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Industrial Engineering

FORECASTING

OUTLINE
1.0 2.0 3.0 4.0 5.0 6.0 Introduction Types of Forecasts by Time Horizon Steps in the Forecasting Process Qualitative Forecasting Methods Quantitative Forecasting Methods Forecasting Errors and Tracking Signals

1.0 INTRODUCTION

DEFINITION OF FORECASTING
A statement

about the future value of a variable of interest such as demand (Stevenson, 2005). Process (art and science) of predicting a future event (Heizer & Render, 2004) Forecasts affect decisions and activities throughout an organization
Accounting,

finance Human resources Marketing MIS Operations Product / service design

. individuals accuracy decreases as time horizon increases I see that you will get an A this semester.Forecasts Forecasts Forecast rarely perfect because of randomness more accurate for groups vs.

Usage of Forecasting Accounting Finance Human Resources Marketing MIS Operations Product/service design Cost/profit estimates Cash flow and funding Hiring/recruiting/training Pricing. services Schedules. workloads New products and services . promotion. MRP. strategy IT/IS systems.

Elements of a Good Forecast Timely Reliable l fu Accurate e s u M ng i n a e Written y s Ea to .

Realities of Forecasting  Forecasts are seldom perfect  Most forecasting methods assume that there is some underlying stability in the system  Both product family and aggregated product forecasts are more accurate than individual product forecasts .

0 TYPES OF FORECASTS BY TIME HORIZON .2.

facility location . worker assignments  Medium-range forecast  3 months to 3 years  Sales & production planning. usually less than 3 months  Job scheduling.Types of Forecasts by Time Horizon  Short-range forecast  Up to 1 year. budgeting  Long-range forecast  3+ years  New product planning.

. Longer-term Forecasting  Medium/long range forecasts deal with more comprehensive issues and support management decisions regarding planning and products.Short-term vs.  Short-term forecasting usually employs different methodologies than longer-term forecasting  Short-term forecasts tend to be more accurate than longer-term forecasts. plants and processes.

0 STEPS IN FORECASTING PROCESS .3.

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 .

FORECASTING APPROACHES .

experience mathematical techniques .Forecasting Approaches Qualitative Methods  Used Quantitative Methods  Used when situation is vague/uncertain & little data exist  New when situation is ‘stable’ & historical data exist  Existing products  New technology  Involves products  Current technology  Involves intuition.

0 QUALITATIVE FORECASTING METHODS .4.

sometimes augment by statistical models  Sales force opinions  Estimates from individual salespersons are reviewed for reasonableness. then aggregated  Consumer Surveys  Ask the customer  Delphi method  Panel of experts.Overview of Qualitative/Judgmental Forecasting Methods Executive opinions  Pool opinions of high-level executives. queried iteratively  .

0 QUANTITATIVE FORECASTING METHODS .5.

Overview of Quantitative Approaches  Naïve approach  Simple Moving Averages  Weighted Moving Average  Exponential smoothing  Trend Projections  Linear Time-series Models regression Associative models (Causal) .

5.0 QUANTITATIVE FORECASTING METHODS (TIME SERIES MODEL) .

7 93.1  Forecast based only on past values  Assumes  Example . monthly etc)  Obtained by observing response variable at regular time periods that factors influencing past and present will continue influence in future Year: Sales: 19981999200020012002 78.763.What is a Time Series?  Set of evenly spaced numerical data (weekly.292.589.

Overview of Time-Series Forecasting Model  Naïve approach  Simple Moving Average  Weighted Moving Average  Exponential smoothing  Trend Projections Techniques for averaging .

If May sales were 48.. then June sales will be 48  Sometimes cost effective © 1995 Corel Corp.Naive Approach  Assumes demand in next period is the same as demand in most recent period  e.g. & efficient .

give me a minute. We sold 250 wheels last week..Naive Forecasts Uh...... Now... next week we should sell. . The forecast for any period equals the previous period’s actual value..

Naïve Forecasts Simple to use Virtually no cost Quick and easy to prepare Data analysis is nonexistent Easily understandable Cannot provide high accuracy .

Simple Moving Average   Used if little or no trend Equation: Demand in Previous n Periods ∑ MA = n MAn = A i ∑ i=1 n n .

You want to forecast sales (000) for 2003 using a 3period moving average.Simple Moving Average Example You’re manager of a museum store that sells historical replicas. 1998 4 1999 6 2000 5 2001 3 2002 7 © 1995 Corel Corp. .

Moving Average Solution Time 1998 1999 2000 2001 2002 2003 Response Yi 4 6 5 3 7 NA Moving Total (n=3) NA NA NA 4+6+5=15 Moving Average (n=3) NA NA NA 15/3 = 5 .

Moving Average Solution Time 1998 1999 2000 2001 2002 2003 Response Yi 4 6 5 3 7 NA Moving Total (n=3) NA NA NA 4+6+5=15 6+5+3=14 Moving Average (n=3) NA NA NA 15/3 = 5 14/3=4 2/3 .

7 15/3=5.Moving Average Solution Time 1998 1999 2000 2001 2002 2003 Response Yi 4 6 5 3 7 NA Moving Total (n=3) NA NA NA 4+6+5=15 6+5+3=14 5+3+7=15 Moving Average (n=3) NA NA NA 15/3=5.0 14/3=4.0 .

& sum to 1.Weighted Moving Average Method Used when trend is present data usually less important Older Weights Often based on intuition lay between 0 & 1.0 Equation WMA = Σ(Weight for period n) (Demand in period n) ΣWeights .

2 . F7 = 0. F6 = 0.2(43) + 0.4(39) + 0.3(41) + 0.30 for the next most recent. If the actual demand for period 6 is 39.1(40) = 41.2(40) + 0. Compute a weighted average forecast using a weight of . . .40 for the most recent period.1(43) = 40.0 b. forecast demand for period 7 using the same weights as in part a.20 for the next. a.  Period 1 2 3 4 5  Demand42 40 43 40 41 a.3(40) + 0. b.10 for the next.Weighted Moving Average: Example Given the following demand data. and .4(41) + 0.

Weighted Moving Average 35 30 Sales Demand 25 20 15 10 5 0 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Month Weighted moving average Actual sales Moving average .Actual Demand. Moving Average.

they will always stay within past levels and will not predict changes to either higher or lower levels.Disadvantages of Techniques for Averaging Methods  Increasing n makes forecast less sensitive to real changes in the data  Cannot pickup trends very well. Because they are averages.  Require much historical data .

 Therefore. . we should give more weight to the more recent time periods when forecasting.Exponential Smoothing Ft = Ft-1 + α(At-1 .Ft-1) • Premise--The most recent observations might have the highest predictive value.

Ft-1) = Forecast value for period t Where. = Forecast value for the previous period  At = Actual value for period t  At-1= Actual value for the previous period  α = Smoothing constant .Exponential Smoothing Equations  Ft  Ft  Ft-1 = Ft-1 + α(At-1 .

Exponential Smoothing

Ft = Ft-1 + α(At-1 - Ft-1)
 Weighted

averaging method based on previous forecast plus a percentage of the forecast error  A-F is the error term, α is the % feedback  If closer to 0 = less responsiveness, greater smoothing  If closer to 1 = greater responsiveness, less smoothing

Exponential Smoothing Example
During the past 8 quarters, the Port of Baltimore has unloaded large quantities of grain. (α = .10). The first quarter forecast was 175. Quarter Actual 1 2 3 4 5 6 7 8 9 180 168 159 175 190 205 180 182 ?

Find the forecast for the 9th quarter.

Exponential Smoothing Solution
Ft = Ft-1 + 0.1(At-1 - Ft-1)
Quarter 1 2 3 4 5 6 Actual 180 168 159 175 190 205 175.00 + Forecast, F t (α = .10) 175.00 (Given)

Exponential Smoothing Solution
Ft = Ft-1 + 0.1(At-1 - Ft-1)
Quarter Actual 1 2 3 4 5 6 180 168 159 175 190 205 175.00 + .10( Forecast, F t (α = .10) 175.00 (Given)

10(180 Forecast.Exponential Smoothing Solution Ft = Ft-1 + 0. Ft (α = .Ft-1) Quarter 1 2 3 4 5 6 Actual 180 168 159 175 190 205 175.00 (Given) .10) 175.00 + .1(At-1 .

Ft-1) Quarter Actual 1 2 3 4 5 6 180 168 159 175 190 205 Forecast.Exponential Smoothing Solution Ft = Ft-1 + 0. Ft (α = .175.10) 175.1(At-1 .00 (Given) 175.10(180 .00 + .00) .

Ft-1) Quarter Actual 1 2 3 4 5 6 180 168 159 175 190 205 Forecast.1(At-1 .10(180 .00) = 175.00 + .00 (Given) 175.175.10) 175.50 . Ft (α = .Exponential Smoothing Solution Ft = Ft-1 + 0.

00 + .00) = 175.50 175.1(At-1 .Exponential Smoothing Solution Ft = Ft-1 + 0.50 + .10(180 .00 (Given) 175.Ft-1) Quarter 1 2 3 4 5 6 Actual 180 168 159 175 190 205 Forecast.75 .50) = 174.175.175.10(168 .10) 175. F t (α = .

75 + .10) 175. F t (α = .175.00) = 175.50 + .10(180 .174.1(At-1 .175.50 175.18 .75)= 173.10(168 .75 174.50) = 174.00 (Given) 175.10(159 .00 + .Ft-1) Quarter Actual 1 2 3 4 5 6 180 168 159 175 190 205 Forecast.Exponential Smoothing Solution Ft = Ft-1 + 0.

Exponential Smoothing Solution Ft = Ft-1 + 0.10(168 . F t (α = .18 173.175.10(159 .75 174.18) = 173.173.00) = 175.75 + .18 + .00 (Given) 175.00 + .75) = 173.50 + .36 .Ft-1) Quarter Actual 1 2 3 4 5 6 180 168 159 175 190 205 Forecast.1(At-1 .174.50 175.10(180 .175.10(175 .10) 175.50) = 174.

50) = 174.75 174.36) = 175.00 (Given) 175.174.00) = 175.10(190 .75 + .00 + .10) 175.10(168 .1(At-1 .75) = 173.36 + .18 + .175.36 173.10(175 .Ft-1) Quarter Actual 1 2 3 4 5 6 180 168 159 175 190 205 Forecast.173.18) = 173.50 + .173.02 .10(159 .50 175.175.18 173.Exponential Smoothing Solution Ft = Ft-1 + 0. F t (α = .10(180 .

Ft-1) Time 4 5 6 7 8 9 Actual 175 190 205 180 Forecast.36 + .18 + .175.02 .02) = 178.18 173.75 + .02 + . F t (α = .174.10(205 .173.02 175.10(159 .75) = 173.10) 174.36) = 175.173.Exponential Smoothing Solution Ft = Ft-1 + 0.10(190 .18) = 173.36 173.1(At-1 .10(175 .

1(At-1 .02) = 178.22 178.02) = 178.10(175 .Exponential Smoothing Solution Ft = Ft-1 + 0.10(205 .02 178.10(182 .22) = 178.36 173.175.173.58 182 ? .36 + .36) = 175.10(159 .Ft-1) Time 4 5 6 7 8 9 Actual 175 190 205 180 Forecast.10(190 .10(180 .174.178.02 + . F t (α = .18) = 173.75) = 173.75 + .02 175.02 + .178.10) 174.18 + .173.22 + .18 173.

1) .Impact of α 250 200 150 Actual Tonage 100 50 0 1 2 3 4 5 Quarter 6 7 8 9 Actual Forecast (0.5) Forecast (0.

linear.TREND PROJECTIONS  A time-series forecasting method that fits a trend line to a series of historical data points and then projects the line into the future for forecasts. quadratic)  We will focus on linear trend only . exponential.  Several mathematical trend equations can be developed (e.g.

Linear Trend Projection  Used for forecasting linear trend line  Assumes relationship between response variable. X. Y. is a linear function Yi = a + bX i  Estimated by least squares method  Minimizes sum of squared errors . and time.

Least Squares Method for finding the bestfitting straight line Actual observation Values of Dependent Variable Deviation Deviation Deviation Deviation Deviation Deviation Deviation Point on regression line ˆ = a + bx Y Time .

Equations Equation: ˆ i = a + bx i Y n Slope: b = i =1 n 2 ∑ xi − nx 2 i =1 ∑ x i y i − nx y Y-Intercept: a = y − bx .

Computation Table Xi X1 X2 : Xn ΣXi Yi Y1 Y2 : Yn ΣYi 2 Xi 2 X1 2 X2 2 Yi 2 Y1 2 Y2 X iY i X 1Y 1 X 2Y 2 : X nY n Σ X iY i : Xn 2 2 ΣXi : Yn 2 2 ΣYi .

Find the overall trend.Edison over the years 1997 – 2003 is given at the left.Using a Trend Line Year 1997 1998 1999 2000 2001 2002 2003 Demand 74 79 80 90 105 142 122 The demand for electrical power at N.Y. .

063 .Finding a Trend Line Year Time Period (x) 1 2 3 4 5 6 7 Σx=28 Power Demand (y) 74 79 80 90 105 142 122 Σy=692 x2 xy 1997 1998 1999 2000 2001 2002 2003 1 4 9 16 25 36 49 74 158 240 360 525 852 854 Σx2=140 Σxy=3.

54(4) = 56.02 megawatts Demand in 2005 = 56.86 n 7 b= Σxy .70 Demand in 2004 = 56.70 + 10.54 2 2 2 Σx − nx 140 − (7)(4) 28 a = y .56 megawatts .10.54(9) = 151.063 − (7)(4)(98.nxy 3.86) 295 = = = 10.70 + 10.54(8) = 141.The Trend Line Equation x= Σx 28 = =4 n 7 y= Σy 692 = = 98.bx = 98.86 .

54x .70 + 10.Actual and Trend Forecast Electric Power Demand 1 60 1 50 1 40 1 30 1 20 1 1 0 1 00 90 80 70 60 1 997 1 998 1 999 2000 2001 Year 2002 2003 2004 2005 Trend line Y = 56.

Linear Trend Equation (2nd Technique) y y = a + bx 0 1 2 3 4 5 y x = Forecast for period x x = Specified number of time periods a = Value of Ft at t = 0 b = Slope of the line .

Calculating a and b n ∑ (xy) .∑ x ∑ y b = 2 2 n∑ x .b∑ x a = n .( ∑ x) ∑ y .

Linear Trend Equation Example t W eek 1 2 3 4 5 Σ t = 15 2 (Σ t) = 2 2 5 Σ t 2 t 1 4 9 16 25 = 55 2 y S a le s 150 157 162 166 177 Σ y = 812 ty 150 314 486 664 885 Σ ty = 2 4 9 9 .

3(15) a = = 143.5 5 y = 143.15(812) 12495-12180 b = = = 6.225 275 -225 812 .3 5(55) .6.Linear Trend Calculation 5 (2499) .5 + 6.3x .

Assignment Sales for last 10 weeks are shown in the table below. Plot the data and visually check to see whether a linear trend line is appropriate. Then determine the equation of trend line. Week Unit sales 1 70 0 2 72 4 3 72 0 4 5 6 7 8 9 10 728 740 742 758 750 770 775 . and predict sales for weeks 11 and 12.

Solution: a) Sales vs Week 800 780 760 Sales 740 720 700 680 660 1 2 3 4 5 6 7 8 9 10 Week Sales vs Week The plot above suggests that a linear trend line is appropriate .

b) Week (t) 1 2 3 4 5 6 7 8 9 10 55 Unit sales (y) ty 700 700 724 1448 720 2160 728 2912 740 3700 742 4452 758 5306 750 6000 770 6930 775 7750 7407 41358 t 1 4 9 16 25 36 49 64 81 100 385 2 TOTAL .

51x .51 a = 7407 – 7.b) b = 10 (41358) – 55 (7407) 10 (385) – 55 (55) = 6195 / 825 = 7.51 (55) = 699.40 + 7.40 10 Thus gives us an equation: y = 699.

40 + 7.51 . the predict sales for weeks 11 and 12 are: y11 = 699.c) Therefore.51(12) = 789.01 y12 = 699.40 + 7.51(11) = 782.

5.0 QUANTITATIVE FORECASTING METHODS (ASSOCIATIVE / CAUSAL MODEL) .

: the sale of IBM PCs might be related to IBM’s advertising budget. associative model usually consider several variables that are related to the quantity being predicted  E. competitors’ prices etc. the company’s prices. other variables = independent variables  Main technique: Linear Regression .ASSOCIATIVE MODEL  Unlike time-series method.  PC sales = dependent variable.g.

Linear Regression Model  Shows linear relationship between dependent & explanatory variables  Example: Sales & advertising (not time) Slope Y-intercept ^ Yi = a + bX i Dependent (response) variable Independent (explanatory) variable .

.Example: Expenditure on advertising is expected to cause an increase in sales volume. or Sales Volume = A + B x advertising expenditure Where : A = Sales volume without advertising B = The amount by which one unit of advertising expenditure can increase sales volume.

Equations Equation: ˆ i = a + bx i Y n Slope: b = i =1 n 2 ∑ xi − nx 2 i =1 ∑ x i y i − nx y Y-Intercept: a = y − bx .

or n ∑ (xy) .∑ x ∑ y b = 2 2 n∑ x .( ∑ x) ∑ y .b∑ x a = n .

Scatter Diagram Sales versus Payroll 4 3 Sales (in $ hundreds of thousands) 2 1 0 0 1 2 3 4 5 6 Area Payroll (in $ hundreds of millions) 7 8 .

2 4.0 9.4 7.5 6. Derive predictive equation for sales based on unemployment levels.6 8.4 3. Period 1 2 3 4 5 6 7 8 9 10 11 Unit Sold 20 41 17 35 25 31 38 50 15 19 14 Unemployment (%) 7.0 7.EXAMPLE Data shows sales of 20” TV and unemployment.0 .0 5.8 6.3 5.

Solution: a ) Plot a graph data Unit Sold vs Level of Unemployment (%) 60 50 Unit Sold 40 30 20 10 0 0.0 2.0 10.0 Level of Unemployment (%) Unit Sold vs Level of Unemployment .0 4.0 6.0 8.

0 Total 70.6 8.1 192. Σ y2 Unemployment (x) 7.3 y2 400 1681 289 1225 625 961 1444 2500 225 361 196 9907.25 46.4 3.0 9.96 70.5 170 186 205.84 16 53.4 7.3 5.0 .29 30.2 Unit Sold (y) 20 41 17 35 25 31 38 50 15 19 14 305.8 6.24 36 29.0 7. Σ y.2 180 126 133 126 1750.0 5.8 x2 51.b) Calculate Σ x. Σ xy.5 6.0 xy 144 164 124.56 49 81 476.2 4. Σ x2.16 12.

85 .2) 11 c) Make the general equation: = 71.36 = -6.2(305) 11 (476.2) = -2152.89x .2 / 312.4) – 70.8) – 70.91)(70.89 a = 305 – (.6.2 (70.b) Calculate value of a and b: b = 11 (1750.6.85 y = 71.

Sales (000 units) 19 18 15 20 18 22 20 . Inc.. Monthly sales for a seven-month period were as follows: Month Feb Mar Apr May Jun July Aug. sells can openers.ASSIGNMENT National Mixer.

v.3 for July. A linear trend equation ii. assume March forecast of 19 (000). 0.6 for Aug. A five-month moving average iii. The naïve approach. Plot the monthly data b. and 0.2.a.1 for June. . A weighted moving average using 0. iv. Forecast September sales using: i.. Exponential smoothing. α = 0.

Plot the monthly data 25 Sales (000 units) 20 15 10 5 0 Feb Mar Apr May Month Jun July Aug Plot data (-2) Tajuk dan unit paksi x (-2) Tajuk dan unit paksi y (-2) .Solution: a.

A linear trend equation Month Feb Mar Apr May Jun July Aug Total Sales (000 units) 19 18 15 20 18 22 20 132 x 1 2 3 4 5 6 7 28 xy 19 36 45 80 90 132 140 542 x2 1 4 9 16 25 36 49 140 . Forecast September sales using: i.b.

5 a = 132 – 0.Calculate value of a and b: b = 7 (542) – 28 (132) 7 (140) – 28 (28) = 98 / 196 = 0.5 (28) = 16.5(8) = 20.860 units (-2) .86 7 (-1) (-1) Thus gives us an equation: y = 16.5x The forecast for September are: (-1) y8 = 16.86 + 0.86 + 0.

b. Forecast September sales using: ii. A five-month moving average MA5 = 20+22+18+20+15 5 = 19.000 units (-3) .

8 18.3456 19.07648 19. Month Feb Mar Apr May Jun July Aug Sept Sales (000 units) 19 18 15 20 18 22 20 F3 = F2 + α (A2F2) iii.432 18.800 units (-3) . Forecast September sales using: forecast of 19 (000). α = 0.04 18.2 (18-19) = 18.b.261184 Example : F3 = 19 + 0. assume March Forecast 19 18.2. Exponential smoothing.

The naïve approach = 20.3(22) + 0.400 units (-4) . 0.1(18) = 20.6(20) + 0.6 for Aug. Forecast September sales using: iv.. A weighted moving average using 0.000 units (-1) v. and 0. F8 = 0.3 for July.b.1 for June.

Principles of Operations Management . Stevenson. B. New York: McGraw-Hill. 8th Edition. Operations Management.J. 5th Edition. and Render. J. (2004). .REFERENCES   Heizer. New Jersey: Prentice Hall. W. (2005).