IND 710-Production and

Inventory Systems
Introduction

A supply chain

Production System
Supply
Uncertainty

Process
Uncertainty

Demand
Uncertainty

Production Management Process

Demand Forecast
Capacity Constraints

Financial Constraints
Aggregate Planning

Workforce Plan

Monthly Production

Inventory Plan

Master Production
Schedule

MRP

Shop floor scheduling

Chapter 2

Forecasting

Introduction

Forecasting is the process of predicting the future

All business planning is based on a forecast in one way or the other

Ex: Sales of exiting products, demand for new products, availability of raw
materials, interest rates, etc.

2 functional areas of a firm that heavily rely on forecasting

Marketing and Production

Characteristics of Forecasting

They are usually wrong

A good forecast is more than a single number

Aggregate forecasts are more accurate

The longer the forecast horizon, the less accurate it will be

Forecasts should not exclude known information

Overview

Introduction

Classification of Forecasting Techniques

Evaluation of Forecasts

Forecasting Stationary Series

Moving Average

Exponential Smoothing

Forecasting Non-stationary Series

Linear trend

Linear Regression

Double Exponential Smoothing

Seasonality

Seasonal Decomposition

Winters Method

Introduction

Classification

Based on Time Horizon

Short-term

: day, week

short-term sales

shift schedule, resource management

Intermediate-term

: week, month

product-family sales

labor planning

Long-term

: month, year

growth trend

capacity planning, facility planning

Based on the Approach

Subjective

: based on human judgment; soliciting opinions for forecasting

Ex: Delphi method

Objective

: based on an analysis of data

Causal models

: Y=f (x1, x2, , xn), e.g., Y=a0+a1x1+a2x2+,+anxn

Time series methods

: Trend, Seasonality, Cycles, and Randomness

Introduction
1.

Evaluation of Forecasts
1.

Notation
D1 ,D2 ,D3 , ,Dt 2 ,Dt 1 ,Dt

Forecasting
F1 , F2 , F3 , , Ft 1 , Ft , Ft + 1

Error:

et= Ft Dt

Introduction
2.

Measuring Errors
1 n
1 n
Mean Absolute Deviation (MAD) = et = Ft - Dt
n t =1
n t =1
Mean Square Error (MSE)

1 n 2
1 n
2
= et = ( Ft - Dt )
n t =1
n t =1

MAD is popular because

No squaring

Used to estimate standard deviation of forecasting error when error Normal

e 1.25 MAD

Unbiased Forecast should be such that

E [ et ] = 0

Forecasting Map
Subjective Method
Causal Model : Regression
Stationary : Moving Average,
Exponential Smoothing

Quantitative Method

Time Series Model

Trend-based : Regression,
Double Expo Smoothing
Non-stationary

Seasonal : Seasonal Decomposition,

Winters Method

Forecasting Stationary Series

Each observation = A constant + A random fluctuation. That is,

Dt = + t

1.

where
E [ t ] 0,=
Var [ t ] 2
=

Moving Average

Simply arithmetic average of the most recent N observations

1 t 1
1
Ft
=
( Dt 1 + Dt 2 + + Dt N ) = Di
N i= t N
N

Example
Month

Demand

MA(3)

Error

MAD

MSE

200

250

175

MA(6)

Error

186

208

22

22

484

225

204

-21

21

441

285

195

-90

90

8100

305

232

-73

73

5329

220

-85

190

272

82

82

6724

238

48

58

4126

Forecasting Stationary Series

Short-cut

Given Ft , Dt

to compute Ft + 1

1 t
Ft+1 =
Di

N i =
t N +1
1
=
( Dt + Dt 1 + + Dt N + 1 )
N

1
( Dt + Dt 1 + + Dt N +1 + Dt N Dt N )
N

1
{Dt + ( Dt 1 + + Dt N + 1 + Dt N ) Dt N }
N

1
1
( Dt 1 + + Dt N + 1 + Dt N ) + ( Dt Dt N )
N
N

Ft +1 =
Ft +

1
( Dt Dt N )
N

Forecasting Stationary Series

D1 , D2 , D3 , D4 , , DN , DN + 1
FN + 1

FN + 2 =
FN + 1 +

1
( DN + 1 D1 )
N

Multi-step Ahead Forecasting

-step ahead forecast: Ft +

D1 , D2 , D3 , , Dt N + 1 , , Dt

Dt +
Ft +

1 t
1
Ft+ = F=
D
=
( Dt + Dt 1 + + Dt N + 1 )
t+1

i
N i =
N
t N +1
Since the underlying time series is stationary

Example
Month

Demand

MA(3)

200

250

175

186

208

225

204

285

195

305

190

Forecasting Stationary Series

2.

Exponential Smoothing

Idea: The forecast is the weighted average of

the last forecast &
the most recent observation

Ft + 1 = Dt + ( 1 - ) Ft ,

0 < 1

= Dt + Ft Ft
=Ft ( Ft Dt )
= Ft et

Q: Alternative interpretation of whats been done?

If et > 0 (over-forecasted), adjust the old forecast by subtracting et

If et < 0 (under-forecasted), adjust the old forecast by adding et

Discussion: Role of the weight (), where is smoothing constant

Forecasting Stationary Series

2.

Exponential Smoothing

How did it get the name?

Ft + 1 = Dt + ( 1 - ) Ft ,

0 < 1

= Dt + ( 1 ) [ Dt 1 + (1 )Ft 1 ]
= Dt + ( 1 ) Dt 1 + (1 )2 Ft 1

= Dt + ( 1 ) Dt 1 + (1 )2 [ Dt 2 + (1 )Ft 2 ]
= Dt + ( 1 ) Dt 1 + (1 )2 Dt 2 + (1 )3 Ft 2

= Dt + ( 1 ) Dt 1 + (1 )2 Dt 2 + (1 )3 Dt 3 +

Forecasting Stationary Series

Exponential Smoothing Weights
1.000
0.900
alpha=0.1

0.800

alpha=0.3

Coefficient

0.700

alpha=0.5
alpha=0.7

0.600

alpha=0.9

0.500
0.400
0.300
0.200
0.100
0.000
1

11

13

15

17

19

Weight

21

23

25

27

29

31

33

Moving Ave. vs. Expo. Smoothing

Period

Demand

MA(1)

MA(2)

MA(3)

MA(4)

ES(0.1)

ES(0.2)

ES(0.3)

ES(0.4)

4.00

4.00

4.00

4.00

4.00

4.00

4.00

4.00

4.10

4.20

4.30

4.40

4.5

4.33

4.5

4.33

4.25

4.09

4.16

4.21

4.24

5.00

4.75

4.28

4.53

4.75

4.94

5.5

5.00

4.35

4.62

4.82

4.97

4.67

4.5

4.22

4.30

4.28

4.18

4.5

4.67

4.40

4.64

4.79

4.91

10

6.5

5.33

5.25

4.66

5.11

5.46

5.74

11

5.33

4.75

4.49

4.69

4.72

4.65

12

3.5

4.67

4.44

4.55

4.50

4.39

13

3.67

4.5

4.40

4.44

4.35

4.23

14

4.5

4.33

4.46

4.55

4.55

4.54

15

4.00

4.31

4.24

4.08

3.92

16

4.5

4.67

4.5

4.48

4.59

4.66

4.75

17

5.5

4.67

4.75

4.53

4.67

4.76

4.85

18

4.67

4.25

4.38

4.34

4.23

4.11

3.5

4.00

4.5

4.34

4.27

4.16

4.07

19

Moving Average

Demand/Forecast

8
7
6
5
4
3
2

Demand

MA(1)

MA(2)

MA(3)

MA(4)

0
1

10

11

Period

12

13

14

15

16

17

18

19

20

Moving Average Vs Exponential Smoothing

8
Demand/Forecast

7
6
5
4
3
2

Demand
ES(0.2)

MA(1)
ES(0.3)

MA(2)
ES(0.4)

MA(3)

MA(4)

ES(0.1)

0
0

10
Period

12

14

16

18

20

Moving Avg vs. Expo Smoothing

Question: How to set values of and N consistently?

Idea: Equate the average age of the data used in both forecasts
Moving Average:
Ft
=

1
( Dt 1 + Dt 2 + + Dt N )
N

Ave. age=

1
( 1 + 2 ++ N
N

1 N ( N + 1)

N
2

N +1
2

Moving Avg vs. Expo Smoothing

Exponential Smoothing:
Ft + 1 = Dt + ( 1 - ) Ft ,

0 < 1

= Dt + ( 1 ) Dt 1 + (1 )2 Dt 2 + (1 )3 Dt 3 +

Ave. age = 1 + (1 ) 2 + (1 )2 3 + (1 )3 4 +

(1 )i 1 i

i=1

=
=

1
i 1

=
(1
)

i=1

Moving Avg vs. Expo Smoothing

Question: How to set values of and N consistently?

Idea: Equate the average age of the data used in both forecasts

In summary, we have
Moving Average:

Ave. age =

Exponential Smoothing:

N +1
2

Ave. age =
N +1 1
=
2

=
N=

2
N +1
2

Moving Avg vs. Expo Smoothing

N vs. \alpha
45.00
40.00
35.00
30.00
25.00
20.00
15.00
10.00
5.00

\alpha

95
0.

85
0.

75
0.

65
0.

55
0.

45
0.

35

0.00

0.

1.00
0.67
0.50
0.40
0.33
0.29
0.25
0.22
0.20
0.18
0.17
0.15
0.14
0.13
0.13
0.12
0.11
0.11
0.10
0.10

25

1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20

0.

15

N
39.00
19.00
12.33
9.00
7.00
5.67
4.71
4.00
3.44
3.00
2.64
2.33
2.08
1.86
1.67
1.50
1.35
1.22
1.11
1.00

0.

2
N +1

05

0.05
0.10
0.15
0.20
0.25
0.30
0.35
0.40
0.45
0.50
0.55
0.60
0.65
0.70
0.75
0.80
0.85
0.90
0.95
1.00

0.

N=

Period

Demand

MA(1)

MA(2)

MA(3)

MA(4)

ES(0.1)

ES(0.2)

ES(0.3)

ES(0.4)

4.00

4.00

4.10

4.20

4.30

4.40

4.5

4.33

4.5

4.33

4.25

4.09

4.16

4.21

4.24

5.00

4.75

4.28

4.53

4.75

4.94

5.5

5.00

4.35

4.62

4.82

4.97

4.67

4.5

4.22

4.30

4.28

4.18

4.5

4.67

4.40

4.64

4.79

4.91

10

6.5

5.33

5.25

4.66

5.11

5.46

5.74

11

5.33

4.75

4.49

4.69

4.72

4.65

12

3.5

4.67

4.44

4.55

4.50

4.39

13

3.67

4.5

4.40

4.44

4.35

4.23

14

4.5

4.33

4.46

4.55

4.55

4.54

15

4.00

4.31

4.24

4.08

3.92

16

4.5

4.67

4.5

4.48

4.59

4.66

4.75

17

5.5

4.67

4.75

4.53

4.67

4.76

4.85

18

4.67

4.25

4.38

4.34

4.23

4.11

3.5

4.00

4.5

4.34

4.27

4.16

4.07

19
MAD

1.25

1.08

MSE

2.04

1.93