6/11/2017

Learning Objectives
List the elements of a good forecast.

Outline the steps in the forecasting process.

Compare qualitative and quantitative approaches to

Forecasting forecasting.

Quantitative- Naïve Forecasts, Averaging Forecasts,

Exponential Smoothing, Linear Trend Forecasts

3-1

Forecasting Forecasting Time Horizons

Process of predicting a future event, scientifically & Short-range forecast
Up to 1 year, generally less than 3 months
with base Purchasing, job scheduling, workforce levels, job assignments, production
levels

Taking historical data & projecting them into the Medium-range forecast
future 3 months to 3 years
Sales and production planning, budgeting
I see that you will
get an A this semester.
Long-range forecast
3+ years
New product planning, facility location, research and development

1
 6/11/2017

Steps in the Forecasting Process Types of Forecasts

Economic forecasts
Address business cycle – inflation rate, money supply, housing
starts, etc.
“The forecast”
Technological forecasts
Predict rate of technological progress
Impacts development of new products
Step 6 - Monitor the forecast Demand forecasts
Step 5 - Prepare the forecast
Predict sales of existing product
Step 4 - Gather and analyze data
Step 3 - Select a forecasting technique
Step 2 - Establish a time horizon
Step 1 - Determine purpose of forecast

Strategic Importance of Forecasting Approaches

Forecasting
Quantitative Methods
Human Resources – Hiring, training, laying off
workers Used when situation is ‘stable’ and historical data
exist
Capacity – Capacity shortages can result in
undependable delivery, loss of customers, loss of Existing products
market share Current technology

Supply-Chain Management – Good supplier relations Involves mathematical techniques

and price advance e.g., forecasting sales of color televisions

2
 6/11/2017

Overview of Quantitative
Forecasting Approaches Approaches
Qualitative Methods

Used when situation is vague and little data exist 1. Naive approach
New products 2. Moving averages Time-Series
Models
New technology 3. Exponential
smoothing
Involves intuition, experience
Associative
Panel of experts, queried iteratively 4. Trend projection Model
5. Linear regression

Time Series Forecasting Components of Demand

Trend
Set of evenly spaced numerical data component

Demand for product or service

Obtained by observing response variable at Seasonal peaks
regular time periods
Actual
demand
Forecast based only on past values
Assumes that factors influencing past and Average
demand over
present will continue influence in future Random four years
variation
| | | |
1 2 3 4
Year Figure 4.1

3
 6/11/2017

Trend Component Seasonal Component

Persistent, overall upward or downward pattern Regular pattern of up and down fluctuations
Changes due to population, technology, age, culture, etc. Due to weather, customs, etc.
Typically several years duration Occurs within a single year

Cyclical Component Random Component

Repeating up and down movements Erratic, unsystematic, ‘residual’ fluctuations
Affected by business cycle, political, and economic factors Due to random variation or unforeseen events
Multiple years duration Short duration and
Often causal or non repeating
associative
relationships

0 5 10 15 20 M T W T F

4
 6/11/2017

Naive Approach Techniques for Averaging

Assumes demand in next period is the same as Moving average

demand in most recent period
e.g., If May sales were 48, then June sales will be 48 Weighted moving average
Sometimes cost effective and efficient Exponential smoothing
Cannot provide high accuracy
Quick and easy to prepare

Moving Average Method (MA) Moving Average Example

Actual 3-Month
A technique that averages a number of recent actual Month Shed Sales Moving Average
values, updated as new values become available.
January 10
Used if little or no trend
February 12
March 13
April 16 (10 + 12 + 13)/3 = 11 2/3
∑ demand in previous n periods May 19 (12 + 13 + 16)/3 = 13 2/3
Moving average = n June 23 (13 + 16 + 19)/3 = 16
July 26 (16 + 19 + 23)/3 = 19 1/3

5
 6/11/2017

Graph of Moving Average Weighted Moving Average (WMA)

Moving
Average Used when trend is present
30 –
28 –
Forecast Weights based on experience and intuition
26 – Actual More recent values in a series are given more weight in
Sales
Shed Sales

24 –
22 –
computing the forecast
20 –
18 –
16 – ∑ (weight for period n)
14 – x (demand in period n)
12 –
Weighted
10 – moving average = ∑ weights
| | | | | | | | | | | |
J F M A M J J A S O N D

Weighted Moving Average Moving Average And

Weights Applied Period
Example 3 Last month
Weighted Moving Average
2 Two months ago
1 Three months ago
6 Sum of weights Weighted
30 – moving
average
Actual 3-Month Weighted 25 –

Sales demand
Month Shed Sales Moving Average
20 – Actual
January 10 sales
February 12 15 –
March 13 Moving
10 – average
April 16 [(3 x 13) + (2 x 12) + (10)]/6 = 121/6
May 19 [(3 x 16) + (2 x 13) + (12)]/6 = 141/3 5 –
June 23 [(3 x 19) + (2 x 16) + (13)]/6 = 17
July 26 [(3 x 23) + (2 x 19) + (16)]/6 = 201/2 | | | | | | | | | | | |
J F M A M J J A S O N D
Figure 4.2

6
 6/11/2017

Potential Problems With

Moving Average Common Measures of Error

Mean Absolute Deviation (MAD)

Increasing n smooths the forecast but makes it less ∑ |actual - forecast|
sensitive to changes MAD =
n
Do not forecast trends well Mean Squared Error (MSE)
Require extensive historical data ∑ (|actual - forecast|)2
MSE =
n-1
Mean Absolute Percentage Error (MAPE)
∑( |actual - forecast| / actual*100)
MAPE =
n

MAD, MSE & MAPE Tutorial

7

Exponential Smoothing
Form of weighted moving average
Weights decline exponentially
Most recent data weighted most
Requires smoothing constant (α)
Ranges from 0 to 1
Subjectively chosen
Involves little record keeping of past data
Choosing α
• The objective is to obtain the most accurate forecast
no matter the technique
• We generally do this by selecting the model that
gives us the lowest forecast error
Forecast error = Actual demand – Forecast value
= At - Ft
6/11/2017
Formula Provided
Ft = Ft-1 + α(At-1-Ft-1)
where Ft = new forecast
Ft – 1 = previous forecast
At-1 = previous actual demand
α = smoothing (or weighting)
constant (0 ≤ a ≥ 1)
Exponential Smoothing Example
Port of Baltimore has unloaded large quantities of grains
from ships during the past eight quarters. The port’s
operation manager wants to test he use of exponential
smoothing to see how well the technique works in
predicting tonnage unloaded. He assumes that the
forecast in the first quarter was 175 tons. Two value of
α for 0.1 and 0.5 are examined.
α
8
 6/11/2017

Information given for past 8 Quarters Calculate Forecast using α = 0.1

Q At Ft = Ft-1 + α (At-1-Ft-1) AD=|At-Ft |

Quarter Actual Tonnage 1 180

Unloaded 2 168
1 180 3 159
2 168 4 175
3 159 5 190
4 175 6 205
5 190 7 180
6 205 8 182
7 180
8 182

Calculate Forecast using α = 0.1 Calculate Forecast using α = 0.1

Q At Ft = Ft-1 + α (At-1-Ft-1) AD=|At-Ft | Q At Ft = Ft-1 + α (At-1-Ft-1) AD=|At-Ft |

1 180 175 |180-175|=5 1 180 175 |180-175|=5

2 168 175+0.1(180-175) = 175.5 |168-175.5|=7.5 2 168 175+0.1(180-175) = 175.5 |168-175.5|=7.5

3 159 3 159 175.5+0.1(168-175.5) = 174.75 |159-174.75|=15.75

4 175 4 175 174.5+0.1(159-174.5) = 173.18 |175-173.18|=1.82

5 190 5 190 173.18+0.1(175-173.18) = 173.36 |190-173.36|=16.64

6 205 6 205 173.36+0.1(190-173.36) = 175.02 |205-175.02|=29.98

7 180 7 180 175.02+0.1(205-175.02) = 178.02 |180-178.02|=1.98

8 182 8 182 178.02+0.1(180-178.02) = 178.22 |182-178.22|=3.78

Σ = 81.83

9
 6/11/2017

Calculate Forecast using α = 0.5 Calculate Forecast using α = 0.5

Q At Ft = Ft-1 + α (At-1-Ft-1) AD=|At-Ft | Q At Ft = Ft-1 + α (At-1-Ft-1) AD=|At-Ft |

1 180 175 |180-175|=5 1 180 175 |180-175|=5

2 168 175+0.5(180-175) =177.5 |168-177.5|=9.5 2 168 175+0.5(180-175) =177.5 |168-177.5|=9.5

3 159 3 159 177.5+0.5(168-177.5) =172.75 |159-172.75|=13.75

4 175 4 175 172.75+0.5(159-172.75) =165.88 |175-165.88|=9.12

5 190 5 190 165.88+0.5(175-165.88) = 170.44 |190-170.44 |=19.56

6 205 6 205 170.44+0.5(190-170.44) =180.22 |205-180.22|=24.78

7 180 7 180 180.22+0.5(205-180.22) = 192.61 |180-192.61|=12.61

8 182 8 182 192.61+0.5(180-192.61) = 186.31 |182-186.31|=4.31

Σ = 98.63

Mean Absolute Deviation (MAD) Tutorial

∑ |actual - forecast|
MAD =
n

81.83
MAD0.1 = = 10.23
8

98.63
MAD0.5 = = 12.33
8
On the basis of this analysis, a smoothing constant of α = 0.1
Is preferred to α = 0.5 because its MAD is smaller.

10
 6/11/2017

Linear Trend Equation

Calculating a and b; Formula Provided
Ft
n ∑ (ty) - ∑ t ∑ y
b =
Ft = a + bt n∑ t 2 - ( ∑ t) 2

0 1 2 3 4 5 t
Ft = Forecast for period t
t = Specified number of time periods ∑ y - b∑ t
a =
a = Value of Ft at t = 0 n
b = Slope of the line

Linear Trend Equation Example Linear Trend Equation Example

Week (t) Sales (y) Week (t) Sales (y) t2 ty

1 150 1 150 1 150

2 157 2 157 4 314
3 162 3 162 9 486
4 166 4 166 16 664
5 177 5 177 25 885
6 ??

Find forecast for week 6

Find forecast for week 6

11
 6/11/2017

Linear Trend Equation Example n ∑ (ty) - ∑ t ∑ y

b =
n∑ t 2 - ( ∑ t) 2
Week (t) Sales (y) t2 ty
5 (2499) - 15(812) 12495-12180
1 150 1 150 b = = = 6.3
5(55) - 225 275 -225
2 157 4 314
3 162 9 486
y - b∑ t
4 166 16 664 a = ∑
5 177 25 885 n
Σt = 15 Σy = 812 Σt2 = 55 Σty = 2499 812 - 6.3(15)
a = = 143.5
(Σt)2 = 225 5

Find forecast for week 6 Ft = a + bt y = 143.5 + 6.3t

Tutorial
Canggih computer services and repairs personal computer at
Find forecast for week 6 its store. It primarily uses part time UiTM students as
technicians thus, they need a good forecasting of demand of
repairs so that they will know how many technicians to hire.
y = 143.5 + 6.3t The company has accumulated the demand data in table
below.
Month Demand
y = 143.5 + 6.3(6) Jan 37
= 181.3 Feb
Mac
40
41
Rounded to 181 Apr 37
May 45
Jun 50
Develop a linear trend line to forecast demand for July.

12
 6/11/2017

Linear Trend Calculation

Month Demand t t2 ty Month Demand t t2 ty

(t) (y) (t) (y)
Jan 37 Jan 37 1 1 37
Feb 40 Feb 40 2 4 80
Mac 41 Mac 41 3 9 123
Apr 37 Apr 37 4 16 148
May 45 May 45 5 25 225
Jun 50 Jun 50 6 36 300
Σy = 250 Σt = 48 Σt2 = 91 Σty = 913
(Σt)2 = 2304

Assignment
Assignment

13
 6/11/2017

Assignment
Assignment

14