Forecasting for Production

Judgmental approach, Delphi Technique, Econometric

Forecasting Methods, Market Survey Regressions Time
series- Moving Average, weighted Moving Average,
Trend adjustments & Projection
What is Forecasting?

FORECAST:
A statement about the future value of a variable of interest
such as demand.
Forecasts affect decisions and activities throughout an
organization
Accounting, finance
Human resources
Marketing
MIS
Operations
Product / service design
What is forecasting
Forecasting is use of past data to determine future
events
It is an objective computation
How forecast is different from prediction?
Prediction is an estimate of a future event achieved
through subjective considerations (Managers
experience etc)
In OM forecasting is mainly used to predict about the
demand for products / services
Uses of Forecasts

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, MRP, workloads

Product/service design New products and services

Costs of Forecasting
IBM continues to struggle with shortages in the Think Pad
line.
 IBM sells out new Aptiva PC. Shortage may cost millions.
Dell stock plunges. Dell was sharply off in its forecast of
demand.
Earnings decline is consequence of [unanticipated] excess
inventories.
Toyota believes it can save $100M/3a [with] accurate
ordering and inventory management. “It’s unbelievable the
number of (after market) parts that are thrown away each
year.”
Common in all forecasts
Assumes causal system
past ==> future
Forecasts rarely perfect because of randomness
Forecasts more accurate for
groups vs. individuals
Forecast accuracy decreases
as time horizon increases
I see that you will
get an A this semester.
Elements of a Good Forecast

Timely

Reliable Accurate

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fu u
n g Written to
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Steps in the Forecasting Process

“The forecast”

Step 6 Monitor the forecast

Step 5 Prepare 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
Forecasting Models
Model Differences
Qualitative – incorporates judgmental & subjective
factors into forecast.

Time-Series – attempts to predict the future by using

historical data.

Causal – incorporates factors that may influence the

quantity being forecasted into the model
Classification
Depending on the time horizon forecasting can be
classified as :
Short range forecasting : up to 1 year
Medium range : up to 3 years
Long range : more than 3 years
Types of forecasts
Economic forecasts : Inflations rates, money supplies,
housing starts & other planning indicators
Demand forecasts : demand for a company’s products /
services. Sometimes called as sales forecasts.
drive a company’s production, capacity, and scheduling systems
serve as inputs to financial, marketing, and personnel planning
Technological forecasts :are concerned with rates of
technological progress, which can result in the birth of
exciting new products, requiring new plants and equipment.
Why forecasting is important?
Planning:
Whether to go for continuous flow High demand
forecasted
Whether to go for intermittent flow Smaller demand
forecasted
Why forecasting is important?
Scheduling
Best use of existing conversion system
3 month, 6 month / 1 year forecasts facilitate to schedule
jobs
Scheduling of work force levels & production rates
Controlling
Control over inventory, production, labor & over all costs
Time series analysis
Used when a manager wants to systematically analyze
historical data for forecasting
How to do time series analysis
Plot demand data on a time scale
Study the plots
Look for consistent shapes or patterns
Might find a constant, trend or seasonal pattern
Demand patterns

LINEAR TREND
PRODUCTION

SEASONAL /
DEMAND

CYCLICAL

CONSTANT

TIME
Forecast Variations

Irregular
variation

Trend

Cycles

90
89
88
Seasonal variations
Noise in demand
Even after finding a demand pattern not all points will
fall on pattern
These points tend to cluster around the pattern
Low noise : most of the points lie close to the pattern
High noise : points lie relatively far away from pattern
Definitions
Time series analysis : In forecasting problems, analysis
of demand data plotted on a time scale to reveal
patterns of demand
Demand pattern : General shape of a time series:
usually constant, trend, seasonal or some combination
of these shapes
Demand stability : Tendency of a time series to retain
the same general pattern over time
Noise : Dispersion of demand about a demand pattern
Dependant Vs Independent demand
Demand for a product / service is termed independent
when it occurs independently for any other product or
service
Demand of bicycles & foot wear
If demand for an item can be linked to the demand for
another item then it is dependant demand
Demand for bicycles & riding helmet
Forecast error
Numeric difference of forecasted demand and actual
demand
2 Methods of measuring forecast error
MAD : Mean absolute deviation
Bias
MAD ( Mean Absolute Deviation)
Sum of the absolute value of forecast error for all periods
MAD =
n
Number of periods
MAD = ∑ forecast error
i=1 n
MAD example
Forecasted demand for june, july & august is 500 pc
each, actual demand is 400,560 & 700
MAD = 500-400 +500-560 + 500-700
3
= (100+60+200) /3
=120
Bias
Considers direction
Bias = sum of core cast errors for all periods divided by
number of periods
Forecasted demand for june, july & august is 500 pc
each, actual demand is 400,560 & 700
Bias = (500-400) +(500-560) + (500-700) / 3

= (100-60-200) /3
= - 53
Some forecasting methods
Delphi technique
Nominal group technique
Simple average
Simple moving average
Weighted moving average
Exponential smoothing
Linear regression
Correlation
Delphi technique
Qualitative model
Group process intended to achieve a consensus forecast
A panel of experts either within or without the organization provide
written comments on the point in question
Procedure
Coordinator poses a question in writing to each expert on a panel, each expert
writes a brief prediction
The coordinator brings the written predictions together edits them and
summarizes them
On the basis of the summary, the coordinator writes a new set of questions
and gives them to experts. These are answered in writing
Again edit & summarize
Process repeated till coordinator is satisfied with over all prediction
synthesized from the experts
Nominal Group Technique
Same like Delphi
But here experts are allowed to discuss
Process
Experts sit around a table
Facilitator hands out copies of question needing forecast
Each expert lists down his ideas regarding the question
Each expert is asked to state one idea from his list
Recorder writes the ideas in a flip chart
Round robin until all ideas are written in flip chart
No discussion happened yet
Next phase of meeting
Discuss ideas presented
Similar ideas are combines
Experts are asked to rank the ideas, in writing according to priority
Group consensus is the mathematically derived outcome of the individual rankings
Simple average
Quantitative
Average of all demands occurring in all previous
periods
SA = (sum of demands for all periods) /
number of periods
Simple moving average
Average of demands occurring in several of the most
recent periods
Most recent periods are added up and older ones
dropped to keep calculations current
Once the number of past periods to be used is
selected, it is held constant
Moving Averages
Moving average – A technique that averages a
number of recent actual values, updated as new
values become available. n
 A i
MAn = i=1

n
The demand for tires in a tire store in the past 5
weeks were as follows. Compute a three-period
moving average forecast for demand in week 6.
83 80 85 90 94
Moving average & Actual demand
Weighted moving average
All periods are not equally weighted
WMA = each periods demand times a weight summed
over all periods in the moving average
n


n = i=1
CiDi

0 < Ci <1
Moving Averages
Weighted moving average – More recent values in
a series are given more weight in computing the
forecast.

Example:
For the previous demand data, compute a
weighted average forecast using a weight of .40 for
the most recent period, .30 for the next most
recent, .20 for the next and .10 for the next.
If the actual demand for week 6 is 91, forecast
demand for week 7 using the same weights.
Exponential smoothing
An averaging methods that exponentially decreases
the weighing of old demands
First order exponential smoothing & double
exponential smoothing
First order Exponential Smoothing

Ft =  Dt-1 + ( 1-)Ft-1
0 <  < 1 , t is the period
Regression
A causal forecasting model in which , from historical
data a functional relationship is established between
variables and then used to forecast dependent variable
values.
Techniques for Trend
 Develop an equation that will suitably describe trend,
when trend is present.

 The trend component may be linear or nonlinear

 We focus on linear trends

Common Nonlinear Trends

Parabolic

Exponential

Growth
Linear Trend Equation

Ft

Ft = a + bt

F = Forecast for period t 0 1 2 3 4 5 t

t
t = Specified number of time periods
a = Value of F at t = 0
t
b = Slope of the line

Example: F =10+2t. Interpret 10 and 2. Plot F

t
Linear Regression
Suppose that J&T has a new product First-Year
called “AppleGlo”, which is a AppleGlo Advertising First-Year
Expenditures Sales
household cleaner. This new product ($ m illions) ($ m illions)
has been introduced into 14 sales Region x y
M aine 1.8 104
regions over the last two years. The N ew H ampshire 1.2 68
Advertising expenditure vs. the first Verm ont 0.4 39
year sales are shown in the table for M assachusetts 0.5 43
Connecticut 2.5 127
each region. The company is Rhode Island 2.5 134
considering introducing AppleGlo into N ew York 1.5 87
N ew Jersey 1.2 77
two new regions, with the advertising Pennsylvania 1.6 102
campaign of $2.0 and $1.5 million. Delaware 1.0 65
M aryland 1.5 101
W est Virginia 0.7 46
Virginia 1.0 52
The company would like to predict Ohio 0.8 33
what the expected first year sales of
AppleGlo would be in each region.
Simple Linear Regression
Simple linear regression analysis analyzes the
linear relationship that exists between two
variables.

y  a  bx
where:
y = Value of the dependent variable
x = Value of the independent variable
 Simple Linear Regression
The coefficients of the line are

n xy   x  y
b
n x  ( x )
2 2

or
a
 y  b x
n
a  y  bx
Correlation

The correlation coefficient is a quantitative

measure of the strength of the linear
relationship between two variables. The
correlation ranges from + 1.0 to - 1.0. A
correlation of  1.0 indicates a perfect linear
relationship, whereas a correlation of 0
indicates no linear relationship.
An algebraic formula for correlation coefficient

n xy   x y
r
[n( x )  ( x) ][n( y )  ( y) ]
2 2 2 2
Econometric model
The Main difference between time series and
econometric model is
Time Series – Only time was taken as an independent
variable
Econometric model – All economic and demographic
variables which influence forecasting variables are
taken as independent variables.
3 Stages of Econometric Model
1. Identification of variables and the functional form.
2. Estimation of Parameter.
3. Finding the forecast values
Classification of Econometric Models
1. Single Equation models
Only one equation is used
2. Simultaneous models
Set of equations are used
A. Endogenous Variable
Values are determined by the model.
B. Exogenous Variables
Values originate from outside the system
 Simultaneous models
When variables are dependent and independent at the
same time , this model is used. S
Set of equations are used where variable affect another
variable and in turn is also affected by the other
variable.
This method is more complex.
It is also known as COMPLETE SYSTEM APPROACH
Example
Y= Ct + Gt + Lt
Ct = Bo + B1 a + Yt
Lt = A0 + A1d + A2 e
Judgmental Forecasts

Executive opinions

Sales force opinions

Consumer surveys

Outside opinion