You are on page 1of 10

Operations Management 1 – Chapter 4 – Handouts 1

OPERATIONS MANAGEMENT 1 – HANDOUTS No 4

Chapter 4 - FORECASTING

  • 1. What is Forecasting?

    • Process of predicting future events

    • Underlying basis of all business decisions

      • Production

      • Inventory

      • Personnel

      • Facilities

  • 2. Forecasting Time Horizons

  • There are 3 categories of Time Horizons:

    • Short-range forecast

      • Up to 1 year, generally less than 3 months

      • Purchasing, job scheduling, workforce levels, job assignments, production levels

  • Medium-range forecast

    • 3 months to 3 years

    • Sales and production planning, budgeting

  • Long-range forecast

    • 3 + years

    • New product planning, facility location, research and development

  • How do medium and long-range forecast differ from short-range forecast?

    They differ by three features:

    (1) Intermediate (medium) and long-range forecasts deal with more comprehensive issues and support management decisions regarding planning and products, plants, and processes. (2) Short-term forecasting usually employs different methodologies than longer-term forecasting. (3) Short-term forecasts tend to be more accurate than longer forecasts because factors that influence demand change every day.

    • 3. Types of Forecasts

    We have the following types of forecast:

    • Economic forecasts

      • Address business cycle – inflation rate, money supply, housing starts, etc.

    • Technological forecasts

      • Predict rate of technological progress

      • Impacts development of new products

  • Demand forecasts

    • Predict sales of existing products and services

  • Operations Management 1 – Chapter 4 – Handouts 1 OPERATIONS MANAGEMENT 1 – HANDOUTS No 4

    Operations Management 1 – Chapter 4 – Handouts 1

    • 4. Steps in the forecasting system

    Operations Management 1 – Chapter 4 – Handouts 1 4. Steps in the forecasting system 5.
    • 5. Forecasting Approaches

    There are two types of forecasting approaches:

    • A. Qualitative Methods

      • Used when situation is vague and little data exist

        • Forecasting new products, new technology

      • Involves intuition, experience

        • e.g., forecasting sales on Internet

  • B. Quantitative Methods

    • Used when situation is ‘stable’ and historical data exist

      • Forecasting existing products, current technology

    • Involves mathematical techniques

      • e.g., forecasting sales of color televisions

  • 5.1 Overview of Qualitative Methods

    Qualitative forecasting methods include:

    • Jury of executive opinion

      • Pool opinions of high-level experts, sometimes augment by statistical models

      • Involves small group of high-level experts and managers

      • Group estimates demand by working together

      • Combines managerial experience with statistical models

      • Relatively quick

      • ‘Group-think’ disadvantage

    Operations Management 1 – Chapter 4 – Handouts 1 4. Steps in the forecasting system 5.
    • Delphi method

      • Panel of experts, queried iteratively

      • Iterative group process, continues until consensus is reached

      • 3 types of participants

      • Decision makers

      • Staff

      • Respondents

  • Sales force composite

  • Operations Management 1 – Chapter 4 – Handouts 1 4. Steps in the forecasting system 5.
    • Estimates from individual salespersons are reviewed for reasonableness, then aggregated

    • Each salesperson projects his or her sales

    Operations Management 1 – Chapter 4 – Handouts 1 4. Steps in the forecasting system 5.

    Operations Management 1 – Chapter 4 – Handouts 1

    • Combined at district and national levels

    • Sales reps know customers’ wants

    • Tends to be overly optimistic

    • Consumer Market Survey

      • Ask the customer

      • Ask customers about purchasing plans

      • What consumers say, and what they actually do are often different

      • Sometimes difficult to answer

    Overview of Quantitative Approaches

    Operations Management 1 – Chapter 4 – Handouts 1  Combined at district and national levels

    Time Series Forecasting

    • Set of evenly spaced numerical data

      • Obtained by observing response variable at regular time periods

    • Forecast based only on past values, no other variables important

      • Assumes that factors influencing past and present will continue influence in future

    Time Series Components

    Operations Management 1 – Chapter 4 – Handouts 1  Combined at district and national levels
    Operations Management 1 – Chapter 4 – Handouts 1  Combined at district and national levels

    Operations Management 1 – Chapter 4 – Handouts 1

    Trend Component

    • Persistent, overall upward or downward pattern

    • Changes due to population, technology, age, culture, etc.

    • Typically several years duration

    Operations Management 1 – Chapter 4 – Handouts 1 Trend Component  Persistent, overall upward or

    Seasonal Component

    • Regular pattern of up and down fluctuations

    • Due to weather, customs, etc.

    • Occurs within a single year

    Operations Management 1 – Chapter 4 – Handouts 1 Trend Component  Persistent, overall upward or

    Cyclical Component

    • Repeating up and down movements

    • Affected by business cycle, political, and economic factors

    • Multiple years duration

    • Often causal or associative relationships

    Operations Management 1 – Chapter 4 – Handouts 1 Trend Component  Persistent, overall upward or

    Random Component

    • Erratic, unsystematic, ‘residual’ fluctuations

    • Due to random variation or unforeseen events

    • Short duration and no repeating

    Operations Management 1 – Chapter 4 – Handouts 1 Trend Component  Persistent, overall upward or
    Operations Management 1 – Chapter 4 – Handouts 1 Trend Component  Persistent, overall upward or

    Naive Approach

    • Assumes demand in next period is the same as demand in most recent period

      • e.g., If January sales were 68, then February sales will be 68

    • Sometimes cost effective and efficient

    • Can be good starting point

    Moving Average Method

    • MA is a series of arithmetic means

    • Used if little or no trend

    • Used often for smoothing

      • Provides overall impression of data over time

    Operations Management 1 – Chapter 4 – Handouts 1 Trend Component  Persistent, overall upward or
    Operations Management 1 – Chapter 4 – Handouts 1 Trend Component  Persistent, overall upward or

    Operations Management 1 – Chapter 4 – Handouts 1

    Moving Average Example

    Donna’s Garden Supply wants a 3-month moving average forecast

    Approach:

    Storage shed are shown in the middle column of the table below. The 3-month moving average is shown on the right.

    Operations Management 1 – Chapter 4 – Handouts 1 Moving Average Example Donna’s Garden Supply wants

    Weighted Moving Average

    • Used when trend is present

      • Older data usually less important

    • Weights based on experience and intuition

    Operations Management 1 – Chapter 4 – Handouts 1 Moving Average Example Donna’s Garden Supply wants

    Weighted Moving Average Example

    Donna’s Garden Supply (See the first example) wants to forecast storage shed sales by weighting the past 3 months, with more given to recent data to make them more significant.

    Approach:

    Assign more weight to recent data as follows:

    Operations Management 1 – Chapter 4 – Handouts 1 Moving Average Example Donna’s Garden Supply wants
    Operations Management 1 – Chapter 4 – Handouts 1 Moving Average Example Donna’s Garden Supply wants
    Operations Management 1 – Chapter 4 – Handouts 1 Moving Average Example Donna’s Garden Supply wants
    Operations Management 1 – Chapter 4 – Handouts 1 Moving Average Example Donna’s Garden Supply wants

    Forecast this month = 3 x Sales last month + 2 x Sales 2 months ago + 1 x Sales 3 months ago Sum of the weights

    Operations Management 1 – Chapter 4 – Handouts 1 Moving Average Example Donna’s Garden Supply wants

    Potential Problems With Moving Average

    • Increasing n smoothes the forecast but makes it less sensitive to changes

    • Do not forecast trends well

    • Require extensive historical data

    Operations Management 1 – Chapter 4 – Handouts 1 Moving Average Example Donna’s Garden Supply wants

    Operations Management 1 – Chapter 4 – Handouts 1

    Exponential Smoothing

    • Form of weighted moving average

      • Weights decline exponentially

      • Most recent data weighted most

  • Requires smoothing constant (a)

    • Ranges from 0 to 1

    • Subjectively chosen

  • Involves little record keeping of past data

  • New forecast = Last period’s forecast + α (Last period’s actual demand – Last period’s forecast)

    F t = F t – 1 +

    α (A t – 1 - F t – 1 )

    Where F t

    F t 1

    a

    =

    =

    =

    new forecast previous forecast smoothing (or weighting) constant (0 ≤ a ≤ 1)

    Exponential Smoothing Example

    In January, a car dealer predicted February demand for 142 Ford Mustangs. Actual February demand was 153 autos. Using a smoothing constant chosen by management of α = 0.20, the dealer wants to forecast March demand using the exponential smoothing model.

    Approach:

    The formula introduced above can be applied

    Predicted demand = 142 Ford Mustangs Actual demand = 153 Smoothing constant a = .20

    Operations Management 1 – Chapter 4 – Handouts 1 Exponential Smoothing  Form of weighted moving
    Operations Management 1 – Chapter 4 – Handouts 1 Exponential Smoothing  Form of weighted moving

    Common Measures of Error

    Operations Management 1 – Chapter 4 – Handouts 1 Exponential Smoothing  Form of weighted moving

    Determining the Mean Absolute Deviation (MAD)

    During the past 8 quarters, the Port of Baltimore has unloaded large quantities of grain from ships. The port’s operations manager wants to test the use of exponential smoothing to see how well the technique works in predicting tonnage unloaded. He guesses that the forecast of grain unloaded in the first quarter was 175 tons. Two values of α are to be examined: α = 0.10 and α = 0.50

    Approach:

    Compare the actual data with the data we forecast (using each of the two α values)

    and then find the absolute deviation and MADs

    Operations Management 1 – Chapter 4 – Handouts 1 Exponential Smoothing  Form of weighted moving

    Operations Management 1 – Chapter 4 – Handouts 1

    Solution:

    The table below shows the detailed calculations for α = 0.10 only

     

    Actual

    Forecast

    Forecast

    Quarter

    Tonnage

    Unloaded

    with α = 0.10

    with α = 0.50

    • 1 180

    175

    175

    • 2 168

    • 175.50 = 175.00 + 0.10(180 – 175)

    177.50

    • 3 159

    • 174.75 = 175.50 + 0.10(168 – 175.50)

    172.75

    • 4 175

    • 173.18 = 174.75 + 0.10(159 – 174.75)

    165.88

    • 5 190

    • 173.36 = 173.18 + 0.10(175 – 173.18)

    170.44

    • 6 205

    • 175.02 = 173.36 + 0.10(190 – 173.36)

    180.22

    • 7 180

    • 178.02 = 175.02 + 0.10(205 – 175.02)

    192.61

    • 8 182

    • 178.22 = 178.02 + 0.10(180 – 178.02)

    186.30

    • 9 ?

    • 178.59 = 178.22 + 0.10(182 – 178.22)

    184.15

    Operations Management 1 – Chapter 4 – Handouts 1 Solution : The table below shows the
    Operations Management 1 – Chapter 4 – Handouts 1 Solution : The table below shows the
    Operations Management 1 – Chapter 4 – Handouts 1 Solution : The table below shows the
    Operations Management 1 – Chapter 4 – Handouts 1 Solution : The table below shows the

    Based on the calculations, it is advisable to perform forecasts using α = 0.10, because the MAD of the forecast with α = 0.10 is the smallest.

    Operations Management 1 – Chapter 4 – Handouts 1 Solution : The table below shows the

    Operations Management 1 – Chapter 4 – Handouts 1

    Practice Problems: Chapter 4, Forecasting

    Problem 1:

    Auto sales at Carmen’s Chevrolet are shown below. Develop a 3-week moving average.

    Week

    Auto

     

    Sales

    1

    8

    2

    10

    3

    9

    4

    11

    5

    10

    6

    13

    7

    -

    Problem 2:

     

    Carmen’s decides to forecast auto sales by weighting the three weeks as follows:

    Weights

    Period

     

    Applied

    3

    Last week

    2

    Two weeks ago

    1

    Three weeks ago

    6

     

    Total

    Problem 3:

     

    A firm uses simple exponential smoothing with α = 0.1 to forecast demand. The forecast for the week of January 1 was 500 units whereas the actual demand turned out to be 450 units. Calculate the demand forecast for the week of January 8.

    Problem 4:

    Exponential smoothing is used to forecast automobile battery sales. Two value of α are examined, α = 0.8 and α = 0.5. Evaluate the accuracy of each smoothing constant. Which is preferable? (Assume the forecast for January was 22 batteries.) Actual sales are given below:

    Month January February March April May June Actual Battery Sales 20 21 15 14 13 16
    Month
    January
    February
    March
    April
    May
    June
    Actual Battery Sales
    20
    21
    15 14
    13 16
    Forecast
    22
    Operations Management 1 – Chapter 4 – Handouts 1 Practice Problems: Chapter 4, Forecasting Problem 1:

    Operations Management 1 – Chapter 4 – Handouts 1

    ANSWERS:

    Problem 1:

    Moving average =

    demand in previous n periods

    n

    Week Auto Three-Week Moving Sales Average 1 8 2 10 3 9 4 11 (8 +
    Week
    Auto
    Three-Week
    Moving
    Sales
    Average
    1
    8
    2
    10
    3
    9
    4
    11
    (8 + 9 + 10) / 3 = 9
    5
    10
    (10 + 9 + 11) / 3 = 10
    6
    13
    (9 + 11 + 10) / 3 = 10
    7
    - (11
    +
    10
    +
    13)
    /
    3
    =
    11
    1/3
    Problem 2:
    (weight for period n)(demand in period n)
    Weighted moving average =
    weights
    Week
    Auto
    Three-Week Moving Average
    Sales
    1
    8
    2
    10
    3
    9
    4
    11
    [(3*9) + (2*10) + (1*8)] / 6 = 9 1/6
    5
    10
    [(3*11) + (2*9) + (1*10)] / 6 = 10 1/6
    6
    13
    [(3*10) + (2*11) + (1*9)] / 6 = 10 1/6
    7
    - [(3*13) + (2*10) + (1*11)] / 6 = 11 2/3
    Problem 3:
    F
    =
    F
    +
    α (
    A
    F
    )
    =
    500
    +
    0 1 450
    .
    (
    500
    )
    =
    495
    units
    t
    t
    1
    t
    1
    t
    1
    Operations Management 1 – Chapter 4 – Handouts 1 ANSWERS: Problem 1: Moving average = ∑

    Operations Management 1 – Chapter 4 – Handouts 1

    Problem 4:

    Month

    Actual Battery

    Rounded

    Absolute

    Rounded

    Absolute

    Sales

    Forecast with

    Deviation

    Forecast

    Deviation

    a =0.8

    with a =0.8

    with a =0.5

    with a =0.5

    January

    20

    22

    2

    22

    2

    February

    21

    20

    1

    21

    0

    March

    15

    21

    6

    21

    6

    April

    14

    16

    2

    18

    4

    May

    13

    14

    1

    16

    3

    June

    16

    13

    3

    14.5

    1.5

               
         

    S = 15

     

    S = 16

    2.56 2.95
     

    2.56

     

    2.95

    SE

    3.5

     

    3.9

    On the basis of this analysis, a smoothing constant of a = 0.8 is preferred to that of a = 0.5 because it has a smaller MAD.

    Operations Management 1 – Chapter 4 – Handouts 1 Problem 4: Month Actual Battery Rounded Absolute