Operations

Management
Chapter 4 –
Forecasting

PowerPoint presentation to accompany

Heizer/Render
Principles of Operations Management, 7e
Operations Management, 9e
© 2008 Prentice Hall, Inc. 4–1
 Outline
 Global Company Profile: Disney
World
 What Is Forecasting?
 Forecasting Time Horizons
 The Influence of Product Life Cycle
 Types Of Forecasts

© 2008 Prentice Hall, Inc. 4–2

 Outline – Continued
 The Strategic Importance of
Forecasting
 Human Resources
 Capacity
 Supply Chain Management
 Seven Steps in the Forecasting
System

© 2008 Prentice Hall, Inc. 4–3

 Outline – Continued
 Forecasting Approaches
 Overview of Qualitative Methods
 Overview of Quantitative Methods

© 2008 Prentice Hall, Inc. 4–4

 Outline – Continued
 Time-Series Forecasting
 Seasonal Variations in Data

© 2008 Prentice Hall, Inc. 4–5

 Outline – Continued
 Associative Forecasting Methods:
Regression and Correlation
Analysis
 Using Regression Analysis for
Forecasting
 Standard Error of the Estimate
 Correlation Coefficients for
Regression Lines

© 2008 Prentice Hall, Inc. 4–6

 Outline – Continued
 Forecasting In The Service Sector

© 2008 Prentice Hall, Inc. 4–7

 Learning Objectives
When you complete this chapter you
should be able to :

 Understand the three time horizons and

which models apply for each use
 Explain when to use qualitative or
quantitative models

© 2008 Prentice Hall, Inc. 4–8

 Learning Objectives
When you complete this chapter you
should be able to :

 Develop seasonal indexes

 Conduct a regression and correlation
analysis

© 2008 Prentice Hall, Inc. 4–9

 Forecasting at Disney World
 Global portfolio includes parks in Hong
Kong, Paris, Tokyo, Orlando, and
Anaheim
 Revenues are derived from people – how
many visitors and how they spend their
money
 Daily management report contains only
the forecast and actual attendance at
each park

© 2008 Prentice Hall, Inc. 4 – 10

 Forecasting at Disney World
 Disney generates daily, weekly, monthly,
annual, and 5-year forecasts
 Forecast used by labor management,
maintenance, operations, finance, and
park scheduling
 Forecast used to adjust opening times,
rides, shows, staffing levels, and guests
admitted

© 2008 Prentice Hall, Inc. 4 – 11

 Forecasting at Disney World
 20% of customers come from outside the
USA
 Economic model includes gross
domestic product, cross-exchange rates,
arrivals into the USA
 A staff of 35 analysts and 70 field people
survey 1 million park guests, employees,
and travel professionals each year

© 2008 Prentice Hall, Inc. 4 – 12

 Forecasting at Disney World
 Inputs to the forecasting model include
airline specials, Federal Reserve
policies, Wall Street trends,
vacation/holiday schedules for 3,000
school districts around the world
 Average forecast error for the 5-year
forecast is 5%
 Average forecast error for annual
forecasts is between 0% and 3%

© 2008 Prentice Hall, Inc. 4 – 13

 What is Forecasting?
 A technique for
using past
experiences to
project ??
expectations for
the future
(Chapman, 2006)

© 2008 Prentice Hall, Inc. 4 – 14

 What is Forecasting?
 Process of
predicting a future
event
 Underlying basis of

all business
decisions
 Production
 Inventory
 Personnel
 Facilities
© 2008 Prentice Hall, Inc. 4 – 15
 Forecasting Time Horizons
 Short-range forecast
 Up to 1 year, generally less than 3 months
 Purchasing, job scheduling, workforce
levels, job assignments, production levels
 Medium-range forecast
 3 months to 3 years
 Sales and production planning, budgeting
 Long-range forecast
 3+ years
 New product planning, facility location,
research and development
© 2008 Prentice Hall, Inc. 4 – 16
 Distinguishing Differences
 Medium/long range forecasts deal with
more comprehensive issues and support
management decisions regarding
planning and products, plants and
processes
 Short-term forecasting usually employs
different methodologies than longer-term
forecasting
 Short-term forecasts tend to be more
accurate than longer-term forecasts

© 2008 Prentice Hall, Inc. 4 – 17

 Influence of Product Life
Cycle
Introduction – Growth – Maturity – Decline
 Introduction and growth require longer
forecasts than maturity and decline
 As product passes through life cycle,
forecasts are useful in projecting
 Staffing levels
 Inventory levels
 Factory capacity

© 2008 Prentice Hall, Inc. 4 – 18

 Product Life Cycle
Introduction Growth Maturity Decline
Best period to Practical to change Poor time to Cost control
Company Strategy/Issues

increase market price or quality change image, critical

share image price, or quality

R&D engineering is Strengthen niche Competitive costs

critical become critical
Defend market
position
CD-ROMs
Internet search engines
Analog TVs
Drive-through
LCD & plasma TVs restaurants

Sales iPods

3 1/2”
Xbox 360 Floppy
disks

Figure 2.5
© 2008 Prentice Hall, Inc. 4 – 19
 The effects of the product/service life
cycle on the organization (Slack et al.,
2001)

© 2008 Prentice Hall, Inc. 4 – 20

 Types of Forecasts
 Economic forecasts
 Address business cycle – inflation rate,
money supply, housing starts, etc.
 Technological forecasts
 Predict rate of technological progress
 Impacts development of new products
 Demand forecasts
 Predict sales of existing products and
services

© 2008 Prentice Hall, Inc. 4 – 21

 Strategic Importance of
Forecasting

 Human Resources – Hiring, training,

laying off workers
 Capacity – Capacity shortages can
result in undependable delivery, loss
of customers, loss of market share
 Supply Chain Management – Good
supplier relations and price
advantages

© 2008 Prentice Hall, Inc. 4 – 22

 Seven Steps in Forecasting
 Determine the use of the forecast
 Select the items to be forecasted
 Determine the time horizon of the
forecast
 Select the forecasting model(s)
 Gather the data
 Make the forecast
 Validate and implement results
© 2008 Prentice Hall, Inc. 4 – 23
 The Realities!

 Forecasts are seldom perfect

 Most techniques assume an
underlying stability in the system
 Product family and aggregated
forecasts are more accurate than
individual product forecasts

© 2008 Prentice Hall, Inc. 4 – 24

 Forecasting Approaches
Qualitative Methods
 Used when situation is vague
and little data exist
 New products
 New technology
 Involves intuition, experience
 e.g., forecasting sales on Internet

© 2008 Prentice Hall, Inc. 4 – 25

 Forecasting Approaches
Quantitative Methods
 Used when situation is ‘stable’ and
historical data exist
 Existing products
 Current technology
 Involves mathematical techniques
 e.g., forecasting sales of color
televisions
© 2008 Prentice Hall, Inc. 4 – 26
 Forecasting Models
Forecasting
Techniques

Qualitative Time Series Causal

Models Methods Methods

Regression
Delphi Methods Moving Average
Analysis

Jury of Executive Exponential Multiple

Opinion Smoothing Regression

Sales Force Trend Projections

Composite

Consumer Market
Survey
Read up on qualitative methods ... Compare and
contrast with quantitative
27
© 2008 Prentice Hall, Inc. 4 – 27
 Seasonal Variations In Data
[Week 1 – 3 hrs end]

The multiplicative
seasonal model
can adjust trend
data for seasonal
variations in
demand

© 2008 Prentice Hall, Inc. 4 – 28

 Seasonal Variations In Data
Steps in the process:
1. Find average historical demand for each
season
2. Compute the average demand over all
seasons
3. Compute a seasonal index for each season
4. Estimate next year’s total demand
5. Divide this estimate of total demand by the
number of seasons, then multiply it by the
seasonal index for that season

© 2008 Prentice Hall, Inc. 4 – 29

 Seasonal Index Example
[(80+85+105)/3 = 90 & (1050+1120+1204)/36 = 93.7 ~ 94

Demand Average Average Seasonal

Month 2008 2009 2010 2008-2010 Monthly Index
Jan 80 85 105 90 94
Feb 70 85 85 80 94
Mar 80 93 82 85 94
Apr 90 95 115 100 94
May 113 125 131 123 94
Jun 110 115 120 115 94
Jul 100 102 113 105 94
Aug 88 102 110 100 94
Sept 85 90 95 90 94
Oct 77 78 85 80 94
Nov 75 72 83 80 94
Dec 82 78 80 80 94
© 2008 Prentice Hall, Inc. 4 – 30
 Seasonal Index Example
Demand Average Average Seasonal
Month 2008 2009 2010 2008-2010 Monthly Index
Jan 80 85 105 90 94 0.957
Feb 70 85 85 80 94
Mar 80 93 average
82 85 monthly 94
2008-2010 demand
Seasonal90index95= 115
Apr 100 94
average monthly demand
May 113 125 131 123 94
= 90/94 = .957
Jun 110 115 120 115 94
Jul 100 102 113 105 94
Aug 88 102 110 100 94
Sept 85 90 95 90 94
Oct 77 78 85 80 94
Nov 75 72 83 80 94
Dec 82 78 80 80 94
© 2008 Prentice Hall, Inc. 4 – 31
 Seasonal Index Example
Demand Average Average Seasonal
Month 2008 2009 2010 2008-2010 Monthly Index
Jan 80 85 105 90 94 0.957
Feb 70 85 85 80 94 0.851
Mar 80 93 82 85 94 0.904
Apr 90 95 115 100 94 1.064
May 113 125 131 123 94 1.309
Jun 110 115 120 115 94 1.223
Jul 100 102 113 105 94 1.117
Aug 88 102 110 100 94 1.064
Sept 85 90 95 90 94 0.957
Oct 77 78 85 80 94 0.851
Nov 75 72 83 80 94 0.851
Dec 82 78 80 80 94 0.851
© 2008 Prentice Hall, Inc. 4 – 32
 Seasonal Index Example
[Estimated annual demand for 2011 = 1,200 units]

Demand Average Average Seasonal

Month 2008 2009 2010 2008-2010 Monthly Index
Jan 80 85 105 90 94 0.957
Feb 70 85 Forecast
85 for802011 94 0.851
Mar 80 93 82 85 94 0.904
Apr 90Expected
95 115annual demand
100 = 1,200
94 1.064
May 113 125 131 123 94 1.309
Jun 110 115 120 1,200 115 94 1.223
Jul Jan 113 12 105
100 102 x .957 = 96
94 1.117
Aug 88 102 110 100 94 1.064
1,200
Sept 85 90 95 90 94 0.957
Oct 77
Feb
78 85 12
x .851 =
80
85
94 0.851
Nov 75 72 83 80 94 0.851
Dec 82 78 80 80 94 0.851
© 2008 Prentice Hall, Inc. 4 – 33
 Seasonal Index Example
2011 Forecast
140 – 2010 Demand
130 – 2009 Demand
2008 Demand
120 –
Demand

110 –
100 –
90 –
80 –
70 –
| | | | | | | | | | | |
J F M A M J J A S O N D
Time
© 2008 Prentice Hall, Inc. 4 – 34
 Associative Forecasting
Used when changes in one or more
independent variables can be used to predict
the changes in the dependent variable

Most common technique is linear

regression analysis

We apply this technique just as we did

in the time series example

© 2008 Prentice Hall, Inc. 4 – 35

 Associative Forecasting

Forecasting an outcome based on predictor

variables using the least squares technique

y^ = a + bx
^ where y = computed value of
the variable to be predicted
(dependent variable)
a = y-axis intercept
b = slope of the regression line
x = the independent variable
though to predict the value of the
dependent variable
© 2008 Prentice Hall, Inc. 4 – 36
 Associative Forecasting Example
[Question: Forecast Sales in year 7, if Payroll is projected at $6b]

Sales Local Payroll

($ millions), y ($ billions), x
2.0 1
3.0 3
2.5 4
4.0 –
2.0 2
2.0 1
3.0 –
3.5 7 Sales
2.0 –

1.0 –
| | | | | | |
0 1 2 3 4 5 6 7
Area payroll

© 2008 Prentice Hall, Inc. 4 – 37

 Associative Forecasting
Example
Sales, y Payroll, x x2 xy Y2
2.0 1 1 2.0 4.0
3.0 3 9 9.0 9.0
2.5 4 16 10.0 6.25
2.0 2 4 4.0 4.0
2.0 1 1 2.0 4.0
3.5 7 49 24.5 12.25
∑y = 15.0 ∑x = 18 ∑x2 = 80 ∑xy = 51.5 39.5
∑xy - nxy 51.5 - (6)(3)(2.5)
x = ∑x/6 = 18/6 = 3 b= = = .25
∑x - nx
2 2 80 - (6)(3 2
)

y = ∑y/6 = 15/6 = 2.5 a = y - bx = 2.5 - (.25)(3) = 1.75

© 2008 Prentice Hall, Inc. 4 – 38

 Associative Forecasting
Example
y^ = 1.75 + .25x Sales = 1.75 + .25(payroll)

If payroll next year

is estimated to be 4.0 –
$6 billion, then: 3.25
Sales
3.0 –

Sales = 1.75 + .25(6) 2.0 –

Sales = $3,250,000
1.0 –
| | | | | | |
0 1 2 3 4 5 6 7
Area payroll
© 2008 Prentice Hall, Inc. 4 – 39
 Standard Error of the
Estimate [Week 2 – 1 hr ends & Allocate Group Assignment #2]

 A forecast is just a point estimate of a

future value
 This point is
4.0 –
actually the 3.25
mean of a 3.0 – Sales
probability
2.0 –
distribution
1.0 –
| | | | | | |
0 1 2 3 4 5 6 7
Area payroll
Figure 4.9
© 2008 Prentice Hall, Inc. 4 – 40
 Standard Error
http://en.wikipedia.org/wiki/Standard_error_(statistics)

• The standard error of a method of measurement or estimation

is the standard deviation of the sampling distribution
associated with the estimation method (Everitt, 2003)
• For example, the sample mean is the usual estimator of a
population mean. However, different samples drawn from that
same population would in general have different values of a
sample mean
• As long as the estimator is unbiased, the standard deviation of
the error (the difference between the estimate and the true
value) is the same as the standard deviation of the estimates
themselves
• The standard error of the mean is the standard deviation of
the sample mean estimate of a population mean

© 2008 Prentice Hall, Inc. 4 – 41

 Standard Error of the
Estimate

∑(y - yc)2
Sy,x =
n-2

where y = y-value of each data

point
yc = computed value of
the dependent variable, from the
regression equation
n = number of data
© 2008 Prentice Hall, Inc.
points 4 – 42
 Standard Error of the
Estimate
Computationally, this equation is
considerably easier to use

∑y2 - a∑y - b∑xy

Sy,x =
n-2

We use the standard error to set up

prediction intervals around the
point estimate

© 2008 Prentice Hall, Inc. 4 – 43

 Standard Error of the
Estimate
∑y2 - a∑y - b∑xy = 39.5 - 1.75(15) - .25(51.5)
Sy,x =
n-2 6-2

Sy,x = .306 4.0 –

3.25
Sales
3.0 –
The standard error
of the estimate is 2.0 –
$306,000 in sales
1.0 –
| | | | | | |
0 1 2 3 4 5 6 7
Area payroll
© 2008 Prentice Hall, Inc. 4 – 44
 Correlation
 How strong is the linear
relationship between the
variables?
 Correlation does not necessarily
imply causality!
 Coefficient of correlation, r,
measures degree of association
 Values range from -1 to +1

© 2008 Prentice Hall, Inc. 4 – 45

 Correlation Coefficient
nxy - xy
r=
[nx2 - (x)2][ny2 - (y)2]

© 2008 Prentice Hall, Inc. 4 – 46

 y y
Correlation Coefficient
nxy - xy
r=
(a) Perfect positive[nxx2 - (x)2][ny2 (b)
- ( y)2]
Positive x
correlation: correlation:
r = +1 0<r<1

y y

(c) No correlation: x (d) Perfect negative x

r=0 correlation:
© 2008 Prentice Hall, Inc. r = -1 4 – 47
 Calculation
nS xy - SxSy
r=
[nSx2 - (Sx)2][nSy2 - (Sy)2]

r= [(6 x 51.5) - (18 x 15)] / √ [(6 x 80) - (18 x 18)] [(6 x 39.5) - (15 x 15)]
(309 - 270) / √ [(480 - 324)] [(237 - 225)]
39 / √ (156 x 12)
39 / √ 1872
39 / 43.267
0.901
2
© 2008 Prentice Hall, Inc. r = 0.812 4 – 48
 Correlation
 Coefficient of Determination, r2,
measures the percent of change in
y predicted by the change in x
 Values range from 0 to 1
 Easy to interpret
For the Nodel Construction example in Text:
r = .901
(0.901 x 0.901 = 0.81)

r2 = .81
© 2008 Prentice Hall, Inc. 4 – 49
 Forecasting in the Service
Sector
 Presents unusual challenges
 Special need for short term records
 Needs differ greatly as function of
industry and product
 Holidays and other calendar events
 Unusual events

© 2008 Prentice Hall, Inc. 4 – 50

 Fast Food Restaurant
Forecast
20% –
Percentage of sales

15% –

10% –

5% –

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

12-1 2-3 4-5 6-7 8-9 10-11
(Lunchtime) (Dinnertime)
Hour of day Figure 4.12
© 2008 Prentice Hall, Inc. 4 – 51
 FedEx Call Center Forecast

12% –

10% –

8% –

6% –

4% –

2% –

0% – 2 4 6 8 10 12 2 4 6 8 10 12
A.M. P.M.
Hour of day
Figure 4.12
© 2008 Prentice Hall, Inc. 4 – 52
 NEXT LECTURE:
Capacity Planning

D. Anthony Chevers
delroy.chevers@uwimona.edu.jm
DOMS, Room #28
53
© 2008 Prentice Hall, Inc. 4 – 53