Forecasting

McGraw-Hill/I rwin
Copyright 2012 by The McGraw-Hill Companies, I nc. All rights reserved.
You should be able to:
1. List the elements of a good forecast
2. Outline the steps in the forecasting process
3. Describe at least three qualitative forecasting techniques and
the advantages and disadvantages of each
4. Compare and contrast qualitative and quantitative
approaches to forecasting
5. Describe averaging techniques, trend and seasonal
techniques, and regression analysis, and solve typical
problems
6. Explain three measures of forecast accuracy
7. Compare two ways of evaluating and controlling forecasts
8. Assess the major factors and trade-offs to consider when
choosing a forecasting technique
3-2
Student Slides
Forecast a statement about the future value of a
variable of interest
We make forecasts about such things as weather,
demand, and resource availability
Forecasts are an important element in making informed
decisions
3-3
Student Slides
n

=
100
Actual
Forecast Actual
MAPE
t
t t
n

=
t t
Forecast Actual
MAD
( )
2
t t
1
Forecast Actual
MSE

n
MAD weights all errors
evenly
MSE weights errors according
to their squared values
MAPE weights errors
according to relative error
3-4
Student Slides
Forecasts that project patterns identified in recent
time-series observations
Time-series - a time-ordered sequence of observations
taken at regular time intervals
Assume that future values of the time-series can be
estimated from past values of the time-series
3-5
Student Slides
These Techniques work best when a series tends to
vary about an average
Averaging techniques smooth variations in the data
They can handle step changes or gradual changes in the
level of a series
Techniques
1. Moving average
2. Weighted moving average
3. Exponential smoothing
3-6
Student Slides
Technique that averages a number of the most recent
actual values in generating a forecast
average moving in the periods of Number
1 period in value Actual
average moving period MA
period for time Forecast
where
MA
1
1
=
=
=
=
= =

=

n
t A
n
t F
n
A
F
t
n
t
n
i
i t
n t
3-7
Student Slides
The most recent values in a time series are given more
weight in computing a forecast
The choice of weights, w, is somewhat arbitrary and
involves some trial and error
etc. , 1 period for value actual the , period for value actual the
etc. , 1 period for weight , period for weight
where
) ( ... ) ( ) (
1
1
1 1
= =
= =
+ + + =

t A t A
t w t w
A w A w A w F
t t
t t
n t n t t t t t t
3-8
Student Slides
A weighted averaging method that is based on the
previous forecast plus a percentage of the forecast
error
period previous the from sales or demand Actual
constant Smoothing =
period previous for the Forecast
period for Forecast
where
) (
1
1
1 1 1
=
=
=
+ =

t
t
t
t t t t
A
F
t F
F A F F
o
o
3-9
Student Slides
A simple data plot can reveal the existence and nature
of a trend
Linear trend equation

F
t
= a + bt
where
F
t
= Forecast for period t
a = Value of F
t
at t = 0
b =Slope of the line
t =Specified number of time periods from t = 0
3-10
Student Slides
Slope and intercept can be estimated from historical
data

b =
n ty t y

n t
2
t

( )

2
a =
y b t

n
or y bt
where
n = Number of periods
y = Value of the time series
3-11
Student Slides
The trend adjusted forecast consists of two
components
Smoothed error
Trend factor

TAF
t +1
= S
t
+ T
t
where
S
t
= Previous forecast plus smoothed error
T
t
= Current trend estimate
3-12
Student Slides
Alpha and beta are smoothing constants
Trend-adjusted exponential smoothing has the ability
to respond to changes in trend

TAF
t +1
= S
t
+ T
t
S
t
= TAF
t
+o A
t
TAF
t
( )
T
t
= T
t1
+ | TAF
t
TAF
t1
T
t1
( )
3-13
Student Slides
Regression - a technique for fitting a line to a set of
data points
Simple linear regression - the simplest form of
regression that involves a linear relationship between
two variables
The object of simple linear regression is to obtain an
equation of a straight line that minimizes the sum of
squared vertical deviations from the line (i.e., the least
squares criterion)
3-14
Student Slides
The better forecasts are, the more able organizations will
be to take advantage of future opportunities and reduce
potential risks
A worthwhile strategy is to work to improve short-term forecasts
Accurate up-to-date information can have a significant effect on
forecast accuracy:
Prices
Demand
Other important variables
Reduce the time horizon forecasts have to cover
Sharing forecasts or demand data through the
supply chain can improve forecast quality
3-15
Student Slides