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You are on page 1of 40

Forecasting

Introduction

a statement about the future value of a

Forecast variable…such as demand….predictions about

the future…

**The better those predictions…the better anticipation of the
**

future…thus …the better planning…consequently…more

informed decisions can be taken.

**Some forecasts are long range (plan the system)…covering several
**

years or more…important for decisions that will have long-term

consequences…deciding the right capacity for the next 20 years…

**…Other forecasts are short term (plan the use of the system)…covering
**

a day or week…important for planning and scheduling day to day

operations…

Introduction

Why forecasting is important for operations

managers

**The primary goal of operations management is to match supply to
**

demand…so, having a forecast of demand is essential for determining

how much capacity or supply will be needed to meet demand.

**Two aspects of forecasts are important…the expected level of demand
**

and the degree of accuracy that can be assigned to a forecast (forecast

error).

Features common to all forecasts

Forecast

Forecast techniques

techniques generally

generally assume

assume

that

that the

the same

same underlying

underlying causal

causal system

system

that

that existed

existed inin the

the past

past will

will continue

continue to

to

exist

exist in

in the

the future.

future.

Forecast

Forecast are

are not

not perfect…actual

perfect…actual results

results

usually

usually differs

differs from

from predicted

predicted values…

values…

allowances

allowances should

should bebe made

made for

for forecast

forecast

errors.

errors.

Forecasts

Forecasts for

for aa group

group ofof items

items tend

tend to

to be

be

more

more accurate

accurate thanthan forecasts

forecasts for for individual

individual

items…grouping

items…grouping may may arise

arise ifif parts

parts oror raw

raw

materials

materials are

are used

used for

for multiple

multiple products

products

Forecasts

Forecasts accuracy

accuracy decreases

decreases as

as the

the time

time

period

period covered

covered by

by the

the forecast

forecast increases

increases

Forecasting accuracy

Forecast accuracy is vital…forecasters want to minimize forecast errors.

Forecast

Forecast error

error isis the

the difference

difference between

between the

the

value

value that

that occurs

occurs and

and thethe value

value that

that was

was

predicted

predicted for

for a

a given

given time

time period…hence,

period…hence,

Error

Error == Actual

Actual –– Forecast

Forecast

e

ett =

=A Att -- F

Ftt

Forecasting accuracy

There are three commonly used measures for summarizing errors:

**• The mean absolute
**

deviation (MAD) …

• The mean squared error

(MSE) …

**• The mean absolute percent
**

error (MAPE) …

Note:

MAD is the easiest to compute…but weights errors linearly.

MSE squares errors, thereby giving more weight to larger errors…which

cause more problems.

MAPE should be used when there is a need to put errors in perspective…

for example, an error of 10 in a forecast of 15 is huge…but insignificant

in a forecast of 10000.

Forecasting accuracy

Example … Compute MAD, MSE, and MAPE for the following data,

showing actual and forecasted numbers of accounts serviced

Forecasting accuracy

Example:

Approaches to forecasting

There are two general approaches to forecasting; qualitative and

quantitative.

Qualitative methods…consists of Quantitative methods…involve either the

subjective input…with no numerical projection of historical data or the

descriptions… development of models with explanatory

It permits inclusion of soft information (ex. variables…

Personal opinions) It only analyze objective data…avoiding

personal bias

In practice, either or both approaches are used to develop a forecast

**There are variety of forecasting techniques that are classified as:
**

•Judgmental forecast…rely on analysis of subjective inputs

•Time series forecasts…attempt to project past experience into the future

•Associative models…use equations that consists of explanatory variables

that can be used to predict demand…(e.g. demand for paint might be related

to the variables price per gallon, amount spent on advertizing, drying time,

etc)

Qualitative forecasts

In some situations, forecasters rely solely on judgment and opinion to

make forecasts…

When

• If managers must have a forecast quickly…they may have no

enough time to collect and analyze quantitative data.

• When a new products will be introduced.

• When no historical data are available or when it is obsolete

especially when political and economic conditions are

changing).

There are several techniques associated with judgment and

opinion; executive opinions, sales force opinions and

consumer surveys

Forecasts based on time series

A time-ordered sequence of observations taken at regular intervals

(hourly, daily, weekly, monthly, quarterly, annually)…

**The data may be measurements of demand, earnings, shipments,
**

output, etc.

**Forecasting techniques…based on time series data…are made
**

on the assumption that future values of the series can be

estimated from past values…with no attempt to identify variables

that influence the series.

Forecasts based on time series

Analysis of time-series data requires the analyst to identify the

underlying behavior of the series. This can be done by plotting the

data and visually examining the plot. One or more pattern may

appear:

• Trend…long-term upward or downward movement in the data.

• Seasonality…short-term, fairly regular variations…generally related

to factors such as the calendar or time of day.

• Cycles…wavelike variations.

• Irregular variations…due to unusual circumstances…severe

weather conditions, etc. They do not reflect typical behavior…

whenever possible, these should be identified and removed from

the data.

• Random variations…residual variations that remain after all other

behaviors have been accounted for.

Forecasts based on time series

Forecasts based on time series

Naïve method:

Uses a single previous value of a time series as the basis of a forecast.

It can be used with a stable series (variations around an average), with

seasonal variations or with trends.

**A demand forecast should be based on a time series of
**

past demand i.e. actual demand…rather than unit sales.

Sales would not truly reflect demand if one or more stock

outs occurred.

Forecasts based on time series

Naïve method:

Stable series:..If demand for a product last week was 20 cases…then…the

forecast for the next week is 20 cases.

**Seasonal variations:..The forecast for this season is equal to the value of the
**

series last season. For example: the forecast for demand for product X this

summer is equal to the demand for product X last summer.

**Trend variations…The forecast is equal to the last value of the series plus or
**

minus the difference between the last two values of the series.

Period Actual Change from previous value Forecast

t-2 50

t-1 53 +3

t 53 + 3 = 56

Forecasts based on time series

Techniques for averaging:

Historical data typically contains a certain amount of random

variations …arising from relatively unimportant factors.

**Averaging techniques smooth variations in the data…to remove
**

randomness and leave only real variations such as changes in demand.

**It smoothes 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.

Forecasts based on time series

Techniques for averaging:

**Many of these movements merely reflect random variability rather
**

than a true change in the series…

Minor variations are treated as random variations…whereas larger

variations are more likely to reflect real changes.

Forecasts based on time series

Averaging techniques generate forecasts that reflects recent values of

a time series (the average value over the last several periods). Three

techniques for averaging:

Moving

Moving average

average

Weighted

Weighted moving

moving

average

average

Exponential

Exponential smoothing

smoothing

Forecasts based on time series

Techniques for averaging: Moving average

It uses a number of the most recent actual data values in generating a

forecast…it can be computed using the following equation:

Forecasts based on time series

Techniques for averaging: Moving average

Example … Compute a three-period moving average forecast given

demand for shopping carts for the last five periods.

Period Demand

1 42

2 40

3 43

4 40

5 41

**If actual demand in period 6 turns out to be 38.
**

Forecasts based on time series

Techniques for averaging: Moving average

The moving average can incorporate as many data points as desired.

moving

moving average

average with

with relatively

relatively few

few data

data moving

moving average

average based

based on

on more

more data

data

points

points points

points

Better responsiveness… permit quick Smooth more but be less responsive to

adjustment to a step change in the real changes…avoiding responding to

data…but it will also cause the forecast random variations.

to be somewhat responsive even to

random variations.

**The decision maker must weight the cost of responding more slowly to
**

changes in the data against the cost of responding to what might

simply be random variations.

Forecasts based on time series

Techniques for averaging: Moving average

The fewer the data point in an average, the more sensitive

(responsive) the average tends to be.

Forecasts based on time series

Techniques for averaging: weighted moving average

It assigns more weight to the most recent values in a time series…for

example, the most recent value might be assigned a weight 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 of 0.1.

**The heaviest weights are assigned to the most recent values.
**

Forecasts based on time series

Techniques for averaging: weighted moving average

Example … Given the following demand

data, Period Demand

1 42

a. Compute a weighted average forecast 2 40

using a weight of 0.40 for the most recent 3 43

period, 0.30 for the next most recent,

0.20 for the next, and 0.10 for the next. 4 40

5 41

**b. If the actual demand for period 6 is 39,
**

forecast demand for period 7 using the

same weights as in part a.

Forecasts based on time series

Techniques for averaging: Exponential smoothing

In exponential smoothing each new forecast is based on the previous

forecast plus a percentage of the difference between the forecast and

the actual value of the series at that point. That is …

**… commonly used values for range from 0.05 to 0.5.
**

Forecasts based on time series

Techniques for averaging: Exponential smoothing

For example … Suppose the previous forecast was 42 units, actual

demand was 40 units and is 0.1.

The new forecast is … Ft = 42 + 0.1(40-42) = 41.8

Note … If is large

(near to 1), we quickly

picks up any changes in

demand … however …

this responds to noise

(unexplained sporadic

increase/decrease in

demand that might not

last very long).

Forecasts based on time series

Example…Compare the error performance of these three forecasting techniques

using MAD, MSE and MAPE: a two period moving average, exponential

smoothing with = 0.1 for periods 3 through 11 using the following data:

Forecasts based on time series

Techniques for trend:

Analysis of trend involves developing an equation that will suitably

describe trend. Trend equation is an important technique that can be

used to develop forecasts when trend is present.

Forecasts based on time series

Techniques for trend…trend equation

For example:

Consider the trend equation Ft = 45 + 5t. The value of Ft when t = 0 is

45 and the slope of the line is 5…which means that on the average,

the value of Ft will increase by five units for each time period.

If t = 10, then the forecast Ft is 45 + 5 (10) = 95 units

**The coefficient of the line a and b,
**

can be computed from historical

data using the following two

equations:

Forecasts based on time series

Techniques for trend…trend equation

Example:

Cell phone sales for a California-based firm over the last 10 weeks are shown in

the table below.

Determine the equation of the trend line, and predict sales for weeks 11 and 12.

Week Unit sales

1 700

2 724

3 720

4 728

5 740

6 742

7 758

8 750

9 770

10 775

Forecasts based on time series

Techniques for trend…trend equation

Week (t) Y ty

n = 10, Σt = 55 and Σt2 = 385

1 700 700

Then:

2 724 1448

10(41358) – 55(7407)

3 720 2160 b = = 7.51

4 728 2912 10(385) – 55(55)

5 740 3700 7407 – 7.51(55)

a = = 699.4

6 742 4452 10

7 758 5306

The trend line is:

8 750 6000

Ft = 699.4 + 7.51t

9 770 6930

10 775 7750

Sum 7407 41358

**Substituting the values of t into this equation, the forecast for the next two
**

periods (at t = 11 and t = 12) are:

F11 = 699.4 + 7.51 (11) = 782.01

F12 = 699.4 + 7.51 (12) = 789.52

Associative forecasting techniques

It relies on identification of related variables that can be used to

predict values of the variables of interest.

**For example: real state prices are usually related to property location
**

and square footage.; crop yield are related to soil conditions and the

amounts and timing of water and fertilizers applications.

**The essence of associative techniques is the development of an
**

equation that summarizes the effect of predictor variables…the primary

method of analysis is known as regression.

Associative forecasting techniques

Simple linear regression

This involves a linear relationship between two variables …

As shown in the following

equation:

Yc = a + bx

Where

Yc = dependent variable

X = independent variable

b = slope of the line

a = value of Yc when X =

0

Associative forecasting techniques

Three conditions are required for an indicator (the

uncontrollable variables that tend to lead or precede changes in

the variable of interest; demand) to be valid:

**The relationship between movements of an indicator and movements
**

of the dependent variable should have a logical explanation.

**Movements of the indicator must precede movements of the
**

dependent variable by enough time so that the forecast isn't outdated

before it can be acted upon.

**A fairly high correlation should exist between the two variables.
**

Associative forecasting techniques

Correlation measures the strength and direction of relationship

between two variables…it ranges from -1.00 to +1.00

**A correlation of +1.00 indicates that changes in one variable
**

is always matched by changes in the other…

**A correlation of -1.00 indicates that increases in one variable
**

are matched by decreases in the other…

**A correlation close to zero indicates little linear relationship
**

between two variables.

Associative forecasting techniques

The correlation between two variables can be calculated using

the following formula:

**The square of the correlation coefficient provides a measure of
**

the percentage of variability in the values of Y that is explained

by the independent variable. It ranges form 0 to -1.

**A high value of r2 indicate that the independent variable is a
**

good predictor of values of the dependent variable.

Associative forecasting techniques

Example:

Sales of new houses and three-months lagged unemployment

are shown in the following table:

Determine if unemployment levels can be used to predict

demand for new houses and if so derive predictive equation.

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

Units sold 20 41 17 35 25 31 38 50 15 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

Associative forecasting techniques

1- plot the data to see if linear model seems reasonable

Associative forecasting techniques

2- check the correlation coefficient to confirm that it is not close

to zero:

r = -o.966

This is a fairly high negative correlation. Then the regression

equation is:

y = 71.85 – 6.91 X

**Note that the equation pertains only to unemployment levels in
**

the range 3.6 to 9.0, because sampled observations covered

only that range.

Associative forecasting techniques

Multiple regression analysis

Is an extension to the simple regression…however, it allows to build a

model with several independent variables

**As shown in the following equation:
**

Y = a + b1x1 + b2x2

Where

Y = dependent variable

X1 and X2= independent variables

b1 and b2= Coefficient for the two independent variables

a = Constant, the value of Y when X = 0

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