BBn
Current factors or conditions
Past experience in a similar situation
Forecasts are the basis for budgeting,
planning capacity, sales, production
and inventory, personnel, purchasing
and more.
Forecasts play an important role in the
planning process because they enable
a manager to anticipate the future so
he can plan accordingly.
Accounting: New product cost estimates,
profit projections, cash management etc.
Human resources: Hiring activities,
recruitment, training etc.
Operations: Scheduling, work assignment,
inventory planning etc.
To help managers plan the system
To help them plan the use of the system
Forecasting techniques generally assume that the same
underlying casual system that existed in the past will
continue to exist in the future.
Forecasts are rarely perfect; actual results usually differ
from predicted values.
Forecasts for groups of items tend to be more accurate
than forecasts for individual items. Because forecasting
errors among items in a group usually has a cancelling
effect.
Forecast accuracy decreases as the time horizon
increases. Short term forecasts have lower uncertainties
than the long-term forecasts.
A properly prepared forecast should fulfill certain
requirements. The forecasts should be:
timely: The forecasting must cover the time
necessary to implement possible changes.
accurate: This enables users to plan for
possible errors and provides a basis for
comparing alternatives
reliable: A technique that sometimes provide
good forecasts and sometimes poor one leaves
users with the uneasy feelings.
in meaningful units: Financial planner needs
to know how many dollars will be needed?
Schedulers should know what machines and
skills will be required?
in writing: A written forecast permits an
objective basis for evaluating the forecast once
actual results are in.
simple to understand: Simple forecasting
techniques enjoy wide spread popularity because
users are more comfortable working with them.
There are six basic steps in the forecasting process:
Determining the purpose of the forecast:
How will it be used and when will it be needed?
It will provide an indication of the level of detail
required in the forecast and the level of the
accuracy necessary.
Establish a time horizon: The forecasts must
indicate a time interval, keeping in mind that
accuracy decreases as the time horizon
increases.
Select a forecast technique
Gather and analyze relevant data: It helps in
identifying any assumptions that are made in
conjunction with preparing and using forecast.
Make the forecast.
Monitor the forecast: It determines whether it is
performed in a satisfactory manner. If it is not,
reexamine the method.
Either or both approaches might be used to
develop forecasts.
Qualitative method: It involves subjective
inputs, numerical description. It includes soft
information (human factor, personal opinion
etc) in the forecasting process.
Quantitative method: It involves either the
projection of historical data or the development
of associative methods which utilize
explanatory variables to make forecasts. This
method mainly analyzes data.
Judgmental
Time series
Associative
Judgmental forecasts rely on analysis of
subjective inputs obtained from various
sources such as opinion from consumer
surveys, sales staff, managers and
executives and experts
Forecasts that project patterns identified in
recent time series observations. It project
past experience into the future
Forecasting technique that uses explanatory
variables to predict future demand. For
example, demand for paint might be related
to variables such as the price per gallon and
the amount spent on advertising and drying
time, ease of cleanup etc.
In some situations, forecasts rely solely on
judgment and opinion. For instances,
If the management must have a forecast quickly,
there may not be enough time to gather and
analyze quantitative data.
At another time, especially when political and
economic conditions are changing, available data
may be out of date and more up-to-date information
might not yet be available.
In such instances forecasts are based on executive
opinions, sales force opinions, consumer surveys, etc.
Marketing manager, financial manager and
operations manager may meet and
collectively develop a forecast. This
approach is used for long-term planning and
new product development.
The sales staff or the customer service staff
is often a good source of information
because of their direct contact with
customers. They are often aware of any
plans the customers may be considering for
the future. One of the drawbacks of this
approach is that they may be unable to
distinguish between what customers would
like to do and what they actually will do.
Since consumers determine demand, it is
better to collect information from them. If
possible every customer or potential
customer can be contacted. However, it is
not all time possible to identify all the
customer or potential customers. So,
managers often rely on sample consumer
opinions.
A time series is a time-oriented sequence of
observations taken at regular intervals
(hourly, weekly, daily, etc). The data may
be measurements of demand, earnings,
profits etc. These techniques are based on
the assumption that future values of the
series can be estimated from the past
values.
Analysis of time series data can be
accomplished by plotting the data in any of
the following patterns:
i.
ii.
iii.
iv.
v.
Trend
Seasonality
Cycles
Irregular variations
Random variations
Trends
Trend: It refers to a long-term upward or
downward movement in the data.
Example: Population shifts, changing incomes
etc.
Seasonality
Seasonality: It refers to short-term regular
variations related to calendar or time of a day.
Example: Restaurants, supermarkets
experiences weekly or daily seasonality.
Cycles
Cycles: Cycles are wavelike variations
lasting more than one year.
Example: Economic, political and
agricultural conditions.
Irregular Trends
Irregular variations: It caused by unusual
circumstances, not relative of typical
behavior. These need to be identified and
remove from the data.
Random variations: Random variations are
residual variations that remains after all other
behaviors have been accounted for. The small
bumps in the figures are random variation.
Naive Methods: It is simple but widely used
method. This is the forecast for any period
equals the previous periods actual value. For
example, if the demand for a product last
week was 50 KGs, the forecast for this week
is 50 KGs. This method has several
advantages: it has no cost, it is quick and
easy, and it is easily understandable.
Techniques for Averaging:
Averaging techniques smooth fluctuations in
a time series because the individual highs
and lows in the data offset each other when
they are combined into an average. A
forecast based on an average thus tends to
exhibit less variability than the original
data. The minor variations are treated as
random variation and larger variations are
viewed as real changes.
The following three techniques widely used
for averaging.
i. Moving average
ii. Weighted moving average
iii. Exponential smoothing
Moving average: Technique that averages a
number of recent actual data values, updated as
new values become available is known as moving
average forecast. The moving average forecast
can be computed using the following formula:
n
Ft MAn
i 1
At i
n
i = An index that corresponds to time period
n = No. of period in the moving average
At= Actual value in period t-i
MA = Moving average
Ft= Forecast for time period t
For example, MA3 implies a three period
moving average forecast,and MA5 implies a
fiveperiod moving average forecast.
Example: Compute a 3-period moving
average forecast given demand for
shopping carts for the last five periods.
Period
Demand
42
40
43
40
41
i = An index that corresponds to time period
n =3= No. of period in the moving average
Ai= Actual value in period t-i
MA = Moving average
Ft= Forecast for time period t
The moving average for period 6 is, F6 MA3
t i
i 1
43 40 41
41.33
3
the actual demand in period 6 turns out to be 38, the moving average
forecast for period 7 would be :
F7 MA3
t i
i 1
40 41 38
39.67
3
A 3 and 5-period moving average forecast against actual
demand for 10 periods.
Note: The more periods in a moving average, the greater the
forecast will lag changes in the data.
* This technique is easy to compute and easy to understand.
* A possible disadvantage is that all values in the average are
weighted equally. For example, in a 10-period moving average,
each value has weight of 1/10. Hence, the oldest value has the
same weight as the most recent value. Decreasing the number of
values in the average increases in weight of more recent values.
Example 2: Given the following data:
Period No. of
complaints
1
60
2
65
55
58
64
(i)Use naive approach to make the forecast for the
next period.
(ii)Compute a 3-period moving average forecast.
Weighted moving average:
A weighted average is similar to
the moving average, except that it
assigns more weight to the most
recent values in a time series. For
example, the most recent value
might be assigned a value of 0.4,
the next most recent value a
weight of 0.3, the next after that a
weight of 0.2, and the next after
that a weight of 0.1. Note that the
sum of the weights is 1.0.
The weighted moving average can be computed by the following
formula:
Ft wn At n wn 1 At ( n 1) wn 2 At ( n 2) ......w2 At 2 w1 At 1
The advantage of a weighted average over a simple
moving average is that the weighted average is more
reflective of the most recent occurrences. However, the
choice of the weight is somewhat arbitrary and
generally involves the use of trial and error to find a
suitable weighting scheme.
Example 1: Given the demand for
shopping carts for the last five periods.
Period
Demand
42
40
43
40
41
(a) Compute a weighted moving average forecast using a
weight of 0.4 for the most recent period, 0.3 for the next
most recent, 0.2 for the next, and the next after that a
weight of 0.1.
(b) If the actual demand for period 6 is 39, forecast
demand for period 7 using the same weights as in part (a).
Solution: (a)
Ft wn At n wn 1 At ( n 1) wn 2 At ( n 2) ......w2 At 2 w1 At 1
F6 w4 At 4 w3 At 3 w2 At 2 w1 At 1
0.1 * 40 0.2 * 43 0.3 * 40 0.4 * 41 41.0
Solution: (b)
Ft wn At n wn1 At ( n 1) wn2 At ( n 2) ......w2 At 2 w1 At 1
F7 w4 At 4 w3 At 3 w2 At 2 w1 At 1
0.1 * 43 0.2 * 40 0.3 * 41 0.4 * 39 40.2
Example 2: Given the following data:
Period
No. of complaints
60
65
55
58
64
(a) Compute a weighted moving average forecast using a
weight of 0.4 for the most recent period, 0.3 for the next
most recent, 0.2 for the next, and the next after that a
weight of 0.1.
(b) If the actual demand for period 6 is 59, forecast demand
for period 7 using the same weights as in part (a).
Exponential smoothing:
Weighted averaging method based on previous forecast plus a
percentage of the forecast error.
It is sophisticated weighted average method that is still relatively easy
to use and understand.
Next forecast = Previous forecast +
(actual previous forecast)
That is,
Ft Ft 1 At 1 Ft 1
= The smoothing constant = % of the error
At 1 = Actual value in the previous period
Ft = Forecast for time period t
Ft 1 = Forecast for the previous time period
Commonly used value of ranges from 0.05 to 0.5. Low values are used when the average tends to be stable. Higher values of
are used when the average is not stable.
Example 1: Given the following data:
Period
No. of complaints
60
65
55
58
64
Use exponential smoothing approach with a smoothing constant of 0.4 to make the forecast for the next period.
Solution:
Period
No. of complaints
60
65
60
60 + 0.4(65-60) = 62
55
62
62 + 0.4(55-62) = 59.2
58
59.2
59.2 + 0.4(58-59.2) = 58.72
64
58.72
58.72 + 0.4(64-58.72) = 60.83
Forecast
Calculations
60 is the initial forecast
60.83
Example 2: Given the demand for shopping
carts for the last five periods.
Period
Demand
42
40
43
40
41
Use exponential smoothing approach with a
smoothing constant of 0.3 to make the forecast
for the next period.
Example: Cell phone for a firm over the last 10 weeks are shown as follows. Would a linear
trend line be appropriate? Determine the equation of the trend line and predict sales for
weeks 11 and 12.
Week
10
Unit Sales
700
724
720
728
740
742
758
750
770
775
This plot suggests that a linear trend is appropriate.
ty
700
700
724
1448
720
2160
728
2912
740
3700
742
4452
758
5306
750
6000
770
6930
10
775
7750
7407
41358
Given
n 10,
55,
n ty t y
n t t
2
385
10 41,358 55 7,407
7.51
10 385 55 55
y b t 7,407 7.51 55
699.4
n
10
The trend line is
Ft a b t 699.4 7.51t
where t = 0 for period 0.
The forecast for period 11 is
F11 a b t 699.4 7.51 11 782.01
The forecast for period 12 is
F11 a b t 699.4 7.51 12 789.52
Example2: Plot the following data on a graph and verify visually
that a linear trend line is appropriate. Develop a line trend
equation. Then use the equation to predict the next two values of
the series.
Period
Demand
44
52
50
54
55
55
60
56
62
Associative forecasting techniques
The essence of associative techniques is the
development of an equation that summarizes the effects
of predictor variables (which is used to predict values of
the variable of interest). Linear regression method is used
for this analysis.
Linear regression method
Technique for fitting a line to a set of points. The objective
in linear regression is to obtain an equation of a straight
y c a bx
line that minimizes
the sum of squared vertical deviations
of data points from the line. The least squares line has
the equation
x = predictor or independent variable
a= Value of at x = 0
b= Slope of the line
yc= Predicted or dependent variable
The line intersect the y axis where y =
a. The slope of the line is b.
The coefficients of the line a and b can
be computed from the formulas:
y
y c a bx
y
x
a
y
x
n xy
n x 2
x y
x
2
and
y b x
a
y bx
n
where n is the number of periods and y is the
time series.
Example: Healthy hamburger has a chain of 12 stores in California. Sales figures and profits for the
stores given below. Obtain a regression line for the data and predict for a store assuming sales of
$10 million.
Unit sales x $
million
14
15
16
12
14
20
15
Profit y
$ million
0.15
0.10
0.13
.15
.25
0.27
0.24
0.2
0.27
0.44
0.34
0.17
Solution:
Step1: Plot the data and decide if a linear model is
reasonable.
x
y
Forecasts
7
.15
0.1621124
0.10
0.0824612
0.13
0.1461822
0.15
0.1143217
14
0.25
0.273624
15
0.27
0.2895543
16
0.24
0.3054845
12
0.20
0.2417636
14
0.27
0.273624
20
0.44
0.3692054
15
0.34
0.2895543
0.17
0.1621124
Step2:
n xy x y
n x 2 x
12 3529 132 271
0.0159
12 1796 132 132
y b x 271 0.0159 132
0.0506
n
12
Obtain the regression yc 0.0506 0.0159 x
For example, for sale of x = 7, estimated profit is
y c 0.0506 0.0159 7 0.1621124
or $162,1124
Example: The owner of a hardware store has noted a sales pattern for window locks that
seems to be parallel the number of break-ins reported each week in the newspaper. The
data are:
sales
46
18
20
22
27
34
14
37
30
Break-ins
c.
a. Plot the data to see the type of the graph
b. Obtain a regression equation for the data.
Estimate sales when the number of break-ins is 5.
Comments on the use of
linear regression:
Variations around the line are random.
Deviations around the line should be
narrowly distributed.
Predictions are made within the range of the
observed values.
Forecast accuracy:
Forecasting accuracy is a significant factor when deciding among forecasting
alternatives. Accuracy is based on the historical error performance of a forecast.
Three common methods for measuring historical errors are:
(i) Mean absolute deviation (MAD): Average absolute error. MAD =
(ii) Mean squared error (MSE): Average of squared errors. MSE =
At Ft
n
t
n 1
(iii) Mean absolute percent error (MAPE): Average absolute percent error.
MAPE =
Ft
At
n
100%
Ft
Example: Compute MAD, MSE, and MAPE for the following
data.
Error Actual 100
Error 2
Error
Period
Actual
Forecast
Error (A-F)
217
215
0.92%
213
216
-3
1.41
216
215
0.46
210
214
-4
16
1.9
213
211
0.94
219
214
25
2.28
216
217
-1
0.46
212
216
-4
16
1.89
-2
22
76
10.26%
(i) Mean absolute deviation (MAD) =
(ii) Mean squared error (MSE) =
Ft
Ft
n 1
76
10.86
8 1
(iii) Mean absolute percent error (MAPE) =
22
2.75
8
Ft
At
n
100%
10.26%
1.28%
8
Example 2: Calculate MAD, MSE and MAPE for the following data and
compare them
Month
Demand
Forecast
Technique 1
Technique 2
492
488
495
470
484
482
485
480
478
493
490
488
498
497
492
492
493
493
Control forecast/ Monitor
forecast:
Tracking signal method:
Tracking signal method is used to monitor a
forecast. This method is an older method which is
the ratio of the cumulative forecast error to the
corresponding value of MAD.
Tracking signalt =
Ft
MADt
Example: For last slide example Tracking signalt =
A F
t
MADt
2
0.7
2.75
The End
