Chapter

3-1 Forecasting

Four
Forecasting
By: Mr. Wendwesen Siyum
Operations Management, Seventh Edition, by William J. Stevenson
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3-2 Forecasting

Chapter Objectives
At the end of this chapter you will
be able to:
• Identify principles of forecasting.
• Explain the steps involved in the
forecasting process.
• Identify types of forecasting methods and
their characteristics.
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3-3 Forecasting

• Forecasting is estimating the future demand for products

and the resources necessary to produce these outputs.
• Sales forecasts are the starting point for all other forecasts
• It becomes an input of both business strategy and
production strategy.
• It is an integral part of planning.

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3-4 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

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3-5 Forecasting

Why forecasting?

 New facility planning /build new factory or design

important new production process.
 Production planning /demands vary form month to month.
 Work force scheduling/ demand vary from week to week.

Operations Management, Seventh Edition, by William J. Stevenson

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3-6 Forecasting

Features of Good Forecasting

The forecast horizon must cover the sufficient time
necessary to implement possible changes.
The degree of accuracy should be stated.
The forecast should be reliable: it should work
consistently.
The forecast should be expressed in meaningful units.
The forecast should presented in writing.
The forecast should be simple to understand and use, or
consistent with historical data intuitively.
Operations Management, Seventh Edition, by William J. Stevenson
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3-7 Forecasting

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

Operations Management, Seventh Edition, by William J. Stevenson

McGraw-Hill/Irwin Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
3-8 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
Operations Management, Seventh Edition, by William J. Stevenson
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3-9 Forecasting

Types of Forecasts
 Qualitative and Quantitative
i. Qualitative methods :consist mainly of subjective inputs.
 It based on Judgmental of forecaster.

ii. Quantitative approaches

 Forecasts generated through mathematical modeling.
• Involves either Time series or Associative models
 Time series - uses historical data assuming the future will
be like the past .
 Associative models - uses explanatory variables to predict
the future.

Operations Management, Seventh Edition, by William J. Stevenson

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3-10 Forecasting

I.Qualitative(Judgmental Forecasts)
• Consumer surveys=asking preference.
• Delphi method= used to develop consumers of expert
opinion.
• Executive opinions
– Opinions of managers and staff
• Sales force.
 The sales staff is often a good source of information because
of its direct contact with customers and experience.
• Jury of executive opinions
 A small group of upper-level managers may meet and
collectively develop a forecast
 Relatively quick
 ‘Group-think
Operations Management, Seventh Edition, by William J. Stevenson
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3-11 Forecasting

II. Quantitative approaches

1.Time series forecasts
• Is a technique that uses a series of past data points to make
a forecast.
• It is a time ordered sequence of observations taken at a
regular interval over a period of time. (e.g. Hourly,
weekly, monthly, quarterly or annually).
• This technique requires analysts to identify the underlying
behavior of the series.

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3-12 Forecasting

Time Series Forecasts…..

The time series typically has five components
• Trend: refers to a gradual, long-term upward or
downward movement in data.
• Seasonality: variation- 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.

Operations Management, Seventh Edition, by William J. Stevenson

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3-13 Forecasting

Forecast Variations
Figure 3-1

Irregular
variation

Trend

cycle
Cycles

90
89
88
Seasonal variations

Operations Management, Seventh Edition, by William J. Stevenson

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3-14 Forecasting

Types of Quantitative Forecasts

• Naïve
• Simple Moving Average
• Weighted Moving Average
• Exponential Smoothing
• Linear Regression

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3-15 Forecasting

a. Naïve Forecast
• It assumes demand in the next period is equal to demand in
the most recent period. i.e., the forecast for any period
equals the previous period's actual value.

Yt = Yt-1 where: Yt = forecast at time t

Yt-1 = actual data at time t

Example: If last week demand was 100 units, the naïve

forecast for the upcoming week is 100 units.

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3-16 Forecasting

Naïve Forecast…

Its Features
 Simple to use.
 Virtually no cost.
 Data analysis is non existent.
 Easily understandable.
 Cannot provide high accuracy.

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3-17 Forecasting

b. Simple Moving Average

• A moving average uses a number of the most recent actual
data values in generating a forecast.
• Smoothes out randomness by averaging positive and
negative random elements over several periods.
• The moving average (MA) forecast can be computed using
the following equation: (simple moving average)
n

 Yi
MAn  i 1
n
• where: i = refers to the most recent period (i = 1, 2, 3, …, n)
n = number of periods in the moving average
yi = actual value with period i
MAn = moving average of the most recent n actual forecast

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3-18 Forecasting

Moving Average
Eg1.n - number of periods (this example uses 4)
Period 1 2 3 4 5 6 7
Demand 74 90 100 60 80 90
Forecast 81 82.5 82.5

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3-19 Forecasting

Moving Average…

Eg2 . 1.Compute a three period moving average forecast

for period six given demand for shipping a product for
the last five periods. (Class work)
Period Age Demand
1 5 42
2 4 40
3 3 43
4 2 40
5 1 41

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3-20 Forecasting

…
Solution
MA3 = (41 + 40 + 43)/3 = 41.33

2. If actual demand in period 6 turns out to

be 39, the moving average forecast for
period 7 would be:
MA3 = ?

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3-21 Forecasting

Moving Average…

• MA3 =
39  41  40
 40
3

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3-22 Forecasting

Points to Know on Moving Averages

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

…. Weighted Moving Average

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3-23 Forecasting

c. 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
ai – weight applied to period t-i+1
t
Ft 1    t  i 1 A i
i  t  n 1

  weights for period n  (demand in period n)

 weights

Operations Management, Seventh Edition, by William J. Stevenson

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3-24 Forecasting

Weighted Moving Average…

• You are given the following data:

– Compute a weighted average forecast using a weight of
0.40 for the most recent period, 0.30 for the next most
recent, 0.20 for the next, and 0.10 for the next.
Period 1 2 3 4 5
Demand 42 40 45 40 41

Solution ?

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3-25 Forecasting

Weighted Moving Average …

Forecast = 0.4 x 41 + 0.3 x 40 + 0.2 x 45 + 0.1(40)
= 41
• If the actual demand for period 6 is 39, forecast demand
for period 7 using the same weights as in above
• WMA=?

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3-26 Forecasting

d. Exponential Smoothing
• Simpler equation, equivalent to WMA
a – exponential smoothing parameter (0< a <1)

• Ft  Ft 1   ( At 1  Ft 1 )
 0.1

Period 1 2 3 4 5 6 7 8 Average
Demand 74 90 100 60
Forecast 72

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3-27 Forecasting

Exponential Smoothing…
• SOLUTION

•
Ft  Ft 1   ( At 1  Ft 1 )
 0.1

Period 1 2 3 4 5 6 7 8 Average
Demand 74 90 100 60
Forecast 72 72.2 73.98

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3-28 Forecasting

Exponential Smoothing (α=0.30)

Ft  Ft 1   ( At 1  Ft 1 )
PERIOD MONTH
DEMAND F2 = 37 + (0.30)(37-37)
1 Jan 37 = 37

2 Feb 40
F3 =37+ (0.30)(40-37)
3 Mar 41
= 37.9
4 Apr 37

5 May 45

6 Jun 50

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3-29 Forecasting

Exponential Smoothing (cont.)

FORECAST, Ft + 1
PERIOD MONTH DEMAND ( = 0.3) ( = 0.5)
1 Jan 37 – –
2 Feb 40 37.00 37.00
3 Mar 41 37.90 38.50
4 Apr 37 38.83 39.75
5 May 45 38.28 38.37
6 Jun 50 40.29 41.68
7 Jul 43 43.20 45.84
8 Aug 47 43.14 44.42
9 Sep 56 44.30 45.71
10 Oct 52 47.81 50.85
11 Nov 55 49.06 51.42
12 Dec 54 50.84 53.21
13 Jan – 51.79 53.61

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3-30 Forecasting

e. Linear Trend Equation

Yt = a + bt
a
0 1 2 3 4 5 t
• b is the line slope.

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3-31 Forecasting

Calculating a & b

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

 y - b t
a =
n

Yes… Linear Regression!!

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3-32 Forecasting

Example1. if the sale per week of CA company

are as below
t y
Week Sales
1 150
2 157
3 162
4 166
5 177

1.Develop Linear Regression Equation

2. what is sale volume at 7th week?

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3-33 Forecasting

Linear Trend Equation Example

t y
Week t2 Sales ty
1 1 150 150
2 4 157 314
3 9 162 486
4 16 166 664
5 25 177 885

 t = 15 t2 = 55  y = 812  ty = 2499

(t)2 = 225

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3-34 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
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3-35 Forecasting

Disadvantage of simple linear regression

1. apply only to linear relationship with only

one independent variable.
2. one needs a considerable amount of data to
establish the relationship ( at least 2).
3. all observations are weighted equally.

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3-36 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

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3-37 Forecasting

Mean Absolute Deviation (MAD)

S At - Ft 
MAD = n
where
t = period number
At = demand in period t
Ft = forecast for period t
n = total number of periods
 = absolute value
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3-38 Forecasting

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 MAD
11 55 49.06 5.94 5.94
12 54 50.84 3.15 3.15
=
557 49.31 53.39

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3-39 Forecasting

Other Accuracy Measures

Mean absolute percent deviation (MAPD)

|At - Ft|
MAPD =
At
Cumulative error
E = et
Average error
et
(E )=
n
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3-40 Forecasting

Forecast Control

• Tracking signal
– monitors the forecast to see if it is biased high
or low.
(At - Ft) E
Tracking signal = =
MAD MAD

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3-41 Forecasting

Tracking Signal Values

DEMAND FORECAST, ERROR E = TRACKING
PERIOD At Ft At - Ft (At - Ft) MAD SIGNAL

1 37 37.00 – – – –
2 40 37.00 3.00 3.00 3.00 1.00
3 41 37.90 3.10 6.10 3.05 2.00
4 37 38.83 -1.83 4.27 2.64 1.62
5 45 38.28 6.72 10.99 3.66 3.00
6 50 40.29 9.69 20.68 4.87 4.25
7 43 43.20 -0.20 20.48 4.09 5.01
8 47 43.14 3.86 24.34 4.06 6.00 Trackin
9 56 44.30 11.70 36.04 5.01 7.19
10 52 47.81 4.19 40.23 4.92 8.18
11 55 49.06 5.94 46.17 5.02 9.20 TS
12 54 50.84 3.15 49.32 4.85 10.17

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3-42 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.

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3-43 Forecasting

End Notes

• The two most important factors in choosing

a forecasting technique:
– Cost
– Accuracy
• Keep it SIMPLE!

Operations Management, Seventh Edition, by William J. Stevenson

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3-44 Forecasting

Ch-3 end!

Thank you !

Operations Management, Seventh Edition, by William J. Stevenson

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