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Forecasting

CHAPTER

Forecasting

McGraw-Hill/Irwin

Operations Management, Eighth Edition, by William J. Stevenson Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

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Forecasting

FORECAST:

A statement about the future value of a variable of interest such as demand. Forecasts affect decisions and activities throughout an organization Accounting, finance Human resources Marketing MIS Operations Product / service design

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Forecasting

Uses of Forecasts
Cost/profit estimates Cash flow and funding

Accounting Finance

Human Resources Marketing

MIS Operations Product/service design

Hiring/recruiting/training Pricing, promotion, strategy

IT/IS systems, services Schedules, MRP, workloads New products and services

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Forecasting

Assumes causal system past ==> future Forecasts rarely perfect because of randomness

Forecasts more accurate for groups vs. individuals

Forecast accuracy decreases as time horizon increases

I see that you will get an A this semester.

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Forecasting

Elements of a Good Forecast

Timely

Reliable

Accurate

Written

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Forecasting

Steps in the Forecasting Process

The forecast

Step 6 Monitor the forecast

Step 5 Prepare the forecast Step 4 Gather and analyze data Step 3 Select a forecasting technique
Step 2 Establish a time horizon Step 1 Determine purpose of forecast

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Forecasting

Types of Forecasts

Judgmental - uses subjective inputs Time series - uses historical data assuming the future will be like the past Associative models - uses explanatory variables to predict the future

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Forecasting

Judgmental Forecasts

Executive opinions
Sales force opinions Consumer surveys Outside opinion method

Delphi

Opinions of managers and staff

Achieves a consensus forecast

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Forecasting

Time Series Forecasts

Trend - long-term movement in data Seasonality - short-term regular variations in data Cycle wavelike variations of more than one years duration Irregular variations - caused by unusual circumstances Random variations - caused by chance

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Forecast Variations
Irregular variatio n

Figure 3.1

Trend

Cycles
90 89 88 Seasonal variations

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Naive Forecasts

Uh, give me a minute.... We sold 250 wheels last week.... Now, next week we should sell....
The forecast for any period equals the previous periods actual value.

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Nave Forecasts

Simple to use Virtually no cost Quick and easy to prepare Data analysis is nonexistent Easily understandable Cannot provide high accuracy Can be a standard for accuracy

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Uses for Nave Forecasts

Stable time series data

F(t) = A(t-1) F(t) = A(t-n) F(t) = A(t-1) + (A(t-1) A(t-2))

Seasonal variations

Data with trends

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Techniques for Averaging

Moving average Weighted moving average Exponential smoothing

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Moving Averages

Moving average A technique that averages a number of recent actual values, updated as new values become available.

MAn =

Ai i=1 n

Weighted moving average More recent values in a series are given more weight in computing the forecast.

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Simple Moving Average

Actual

MA5

47 45 43 41 39 37 35 1 2 3 4 5 6 7
n

MA3
8 9 10 11 12

MAn =

Ai i=1 n

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Exponential Smoothing

Ft = Ft-1 + (At-1 - Ft-1)

Premise--The most recent observations might have the highest predictive value.

Therefore, we should give more weight to the more recent time periods when forecasting.

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Exponential Smoothing

Ft = Ft-1 + (At-1 - Ft-1)

Weighted averaging method based on previous forecast plus a percentage of the forecast error A-F is the error term, is the % feedback

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Example 3 - Exponential Smoothing

Period 1 2 3 4 5 6 7 8 9 10 11 12 Actual 42 40 43 40 41 39 46 44 45 38 40 Alpha = 0.1 Error 42 41.8 41.92 41.73 41.66 41.39 41.85 42.07 42.36 41.92 41.73 -2.00 1.20 -1.92 -0.73 -2.66 4.61 2.15 2.93 -4.36 -1.92 Alpha = 0.4 Error 42 41.2 41.92 41.15 41.09 40.25 42.55 43.13 43.88 41.53 40.92 -2 1.8 -1.92 -0.15 -2.09 5.75 1.45 1.87 -5.88 -1.53

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Picking a Smoothing Constant

Actual

50
Demand

.4

45 40 35 1 2 3 4 5 6 7 8

.1

9 10 11 12

Period

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Common Nonlinear Trends

Figure 3.5

Parabolic

Exponential

Growth

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Linear Trend Equation

Ft

Ft = a + bt

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

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Calculating a and b
n (ty) - t y b = 2 2 n t - ( t)

y - b t a = n

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Linear Trend Equation Example

t Week 1 2 3 4 5 t2 1 4 9 16 25 y Sales 150 157 162 166 177 ty 150 314 486 664 885

t = 15 t2 = 55 2 ( t) = 225

y = 812 ty = 2499

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Linear Trend Calculation

5 (2499) - 15(812) 5(55) - 225 = 12495 -12180 275 -225 = 6.3

b =

812 - 6.3(15) a = = 143.5 5

y = 143.5 + 6.3t

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Associative Forecasting

Predictor variables - used to predict values of variable interest

Regression - technique for fitting a line to a set of points Least squares line - minimizes sum of squared deviations around the line

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Linear Model Seems Reasonable

X 7 2 6 4 14 15 16 12 14 20 15 7 Y 15 10 13 15 25 27 24 20 27 44 34 17

Computed relationship
50 40 30 20 10 0 0 5 10 15 20 25

A straight line is fitted to a set of sample points.

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Forecast Accuracy

Error - difference between actual value and predicted value

Mean Absolute Deviation (MAD)

Average absolute error

Mean Squared Error (MSE)

Average of squared error

Mean Absolute Percent Error (MAPE)

Average absolute percent error

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MAD, MSE, and MAPE

Actual forecast

MAD

n
MSE = ( Actual forecast)
2

n -1
( Actual forecas t n

MAPE =

/ Actual*100)

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Example 10
Forecast 215 216 215 214 211 214 217 216 (A-F) 2 -3 1 -4 2 5 -1 -4 -2 |A-F| 2 3 1 4 2 5 1 4 22 (A-F)^2 4 9 1 16 4 25 1 16 76 (|A-F|/Actual)*100 0.92 1.41 0.46 1.90 0.94 2.28 0.46 1.89 10.26

Period 1 2 3 4 5 6 7 8

Actual 217 213 216 210 213 219 216 212

MAD= MSE= MAPE=

2.75 10.86 1.28

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Controlling the Forecast

Control chart

A visual tool for monitoring forecast errors Used to detect non-randomness in errors

Forecasting errors are in control if

All errors are within the control limits No patterns, such as trends or cycles, are present

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Sources of Forecast errors

Model may be inadequate Irregular variations Incorrect use of forecasting technique

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Tracking Signal

Tracking signal
Ratio of cumulative error to MAD

(Actual-forecast) Tracking signal = MAD

Bias Persistent tendency for forecasts to be Greater or less than actual values.

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Choosing a Forecasting Technique

No single technique works in every situation Two most important factors

Cost Accuracy

Other factors include the availability of:

Historical data Computers Time needed to gather and analyze the data Forecast horizon

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Exponential Smoothing

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Linear Trend Equation

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Simple Linear Regression

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Workload/Scheduling

SSU9 United Airlines example