QUANTITATIVE METHODS

(ISD 251)
Lecturer: Barima Okyere Anim
Dept: Supply Chain and Information Systems Dept.
Office: FF 24, Inner 1 KSB Undergraduate Block
FORECASTING IN
BUSINESS
Overview
• What Is Forecasting
• Types of Forecasting (Qualitative & Quantitative)
• Qualitative Forecasting
• Quantitative Forecasting
• Simple Moving Averages
• Weighted Moving Averages
• Exponential Smoothing
• Measures of Forecast Accuracy
• MAD
• MSE
• MAPE
• Regression
• Simple & Multiple Regression
What Is Forecasting
• To forecast simply means to predict
• Forecasting is a core concern of every organization
• All decisions become effective at some point in the future.
• Managerial decision should be based on;
• present circumstances
• Conditions that will prevail when the decisions become effective

• The aim of forecasting is to make the best possible

predictions for future events, minimize errors and
provide the most reliable information possible.
Classification of forecasts
• One classification of forecasting methods is based on
the time horizon they cover. The three types are;
• Long-term forecasts look ahead several years – the
time typically needed to plan to build a new factory

• Medium-term forecasts look ahead between three

months and two years – the time typically needed to
introduce a new product

• Short-term forecasts cover the next few weeks –

describing the continuing demand for a product.
Classification of forecasts 2
• Another classification is based on whether numerical
data is utilized or not. The two types are;
• Qualitative Forecasting
• Also known as Judgmental Sampling
• Useful when subjective factors are expected to be very
important or when accurate quantitative data are difficult to
obtain.

• Quantitative Forecasting
• Time Series Analysis
• Causal Relationships
• Simulation
Review Question

•What factors should

you consider when
choosing a forecasting
method?
 Qualitative Methods
• Used when there is the lack of historical data
• New product introduction
• Time horizon too far into the future (present data will be irrelevant
to the future)
• Utilize opinions and subjective views of informed people

Jury of executive Opinion Sales Force Composite

Qualitative
Methods

Consumer Market
Delphi Method
Survey
Qualitative Methods
Delphi Method:
• An iterative group process that allows experts, who may be
located in different places, to make forecasts.
• Three different types of participants in the Delphi process:
decisions makers, staff personnel, and respondents.
• The decision making group usually consists of 5 to 10
experts who will be making the actual forecast.
• The staff personnel assist the decision makers by preparing,
distributing, collecting, and summarizing a series of
questionnaires and survey results.
• The respondents are a group of people whose judgments
are valued and are being sought. This group provides inputs
to the decision makers before the forecasts are made.
Qualitative Methods
Jury of executive opinion:
• Takes the opinions of a small group of high level managers, and leads
to a group estimate of demand.

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.

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.
 Simple Moving Average Formula
• The simple moving average model assumes an average is a
good estimator of future behavior.
• The formula for the simple moving average is:

A t-1 + A t-2 + A t-3 +...+A t-n

Ft =
n
Ft = Forecast for the coming period
n = Number of periods to be averaged
A t-1 = Actual occurrence in the past period for
up to “n” periods
Simple Moving Average Problem (1)
A t-1 + A t-2 + A t-3 +...+A t-n
Week Demand Ft =
1 650
n
2 678 • Question: What are the 3-week
3 720 and 6-week moving average
4 785 forecasts for demand?
5 859 • Assume you only have 3 weeks
6 920 and 6 weeks of actual demand
7 850 data for the respective forecasts
8 758
9 892
10 920
11 789
12 844
 13
Calculating the moving averages gives us:
Week Demand 3-Week 6-Week
1 650 F4=(650+678+720)/3
2 678
=682.67
3 720 F7=(650+678+720
4 785 682.67 +785+859+920)/6
5 859 727.67 =768.67
6 920 788.00
7 850 854.67 768.67
8 758 876.33 802.00
9 892 842.67 815.33
10 920 833.33 844.00
11 789 856.67 866.50
12 844 867.00 854.83
©The McGraw-Hill Companies, Inc., 2001
Plotting the moving averages and comparing them
shows how the lines smooth out to reveal the overall
upward trend in this example.

950
900
850
d 800 Demand
n
a 750
m 700 3-Week
e 650
D 6-Week
600
550
500
1 2 3 4 5 6 7 8 9 10 11 12
Week
Simple Moving Average Problem (2) Data
• Question: What is the 3
week and 5 week moving
average forecast for this
data?
Week Demand
1 820
2 775
3 680
4 655
5 620
6 600
7 575
Simple Moving Average Problem (2)
Solution

Week Demand 3-Week 5-Week

1 820
2 775
3 680
4 655 758.33
5 620 703.33
6 600 651.67 710.00
7 575 625.00 666.00
 Weighted Moving Average Formula
While the moving average formula implies an equal
weight being placed on each value that is being
averaged, the weighted moving average permits an
unequal weighting on prior time periods.

The formula for the moving average is:

Ft = w 1 A t-1 + w 2 A t-2 + w 3 A t-3 +...+w n A t-n
n

w
i=1
i

wt = weight given to time period “t” occurrence. n

w =1 i

(Weights must add to one.) i=1

Weighted Moving Average Problem (1)
Data
Question: Given the weekly demand and weights, what is
the forecast for the 4th period or Week 4?

Week Demand Weights:

1 650
2 678 t-1 .5
3 720 t-2 .3
4 t-3 .2

Note that the weights place more emphasis on the

most recent data, that is time period “t-1”.
Weighted Moving Average Problem (1)
Solution

Week Demand Forecast

1 650
2 678
3 720
4 693.4

F4 = 0.5(720)+0.3(678)+0.2(650)=693.4
Weighted Moving Average Problem
(2) Data
Question: Given the weekly demand information and
weights, what is the weighted moving average
forecast of the 5th period or week?

Week Demand Weights:

1 820 t-1 .7
2 775 t-2 .2
3 680
t-3 .1
4 655
Weighted Moving Average Problem (2)
Solution

Week Demand Forecast

1 820
2 775
3 680
4 655
5 672

F5 = (0.7)(655) +(0.2)(680) +(0.1)(755)= 672

 Exponential Smoothing Model

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

a = smoothing constant
• Premise: The most recent observations might have the
highest predictive value.
• Therefore, we should give more weight to the more recent
time periods when forecasting.
Exponential Smoothing Problem (1) Data
• Question: Given the weekly
Week Demand
demand data, what are the
1 820
exponential smoothing forecasts
2 775
for periods 2-10 using a=0.10 and
3 680 a=0.60?
4 655 • Assume F1=D1
5 750
6 802
7 798
8 689
9 775
10
Answer: The respective alphas columns denote the forecast values.
Note that you can only forecast one time period into the future.
Week Demand 0.1 0.6
1 820 820.00 820.00
2 775 820.00 820.00
3 680 815.50 793.00
4 655 801.95 725.20
5 750 787.26 683.08
6 802 783.53 723.23
7 798 785.38 770.49
8 689 786.64 787.00
9 775 776.88 728.20
10 776.69 756.28
Exponential Smoothing Problem (1) Plotting

Note how that the smaller alpha the smoother the line in this
example.

850
800
d 750 Demand
n 700
a 0.1
m 650
e 600 0.6
D
550
500
1 2 3 4 5 6 7 8 9 10
Week
Exponential Smoothing Problem (2) Data

Week Demand Question: What are the

exponential smoothing
1 820 forecasts for periods 2-5 using
2 775 a =0.5?
3 680
Assume F1=D1
4 655
5
Exponential Smoothing Problem (2) Solution

F1=820+(0.5)(820-820)=820 F3=820+(0.5)(775-820)=797.75

Week Demand 0.5

1 820 820.00
2 775 820.00
3 680 797.50
4 655 738.75
5 696.88
 The MAD Statistic to Determine Forecasting Error

Forecast Error = Actual Value – Forecast Value

• MAD = Mean Absolute Deviation
• This is computed by taking the sum of the absolute values of
the individual forecast errors and dividing by the numbers of
errors (n);
n

MAD 
 forecast error A
t=1
t - Ft
n MAD =
n
• The ideal MAD is zero. That would mean there is no forecasting
error.
The larger the MAD, the less the desirable the resulting model.
MAD Problem Data
Question: What is the MAD value given
the forecast values in the table below?

Month Sales Forecast

1 220 n/a
2 250 255
3 210 205
4 300 320
5 325 315
MAD Problem Solution
Month Sales Forecast Abs Error
1 220 n/a
2 250 255 5
3 210 205 5
4 300 320 20
5 325 315 10

40

n
Note that by itself, the MAD
A
t=1
t - Ft
40 only lets us know the mean
MAD = = = 10 error in a set of forecasts.
n 4
 The MSE Statistic to Determine Forecasting
Error
• Forecast error = actual value – forecast value
• MSE = Mean Squared Error
• MSE is the average of the squared errors:

• The ideal MSE is zero. That would mean there is no forecasting

error.
The larger the MSE, the less the desirable the resulting model.
 The MAPE Statistic to Determine Forecasting
Error
• MAPE = Mean Absolute Percent Error
• The MAPE is the average of the absolute values of the
errors expressed as percentages of the actual values.
• This is computed as follows:

• The ideal MAPE is zero. That would mean there is no

forecasting error.
The larger the MAPE, the less the desirable the resulting model.
Why Bias Is not used?
• Another common term associated with
error in forecasting is known as BIAS
• Bias is the average error and tells whether
the forecast tends to be too high or too low
and by how much.
• Bias may be negative or positive.
• It is not a good measure of the actual size
of the errors because the negative errors
can cancel out the positive errors.
Simple Linear
Regression
 Some Terminology 1
• Dependent Variable - A dependent or outcome variable is
any variable that changes its value in response to another
variable
• Independent Variable - An independent or predictor or
explanatory variable is a variable that influences another
variable
• Correlation - is a statistical method used to determine
whether a linear relationship exists between any two
variables. It allows you to find out if there is a statistically
significant relationship between TWO variables
• Regression - is a statistical method used to describe the
nature of the relationship (causation) between any two
variables. It allows you to make predictions based on the
Some Terminology 2
• The Correlation Coefficient: A single summary
number that tells you whether a relationship
exists between two variables, how strong that
relationship is and whether the relationship is
positive or negative (indicated as R).
•R=

• The Coefficient of Determination: A single

summary number that tells you how much
variation in one variable is directly related to
variation in another variable (indicated as R2)
 37

The General Idea

• Simple Regression Analysis
• Considers the relationship between two variables (an
independent variable (X) and a dependent variable (Y))
OR between a single explanatory variable and response
variable
 38

The General Idea

• Multiple regression simultaneously considers
the influence of multiple explanatory variables
(X1, X2…Xk) on a response variable Y

The intent is to look at

the independent effect
of each variable as well
as the combined effect
 Simple Linear Regression Model
A regression analysis can be used to
develop an equation showing how the Y
dependent variable(y) is related to the
independent variable (x). A simple a
linear regression equation can be
0 1 2 3 4 5 x
expressed as: (Time)

Y = a + bx
I

Y’ is the dependent variable in the model,

x is independent variable in the model
a is the intercept value of the regression line, and
b is the slope of the regression line.
Simple Linear Regression Formulas for Calculating “a” and “b”
ŷ
YI = a + bx
a= -b
X
b=
(Formula 1)
Where;
= values of independent var.
b= = values of dependent var.
(Formula 2) mean of the dependent var.
mean of independent var.
n = total no. of observations
Simple Linear Regression Problem Data
Question: Given the data below, what is the simple linear
regression model that can be used to predict sales?

Week Sales
1 150
2 157
3 162
4 166
5 177
 42

First, using the linear regression formulas, we can compute “a” and “b”.

Week (x) x squared Sales (y) xy

1 1 150 150
2 4 157 314
3 9 162 486
4 16 166 664
5 25 177 885
3 55 162.4 2499

Avg of x = Sum of x Avg of y = Sum of xy

3 squared = 55 162.4 = 2499

b=
 xy - n( y)(x) 2499 - 5(162.4)(3) 63
=  = 6.3
 x - n(x )
2 2
55  5(9 ) 10

a = y - bx = 162.4 - (6.3)(3) = 143.5

 Resulting regression
Y = 143.5 + 6.3x
I

180 model
175
170
165
160 Sales
Sales

155 Forecast
150
145
140
135
1 2 3 4 5
Period

Now if we plot the regression generated forecasts against the

actual sales we obtain the following chart:
 Multiple Regression Model 1
ŷ
• Y = a + b 1x 1 + b 2x 2
I
X2
Formula for multiple linear regression
with two independent variables X1

Multiple regression equation with k independent

variables:
Estimated Estimated
(or predicted) Estimated slope coefficients
value of Y intercept

Ŷi  b0  b1X1  b2 X 2    b k X k  e
 Basic Biostat 15: Multiple Linear Regression 45

Regression Modeling
• A simple regression model (one
independent variable) fits a
regression line in 2-
Y dimensional space
Ŷ  b0  b1X1  b 2 X 2

• A multiple regression model with

X1
two explanatory variables fits a b le
regression plane in aria
orv
3-dimensional space pe f X
o
Sl
r v ari abl e X 2
fo
Slope

X1
 Multiple Regression Model 2
Formula for multiple linear
•Y = a + b1x1 + b2x2
I regression with two
independent variables

We will be calculating a, b1
and b2 using excel software
 Multiple Regression Equation
2 Variable Example
• A distributor of frozen dessert pies wants to evaluate
factors thought to influence demand

• Dependent variable: Pie sales (units per week)

• Independent variables: Price (in $)
Advertising ($100’s)
• Data are collected for 15 weeks

Statistics for Managers Using Microsoft Excel, 5e © 2008 Prentice-Hall, Inc. Chap 14-47
Multiple Regression Equation
2 Variable Example
Price Advertising
Week Pie Sales ($) ($100s)

1 350 5.50 3.3

2 460 7.50 3.3 Multiple regression equation:
3 350 8.00 3.0
4 430 8.00 4.5
• Sales = b0 + b1 (Price) + b2
5 350 6.80 3.0
6 380 7.50 4.0 (Advertising)
7 430 4.50 3.0
8 470 6.40 3.7
• Sales = b0 +b1X1 + b2X2
9 450 7.00 3.5
10 490 5.00 4.0
11 340 7.20 3.5
Where X1 = Price
12 300 7.90 3.2
13 440 5.90 4.0 X2 = Advertising
14 450 5.00 3.5
15 300 7.00 2.7
 Estimating a Multiple Linear
Regression Equation

• Excel will be used to generate the coefficients and

measures of goodness of fit for multiple regression

• Excel:
• Tools / Data Analysis... / Regression
 Multiple Regression Equation
2 Variable Example, Excel
Regression Statistics
Multiple R 0.72213
R Square 0.52148
Adjusted R Square 0.44172
Standard Error 47.46341
Observations 15
Sales  306.526 - 24.975(X1 )  74.131(X 2 )

ANOVA df SS MS F Significance F
Regression 2 29460.027 14730.013 6.53861 0.01201
Residual 12 27033.306 2252.776
Total 14 56493.333

Coefficients Standard Error t Stat P-value Lower 95% Upper 95%

Intercept 306.52619 114.25389 2.68285 0.01993 57.58835 555.46404
Price -24.97509 10.83213 -2.30565 0.03979 -48.57626 -1.37392
Advertising 74.13096 25.96732 2.85478 0.01449 17.55303 130.70888
 Multiple Regression Equation
2 Variable Example

Sales  306.526 - 24.975(X 1 )  74.131(X 2 )

where
Sales is in number of pies per week
Price is in $
Advertising is in $100’s.

b1 = -24.975: sales will b2 = 74.131: sales will

decrease, on average, by
24.975 pies per week for each
$1 increase in selling price,
net of the effects of changes
due to advertising
increase, on average, by
74.131 pies per week for
each $100 increase in
advertising, net of the
effects of changes due to
price
Multiple Regression Equation
2 Variable Example

Predict sales for a week in which the selling price is

$5.50 and advertising is $350:

Sales  306.526 - 24.975(X1 )  74.131(X 2 )

 306.526 - 24.975 (5.50)  74.131 (3.5)
 428.62

Note that Advertising is in

Predicted sales is $100’s, so $350 means that X2
428.62 pies = 3.5
END OF SESSION

• ANY
QUESTIONS?