

complex and generally done on the
computer
Multiple Regression Analysis

In the Nodel example, including interest rates in

the model gives the new equation:

y^ = 1.80 + .30x1 - 5.0x2

An improved correlation coefficient of r = .96

means this model does a better job of predicting
the change in construction sales

Sales = 1.80 + .30(6) - 5.0(.12) = 3.00

Sales = $3,000,000
 MONITORING AND
CONTROLLING FORECAST
Monitoring and Controlling Forecasts

Tracking Signal
 Measures how well the forecast is predicting
actual values
 Ratio of running sum of forecast errors (RSFE) to
mean absolute deviation (MAD)
 Good tracking signal has low values
 If forecasts are continually high or low, the forecast
has a bias error
Monitoring and Controlling Forecasts

Tracking RSFE
signal =
MAD

∑(Actual demand in
period i -
Forecast demand
Tracking in period i)
signal = (∑|Actual - Forecast|/n)
 Tracking Signal
Signal exceeding limit
Tracking signal
Upper control limit
+

0 MADs Acceptable
range

–
Lower control limit

Time
THANK YOU!