Classical Decomposition

Boise State University By: Kurt Folke Spring 2003

Overview:
Time series models & classical decomposition Brainstorming exercise Classical decomposition explained Classical decomposition illustration Exercise Summary Bibliography & readings list Appendix A: exercise templates

Time Series Models & Classical Decomposition

Time series models are sequences of data that follow non-random orders
Examples of time series data:
Sales Costs

Time series models are composed of trend, seasonal, cyclical, and random influences

Time Series Models & Classical Decomposition

Decomposition time series models:
Multiplicative: Additive:

Y=TxCxSxe Y=T+C+S+e

T = Trend component C = Cyclical component S = Seasonal component e = Error or random component

Time Series Models & Classical Decomposition

Classical decomposition is used to isolate trend, seasonal, and other variability components from a time series model
Benefits:
Shows fluctuations in trend Provides insight to underlying factors affecting the time series

Brainstorming Exercise
Identify how this tool can be used in your organization

Classical Decomposition Explained

Basic Steps:
1. Determine seasonal indexes using the ratio to moving average method 2. Deseasonalize the data 3. Develop the trend-cyclical regression equation using deseasonalized data 4. Multiply the forecasted trend values by their seasonal indexes to create a more accurate forecast

Classical Decomposition Explained: Step 1

Determine seasonal indexes

Start with multiplicative model

Y = TCSe
Equate

Se = (Y/TC)

Classical Decomposition Explained: Step 1

To find seasonal indexes, first estimate trend-cyclical components

Se = (Y/TC)
Use centered moving average
Called ratio to moving average method

For quarterly data, use four-quarter moving average

Averages seasonal influences
Example

Classical Decomposition Explained: Step 1

Four-quarter moving average will position average at
end of second period and beginning of third period

Use centered moving average to position data in middle of the period

Example

Classical Decomposition Explained: Step 1

Find seasonal-error components by dividing original data by trendcyclical components

Se = (Y/TC)

Se = Seasonal-error components Y = Original data value TC = Trend-cyclical components (centered moving average value)
Example

Classical Decomposition Explained: Step 1

Unadjusted seasonal indexes (USI) are found by averaging seasonalerror components by period
Example

Develop adjusting factor (AF) so USIs are adjusted so their sum equals the number of quarters (4)
Reduces error
Example

Classical Decomposition Explained: Step 1

Adjusted seasonal indexes (ASI) are derived by multiplying the unadjusted seasonal index by the adjusting factor
ASI = USI x AF

ASI = Adjusted seasonal index USI = Unadjusted seasonal index AF = Adjusting factor

Example

Classical Decomposition Explained: Step 2

Deseasonalized data is produced by dividing the original data values by their seasonal indexes
(Y/S) = TCe

Y/S = Deseasonalized data TCe = Trend-cyclical-error component

Example

Classical Decomposition Explained: Step 3

Develop the trend-cyclical regression equation using deseasonalized data Tt = a + bt

Tt = Trend value at period t a = Intercept value b = Slope of trend line

Example

Classical Decomposition Explained: Step 4

Use trend-cyclical regression equation to develop trend data
Example

Create forecasted data by multiplying the trend data values by their seasonal indexes
More accurate forecast
Example

Classical Decomposition Explained: Step Summary

Summarized Steps: 1. Determine seasonal indexes 2. Deseasonalize the data 3. Develop the trend-cyclical regression equation 4. Create forecast using trend data and seasonal indexes

Classical Decomposition: Illustration

Gem Companys operations department has been asked to deseasonalize and forecast sales for the next four quarters of the coming year The Company has compiled its past sales data in Table 1 An illustration using classical decomposition will follow
Table 1: Gem Company's Sales Data
Original Year Quarter Period Sales t Y 1 1 1 55 2 2 47 3 3 65 4 4 70 2 1 5 65 2 6 58 3 7 75 4 8 80 3 1 9 65 2 10 62 3 11 80 4 12 85 4 1 13 70 2 14 65 3 15 85 4 16 90 5 1 17 2 18 3 19 4 20 Forecasted Sales TS ? ? ? ?

Classical Decomposition Illustration: Step 1

(a) Compute the four-quarter simple moving average Ex: simple MA at end of Qtr 2 and beginning of Qtr 3 (55+47+65+70)/4 = 59.25
Explain
Table 2: Four-Quarter Moving Average
Simple Centered Moving Moving Year Quarter Period Sales Average Average t Y TC 1 1 1 55 2 2 47 59.25 3 3 65 61.75 60.500 4 4 70 64.50 63.125 2 1 5 65 67.00 65.750 2 6 58 69.50 68.250 3 7 75 69.50 69.500 4 8 80 70.50 70.000 3 1 9 65 71.75 71.125 2 10 62 73.00 72.375 3 11 80 74.25 73.625 4 12 85 75.00 74.625 4 1 13 70 76.25 75.625 2 14 65 77.50 76.875 3 15 85 4 16 90 Percent Moving Average Se=Y/(TC)

1.074 1.109 0.989 0.850 1.079 1.143 0.914 0.857 1.087 1.139 0.926 0.846

Classical Decomposition Illustration: Step 1

(b) Compute the two-quarter centered moving average Ex: centered MA at middle of Qtr 3
Table 2: Four-Quarter Moving Average
Simple Centered Moving Moving Year Quarter Period Sales Average Average t Y TC 1 1 1 55 2 2 47 59.25 3 3 65 61.75 60.500 4 4 70 64.50 63.125 2 1 5 65 67.00 65.750 2 6 58 69.50 68.250 3 7 75 69.50 69.500 4 8 80 70.50 70.000 3 1 9 65 71.75 71.125 2 10 62 73.00 72.375 3 11 80 74.25 73.625 4 12 85 75.00 74.625 4 1 13 70 76.25 75.625 2 14 65 77.50 76.875 3 15 85 4 16 90 Percent Moving Average Se=Y/(TC)

(59.25+61.25)/2 = 60.500
Explain

1.074 1.109 0.989 0.850 1.079 1.143 0.914 0.857 1.087 1.139 0.926 0.846

Classical Decomposition Illustration: Step 1

Table 2: Four-Quarter Moving Average

(c) Compute the seasonal-error component (percent MA) Ex: percent MA at Qtr 3 (65/60.500) = 1.074
Explain

Simple Centered Moving Moving Year Quarter Period Sales Average Average t Y TC 1 1 1 55 2 2 47 59.25 3 3 65 61.75 60.500 4 4 70 64.50 63.125 2 1 5 65 67.00 65.750 2 6 58 69.50 68.250 3 7 75 69.50 69.500 4 8 80 70.50 70.000 3 1 9 65 71.75 71.125 2 10 62 73.00 72.375 3 11 80 74.25 73.625 4 12 85 75.00 74.625 4 1 13 70 76.25 75.625 2 14 65 77.50 76.875 3 15 85 4 16 90

Percent Moving Average Se=Y/(TC)

1.074 1.109 0.989 0.850 1.079 1.143 0.914 0.857 1.087 1.139 0.926 0.846

Classical Decomposition Illustration: Step 1

(d) Compute the unadjusted seasonal index using the seasonal-error components from Table 2
Ex (Qtr 1): [(Yr 2, Qtr 1) + (Yr 3, Qtr 1) + (Yr 4, Qtr 1)]/3 = [0.989+0.914+0.926]/3 = 0.943
Table 3: Seasonal Index Computation
Quarter 1 2 3 4 Average (0.989+0.914+0.926)/3 (0.850+0.857+0.846)/3 (1.074+1.079+1.087)/3 (1.109+1.143+1.139)/3 Unadjusted Seasonal Index 0.943 0.851 1.080 1.130 4.004 Adjusting Factor (4.000/4.004) (4.000/4.004) (4.000/4.004) (4.000/4.004) Adjusted Seasonal Index 0.942 0.850 1.079 1.129 4.000

= = = =

x x x x

= = = =

Explain

Classical Decomposition Illustration: Step 1

(e) Compute the adjusting factor by dividing the number of quarters (4) by the sum of all calculated unadjusted seasonal indexes = 4.000/(0.943+0.851+1.080+1.130) = (4.000/4.004)
Table 3: Seasonal Index Computation
Quarter 1 2 3 4 Average (0.989+0.914+0.926)/3 (0.850+0.857+0.846)/3 (1.074+1.079+1.087)/3 (1.109+1.143+1.139)/3 Unadjusted Seasonal Index 0.943 0.851 1.080 1.130 4.004 Adjusting Factor (4.000/4.004) (4.000/4.004) (4.000/4.004) (4.000/4.004) Adjusted Seasonal Index 0.942 0.850 1.079 1.129 4.000

= = = =

x x x x

= = = =

Explain

Classical Decomposition Illustration: Step 1

(f) Compute the adjusted seasonal index by multiplying the unadjusted seasonal index by the adjusting factor

Ex (Qtr 1): 0.943 x (4.000/4.004) = 0.942

Table 3: Seasonal Index Computation
Quarter 1 2 3 4 Average (0.989+0.914+0.926)/3 (0.850+0.857+0.846)/3 (1.074+1.079+1.087)/3 (1.109+1.143+1.139)/3 Unadjusted Seasonal Index 0.943 0.851 1.080 1.130 4.004 Adjusting Factor (4.000/4.004) (4.000/4.004) (4.000/4.004) (4.000/4.004) Adjusted Seasonal Index 0.942 0.850 1.079 1.129 4.000

= = = =

x x x x

= = = =

Explain

Classical Decomposition Illustration: Step 2

Compute the deseasonalized sales by dividing original sales by the adjusted seasonal index
Ex (Yr 1, Qtr 1): (55 / 0.942) = 58.386
Table 4: Deseasonalizing Sales
Adjusted Original Seasonal Deseasonalized Year Quarter Period Sales Index Sales t Y S TCe 1 1 1 55 0.942 58.386 2 2 47 0.850 55.294 3 3 65 1.079 60.241 4 4 70 1.129 62.002 2 1 5 65 0.942 69.002 2 6 58 0.850 68.235 3 7 75 1.079 69.509 4 8 80 1.129 70.859 3 1 9 65 0.942 69.002 2 10 62 0.850 72.941 3 11 80 1.079 74.143 4 12 85 1.129 75.288 4 1 13 70 0.942 74.310 2 14 65 0.850 76.471 3 15 85 1.079 78.777 4 16 90 1.129 79.717

Explain

Classical Decomposition Illustration: Step 3

Compute the trendcyclical regression equation using simple linear regression
Tt = a + bt t-bar = 8.5 T-bar = 69.6 b = 1.465 a = 57.180 Tt = 57.180 + 1.465t
Explain
Table 5: Regression Equation Values
Deseasonalized Year Quarter Period Sales t TCe = (Y/S) 1 1 1 58.386 2 2 55.294 3 3 60.241 4 4 62.002 2 1 5 69.002 2 6 68.235 3 7 69.509 4 8 70.859 3 1 9 69.002 2 10 72.941 3 11 74.143 4 12 75.288 4 1 13 74.310 2 14 76.471 3 15 78.777 4 16 79.717 136 1114.176 t2 1 4 9 16 25 36 49 64 81 100 121 144 169 196 225 256 1496

t( Y/S) 58.386 110.588 180.723 248.007 345.011 409.412 486.562 566.873 621.019 729.412 815.570 903.454 966.030 1070.588 1181.650 1275.465 9968.750

Classical Decomposition Illustration: Step 4

(a) Develop trend sales Tt = 57.180 + 1.465t Ex (Yr 1, Qtr 1): T1 = 57.180 + 1.465(1) = 58.645
Table 6: Trend Sales
Year Quarter Period t 1 1 1 2 2 3 3 4 4 2 1 5 2 6 3 7 4 8 3 1 9 2 10 3 11 4 12 4 1 13 2 14 3 15 4 16 5 1 17 2 18 3 19 4 20 Original Deseasonalized Sales Sales Y TCe = (Y/S) 55 58.386 47 55.294 65 60.241 70 62.002 65 69.002 58 68.235 75 69.509 80 70.859 65 69.002 62 72.941 80 74.143 85 75.288 70 74.310 65 76.471 85 78.777 90 79.717 Trend Sales T 58.645 60.110 61.575 63.040 64.505 65.970 67.435 68.900 70.365 71.830 73.295 74.760 76.225 77.690 79.155 80.620 82.085 83.550 85.015 86.480

Explain

Classical Decomposition Illustration: Step 4

(b) Forecast sales for each of the four quarters of the coming year Ex (Yr 5, Qtr 1): 0.942 x 82.085 = 77.324
Table 7: Forecasted Sales
Year Quarter Period t 1 1 1 2 2 3 3 4 4 2 1 5 2 6 3 7 4 8 3 1 9 2 10 3 11 4 12 4 1 13 2 14 3 15 4 16 5 1 17 2 18 3 19 4 20 Seasonal Index S 0.942 0.850 1.079 1.129 0.942 0.850 1.079 1.129 0.942 0.850 1.079 1.129 0.942 0.850 1.079 1.129 0.942 0.850 1.079 1.129 Trend Sales T 58.645 60.110 61.575 63.040 64.505 65.970 67.435 68.900 70.365 71.830 73.295 74.760 76.225 77.690 79.155 80.620 82.085 83.550 85.015 86.480 Forecasted Sales TS

Explain

77.324 71.018 91.731 97.636

Classical Decomposition Illustration: Graphical Look

Graph 1: Comparison of Trend, Original, and Deseasonalized Sales
100 90 80

Sales ($)

(Y/S) = TCe Deseasonalized T Trend Y Original

70 60 50 40 0 2 4 6 8 Quarter 10 12 14

16

18

Classical Decomposition: Exercise

Assume you have been asked by your boss to deseasonalize and forecast for the next four quarters of the coming year (Yr 5) this data pertaining to your companys sales Use the steps and examples shown in the explanation and illustration as a reference
Basic Steps Explanation Illustration Templates
Table 8: Your Company's Sales Data
Original Year Quarter Period Sales t Y 1 1 1 5.0 2 2 2.3 3 3 8.3 4 4 10.0 2 1 5 8.3 2 6 6.0 3 7 11.7 4 8 13.3 3 1 9 8.3 2 10 7.3 3 11 13.3 4 12 15.0 4 1 13 10.0 2 14 8.3 3 15 15.0 4 16 16.7 5 1 17 2 18 3 19 4 20 Forecasted Sales TS ? ? ? ?

Summary
Time series models are sequences of data that follow non-arbitrary orders
Classical decomposition isolates the components of a time series model Benefits: Insight to fluctuations in trend Decomposes the underlying factors affecting the time series

Bibliography & Readings List

DeLurgio, Stephen, and Bhame, Carl. Forecasting Systems for Operations Management. Homewood: Business One Irwin, 1991.
Shim, Jae K. Strategic Business Forecasting. New York: St Lucie, 2000. StatSoft Inc. (2003). Time Series Analysis. Retrieved April 21, 2003, from http://www.statsoft.com/textbook/sttimser.html

Appendix A: Exercise Templates

Table 9: Four-Quarter Moving Average
Simple Centered Moving Moving Year Quarter Period Sales Average Average t Y TC 1 1 1 5 2 2 2.3 3 3 8.3 4 4 10 2 1 5 8.3 2 6 6 3 7 11.7 4 8 13.3 3 1 9 8.3 2 10 7.3 3 11 13.3 4 12 15 4 1 13 10 2 14 8.3 3 15 15 4 16 16.7 Percent Moving Average Se=Y/(TC)

Appendix A: Exercise Templates

Table 10: Seasonal Index Computation

Quarter 1 2 3 4 Average = = = = Unadjusted Seasonal Index x x x x Adjusting Factor = = = = Adjusted Seasonal Index

Appendix A: Exercise Templates

Table 11: Deseasonalizing Sales
Adjusted Original Seasonal Deseasonalized Year Quarter Period Sales Index Sales t Y S TCe 1 1 1 5 2 2 2.3 3 3 8.3 4 4 10 2 1 5 8.3 2 6 6 3 7 11.7 4 8 13.3 3 1 9 8.3 2 10 7.3 3 11 13.3 4 12 15 4 1 13 10 2 14 8.3 3 15 15 4 16 16.7

Appendix A: Exercise Templates

Table 12: Trend Sales
Year Quarter Period t 1 1 1 2 2 3 3 4 4 2 1 5 2 6 3 7 4 8 3 1 9 2 10 3 11 4 12 4 1 13 2 14 3 15 4 16 5 1 17 2 18 3 19 4 20 Original Deseasonalized Sales Sales Y TCe = (Y/S) 5 2.3 8.3 10 8.3 6 11.7 13.3 8.3 7.3 13.3 15 10 8.3 15 16.7 Trend Sales T

Appendix A: Exercise Templates

Table 13: Forecasted Sales
Year Quarter Period t 1 1 1 2 2 3 3 4 4 2 1 5 2 6 3 7 4 8 3 1 9 2 10 3 11 4 12 4 1 13 2 14 3 15 4 16 5 1 17 2 18 3 19 4 20 Seasonal Index S Trend Sales T Forecasted Sales TS

80.000 75.000 70.000 65.000