SCM350: OPERATIONS MANAGEMENT
Instructor: Dr. Mohammed Hejazi
Ch.3 Forecasting
1
q Forecast – a statement about the future value of
a variable of interest
q We make forecasts about such things as
weather, demand, and resource availability
q Forecasts are important to making informed
decisions
2
Types of Forecasting
q Economic forecasts
q Address business cycle – inflation rate, money
supply, housing starts, etc.
q Technological forecasts
q Predict rate of technological progress
q Impacts development of new products
q Demand forecasts
q Predict sales of existing products and services
3
1. Short-range forecast
▶ Up to 1 year, generally less than 3 months
▶ Purchasing, job scheduling, workforce levels, job
assignments, production levels
2. Medium-range forecast
▶ 3 months to 3 years
▶ Sales and production planning, budgeting
3. Long-range forecast
▶ 3+ years
▶ New product planning, facility location, research and
development
4
Elements of Good Forecasting
Timely
Reliable Accurate
Written
5
Steps in the Forecasting Process
“The forecast”
Step 6 Monitor the forecast
Step 5 Prepare the forecast
Step 4 Gather and analyze data
Step 3 Select a forecasting technique
Step 2 Establish a time horizon
Step 1 Determine purpose of forecast
6
Forecast Accuracy and Control
q Allowances should be made for forecast errors
q It is important to provide an indication of the extent to
which the forecast might deviate from the value of the
variable that actually occurs
q Forecast errors should be monitored
q Error = Actual – Forecast
q If errors fall beyond acceptable bounds, corrective action
may be necessary
7
q Mean absolute deviation (MAD) The average absolute forecast
error.
q Mean squared error (MSE) The average of squared forecast
errors.
q Mean absolute percent error (MAPE) The average
absolute percent error.
MAD weights all errors
evenly
MSE weights errors according
to their squared values
MAPE weights errors
according to relative error
Actual Forecast (A-F)
Period
(A) (F) Error |Error| Error2 [|Error|/Actual]x100
1 107 110
2 125 121
3 115 112
4 118 120
5 108 109
Sum
MAD MSE MAPE
Actual Forecast (A-F)
Period
(A) (F) Error |Error| Error2 [|Error|/Actual]x100
1 107 110 -3 3 9 2.80%
2 125 121 4 4 16 3.20%
3 115 112 3 3 9 2.61%
4 118 120 -2 2 4 1.69%
5 108 109 1 1 1 0.93%
Sum 13 39 11.23%
n = 5 n-1 = 4 n = 5
MAD MSE MAPE
= 2.6 = 9.75 = 2.25%
Features Common to All
Forecasts
q Techniques assume some underlying causal system
that existed in the past will persist into the future
q Forecasts are not perfect
q Forecasts for groups of items are more accurate than
those for individual items
q Forecast accuracy decreases as the forecasting
horizon increases
Forecasting Approaches/Methods
Product Life Cycle
Forecasting During the Life Cycle
1. Qualitative Forecasting Methods
q Qualitative Forecasting
q Qualitative techniques permit the inclusion of :
q Human factors
q Personal opinions
q Hunches
q Used when situation is vague and little data exist
q New products
q New technology
q These factors are difficult, or impossible, to quantify
q Quantitative Forecasting
q These techniques rely on hard data
q Quantitative techniques involve either the projection of historical data or the
development of associative methods that attempt to use causal variables to make a
forecast
Executive Opinion
q Involves small group of high-level experts
and managers
q Group estimates demand by working
together
q Combines managerial experience with
statistical models
q Relatively quick
Slide 19
Sales Force Composite/
Estimates
q Each salesperson projects his or her
sales
q Combined at district and national
levels
q Sales reps know customers’ wants
q May be overly optimistic
Market Survey
q Ask customers about purchasing
plans
q Useful for demand and product
design and planning
q What consumers say, and what they
actually do may be different
q May be overly optimistic
Summary of Qualitative Forecast methods
q Forecasts that use subjective inputs such as opinions from consumer
surveys, sales staff, managers, executives, and experts
q Executive opinions
q a small group of upper-level managers may meet and collectively develop a
forecast
q Sales force opinions
q members of the sales or customer service staff can be good sources of
information due to their direct contact with customers and may be aware of plans
customers may be considering for the future
q Consumer surveys
q since consumers ultimately determine demand, it makes sense to solicit input
from them
q consumer surveys typically represent a sample of consumer opinions
q Other approaches
q managers may solicit opinions from other managers or staff people or outside
experts to help with developing a forecast.
q the Delphi method is an iterative process intended to achieve a consensus
2. Quantitative Forecasting Methods
Slide 23
Quantitative Methods
q Used when situation is ‘stable’ and
historical data exist
q Existing products
q Current technology
q Involves mathematical techniques
q e.g., forecasting sales of HTC
smartphones
Overview of Quantitative Approaches
1. Naive approach
2. Moving averages Time-series
models
3. Exponential smoothing
4. Trend projection
Associative
5. Linear regression model
Time-Series Forecasting
q Set of evenly spaced numerical data
q Obtained by observing response variable
at regular time periods
q Forecast based only on past values, no other
variables important
q Assumes that factors influencing past and
present will continue influence in future
Time-Series Components
Trend Cycle
Seasonal Variation
Trend Component
q Persistent, overall upward or downward
pattern
q Changes due to population, technology,
age, culture, etc.
q Typically several years duration
Seasonal Component
q Regular pattern of up and down fluctuations
q Due to weather, customs, etc.
q Occurs within a single year
PERIOD LENGTH “SEASON” LENGTH NUMBER OF “SEASONS” IN
PATTERN
Week Day 7
Month Week 4 – 4.5
Month Day 28 – 31
Year Quarter 4
Year Month 12
Year Week 52
Cycle Component
q Repeating up and down movements
q Affected by business cycle, political, and economic
factors
q Multiple years duration
q Often causal or
associative
relationships
0 5 10 15 20
Variation Component
q Short duration and nonrepeating
q Irregular variation Caused
q by unusual circumstances, not
reflective of typical behavior.
q Random variations
q Residual variations after all other behaviors
are accounted for.
q Erratic, unsystematic, ‘residual’ fluctuations.
Trends and Seasonality
• Trend
– A long-term upward or downward movement in data
• Population shifts
• Changing income
• Seasonality
– Short-term, fairly regular variations related to the calendar or
time of day
– Restaurants, service call centers, and theaters all experience
seasonal demand
Cycles and Variations
q Cycle
q Wavelike variations lasting more than one year
q These are often related to a variety of economic, political, or even agricultural
conditions
q Irregular variation
q Due to unusual circumstances that do not reflect typical behavior
q Labor strike
q Weather event
q Random Variation
q Residual variation that remains after all other behaviors have been accounted for
Components of Demand
Slide 34
1.Naive Approach
q Assumes demand in next
period is the same as
demand in most recent period
q e.g., If January sales were 68, then February sales
will be 68
q Sometimes cost effective and efficient
q Can be good starting point
q Weakness: doesn’t smooth the data.
q Data smoothing: attempts
to
capture
important patterns in
the
data,
while
leaving
out noise
Naïve (Cont.)
q Check if the resulting accuracy is acceptable
q The higher the accuracy, often the higher the cost.
q Do we really need our forecast that accurate? Is it worth the
additional resources?
qWhy do you need forecasts for? How critical they are for
operations?
36
2. Moving Average
• Assumes an average is a good estimator of future behavior
– Used if little or no trend
– Used for smoothing
A t + A t -1 + A t -2 + ... + A t -n +1
Ft +1 =
n
Moving Average Method (cont.)
q MA is a series of arithmetic means
q Assumes an average is a good estimator of future behavior
q Used if little or no trend
q Used often for smoothing
q Provides overall impression of data over time
∑ demand in previous n periods
Moving average =
n
A t + A t -1 + A t -2 + ... + A t -n +1
Ft +1 =
n
Ft+1 = Forecast for the upcoming period, t+1
n = Number of periods to be averaged
At = Actual occurrence in period t
Moving Average Example
MONTH ACTUAL SHED SALES 3-MONTH MOVING AVERAGE
January 10 10
February 12 12
March 13 13
(10 + 12 + 13)/3 = 11 2/3
April 16
(12 + 13 + 16)/3 = 13 2/3
May 19
(13 + 16 + 19)/3 = 16
June 23
(16 + 19 + 23)/3 = 19 1/3
July 26
(19 + 23 + 26)/3 = 22 2/3
August 30
(23 + 26 + 30)/3 = 26 1/3
September 28
(29 + 30 + 28)/3 = 28
October 18
(30 + 28 + 18)/3 = 25 1/3
November 16
(28 + 18 + 16)/3 = 20 2/3
December 14
Moving Average Ft +1 =
A t + A t -1 + A t -2 + ... + A t -n +1
n
You’re manager in Amazon’s electronics
department. You want to forecast ipod sales for
months 4-6 using a 3-period moving average.
Sales Moving Average
Month (000) (n=3)
1 4 NA
2 6 NA
3 5 NA
4 ? (4+6+5)/3=5
5 ?
6 ?
Moving Average
Forecast for Month 5?
Sales Moving Average
Month (000) (n=3)
1 4 NA
2 6 NA
3 5 NA
4 3 5
5 ? (6+5+3)/3=4.667
6 ?
Moving Average -- example
MONTH Demand Month Demand
January 89 July 223
February 57 August 286
March 144 September 212
April 221 October 275
May 177 November 188
June 280 December 312
q 3 month MA: (oct+nov+dec)/3=258.33
q 6 month MA: (jul+aug+…+dec)/6=249.33
q 12 month MA: (Jan+feb+…+dec)/12=205.33
Summary of Moving Averages
q Advantages of Moving Average Method
q Easily understood
q Easily computed
q Provides stable forecasts
q Disadvantages of Moving Average Method
q Requires saving lots of past data points: at least the N periods
used in the moving average computation
q Lags behind a trend
q Ignores complex relationships in data
What about Weighted Moving Averages?
q This method looks at past data and tries to logically attach
importance to certain data over other data
q Weighting factors must add to one
q Can weight recent higher than older or specific data above
others
q If forecasting staffing, we could use data from the last four weeks
where Tuesdays are to be forecast.
q Weighting on Tuesdays is: T-1 is .25;; T-2 is .20;; T-3 is .15;; T-4 is .10
and Average of all other days is weighed .30.
Weighted Moving Average
q Used when some trend might be present
q Older data usually less important
q Weights based on experience and intuition
((
Weighted ∑ Weight for period n Demand in period n
moving =
)( ))
average ∑ Weights
Weighted Moving Average
qGives more emphasis to recent data
qWeights
q decrease for older data
Ft +1 = w1A t + w 2 A t -1 + w 3A t -2 + ... + w n A t -n +1
Simple moving
average models
weight all previous
periods equally
Weight MA Example
a) Compute a weighted average forecast using a weight of .40 for the
most recent period, .30 for the next most recent, .20 for the next,
and .10 for the next.
b) If the actual demand for period 6 is 39, forecast demand for period
7 using the same weights as in part a.
Period Demand
1 42
2 40
3 43
4 40
5 41
Exponential Smoothing
• A weighted averaging method that is based on the previous
forecast plus a percentage of the forecast error
Ft = Ft -1 + a ( At -1 - Ft -1 )
where
Ft = Forecast for period t
Ft -1 = Forecast for the previous period
a = Smoothing constant
At -1 = Actual demand or sales from the previous period
