Forecasting
Y.-H. Chen, Ph.D.
Production / Operations Management
International College
Ming-Chuan University
Forecasting Outline
Introduction
Forecasting
Process
Forecasting Methods
Forecast Accuracy and Control
Forecast Method Selection and Usage
Introduction
I see that you will
get an A this semester.
A forecast
is a statement of future,
is a basis for planning,
is not for forecasting demand only,
requires a skillful blending of art and science,
assumes that the underlying system will
continue to exist in the future, and
is rarely perfect.
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
Elements of A Good Forecast
The forecast horizon must cover the time necessary
to implement possible changes.
The degree of accuracy should be stated.
The forecast should be reliable; it should work
consistently.
The forecast should be expressed in meaningful
units.
The forecast should be in writing.
The forecast should be simply to understand and
use, or consistent with historical data intuitively.
Additional Properties
Forecasts for groups of
items tend to be more
accurate than forecasts for
individual items, because
forecasting errors among
items in a group usually
have a canceling effect.
Forecast accuracy
decreases as the time
period covered by the
forecast increases.
Timely
Reliable
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ng
i
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Accurate
Written
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to
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us
Forecasting Methods
Basic
Methods
Judgmental Forecast
Statistical (Time Series) Forecast
Trend
Seasonality
Cycle
Association
Basic Forecasting Methods
Judgmental
Forecast
Statistical (Time Series) Forecast
Averaging
Weighted Moving Average
Exponential Smoothing
Judgmental Forecast
Executive opinions.
Mostly for long-range planning and introduction of new products. The view of one
person may prevail.
Direct customer contact composites.
Unable to distinguish between what customers would like to do and what they
will actually do.
Could overly influenced by recent sales experiences. Low sales could lead to
low estimates.
Conflict of interest. Low sales estimates lead to better sales performance.
Consumer survey or point-of-sales (POS) data.
Expensive and time-consuming.
Possible existence of irrational patterns.
Low response rates.
Opinions of managers and staff.
Delphi method (Rand Corp., 1948): Managers and staff complete a series of
questionnaires, each developed from the previous one, to achieve a consensus
forecast.
Technological forecasting. Long-term single-time forecasting. Data are costly to obtain.
Statistical (Time Series)
Forecast
It is extremely important to plot data and examine them before doing
any analysis or forecast. A demand forecast should be based on a time
series of past demand rather than sales or shipment.
Data patterns:
Trend
A long term upward or downward movement in data.
Seasonality
Short-term regular variations related to weather, holiday, or other factors.
Cycle
Wavelike variation lasting more than one year.
Irregular Variation
Caused by unusual circumstances, not reflective of typical behavior.
Random variation
Residual variation after all other behaviors are accounted for.
Data Patterns
Irregular
variation
Trend
Cycles
90
89
88
Seasonal variations
Simple Naive Forecast
Yt yt 1
No cost.
Quick and easy to prepare.
Easy to understand.
Can be applied to data with seasonality and trend
General Naive Forecast
Yt yt 1 ct
Weighted Moving Average
n
MAn
y
i 1
or MAn wi yi
i 1
Moving Average Example
a)
Compute a 3-period moving average
forecast given demand for shopping
carts for the last five periods.
43 40 41
MA3
41.33
3
b)
If the actual demand in period 6 turns out
to be 39, what would be the moving
average forecast for period 7?
MA3
40 41 39
40.00
3
Period
1
2
3
4
5
6
7
Demand
42
40
43
40
41
? 41.33 39
? 40.00
Weighted Moving Average
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.
Forecast .40( 41) .30(40) .20(43) .10(40) 41.0
b)
If the actual demand in period 6 turns out
to be 39, what would be the weighted
moving average forecast for period 7?
Forecast .40(39) .30(41) .20(40) .10(43) 40.2
Period
1
2
3
4
5
6
7
Demand
42
40
43
40
41
? 41.0 39
? 40.2
Properties of Weighted Moving
Average
Easy to compute and understand.
Moving average forecast lags and
smoothens the actual forecast.
The number of data points in the
average determines its sensitivity to
each new data point: the fewer the
data points in an average, the more
responsive the average tends to be.
Weights can be added to values in
the average to make the resulting
average more responsive to some
recent data points. However, weights
involve the use of trial-and-error to
find suitable weights.
Exponential Smoothing
Exponential smoothing is a weighted averaging method based
on previous forecast plus a percentage of its forecast error.
Yt yt 1 (d t 1 yt 1 )
Properties of Exponential
Smoothing
Commonly used values of
alpha range from 0.05 to
0.50. Low values are used
when the underlying average
tends to be stable; higher
values are used when the
underlying average is
susceptible to change.
Moving average or naive
forecast can be used to
generate starting forecast for
exponential smoothing.
Picking A Smooth Constant
Exponential Smoothing
Example
Use exponential smoothing to
develop a series of forecasts
for the data, and compute
(actual-forecast)=error for
each period.
a)
b)
c)
Use a smoothing factor of .10.
Use a smoothing factor of .40.
Plot the actual data and both
sets of forecasts on a single
graph.
Period (t)
Actual
42
40
43
40
41
39
46
44
45
10
38
11
40
12
Exponential Smoothing
Example
alpha=.10
Period (t)
Actual
Forecast
alpha=.40
Error
Forecast
Error
42.00
40.00
42.00
-2.00
42.00
-2.00
43.00
41.80
1.20
41.20
1.80
40.00
41.92
-1.92
41.92
-1.92
41.00
41.73
-0.73
41.15
-0.15
39.00
41.66
-2.66
41.09
-2.09
46.00
41.39
4.61
40.25
5.75
44.00
41.85
2.15
42.55
1.45
45.00
42.07
2.93
43.13
1.87
10
38.00
42.36
-4.36
43.88
-5.88
11
40.00
41.92
-1.92
41.53
-1.53
12
41.73
40.92
Forecasting Method Extension
Trend
Linear Trend
Trend-Adjusted Exponential Smoothing
Seasonality
Cycle
Association
Linear Trend
Yt a bt
Linear Trend Coefficients
b
t 1
t 1
t 1
n tyt t yt
n
n t
t 1
t 1
y
t 1
b t
t 1
y bt
Linear Trend Example
Calculate sales for a California-based
firm over the last 10 weeks are
shown in the table. Plot the data
and visually check to see if a linear
trend line would be appropriate.
Then, determine the equation of the
trend line, and predict sales for
weeks 11 and 12.
Week
Unit Sales
700
724
720
728
740
742
758
750
770
10
775
11
12
Linear Trend Example Solution
a. A plot suggests that a linear trend line would be appropriate.
b. For n=10, we have
10
t 55
t 1
10
385
t 1
10(41,358) 55(7,407) 6,195
7.51
10(385) 55(55)
825
7,407 7.51(55)
699.40
10
Thus, the trend line is yt=699.40+7.51t,
where t=0 for period 0.
c. By letting t=11 and t=12, we have
y11 699.40 7.51(11) 782.01
y12 699.40 7.51(12) 789.51
Seasonality
Cycle
Cycles are similar to
seasonal variations but of
longer duration, e.g., two to
six years between peaks.
It is difficult to project cycles
from past data, because
turning points are difficult to
identify.
A short moving average or a
naive approach may be of
some value.
Associative Forecasts
High correlation of a
forecast with leading
variables can be useful
in computing the
forecast.
The simple linear
regression is the
simplest and most
widely used method.
Y a bX
Simple Linear Regression
Coefficients
n
b
x y
i
i 1
i 1
y
i 1
x
i
x y
i 1
x
i 1
i 1
2
b xi
i 1
y bx
Simple Linear Regression
Example
Healthy Hamburgers has
a chain of 12 stores in
northern Illinois. Sales
figures and profits for
the stores are given in
the following table.
Obtain a regression line
for the data and predict
profit for a store
assuming sales of $10
million.
Sales, X
Profits, Y
(in millions of dollars)
7
0.15
0.10
0.13
0.15
14
0.25
15
0.27
16
0.24
12
0.20
14
0.27
20
0.44
15
0.34
0.17
Simple Linear Regression
Example: Data Plot
Simple Linear Regression
Example: Solution
x
xy
x^2
y^2
0.15
1.05
49
0.0225
0.10
0.20
0.0100
0.13
0.78
36
0.0169
0.15
0.60
16
0.0225
14
0.25
3.50
196
0.0625
15
0.27
4.05
225
0.0729
16
0.24
3.84
256
0.0576
12
0.20
2.40
144
0.0400
14
0.27
3.78
196
0.0729
20
0.44
8.80
400
0.1936
15
0.34
5.10
225
0.1156
0.17
1.19
49
0.0289
132
2.71
35.29
1796
0.7159
n xy x y
n x2 x
12(35.29) 132(2.71)
0.01593
12(1796) 132(132)
y b x
n
2.71 0.01593(132)
0.0506
12
Y 0.0506 0.01593 X
Y 0.2099 (million $) for X 10
An Important Measure of
Simple Linear Regression
Correlation measures the strength and direction of the
relationship between two variables.
+1, positive correlation.
-1, negative correlation.
0, zero correlation.
n xy x y
n x 2 x n y 2 y
2
The square of the correlation coefficient provides a
measure of how well a regression line fits the data. The
values ranges from 0 to 1.00.
[0.80,1.00], good fit.
[0.25,0.80), moderate fit.
[0.00,0.25), poor fit.
Simple Linear Regression and
Correlation Example
Sales of 19-inch color television sets and 3-month
lagged unemployment are shown in the table below.
Determine if unemployment levels can be used to
predict demand for 19-inch color TVs and, if so,
derive a predictive equation.
Period
Units sold
20 41
17
35
25 31
38
50
9 10
15
11
19 14
Unemployment % 7.2 4.0 7.3 5.5 6.8 6.0 5.4 3.6 8.4 7.0 9.0
(3-month lag)
Simple Linear Regression and
Correlation Example: Data Plot
Simple Linear Regression and
Correlation Example: Solution
x
xy
x^2
y^2
7.2
20
144.0
51.8
400
4.0
41
164.0
16.0
1681
7.3
17
124.1
53.3
289
5.5
35
192.5
30.3
1225
6.8
25
170.0
46.2
625
6.0
31
186.0
36.0
961
5.4
38
205.2
29.2
1444
3.6
50
180.0
13.0
2500
8.4
15
126.0
70.6
225
7.0
19
133.0
49.0
361
9.0
14
126.0
81.0
196
70.2
305
1750.8
476.3
9907
n xy x y
n x2 x
11(1750.8) 70.2(305)
6.91
11(476.4) 70.2(70.2)
y b x
n
305 ( 6.91)(70.2)
71.85
11
Y 71.85 6.91X
r
n xy x y
n x2 x n y 2 y
2
11(1750.8) 70.2(305)
11(476.4) (70.2) 2 11(9907) (305) 2
0.966
Linear Regression
Assumptions
No
patterns such as cycles or trends should
be apparent.
Deviations around the line should be
normally distributed.
Predictions are best being made within the
range of observed values.
Linear Regression Usage
Guidelines
Always
plot the data to verify that a linear
relationship is appropriate.
The data may be time-dependent. If patterns
appear, use analysis of time series or use
time as an independent variable as part of a
multiple regression analysis.
A small correlation may imply that other
variables are important.
Linear Regression Summary
Simple
linear regression applies only to linear
relationship with one independent variable.
One needs a considerable amount of data to
establish the relationship --- in practice, 20 or
more observations.
All observations are weighted equally.
Forecast Accuracy
Error
- difference between actual value and
predicted value
Mean absolute deviation (MAD)
Average absolute error
Mean
squared error (MSE)
Average of squared error
Forecast Accuracy:
MAD & MSE
Actual forecast
MAD =
n
2
(Actual forecast)
MSE =
n-1
Example 10 (page 97).
Forecast Control
It is necessary to monitor forecast errors to ensure
that the forecast is performing adequately over
time. This is generally accomplished by comparing
forecast errors to predefined values, or action
limits.
Why Do We Need Forecast
Control?
The
omission of an important variable.
Appearance of a new variable.
A sudden or unexpected change in the
variable (causing by severe weather or other
nature phenomena, temporary shortage or
breakdown, catastrophe, or similar events).
Being used incorrectly.
Data being misinterpreted.
Random variation.
Forecasting Control Methods
Tracking
Signal
Control Chart
Forecast Control: Tracking
Signal
tracking signal
yt
MAD
MADt MADt 1 dt yt MADt 1
Forecast Control: Control
Chart
The control chart sets the limits as multiples of
the squared root of MSE.
Forecast Control: Control
Chart
s MSE
For a normal distribution, 95% of the errors fall within
+/-2s, and approximately 99.7% of the errors fall
within +/-3s. Errors fall outside these limits should be
regarded as evidence that corrective action is
needed.
Example 11 (Page 93).
Forecast Method Selection
Most important
Cost
Accuracy
Need to consider
Historical performance
Ability to respond to
change
