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# 3

Forecasting

McGraw-Hill/Irwin

Learning Objectives
   List the elements of a good forecast. Outline the steps in the forecasting process. Describe at least three qualitative forecasting techniques and the advantages and disadvantages of each. Compare and contrast qualitative and quantitative approaches to forecasting.

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Learning Objectives
 Briefly describe averaging techniques, trend and seasonal techniques, and regression analysis, and solve typical problems. Describe two measures of forecast accuracy. Describe two ways of evaluating and controlling forecasts. Identify the major factors to consider when choosing a forecasting technique.
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 

How the car buyer think ?
 He want it as soon as possible  He do not have to wait any time for delivery  If the dealer is not ready to deliver at once the buyer look elsewhere

Hence
 It is important for a dealer to anticipate buyer wants and to have those models, with the necessary options, in stock
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How the car buyer think ?
The dealer who can correctly forecast buyer wants, and who have those cars available, is going to be much more successful than a competitor who guesses instead of forecasting  He usually
 Guesses wrong !!!!!!  Gets stuck with cars customers don’t want !!!!!!!

 So, how does the dealer know how many cars of each type to stock ?  The answer is : The dealer doesn’t know for sure, but by analyzing previous buying patterns, and perhaps making allowances for current conditions, the dealer can come up with a reasonable approximation of what buyers will want

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Planning and Uncertainties  The manager is a planner  Uncertainty make planning difficult  Forecasting reduce uncertainty Forecasting enable manager to develop more meaningful plans so What is forecasting ? 3-6 .

 Long-range ( several years. operation  People make and use forecasts all the time both in their jobs and in everyday life 3-7 . country. city ……. )  Short-range ( several weeks.  Forecasting is used to make informed decisions. organization. days. town.What is forecasting ? FORECASTING IS:  A statement about the future value of a variable of interest such as demand.

finance  Human resources  Marketing  MIS  Operations  Product / service design 3-8 .Forecasts  Forecasts affect decisions and activities throughout an organization  Accounting.

to locate 2.Uses of Forecasts 1. Help managers plan the system ( long term )  Types of products to offer  Facilities and equipment to have. Help managers plan the use of the system ( short term )     Planning inventory Work force level Planning purchasing and production Budgeting and scheduling 3-9 .

MRP. promotion. services Schedules. strategy IT/IS systems. workloads New products and services 3-10 .Uses of Forecasts Accounting Finance Cost/profit estimates Cash flow and funding Human Resources Marketing MIS Operations Product/service design Hiring/recruiting/training Pricing.

 Forecast accuracy decreases as time horizon increases 3-11 .Features of Forecasts  Assumes causal system past ==> future  Forecasts rarely perfect because of randomness  Forecasts more accurate for groups vs. individuals I see that you will get an A this semester.

Elements of a Good Forecast 3-12 .

Steps in the Forecasting Process “The forecast” Step 6 Monitor the forecast Step 5 Make the forecast Step 4 Obtain. clean and analyze data Step 3 Select a forecasting technique Step 2 Establish a time horizon Step 1 Determine purpose of forecast 3-13 .

analyzing objectives) 3-14 . personal opinion)  Quantitative:  Consists of objective inputs  Involve hard data (projection of historical data.Approaches to forecasting  Qualitative:  Consists of subjective inputs  Includes soft information (human factors.

uses historical data assuming the future will be like the past  Associative models .uses subjective inputs obtained from various resources  Time series .Types of forecasting techniques  Judgmental .uses explanatory variables to predict the future 3-15 .

Judgmental Forecasts  Executive opinions  Sales force opinions  Consumer surveys  Outside opinion  Delphi method  Opinions of managers and staff  Achieves a consensus forecast 3-16 .

* prob. Production manager marketing manager Financial manager 125 40% 50 160 35% 56 100 25% 25 General manager 131 3-17 .Executive opinions estimation probability Est.

5 4 Expert 4 6 5 4.Delphi method Session 1 Session 2 Session 3 Session 4 Expert 1 5 4.5 Expert 3 4.5 4 3-18 .5 3.5 4 4 Expert 2 3 3.5 4 4.5 3.

caused by chance 3-19 .long-term movement in data  Seasonality .short-term regular variations in data  Cycle – wavelike variations of more than one year’s duration  Irregular variations .Time Series Forecasts Plotting the past data and visually examining the appeared pattern:  Trend .caused by unusual circumstances  Random variations .

1 Irregular variation Trend Cycles 90 89 88 Seasonal variations 3-20 .Forecast Variations Figure 3.

Now.... give me a minute.. 3-21 . We sold 250 wheels last week. next week we should sell. The forecast for any period equals the previous period’s actual value..Naive Forecasts Uh.....

Naïve Forecasts        Simple to use Virtually no cost Quick and easy to prepare Data analysis is nonexistent Easily understandable Cannot provide high accuracy Can be a standard for accuracy 3-22 .

Uses for Naïve Forecasts  Stable time series data  F(t) = A(t-1)  Seasonal variations  F(t) = A(t-n)  Data with trends  F(t) = A(t-1) + (A(t-1) – A(t-2)) 3-23 .

Techniques for Averaging  Moving average  Weighted moving average  Exponential smoothing 3-24 .

Ft = WMAn= wnAt-n + … wn-1At-2 + w1At-1 n 3-25 . updated as new values become available. Ft = MAn= At-n + … At-2 + At-1 n  Weighted moving average – More recent values in a series are given more weight in computing the forecast.Moving Averages  Moving average – A technique that averages a number of recent actual values.

Simple Moving Average Actual MA5 47 45 43 41 39 37 35 1 2 3 4 5 6 7 8 9 10 11 12 MA3 Ft = MAn= At-n + … At-2 + At-1 n 3-26 .

3-27 .Exponential Smoothing Ft = Ft-1 + (At-1 . we should give more weight to the more recent time periods when forecasting.  Therefore.Ft-1) • Premise--The most recent observations might have the highest predictive value.

Exponential Smoothing Ft = Ft-1 + (At-1 .Ft-1)  Weighted averaging method based on previous forecast plus a percentage of the forecast error  A-F is the error term.  is the % feedback 3-28 .

20 -1.09 5.92 41.36 41.55 43.53 40.92 -2 1.92 -0.4 Error 42 41.75 1.66 4.88 -1.15 2.92 -0.53 3-29 .73 41.39 41.85 42.45 1.15 41.92 41.00 1.15 -2.8 41.88 41.8 -1.73 -2.92 41.93 -4.25 42.66 41.Example 3 .73 -2.87 -5.36 -1.13 43.09 40.07 42.61 2.1 Error 42 41.2 41.Exponential Smoothing Period 1 2 3 4 5 6 7 8 9 10 11 12 Actual 42 40 43 40 41 39 46 44 45 38 40 Alpha = 0.92 Alpha = 0.

Picking a Smoothing Constant Actual 50 Demand   .1 9 10 11 12 Period 3-30 .4 45 40 35 1 2 3 4 5 6 7 8   .

Common Nonlinear Trends Figure 3.5 Parabolic Exponential Growth 3-31 .

Linear Trend Equation Ft Ft = a + bt 0 1 2 3 4 5 t     Ft = Forecast for period t t = Specified number of time periods a = Value of Ft at t = 0 b = Slope of the line 3-32 .

( t) 2 n t   y .b t a = n 3-33 . t  y b = 2 .Calculating a and b n  (ty) .

Linear Trend Equation Example t Week 1 2 3 4 5 t2 1 4 9 16 25 y Sales 150 157 162 166 177 ty 150 314 486 664 885  t = 15  t2 = 55 2 ( t) = 225  y = 812  ty = 2499 3-34 .

Linear Trend Calculation b = 5 (2499) .3(15) a = = 143.3 812 .5 + 6.225 = 12495 -12180 275 -225 = 6.3t 3-35 .6.5 5 y = 143.15(812) 5(55) .

 Seasonal relative  Percentage of average or trend  Centered moving average  A moving average positioned at the center of the data that were used to compute it.Techniques for Seasonality  Seasonal variations  Regularly repeating movements in series values that can be tied to recurring events. 3-36 .

Associative Forecasting  Predictor variables .technique for fitting a line to a set of points  Least squares line .minimizes sum of squared deviations around the line 3-37 .used to predict values of variable interest  Regression .

Linear Model Seems Reasonable X 7 2 6 4 14 15 16 12 14 20 15 7 Y 15 10 13 15 25 27 24 20 27 44 34 17 Computed relationship 50 40 30 20 10 0 0 5 10 15 20 25 A straight line is fitted to a set of sample points. 3-38 .

Linear Regression Assumptions  Variations around the line are random  Deviations around the line normally distributed  Predictions are being made only within the range of observed values  For best results:  Always plot the data to verify linearity  Check for data being time-dependent  Small correlation may imply that other variables are important 3-39 .

difference between actual value and predicted value  Mean Absolute Deviation (MAD)  Average absolute error  Mean Squared Error (MSE)  Average of squared error  Mean Absolute Percent Error (MAPE)  Average absolute percent error 3-40 .Forecast Accuracy  Error .

MAD. and MAPE MAD =  Actual  forecast n MSE =  ( Actual  forecast) 2 n -1 ( Actual  forecas t n MAPE = / Actual*100) 3-41 . MSE.

MAD. MSE and MAPE  MAD  Easy to compute  Weights errors linearly  MSE  Squares error  More weight to large errors  MAPE  Puts errors in perspective 3-42 .

28 3-43 .26 MAD= MSE= MAPE= 2.92 1.41 0.Example 10 Period 1 2 3 4 5 6 7 8 Actual 217 213 216 210 213 219 216 212 Forecast 215 216 215 214 211 214 217 216 (A-F) 2 -3 1 -4 2 5 -1 -4 -2 |A-F| 2 3 1 4 2 5 1 4 22 (A-F)^2 4 9 1 16 4 25 1 16 76 (|A-F|/Actual)*100 0.94 2.90 0.46 1.28 0.86 1.46 1.89 10.75 10.

Controlling the Forecast  Control chart  A visual tool for monitoring forecast errors  Used to detect non-randomness in errors  Forecasting errors are in control if  All errors are within the control limits  No patterns. such as trends or cycles. are present 3-44 .

Sources of Forecast errors  Model may be inadequate  Irregular variations  Incorrect use of forecasting technique 3-45 .

Tracking Signal •Tracking signal –Ratio of cumulative error to MAD (Actual-forecast) Tracking signal = MAD Bias – Persistent tendency for forecasts to be Greater or less than actual values. 3-46 .

Choosing a Forecasting Technique  No single technique works in every situation  Two most important factors  Cost  Accuracy  Other factors include the availability of:     Historical data Computers Time needed to gather and analyze the data Forecast horizon 3-47 .

Operations Strategy  Forecasts are the basis for many decisions  Work to improve short-term forecasts  Accurate short-term forecasts improve      Profits Lower inventory levels Reduce inventory shortages Improve customer service levels Enhance forecasting credibility 3-48 .

Supply Chain Forecasts  Sharing forecasts with supply can  Improve forecast quality in the supply chain  Lower costs  Shorter lead times  Gazing at the Crystal Ball (reading in text) 3-49 .

Exponential Smoothing 3-50 .

Linear Trend Equation 3-51 .

Simple Linear Regression 3-52 .