Learning Objectives

• List the elements of a good forecast.

• Outline the steps in the forecasting process.
• Compare and contrast qualitative and
quantitative approaches to forecasting.
• Briefly describe averaging techniques, trend
and seasonal techniques, and regression
analysis, and solve typical problems.
• Describe measure(s) of forecast accuracy.
• Describe evaluating and controlling forecasts.
1
 Introduction
FORECAST:
• A statement about the future value of a variable of
interest such as demand.
• Forecasting is used to make informed decisions
– Match supply to demand.
• Two important aspects:
– Level of demand
– Degree of accuracy
• Long-range – plan the system (strategic)
• Short-range – plan to use the system (on-going
operations)

2
 Introduction
• Forecasts affect decisions and activities
throughout an organization.
Accounting Cost/profit estimates
Finance Cash flow and funding
Human Resources Hiring/recruiting/training
Marketing Pricing, promotion, strategy
MIS IT/IS systems, services
Operations Schedules, workloads
Product/service design New products and services

3
 Features of Forecasts
• Assumes causal system past ==> future
• Forecasts are rarely perfect
• Forecast accuracy decreases as time horizon
increases

4
Elements of a Good Forecast

Timely

Reliable Accurate

Written

Cost Effective 5
 Steps in the Forecasting Process

“The forecast”

Step 6 Monitor the forecast

Step 5 Make the forecast
Step 4 Obtain, clean and analyze data
Step 3 Select a forecasting technique
Step 2 Establish a time horizon
Step 1 Determine purpose of forecast

6
 Forecasting Process
1. Identify the purpose 2. Collect historical data 3. Plot data and identify
of forecast patterns

6. Check forecast 5. Develop/compute 4. Select a forecast

accuracy with one or forecast for period of model that seems
more measures historical data appropriate for data

7.
Is accuracy of No 8b. Select new forecast
forecast model or adjust
acceptable? parameters of existing
model
Yes
9. Adjust forecast based 10. Monitor results and
8a. Forecast over
on additional qualitative measure forecast
planning horizon
information and insight accuracy

7
8
 Introduction

• Managers of firms have to predict the demands of products

before their production. Always, there exists a certain level of
uncertainty on requirements of anything. Managers always try
to reduce the level of uncertainty by forecasting.
• Both qualitative (based on intuition and experience) and
quantitative methods (based on available data) are used in
forecasting. However, for every forecast, the following 8 basic
steps should be followed.
1. Determine the objective of forecasting – what do you want to attain by
forecasting?
2. Select what to be forecasted!
3. Determine the time horizon of forecast (short term, medium term or long
term).
4. Identify the forecasting model.
9
 Introduction

• 5. Collect the required data to make the forecast.

• 6. Test and validate the forecasting model
• 7. Make the forecast
• 8. Implement the results
• There is seldom a single superior forecasting method. One
organization may find a particular method effective, another
may use several methods and a third may combine both
subjective and quantitative techniques.
• The tool that works best is the one that should be used in
forecasting.
• Types of Forecasting Models
• There are 3 types of forecasting models

10
 Types of Forecasts
• 1. Judgmental model
• It makes its decision based on qualitative or subjective
factors. It depends on expert’s opinions, individual
experiences and judgments and other subjective factors. This
type of model is useful when quantitative data is unavailable
or when subjective factors are very important.
• Executive opinions
• Sales force opinions
• Consumer surveys
• Outside opinion
• Delphi method
– Opinions of managers and staff
– Achieves a consensus forecast
11
 Introduction

• 2. Time series models – These predict the future using

historical data assuming that the future will be like the past.
• We will study three types of time series models here – Moving
average, Exponential smoothing and Trend projections.
• 3. Causal models - These incorporate the variables or factors
into the forecasting model that might influence the quantity
being forecasted. For example, daily sales of a soft drink might
depend on the season, the average temperature, the average
humidity, whether it is a week-end or weekday, and so on. Like
time series models, causal models may also include past data.
• 4. Associative models - uses explanatory variables to predict
the future
• Various types of forecasting models are shown in the following
figure:
12
 Introduction

Forecasting
Models

Judgmental Time Series Causal

Models Models Models

Delphi Moving Simple linear

Method Average Regression
Analysis

Exponential
Smoothing Multiple
Regression
Analysis
Trend
Projections

Types of Forecasting models

13
 Time Series Forecasts
• Trend - long-term movement in data
• Seasonality - short-term regular variations in
data
• Cycle – wavelike variations of more than one
year’s duration
• Irregular variations - caused by unusual
circumstances
• Random variations - caused by chance

14
 Scatter Diagram

• To get a rapid idea about the existence of a relationship between variables, a

scatter diagram may be plotted on a two-dimensional graph.
• The values of the independent variable (such as time) may be measured on the
horizontal axis and the proposed dependent variables (such as sales) placed on
the vertical axis.
• Let us consider an example of the Wacker Distributors, a firm that needs to
forecast sales for three different products. Annual sales over the past 10 years
for 3 of its products are given in the following table:
Annual demands of Televisions, radios and stereos

Year Televisions Radios Stereos

1 250 300 110
2 250 310 100
3 250 320 120
4 250 330 140
5 250 340 170
6 250 350 150
7 250 360 160
8 250 370 190
9 250 380 200
10 250 390 190
• A scatter diagram for each product is shown below: 15
 Scatter Diagram

300
250
200
150 Series1
100
50
0
0 5 10 15

A scatter diagram of demands for televisions

500
400
300
Series1
200
100
0
1 2 3 4 5 6 7 8 9 10

A scatter diagram of demands for radios

250
200
150
Series1
100
50
0
0 5 10 15
16
A scatter diagram of demands for stereos
 Time series forecasting models
• A time series is based on evenly spaced (weekly, monthly, quarterly and so
on) data points.
• Forecasting time series data implies that future values are predicted based
on the past values only, no matter how potentially valuable they are.
• A time series typically has 4 components: trend, seasonality, cycles, and
random variation.
• Analyzing time series means splitting past data into components and then
projecting them forward. The components are as follows:
1. Trend (T) is the gradual upward or downward movement of data over time.
2. Seasonality (S) is a pattern of the demand fluctuation above or below the trend
line that occurs every year.
3. Cycles (C) are patterns in the data that occur every several years. They are
usually tied into the business cycle.
• 4. Random Variations (R) are “blips” in the data caused by chance and unusual
• situations; they do not follow any noticeable pattern.
• The following figure shows a time series and its components
•   17
 Time series forecasting models

Demand or Service Trend Component

Seasonal Peaks

Actual Demand
curve

Average Demand over 4 years

Year1 Year2 Year3 Year4

Demand charted over 4 years with trend and seasonality indicated

18
Forecast Variations
Irregular
variation

Cycles

Seasonal variations

19
 Naive Forecasts
Uh, give me a minute....
We sold 250 wheels last
week.... Now, next week
we should sell....

The forecast for any period equals the previous

period’s actual value.

20
 Naïve Forecasts
• Simple to use
• Virtually no cost
• Quick and easy to prepare
• Data analysis is nonexistent
• Easily understandable
• Cannot provide high accuracy
• Can be a standard for accuracy

21
 Moving Average

• This method is applied when market demands stay fairly steady over
time.
• Moving Average is defined as follows:

• With each passing month, the earliest month’s data are dropped and
the most recent month’s data is added. This tends to smooth out
short-term irregularities in the data series.
• Example 1 The 3-months moving average of shed sales at Wallace
Garden Supply is shown in the following table:

22
 Moving Average
• Three-month Moving Average of actual shed sales
Month Actual shed sales 3-month Moving Average
Jan 10
Feb 12
Mar 13
Apr 16 (10+12+13)/3 = 11.67
May 19 (12+13+16)/3 = 13.67
Jun 23 (13+16+19)/3 = 16
Jul 26 (16+19+23)/3 = 19.33
Aug 30 (19+23+26)/3 = 22.67
Sep 28 (23+26+30)/3 = 26.33
Oct 18 (26+30+28)/3 = 28
Nov 16 (30+28+18)/3 = 25.33
Dec 14 (28+18+16)/3 = 20.67

23
 Weighted moving average (WMA)
• When there is a trend or pattern, weights is used to give more emphasis on recent
values. This makes the technique more responsive since later periods may be more
heavily weighted.
• Usually, the latest period is weighted too heavily to reflect a larger unusual change
in the demand or sales pattern too quickly. Mathematically, an n-period weighted
moving average (WMA) is defined as follows:

• A 3-month weighted moving average to forecast storage shed sales for Walace
Garden Supply can be obtained as follows:

• Example 2 Weighted Moving Average forecasts for Wallace Garden Supply problem
are shown in the table below:
•  
24
 Weighted moving average
•

• Weighting the latest month heavily leads to more accurate projection.

• Both simple and weighted moving averages are effective in smoothing out sudden
fluctuations in the demand pattern in order to provide stable estimate. But they
have some limitations as follows:
• Increasing in size n (the no. of periods averaged) does smooth out fluctuations
better, but it makes the method less sensitive to real changes in data.
• Moving Averages cannot consider trends very well.
• Moving Averages require extensive record keeping of past data. 25
 Exponential Smoothing Model
• New forecast = Last period’s forecast + (last period’s actual demand – last
period’s forecast) where is a smoothing constant.
• Mathematically, it can be formulated s follows:
Ft  Ft 1   ( At 1  Ft 1 )
where Ft = Forecast in the current period t
At 1 = Actual demand in previous period t – 1
 = smoothing constant (0    1).
• The values of are used to give more emphasis on recent data while
the rest of the values of are used to give less emphasis on the recent data.
Example 3 Suppose a demand of 162 units for a certain electronic good for the
2nd quarter of the year is predicted in the 1st quarter of the year. Actual 2nd quarter
demand was found to be 170. Using a smoothing constant  = 0.3, we can use
exponential smoothing model to forecast the demand for the 3rd quarter of the year
as follows:
F3  162  0.3(170  162) = 164.4 [Here F2 = 162 and A2 = 170]
= 164 [Rounding off value]
If the actual demand in the 2 quarter was 155, demand forecast for the 3rd quarter
nd

would be
F3  162  0.3(155  162) = 159.9
= 160 (rounded off) 26
 Forecast Error
Forecast error = Actual demand – forecasted value
Mean Absolute Deviation (MAD) is a kind of measure for the overall forecast
error and is defined by

MAD
 Forecast error of each of n periods
n
• Mean squared error (MSE) is the average of the squared differences
between the observed and the forecasted value.
• Mean absolute percentage error (MAPE) is the absolute difference between
the observed and the forecasted value expressed as a percentage of the
observed values.
• The forecasted value is dependent of the smoothing constant . This is shown
by an example below for = 0.2 and = 0.5:
• Example 4 The port of Baltimore has unloaded large quantities of a grain
from ships during the past eight quarters. The operations manager of the
port wants to test the use of exponential smoothing to see how well it works
in predicting tonnage unloaded. He assumes that the forecast of the grain
unloaded in the first quarter was 175.
•
27
 Exponential Smoothing Model
Exponential smooth forecasts with absolute deviations and MAD

Quarter Actual Rounded Absolute Rounded Absolute

tonnage forecast with deviations Forecast with deviations
unloaded  = 0.2 with  = 0.2  = 0.5 with  = 0.5
1 180 175 5 175 5
2 168 176 8 178 10
3 159 174 15 173 14
4 175 171 4 166 9
5 190 172 18 170 20
6 205 176 29 180 25
7 180 182 2 193 13
8 182 181 1 186 4
9 --- 181

Here MAD with  = 0.2 is 82/8 = 10.25 and MAD with  = 0.5 is 12.5. Since MAD
with  = 0.2 has smaller value, we prefer  = 0.2.

28
Exponential Smoothing with Trend Adjustment
Forecast including trend (FITt) = New Forecast (Ft) + Trend correction (Tt)
Trend correction, Tt can be defined as
Tt  Tt 1   ( Ft  Ft 1 )
where Tt  smooth trend for the current period t
 = trend smoothing constant ( 0    1
The 3 steps below can be followed to calculate a trend adjusted forecast:

Step 0 Calculate Ft.

Step 1 Compute Tt using the formula Tt  Tt 1   ( Ft  Ft 1 )
(Initially, a trend value either by guess or by observed past data is inserted)
Step 2 Calculate FITt using the formula FITt = Ft + Tt

Example 5 A manufacturing company that uses exponential smoothing to forecast

demand for one of its product. It appears that a trend is present. Data are given in the
following table:

Table 1.4 Data for exponential smoothing with trend adjustment

Month 1 2 3 4 5 6 7 8 9
Demands 12 17 20 19 24 26 31 32 36

Smoothing constants are assumed as   0.2 and   0.4 and 11 units were assigned
as the initial forecast for month 1.
29
 Exponential Smoothing with Trend Adjustment
Step 0 Forecast for month 2 (F2) = Forecast for month 1 (F1)
+  (Demand for month 1 – Forecast for month 1)
That is, F2  11  0.2(12  11)  11 .0  0.2  11 .2 units.
Step 1 Assume T1 = 0. T2  T1   ( F2  F1 )  0  0.4(11 .2  11 .0)  0.08.
Step 2 FIT2  F2  T2  11 .2  0.08  11 .28.
• In the same way we do the calculations for the other months. The results
are given in the following table
Forecast by exponential smoothing with trend adjustment for an example problem

Month Actual Ft (Forecast Trend FIT2

Demand without trend) (Adjusted)
1 12 11.00 0.00 ----
2 17 11.20 0.08 11.28
3 20 12.36 0.54 12.90
4 19 13.89 1.15 15.04
5 24 14.91 1.56 16.47
6 26 16.73 2.29 19.02
7 31 18.58 3.03 21.61
8 32 21.07 4.03 25.09
9 36 23.25 4.90 28.15
30
 Exponential Smoothing with Trend Adjustment
• Different kinds of trends are shown by line charts in the following figure:

In the figure above the series 1 represents the actual demand, the series 2 represents
the forecast including trend and the series 3 represents forecast without trend.
The value of the trend smoothing constant  , resembles the constant  in that a high
 value is more responsive to recent changes in trend. A low  value gives less
weight to the most recent trends to smooth out the trend present.
Values of  can be found out by the trial-error approach, with MAD used as a
measure of comparison.
Simple exponential smoothing is often referred to as first-order smoothing and trend
adjusted smoothing is called 2nd order or double smoothing. Other exponential
smoothing such as seasonal adjusted and triple smoothing are also in use but these are31
not included here.
 Trend Projections
• Often we try to predict the value of the dependent variable from the given value of the
independent variable. For instance,
• Dependent Variable Independent variable
• Sales of product price of products
• Automobile sales Interest rate
• Total production cost No. of units produced
• The trend projection technique fits a trend line to a series of historical data points, and
then projects the line for medium-to long-range forecasts.
• Though there are several mathematical trend equations (e.g. quadratic and exponential)
available, we will restrict our discussion to a linear trend (simple linear regression only).
• To develop this linear trend the least square method (a statistical method) may be
applied.
• This method projects a straight line that minimizes the sum of the squares of the vertical
distances from the line to each of actual observations.
• The figure below illustrates the least square approach:
•  

32
 Trend Projections
Values of dependent variable
*
Dist 72
* *
Dist 52
Dist 32 Dist 62
Dist 42 *
* *
Dist12 Dist 22

*
Time
Least Square Method for finding the best fitting straight line

A least square line is described in terms of its Y-intercept (the height at which it
intercepts the Y-axis) and its slope (tangent of the angle of the line). Computation of
the Y-intercept and the slope leads to the equation of the line as follows:
y i  a  bxi   i
where  i is an error term representing the fact that for given value of xi, the value of yi
might not always equal to a  bxi .
33
 Trend Projections
Suppose we have data points ( x1 , y1 ), ( x 2 , y 2 ),..., ( x n , y n ). We need to select the values
of a and b in such a way that the sum of the square of the distance
 i  yi  (a  bxi ) , i = 1, 2,…,n
is minimum. That is, we need to determine the values of a and b that leads to
minimum value of the function
n n
F (a, b)    i    y i  a  bxi 
2 2

i 1 i 1
Equating the partially differentiated values of this function with respect to a and b to
zero obtain their optimal values a* and b* as follows (proof is shown in the Appendix
1):
  xi  x  yi  y  
b 
*
; a *
 y  b x; (1)
 ( xi  x ) 2

where x = average value of all xi’s and y  average value of all yi’s.

34
 Trend Projections
The 1st equation in (1.1) can be written as
n
 n   n 
i 1
xi y i  ny   xi  / n  nx   y i  / n  nx y
 i 1   i 1 
b  n
 n

 xi  2nx   xi  / n  nx 2
2

i 1  i 1 

implying b* 
 x i y i  nx y ; a *  y  b * x ; (1.2)
 i
2
x  n x 2

Thus using equation (1.2) we can find out the values of a and b and hence the
equation of the least square regression line Y  a *  b * X .

Example 6 The demand data for electrical generators over the period 2000-2006 of
the Midwestern Manufacturing Company is given in the following table:
Table1.6 Demand data for electrical generators of Midwestern Manufacturing Company

Year Electrical
Generators sold
2000 74
2001 79
2002 80
2003 90
2004 105
2005 142
2006 122

Find the equation of the least square regression line and hence estimate the demands
for 2007 and 2008. 35
 Trend Projections
• Solution. Designating 2000 as year1, 2001 as year2 and so on, the values
of are shown in the following table:
Table 7 Trend calculations of demand data

Year Time Period Generator xi

2
xi y i
( xi ) Demand ( y i )
2000 1 74 1 74
2001 2 79 4 158
2002 3 80 9 240
2003 4 90 16 360
2004 5 105 25 525
2005 6 142 36 852
2006 7 122 49 854
x i  28 y i  692 x i
2
 140 x y
i i  3063

Now x
x i 28
  4; y 
 yi  692  98.86
7 7 7 7

b* 
 xi yi  nx y  3063  7(4)(98.86)  294.92  10.53(appr.);
 x i  nx 2 140  7( 4 2 )
2
28
a *  y  b * x  98.86  10.53( 4)  56.74;

36
 Trend Projections
• Hence the equation of the least square regression line is which is shown in
combination with the actual demand line in the following figure:

150

100
Series1
Series2
50

0
1 2 3 4 5 6 7

Figure 6 Actual demand and the trend line of electrical generators

• The year 2007 and 2008 are denoted by the periods 8 and 9 respectively. So
respective sales forecasts for these years are given respectively by
• Sales forecast for 2007 = 56.74 + 10.53(8) =140.98 = 141 (appr.)
• Sales forecast for 2008 = 56.74 + 10.53(9) =151.51 = 152 (appr.)
37
 Seasonal Variations
• Time series forecasting such as described above depends on the trend of
data over a series of time observations. Sometimes, recurring variations
at certain seasons make seasonal adjustment in the trend line forecast
necessary. For example, demand for coal and fuel oil, usually peaks during
cold winter months. Seasonal index defined by
Average two - year demand
Seasonal Index 
Average monthly demand
Average two - year demand
Average monthly demand 
12
• is used to forecast demands for different periods.
• Example 7 Monthly sales of one brand of telephone answering machine of
a company for the two most recent years are given in the following table:

38
 Seasonal Variations
Table 8 Answer machine sales and seasonal indices

Sales Demand Average Two-year Average Seasonal index

demand monthly
Month
Yr1 Yr2 demand
Jan 80 100 90 94 0.957
Feb 75 85 80 94 0851
Mar 80 90 85 94 0.904
Apr 90 110 100 94 1.064
May 115 131 123 94 1.309
Jun 110 120 115 94 1.223
Jul 100 110 105 94 1.117
Aug 90 100 100 94 1.064
Sep 85 95 90 94 0.957
Oct 75 85 80 94 0.851
Nov 75 85 80 94 0.851
Dec 80 80 80 94 0.851
1055 1201 Total Av. Demand
= 1128

39
 Seasonal Variations
Consider last two year’s demands as follows:
Year (X) Demand (Y)
1 1055
2 1201

Then we can find the least square regression line as follows:

Y  a   b X
3457  2(1.5)(1128 )
where b    146 and a 
 1128  146(1.5)  909
5  2(1.5) 2

So, the third year’s demand is given by Y = 909 + 3(146) = 1347

Using the seasonal indices from the above table and expected third year’s annual
demand for answer machine to be 1347 units, we can forecast the monthly demand
(rounded off values) for that year as follows:

Jan 1347(0.957)/12 = 107 Jul 1347(1.117)/12 = 125

Feb 1347(0.851)/12 = 96 Aug 1347(1.064)/12 = 119
Mar 1347(0.904)/12 = 101 Sep 1347(0.957)/12 = 107
Apr 1347(1.064)/12 = 119 Oct 1347(0.851)/12 = 96
May 1347(1.309)/12 = 147 Nov 1347(0.851)/12 = 96
Jun 1347(1.223)/12 = 137 Dec 1347(0.851)/12 = 96
40
 Causal forecasting Methods

• In causal forecasting models the variable to be predicted depends on several

variables.
• Based on these related variables a statistical model is built and used to
forecast the variable of interest. This method is more powerful than the
time series methods that use only the historic values of the forecasted
variable.
• Sales of a product is affected by many factors such as advertising budget,
the price charged, competitor’s prices, promotional strategies and economy
and unemployment rates.
• The Sale of the product is called the dependent variable while the other
related variables are called independent variables.
• The least square regression analysis may be used to establish the statistical
model.
• The weakness of the causal forecasting model is the difficulty of determining
the values of the independent variables in the future because of effect of
various factors such as unemployment rates, Gross National Products, price
indices etc.
41
 Causal forecasting Methods

• Example 8 The Triple A Construction Company renovates old homes in

Albany. Over time, the company has found that its dollar volume of
renovation work is dependent on the Albany area payroll. The figures for
Triple A’s revenues and the amount of money earned by wage earners in
Albany for the past six years are given in the following table:
Table 1Triple A Construction Company sales and local payroll

Tripl A’s Sales (Y) Local payroll (X)

($100,000s) ($100,000,000s)
2.0 1
3.0 3
2.5 4
2.0 2
2.0 1
3.5 7
The least square regression line
Y  a  b X

where x 
 xi  18  3; y   yi  15  2.5 and
n 6 n 6

b 
 xi yi  nx y  51.5  6(3)( 2.5)  0.25 and a   y  b  x  2.5  3(0.25)  1.75
 x i  nx 2 80  6(3 2 )
2

So, the estimated regression equation is given by

Y  1.75  0.25 X 42
or Sales = 1.75 + 0.25(payroll)
 Causal forecasting Methods
• The regression line is shown in the following figure:

Y Regression line y i  1.75  0.25 xi

3  

 
2

0 1 2 3 4 5 6 7 X
Figure7 Regression line of a numerical example problem

If the local chamber of commerce predicts that the Albany area payroll will be 6
hundred million dollars next year, an estimate of sales for Triple A is found with the
above regression equation as follows:
Sales = 1.75 + 0.25(6) = 3.25 i. e. $325,000

43
 Standard Error of the estimate

Standard Error of estimate, S y , x is given by

S y,x 
(y i  Yc ) 2
n2
where yi = the y-value of data i
yc = a   b  xi , the computed value of the dependent variable from the regression
equation
for the corresponding xi
n = the number of data points.
The standard error for the previous example is given by
0  0.25  0.0625  0.0625  0  0
S y,x 
62
0.375
=  0.306
4
Thus the standard error of the estimate is $30600 in sales.

This formula can also be written as

S y,x 
y 2
 a  y  b xy
n2
The proof is given in Appendix 2. 44
 Correlation coefficient for regression lines

• The coefficient of correlation measure expresses the degree or strength of

the linear relationship of the variables. It is usually denoted by r and lies
between 0 and 1 inclusive. The following figures illustrate what different
values of r might look like. *
• * * * *

• * * *
• * * * * *
• * *
• * * *
• * *
• Figure 8(a) Perfect positive correlation ( r = 1) Figure 8(b) Positive correlation ( 0 < r < 1)


 
 
   
 
  
 
Figure 8(c) Perfect negative correlation (r = -1) Figure 8(d) No correlation (r = 0) 45
 Correlation coefficient for regression lines

The correlation coefficient r can be calculated as follows:

n xi y i   xi  y i

 
r
n  xi    xi  n  y i   y i 
2 2 2 2

For the Triple A construction Company (Example 8) the value of r is given by

(6)(51.5)  (18)(15.0) 309  270

r   0.901
[( 6)(80)  (18) ][( 6)(39.5)  (15.0) ]
2 2
(156)(12)

Thus r = 0.9021seems to be a significant correlation and helps to confirm the

closeness of the relationship of the two variables. Another measure-the coefficient of
determination, the square of the coefficient of correlation (r2) that lies between 0 and
1 inclusive is also used to describe the relationship between two variables. In Triple
A’s case the value of r2 = 0.81 indicates that 81% of the total variation is explained
by the regression line.

46
 Multiple Regression Analysis

Multiple regression models are an extension of the linear regression models. It allows
in building a model with several independent variables. The model for two
independent variables is given by
Y  a  b1 X 1  b2 X 2 ,
where Y = the dependent variable
a = Y-intercept
Xi (i = 1,2) = the independent variable i
bi = Slope for independent variable Xi (i = 1, 2).
The mathematics of multiple regression is quite complex. So the formulae for a, b1
and b2 are not included here.

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 Monitoring and Controlling Forecasts

• It is important to monitor and control forecast.

• One way to monitor forecasts to ensure that they are performing well is to
employ a tracking signal.
• A tracking signal is a measurement of how well the forecast is predicting actual
values.
• As forecasts are updated every week, month or quarter, the newly available
demand data are compared to the forecast values.
• The tracking signal is computed as the running sum of the forecast errors
(RSFE) divided by the mean absolute deviation. That is,

• Positive tracking signals indicate that demand is grater than the forecast while
negative tracking signal means that demand is less than the forecast.
• A good tracking signal is one with a low RSFE, has about as much positive as
negative error. Small deviations are okay, but the positive and negative ones
should balance one another so the tracking signal centers closely around zero.
• Plot of tracking signal is shown in the following figure:
48
 Monitoring and Controlling Forecasts
• Once tracking signals are calculated, they are compared to predetermined
control limits, an upper and lower tracking limits. There is no single answer
in deciding the tracking limits.
• George Plossl and Oliver Wight, two inventory control experts suggest to use
Maximums of  4 MADs (for high-volume stock items) and  8 MADs (for lower-
volume items). Other forecasters suggest slightly lower ranges.
One MAD is equivalent to 0.8 standard deviations, so that  2 MADs =  1.6
standard deviations,  3 MADs =  2.4 standard deviations and  4 MADs =  3.2
standard deviations.
Using 1.6, 2.4 and 3.2 standard deviations in Normal distribution table find the
expected percentage errors falling within  2 MADs,  3 MADs and  4 MADs
respectively as 94.52%, 99.18% and 99.93%.
• Example 9 A bakery’s quarterly sales of a product (in thousands) as well as
forecast demand and error computations are shown in the following table:
The objective is to compute the tracking signal and determine whether
forecasts are performing adequately.

49
 Monitoring and Controlling Forecasts
Table 10 Data to calculate Tracking signal for a product of a bakery
Quar Forecast Actual Error RSFE Absolute Cum. MAD Tracking
ter Demand Demand forecast error error Signal
1 100 90 -10 -10 10 10 10.0 -1
2 100 95 -5 -15 5 15 7.5 -2
3 100 115 +15 0 15 30 10.0 0
4 110 100 -10 -10 10 40 10.0 -1
5 110 125 +15 +5 15 55 11.0 +0.5
6 110 140 +30 +35 30 85 14.2 +2.5

RSFE 35
Tracking signal =   2.5
MAD 14.2
This tracking signal is within acceptable limit. It can be seen that it drifted from -2.0
to + 2.5.

• Adaptive Smoothing
• Adaptive smoothing refers to computer monitoring of tracking signals and self
adjustment if a signal exceeds its limit.
• In exponential smoothing, the coefficients are first selected based on values that
minimize error forecasts and then adjusted accordingly whenever the computer
notes an errant tracking signal. This is called adaptive smoothing.
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 The Delphi Technique

• This is a popular judgmental forecasting technique. It is a group process that allows

experts who may be located in different geographical areas to make forecasts.
• There are three different types of participants in this process:
• 1) decision makers 2) staff personnel and 3) respondents.
• The decision makers consist of a group of experts who will be making the actual
forecast.
• The staff personnel assist the decision makers. They do the preparation,
distribution, collection, and summarization of questionnaires and survey results.
• The respondents are a group of people whose judgments are valued and are being
sought. The forecasting procedure is as follows:
– Select decision maker, staff and respondent groups.
– Develop and administer first questionnaire.
– Analyze first questionnaire.
– Develop and administer 2nd questionnaire.
– Analyze 2nd questionnaire
– Do final analysis and present results
– Develop the forecast.
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 The Delphi Technique
• The main idea behind the Delphi approach is a feedback process.
• The results of the first questionnaire are tabulated and sent back to the
respondents along with a 2nd questionnaire that is made based on the
insights and results from the first questionnaire.
• The respondents answer the 2nd questionnaire. Then the decision makers
tabulate the final results and make the forecast using their judgment,
experience and the result of the two questionnaires.
• Use of Computer in Forecasting
• Numerous software packages such as SAS, SPSS, BIOMED, SYSTEB, Minitab
etc. are readily available to handle time series and causal forecasting
projections. Even spreadsheet software such as Lotus1-2-3, can effectively
manage small-to-medium range forecasting problems.

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