Chapter

3-1 Forecasting

Four
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

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.
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

• 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.

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

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.
3-5 Forecasting

Why forecasting?

 New facility planning /build new factory or design

important new production process.
 Production planning /demands vary from month to month.

 Work force scheduling/ demand vary from week to week.

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

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
McGraw-Hill/Irwin Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
3-7 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.
3-8 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
McGraw-Hill/Irwin Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
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
McGraw-Hill/Irwin Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
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
McGraw-Hill/Irwin Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
3-11 Forecasting

II. Quantitative approaches

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.

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

Types of Quantitative Forecasts

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

Operations Management, Seventh Edition, by William J. Stevenson

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

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

Naïve Forecast…

Its Features
 Simple to use.
 Virtually no cost.
 Data analysis is non existent.
 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.
3-15 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

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

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

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

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

Operations Management, Seventh Edition, by William J. Stevenson

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3-18 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 = ?

Operations Management, Seventh Edition, by William J. Stevenson

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3-19 Forecasting

Moving Average…

• MA3 =
39  41  40
 40
3

Operations Management, Seventh Edition, by William J. Stevenson

McGraw-Hill/Irwin Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
3-20 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.
3-21 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
i – 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

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

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

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=?

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

d. 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

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

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

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

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.
3-27 Forecasting

• The two most important factors in choosing

a forecasting technique:
– Cost
– Accuracy

Operations Management, Seventh Edition, by William J. Stevenson

McGraw-Hill/Irwin Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
3-28 Forecasting

Ch-4 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.