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Forecasting

Forecasting
Predicting the Future
Qualitative forecast methods

subjective

Quantitative forecast
methods

based on mathematical
formulas

Qualitative Methods
Executive Judgment

Historical analogy

Grass Roots

Qualitative

Market Research

Methods

Delphi Method

Panel Consensus

Delphi Method
l. Choose the experts to participate representing a variety
of knowledgeable people in different areas
2. Through a questionnaire (or E-mail), obtain forecasts
(and any premises or qualifications for the forecasts)
from all participants
3. Summarize the results and redistribute them to the
participants along with appropriate new questions
4. Summarize again, refining forecasts and conditions, and
again develop new questions
5. Repeat Step 4 as necessary and distribute the final
results to all participants

Forecasting and Supply Chain


Management
Accurate forecasting determines how much inventory a
company must keep at various points along its supply
chain
Continuous replenishment

supplier and customer share continuously updated data


typically managed by the supplier
reduces inventory for the company
speeds customer delivery

Variations of continuous replenishment

quick response
JIT (just-in-time)
VMI (vendor-managed inventory)
stockless inventory

Forecasting and TQM


Accurate forecasting customer demand is a
key to providing good quality service
Continuous replenishment and JIT
complement TQM

eliminates the need for buffer inventory, which, in


turn, reduces both waste and inventory costs, a
primary goal of TQM
smoothes process flow with no defective items
meets expectations about on-time delivery, which is
perceived as good-quality service

Types of Forecasting Methods


Depend on

time frame
demand behavior
causes of behavior

Time Series Analysis


Time series forecasting models try to
predict the future based on past data
You can pick models based on:
1. Time horizon to forecast
2. Data availability
3. Accuracy required
4. Size of forecasting budget
5. Availability of qualified personnel

Time Frame
Indicates how far into the future is
forecast

Short- to mid-range forecast


typically

encompasses the immediate future


daily up to two years

Long-range forecast
usually

encompasses a period of time longer


than two years

Demand Behavior
Trend

a gradual, long-term up or down movement of


demand

Random variations

movements in demand that do not follow a pattern

Cycle

an up-and-down repetitive movement in demand

Seasonal pattern

an up-and-down repetitive movement in demand


occurring periodically

Demand

Demand

Forms of Forecast Movement

Random
movement
Time
(b) Cycle

Demand

Demand

Time
(a) Trend

Time
(c) Seasonal pattern

Time
(d) Trend with seasonal pattern

Forecasting Methods
Qualitative

use management judgment, expertise, and opinion to


predict future demand

Time series

statistical techniques that use historical demand data to


predict future demand

Regression methods

attempt to develop a mathematical relationship


between demand and factors that cause its behavior

Qualitative Methods
Management, marketing, purchasing,
and engineering are sources for internal
qualitative forecasts
Delphi method

involves soliciting forecasts about


technological advances from experts

Forecasting Process
1. Identify the
purpose of forecast

2. Collect historical
data

3. Plot data and identify


patterns

6. Check forecast
accuracy with one or
more measures

5. Develop/compute
forecast for period of
historical data

4. Select a forecast
model that seems
appropriate for data

7.
Is accuracy of
forecast
acceptable?

No

8b. Select new


forecast model or
adjust parameters of
existing model

Yes
8a. Forecast over
planning horizon

9. Adjust forecast based


on additional qualitative
information and insight

10. Monitor results


and measure forecast
accuracy

Time Series
Assume that what has occurred in the past will
continue to occur in the future
Relate the forecast to only one factor - time
Include

moving average
exponential smoothing
linear trend line

Moving Average
Naive forecast

demand of the current period is used as


next periods forecast

Simple moving average

stable demand with no pronounced


behavioral patterns

Weighted moving average

weights are assigned to most recent data

Moving Average:
Nave Approach
MONTH
Jan
Feb
Mar
Apr
May
June
July
Aug
Sept
Oct
Nov

ORDERS
PER MONTH
120
90
100
75
110
50
75
130
110
90
-

FORECAST
120
90
100
75
110
50
75
130
110
90

Simple Moving Average


n

i = 1 Di

MAn =

where
n
Di

= number of periods
in the moving
average
= demand in period i

3-month Simple Moving Average


ORDERS
MONTH
Jan
MONTH

PER

120

Feb

90

Mar

100

Apr

75

May

110

June

50

July

75

MOVING
AVERAGE

103.3
88.3
95.0
78.3
78.3
85.0
105.0
110.0

i=1

MA3 =
=

Di

3
90 + 110 + 130
3

= 110 orders
for Nov

5-month Simple Moving Average


ORDERS
MONTH
Jan
MONTH

PER

120

Feb

90

Mar

100

Apr

75

May

110

June

50

July

75

MOVING
AVERAGE

99.0
85.0
82.0
88.0
95.0
91.0

i=1

MA5 =
=

Di

90 + 110 + 130+75+50
5
= 91 orders
for Nov

Smoothing Effects
150
125

5-month

Orders

100
75
50
3-month

25
Actual

0
|
Jan

|
Feb

|
Mar

|
|
Apr May

|
|
June July

Month

|
|
Aug Sept

|
Oct

|
Nov

Weighted Moving Average


Adjusts
moving
average
method to
more closely
reflect data
fluctuations

WMAn = Wi Di
i=1
i=1

where

Wi = the weight for period i,


between 0 and 100
percent

W = 1.00
i

Weighted Moving Average Example


MONTH

WEIGHT

DATA

17%
33%
50%

130
110
90

August
September
October
November Forecast

WMA3 = i
= 1 Wi Di

= (0.50)(90) + (0.33)(110) + (0.17)(130)


= 103.4 orders

Exponential Smoothing

Averaging method
Weights most recent data more strongly
Reacts more to recent changes
Widely used, accurate method

Exponential Smoothing (cont.)


Ft +1 = Dt + (1 - )Ft
where:
Ft +1 = forecast for next period
Dt =

actual demand for present period

Ft = previously determined forecast


for present period
= weighting factor, smoothing constant

Effect of Smoothing Constant


0.0 1.0
If = 0.20, then Ft +1 = 0.20Dt + 0.80 Ft
If = 0, then Ft +1 = 0Dt + 1 Ft 0 = Ft
Forecast does not reflect recent data

If = 1, then Ft +1 = 1Dt + 0 Ft =Dt


Forecast based only on most recent data

Exponential Smoothing (=0.30)


PERIOD
DEMAND

MONTH

Jan

37

Feb

40

Mar

41

Apr

37

May

45

F2 = D1 + (1 - )F1
= (0.30)(37) + (0.70)(37)
= 37
F3 = D2 + (1 - )F2
= (0.30)(40) + (0.70)(37)
= 37.9
F13 = D12 + (1 - )F12
= (0.30)(54) + (0.70)(50.84)
= 51.79

Jun

50

Jul

43

Exponential Smoothing
(cont.)
FORECAST, F

t+1

PERIOD

MONTH

DEMAND

( = 0.3)

( = 0.5)

1
2
3
4
5
6
7
8
9
10
11
12
13

Jan
Feb
Mar
Apr
May
Jun
Jul
Aug
Sep
Oct
Nov
Dec
Jan

37
40
41
37
45
50
43
47
56
52
55
54

37.00
37.90
38.83
38.28
40.29
43.20
43.14
44.30
47.81
49.06
50.84
51.79

37.00
38.50
39.75
38.37
41.68
45.84
44.42
45.71
50.85
51.42
53.21
53.61

Exponential Smoothing (cont.)


70
60

= 0.50

Actual

50

Orders

40
30

= 0.30

20
10
0
|
1

|
2

|
3

|
4

|
5

|
6
Month

|
7

|
8

|
9

|
10

|
11

|
12

|
13

Adjusted Exponential Smoothing


AFt +1 = Ft +1 + Tt +1
where
T = an exponentially smoothed trend factor
Tt +1 = (Ft +1 - Ft) + (1 - ) Tt
where
Tt = the last period trend factor
= a smoothing constant for trend

Adjusted Exponential
Smoothing (=0.30)
T3

PERIOD
DEMAND

MONTH

Jan

37

Feb

40

Mar

41

= (F3 - F2) + (1 - ) T2
= (0.30)(38.5 - 37.0) + (0.70)(0)
= 0.45

AF3 = F3 + T3 = 38.5 + 0.45


= 38.95
T13 = (F13 - F12) + (1 - ) T12

Apr

37

= (0.30)(53.61 - 53.21) + (0.70)


(1.77)

May

45

= 1.36

Jun

50

AF13 = F13 + T13 = 53.61 + 1.36 = 54.96

Adjusted Exponential Smoothing:


Example
PERIOD

MONTH

DEMAND

FORECAST
Ft +1

1
2
3
4
5
6
7
8
9
10
11
12
13

Jan
Feb
Mar
Apr
May
Jun
Jul
Aug
Sep
Oct
Nov
Dec
Jan

37
40
41
37
45
50
43
47
56
52
55
54

37.00
37.00
38.50
39.75
38.37
38.37
45.84
44.42
45.71
50.85
51.42
53.21
53.61

TREND
Tt +1

ADJUSTED
FORECAST AFt +1

0.00
0.45
0.69
0.07
0.07
1.97
0.95
1.05
2.28
1.76
1.77
1.36

37.00
38.95
40.44
38.44
38.44
47.82
45.37
46.76
58.13
53.19
54.98
54.96

Adjusted Exponential Smoothing


Forecasts
70
Adjusted forecast ( = 0.30)

60

Actual

50

Demand

40
30
Forecast ( = 0.50)

20
10
0
|
1

|
2

|
3

|
4

|
5

|
|
6
7
Period

|
8

|
9

|
10

|
11

|
12

|
13

Linear Trend Line


y = a + bx
where
a = intercept
b = slope of the line
x = time period
y = forecast for
demand for period x

xy - nxy
b = x2 - nx2
a = y-bx
where
n = number of periods
x
x = n = mean of the x values
y
y = n = mean of the y values

Least Squares Example


x(PERIOD)

y(DEMAND)

xy

x2

1
2
3
4
5
6
7
8
9
10
11
12

73
40
41
37
45
50
43
47
56
52
55
54

37
80
123
148
225
300
301
376
504
520
605
648

1
4
9
16
25
36
49
64
81
100
121
144

78

557

3867

650

Least Squares Example


(cont.)
78
= 6.5
12
557
y =
= 46.42
12
xy - nxy
3867 - (12)(6.5)(46.42)
b =
=
=1.72
2
2
2
x - nx
650 - 12(6.5)
x =

a = y - bx
= 46.42 - (1.72)(6.5) = 35.2

Linear trend line y = 35.2 + 1.72x


Forecast for period 13 y = 35.2 + 1.72(13) = 57.56 units
70
60
Actual
Demand

50
40
30

Linear trend line

20
10
0

|
1

|
2

|
3

|
4

|
5

|
|
6
7
Period

|
8

|
9

|
10

|
11

|
12

|
13

Seasonal Adjustments
Repetitive increase/ decrease in demand
Use seasonal factor to adjust forecast

Seasonal factor = Si =

Di
D

Seasonal Adjustment (cont.)


YEAR
2002
2003
2004
Total

DEMAND (1000S PER QUARTER)


1
2
3
4
Total
12.6
14.1
15.3
42.0

D1

42.0
S1 =
=
= 0.28
D 148.7
D2

29.5
S2 =
=
= 0.20
148.7
D

8.6
10.3
10.6
29.5

6.3
7.5
8.1
21.9

17.5
18.2
19.6
55.3

45.0
50.1
53.6
148.7

D3

21.9
S3 =
=
= 0.15
D 148.7
D4

55.3
S4 =
=
= 0.37
148.7
D

Seasonal Adjustment (cont.)


For 2005
y = 40.97 + 4.30x = 40.97 + 4.30(4) = 58.17
SF1 = (S1) (F5) = (0.28)(58.17) = 16.28
SF2 = (S2) (F5) = (0.20)(58.17) = 11.63
SF3 = (S3) (F5) = (0.15)(58.17) = 8.73
SF4 = (S4) (F5) = (0.37)(58.17) = 21.53

Forecast Accuracy
Forecast error

difference between forecast and actual demand


MAD

MAPD

mean absolute deviation


mean absolute percent deviation

Cumulative error
Average error or bias

Mean Absolute Deviation


(MAD)
Dt - Ft
MAD =
n
where

t = period number
Dt = demand in period t
Ft = forecast for period t
n = total number of periods
= absolute value

MAD Example
PERIOD
1
2
3
4
5
6
7
8
9
10
11
12

DEMAND, Dt
37
40
41
37
MAD
45
50
43
47
56
52
55
54
557

=
=
=

Ft ( =0.3)

37.00
37.00
37.90
D38.83
t - Ft
n38.28
40.29
53.39
43.20
1143.14
44.30
4.85 47.81
49.06
50.84

( Dt - F t )

|Dt - Ft|

3.00
3.10
-1.83
6.72
9.69
-0.20
3.86
11.70
4.19
5.94
3.15

3.00
3.10
1.83
6.72
9.69
0.20
3.86
11.70
4.19
5.94
3.15

49.31

53.39

Other Accuracy Measures


Mean absolute percent deviation (MAPD)
MAPD =

|Dt - Ft|
Dt

Cumulative error
E = et
Average error

et

E= n

Comparison of Forecasts

FORECAST

MAD

MAPD

(E)

Exponential smoothing ( = 0.30)


Exponential smoothing ( = 0.50)
Adjusted exponential smoothing
( = 0.50, = 0.30)
Linear trend line

4.85
4.04
3.81

9.6%
8.5%
7.5%

49.31
33.21
21.14

4.48
3.02
1.92

2.29

4.9%

Forecast Control
Tracking signal

monitors the forecast to see if it is biased


high or low
(Dt - Ft)
E
Tracking signal =
= MAD
MAD
1 MAD 0.8
Control limits of 2 to 5 MADs are used most
frequently

Tracking Signal Values


PERIOD

DEMAND
Dt

1
2
3
4
5
6
7
8
9
10
11
12

37
40
41
37
45
50
43
47
56
52
55
54

FORECAST,
Ft

ERROR
Dt - Ft

E =
(Dt - Ft)

37.00

37.00
3.00
3.00
37.90
3.10
6.10
38.83
-1.83
4.27
38.28
6.72 for period
10.99 3
Tracking
signal
40.29
9.69
20.68
43.20
-0.20
6.10 20.48
43.14
TS3 = 3.86 =24.34
2.00
3.05
44.30
11.70
36.04
47.81
4.19
40.23
49.06
5.94
46.17
50.84
3.15
49.32

MAD

3.00
3.05
2.64
3.66
4.87
4.09
4.06
5.01
4.92
5.02
4.85

TRACKING
SIGNAL

1.00
2.00
1.62
3.00
4.25
5.01
6.00
7.19
8.18
9.20
10.17

Tracking Signal Plot


Tracking signal (MAD)

3
2

Exponential smoothing ( = 0.30)

1
0
-1
-2
-3

|
0

Linear trend line

|
1

|
2

|
3

|
4

|
5

|
6
Period

|
7

|
8

|
9

|
10

|
11

|
12

Statistical Control Charts


Using we can calculate
statistical control limits for the
forecast error
Control limits are typically set at
3

Statistical Control Charts


2= ((Dt - Ft)2) / (n 1)

Statistical Control Charts


18.39
12.24

UCL = +3

Errors

6.12
0
-6.12

-12.24
-18.39
LCL = -3
|
0

|
1

|
2

|
3

|
4

|
5

|
6
Period

|
7

|
8

|
9

|
10

|
11

|
12

Regression Methods
Linear regression

a mathematical technique that relates a


dependent variable to an independent
variable in the form of a linear equation

Correlation

a measure of the strength of the relationship


between independent and dependent
variables

Linear Regression
y = a + bx

a = y-bx
xy - nxy
b = x2 - nx2
where
a = intercept
b = slope of the line
x
x = n = mean of the x data
y
y = n = mean of the y data

Linear Regression Example


x
(WINS)

y
(ATTENDANCE)

xy

x2

4
6
6
8
6
7
5
7

36.3
40.1
41.2
53.0
44.0
45.6
39.0
47.5

145.2
240.6
247.2
424.0
264.0
319.2
195.0
332.5

16
36
36
64
36
49
25
49

49

346.7

2167.7

311

Linear Regression Example (cont.)


49
= 6.125
8
346.9
y=
= 43.36
8
x=

xy - nxy2
b=
x2 - nx2
(2,167.7) - (8)(6.125)(43.36)
=
(311) - (8)(6.125)2
= 4.06
a = y - bx
= 43.36 - (4.06)(6.125)
= 18.46

Linear Regression Example (cont.)


Regression equation

Attendance forecast for 7 wins

y = 18.46 + 4.06x

y = 18.46 + 4.06(7)
= 46.88, or 46,880

60,000
50,000

Attendance, y

40,000
30,000
20,000

Linear regression line,


y = 18.46 + 4.06x

10,000

|
0

|
1

|
2

|
3

|
4

|
5
Wins, x

|
6

|
7

|
8

|
9

|
10

Simple Linear Regression Model


The
Thesimple
simplelinear
linearregression
regression
model
modelseeks
seeksto
tofit
fitaaline
line
through
throughvarious
variousdata
dataover
over
time
time

Yt = a + bx

a
0 1 2 3 4 5

(Time)

Is
Isthe
thelinear
linearregression
regressionmodel
model

Yt is the regressed forecast value or dependent variable


in the model, a is the intercept value of the the
regression line, and b is similar to the slope of the
regression line. However, since it is calculated with the
variability of the data in mind, its formulation is not as
straight forward as our usual notion of slope.

Simple Linear Regression Problem Data


Question:
Question:Given
Giventhe
thedata
databelow,
below,what
whatisisthe
thesimple
simplelinear
linear
regression
regressionmodel
modelthat
thatcan
canbe
beused
usedto
topredict
predictsales
salesin
infuture
future
weeks?
weeks?

Week
1
2
3
4
5

Sales
150
157
162
166
177

59

Answer:
Answer: First,
First, using
using the
the linear
linear regression
regressionformulas,
formulas, we
we
can
cancompute
computea
aand
andb
b

Week Week*Week
Sales Week*Sales
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
Average
Sum Average
Sum
xy
--5(162.4)(3)
63

xy--n(y)(x)
n(y)(x) 2499
2499
5(162.4)(3)
63= 6.3

bb==
=

=
10 = 6.3
22
22
55

5
(
9
)
x
n(x
)

55 5(9 )
10
x - n(x )
aa== yy--bx
bx==162.4
162.4--(6.3)(3)
(6.3)(3)==143.5
143.5

60

The resulting regression model


is:

Yt = 143.5 + 6.3x

Sales

Now if we plot the regression generated forecasts against the


actual sales we obtain the following chart:
180
175
170
165
Sales
160
155
Forecast
150
145
140
135
1
2
3
4
5
Period

Correlation and Coefficient of


Determination
Correlation, r
Measure of strength of relationship
Varies between -1.00 and +1.00

Coefficient of determination, r2
Percentage of variation in dependent
variable resulting from changes in the
independent variable

Computing Correlation
r=

n xy - x y
[n x2 - ( x)2] [n y2 - ( y)2]
(8)(2,167.7) - (49)(346.9)

r=

[(8)(311) - (49)2] [(8)(15,224.7) - (346.9)2]


r = 0.947
Coefficient of determination
r2 = (0.947)2 = 0.897

Multiple Regression
Study the relationship of demand to two or
more independent variables
y = 0 + 1x1 + 2x2 + kxk
where
0
= the intercept
1, , k = parameters for the
independent variables
x1, , xk = independent variables

Question Bowl
Which of the following is a classification of a
basic type of forecasting?
a. Transportation method
b. Simulation
c. Linear programming
d. All of the above
e. None of the above
Answer: b. Simulation (There are four types including
Qualitative, Time Series Analysis, Causal
Relationships, and Simulation.)

Question Bowl
Which of the following is an example of a
Qualitative type of forecasting technique
a.
b.
c.
d.
e.

or model?
Grass roots
Market research
Panel consensus
All of the above
None of the above

Answer: d. All of the above (Also includes


Historical Analogy and Delphi Method.)

Question Bowl

Which of the following is an example of a


Time Series Analysis type of forecasting
technique or model?
a. Simulation
b. Exponential smoothing
c. Panel consensus
d. All of the above
e. None of the above
Answer: b. Exponential smoothing (Also includes Simple Moving
Average, Weighted Moving Average, Regression Analysis, Box
Jenkins, Shiskin Time Series, and Trend Projections.)

Question Bowl
Which of the following is a reason why a
firm should choose a particular forecasting
model?
a. Time horizon to forecast
b. Data availability
c. Accuracy required
d. Size of forecasting budget
e. All of the above
Answer: e. All of the above (Also should include
availability of qualified personnel .)

Question Bowl
Which of the following are ways to
choose weights in a Weighted Moving
a.
b.
c.
d.
e.

Average forecasting model?


Cost
Experience
Trial and error
Only b and c above
None of the above

Answer: d. Only b and c above

Question Bowl
Which of the following are reasons why the
Exponential Smoothing model has been a well
a.
b.
c.
d.
e.

accepted forecasting methodology?


It is accurate
It is easy to use
Computer storage requirements are small
All of the above
None of the above

Answer: d. All of the above

Question Bowl

a.
b.
c.
d.
e.

The value for alpha or must be between


which of the following when used in an
Exponential Smoothing model?
1 to 10
1 to 2
0 to 1
-1 to 1
Any number at all

Answer: c. 0 to 1

Question Bowl
Which of the following are sources of error in
forecasts?
a. Bias
b. Random
c. Employing the wrong trend line
d. All of the above
e. None of the above

Answer: d. All of the above

Question Bowl
Which of the following would be the
best MAD values in an analysis of the
accuracy of a forecasting model?
a. 1000
b. 100
c. 10
d. 1
e. 0

Answer: e. 0

Question Bowl
If a Least Squares model is: Y=25+5x, and x is
equal to 10, what is the forecast value using
this model?
a. 100
b. 75
c. 50
d. 25
e. None of the above

Answer: b. 75 (Y=25+5(10)=75)

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