Forecasting

Demand Characteristics
Independent demand Dependent demand

100 x 1 =
100 tabletops

100 tables 100 x 4 = 400 table legs

Continuous demand
Discrete demand
400 –
400 –
No. of tables

300 –
No. of tables
300 –
200 –
200 –
100 –
100 –
1 2 3 4 5
Week M T W Th F M T W Th F
14-2
Demand Management

 Independent demand items are

the only items demand for which
needs to be forecasted
 These items include:
 Finished goods and
 Spare parts
Demand Management

Independent Demand
(finished goods and spare parts)

A Dependent Demand
(components)

B(4) C(2)

D(2) E(1) D(3) F(2)

Introduction
 Demand estimates for independent demand
products and services are the starting point
for all the other forecasts in POM.
 Management teams develop sales forecasts
based in part on demand estimates.
 Sales forecasts become inputs to both
business strategy and production resource
forecasts.
What is Forecasting?

 Process of predicting a future event based

on historical data
Sales will be
 Educated Guessing $200 Million!

 Underlying basis of
all business decisions
 Production
 Inventory
 Personnel
 Facilities
Importance of Forecasting in POM
 Departments throughout the organization depend
on forecasts to formulate and execute their plans.

 Finance needs forecasts to project cash flows

and capital requirements.

 Human resources need forecasts to anticipate

hiring needs.

 Production needs forecasts to plan production

levels, workforce, material requirements,
inventories, etc.
The Effect of Inaccurate Forecasting
Product Demand over Time
Demand for product or service

Year Year Year Year

1 2 3 4
Product Demand over Time
Trend component
Seasonal peaks
Demand for product or service

Actual demand
Random line
variation
Year Year Year Year
1 2 3 4
Now let’s look at some time series approaches to forecasting…
Forms of Forecast Movement
Types of Forecasts by Time Horizon
Quantitativ
 Short-range forecast e
methods
 Usually < 3 months
 Job scheduling, worker assignments
Detailed
 Medium-range forecast use of
system
 3 months to 2 years
 Sales/production planning

 Long-range forecast
 > 2 years
Design
 New product planning
of system
Qualitative
Methods
Forecasting Methods

 Time series
 statistical techniques that use historical demand
data to predict future demand
 Regression methods
 attempt to develop a mathematical relationship
between demand and factors that cause its behavior
 Qualitative
 use management judgment, expertise, and
opinion to predict future demand
 Forecasting Approaches

Qualitative Methods Quantitative Methods

(opinion based) (statistics based)
 Used when situation is vague  Used when situation is stable &
& little data exist historical data exist
 New products  Existing products
 New technology  Current technology
 Involves intuition, experience  Involves mathematical
 e.g forecasting sales on techniques
internet  e.g., forecasting sales of
color televisions
Qualitative Forecasting Methods

Qualitative
Forecasting

Models
Executive Sales force Market
judgement survey research/ Delphi Method
survey
Qualitative Methods

 Executive committee consensus

 Delphi method
 Survey of sales force
 Survey of customers
 Historical analogy
 Market research
 Qualitative Methods
Briefly, the qualitative methods are:
Executive Judgment: Opinion of a group of high level
experts or managers is pooled

Sales Force Composite: Each regional salesperson

provides his/her sales estimates. Those forecasts are then
reviewed to make sure they are realistic. All regional
forecasts are then pooled at the district and national levels
to obtain an overall forecast.

Market Research/Survey: Solicits input from customers

pertaining to their future purchasing plans. It involves the
use of questionnaires, consumer panels and tests of new
products and services.
 Qualitative Methods
Delphi Method: As opposed to regular panels where the
individuals involved are in direct communication, this method
eliminates the effects of group potential dominance of the most
vocal members. The group involves individuals from inside as
well as outside the organization. Typically, the procedure
consists of the following steps:
 Each expert in the group makes his/her own forecasts in form
of statements
 The coordinator collects all group statements and
summarizes them
 The coordinator provides this summary and gives another
set of questions to each group member including feedback
as to the input of other experts.
 The above steps are repeated until a consensus is reached.
Quantitative Forecasting Approaches

 Based on the assumption that the “forces”

that generated the past demand will generate
the future demand, i.e., history will tend to
repeat itself
 Analysis of the past demand pattern provides
a good basis for forecasting future demand
 Majority of quantitative approaches fall in the
category of time series analysis
Quantitative Forecasting Methods

Quantitative
Forecasting

Time Series Regression

Models Models

2. Moving 3. Exponential
1. Naive
Average Smoothing
a) simple a) level
b) weighted b) trend
c) seasonality
Time Series Models

 Try to predict the future based on past

data
 Assume that factors influencing the past will
continue to influence the future
 A time series is a set of numbers where the order
or sequence of the numbers is important, e.g.,
historical demand
 Analysis of the time series identifies patterns
 Once the patterns are identified, they can be used
to develop a forecast
Components of Time Series

What’s going on here?

x
x x
x x
x x
x x
x x x
Sales

xx x x
x xx x x
x
x
x x x x x x
x x x x x x
x x x
x xxxxx
x
x x

1 2 3 4
Year
Components of Time Series
 Trends are noted by an upward or
downward sloping line
 Seasonality is a data pattern that repeats
itself over the period of one year or less
 Cycle is a data pattern that repeats itself...
may take years
 Irregular variations are jumps in the level of
the series due to extraordinary events
 Random fluctuation from random variation
or unexplained causes
1. Simple Naive Approach

 Demand in next period is the same as

demand in most recent period
 May sales = 48 → June forecast = 48

 Usually not good

Moving Average: Naïve Approach

ORDERS
MONTH PER MONTH FORECAST
Jan 120

Feb 90

Mar 100

Apr 75

May 110

Nov
June -
50

July 75

Aug 130
Example: Naïve Approach
ORDERS
MONTH PER MONTH FORECAST
Jan 120 -
120
Feb 90 90
100
Mar 100 75
110
Apr 75 50
75
May 110 130
110
Nov
June -
50 90

July 75

Aug 130
Simple Moving Average

 An averaging period (AP) is selected

 Assumes an average is a good estimator of
future behavior
 It is called a “simple” average because
each period used to compute the
average is equally weighted
Simple Moving Average
 The forecast for the next period is the arithmetic
average of the AP most recent actual demands
 By increasing the AP, the forecast is less
responsive to fluctuations in demand (low
impulse response)
 By decreasing the AP, the forecast is more
responsive to fluctuations in demand (high
impulse response)
2a. Simple Moving Average

AAt t ++AAt -t1-1++AAt -t 2-2 ++...

...++AAt -t n-n11
FFt t 11 ==
nn

Ft+1 = Forecast for the upcoming period, t+1

n = Number of periods to be averaged
At = Actual occurrence in period t
 AAt ++AAt -1 ++AAt -2 ++......++AAt -n 1
FFt 1 == t t -1 t -2 t - n 1
t 1 nn
2a. Simple Moving Average

You’re manager in Amazon’s electronics

department. You want to forecast ipod sales for
months 4-6 using a 3-period moving average.
Sales
Month (000)
1 4
2 6
3 5
4 ?
5 ?
6 ?
 A + A + A + ... + A
FFt 1 == At t + At -t1-1 + At -t2-2 + ... + At -tn-n11
t 1 nn
2a. Simple Moving Average

Sales Moving Average

Month (000) (n=3)
1 4 NA
2 6 NA
3 5 NA
4 ? (4+6+5)/3=5
5 ?
6 ?
2a. Simple Moving Average

What if ipod sales were actually 3 in month 4

Sales Moving Average

Month (000) (n=3)
1 4 NA
2 6 NA
3 5 NA
4 3? 5
5 ?
6 ?
2a. Simple Moving Average

Forecast for Month 5?

Sales Moving Average

Month (000) (n=3)
1 4 NA
2 6 NA
3 5 NA
4 3 5
5 ? (6+5+3)/3=4.667
6 ?
2a. Simple Moving Average

Actual Demand for Month 5 = 7

Sales Moving Average

Month (000) (n=3)
1 4 NA
2 6 NA
3 5 NA
4 3 5
5 ?7 4.667
6 ?
2a. Simple Moving Average

Forecast for Month 6?

Sales Moving Average

Month (000) (n=3)
1 4 NA
2 6 NA
3 5 NA
4 3 5
5 7 4.667
6 ? (5+3+7)/3=5
Simple Moving Average

At-1 + At-2 + At-3 +...+At-n

Ft =
Week Demand n
1 650
2 678  Let’s develop 3-week and
3 720
4 785 6-week moving average
5 859 forecasts for demand.
6 920
7 850  Assume you only have 3
8 758 weeks and 6 weeks of
9 892
10 920
actual demand data for
11 789 the respective forecasts
12 844
Simple Moving Average

Week Demand 3-Week 6-Week

1 650
2 678
3 720
4 785 682.67
5 859 727.67
6 920 788.00
7 850 854.67 768.67
8 758 876.33 802.00
9 892 842.67 815.33
10 920 833.33 844.00
11 789 856.67 866.50
12 844 867.00 854.83
Simple Moving Average

1000
900
Demand
800
Demand

3-Week
700
6-Week
600
500
1 2 3 4 5 6 7 8 9 10 11 12
Week
Weighted Moving Average
 This is a variation on the simple moving
average where instead of the weights
used to compute the average being
equal, they are not equal
 This allows more recent demand data to
have a greater effect on the moving
average, therefore the forecast
 . . . more
Weighted Moving Average

 The weights must add to 1.0 and

generally decrease in value with the
age of the data
 The distribution of the weights
determine impulse response of the
forecast
 Weighted Moving Average
• Adjusts moving average method to more
closely reflect data fluctuations
n
WMAn =  W i Di
i=1
where
Wi = the weight for period i,
between 0 and 100
percent
 W = 1.00
i
Weighted Moving Average
Ft = w 1A t-1 + w 2 A t-2 + w 3 A t-3 +...+w n A t-n

Week Demand
1 650
Determine the 3-period
2 678 weighted moving average
3 720 forecast for period 4
4

Weights (adding up to 1.0):

n
t-1: .5
w
i=1
i =1
t-2: .3
t-3: .2
Solution

Week Demand Forecast

1 650
2 678
3 720
4 693.4

F=
4 .5(720)+.3(678)+.2(650)
Weighted Moving Average Example

MONTH WEIGHT DATA

August 17% 130
September 33% 110
October 50% 90
3
November Forecast  Wi Di
i=1
Weighted Moving Average Example

MONTH WEIGHT DATA

August 17% 130
September 33% 110
October 50% 90
3
November Forecast  Wi Di
i=1

= (0.50)(90) + (0.33)(110) + (0.17)(130)

= 103.4 orders
 Exponential Smoothing

• Averaging method
• Weights most recent data more strongly
• Reacts more to recent changes
• Widely used, accurate method
• Smoothing constant, α
• applied to most recent data
3a. Exponential Smoothing

 Assumes the most recent observations have

the highest predictive value
 gives more weight to recent time periods

FFt+1
t+1
=
= F
Ftt
+
+ (A
(Att
-
- F
F t)
t) Need
Needinitial
initial
forecast
forecastFFt
et to
t

tostart.
start.

Ft+1 = Forecast value for time t+1

At = Actual value at time t
 = Smoothing constant
3a. Exponential Smoothing – Example 1
FFt+1
t+1
=
= F
Ftt
+
+ (A
(Att
-
- F
Ft )
t)
i Ai
Week Demand
1 820 Given
Given the
the weekly
weekly demand
demand
2 775 data
data what
what are
are the
the exponential
exponential
3 680 smoothing
smoothing forecasts
forecasts for
for
4 655 periods
periods 2-10 using =0.10?
2-10 using =0.10?
5 750
6 802 Assume
Assume FF11=D
=D11
7 798
8 689
9 775
10
3a. Exponential Smoothing – Example 1
FFt+1
t+1
=
= F
Ftt
+
+ (A
(Att
-
- F
Ft )
t)
i Ai Fi
Week Demand  = 0.1 0.6
1 820 820.00 820.00
2 775 820.00 820.00
3 680 F2815.50
= F1+ (A793.00
1–F1) =820+(820–820)
4 655 801.95 725.20=820
5 750 787.26 683.08
6 802 783.53 723.23
7 798 785.38 770.49
8 689 786.64 787.00
9 775 776.88 728.20
10 776.69 756.28
3a. Exponential Smoothing – Example 1
FFt+1
t+1
=
= F
Ftt
+
+ (A
(Att
-
- F
Ft )
t)
i Ai Fi
Week Demand  = 0.1 0.6
1 820 820.00 820.00
2 775 820.00 820.00
3 680 815.50 793.00
F3 = F2+ (A2–F2) =820+(775–820)
4 655 801.95 725.20
5 750 787.26 683.08=815.5
6 802 783.53 723.23
7 798 785.38 770.49
8 689 786.64 787.00
9 775 776.88 728.20
10 776.69 756.28
3a. Exponential Smoothing – Example 1
FFt+1
t+1
=
= F
Ftt
+
+ (A
(Att
-
- F
Ft )
t)
i Ai Fi
Week Demand  = 0.1 0.6
1 820 820.00 820.00
2 775 820.00 820.00
3 680 815.50 793.00
4 655 801.95 725.20
5 750 787.26 683.08
6 802 783.53 723.23This process
7 798 785.38 770.49 continues
8 689 786.64 787.00
through week 10
9 775 776.88 728.20
10 776.69 756.28
3a. Exponential Smoothing – Example 1
FFt+1
t+1
=
= F
Ftt
+
+ (A
(Att
-
- F
Ft )
t)
i Ai Fi
Week Demand  = 0.1  = 0.6
1 820 820.00 820.00
2 775 820.00 820.00
3 680 815.50 793.00
4 655 801.95 725.20
5 750 787.26 683.08 What if the
6 802 783.53 723.23  constant
7 798 785.38 770.49 equals 0.6
8 689 786.64 787.00
9 775 776.88 728.20
10 776.69 756.28
3a. Exponential Smoothing – Example 2
FFt+1
t+1
=
= F
Ftt
+
+ (A
(Att
-
- F
Ft )
t)
i Ai Fi
Month Demand  = 0.3  = 0.6
January 120 100.00 100.00
February 90 106.00 112.00
March 101 101.20 98.80
April 91 101.14 100.12
May 115 98.10 94.65 What if the
June 83 103.17 106.86  constant
July 97.12 92.54 equals 0.6
August
September
 3a. Exponential Smoothing – Example 3

Company
Company A, A, aa personal
personal computer
computer producer
producer
purchases
purchases generic
generic parts
parts and
and assembles
assembles themthem toto
final
final product.
product. Even
Even though
though mostmost ofof the
the orders
orders
require
require customization,
customization, they
they have
have many
many common
common
components.
components. Thus,
Thus, managers
managers of of Company
Company A A need
need
aa good
good forecast
forecast ofof demand
demand so so that
that they
they can
can
purchase
purchase computer
computer parts
parts accordingly
accordingly to to minimize
minimize
inventory
inventory cost
cost while
while meeting
meeting acceptable
acceptable service
service
level.
level. Demand
Demand datadata for
for its
its computers
computers for for the
the past
past 55
months
months isis given
given in
in the
the following table..
following table
3a. Exponential Smoothing – Example 3
FFt+1
t+1
=
= F
Ftt
+
+ (A
(Att
-
- F
Ft )
t)
i Ai Fi
Month Demand  = 0.3  = 0.5
January 80 84.00 84.00
February 84 82.80 82.00
March 82 83.16 83.00
April 85 82.81 82.50
May 89 83.47 83.75 What if the
June 85.13 86.38  constant
July ?? ?? equals 0.5
To Use a Forecasting Method

 Collect historical data

 Select a model
 Moving average methods
 Select n (number of periods)
 For weighted moving average: select weights
 Exponential smoothing
 Select 

 Selections should produce a good forecast

…but what is a good forecast?
A Good Forecast

 Has a small error

 Error = Demand - Forecast
Measures of Forecast Error
et
nn

a. MAD = Mean Absolute Deviation 

 AA --FF
t=1
tt tt
MAD
MAD== t=1
nn

nn

b. MSE = Mean Squared Error   A - F 

  At t - Ft t 
22

t =1
MSE
MSE== t =1
nn

c. RMSE = Root Mean Squared Error RMSE

RMSE == MSE
MSE

 Ideal values =0 (i.e., no forecasting error)

Mean Absolute Deviation (MAD)

 Actual demand - Forecast demand

i =1
i

MAD =
n
nn

 (A
(A -- FF ))
ii ii

MAD 
MAD ii11
nn
 nn

MAD Example 
 AA --FF
t=1
tt tt = 40 =10
MAD
MAD== t=1 4
nn

What
What isis the
the MAD
MAD value
value given
given the
the
forecast
forecast values
values in
in the
the table
table below?
below?
At Ft
Month Sales Forecast |At – Ft|
1 220 n/a
2 250 255 5
3 210 205 5
4 300 320 20
5 325 315 10
= 40
 MAD Example

PERIOD DEMAND, At Ft ( =0.3) (At - Ft) |At - Ft|

1 37 37.00 – –
2 40 37.00 3.00 3.00
3 41 37.90 3.10 3.10
4 37 38.83 -1.83 1.83
5 45 38.28 6.72 6.72
6 50 40.29 9.69 9.69
7 43 43.20 -0.20 0.20
8 47 43.14 3.86 3.86
9 56 44.30 11.70 11.70
10 52 47.81 4.19 4.19
11 55 49.06 5.94 5.94
12 54 50.84 3.15 3.15
557 49.31 53.39
MAD Calculation

 At - Ft 
MAD = n
53.39
=
11
= 4.85
 nn

  A - F 
  At t - Ft t 
22

= 550 =137.5
MSE/RMSE Example MSE =
MSE =
t =t =11

nn 4

What
What isis the
the MSE
MSE value?
value? RMSE = √137.5
=11.73
At Ft
Month Sales Forecast |At – Ft| (At – Ft)2
1 220 n/a
2 250 255 5 25
3 210 205 5 25
4 300 320 20 400
5 325 315 10 100
= 550
Quantitative Forecasting Methods

Quantitative
Forecasting

Time Series Regression

Models Models

2. Moving 3. Exponential
1. Naive
Average Smoothing
a) simple a) level
b) weighted b) trend
c) seasonality
Regression Methods
 Linear regression
 mathematical technique that relates a
dependent variable to an independent
variable in the form of a linear equation
 Correlation
 a measure of the strength of the relationship
between independent and dependent
variables
Simple Linear Regression

 Relationship between one independent

variable, X, and a dependent variable, Y.
 Assumed to be linear (a straight line)
 Form: Y = a + bX
 Y = dependent variable
 X = independent variable
 a = y-axis intercept
 b = slope of regression line
Simple Linear Regression Model

Yt = a + bx Y

0 1 2 3 4 5 x (weeks)

 b is similar to the slope. However, since it

is calculated with the variability of the data
in mind, its formulation is not as straight-
forward as our usual notion of slope
Calculating a and b

a = y - bx

 xy - n(y)(x)
b= 2 2
 x - n(x )
Regression Equation Example

Week Sales
1 150
2 157
3 162
4 166
5 177

Develop a regression equation to predict sales

based on these five points.
 Regression Equation Example
Week Week*Week Sales Week*Sales
1 1 150 150
2 4 157 314
3 9 162 486
4 16 166 664
5 25 177 885
3 55 162.4 2499
Average Sum Average Sum

b=
 xy - n( y)(x) 2499 - 5(162.4)(3) 63
=  = 6.3
 x - n(x )
2 2
55  5(9 ) 10

a = y - bx = 162.4 - (6.3)(3) = 143.5 Slide 70 of 55

 Regression Equation Example

y = 143.5 + 6.3t
180
175
170
165
160 Sales
Sales

155 Forecast
150
145
140
135
1 2 3 4 5 Period
Slide 71 of 55
Linear Regression Example
x y
(WINS) (ATTENDANCE) xy x2
4 36.3
6 40.1
6 41.2
8 53.0
6 44.0
7 45.6
5 39.0
7 47.5
Linear Regression Example

x=

y=

xy - nxy2
b=
x2 - nx2

a = y - bx
Linear Regression Example
x y
(WINS) (ATTENDANCE) xy x2
4 36.3 145.2 16
6 40.1 240.6 36
6 41.2 247.2 36
8 53.0 424.0 64
6 44.0 264.0 36
7 45.6 319.2 49
5 39.0 195.0 25
7 47.5 332.5 49
49 346.7 2167.7 311
Linear Regression Example

49
x= = 6.125
8
346.9
y= = 43.36
8

xy - nxy2
b=
x2 - nx2
(2,167.7) - (8)(6.125)(43.36)
=
(311) - (8)(6.125)2
= 4.06

a = y - bx
= 43.36 - (4.06)(6.125)
= 18.46
Linear Regression Example
60,000 –

50,000 –

40,000 –
Attendance, y

Linear regression line,

30,000 – y = 18.46 + 4.06x
Attendance forecast for 7 wins
20,000 –
y = 18.46 + 4.06(7)
= 46.88, or 46,880
10,000 –

| | | | | | | | | | |
0 1 2 3 4 5 6 7 8 9 10
Wins, x
Regression – Example
yy == aa++ bb X
X b
 xy  n x y a  y  bx
 x  nx
2 2

MonthAdvertising Sales X 2 XY
January 3 1 9.00 3.00
February 4 2 16.00 8.00
March 2 1 4.00 2.00
April 5 3 25.00 15.00
May 4 2 16.00 8.00
June 2 1 4.00 2.00
July

TOTAL 20 10 74 38
Linear Regression Example
x y
(WINS) (ATTENDANCE) xy x2
4 36.3 145.2 16
6 40.1 240.6 36
6 41.2 247.2 36
8 53.0 424.0 64
6 44.0 264.0 36
7 45.6 319.2 49
5 39.0 195.0 25
7 47.5 332.5 49
49 346.7 2167.7 311
Linear Regression Example

49
x= = 6.125
8
346.9
y= = 43.36
8

xy - nxy2
b=
x2 - nx2
(2,167.7) - (8)(6.125)(43.36)
=
(311) - (8)(6.125)2
= 4.06

a = y - bx
= 43.36 - (4.06)(6.125)
= 18.46