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# Forecasting

Why Forecast?

• Assess long-term capacity needs

**• Develop budgets, hiring plans, etc.
**

• Plan production or order materials • Get agreement within firm and across supply chain partners

©2006 Pearson Prentice Hall — Introduction to Operations and Supply Chain Management — Bozarth & Handfield

Chapter 9, Slide 2

Forecast Characteristics

• Almost always wrong by some amount • More accurate for groups or families • More accurate for shorter time periods • No substitute for calculated demand.

©2006 Pearson Prentice Hall — Introduction to Operations and Supply Chain Management — Bozarth & Handfield

Chapter 9, Slide 3

Forecasting Approaches

Qualitative Methods

• Used when situation is vague and little data exists

– New products – New technology

Quantitative Methods

• Used when situation is „stable‟ and historical data exists

– Existing products – Current technology

**• Involves intuition, experience
**

***************************** • E.g., forecasting sales to a new market

**• Heavy use of mathematical techniques ******************************* • E.g., forecasting sales of a mature product
**

Chapter 9, Slide 4

©2006 Pearson Prentice Hall — Introduction to Operations and Supply Chain Management — Bozarth & Handfield

Slide 5 .“Q2” Forecasting Quantitative. then qualitative factors to “filter” the answer ©2006 Pearson Prentice Hall — Introduction to Operations and Supply Chain Management — Bozarth & Handfield Chapter 10.

Qualitative Forecasting • Executive opinions • Sales force composite • Consumer surveys • Outside opinions • Delphi method ©2006 Pearson Prentice Hall — Introduction to Operations and Supply Chain Management — Bozarth & Handfield Chapter 9. Slide 6 .

Demand Forecasting • Basic time series models • Linear regression – For time series or causal modeling • Measuring forecast accuracy • Mini-case: Northcutt Bikes (A) ©2006 Pearson Prentice Hall — Introduction to Operations and Supply Chain Management — Bozarth & Handfield Chapter 9. Slide 7 .

Time Series Models Period 1 2 3 4 5 6 7 8 Demand 12 15 11 9 10 8 14 12 What assumptions must we make to use this data to forecast? ©2006 Pearson Prentice Hall — Introduction to Operations and Supply Chain Management — Bozarth & Handfield Chapter 9. Slide 8 .

.Time Series Components of Demand . . Demand . . Slide 9 . randomness Time ©2006 Pearson Prentice Hall — Introduction to Operations and Supply Chain Management — Bozarth & Handfield Chapter 9. .

. randomness and trend Time ©2006 Pearson Prentice Hall — Introduction to Operations and Supply Chain Management — Bozarth & Handfield Chapter 9.Time Series with . . Slide 10 . . Demand . .

. . . Slide 11 ©2006 Pearson Prentice Hall — Introduction to Operations and Supply Chain Management — Bozarth & Handfield . .Time series with . randomness. Demand . trend and seasonality May May May May Chapter 9.

Slide 12 .Idea Behind Time Series Models Distinguish between random fluctuations and true changes in underlying demand patterns. ©2006 Pearson Prentice Hall — Introduction to Operations and Supply Chain Management — Bozarth & Handfield Chapter 10.

Moving Average Models Period 1 2 3 4 5 6 7 8 Demand 12 15 11 9 10 8 14 12 Ft 1 i 1 Dt 1i n n (14 + 8 + 10) / 3 10.67 Chapter 9. Slide 13 3-period moving average forecast for Period 8: = = ©2006 Pearson Prentice Hall — Introduction to Operations and Supply Chain Management — Bozarth & Handfield .

Slide 14 .3 + 0.5 + 0.2 10)] / (0.4 What are the advantages? What do the weights add up to? Could we use different weights? Compare with a simple 3-period moving average.3 8) + (0. ©2006 Pearson Prentice Hall — Introduction to Operations and Supply Chain Management — Bozarth & Handfield Chapter 9.Weighted Moving Averages Ft 1 i 1 Wt 1i Dt 1i i 1 n Wt 1i n Forecast for Period 8 = [(0.1) = 11.5 14) + (0.

4 10.9 Two-Period Moving Average Forecast Three-Period Weighted Moving Average Forecast Weights = 0.Table of Forecasts and Demand Values . Slide 15 ©2006 Pearson Prentice Hall — Introduction to Operations and Supply Chain Management — Bozarth & Handfield .2 7 8 9 14 12 9 11 13 8.4 11.5 12.5 13 10 9.8 9. Period 1 2 3 4 5 6 Actual Demand 12 15 11 9 10 8 13.3. 0. 0.5.8 Chapter 9. . .8 11.

and Resulting Graph 20 15 Demand 2-Period Avg 3-Period Wt. Avg. Volume 10 5 0 1 2 3 4 5 Period 6 7 8 9 Note how the forecasts smooth out variations ©2006 Pearson Prentice Hall — Introduction to Operations and Supply Chain Management — Bozarth & Handfield Chapter 9. .. Slide 16 . .

Exponential Smoothing I • Sophisticated weight averaging model • Needs only three numbers: Ft Dt = Forecast for the current period t = Actual demand for the current period t = Weight between 0 and 1 a ©2006 Pearson Prentice Hall — Introduction to Operations and Supply Chain Management — Bozarth & Handfield Chapter 9. Slide 17 .

Slide 18 .Exponential Smoothing II Formula Ft+1 = Ft + a (Dt – Ft) = a × Dt + (1 – a) × Ft • Where did the current forecast come from? • What happens as a gets closer to 0 or 1? • Where does the very first forecast come from? ©2006 Pearson Prentice Hall — Introduction to Operations and Supply Chain Management — Bozarth & Handfield Chapter 9.

76 9.41 ©2006 Pearson Prentice Hall — Introduction to Operations and Supply Chain Management — Bozarth & Handfield Chapter 9.00 2 3 4 5 15 11 9 10 11.3×15 + 0.Exponential Smoothing Forecast with a = 0.09 F2 = 0.99 11.15 11.3 = 12.41 F3 = 0.30 12.3×12 + 0.41 11.3 Period 1 Actual Demand 12 Exponential Smoothing Forecast 11. Slide 19 .7 = 11.3 6 7 8 9 8 14 12 10.7×11.6 + 7.7×11 = 3.93 11.

Resulting Graph 16 14 12 10 8 6 4 2 0 1 2 3 4 5 6 7 8 9 Period ©2006 Pearson Prentice Hall — Introduction to Operations and Supply Chain Management — Bozarth & Handfield Demand Demand Forecast Chapter 9. Slide 20 .

Trends What do you think will happen to a moving average or exponential smoothing model when there is a trend in the data? ©2006 Pearson Prentice Hall — Introduction to Operations and Supply Chain Management — Bozarth & Handfield Chapter 10. Slide 21 .

00 11.06 Since the model is based on historical demand.00 11.81 12. it always lags the obvious upward trend Chapter 9.94 15.30 11.Same Exponential Smoothing Model as Before: Period 1 2 3 4 5 6 7 Actual Demand 11 12 13 14 15 16 17 Exponential Smoothing Forecast 11.47 13. Slide 22 8 9 18 14.23 14.86 ©2006 Pearson Prentice Hall — Introduction to Operations and Supply Chain Management — Bozarth & Handfield .

Adjusting Exponential Smoothing for Trend • Add trend factor and adjust using exponential smoothing • Needs only two more numbers: Tt = Trend factor for the current period t = Weight between 0 and 1 • Then: Tt+1 = × (Ft+1 – Ft) + (1 – ) × Tt • And the Ft+1 adjusted for trend is = Ft+1 + Tt+1 ©2006 Pearson Prentice Hall — Introduction to Operations and Supply Chain Management — Bozarth & Handfield Chapter 9. Slide 23 .

Slide 24 .Simple Linear Regression • Time series OR causal model • Assumes a linear relationship: y y = a + b(x) x ©2006 Pearson Prentice Hall — Introduction to Operations and Supply Chain Management — Bozarth & Handfield Chapter 9.

Definitions Y = a + b(X) Y = predicted variable (i. Slide 25 . demand) X = predictor variable “X” can be the time period or some other type of variable (examples?) ©2006 Pearson Prentice Hall — Introduction to Operations and Supply Chain Management — Bozarth & Handfield Chapter 9..e.

The Trick is Determining a and b: xi y i n 2 n ( x i )( y i i 1 i 1 n n b i 1 i 1 xi n n 2 ( xi ) i 1 n a y bx ©2006 Pearson Prentice Hall — Introduction to Operations and Supply Chain Management — Bozarth & Handfield Chapter 9. Slide 26 .

Slide 27 5 15 490 1520 25 55 2450 5540 ©2006 Pearson Prentice Hall — Introduction to Operations and Supply Chain Management — Bozarth & Handfield .Example: Regression Used for Time Series Period (X) 1 2 3 4 Demand (Y) 110 190 320 410 X2 1 4 9 16 XY 110 380 960 1640 15 1520 5540 5 b 98 2 15 55 5 1520 15 a 98 10 5 5 Column Sums Chapter 9.

Slide 28 .Resulting Regression Model: Forecast = 10 + 98×Period 600 500 400 Y 300 200 100 0 1 2 3 X 4 5 Demand Regression ©2006 Pearson Prentice Hall — Introduction to Operations and Supply Chain Management — Bozarth & Handfield Chapter 9.

regression becomes much simpler – a now equals the average of the y values – b simplifies to the sum of the xy products divided by the sum of the x2 values ©2006 Pearson Prentice Hall — Introduction to Operations and Supply Chain Management — Bozarth & Handfield Chapter 9. Slide 29 .Example: Simplified Regression I • If we redefine the X values so that their sum adds up to zero.

Example: Simplified Regression II Period (X) 1 2 3 4 5 Period (X)' -2 -1 0 1 2 Demand (Y) 110 190 320 410 490 X2 4 1 0 1 4 XY -220 -190 0 410 980 0 1520 980 5 b 98 2 0 10 5 1520 0 a 98 304 5 5 0 1520 10 980 Chapter 9. Slide 30 ©2006 Pearson Prentice Hall — Introduction to Operations and Supply Chain Management — Bozarth & Handfield .

Dealing with Seasonality Quarter Winter 02 Spring Summer Fall Winter 03 Spring Summer Fall Period 1 2 3 4 5 6 7 8 Demand 80 240 300 440 400 720 700 880 Chapter 9. Slide 31 ©2006 Pearson Prentice Hall — Introduction to Operations and Supply Chain Management — Bozarth & Handfield .

1 24.57 + 108.4 850 -124.7 Forecast Error -10 41.57 x Period Actual Demand 80 240 300 440 Period Winter 02 Spring Summer Fall Regression Forecast 90 198.2 -41.3 632.What Do You Notice? Forecasted Demand = –18.3 1 2 3 4 Winter 03 Spring Summer Fall 5 6 7 8 400 720 700 880 524. Slide 32 ©2006 Pearson Prentice Hall — Introduction to Operations and Supply Chain Management — Bozarth & Handfield .6 307.1 415.9 741.4 30 Chapter 9.4 -7.3 87.

but not seasonality effect 1000 800 600 400 200 0 1 2 3 4 5 6 7 8 Demand Forecast ©2006 Pearson Prentice Hall — Introduction to Operations and Supply Chain Management — Bozarth & Handfield Chapter 9.Regression picks up trend. Slide 33 .

83 Interpret! ©2006 Pearson Prentice Hall — Introduction to Operations and Supply Chain Management — Bozarth & Handfield Chapter 9.76 Average of these two = 0.Calculating Seasonal Index: Winter Quarter (Actual / Forecast) for Winter Quarters: Winter „02: Winter „03: (80 / 90) = 0.3) = 0.89 (400 / 524. Slide 34 .

57×Period ] × 0.57 + 108. Slide 35 .57 × Period ] × Seasonal Index ©2006 Pearson Prentice Hall — Introduction to Operations and Supply Chain Management — Bozarth & Handfield Chapter 9.83 Or more generally: [ –18.57 + 108.Seasonally adjusted forecast model For Winter Quarter [ –18.

96 1.98 435.05 0.94 1.1 415.57 x Period Seasonally Adjusted Forecast Period Actual Demand Regression Forecast Demand/ Forecast Seasonal Index Forecast Error Winter 02 Spring Summer Fall Winter 03 Spring Summer Fall 1 2 3 4 5 6 7 8 80 240 300 440 400 720 700 880 90 198.97 294.83 1.57 + 108.96 1.84 5.17 0.3 632.02 742.7 524.6 307.13 889.02 -22.42 712.42 -12.04 0.Seasonally adjusted forecasts Forecasted Demand = –18.81 -33.83 1.17 0.05 74.21 0.03 5.14 0.89 1.33 232.84 ©2006 Pearson Prentice Hall — Introduction to Operations and Supply Chain Management — Bozarth & Handfield Chapter 9.02 4.9 741.4 850 0.98 1.19 433.06 0.76 1.13 -9. Slide 36 .67 7.

Would You Expect the Forecast Model to Perform This Well With Future Data? 1000 800 600 400 200 0 1 2 3 4 5 6 7 8 Demand forecast ©2006 Pearson Prentice Hall — Introduction to Operations and Supply Chain Management — Bozarth & Handfield Chapter 9. Slide 37 .

Slide 38 .More Regression Models I Non-linear models – Example: y = a + b × ln(x) ©2006 Pearson Prentice Hall — Introduction to Operations and Supply Chain Management — Bozarth & Handfield Chapter 9.

More Regression Models II Multiple regression – More than one independent variable y y = a + b1 × x + b2 × z x z ©2006 Pearson Prentice Hall — Introduction to Operations and Supply Chain Management — Bozarth & Handfield Chapter 9. Slide 39 .

Causal Models Time series assume that demand is a function of time. Dollars spent on drought relief. Lumber sales. 2. 3. Linear regression can be used in these situations as well. Pounds of BBQ eaten at party. Slide 40 . ©2006 Pearson Prentice Hall — Introduction to Operations and Supply Chain Management — Bozarth & Handfield Chapter 9. 1. This is not always true.

Slide 41 .Measuring Forecast Accuracy How do we know: If a forecast model is “best”? If a forecast model is still working? What types of errors a particular forecasting model is prone to make? Need measures of forecast accuracy ©2006 Pearson Prentice Hall — Introduction to Operations and Supply Chain Management — Bozarth & Handfield Chapter 9.

Measures of Forecast Accuracy Error = Actual demand – Forecast or Et = Dt – Ft ©2006 Pearson Prentice Hall — Introduction to Operations and Supply Chain Management — Bozarth & Handfield Chapter 9. Slide 42 .

Mean Forecast Error (MFE) For n time periods where we have actual demand and forecast values: MFE i 1 Ei ) n Chapter 9. Slide 43 n ©2006 Pearson Prentice Hall — Introduction to Operations and Supply Chain Management — Bozarth & Handfield .

Mean Absolute Deviation (MAD) For n time periods where we have actual demand and forecast values: MAD i 1 Ei n Chapter 9. Slide 44 n What does this tell us that MFE doesn’t? ©2006 Pearson Prentice Hall — Introduction to Operations and Supply Chain Management — Bozarth & Handfield .

Slide 45 .0 What is the MFE? The MAD? Interpret! ©2006 Pearson Prentice Hall — Introduction to Operations and Supply Chain Management — Bozarth & Handfield Chapter 9.0 0.5 -4.5 5.0 1.5 5.0 Absolute Error 2.5 9 11 Error -2.Example Period Demand Forecast 3 4 5 6 7 8 11 9 10 8 14 12 13.5 13 10 9.0 1.5 4.0 0 -1.0 1.

MFE and MAD: A Dartboard Analogy Low MFE and MAD: The forecast errors are small and unbiased ©2006 Pearson Prentice Hall — Introduction to Operations and Supply Chain Management — Bozarth & Handfield Chapter 9. Slide 46 .

the arrows hit the bulls eye (so much for averages!) ©2006 Pearson Prentice Hall — Introduction to Operations and Supply Chain Management — Bozarth & Handfield Chapter 9. but high MAD: On average.An Analogy (continued) Low MFE. Slide 47 .

An Analogy (concluded) High MFE and MAD: The forecasts are inaccurate and biased ©2006 Pearson Prentice Hall — Introduction to Operations and Supply Chain Management — Bozarth & Handfield Chapter 9. Slide 48 .