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What is Forecasting?

Process of predicting a future event Underlying basis of all business decisions
Production Inventory Personnel Facilities

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Demand Management

Independent Demand: Finished Goods Dependent Demand: Raw Materials, Component parts, Sub-assemblies, etc.
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D(2)

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Independent Demand: What a firm can do to manage it?

‡ Can take an active role to influence demand

‡ Can take a passive role and simply respond to demand

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job scheduling. job assignments. budgeting Long-range forecast 3+ years New product planning. generally less than 3 months Purchasing. production levels Medium-range forecast 3 months to 3 years Sales and production planning. workforce levels.Forecasting Time Horizons Short-range forecast Up to 1 year. research and development mks . facility location.

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 mks .Distinguishing Differences Medium/long range forecasts deal with more comprehensive issues and support management decisions regarding planning and products.

Types of Forecasts Economic forecasts Address business cycle inflation rate. housing starts. Technological forecasts Predict rate of technological progress Impacts development of new products Demand forecasts Predict sales of existing products and services mks . etc. money supply.

The Realities Forecasts are seldom perfect Most techniques assume an underlying stability in the system Product family and aggregated forecasts are more accurate than individual product forecasts mks .

. At n n Ft = Forecast for the coming period At 1 = Actual value in period t 1 n = Number of periods to be averaged At 2. At n Actual occurrences two periods ago .three periods ago and so on up to n periods ago mks .Simple Moving Average ‡ Ft = At ‡ ‡ ‡ ‡ 1 + At 2 + At 3+ . At 3 .

Moving Average Example Month January February March April May June July Actual Shed Sales 10 12 13 16 19 23 26 3-Month Moving Average (10 + 12 + 13)/3 = 11 2/3 13)/3 (12 + 13 + 16)/3 = 13 2/3 (13 + 16 + 19)/3 = 16 (16 + 19 + 23)/3 = 19 1/3 mks .

Three period Moving Average If actual demand in period 6 turns out to be 38. the moving average forecast for period 7 would be mks .

Three Period Moving Average mks .

Weighted Moving Average The formula for a weighted moving average Ft = w At 1 + w At 2+ .. mks . + wn At n w = weight to be given to actual occurrence for the period t-1 w = weight to be given to actual occurrence for the period t-2 wn = weight to be given to actual occurrence for the period t-n n =Total Number of Periods in the forecast .

more distant data may have greater weights than more recent data) the sum of all the weights must be equal to 1. mks .the most recent past is the most important indicator of what to expect in the future and therefore it should get a higher weighting .g.Weighted Moving Average Although many periods may be ignored (that is their weights are zero ) and the weighting scheme may be in any order (for e.As a general rule . Choosing Weights ---Experience and trial and error are the simplest ways to choose weights .

and .0 F7 = . forecast demand for period 7 using the same weights as in part a.40 for the most recent period. Period 1 2 3 4 5 Demand 42 40 43 40 41 Solution: --F6 = .30(40) + . b)If the actual demand for period 6 is 39.20(43) + .20 for the next.10 for the next.20(40) + .30 for the next most recent. a) Compute a weighted average forecast using a weight of .Illustration Given the following demand data.10(43) + .40(39) = 40.30(41) + .2 mks . . .10(40) + .40(41) = 41.

Moving Average And Weighted Moving Average 30 25 Sales demand 20 15 10 5 | J | F | M | A | M | J | J | A | S | O | N | D Moving average Actual sales Weighted moving average .

Exponential Smoothing Form of weighted moving average Weights decline exponentially Most recent data weighted most Requires smoothing constant (E) Ranges from 0 to 1 Subjectively chosen Involves little record keeping of past data mks .

20 percent of three month ago and 10 percent of four month ago .5 mks .If actual sales experience was Month 1 Month2 Month3 Month4 100 90 105 95 ? ‡ The forecast for month 5 would be ‡ F5=0.30 percent of two months ago .10(100)= ‡ =38+31.Illustration ‡ A department store may find that in a four month period the best forecast is derived using 40percent of the actual sales for the most recent month .5+18+10 ‡ =97.40 (95)+0.20(90)+ .30(105)+0.

‡ Many processes in nature have exponential dependencies .The decay with time of the amplitude of a pendulum swinging in air .the decrease in time of the temperature of an object that is initially warmer than its surroundings and the growth in time of an initially small bacterial colony are all processes that are well modelled exponential relationships .Exponential dependencies. mks .

Y=exp(x) ‡ . mks .

= Actual demand in the prior period mks .Exponential Smoothing -1 Ft = Ft ‡ Ft ‡ Ft 1 ‡ ‡ At 1 1 + (At 1 .Ft 1) = Exponentially smoothed forecast for Period t = Exponentially smoothed forecast for Period t-1 = Smoothing constant .

the next forecast would be Ft = 41.8 +0. if the actual demand turns out to be 43.10(40-42)=41. and = . Each new forecast is equal to the previous forecast plus a percentage of the previous error. actual demand was 40 units. The new forecast would be computed as follows: Ft =42+0.Exponential Smoothing -2 ‡ The smoothing constant represents a percentage of the forecast error.8 Then. suppose the previous forecast was 42 units. ‡ For example.10(43-41.10.92 mks .8)=41.

Ft 1) ‡ ‡ =1050+0.what would be the the forecast for this month ? ‡ Ft = Ft 1 + (At 1 .05 is considered appropriate .05(1000-1050) ‡ =1050+0.If 1000 actually were demanded rather than 1050 .Illustration ‡ The long run demand for the product under study is relatively stable and a smoothing constant (alpha) of 0.05(-50) ‡ =1047.Assume that last month s forecast Ft 1 was 1050 units .If the exponential method were used as a continuing policy a forecast would have been made for last month .5 units mks .

‡ Single exponential smoothing has the shortcoming of lagging changes in demand .the more closely the forecast follows the actual . mks .Adjusting the value of alpha also helps .Exponential Smoothing -3 ‡ Higher the value of alpha .a trend factor may be added . ‡ To more closely track actual demand .

Impact of Different Alpha mks .

The mean absolute deviation (MAD) 2. The mean absolute percent error (MAPE). The mean squared error (MSE) 3. and MAPE are as follows: mks . MSE.Forecast Accuracy Three commonly used measures for summarizing historical errors are. The formulas used to compute MAD. 1.

Common Measures of Error Mean Absolute Deviation (MAD) MAD) MAD = |Actual .Forecast| n Mean Squared Error (MSE) MSE) MSE = (Forecast Errors)2 Errors) n mks .

Forecasti|/Actuali MAPE = i=1 n mks .Common Measures of Error Mean Absolute Percent Error (MAPE) MAPE) n 100|Actual 100|Actuali .

F t ) §et2 MSE = t = 1 = t =1 n n mks . n n 2 § ( A t .Measuring Forecast Accuracy ‡ Mean Squared Error (MSE) represents the variance of errors in a forecast. This criterion is most useful if you want to minimize the occurrence of a major error(s).

Ft | = §| e t =1 t | where: At = actual value in period t. A sign of an error. which represents over.Measuring Forecast Accuracy ‡ Mean Absolute Deviation (MAD) measures the average absolute error of a forecast. n = number of periods. et = forecast error in period t. mks n n . is really not important in most cases. n n t §| A MAD = t =1 . we are rather concerned with the value of deviation. Ft = forecasted value in period t.or underestimation.

Accuracy and Control of Forecasts Forecast error: is the difference between the value that occurs and the value that was predicted for a given time period. Error = Actual Forecast mks .

showing actual and predicted numbers of accounts serviced. mks . and MAPE for the following data.Illustration Compute MAD. MSE.

MAD/MAPE/MSE ‡ ‡ ‡ MSE = (e) ² = 76/8=9.5 n mks .