Forecasting

Dr A R M Harunur Rashid

Reference
Operations Management by Schroeder,
pg 97

Forecasting
Forecasting is the art and science of
predicting the future events.
Previously it was art, but now it has
become science with mathematical tools.

Forecasting

Qualitative

Delphi

Sales force/consumer
Survey/Poll

Quantitative

Time series

Causal (regression)

Use of forecasting for different

segments
Process design purpose: to decide which
process to be selected, intermittent manual or
line with more automation.
Capacity decision purpose: how many people to
be hired,machines to be bought, assignment of
people and machine to different activities.
Inventory decision purpose: how many to be
purchased so that it could be stored as well as
meet the customers demand.

Forecasting Methods
Qualitative: Delphi method, Sales force polling,
customer surveys, Life cycle analogy of the
similar products, expert opinions (also termed as
informed judgment).
Time series forecasting
Moving average
Exponential smoothing
Forecast error

Causal forecasting (also known as Regression

method)
Computerized forecasting method

Qualitative
When to be used: past data are not
reliable enough as economic conditions
change very rapidly, launching of new
product

Delphi Method
Named after the famous Greek oracle of Delphi.
Also called Pooled ignorance.
First round:each person of the panel provides a written
response to the questions provided. No communication
among the panel members.
Second round: all the responses are summarized(may
be median, average etc) and returned back to each
panel members. No name is mentioned in this feedback.
After reconsidering answers, everyone sends back his
response of the same questions.
Process is repeated for a minimum three rounds till
sufficient convergence is reached.

Time series
From previous historical data, the future may be
forecasted. Here to forecast the future, five
things are considered.
Cycle: looks like hillocks parts one after another
or may be said like waves.
Seasonal pattern: looks like upside down
glasses one after another.
Trend: straight line going up or down
Level: horizontal straight line
Random(random error): looks like graph found
from the heartbeat of a human being!

Moving average
Average demand for the past N periods(every 3 months)
from the point at time t(say 2014) is found.
For example in Box 4.2 pg 98,three period moving
average(i.e. average of three periods) is found and for
the fourth period, this moving average(three period
moving average) becomes forecast(three period
forecast=19).
When we come to the fifth period, actual moving average
of the last three periods(i.e. period 2,3,4) is calculated
and this is projected as forecast(i.e.20.7).

Features of moving average

The longer the averaging period(say from
three periods vs six periods), the slower
the response to demand changes.
To overcome this, weighted moving
average may be used where higher weight
is put to the recent period.

Simple Moving Average

Week
1
2
3
4
5
6
7
8
9
10
11
12

Demand
650
678
720
785
859
920
850
758
892
920
789
844

Ft 1 =

D t + D t -1 + D t -2 + ... + D t -n 1
n

Lets develop 3-week and

6-week moving average
forecasts for demand.
Assume you only have 3
weeks and 6 weeks of
actual demand data for
the respective forecasts
15

Week
1
2
3
4
5
6
7
8
9
10
11
12

Demand 3-Week 6-Week

650
Here average of
first 3 weeks =
678
(650+678+720)/
720
3=682.67, that
is the coming 4
785
682.67
weeks forecast
859
727.67
920
788.00
850
854.67
768.67
758
876.33
802.00
892
842.67
815.33
920
833.33
844.00
789
856.67
866.50
844
867.00
854.83

th

16

Demand
actual

3 weeks
moving
avg

6 weeks
moving
avg

17

In-Class Exercise
Week
1
2
3
4
5
6
7

Demand
820
775
680
655
620
600
575

Develop 3-week
and 5-week moving
average forecasts
for demand.
Assume you only
have 3 weeks and 5
weeks of actual
demand data for the
respective forecasts
18

In-Class Exercise (Solution)

Week
1
2
3
4
5
6
7

Demand
820
775
680
655
620
600
575

3-Week

5-Week

758.33
703.33
651.67
625.00

710.00
666.00
19

Weighted moving average

In weighted moving average may be used
where higher weight is put to the recent
period.
Weight assigning is upto the discretion of
forecaster. And all weight when summed
up should be equal to 1.
Weighted moving average responds to
demand more rapidly

 .
Disadvanages>>>
Entire demand history for N periods is to
be carried along with the computations.
Response can not be changed without
changing each of the weights which would
be very cumbersome

Weighted Moving Average(contd)

Week
1
2
3
4

Demand
650
678
720

Determine the 3-period

weighted moving average
forecast for period 4.
Weights:
w1 .5
w2 .3
w3 .2

20

Solution
Week
1
2
3
4

Demand Forecast
650
678
720
693.4

F4 = .5(720)+.3(678)+.2(650)

21

In-Class Exercise

Week
1
2
3
4

Demand
820
775
680
655

Determine the 3-period

weighted moving average
forecast for period 5.
Weights:
.7
.2
.1

22

Solution
Week
1
2
3
4
5

Demand Forecast
820
775
680
655
672

23

Exponential Smoothing
A new average(moving average) can be computed from
an old average(old moving average) and the most recent
observed demand.
The user has to decide what weight should be put on the
old average and what on the most recent observed
demand.
Alpha is the weight put on the most recent demand.
Then (1-alpha) is the weight put on the old moving
average.
Large value of alpha will be more responsive to the
recent demand, whereas small value of alpha will show
slower response to the recent demand.
Usually alphas value is taken between 0.1 to 0.3

 Mathematically it could be shown that weights

on the demand decrease exponentially over
time(i.e. highest weight on the recent demand, a
little less to the previous and so on). Again, sum
of all these weights should be 1.
In general, more importance should be given to
the recent demand rather than older demand.
This approach is reflected in exponential
smoothing. For distant demand, weightage is
reduced exponentially.

Box 4.3, pg101,OM by Schroeder

Here in the first period assume the forecast is 15. Now
the forecast for the second period using exponential
smoothing(formula 4.5,pg100) is = 10*.1 + (1-.1)*15=
14.5 here alpha used is 0.1
The assumption of forecast value for the first period
should be made looking at the previous data. There
should not be large difference between the assumed
value with the previous available datas highest or
lowest actual demand value.
The assumption of forecast value for the first period
may be same as actual demand on first period

Exponential Smoothing

Ft+1 = Ft + (Dt - Ft)

Ft+1 = Dt + 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
24

Exponential Smoothing
Example
Week
1
2
3
4
5
6
7
8
9
10

Demand
820
775
680
655
750
802
798
689
775

Determine
exponential
smoothing
forecasts for
periods 2-10 using
=.10 and =.60.

Let F1=D1
25

Week
1
2
3
4
5
6
7
8
9
10

Demand
820
775
680
655
750
802
798
689
775

0.1
820.00
820.00
815.50
801.95
787.26
783.53
785.38
786.64
776.88
776.69

0.6
820.00
820.00
820.00
817.30
808.09
795.59
788.35
786.57
786.61
780.77
26

Effect of on Forecast

27

In-Class Exercise
Week
1
2
3
4
5

Demand
Determine exponential
820 smoothing forecasts for
775 periods 2-5 using =.50
680
655
Let F1=D1

28

In-Class Exercise (Solution)

Week
1
2
3
4
5

Demand
820
775
680
655

0.5
820.00
820.00
797.50
738.75
696.88
29

Advantages of exponential
smoothing
To do exponential smoothing only the
latest demand and forecast for present
time unit are required. Whereas in the
moving averagte, previous many demand
values are required.

Selection of alpha, trial and error

Use different values of alpha for
exponential smoothing, and take the value
of alpha for which both bias and deviation
are less.
Use different values of alpha and selects
the one which gives less bias (positive or
negative) and less deviation.
If such could not be found, a trade off to
be made.

Recommendation on selection
of alpha
Both lower deviation and lower bias are
preferred.
If one value of alpha produces less
deviation and less bias for a couple of
forecast, then this alpha value may be
selected for future use.

Forecast error
summation(usual and absolute)
Arithmetic sum of all errors(keep negative sign): it
reflects the bias in the forecasting method. The less of
it, the better. Ideally this sum should be zero. It shows
bias on the positive(under forecast) or
negative(overforecast) side.
Absolute deviation: taking the absolute of the
difference between forecast and demand in each
period and summing them up. The less of it, the
better. It shows overall deviation.
Next we will look into mean of the above mentioned
forecast error as MFE and MAD.

Mean Forecast Error = MFE

Error = Actual Demand Forecast
MFE = summation of error(keep negative
sign as it is) / total no of period(i.e. if year
is the time unit, how many years are
considerd)
Ideal value of MFE is zero.
MFE > 0, underforecasted
MFE <0, overforecasted

Bias
A positive bias indicates that the model
under forecasts when difference is taken
as Actual Demand minus forecast. That is
actual demand is more than the forecast.
A negative bias indicates that the model
over forecasts.

Forecast Error-- MAD

n

MAD =

t =1

- Ft

1 MAD 0.8 standard deviation

1 standard deviation 1.25 MAD

30

MAD =Mean Absolute Deviation

Summation of absolute deviation divided
by number of periods included is called
MAD.

Example--MAD
Month
1
2
3
4
5

Sales
220
250
210
300
325

Forecast
n/a
255
205
320
315

Determine the MAD for the four forecast periods

31

Solution
Month
1
2
3
4
5

Sales
220
250
210
300
325

Forecast Abs Error

220
255
5
205
5
320
20
315
10
40

MAD =

t =1

- Ft

Here if you include the first

period and take F1=D1(i.e.
Forecast1=sales1=220), then
MAD= 40/5 =8
32

 MFE and MAD, the lesser the better.

Smoothed MAD
Smoothed MAD will be only used with
exponential smoothing.

Smoothed
MAD
formula

Forecast error>>smoothed MAD

Mean absolute deviation is called MAD
When absolute value of difference between forecast and demand
on that period exceeds 3.75*MAD, here demand or forecast may
be an extreme value(i.e.outlier). Be noted, 1 standard deviation =
1.25 MAD. We know that 99.9% observed data stay within 3
standard deviation from the mean. So if it goes beyond 3
standard deviation, it is kind of extreme value that is not usual.
It is like determining whether an observed demand or forecast
value lies outside three standard deviations for the normal
distribution.
In box 4.3,for the first period, previous MAD(i.e. MAD at zero
period)is assumed as 7
So MAD at period 1(where alpha is 0.3) is = 0.3*5+(1-.3)*7=
1.5+4.9=6.4

How initially MAD assumed?

Usually you may know the absolute deviation at
different periods from the given data. Now for
MAD o or MAD1 you may assume the average of
the absolute deviations you already come across
from the data provided.
MAD at 0 period is assumed. However, if it is
assumed at period 1 thats ok too.
Alternatively you could take the MAD for the first
period as equal to absolute deviation on the first
period.

If one absolute deviation in a period

is greater than 3.75*MAD,what
should be done?

The corresponding actual demand may be

an outlier.
Another way is to assume some value for
that period that would be within 3.75*MAD.
You may look into how things work if you
use other values of alpha. If another alpha
works fine, use that one for your analysis.

Tracking signal

Tracking signal = T = cumulative sum(keeping

negative) of forecast deviation divided by MAD
So in Box 4.3, for the first period, T = -5/6.4=-0.78 ~-0.8
So in Box 4.3, for the second period, T = (-5+4.5)/5.8=0.086 ~-0.1
When tracking signal exceeds +6 or -6, the forecasting
method should be stopped. So between +6 and -6 all
data are ok.
After stopping it may be reset to more nearly equal
observed demand.
Outlier may be modified to be within the limit.

In Class Exercise

Causal Forecasting, cause and

effect
Best known and largely used causal forecasting
method is regression.
Single variable linear regression model is the
simplest.
Here y is dependent variable and x is
independent variable.
In the best fit(i.e.least square) regression straight
line,observed y may fall outside the line. So two
notation is used. Just y means observed
value(actual demand) and y cap means
corresponding forecasted point of that y in the
regression line.

 So the error is y cap minus y.

Total variance or squared error would be
given by a formula.
So if we could find the value of a and b
such that squared error equation has
minimum value, that will be great. To do
so, calculus maxima-minima method is
used.

Simple Linear Regression

Model
Y = a + bx

0 1 2 3 4 5

(weeks)

b is similar to the slope. However, since it

is calculated with the variability of the data
in mind, its formulation is not as straightforward as our usual notion of slope
35

coefficient of
determination(i.e.sometimes called
square of coefficient of correlation)

Another thing coefficient of

determination(i.e.sometimes called square of
coefficient of correlation) denoted by r^2 may be
found. r^2 represents proportion of the variation
caused by independent variable x for the
regression line.
So the closer the r^2 value to 1, the better.
So a value of r^2=0.8 indicates that 80 percent
of the variation in y is predicted or explained by
the regression with independent variable
x(i.e.caused by x); whereas 20 percents is due
to other factors or chance.

Example, schroeder
Here population is the independent
variable(x) and newspaper circulation is
the dependent variable(y).
Now doing the regression analysis, we
could easily forecast newspaper
circulation if the population becomes
some value.

Regression Equation Example

Week
1
2
3
4
5

Sales
150
157
162
166
177

Develop a regression equation to predict sales

based on these five points.
37

 In this problem, time period , that is week,

is the independent variable(x) and sales is
the dependent variable(y).
Here we could forecast sales if certain
week is given(e.g. we could find out what
would be sales on 12 th week)

Week Week*Week
Sales Week*Sales
1
1
150
150
2
4
157
314
3
9
162
486
4
16
166
664
5
25
177
885
3
55
162.4
2499
Average
Sum Average
Sum

38

Sales

y = 143.5 + 6.3x
180
175
170
165
160
155
150
145
140
135

Sales
Forecast

Period
39

More than one variable

Usually it is assumed the variables are
independent. However, in real life variables are
in general somehow related.
For most of the purpose, assuming variables as
independent will give reasonably correct
estimate. So the method is helpful.
Multiple regression may be used when more
than one independent variables are considered.
However, it is out of scope for this course.

Time series vs regression(causal)

Causal models are more accurate for
medium and long range forecasts,
whereas time series(e.g. moving
average.exponential smoothing) is good
for short term forecasts.

Ans of c>>>132.0339tires
may be used on that month for
the provided miles traveled

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