Operations

Management
Chapter 4 -
Forecasting
PowerPoint presentation to accompany
Heizer/Render
Principles of Operations Management, 6e
Operations Management, 8e

© 2006 Prentice Hall, Inc.

 What is Forecasting?
 Process of
predicting a future
event
 Underlying basis of
??
all business
decisions
 Production
 Inventory
 Personnel
 Facilities
Forecasting Time Horizons
 Short-range forecast
 Generally less than 3 months
 Purchasing, job scheduling, workforce levels, job
assignments, production levels
 Medium-range forecast
 More than a quarter
 Sales and production planning, budgeting
 Long-range forecast
 3+ years
 New product planning, facility location, research and
development
 Distinguishing Differences
Medium/long range forecasts deal with more
comprehensive and broader issues and support
management decisions regarding long-term
planning and products, plants and processes
Short-term forecasting usually employs different
methodologies than longer-term forecasting
Short-term forecasts tend to be more accurate
than longer-term forecasts
Influence of Product Life Cycle

Introduction – Growth – Maturity – Decline

 Introduction and growth require precise
forecasts than maturity and decline
 As product passes through life cycle, forecasts
are useful in projecting
 Staffing levels
 Inventory levels
 Factory capacity
 Types of Forecasts
 Economic forecasts
 Inflation rate, money supply, growth rates etc.
 Technological forecasts
 Predict rate of technological progress
 Potential new products
 Potential new innovations and technologies
 Demand forecasts
 Predict sales of existing product in the market
Strategic Importance of
Forecasting
 Human Resources – Hiring, training,
laying off workers
 Capacity – Capacity shortages can result
in excessive delivery or loss of customers
and market share
 Supply-Chain Management – Good
supplier relations by projecting new
collaborations and cooperative
arrangements
 Seven Steps in Forecasting
 Determine the type and use of the forecast
 Select the items to be forecasted
(product/tech/sales)
 Determine the time horizon of the forecast
 Select the forecasting model
 Gather the data
 Make the forecast
 Validate results
 Forecasting Approaches
Qualitative Methods
 Used when situation is vague
and little data exist
 New products
 New technology
 Involves intuition, experience
 Forecasting Approaches
Quantitative Methods
 Used when situation is ‘stable’ and
historical data exist
 Existing products
 Current technology
 Involves mathematical and
statistical techniques
 e.g., forecasting sales of televisions
Jury of Executive Opinion
 Involves small group of high-level
managers and experts
 Group estimates demand and trend by
working together
 Relatively quick
 ‘Group-think’
disadvantage
 Delphi Method
 Iterative group process, continues until
consensus is reached
 3 types of participants
 Decision makers
 Staff
 Respondents
 Sales Force Composite
 Each salesperson projects his or
her sales
 Combined at district and national
levels
 Sales reps know customers’ wants
for their specific designated
markets
 Consumer Market Survey
 Ask customers about purchasing
plans
 Market surveys and questionnaires
 Overview of Quantitative
Approaches
1. Naive approach
2. Moving averages
Time-Series
3. Exponential smoothing Models
4. Trend projection
5. Linear regression Associative
Model
 Time Series Forecasting
 Obtained by observing response variable at
regular time periods
 Forecast based only on past values
Time Series Components

Trend Cyclical

Seasonal Random
 Components of Demand
Trend
component

Demand for product or service

Seasonal peaks

Actual
demand

Average
demand over
Random four years
variation
| | | |
1 2 3 4
Year Figure 4.1
Trend Component
 Persistent, overall upward or downward
pattern for a long period of time
 Changes due to persistent change in
population demographic, technology, age,
culture, etc over a long time.
 Typically several years or decades
duration
 Cyclical Component
 Repeating up and down movements for more
than a year
 Affected by business cycle, political, and
economic factors occurring every few years
 Few years duration
 Often causal or
associative
relationships

0 5 10 15 20
 Seasonal Component
 Regular pattern of up and down
fluctuations within a year
 Due to weather, customs, etc.
 Occurs within a single year

0 5 10 15 20
 Random Component
 Erratic, unsystematic, fluctuations
 Due to random variation or unforeseen
events
 Short duration

M T W T F
 Naive Approach
 Assumes demand in next period is
the same as demand in most
recent period
 e.g., If May sales were 48, then June
sales will be 48
 Sometimes cost effective and
efficient
 Moving Average Method
 MA is a series of arithmetic means
 Used if little or no trend

 Provides overall impression of data over time

∑ demand in previous n periods

Moving average =
n
Moving Average Example
Actual 3-Month
Month Shed Sales Moving Average
January 10
February 12
March 13
April 16 (10 + 12 + 13)/3 = 11 2/3
May 19 (12 + 13 + 16)/3 = 13 2/3
June 23 (13 + 16 + 19)/3 = 16
July 26 (16 + 19 + 23)/3 = 19 1/3
Weighted Moving Average
 Used when trend is present
 Older data usually less important
 Weights based on experience and intuition

∑ (weight for period n)

Weighted x (demand in period n)
moving average =
∑ weights
 Weights Applied Period
Weighted Moving Average
3 Last month
2 Two months ago
1 Three months ago
6 Sum of weights

Actual 3-Month Weighted

Month Shed Sales Moving Average
January 10
February 12
March 13
April 16 [(3 x 13) + (2 x 12) + (10)]/6 = 121/6
May 19 [(3 x 16) + (2 x 13) + (12)]/6 = 14 1/3
June 23 [(3 x 19) + (2 x 16) + (13)]/6 = 17
July 26 [(3 x 23) + (2 x 19) + (16)]/6 = 20 1/2
Exponential Smoothing
 Form of weighted moving average
 Weights decline exponentially
 Most recent data weighted most with high alpha and
vice versa
 Requires smoothing constant ()
 Ranges from 0 to 1
 Subjectively chosen
 Effect of
Smoothing Constants (a)

Weight Assigned to
Most 2nd Most 3rd Most 4th Most 5th Most
Recent Recent Recent Recent Recent
Smoothing Period Period Period Period Period
Constant (a) a(1 - a) a(1 - a)2 a(1 - a)3 a(1 - a)4

a = .1 .1 .09 .081 .073 .066

a = .5 .5 .25 .125 .063 .031

 Effect of
Smoothing Constants (a)
Year Small α for long term Large α for more recent past Large α for only
historical data data recent past data
α= 0.1 α= 0.5 α= 0.9
2020 α= 0.1 α= 0.5 α= 0.9
2019 α= α(1- α)= 0.09 α= α(1- α)= 0.5 0.09
2018 α= α(1- α)2 = 0.08 α= α(1- α)2= 0.25 0.009
2017 α= α(1- α)3 = 0.07 α= α(1- α)3= 0.12 0.0009
2016 α= α(1- α)4 = 0.06 α= α(1- α)4= 0.06 0.00009
2015 α= α(1- α)5 = 0.05 α= α(1- α)5 = 0.03
2014 α= α(1- α)6 = 0.04 α= α(1- α)6 = 0.015
 Impact of Different 

225 –
Actual a = .5
demand
200 –
Demand

175 –
a = .1
| | | | | | | | |
150 –
1 2 3 4 5 6 7 8 9
Quarter
 Exponential Smoothing

w forecast = last period’s forecast

+ a (last period’s actual demand
– last period’s forecast)

Ft = Ft – 1 + a(At – 1 - Ft – 1)

where Ft = new forecast

Ft – 1 = previous forecast
a = smoothing (or weighting)
constant (0  a  1)
Exponential Smoothing Example

Forecasted demand = 142 Ford Mustangs

Actual demand = 153
Smoothing constant a = .20
Exponential Smoothing Example

Forecasted demand = 142 Ford Mustangs

Actual demand = 153
Smoothing constant a = .20

New forecast = 142 + .2(153 – 142)

Exponential Smoothing Example

Forecasted demand = 142 Ford Mustangs

Actual demand = 153
Smoothing constant a = .20

New forecast = 142 + .2(153 – 142)

= 142 + 2.2
= 144.2 ≈ 144 cars
Choosing  for Reducing Error
The objective is to obtain the most
accurate forecast no matter the technique

We generally do this by selecting the model that

gives us the lowest forecast error

Forecast error = Actual demand - Forecast value

= At - Ft
Common Measures of Error

Mean Absolute Deviation (MAD)

∑ |actual - forecast|
MAD =
n

Mean Squared Error (MSE)

∑ (forecast errors)2
MSE =
n
Common Measures of Error

Mean Absolute Percent Error (MAPE)

n
∑ 100|actuali - forecasti|/actuali
MAPE = i=1
n
 Comparison of Forecast Error
Rounded Absolute Rounded Absolute
Actual Forecast Deviation Forecast Deviation
Tonnage with for with for
Quarter Unloaded a = .10 a = .10 a = .50 a = .50
1 180 175 5 175 5
2 168 176 8 178 10
3 159 175 16 173 14
4 175 173 2 166 9
5 190 173 17 170 20
6 205 175 30 180 25
7 180 178 2 193 13
8 182 178 4 186 4
84 100
 Comparison of Forecast Error
∑ |deviations|
Rounded Absolute Rounded Absolute
MADActual
= Forecast Deviation Forecast Deviation
Tonage n
with for with for
Quarter Unloaded a = .10 a = .10 a = .50 a = .50
1
For a = .10
180 175 5 175 5
2 168 = 84/8176 = 10.50 8 178 10
3 159 175 16 173 14
4 For a =175
.50 173 2 166 9
5 190 173 17 170 20
6 205 = 100/8
175= 12.50 30 180 25
7 180 178 2 193 13
8 182 178 4 186 4
84 100
 Comparison of Forecast Error
∑ (forecast errors) 2
MSE = Actual Rounded
Forecast
Absolute
Deviation
Rounded
Forecast
Absolute
Deviation
Tonage n
with for with for
Quarter Unloaded a = .10 a = .10 a = .50 a = .50
1
For a = .10
180 175 5 175 5
2 = 1,558/8176
168 = 194.75 8 178 10
3 159 175 16 173 14
4 For a =175
.50 173 2 166 9
5 190 173 17 170 20
6 = 1,612/8175
205 = 201.50 30 180 25
7 180 178 2 193 13
8 182 178 4 186 4
84 100
MAD 10.50 12.50
 Comparison
n
of Forecast Error
∑ 100 |deviationi|/actuali
MAPE = i=1 Rounded Absolute Rounded Absolute
Actual Forecast Deviation Forecast Deviation
Tonage with n for with for
Quarter Unloaded a = .10 a = .10 a = .50 a = .50
1
For a180
= .10 175 5 175 5
2 168 = 45.62/8
176 = 5.70%
8 178 10
3 159 175 16 173 14
4 For a175
= .50 173 2 166 9
5 190 173 17 170 20
6 205 = 54.8/8
175 = 6.85%
30 180 25
7 180 178 2 193 13
8 182 178 4 186 4
84 100
MAD 10.50 12.50
MSE 194.75 201.50
 Comparison of Forecast Error
Rounded Absolute Rounded Absolute
Actual Forecast Deviation Forecast Deviation
Tonnage with for with for
Quarter Unloaded a = .10 a = .10 a = .50 a = .50
1 180 175 5 175 5
2 168 176 8 178 10
3 159 175 16 173 14
4 175 173 2 166 9
5 190 173 17 170 20
6 205 175 30 180 25
7 180 178 2 193 13
8 182 178 4 186 4
84 100
MAD 10.50 12.50
MSE 194.75 201.50
MAPE 5.70% 6.85%
Exponential Smoothing with Trend
Adjustment
When a trend is present, exponential smoothing
is a better way to go

Forecast exponentially exponentially

including (FITt) =
trend smoothed (Ft) + (Tt) smoothed
forecast trend
Exponential Smoothing with Trend
Adjustment

Ft = a(At - 1) + (1 - a)(Ft - 1 + Tt - 1)

Tt = b(Ft - Ft - 1) + (1 - b)Tt - 1

Step 1: Compute Ft
Step 2: Compute Tt
Step 3: Calculate the forecast FITt = Ft + Tt
 Exponential Smoothing with Trend
Adjustment Example
Forecast
Actual Smoothed Smoothed Including
Month(t) Demand (At) Forecast, Ft Trend, Tt Trend, FITt
1 12 11 2 13.00
2 17
3 20
4 19
5 24
6 21
7 31
8 28
9 36
10
Table 4.1
 Exponential Smoothing with Trend
Adjustment Example
Forecast
Actual Smoothed SmoothedIncluding
Month(t) Demand (At) Forecast, Ft Trend, Tt
Trend, FITt
1 12 11 2 13.00
2 17
3 20
4 19
Step 1: Forecast for Month 2
5 24
6 21
7 31 F2 = aA1 + (1 - a)(F1 + T1)
8 28
9 36 F2 = (.2)(12) + (1 - .2)(11 + 2)
10 = 2.4 + 10.4 = 12.8 units
Table 4.1
 Exponential Smoothing with Trend
Adjustment Example
Forecast
Actual Smoothed Smoothed Including
Month(t) Demand (At) Forecast, Ft Trend, Tt
Trend, FITt
1 12 11 2 13.00
2 17 12.80
3 20
4 19
Step 2: Trend for Month 2
5 24
6 21
7 31 T2 = b(F2 - F1) + (1 - b)T1
8 28
9 36 T2 = (.4)(12.8 - 11) + (1 - .4)(2)
10 = .72 + 1.2 = 1.92 units
Table 4.1
 Exponential Smoothing with Trend
Adjustment Example
Forecast
Actual Smoothed Smoothed Including
Month(t) Demand (At) Forecast, Ft Trend, Tt Trend, FITt
1 12 11 2 13.00
2 17 12.80 1.92
3 20
4 19
Step 3: Calculate FIT for Month 2
5 24
6 21
7 31 FIT2 = F2 + T1
8 28
9 36
FIT2 = 12.8 + 1.92
10 = 14.72 units
Table 4.1
 Exponential Smoothing with Trend
Adjustment Example
Forecast
Actual Smoothed Smoothed Including
Month(t) Demand (At) Forecast, Ft Trend, Tt Trend, FITt
1 12 11 2 13.00
2 17 12.80 1.92 14.72
3 20 15.18 2.10 17.28
4 19 17.82 2.32 20.14
5 24 19.91 2.23 22.14
6 21 22.51 2.38 24.89
7 31 24.11 2.07 26.18
8 28 27.14 2.45 29.59
9 36 29.28 2.32 31.60
10 32.48 2.68 35.16
Table 4.1
Exponential Smoothing with Trend
Adjustment Example
35 –
Actual demand (At)
Product demand 30 –

25 –

20 –

15 –

10 –
Forecast including trend (FITt)

5 –

0 – | | | | | | | | |
1 2 3 4 5 6 7 8 9
Figure 4.3
Time (month)
Trend Projections
Fitting a trend line to historical data points to
project into the medium-to-long-range
Linear trends can be found using the least squares
technique
^
y = a + bx
^ where y = computed value of the
variable to be predicted (dependent
variable)
a = y-axis intercept
b = slope of the regression line
x = the independent variable
Least Squares Method

Values of Dependent Variable

Actual observation Deviation7
(y value)

Deviation5 Deviation6

Deviation3

Deviation4

Deviation1
Deviation2
Trend line, y =^ a + bx

Time period Figure 4.4

Least Squares Method

Values of Dependent Variable

Actual observation Deviation7
(y value)

Deviation5 Deviation6

Deviation3
Least squares method minimizes the sum
of the squared errors (deviations)
Deviation4

Deviation1
Deviation2
Trend line, y =^ a + bx

Time period Figure 4.4

Least Squares Method
Equations to calculate the regression variables

^
y = a + bx

Sxy - nxy
b=
Sx2 - nx2

a = y - bx
Least Squares Example
Time Electrical Power
Year Period (x) Demand x2 xy
1999 1 74 1 74
2000 2 79 4 158
2001 3 80 9 240
2002 4 90 16 360
2003 5 105 25 525
2004 6 142 36 852
2005 7 122 49 854
∑x = 28 ∑y = 692 ∑x2 = 140 ∑xy = 3,063
x=4 y = 98.86

∑xy - nxy 3,063 - (7)(4)(98.86)

b= = = 10.54
∑x - nx
2 2 140 - (7)(4 )
2

a = y - bx = 98.86 - 10.54(4) = 56.70

Least Squares Example
Time Electrical Power
Year Period (x) Demand x2 xy
1999 1 74 1 74
2000 2 79 4 158
2001The trend3 line is 80 9 240
2002 4 90 16 360
^
2003 y =5 56.70 + 10.54x
105 25 525
2004 6 142 36 852
2005 7 122 49 854
Sx = 28 Sy = 692 Sx2 = 140 Sxy = 3,063
x=4 y = 98.86

Sxy - nxy 3,063 - (7)(4)(98.86)

b= = = 10.54
Sx - nx
2 2 140 - (7)(4 )
2

a = y - bx = 98.86 - 10.54(4) = 56.70

 Least Squares Example
Trend line,
160 – y^ = 56.70 + 10.54x
150 –
140 –
Power demand

130 –
120 –
110 –
100 –
90 –
80 –
70 –
60 –
50 –
| | | | | | | | |
1999 2000 2001 2002 2003 2004 2005 2006 2007
Year
 Seasonal Variations In Data
The multiplicative seasonal model can modify
trend data to accommodate seasonal variations in
demand

1. Find average historical demand for each season (month)

2. Compute the average demand for all seasonal (monthly)
averages altogether
3. Compute a seasonal index for each season by dividing average
seasonal by average overall.
4. Estimate next year’s total demand
5. Divide this estimate of total demand by the number of seasons,
then multiply it by the seasonal index for that season
 Seasonal Index Example
Demand Average (seasonal) Average Seasonal
Month 2016 2017 2018 2016-2018 Overall Index
Jan 80 85 105 90 94
Feb 70 85 85 80 94
Mar 80 93 82 85 94
Apr 90 95 115 100 94
May 113 125 131 123 94
Jun 110 115 120 115 94
Jul 100 102 113 105 94
Aug 88 102 110 100 94
Sept 85 90 95 90 94
Oct 77 78 85 80 94
Nov 75 72 83 80 94
Dec 82 78 80 80 94
 Seasonal Index Example
Demand Average (Seasonal) Average Seasonal
Month 2016 2017 2018 2016-2018 Overall Index
Jan 80 85 105 90 94 0.957
Feb 70 85 85 80 94
Mar 80 93 average
82 85 seasonal demand
2016-2018 94
Seasonal index
Apr 90 = 95 115 average100 overall demand94
May 113 125 131 123 94
Jun 110 115= 90/94
120= .957 115 94
Jul 100 102 113 105 94
Aug 88 102 110 100 94
Sept 85 90 95 90 94
Oct 77 78 85 80 94
Nov 75 72 83 80 94
Dec 82 78 80 80 94
 Seasonal Index Example
Demand Average (Seasonal) Average Seasonal
Month 2016 2017 2018 2016-2018 Overall Index
Jan 80 85 105 90 94 0.957
Feb 70 85 85 80 94 0.851
Mar 80 93 82 85 94 0.904
Apr 90 95 115 100 94 1.064
May 113 125 131 123 94 1.309
Jun 110 115 120 115 94 1.223
Jul 100 102 113 105 94 1.117
Aug 88 102 110 100 94 1.064
Sept 85 90 95 90 94 0.957
Oct 77 78 85 80 94 0.851
Nov 75 72 83 80 94 0.851
Dec 82 78 80 80 94 0.851
 Seasonal Index Example
Demand Average (Seasonal) Average Seasonal
Month 2016 2017 2018 2016-2018 Overall Index
Jan 80 85 105 90 94 0.957
Feb 70Suppose,
85 85 80 94 0.851
Mar 80Forecast
93for 2019
82 is, 85 94 0.904
Apr 90Expected
95 annual
115 demand (2019)
100= 1,200 94 1.064
May 113 125 131 123 94 1.309
Jun 110 115 120 1,200 115 94 1.223
Jul 100 102 Jan 113 12 x105 .957 = 96 94 1.117
Aug 88 102 110 100 94 1.064
1,200
Sept 85 90
Feb 95 x90
.851 = 85 94 0.957
12
Oct 77 78 85 80 94 0.851
Nov 75 72 83 80 94 0.851
Dec 82 78 80 80 94 0.851
Seasonal Index Example
2019 Forecast
140 – 2018 Demand
130 – 2017 Demand
2016 Demand
120 –
Demand

110 –
100 –
90 –
80 –
70 –
| | | | | | | | | | | |
J F M A M J J A S O N D
Time