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Sunday, June 26, 2011, 2:45 PM Categories: Financials , Budgeting and Forecasting , SCM , Planning and Forecasting , Project Management , Manufacturing , Manufacturing , Planning , BI-BW , SAP BusinessObjects , Integration , SAP BusinessObjects , Business Planning and Consolidation , Project Management , Financials , SCM , BI , Integration By Dr. Berg Every spring I teach a Management Science class for MBA’s where we cover the latest in advanced forecasting. For example, in ECC we have options that use factors to discover and adjust for weekly trends, underlying growth patters and changes. We call these Alpha, Beta, Delta and Gamma factors. Unfortunately, these models have limited support in BPC. In this Blog, I will demonstrate how you can make use of these options by a step-by-step example using basic Excel functions.

The Problem

We are trying to forecast sales by month for a product that has extremely high season changes. The historical unit sales over the last 108 months appear to be erratic as in the figure below. We will use this data to build a model that can forecast sales for 2011.

The problem is to build a model that can predict this sales pattern 100% correctly (yes, it can be done), let us see how:

Step- 1 Determining Base Line Seasonality

less the seasonal factor.2 The First Base Line Forecast For the last period (month) of the overall period (year). we create the first baseline forecast. In our example it is 102 less 1 = 101 Step. This is 14 items more than the average for the other months of the year. but this is also growing at 4 items each year.3 The First Trend factor is zero In the last period (month) of the overall period (year).e. Step.We look at the average sales in a time overall period (i. But what if in July 2002 it increases to 119 items (+4) and to in July 2003 to 123 items (+4)? . we may have 14 more items sold in July than the other months of the year. In short.We may then say that the Gamma represents an increase of + 4. We then determine the seasonality as: the actual for the period (month) less the mean for the overall period (year) Gamma is the term use to see if there are changes in the seasonality. . year) and establish the mean. we have no trends in our forecast yet. This is simply the Actual sale. For example: In July 2001 we have sales of 115 items. Later we will use a term called “Beta” to calculate this (more on this later). We simply flag it as “zero”.

For the first forecast for 2002 we introduce the term ‘beta’.5.5) * (101 + 0) = 50. In our example alpha is 0. we simply selected a beta of 0. Beta is normally expressed in a number from 0. We add them together and get the Base level forecast for the current period = 55 + 50. seasonal factors and previous forecasts. so we get: 0. This is long-term ‘hidden’ trends in our data. we had no trends in our forecast yet. we use Alpha to look at the seasonal change.0.Step.25.4 The Overall long-term trend . It is a number from 0 to 1 and is used in relations to trends.5 Step. In our example. but can sometimes exceed this.0.5*(actual – seasonal factor same period last year) or: 0.5 Finding the Trend factor – we call it Beta In step 3.5. So we get: (1-alpha) * (base level prior period plus seasonal factor last period) or: (1. We simply flagged it as “zero’.0 to 1.Alpha Alpha looks at the ‘big picture’.5 * (104 . We will find the correct beta later. First. for the last period for the first year. Beta is calculated in three steps: .5 = 105. we use the ‘opposite’ of Alpha to look at the base level and prior period trend.(-6)) = 55 Second.

25 the best? Is our gamma of 2.13 + 0. we look at the base-level forecast for January 2002 and compare it to prior period (Dec.13 Step.75 * 0 = 0.5 the best? Is our beta of 0.63 Step-7 Crating a Forecast for all periods we have data for We can now click and drag the formulas and create a forecast based for all periods we have actual data for. Now we will create the actual forecast based on all these factors.beta or: 1 .75. We simply add these together: Baseline forecast 105.00 = 100. 2001): 105. calculated as 1. base line forecast and seasonality adjustments.13 + Seasonal factor . Is our alpha of 0.25 = 0.5 -101 = 4. We use this to look at the trend prior period: 0.6. We add this together and find the trend value for the period: 1.00 = 1.50 + Trend 1.13. We will see how good our forecasting model is.5 *0. Second.6 Bringing together the Real Forecast This is a simple step. we take the ‘opposite’ of beta.0.00 Third.First. We multiply this with Beta: 4.00 the best? In our example we have 9 years (2001-2010) of .5. So far we only created a trend.25 = 1.

and we simply copy the formulas we did in steps one to six to get our forecasts Step. As we can see. The Blue line is actual sales for 108 months (2001-2010) and the Red line if our forecast. .data left to test the forecasting model against. or forecasting model is close.8 Examining the forecasting model visually We graph our forecast and see how our forecast is fitting the actual data.

Step.000 (this is done for all 108 months) Second.9 Examining the model – Mean Square Error (MSE) We now calculate the MSE by: First. MAPE for each forecasted period is calculated as: .357 + Feb 2002 = (101 – 100)2 = 1. beta and gamma Step. Sum the (The forecasted value – the actual value)2 for all forecasts. Jan 2002 = (100. I.10 How good is the Forecast Model – MAPE MAPE is the ‘Mean Absolute Percent Error’. Divide the sum by number of periods in the forecast (nine years of 12 months) = 108. MSE for our example is now 193.e.6.63 – 104)2 = 11. Our goal is to reduce the MSE to as small as possible by changing the alpha.

beta. and gamma.As we use Excel GoalSeek or a BPC script. we see that our forecast is dramatically improving Data fits perfectly!!! The forecast data fits almost perfectly our real data for 10 years. and we know alpha. All this is used to forecast the data for 2011 with a very high degree of accuracy!! .

as some observant readers may notice.For those interested. Just look under the spreaadsheet tab called "problem 2. 12 months) Gut-feeling (very popular) Simple or multiple regression Clustering by period Exponential smoothing Summary As you can see. This includes: • • • • • • • Last months demand Average for the previous year Rolling average (i. exponential smoothing methods with alpha. beta and gamma are popular and great methods.com/3sov8y2 (spreadsheet) tinyurl. tinyurl. and that is for another day… .com/3rrejmh (ppt) Other forecasting techniques There are many other forecasting methods with lesser accuracy. you can download my university lecture deck and spreadsheet at the links below. However. that can be added in Excel or via scripts.e.5B". That is a used to smooth the absolute mean. I skipped the Delta factor.

Berg FYI: the SAP ECC default/initial settings are: alpha = 0.1.Dr.3 and gamma = 0. delta = 0.3 . beta = 0.2.

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