3-1

Forecasting

Chapter 3

Forecasting

McGraw-Hill/Irwin

Operations Management, Seventh Edition, by William J. Stevenson

Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.

3-2

Forecasting

FORECAST:
A statement about the future
Used to help managers
Plan the system
Plan the use of the system

McGraw-Hill/Irwin

Operations Management, Seventh Edition, by William J. Stevenson

Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.

3-3

Forecasting

Forecast Uses
Plan the system
Generally involves long-range plans related to:
Types of products and services to offer
Facility and equipment levels
Facility location

Plan the use of the system

Generally involves short- and medium-range plans related to:
Inventory management
Workforce levels
Purchasing
Budgeting

McGraw-Hill/Irwin

Operations Management, Seventh Edition, by William J. Stevenson

Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.

3-4

Forecasting

Common Features
Assumes causal system
past ==> future
Forecasts rarely perfect because of randomness
Forecasts more accurate for
groups vs. individuals
I see that you will
get an A this quarter.
Forecast accuracy decreases
as time horizon increases

McGraw-Hill/Irwin

Operations Management, Seventh Edition, by William J. Stevenson

Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.

3-5

Forecasting

Elements of a Good Forecast

Timely

Reliable

i
n
ea

McGraw-Hill/Irwin

ng

l
u
f

e
it v
c
e
ff
e
t
s
Co

Accurate

Written

y
s
Ea

to

e
s
u

Operations Management, Seventh Edition, by William J. Stevenson

Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.

3-6

Forecasting

Steps in the Forecasting Process

The forecast

Step 6 Monitor the forecast

Step 5 Make 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

McGraw-Hill/Irwin

Operations Management, Seventh Edition, by William J. Stevenson

Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.

3-7

Forecasting

Types of Forecasts
Judgmental - uses subjective inputs (qualitative)
Time series - uses historical data assuming the
future will be like the past (quantitative)
Associative models - uses explanatory variables
to predict the future

McGraw-Hill/Irwin

Operations Management, Seventh Edition, by William J. Stevenson

Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.

3-8

Forecasting

Judgmental Forecasts
(Qualitative)

Consumer surveys
Delphi method
Executive opinions
Opinions of managers and staff

Sales force.
McGraw-Hill/Irwin

Operations Management, Seventh Edition, by William J. Stevenson

Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.

3-9

Forecasting

Time Series Forecasts

(Quantitative)

Trend - long-term movement in data

Seasonality - short-term regular variations in data
Irregular variations - caused by unusual circumstances
Random variations - caused by chance

CYCLE- wave like variations lasting more than one year

McGraw-Hill/Irwin

Operations Management, Seventh Edition, by William J. Stevenson

Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.

3-10

Forecasting

Forecast Variations
Figure 3-1
Irregular
variation

Trend
cycle
Cycles
90
89
88
Seasonal variations

McGraw-Hill/Irwin

Operations Management, Seventh Edition, by William J. Stevenson

Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.

3-11

Forecasting

The Forecast of Forecasts

Nave
Simple Moving Average
Weighted Moving Average
Exponential Smoothing
ES with Trend and Seasonality

McGraw-Hill/Irwin

Operations Management, Seventh Edition, by William J. Stevenson

Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.

3-12

Forecasting

Nave Forecast

Simple to use
Virtually no cost
Data analysis is nonexistent
Easily understandable
Cannot provide high accuracy

McGraw-Hill/Irwin

Operations Management, Seventh Edition, by William J. Stevenson

Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.

3-13

Forecasting

NAVE METHOD
No smoothing of data

McGraw-Hill/Irwin

Operations Management, Seventh Edition, by William J. Stevenson

Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.

3-14

Forecasting

Techniques for Averaging

Moving average
Weighted moving average
Exponential smoothing

McGraw-Hill/Irwin

Operations Management, Seventh Edition, by William J. Stevenson

Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.

3-15

Forecasting

Simple Moving Average

Smoothes out randomness by averaging positive and
negative random elements over several periods
n - number of periods (this example uses 4)

McGraw-Hill/Irwin

Operations Management, Seventh Edition, by William J. Stevenson

Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.

3-16

Forecasting

Points to Know on Moving Averages

Pro: Easy to compute and understand
Con: All data points were created equal.
. Weighted

McGraw-Hill/Irwin

Moving Average

Operations Management, Seventh Edition, by William J. Stevenson

Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.

3-17

Forecasting

Weighted Moving Average

Similar to a moving average methods except that it assigns
more weight to the most recent values in a time series.
n -- number of periods
i weight applied to period t-i+1

Ft 1

McGraw-Hill/Irwin

t i 1 A i

i t n 1

1
Alpha

0.6

0.3

0.1

Operations Management, Seventh Edition, by William J. Stevenson

Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.

3-18

Forecasting

Exponential Smoothing
Simpler equation, equivalent to WMA
exponential smoothing parameter (0<

Ft Ft 1 ( At 1 Ft 1 )

McGraw-Hill/Irwin

0.1

Operations Management, Seventh Edition, by William J. Stevenson

Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.

3-19

Forecasting

Exponential Smoothing (=0.30)

Ft Ft 1 ( At 1 Ft 1 )
PERIOD
DEMAND

MONTH

Jan

37

Feb

40

Mar

41

Apr

37

May

45

Jun

50

7
Jul
McGraw-Hill/Irwin

43

F2

37 + (0.30)(37-37)

= 37

F3 =37+ (0.30)(40-37)
= 37.9

Operations Management, Seventh Edition, by William J. Stevenson

Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.

3-20

Forecasting

Exponential Smoothing (cont.)

PERIOD

MONTH

DEMAND

1
2
3
4
5
6
7
8
9
10
11
12
13

Jan
Feb
Mar
Apr
May
Jun
Jul
Aug
Sep
Oct
Nov
Dec
Jan

37
40
41
37
45
50
43
47
56
52
55
54

McGraw-Hill/Irwin

FORECAST, Ft + 1
( = 0.3)
( = 0.5)

37.00
37.90
38.83
38.28
40.29
43.20
43.14
44.30
47.81
49.06
50.84
51.79

37.00
38.50
39.75
38.37
41.68
45.84
44.42
45.71
50.85
51.42
53.21
53.61

Operations Management, Seventh Edition, by William J. Stevenson

Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.

3-21

Forecasting

Adjusted Exponential Smoothing

AFt +1 = Ft +1 + Tt +1
where
T = an exponentially smoothed trend factor
Tt +1 = (Ft +1 - Ft) + (1 - ) Tt
where
Tt = the last period trend factor
= a smoothing constant for trend

McGraw-Hill/Irwin

Operations Management, Seventh Edition, by William J. Stevenson

Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.

3-22

Forecasting

Adjusted Exponential Smoothing

(=0.30)
T3

= (F3 - F2) + (1 - ) T2

PERIOD
DEMAND

MONTH

Jan

37

Feb

40

AF3 = F3 + T3 = 38.5 + 0.45

= 38.95

Mar

41

T13

= (0.30)(38.5 - 37.0) + (0.70)(0)

Apr

37

May

45

Jun

McGraw-Hill/Irwin

50

= 0.45

= (F13 - F12) + (1 - ) T12

= (0.30)(53.61 - 53.21) + (0.70)(1.77)
= 1.36

AF13 = F13 + T13 = 53.61 + 1.36 = 54.96

Operations Management, Seventh Edition, by William J. Stevenson
Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.

3-23

Forecasting

Adjusted Exponential Smoothing:

Example
PERIOD

MONTH

DEMAND

FORECAST
Ft +1

1
2
3
4
5
6
7
8
9
10
11
12
13

Jan
Feb
Mar
Apr
May
Jun
Jul
Aug
Sep
Oct
Nov
Dec
Jan

37
40
41
37
45
50
43
47
56
52
55
54

37.00
37.00
38.50
39.75
38.37
38.37
45.84
44.42
45.71
50.85
51.42
53.21
53.61

McGraw-Hill/Irwin

TREND
Tt +1

ADJUSTED
FORECAST AFt +1

0.00
0.45
0.69
0.07
0.07
1.97
0.95
1.05
2.28
1.76
1.77
1.36

37.00
38.95
40.44
38.44
38.44
47.82
45.37
46.76
58.13
53.19
54.98
54.96

Operations Management, Seventh Edition, by William J. Stevenson

Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.

3-24

Forecasting

Linear Trend Equation

Y

Yt = a + bt
a
0 1 2 3 4 5

b is the line slope.

McGraw-Hill/Irwin

Operations Management, Seventh Edition, by William J. Stevenson

Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.

3-25

Forecasting

Calculating a and b

n (ty) - t y
b =
2
2
n t - ( t)

y - b t
a =
n

Yes Linear Regression!!

McGraw-Hill/Irwin

Operations Management, Seventh Edition, by William J. Stevenson

Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.

3-26

Forecasting

Linear Trend Equation Example

McGraw-Hill/Irwin

Operations Management, Seventh Edition, by William J. Stevenson

Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.

3-27

Forecasting

Linear Trend Calculation

5 (2499) - 15(812)
12495-12180
b =
=
= 6.3
5(55) - 225
275 -225

812 - 6.3(15)
a =
= 143.5
5

y = 143.5 + 6.3t
McGraw-Hill/Irwin

Look on page 85

Operations Management, Seventh Edition, by William J. Stevenson

Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.

3-28

Forecasting

Disadvantage of simple linear regression

1-apply only to linear relationship with an
independent variable.
2-one needs a considerable amount of data to
establish the relationship ( at least 20).
3-all observations are weighted equally

McGraw-Hill/Irwin

Operations Management, Seventh Edition, by William J. Stevenson

Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.

3-29

Forecasting

Forecast Accuracy

Forecast error
difference between forecast and actual demand
MAD
mean absolute deviation

MAPD
mean absolute percent deviation

Cumulative error
Average error or bias

McGraw-Hill/Irwin

Operations Management, Seventh Edition, by William J. Stevenson

Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.

3-30

Forecasting

Mean Absolute Deviation (MAD)

At - Ft
MAD =
n
where

McGraw-Hill/Irwin

t = period number
At = demand in period t
Ft = forecast for period t
n = total number of periods
= absolute value
Operations Management, Seventh Edition, by William J. Stevenson
Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.

3-31

Forecasting

MAD Example
PERIOD
1
2
3
4
5
6
7
8
9
10
11
12

DEMAND, At
37
40
41
37
MAD
45 =
50
43
=
47
56
52
=
55
54
557

McGraw-Hill/Irwin

Ft ( =0.3)

37.00
37.00
37.90
- Ft
At38.83
n38.28
40.29
53.39
43.20
1143.14
44.30
4.85 47.81
49.06
50.84

(A t - F t )

|At - Ft|

3.00
3.10
-1.83
6.72
9.69
-0.20
3.86
11.70
4.19
5.94
3.15

3.00
3.10
1.83
6.72
9.69
0.20
3.86
11.70
4.19
5.94
3.15

49.31

53.39

Operations Management, Seventh Edition, by William J. Stevenson

Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.

3-32

Forecasting

Other Accuracy Measures

Mean absolute percent deviation (MAPD)
MAPD =

|At - Ft|
At

Cumulative error
E = et
Average error

McGraw-Hill/Irwin

et
(E )=
n
Operations Management, Seventh Edition, by William J. Stevenson
Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.

3-33

Forecasting

Comparison of Forecasts

FORECAST
Exponential smoothing ( = 0.30)
Exponential smoothing ( = 0.50)
Adjusted exponential smoothing
( = 0.50, = 0.30)

McGraw-Hill/Irwin

MAD

MAPD

(E)

4.85
4.04
3.81

9.6%
8.5%
7.5%

49.31
33.21
21.14

4.48
3.02
1.92

Operations Management, Seventh Edition, by William J. Stevenson

Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.

3-34

Forecasting

Forecast Control
Tracking signal
monitors the forecast to see if it is biased high
or low
(At - Ft)
E
Tracking signal =
=
MAD
MAD

McGraw-Hill/Irwin

Operations Management, Seventh Edition, by William J. Stevenson

Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.

3-35

Forecasting

Tracking Signal Values

PERIOD

DEMAND
At

1
2
3
4
5
6
7
8
9
10
11
12

37
40
41
37
45
50
43
47
56
52
55
54

McGraw-Hill/Irwin

E =
(At - Ft)

MAD

37.00

37.00
3.00
3.00
37.90
3.10
6.10
38.83
-1.83
4.27
38.28
6.72 for period
10.99 3
Tracking
signal
40.29
9.69
20.68
43.20
-0.20
6.10 20.48
43.14TS = 3.86
= 24.34
2.00
3
3.05
44.30
11.70
36.04
47.81
4.19
40.23
49.06
5.94
46.17
50.84
3.15
49.32

3.00
3.05
2.64
3.66
4.87
4.09
4.06
5.01
4.92
5.02
4.85

FORECAST,
Ft

ERROR
At - Ft

TRACKING
SIGNAL

1.00
2.00
1.62
3.00
4.25
5.01
6.00
7.19
8.18
9.20
10.17

Operations Management, Seventh Edition, by William J. Stevenson

Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.

3-36

Forecasting

Sources of forecast errors

The model may be inadequate.
Irregular variation may be occur.
The forecasting technique may be used
incorrectly or the results misinterpreted.
There are always random variation in the
data.

McGraw-Hill/Irwin

Operations Management, Seventh Edition, by William J. Stevenson

Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.

3-37

Forecasting

End Notes
The two most important factors in choosing
a forecasting technique:
Cost
Accuracy

Keep it SIMPLE!
=FORECAST(70,{23,34,12},{67,76,56})
(if you canlet the computer do it)

McGraw-Hill/Irwin

Operations Management, Seventh Edition, by William J. Stevenson

Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.