RMIT Classification: Trusted

Operations Management

Week 2
Forecasting

The best way to predict the future is to create it.

Abraham Lincoln
 RMIT Classification: Trusted

You should be able to:

1. Compare and contrast qualitative and
quantitative approaches to forecasting
2. Describe time series and associative models
3. Explain three measures of forecast accuracy
4. Explain about Tracking Signal

3
 RMIT Classification: Trusted

Forecast – a statement about the future value of a

variable of interest
 We make forecasts about such things as weather,
demand, and resource availability
 Forecasts are an important element in making informed
decisions

4
 RMIT Classification: Trusted

 Qualitative Forecasting
 Qualitative techniques permit the inclusion of soft information such as:
 Human factors
 Personal opinions
 Hunches
 These factors are difficult, or impossible, to quantify
 Quantitative Forecasting
 Quantitative techniques involve :
1. Time series: the projection of historical data
2. Associative model: attempts to use causal variables to make a forecast
 These techniques rely on hard data

5
 RMIT Classification: Trusted

Forecasts that project patterns identified in

recent time-series observations
 Time-series - a time-ordered sequence of
observations taken at regular time intervals
Assume that future values of the time-series can
be estimated from past values of the time-series

6
 RMIT Classification: Trusted

Trend
Seasonality
Cycles
Irregular variations
Random variation

7
RMIT Classification: Trusted

8
 RMIT Classification: Trusted

Naïve Forecast
 Uses a single previous value of a time series as the basis
for a forecast
The forecast for a time period is equal to the
previous time period’s value
 Can be used with
a stable time series
seasonal variations
trend

9
 RMIT Classification: Trusted

These Techniques work best when a series tends to

vary about an average
 Averaging techniques smooth variations in the data
 They can handle step changes or gradual changes in the
level of a series

 Techniques
1. Moving average
2. Weighted moving average
3. Exponential smoothing

10
 RMIT Classification: Trusted

Technique that averages a number of the most recent

actual values in generating a forecast
n

A t i
Ft  MA n  i 1

n
actual demand period 1  actual demand period 2  ...  actual demand period n
n
where
Ft  Forecast for time period t
MA n  n period moving average
At 1  Actual value in period t  1
n  Number of periods in the moving average
11
 RMIT Classification: Trusted

Demand for product A is given in the following table. Forecast using

moving average with n=3 for Period 5.

Period 1 2 3 4 5 6 7 8
Actual demand 10 12 11 13 14 12 13 12

compare
Answer:
F5 = (12+11+13)/3 = 12.03

Note: You can use Data Analysis package in Excel to forecast using Moving
Average method. Please see the Data Analysis package.doc on Canvas

12
 RMIT Classification: Trusted

The most recent values in a time series are given more

weight in computing a forecast
 The choice of weights, w, is somewhat arbitrary and
involves some trial and error
Ft  wt ( At )  wt 1 ( At 1 )  ...  wt  n ( At  n )
 ( weight period 1* actual demand period 1  weight period 2 * actual demand period 2 
...  weight period n * actual demand period n) /( sum of weights )
where
wt  weight for period t , wt 1  weight for period t  1, etc.
At  the actual value for period t , At 1  the actual value for period t  1, etc.
in above formula 0  w  1,
w t
1

13
 RMIT Classification: Trusted

Demand for product A is given in the following table. Forecast

using weighted moving average with n=2 for period 6.
Weight for latest period =0.7
Weight for old period = 0.3

Period 1 2 3 4 5 6 7 8
Answer:
Actual demand 10 12 11 13 14 12 13 12
F6 = 14(0.7)+13(0.3)= 13.7
compare

14
 RMIT Classification: Trusted

Smoothing
constant
0≤ α≤1

Forecast of
period t Actual
Forecast of
previous demand of
period previous
period
15
 RMIT Classification: Trusted

Demand for product A is given in the following table. Forecast using

exponential smoothing for period 3 using alpha=0.2.

Period 1 2 3 4 5 6 7 8
Answer:Actual demand 10 12 11 13 14 12 13 12
F2= F1+0.2(A1-F1)  F1 is unknown
Assumption: A1=F1
F2 = 10 + 0.2 (10-10) =10
F3 = 10 + 0.2 (12-10) =10.4

16
 RMIT Classification: Trusted

• A simple data plot can reveal the existence and nature of a

trend
• Linear trend equation

b= Slope of
the line

t= Time period

17
 RMIT Classification: Trusted

Method 1: Use Line Chart in Excel

Method 2: TREND formula
Method 3: Data Analysis package
Method 4: Manual method
n ty   t  y
b
n t 2   
t
2

a
 y  b t
or y  bt
n
where
n  Number of periods
y  Value of the time series

18

 RMIT Classification: Trusted

Associative techniques are based on the

development of an equation that summarizes
the effects of predictor variables
Predictor variables - variables that can be used to
predict values of the variable of interest
Home values may be related to such factors as home and
property size, location, number of bedrooms, and number
of bathrooms

19
 RMIT Classification: Trusted

1. Variations around the line are random

2. Deviations around the average value (the line)
should be normally distributed
3. Predictions are made only within the range of
observed values

20
 RMIT Classification: Trusted

3-21
a = Value of Y b= Slope of
when x = 0 the line

Y =Dependent
x=Independent
variable
variable
21
 RMIT Classification: Trusted

Method 1: Slope and intercept using the following formula:

Finding values of a and b for Regression using:

a. Graph
b. Excel formula
c. Data Analysis package
d. Manual method

22
 RMIT Classification: Trusted

Forecasters want to minimize forecast errors

 It is nearly impossible to correctly forecast real-world
variable values on a regular basis
 So, it is important to provide an indication of the extent
to which the forecast might deviate from the value of the
variable that actually occurs
Forecast accuracy should be an important forecasting
technique selection criterion
 Error = Actual – Forecast
 If errors fall beyond acceptable bounds, corrective action
may be necessary

23
 RMIT Classification: Trusted

MAD 
 Actual t  Forecast t MAD weights all errors
n evenly

 Actual t  Forecast t 
2
MSE weights errors according
MSE  to their squared values
n 1

Actualt  Forecast t
 Actualt
 100
MAPE weights errors
MAPE 
n according to relative error
24
 RMIT Classification: Trusted

 Tracking forecast errors and analyzing them can provide useful

insight into whether forecasts are performing satisfactorily
 Sources of forecast errors:
 The model may be inadequate due to
a. Omission of an important variable
b. A change or shift in the variable the model cannot handle
c. The appearance of a new variable
 Irregular variations may have occurred
 Random variation
 Tracking signals can be used to detect forecast bias

25
RMIT Classification: Trusted

26
 RMIT Classification: Trusted

The manager of a travel agency has been using a seasonally

adjusted forecast to predict demand for packaged tours.
The actual and predicted values are as follows:
Period Demand Predicted
1 129 124
2 194 200
3 156 150 Compute a tracking signal for
4 91 94 periods 5 through 14 using the
5 85 80
6 132 140 initial and updated MADs with
7 126 128 alpha = 0.3.
8 126 124
9 95 100 If limits of 4 are used, what can
10 149 150 you conclude?
11 98 94
12 85 80
13 137 140
Excel solution is available on Canvas
14 134 128
27
 RMIT Classification: Trusted

Step 1

Step 2
Cum. Tracking
Predicte |e| MADt
Period Demand Error Error Signal
d
1 129 124 5 5 5
2 194 200 –6 6 –1
3 156 150 6 6 5
4 91 94 –3 3 2
5 85 80 5 5 7 5.00 1.40
Step 4
6 132 140 –8 8 –1 5.90 –0.17
7 126 128 –2 2 –3 4.73 –0.63
8 126 124 2 2 –1 3.91 –0.26
9 95 100 –5 5 –6 4.24 –1.42
10 149 150 –1 1 –7 3.27 –2.14
11 98 94 4 4 –3 3.49 –0.86
12 85 80 5 5 2 3.94 0.51
13 137 140 –3 3 –1 3.66 –0.27
14 134 128 6 6 5 4.36 1.15

Step 3

Conclusion: As all tracking signals are within the limits of 4 28

then we can conclude the no issue regarding the error was found.
RMIT Classification: Trusted

Questions

29