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13

Forecasting Demand

PowerPoint Slides by Jeff Heyl


Copyright 2010 Pearson Education, Inc.

For Operations Management, 9e (Global Edition) by Krajewski/Ritzman/Malhotra 2010 Pearson Education

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Forecasting
Forecasts are critical inputs to business plans, annual plans, and budgets Finance, human resources, marketing, operations, and supply chain managers need forecasts to plan: output levels, purchases of services and materials, workforce and output schedules, inventories, and long-term capacities

Forecasts are made on many different variables


Forecasts are important to managing both processes and managing supply chains

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Demand Patterns
A time series is the repeated observations of demand for a service or product in their order of occurrence There are five basic time series patterns
Horizontal Trend Seasonal Cyclical Random

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Demand Patterns
Figure 13.1 Patterns of Demand

Quantity

Time (a) Horizontal: Data cluster about a horizontal line


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Demand Patterns
Figure 13.1 Patterns of Demand

Quantity

Time (b) Trend: Data consistently increase or decrease


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Demand Patterns
Figure 13.1 Patterns of Demand

Quantity

Year 1

Year 2 | J | F | M | A | M | | J J Months | A | S | O | N | D

(c) Seasonal: Data consistently show peaks and valleys


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Demand Patterns
Figure 13.1 Patterns of Demand

Quantity

| 1

| 2

| 3 Years

| 4

| 5

| 6

(d) Cyclical: Data reveal gradual increases and decreases over extended periods
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Key Decisions
Deciding what to forecast
Level

of aggregation Units of measure

Choosing a forecasting system Choosing the type of forecasting technique


Judgment

and qualitative methods Causal methods Time-series analysis

Key factor in choosing the proper forecasting approach is the time horizon for the decision requiring forecasts
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Judgment Methods
Other methods (casual and time-series) require an adequate history file, which might not be available Judgmental forecasts use contextual knowledge gained through experience Salesforce estimates

Executive opinion is a method in which opinions, experience, and technical knowledge of one or more managers are summarized to arrive at a single forecast Delphi method

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Judgment Methods
Market research is a systematic approach to determine external customer interest through data-gathering surveys

Delphi method is a process of gaining consensus from a group of experts while maintaining their anonymity
Useful when no historical data are available Can be used to develop long-range forecasts and technological forecasting

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Linear Regression
A dependent variable is related to one or more independent variables by a linear equation

The independent variables are assumed to cause the results observed in the past
Simple linear regression model is a straight line Y = a + bX
where Y X a b = dependent variable = independent variable = Y-intercept of the line = slope of the line

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Linear Regression
Y Deviation, or error Estimate of Y from regression equation Actual value of Y

Regression equation: Y = a + bX

Dependent variable

Value of X used to estimate Y X

Independent variable
Figure 13.2 Linear Regression Line Relative to Actual Data
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Linear Regression
The sample correlation coefficient, r

Measures the direction and strength of the relationship between the independent variable and the dependent variable. The value of r can range from 1.00 r 1.00 Measures the amount of variation in the dependent variable about its mean that is explained by the regression line

The sample coefficient of determination, r2

The values of r2 range from 0.00 r2 1.00

The standard error of the estimate, syx

Measures how closely the data on the dependent variable cluster around the regression line
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Using Linear Regression


EXAMPLE 13.1

The supply chain manager seeks a better way to forecast the demand for door hinges and believes that the demand is related to advertising expenditures. The following are sales and advertising data for the past 5 months:
Month 1 2 3 4 5 Sales (thousands of units) 264 116 165 101 209 Advertising (thousands of $) 2.5 1.3 1.4 1.0 2.0

The company will spend $1,750 next month on advertising for the product. Use linear regression to develop an equation and a forecast for this product.
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Using Linear Regression


SOLUTION

We used POM for Windows to determine the best values of a, b, the correlation coefficient, the coefficient of determination, and the standard error of the estimate
a= b= r= r2 = syx = 8.135 109.229X 0.980 0.960 15.603

The regression equation is Y = 8.135 + 109.229X

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Using Linear Regression


The regression line is shown in Figure 13.3. The r of 0.98 suggests an unusually strong positive relationship between sales and advertising expenditures. The coefficient of determination, r2, implies that 96 percent of the variation in sales is explained by advertising expenditures.
Brass Door Hinge 250 Sales (000 units) 200 150 100 50 0
| |

X X X X Forecasts X Data

1.0

2.0 Advertising ($000)

Figure 13.3 Linear Regression Line for the Sales and Advertising Data
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Time Series Methods


In a naive forecast the forecast for the next period equals the demand for the current period (Forecast = Dt) Estimating the average: simple moving averages
Used

to estimate the average of a demand time series and thereby remove the effects of random fluctuation Most useful when demand has no pronounced trend or seasonal influences The stability of the demand series generally determines how many periods to include

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Time Series Methods


450 430 Patient arrivals 410 390 370 350

10

15 Week

20

25

30

Figure 13.4 Weekly Patient Arrivals at a Medical Clinic


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Simple Moving Averages


Specifically, the forecast for period t + 1 can be calculated at the end of period t (after the actual demand for period t is known) as
Dt + Dt-1 + Dt-2 + + Dt-n+1 Sum of last n demands Ft+1 = = n n where Dt = actual demand in period t n = total number of periods in the average Ft+1 = forecast for period t + 1

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Simple Moving Averages


For any forecasting method, it is important to measure the accuracy of its forecasts. Forecast error is simply the difference found by subtracting the forecast from actual demand for a given period, or
Et = Dt Ft
where Et = forecast error for period t Dt = actual demand in period t Ft = forecast for period t

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Using the Moving Average Method


EXAMPLE 13.2 a. Compute a three-week moving average forecast for the arrival of medical clinic patients in week 4. The numbers of arrivals for the past three weeks were as follows:
Week 1 Patient Arrivals 400

2
3

380
411

b. If the actual number of patient arrivals in week 4 is 415, what is the forecast error for week 4?
c. What is the forecast for week 5?

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Using the Moving Average Method


SOLUTION a. The moving average forecast at the end of week 3 is F4 =
Week 1 2 3 Patient Arrivals 400 380 411

411 + 380 + 400 = 397.0 3

b. The forecast error for week 4 is


E4 = D4 F4 = 415 397 = 18 c. The forecast for week 5 requires the actual arrivals from weeks 2 through 4, the three most recent weeks of data F5 = 415 + 411 + 380 = 402.0 3
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Application 13.1a
Estimating with Simple Moving Average using the following customer-arrival data
Month 1 2 3 4 Customer arrival 800 740 810 790

Use a three-month moving average to forecast customer arrivals for month 5


D4 + D3 + D2 790 + 810 + 740 F5 = = = 780 3 3

Forecast for month 5 is 780 customer arrivals


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Application 13.1a
If the actual number of arrivals in month 5 is 805, what is the forecast for month 6?
Month 1 2 3 4 Customer arrival 800 740 810 790

D5 + D4 + D3 805 + 790 + 810 F6 = = = 801.667 3 3

Forecast for month 6 is 802 customer arrivals

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Application 13.1a
Forecast error is simply the difference found by subtracting the forecast from actual demand for a given period, or Et = Dt Ft Given the three-month moving average forecast for month 5, and the number of patients that actually arrived (805), what is the forecast error?

E5 = 805 780 = 25
Forecast error for month 5 is 25

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Weighted Moving Averages


In the weighted moving average method, each historical demand in the average can have its own weight, provided that the sum of the weights equals 1.0. The average is obtained by multiplying the weight of each period by the actual demand for that period, and then adding the products together:
Ft+1 = W1D1 + W2D2 + + WnDt-n+1

A three-period weighted moving average model with the most recent period weight of 0.50, the second most recent weight of 0.30, and the third most recent might be weight of 0.20
Ft+1 = 0.50Dt + 0.30Dt1 + 0.20Dt2
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Application 13.1b
Revisiting the customer arrival data in Application 13.1a. Let W1 = 0.50, W2 = 0.30, and W3 = 0.20. Use the weighted moving average method to forecast arrivals for month 5. F5 = W1D4 + W2D3 + W3D2 = 0.50(790) + 0.30(810) + 0.20(740) = 786 Forecast for month 5 is 786 customer arrivals Given the number of patients that actually arrived (805), what is the forecast error? E5 = 805 786 = 19

Forecast error for month 5 is 19


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Application 13.1b
If the actual number of arrivals in month 5 is 805, compute the forecast for month 6 F6 = W1D5 + W2D4 + W3D3 = 0.50(805) + 0.30(790) + 0.20(810) = 801.5

Forecast for month 6 is 802 customer arrivals

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Exponential Smoothing
A sophisticated weighted moving average that calculates the average of a time series by giving recent demands more weight than earlier demands Requires only three items of data

The last periods forecast The demand for this period A smoothing parameter, alpha (), where 0 1.0

The equation for the forecast is


Ft+1 = (Demand this period) + (1 )(Forecast calculated last period) = Dt + (1 )Ft

or the equivalent
Ft+1 = Ft + (Dt Ft)
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Exponential Smoothing
The emphasis given to the most recent demand levels can be adjusted by changing the smoothing parameter Larger values emphasize recent levels of demand and result in forecasts more responsive to changes in the underlying average

Smaller values treat past demand more uniformly and result in more stable forecasts
Exponential smoothing is simple and requires minimal data When the underlying average is changing, results will lag actual changes
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Exponential Smoothing and Moving Average


450 430 410 390 370 Exponential smoothing = 0.10
| | | | | |

3-week MA forecast

6-week MA forecast

Patient arrivals

10

15 Week

20

25

30

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Using Exponential Smoothing


EXAMPLE 13.3 a. Reconsider the patient arrival data in Example 13.2. It is now the end of week 3. Using = 0.10, calculate the exponential smoothing forecast for week 4. b. What was the forecast error for week 4 if the actual demand turned out to be 415? c. What is the forecast for week 5?
Week 1 2 Patient Arrivals 400 380

3
4

411
415

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Using Exponential Smoothing


SOLUTION

a. The exponential smoothing method requires an initial forecast. Suppose that we take the demand data for the first two weeks and average them, obtaining (400 + 380)/2 = 390 as an initial forecast. (POM for Windows and OM Explorer simply use the actual demand for the first week as a default setting for the initial forecast for period 1, and do not begin tracking forecast errors until the second period). To obtain the forecast for week 4, using exponential smoothing with and the initial forecast of 390, we calculate the average at the end of week 3 as
F4 = 0.10(411) + 0.90(390) = 392.1 Thus, the forecast for week 4 would be 392 patients.

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Using Exponential Smoothing


b. The forecast error for week 4 is E4 = 415 392 = 23

c. The new forecast for week 5 would be


F5 = 0.10(415) + 0.90(392.1) = 394.4 or 394 patients. Note that we used F4, not the integer-value forecast for week 4, in the computation for F5. In general, we round off (when it is appropriate) only the final result to maintain as much accuracy as possible in the calculations.

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Application 13.1c
Suppose the value of the customer arrival series average in month 3 was 783 customers (let it be F4). Use exponential smoothing with = 0.20 to compute the forecast for month 5. Ft+1 = Ft + (Dt Ft) = 783 + 0.20(790 783) = 784.4

Forecast for month 5 is 784 customer arrivals


Given the number of patients that actually arrived (805), what is the forecast error? E5 = 805 784 = 21 Forecast error for month 5 is 21

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Application 13.1c
Given the actual number of arrivals in month 5, what is the forecast for month 6?
Ft+1 = Ft + (Dt Ft) = 784.4 + 0.20(805 784.4) = 788.52

Forecast for month 6 is 789 customer arrivals

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Including a Trend
A trend in a time series is a systematic increase or decrease in the average of the series over time The forecast can be improved by calculating an estimate of the trend Trend-adjusted exponential smoothing requires two smoothing constants

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Including a Trend
For each period, we calculate the average and the trend:
At = (Demand this period)

+ (1 )(Average + Trend estimate last period)


= Dt + (1 )(At1 + Tt1) Tt = (Average this period Average last period) + (1 )(Trend estimate last period) = (At At1) + (1 )Tt1 Ft+1 = At + Tt
where At = Tt = = = Ft+1 = exponentially smoothed average of the series in period t exponentially smoothed average of the trend in period t smoothing parameter for the average, with a value between 0 and 1 smoothing parameter for the trend, with a value between 0 and 1 forecast for period t + 1
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Using Trend-Adjusted Exponential Smoothing


EXAMPLE 13.4 Medanalysis, Inc., provides medical laboratory services Managers are interested in forecasting the number of blood analysis requests per week There has been a national increase in requests for standard blood tests Medanalysis recently ran an average of 28 blood tests per week and the trend has been about three additional patients per week

This weeks demand was for 27 blood tests


We use = 0.20 and = 0.20 to calculate the forecast for next week

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Using Trend-Adjusted Exponential Smoothing


SOLUTION A0 = 28 patients and T0 = 3 patients The forecast for week 2 (next week) is A1 = 0.20(27) + 0.80(28 + 3) = 30.2 T1 = 0.20(30.2 28) + 0.80(3) = 2.8 F2 = 30.2 + 2.8 = 33 blood tests If the actual number of blood tests requested in week 2 proved to be 44, the updated forecast for week 3 would be A2 = 0.20(44) + 0.80(30.2 + 2.8) = 35.2 T2 = 0.2(35.2 30.2) + 0.80(2.8) = 3.2 F3 = 35.2 + 3.2 = 38.4 or 38 blood tests

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Using Trend-Adjusted Exponential Smoothing


TABLE 13.1 | | FORECASTS FOR MEDANALYSIS USING THE TREND-ADJUSTED EXPONENTIAL SMOOTHING MODEL Calculations to Forecast Arrivals for Next Week Week 0 1 2 3 4 5 6 7 Arrivals 28 27 44 37 35 53 38 57 Smoothed Average 28.00 Trend Average 3.00 Forecast for This Week Forecast Error

8
9 10 11

61
39 55 54

12
13 14 15

52
60 60 75
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Using Trend-Adjusted Exponential Smoothing


TABLE 13.1 | | FORECASTS FOR MEDANALYSIS USING THE TREND-ADJUSTED EXPONENTIAL SMOOTHING MODEL Calculations to Forecast Arrivals for Next Week Week 0 1 2 3 4 5 6 7 Arrivals 28 27 44 37 35 53 38 57 Smoothed Average 28.00 30.20 35.23 38.21 40.14 45.08 46.35 50.83 55.46 54.99 57.17 58.63 59.21 60.99 62.37 66.38 Trend Average 3.00 2.84 3.28 3.22 2.96 3.36 2.94 3.25 3.52 2.72 2.62 2.38 2.02 1.97 1.86 2.29 28.00 + 3.00 = 31.00 30.20 + 2.84 = 33.04 35.23 + 3.28 = 38.51 38.21 + 3.22 = 41.43 40.14 + 2.96 = 43.10 45.08 + 3.36 = 48.44 46.35 + 2.94 = 49.29 50.83 + 3.25 = 54.08 4 10.96 1.51 6.43 9.90 10.44 7.71 6.92 Forecast for This Week Forecast Error

8
9 10 11

61
39 55 54

55.46 + 3.52 = 58.98


54.99 + 2.72 = 57.71 57.17 + 2.62 = 59.79

19.98
2.71 5.79

12
13 14 15

52
60 60 75

58.63 + 2.38 = 61.01


59.21 + 2.02 = 61.23 60.99 + 1.97 = 62.96 62.37 + 1.86 = 64.23

9.01
1.23 2.96 10.77
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Using Trend-Adjusted Exponential Smoothing


80 70 Patient arrivals 60 50

Trend-adjusted forecast

40
30

Actual blood test requests

8 Week

9 10 11 12 13 14 15

Figure 13.5 Trend-Adjusted Forecast for Medanalysis


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Application 13.2
The forecaster for Canine Gourmet dog breath fresheners estimated (in March) the sales average to be 300,000 cases sold per month and the trend to be +8,000 per month. The actual sales for April were 330,000 cases. What is the forecast for May, assuming = 0.20 and = 0.10?
AApr = Dt + (1 )(AMar + TMar) = 0.20(330,000) + 0.80(300,000 + 8,000) = 312,400 cases TApr = (AApr AMar) + (1 )TMar = 0.10(312,400 300,000) + 0.90(8,000) = 8,440 cases Forecast for May = AApr + pTApr = 312,400 + (1)(8,440) = 320,840 cases

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Application 13.2
Suppose you also wanted the forecast for July, three months ahead. To make forecasts for periods beyond the next period, we multiply the trend estimate by the number of additional periods that we want in the forecast and add the results to the current average.
Forecast for July = AApr + pTApr = 312,400 + (3)(8,440) = 337,720 cases

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Seasonal Patterns
Seasonal patterns are regularly repeated upward or downward movements in demand measured in periods of less than one year Account for seasonal effects by using one of the techniques already described but to limit the data in the time series to those periods in the same season This approach accounts for seasonal effects but discards considerable information on past demand

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Multiplicative Seasonal Method


Multiplicative seasonal method, whereby seasonal factors are multiplied by an estimate of the average demand to arrive at a seasonal forecast
1. For each year, calculate the average demand for each season by dividing annual demand by the number of seasons per year 2. For each year, divide the actual demand for each season by the average demand per season, resulting in a seasonal index for each season 3. Calculate the average seasonal index for each season using the results from Step 2 4. Calculate each seasons forecast for next year
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Using the Multiplicative Seasonal Method


EXAMPLE 13.5 The manager of the Stanley Steemer carpet cleaning company needs a quarterly forecast of the number of customers expected next year. The carpet cleaning business is seasonal, with a peak in the third quarter and a trough in the first quarter. Following are the quarterly demand data from the past 4 years:
Quarter 1 2 3 4 Total Year 1 45 335 520 100 1000 Year 2 70 370 590 170 1200 Year 3 100 585 830 285 1800 Year 4 100 725 1160 215 2200

The manager wants to forecast customer demand for each quarter of year 5, based on an estimate of total year 5 demand of 2,600 customers
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Using the Multiplicative Seasonal Method


SOLUTION Figure 13.6 shows the solution using the Seasonal Forecasting Solver in OM Explorer. For the Inputs the forecast for the total demand in year 5 is needed. The annual demand has been increasing by an average of 400 customers each year (from 1,000 in year 1 to 2,200 in year 4, or 1,200/3 = 400). The computed forecast demand is found by extending that trend, and projecting an annual demand in year 5 of 2,200 + 400 = 2,600 customers. The Results sheet shows quarterly forecasts by multiplying the seasonal factors by the average demand per quarter. For example, the average demand forecast in year 5 is 650 customers (or 2,600/4 = 650). Multiplying that by the seasonal index computed for the first quarter gives a forecast of 133 customers (or 650 0.2043 = 132.795).

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Using the Multiplicative Seasonal Method

Figure 13.6 Demand Forecasts Using the Seasonal Forecast Solver of OM Explorer
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Application 13.3
Suppose the multiplicative seasonal method is being used to forecast customer demand. The actual demand and seasonal indices are shown below.
Year 1 Quarter 1 Demand 100 Index 0.40 192 Year 2 Demand Index 0.64 Average Index 0.52

2
3 4 Average

400
300 200 250

1.60
1.20 0.80

408
384 216 300

1.36
1.28 0.72

1.48
1.24 0.76

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Application 13.3
If the projected demand for Year 3 is 1320 units, what is the forecast for each quarter of that year? 1320 units 4 quarters = 330 units
Quarter 1 2 3 Average Index 0.52 1.48 1.24

0.76

Forecast for Quarter 1 = 0.52(330) 172 units Forecast for Quarter 2 = 1.48(330) 488 units Forecast for Quarter 3 = 1.24(330) 409 units Forecast for Quarter 4 = 0.76(330) 251 units

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Seasonal Patterns

(a) Multiplicative pattern

Demand
|

8 Period

10

12

14

16

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Seasonal Patterns

(b) Additive pattern

Demand
|

8 Period

10

12

14

16

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Choosing a Time-Series Method


Forecast performance is determined by forecast errors

Forecast errors detect when something is going wrong with the forecasting system
Forecast errors can be classified as either bias errors or random errors Bias errors are the result of consistent mistakes Random error results from unpredictable factors that cause the forecast to deviate from the actual demand

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Measures of Forecast Error


(Et E )2
n1

CFE = Et

CFE E= n

MAD =

|Et |
n

MSE =

Et2
n

MAPE =

(|Et |/ Dt)(100)
n

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Calculating Forecast Errors


EXAMPLE 13.6 The following table shows the actual sales of upholstered chairs for a furniture manufacturer and the forecasts made for each of the last eight months. Calculate CFE, MSE, , MAD, and MAPE for this product.
Month t 1 2 Demand Dt 200 240 Forecast Ft 225 220 Error Et 25 20 Error2 Et2 Absolute Error |Et| Absolute % Error (|Et|/Dt)(100)

3
4 5 6 7

300
270 230 260 210

285
290 250 240 250

15
20 20 20 40 400 400 1,600 20 20 40 8.7 7.7 19.0

275

240
Total

35
15

1,225
5,275

35
195

12.7
81.3%

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Calculating Forecast Errors


EXAMPLE 13.6 The following table shows the actual sales of upholstered chairs for a furniture manufacturer and the forecasts made for each of the last eight months. Calculate CFE, MSE, , MAD, and MAPE for this product.
Month t 1 2 Demand Dt 200 240 Forecast Ft 225 220 Error Et 25 20 Error2 Et2 625 400 Absolute Error |Et| 25 20 Absolute % Error (|Et|/Dt)(100) 12.5% 8.3

3
4 5 6 7

300
270 230 260 210

285
290 250 240 250

15
20 20 20 40

225
400 400 400 1,600

15
20 20 20 40

5.0
7.4 8.7 7.7 19.0

275

240
Total

35
15

1,225
5,275

35
195

12.7
81.3%

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Calculating Forecast Errors


SOLUTION Using the formulas for the measures, we get

Cumulative forecast error (bias):


CFE = 15 Average forecast error (mean bias): E= Mean squared error: Et2 5,275 MSE = n = 8 CFE n = 1.875

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Calculating Forecast Errors


Standard deviation: =

[Et (1.875)]2
n1

= 27.4

Mean absolute deviation:


|Et | 195 = = 24.4 MAD = n 8 Mean absolute percent error: (|Et |/ Dt)(100) 81.3% = = 10.2% MAPE = n 8

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Calculating Forecast Errors


A CFE of 15 indicates that the forecast has a slight bias to overestimate demand. The MSE, , and MAD statistics provide measures of forecast error variability. A MAD of 24.4 means that the average forecast error was 24.4 units in absolute value. The value of , 27.4, indicates that the sample distribution of forecast errors has a standard deviation of 27.4 units. A MAPE of 10.2 percent implies that, on average, the forecast error was about 10 percent of actual demand. These measures become more reliable as the number of periods of data increases.

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Tracking Signals
A measure that indicates whether a method of forecasting is accurately predicting actual changes in demand Useful when forecast systems are computerized because it alerts analysts when forecast are getting far from desirable limits CFE Tracking signal = MAD Each period, the CFE and MAD are updated to reflect current error, and the tracking signal is compared to some predetermined limits
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Tracking Signals
The MAD can be calculated as a weighted average determined by the exponential smoothing method MADt = |Et| + (1 )MADt-1

If forecast errors are normally distributed with a mean of 0, the relationship between and MAD is simple
= ( /2)(MAD) 1.25(MAD) MAD = 0.7978 0.8

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Tracking Signals
+2.0 +1.5 Tracking signal +1.0 +0.5 Out of control Control limit

0
0.5 1.0 1.5
|

Control limit
| | | |

10 15 20 Observation number

25

Figure 13.7 Tracking Signal


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Criteria for Selecting Methods


Criteria to use in making forecast method and parameter choices include
1. Minimizing bias
2. Minimizing MAPE, MAD, or MSE 3. Meeting managerial expectations of changes in the components of demand

4. Minimizing the forecast error last period

Statistical performance measures can be used


1. For projections of more stable demand patterns, use lower and values or larger n values
2. For projections of more dynamic demand patterns try higher and values or smaller n values

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Using Multiple Techniques


Combination forecasts are forecasts that are produced by averaging independent forecasts based on different methods or different data or both Focus forecasting selects the best forecast from a group of forecasts generated by individual techniques

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Forecasting as a Process
A typical forecasting process
Step 1: Adjust history file Step 2: Prepare initial forecasts

Step 3: Consensus meetings and collaboration


Step 4: Revise forecasts Step 5: Review by operating committee Step 6: Finalize and communicate

Forecasting is not a stand-alone activity, but part of a larger process

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Forecasting as a Process

Adjust history file 1

Prepare initial forecasts 2

Consensus meetings and collaboration 3

Finalize and communicate 6

Review by Operating Committee 5

Revise forecasts 4

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Forecasting Principles
TABLE 13.2 | SOME PRINCIPLES FOR THE FORECASTING PROCESS Better processes yield better forecasts Demand forecasting is being done in virtually every company, either formally or informally. The challenge is to do it wellbetter than the competition Better forecasts result in better customer service and lower costs, as well as better relationships with suppliers and customers The forecast can and must make sense based on the big picture, economic outlook, market share, and so on The best way to improve forecast accuracy is to focus on reducing forecast error Bias is the worst kind of forecast error; strive for zero bias

Whenever possible, forecast at more aggregate levels. Forecast in detail only where necessary
Far more can be gained by people collaborating and communicating well than by using the most advanced forecasting technique or model

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Solved Problem 1
The monthly demand for units manufactured by the Acme Rocket Company has been as follows:
Month Units Month Units

May June July


August

100 80 110
115

September October November


December

105 110 125


120

a. Use the exponential smoothing method to forecast June to January. The initial forecast for May was 105 units; = 0.2.

b. Calculate the absolute percentage error for each month from June through December and the MAD and MAPE of forecast error as of the end of December.
c. Calculate the tracking signal as of the end of December. What can you say about the performance of your forecasting method?
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Solved Problem 1
SOLUTION a.
Current Month, t May June July Calculating Forecast for Next Month Ft+1 = Dt + (1 )Ft 0.2(100) + 0.8(105) 0.2(110) + 0.8(99.2) = 104.0 or 104 99.2 or 99 = 101.4 or 101 0.2(80) + 0.8(104.0) = Forecast for Month t + 1 June July August

August
September October November December

0.2(115) + 0.8(101.4) = 104.1 or 104

September
October November December January

0.2(105) + 0.8(104.1) = 104.3 or 104 0.2(110) + 0.8(104.3) = 105.4 or 105


0.2(125) + 0.8(105.4) = 109.3 or 109 0.2(120) + 0.8(109.3) = 111.4 or 111

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Solved Problem 1
b.
Actual Demand, Dt 80 Absolute Percent Error, (|Et|/Dt)(100) 30.0% 10.0 12.0 1.0 5.5 16.0 9.2 83.7%

Month, t June

Forecast, Ft 104

Error, Et = Dt Ft 24 11 14 1 6 20 11 39

Absolute Error, |Et| 24 11 14 1 6 20 11 87

July
August September October November December Total

110
115 105 110 125 120 765

99
101 104 104 105 109

|Et | 87 MAD = n = = 12.4 7


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(|Et |/Dt)(100) 83.7% MAPE = = = 11.96% n 7


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Solved Problem 1
c. As of the end of December, the cumulative sum of forecast errors (CFE) is 39. Using the mean absolute deviation calculated in part (b), we calculate the tracking signal: CFE 39 = = 3.14 MAD 12.4

Tracking signal =

The probability that a tracking signal value of 3.14 could be generated completely by chance is small. Consequently, we should revise our approach. The long string of forecasts lower than actual demand suggests use of a trend method.

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Solved Problem 2
The Polish Generals Pizza Parlor is a small restaurant catering to patrons with a taste for European pizza. One of its specialties is Polish Prize pizza. The manager must forecast weekly demand for these special pizzas so that he can order pizza shells weekly. Recently, demand has been as follows:
Week June 2 Pizzas 50 Week June 23 Pizzas 56

June 9
June 16

65
52

June 30
July 7

55
60

a. Forecast the demand for pizza for June 23 to July 14 by using the simple moving average method with n = 3 then using the weighted moving average method with and weights of 0.50, 0.30, and 0.20, with 0.50. b. Calculate the MAD for each method.
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Solved Problem 2
SOLUTION a. The simple moving average method and the weighted moving average method give the following results:
Current Week June 16 Simple Moving Average Forecast for Next Week Weighted Moving Average Forecast for Next Week [(0.5 52) + (0.3 65) + (0.2 50)] = 55.5 or 56 [(0.5 56) + (0.3 52) + (0.2 65)] = 56.6 or 57 [(0.5 55) + (0.3 56) + (0.2 52)] = 54.7 or 55 [(0.5 60) + (0.3 55) + (0.2 56)] = 57.7 or 58

52 + 65 + 50 = 55.7 or 56 3
56 + 52 + 65 = 57.7 or 58 3 55 + 56 + 52 = 54.3 or 54 3 60 + 55 + 56 = 57.0 or 57 3

June 23
June 30 July 7

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Solved Problem 2
b. The mean absolute deviation is calculated as follows:
Simple Moving Average Week June 23 June 30 July 7 Actual Demand 56 55 60 Forecast for This Week 56 58 54 Absolute Errors |Et| |56 56| = 0 |55 58| = 3 |60 54| = 6 MAD = 0+3+6 =3 3 Weighted Moving Average Forecast for This Week 56 57 55 Absolute Errors |Et| |56 56| = 0 |55 57| = 2 |60 55| = 5 MAD = 0+2+2 = 2.3 3

For this limited set of data, the weighted moving average method resulted in a slightly lower mean absolute deviation. However, final conclusions can be made only after analyzing much more data.
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Solved Problem 3
Chicken Palace periodically offers carryout five-piece chicken dinners at special prices. Let Y be the number of dinners sold and X be the price. Based on the historical observations and calculations in the following table, determine the regression equation, correlation coefficient, and coefficient of determination. How many dinners can Chicken Palace expect to sell at $3.00 each?
Observation 1 Price (X) $2.70 Dinners Sold (Y) 760

2
3

$3.50
$2.00

510
980

4
5 6 Total Average
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$4.20
$3.10 $4.05 $19.55 $3.258

250
320 480 3,300 550
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Solved Problem 3
SOLUTION We use the computer to calculate the best values of a, b, the correlation coefficient, and the coefficient of determination a= b= r= r2= The regression line is Y = a + bX = 1,454.60 277.63X For an estimated sales price of $3.00 per dinner 1,454.60 277.63 0.84 0.71

Y = a + bX = 1,454.60 277.63(3.00)
= 621.71 or 622 dinners
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Solved Problem 4
The Northville Post Office experiences a seasonal pattern of daily mail volume every week. The following data for two representative weeks are expressed in thousands of pieces of mail:
Day Sunday Monday Tuesday Wednesday Thursday Friday Saturday Total Week 1 5 20 30 35 49 70 15 224 Week 2 8 15 32 30 45 70 10 210

a. Calculate a seasonal factor for each day of the week. b. If the postmaster estimates 230,000 pieces of mail to be sorted next week, forecast the volume for each day.
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Solved Problem 4
SOLUTION a. Calculate the average daily mail volume for each week. Then for each day of the week divide the mail volume by the weeks average to get the seasonal factor. Finally, for each day, add the two seasonal factors and divide by 2 to obtain the average seasonal factor to use in the forecast.

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Solved Problem 4
Week 1 Mail Volume 5 20 30 35 49 70 15 224 224/7 = 32 Seasonal Factor (1) 5/32 = 0.15625 20/32 = 0.62500 30/32 = 0.93750 35/32 = 1.09375 49/32 = 1.53125 70/32 = 2.18750 15/32 = 0.46875 Mail Volume 8 15 32 30 45 70 10 210 210/7 = 30 Week 2 Seasonal Factor (2) 8/30 = 0.26667 15/30 = 0.50000 32/30 = 1.06667 30/30 = 1.00000 45/30 = 1.50000 70/30 = 2.33333 10/30 = 0.33333 Average Seasonal Factor [(1) + (2)]/2 0.21146 0.56250 1.00209 1.04688 1.51563 2.26042 0.40104

Day
Sunday Monday Tuesday Wednesday Thursday Friday Saturday Total Average

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Solved Problem 4
b. The average daily mail volume is expected to be 230,000/7 = 32,857 pieces of mail. Using the average seasonal factors calculated in part (a), we obtain the following forecasts:
Day Sunday Monday Tuesday Wednesday Thursday Friday Saturday Calculations 0.21146(32,857) = 0.56250(32,857) = Forecast 6,948 18,482 32,926 34,397

1.00209(32,857) =
1.04688(32,857) = 1.51563(32,857) = 2.26042(32,857) = 0.40104(32,857) = Total

49,799
74,271

13,177
230,000

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