OM

Operations Management
Forecasting
Chapter 4 (Heizer & Render)
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What Is Forecasting?
• The forecast is the only estimate of demand until actual demand becomes known.
Making good estimates is the main purpose of forecasting.
• Forecasting is the art and science of predicting future events.
• Forecasting may involve taking historical data (such as past sales) and projecting
them into the future with a mathematical model.
• It may be a subjective or an intuitive prediction (e.g., “this is a great new product
and will sell 20% more than the old one”).
• It may be based on demand-driven data, such as customer plans to purchase, and
projecting them into the future. Or the forecast may involve a combination of these,
that is, a mathematical model adjusted by a manager’s good judgment.
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Forecasting Time Horizons
• 1. Short-range forecast: This forecast has a time span of up to 1 year but
is generally less than 3 months. It is used for planning purchasing, job
scheduling, workforce levels, job assignments, and production levels.
• 2. Medium-range forecast: A medium-range, or intermediate, forecast
generally spans from 3 months to 3 years. It is useful in sales planning,
production planning and budgeting, cash budgeting, and analysis of
various operating plans.
• 3. Long-range forecast: Generally 3 years or more in time span, long-
range forecasts are used in planning for new products, capital
expenditures, facility location or expansion, and research and
development.
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Types of Forecasts
• 1. Economic forecasts address the business cycle by predicting inflation
rates, money supplies, housing starts, and other planning indicators.
• 2. Technological forecasts are concerned with rates of technological
progress, which can result in the birth of exciting new products,
requiring new plants and equipment.
• 3. Demand forecasts are projections of demand for a company’s
products or services. Forecasts drive decisions, so managers need
immediate and accurate information about real demand. They need
demand-driven forecasts, where the focus is on rapidly identifying and
tracking customer desires.

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 Seven Steps in the Forecasting FR
System
• 1. Determine the use of the forecast:
• 2. Select the items to be forecasted:
• 3. Determine the time horizon of the forecast:
• 4. Select the forecasting model(s):
• 5. Gather the data needed to make the forecast:
• 6. Make the forecast.
• 7. Validate and implement the results:

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Types of Forecasting Models/Approaches

Qualitative forecasts
incorporate such Quantitative
factors as the decision forecasts use a variety
maker’s intuition, of mathematical
emotions, personal models that rely on
experiences, and value historical data and/or
system in reaching a associative variables to
forecast. forecast demand.

Figure: Forecasting Models 6

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Qualitative Forecasting Techniques
• 1. Delphi method. This iterative group process allows experts, who may be located
in different places, to make forecasts. There are three different types of participants
in the Delphi process: decision makers, staff personnel, and respondents.
(A forecasting process framework based on the results of multiple round of questionnaires sent to a panel of
experts.)

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Qualitative Forecasting Techniques
• 2. Jury of executive opinion. This method takes the opinions of a small group of
high-level managers, often in combination with statistical models, and results in a
group estimate of demand.
• + Relatively quick; - ‘Group-think’; - Leader may dominate
• 3. Sales force composite. In this approach, each salesperson estimates what sales
will be in his or her region; these forecasts are reviewed to ensure that they are
realistic and are then combined at the district and national levels to reach an overall
forecast.
• With this procedure salespeople project volume for customers in their own territory, and the
estimates are aggregated and reviewed at higher management levels.
• 4. Consumer market survey. This method solicits input from customers or potential
customers regarding their future purchasing plans. It can help not only in preparing
a forecast but also in improving product design and planning for new products.
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Causal Models
• Forecasting models are identified as causal models if the variable to be forecast is
influenced by or correlated with other variables included in the model.
• A causal model would include factors such as these in the mathematical model.
• Regression models and other more complex models would be classified as causal
models.

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Time-Series Models
• Time series are also quantitative models, and many time-series
methods are available. A time series model is a forecasting
technique that attempts to predict the future values of a
variable by using only historical data on that one variable.
These models are extrapolations of past values of that series.
While other factors may have influenced these past values, the
impact of those other factors is captured in the previous values
of the variable being predicted.

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Time Series Forecasts
Time ordered sequence of observations taken at regular
observations taken at regular intervals.

Statistical techniques that make use of historical data

collected over a long period of time.

Methods assume that what has occurred in the past will

continue to occur in the future.

Forecasts based on only one factor - time.

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Components of a Time-Series
• A time series is sequence of values recorded at successive intervals of time. The
intervals can be days, weeks, months, years, or other time units.
• Examples include weekly sales of HP personal computers, quarterly earnings reports
of Microsoft Corporation, daily shipments of Eveready batteries, and annual U.S.
consumer price indices.
• A time series may consist of four possible components—trend, seasonal, cyclical,
and random.

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Components of a Time-Series/ Decomposition of a Time Series
• Time series: The repeated observations of demand for a service or product in their
order of occurrence.

• Horizontal: The fluctuation of data around a constant mean.

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Components of a Time-Series/ Decomposition of a Time Series
• The trend (T) component is the general upward or downward movement of the
data over a relatively long period of time.
• For example, total sales for a company may be increasing consistently over time.
The consumer price index, one measure of inflation, is increasing over time.
• While consistent upward (or downward) movements are indicative of a trend, there
may be a positive (or negative) trend present in a time series and yet the values do
not increase (or decrease) in every time period.
• There may be an occasional movement that seems inconsistent with the trend due
to random or other fluctuations.

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Components of a Time-Series
• The seasonal (S) component is a pattern of fluctuations above or below an average
value that repeats at regular intervals.
• For example, with monthly sales data of winter clothing, sales tend to be high in
December and January and lower in summer months, and this pattern is expected
to repeat every year. Quarterly sales for a consumer electronics store may be higher
in the fourth quarter of every year and lower in other quarters. Daily sales in a retail
store may be higher on Saturdays than on other days of the week. Hourly sales in a
fast-food restaurant are usually expected to be higher around the lunch hour and
the dinner hour, while other times are not as busy.

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Components of a Time-Series
• A cyclical (C) component of a time series is a pattern in annual data that tends to
repeat every several years. The cyclical component of a time series is used only
when making very long range forecasts, and it is usually associated with the
business cycle.
• Sales or economic activity might reach a peak and then begin to recede and
contract, reaching a bottom or trough. At some point after the trough is reached,
activity would pick up as recovery and expansion take place. A new peak would be
reached, and the cycle would begin again.

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Components of a Time-Series
• The random (R) component consists of irregular, unpredictable
variations in a time series. Any variation in a times series that cannot be
attributed to trend, seasonal, or cyclical variations would fall into this
category. If data for a time series tend to be level with no discernible
trend or seasonal pattern, random variations would be the cause for any
changes from one time period to the next.

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Components of a Time-Series
Demand Charted over 4 Years, with a Growth Trend and Seasonality Indicated

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Time Series Patterns FR
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Components of a Time-Series
• There are two general forms of time-series models in statistics.
• The first is a multiplicative model, which assumes that demand is the product of the
four components. It is stated as follows:
• Demand = T * S * C * R
• An additive model adds the components together to provide an estimate. Multiple
regression is often used to develop additive models. This additive relationship is
stated as follows:
• Demand = T + S + C + R
• There are other models that may be a combination of these. For example, one of
the components (such as trend) might be additive, while another (such as
seasonality) could be multiplicative. Understanding the components of a time series
will help in selecting an appropriate forecasting technique to use.
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Demand Management Options
• Matching supply with demand becomes a challenge when forecasts call for uneven
demand patterns—and uneven demand is more the rule than the exception.
• Demand management is the process of changing demand patterns using one or
more demand options.
• Various options are available in managing demand, including
• complementary products, (have similar resource requirements but different demand cycles.)
• promotional pricing,
• prescheduled appointments,
• reservations,
• revenue management,
• backlogs, backorders, and
• stockouts.

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Time Series Forecasts

Naive Techniques for Techniques for Techniques for Techniques for

Forecasts Averaging Trend Seasonality Cycles

Weighted
Moving Exponential
Moving
Average Smoothing
Average
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Naive Forecasts
Uh, give me a minute....
We sold 250 wheels last
week.... Now, next week we should sell....

The recent periods are the best predictors of the future

The forecast for any period equals the

previous period’s actual value.
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Naïve Forecasts
Simple to use

Virtually no cost

Quick and easy to prepare

Data analysis is nonexistent

Easily understandable

Cannot provide high accuracy

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Uses for Naïve Forecasts at
different data patterns
Stable time series
data • F(t) = A(t-1)
(stationer)

Data with • F(t) = A(t-1) +

trends (A(t-1) – A(t-2))

Seasonal variations • F(t) = A(t-n)

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Naïve Forecasts
Ex. Demand Year
390 2006
420 2007
380 2009
400 2010

Stationer

F(t) = A(t-1)

400 2011
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Naïve Forecasts
Ex. Demand Year
390 2006
420 2007
440 2009
480 2010

Trend

F(t) = A(t-1) + (A(t-1) – A(t-2))

520 2011
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Naïve Forecasts
Ex. Demand Year
10 1/2008
90 7/2008
15 1/2009
100 7/2009
12 1/2010
95 7/2010

Seasonal

F(t) = A(t-n)

12 1/2011
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Naïve Forecast Graph
Wallace Garden - Naive Forecast

25

20

15
Actual Value
Sheds

Naïve Forecast
10

0
February March April May June July August September October November December
Period
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Moving Averages, no pattern
( random variation )
A technique that averages a number of recent actual
values, updated as new values become available.

At-n + … At-2 + At-1

Ft = MAn= n
Ft = forecast for time period t
MAn = n period moving average
At-1 = actual value in period t-1
n = number of periods ( data points )
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Moving Averages
Ex.
Compute a 3-period moving average forecast given
demand for shopping carts for the last five periods
as shown:
2006 2005 2004 2003 2002 2001 period
??? 41 40 43 40 42 demand

At-n + … At-2 + At-1

t=6 Ft = MAn= n
A3 + A 4 + A 5
F6 = MA3 = = 41.33
3
 Moving Averages FR
Ex. (cont.)
forecast
2007 2006 2005 2004 2003 2002 2001 period

??? 41.33 41 40 43 40 42 demand

t=7 actual
2007 2006 2005 2004 2003 2002 2001 period

??? 38 41 40 43 40 42 demand
A4 + A 5 + A 6
F7 = MA3= = 39.67
3
forecast
2007 2006 2005 2004 2003 2002 2001 period
39.67 38 41 40 43 40 42 demand
Ex. Moving Averages FR

period data MA3 MA4 MA5

1 42
2 40
3 43
4 40 41.66667
5 41 41 41.25
6 39 41.33333 41 41.2
7 38 40 40.75 40.6
8 42 39.33333 39.5 40.2
9 44 39.66667 40 40
10 40 41.33333 40.75 40.8
11 42 42 41 40.6
12 41 42 42 41.2
13 41 41 41.75 41.8
14 43 41.33333 41 41.6
15 39 41.66667 41.75 41.4
16 41 41 41.2
 Moving Averages FR
Ex. (cont.)

45
44
43
42

data 41
MA3 40
MA4
MA5 39
38
37
36
35
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15
Ex. Moving Averages FR

3-Period 5-Period
MA MA
Period Demand Forecast Forecast
1 53
2 62
3 84
4 78 66.3
5 95 74.7
6 75 85.7 74.4
7 66 82.7 78.8
8 82 78.7 79.6
9 71 74.3 79.2
10 83 73.0 77.8
78.7 75.4
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Ex. (cont.)
Moving Averages
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Ex. Moving Averages
Paper company
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Stability vs. Responsiveness
•Should I use a 2-period moving average or a 3-
period moving average?
• The larger the “n” the more stable the forecast.
• A 2-period model will be more responsive to
change.
• We must balance stability with responsiveness
• If responsiveness is required, average with few
data points should be used,
 Moving Averages FR

Decreasing the number of data points in an moving average

technique, increase the weight of more recent values

As data points in an moving average technique increased, the

sensitivity (responsiveness) of the average to new values
decreased.

If responsiveness is required, average with few data points should be used.

 Moving Averages FR

It is easy to compute All values in the average are

It is easy to understand weighted equally, the oldest
value has the same weight
as the most recent value

But
Idea

most recent observations must be better indicators of the

future than older observations
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Weighted Moving Averages

Historical values of
the time series are
assigned different
weights when
performing the
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Weighted Moving Averages

More recent values in a series are given

more weight in computing the forecast.

Trial and error used to find the suitable

weighting scheme

The sum of all weights must be = 1

Weighted average technique is more

reflective of the most recent occurrences.
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Weighted Moving Averages

In a weighted moving average, weights are assigned to the

most recent data.
Formula:
n
WMAn   W A
i1 i i
where W  the weight for period i, between 0% and 100%
i
Wi  1.00

Example : Paper company we ights 50% for October, 33%

for September, 17% for August forecast for November ? :
3
WMA   W A  (.50)(90)  (.33)(110)  (.17)(130)  103.4 orders
3 i1 i i
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Weighted Moving Averages
Ex.

Compute a 4-period weighted moving average forecast given

demand for shopping carts for the last periods values and
weights as shown:
6 5 4 3 2 1 period
??? 41 40 43 40 42 demand
0.4 0.3 0.2 0.1 0 weight

F6 = W5*A5 + W4*A4 + W3*A3 + W2*A2

F6 = 0.4(41) + 0.3(40) + 0.2(43) + 0.1(40) = 41
If the actual value of F6 is 39 then
F7 = 0.4(39) + 0.3(41) + 0.2(40) + 0.1(43) = 40.2
 Weighted Moving Averages FR

Market Mixer, Inc. sells can openers. Monthly sales for an eight-month period were as follows:
Month Sales Month Sales
1 450 5 460
2 425 6 455
3 445 7 430
4 435 8 420
Forecast next month’s sales using a 3-month weighted moving average, where the weight for the most
recent data value is 0.60; the next most recent, 0.30; and the earliest, 0.10.
Solution:
Period Sales Weighted Moving Average Forecast
Comments:
1 450 1. Any forecasts beyond Period 9
2 425 will have the same value as
3 445 the Period 9 forecast, i.e., 427.
4 435 (450*.10) + (425*.30) + (445*.60) = 440 3. WMA gives greater weight to
5 460 (425*.10) + (445*.30) + (435*.60) = 437 more recent values in the
6 455 (445*.10) + (435*.30) + (460*.60) = 451 moving average and is more
7 430 (435*.10) + (460*.30) + (445*.60) = 455 responsive to recent changes
8 420 (460*.10) + (455*.30) + (430*.60) = 441 in the data.
9 (455*.10) + (430*.30) + (420*.60) = 427
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Exponential Smoothing

•The most recent observations might

have the highest predictive value.
•Therefore, we should give more
weight to the more recent time
periods when forecasting.
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Exponential Smoothing
Weighted averaging method based on
previous forecast plus a percentage of the
forecast error

Ft = Ft-1 + (At-1 - Ft-1)

Determination of  is usually judgmental and subjective and often based on trial-
and -error experimentation.
The most commonly used values of  are between .10 and .50.
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Exponential Smoothing
Ex.
Period Actual Alpha = 0.1 Error Alpha = 0.4 Error
1 42
2 40 42 -2.00 42 -2
3 43 41.8 1.20 41.2 1.8
4 40 41.92 -1.92 41.92 -1.92
5 41 41.73 -0.73 41.15 -0.15
6 39 41.66 -2.66 41.09 -2.09
7 46 41.39 4.61 40.25 5.75
8 44 41.85 2.15 42.55 1.45
9 45 42.07 2.93 43.13 1.87
10 38 42.36 -4.36 43.88 -5.88
11 40 41.92 -1.92 41.53 -1.53
12 41.73 40.92
 Picking a Smoothing Constant FR

Actual
50
.4
Demand
 .1
45

40

35
1 2 3 4 5 6 7 8 9 10 11 12
Period

Selecting a smoothing constant α is a matter

of judgment or trial and error
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Techniques for Trend
Nonlinear Trends
 FR
Techniques for Trend
Linear Trends

Chart Title
8
7 7
6 6
5 5
4 4
3 3
2 2
1 1
0 0
 Techniques for Trend FR

Ft

Ft = a + bt
0 1 2 3 4 5 t

• Ft = Forecast for period t

• t = Specified number of time periods
• a = Value of Ft at t = 0
• b = Slope of the line
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Calculating a and b

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

 y - b  t
a =
n
 Linear Trend Equation FR

Ex.
t y
2
W eek t S a le s ty
1 1 150 150
2 4 157 314
3 9 162 486
4 16 166 664
5 25 177 885

2
 t = 15  t = 55  y = 812  ty = 2 4 9 9
2
(  t) = 2 2 5
 Linear Trend Equation FR

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
Techniques for Averaging FR

Weighted
Moving Exponential
moving
average smoothing
average
 Thank You.

OM
Operations Management
Md. Tanvir Alam, Assistant Professor, DU
+8801831704344
tanvir.alam@du.ac.bd
https://www.du.ac.bd/

Few References from Dr. Abdulfatah Salem