3-1 Forecasting

Chapter 3

Forecasting

Operations Management, Seventh Edition, by William J. Stevenson

McGraw-Hill/Irwin Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
3-2 Forecasting

FORECAST:
• A statement about the future

• Used to help managers

– Plan the system
– Plan the use of the system

Operations Management, Seventh Edition, by William J. Stevenson

McGraw-Hill/Irwin Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
3-3 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

Operations Management, Seventh Edition, by William J. Stevenson

McGraw-Hill/Irwin Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
3-4 Forecasting

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

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.
3-5 Forecasting

Elements of a Good Forecast

Timely

e
it v
c
ff e
Reliable Accurate t e
s
Co
l s e
fu u
i ng Written y
to
n s
ea Ea
M

Operations Management, Seventh Edition, by William J. Stevenson

McGraw-Hill/Irwin Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
3-6 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

McGraw-Hill/Irwin Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
3-7 Forecasting

Types of Forecasts
• Judgmental - uses subjective inputs (qualitative)
• Time series - uses historical data assuming the
future will be like the past (quantitative)
• Associative models - uses explanatory variables
to predict the future

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

Judgmental Forecasts
(Qualitative)
• Consumer surveys
• Delphi method
• Executive opinions
– Opinions of managers and staff

• Sales force.

Operations Management, Seventh Edition, by William J. Stevenson

McGraw-Hill/Irwin Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
3-9 Forecasting

Time Series Forecasts

(Quantitative)
• Trend - long-term movement in data
• Seasonality - 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

McGraw-Hill/Irwin Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
3-10 Forecasting

Forecast Variations
Figure 3-1

Irregular
variation

Trend

cycle
Cycles

90
89
88
Seasonal variations

Operations Management, Seventh Edition, by William J. Stevenson

McGraw-Hill/Irwin Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
3-11 Forecasting

The Forecast of Forecasts

• Naïve
• Simple Moving Average
• Weighted Moving Average
• Exponential Smoothing
• ES with Trend and Seasonality

Operations Management, Seventh Edition, by William J. Stevenson

McGraw-Hill/Irwin Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
3-12 Forecasting

Naïve Forecast
• Simple to use
• Virtually no cost
• Data analysis is nonexistent
• Easily understandable
• Cannot provide high accuracy

Operations Management, Seventh Edition, by William J. Stevenson

McGraw-Hill/Irwin Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
3-13 Forecasting

NAÏVE METHOD
• No smoothing of data

Period 1 2 3 4 5 6 7 8 Average
Demand 74 86 88
Forecast 98 90
change 12 2

Operations Management, Seventh Edition, by William J. Stevenson

McGraw-Hill/Irwin Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
3-14 Forecasting

Techniques for Averaging

• Moving average
• Weighted moving average
• Exponential smoothing

Operations Management, Seventh Edition, by William J. Stevenson

McGraw-Hill/Irwin Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
3-15 Forecasting

Simple Moving Average

• Smoothes out randomness by averaging positive and
negative random elements over several periods
• 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

Operations Management, Seventh Edition, by William J. Stevenson

McGraw-Hill/Irwin Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
3-16 Forecasting

Points to Know on Moving Averages

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

…. Weighted Moving Average

Operations Management, Seventh Edition, by William J. Stevenson

McGraw-Hill/Irwin Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
3-17 Forecasting

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
i – weight applied to period t-i+1

t
Ft 1    t  i 1 A i 1 2 3
i  t  n 1 Alpha 0.6 0.3 0.1

Period 1 2 3 4 5 6 7 8 Average
Demand 46 48 47 23 40
Forecast 32.70 35.60

Operations Management, Seventh Edition, by William J. Stevenson

McGraw-Hill/Irwin Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
3-18 Forecasting

Exponential Smoothing
• Simpler equation, equivalent to WMA
  – exponential smoothing parameter (0< 

• 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

Operations Management, Seventh Edition, by William J. Stevenson

McGraw-Hill/Irwin Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
3-19 Forecasting

Exponential Smoothing (α=0.30)

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

2 Feb 40
F3 =37+ (0.30)(40-37)

3 Mar 41 = 37.9

4 Apr 37

5 May 45

6 Jun 50
Operations Management, Seventh Edition, by William J. Stevenson
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3-20 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

Operations Management, Seventh Edition, by William J. Stevenson

McGraw-Hill/Irwin Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
3-21 Forecasting

Adjusted Exponential Smoothing

AFt +1 = Ft +1 + Tt +1
where
T = an exponentially smoothed trend factor

Tt +1 = (Ft +1 - Ft) + (1 - ) Tt
where
Tt = the last period trend factor
= a smoothing constant for trend

Operations Management, Seventh Edition, by William J. Stevenson

McGraw-Hill/Irwin Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
 3-22 Forecasting

Adjusted Exponential Smoothing

(β=0.30)

T3 = (F3 - F2) + (1 - ) T2
PERIOD MONTH
= (0.30)(38.5 - 37.0) + (0.70)(0)
DEMAND
= 0.45
1 Jan 37
AF3 = F3 + T3 = 38.5 + 0.45
2 Feb 40 = 38.95

3 Mar 41 T13 = (F13 - F12) + (1 - ) T12

= (0.30)(53.61 - 53.21) + (0.70)(1.77)
4 Apr 37
= 1.36
5 May 45
AF13 = F13 + T13 = 53.61 + 1.36 = 54.96
6 Jun 50
Operations Management, Seventh Edition, by William J. Stevenson
McGraw-Hill/Irwin Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
3-23 Forecasting

Adjusted Exponential Smoothing:

Example
FORECAST TREND ADJUSTED
PERIOD MONTH DEMAND Ft +1 Tt +1 FORECAST AFt +1

1 Jan 37 37.00 – –
2 Feb 40 37.00 0.00 37.00
3 Mar 41 38.50 0.45 38.95
4 Apr 37 39.75 0.69 40.44
5 May 45 38.37 0.07 38.44
6 Jun 50 38.37 0.07 38.44
7 Jul 43 45.84 1.97 47.82
8 Aug 47 44.42 0.95 45.37
9 Sep 56 45.71 1.05 46.76
10 Oct 52 50.85 2.28 58.13
11 Nov 55 51.42 1.76 53.19
12 Dec 54 53.21 1.77 54.98
13 Jan – 53.61 1.36 54.96
Operations Management, Seventh Edition, by William J. Stevenson
McGraw-Hill/Irwin Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
3-24 Forecasting

Linear Trend Equation

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

Operations Management, Seventh Edition, by William J. Stevenson

McGraw-Hill/Irwin Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
3-25 Forecasting

Calculating a and b

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

 y - b t
a =
n

Yes… Linear Regression!!

Operations Management, Seventh Edition, by William J. Stevenson
McGraw-Hill/Irwin Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
3-26 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

Operations Management, Seventh Edition, by William J. Stevenson

McGraw-Hill/Irwin Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
3-27 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
Operations Management, Seventh Edition, by William J. Stevenson
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3-28 Forecasting

Disadvantage of simple linear regression

1-apply only to linear relationship with an

independent variable.
2-one needs a considerable amount of data to
establish the relationship ( at least 20).
3-all observations are weighted equally

Operations Management, Seventh Edition, by William J. Stevenson

McGraw-Hill/Irwin Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
3-29 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

Operations Management, Seventh Edition, by William J. Stevenson

McGraw-Hill/Irwin Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
3-30 Forecasting

Mean Absolute Deviation (MAD)

 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
Operations Management, Seventh Edition, by William J. Stevenson
McGraw-Hill/Irwin Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
3-31 Forecasting

MAD Example
PERIOD DEMAND, At Ft ( =0.3) ( A t - Ft ) | A t - Ft |
1 37 37.00 – –
2 40 37.00 3.00 3.00
3 41 37.90 3.10 3.10
4 37
 - Ft 
 t38.83
A -1.83 1.83
5 MAD
45 = n38.28 6.72 6.72
6 50 40.29 9.69 9.69
7 43 53.3943.20 -0.20 0.20
=
8 47 1143.14 3.86 3.86
9 56 44.30 11.70 11.70
10 52 = 4.85 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

Operations Management, Seventh Edition, by William J. Stevenson

McGraw-Hill/Irwin Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
3-32 Forecasting

Other Accuracy Measures

Mean absolute percent deviation (MAPD)

|At - Ft|
MAPD =
At
Cumulative error
E = et
Average error
et
(E )=
n
Operations Management, Seventh Edition, by William J. Stevenson
McGraw-Hill/Irwin Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
3-33 Forecasting

Comparison of Forecasts

FORECAST MAD MAPD E (E)

Exponential smoothing (= 0.30) 4.85 9.6% 49.31 4.48
Exponential smoothing (= 0.50) 4.04 8.5% 33.21 3.02
Adjusted exponential smoothing 3.81 7.5% 21.14 1.92
(= 0.50, = 0.30)

Operations Management, Seventh Edition, by William J. Stevenson

McGraw-Hill/Irwin Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
3-34 Forecasting

Forecast Control

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

Operations Management, Seventh Edition, by William J. Stevenson

McGraw-Hill/Irwin Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
3-35 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
Tracking 6.72 for period
signal 10.99 3 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
6.10
43.14TS = 3.86
8 47
3 = 24.34
2.00 4.06 6.00
9 56 44.30 3.05 36.04
11.70 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
12 54 50.84 3.15 49.32 4.85 10.17

Operations Management, Seventh Edition, by William J. Stevenson

McGraw-Hill/Irwin Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
3-36 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.

Operations Management, Seventh Edition, by William J. Stevenson

McGraw-Hill/Irwin Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
3-37 Forecasting

End Notes

• The two most important factors in choosing

a forecasting technique:
– Cost
– Accuracy
• Keep it SIMPLE!
• =FORECAST(70,{23,34,12},{67,76,56})
(if you can…let the computer do it)

Operations Management, Seventh Edition, by William J. Stevenson

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