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Forecasting

Forecasting
Essential preliminary to effective
planning
Engineering manager must be
concerned with both future markets
and future technology

Why Forecasting?
New facility planning
Production planning
Work force scheduling

Long Range Forecasts


Design new products
Determine capacity for new product
Long range supply of materials

Short Range Forecasts


Amount of inventory for next month
Amount of product to produce next
week
How much raw material delivered
next week
Workers schedule next week

Types of Forecasting
Methods
Forecasting methods are classified
into two groups:

Wiley 2010

Forecasting
Qualitative Methods
Judgment Methods
Jury of Executive Opinion
Delphi

Sales Force Composite


Users Expectation (Surveys)

Jury of Executive Opinion

Simplest method
Executives provide an estimate
Educated guess
Average of estimates taken

Delphi Method
Eliminates effects of interactions
between members
Experts do not need to know who
other experts are
Delphi coordinator asks for opinions,
forecasts on subject through
questionnaires

Delphi Method, cont

Develop objective of forecast


Determine number of participants
Select and contact participants
Develop first questionnaire and
submit
Coordinator analyzes responses

Delphi Method, cont


Develop second questionnaire based on
results of first
Share aggregate results of first round
Analyze responses
This technique eliminates the effects of
interaction among experts
Rounds continue until consensus reached
or experts opinions cease to change

Sales Force Composite


Members of the sales force estimate
sales in their own territory
Regional Sales Managers adjust for
their opinion of the optimism or
pessimism of individual sales people
General Sales Manager massages the
figures to account for new products or
factors others are unaware of

Users Expectation (Market


research)
When small customer base, simplest
method is to ask customers to project
their need for the future period
Market testing or market surveys
Information expensive to obtain
Often customers dont know their
future need

Qualitative Methods

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Forecasting
Quantitative Methods
Time Series Methods
Moving Average
Weighted Moving Average
Exponential Smoothing

Association or Causal Method


Simple Regression
Multiple Regression

Quantitative Methods
Time Series Models:
Assumes information needed to generate a
forecast is contained in a time series of data
Assumes the future will follow same patterns as
the past

Causal Models or Associative Models


Explores cause-and-effect relationships
Uses leading indicators to predict the future

Time Series Models


Forecaster looks for data patterns as
Data = historic pattern + random variation

Historic pattern to be forecasted:


Level (long-term average): data fluctuates around a constant mean
Trend: data exhibits an increasing or decreasing pattern
Seasonality: any pattern that regularly repeats itself and is of a
constant length
Cycle: patterns created by economic fluctuations

Random Variation cannot be predicted


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Time Series Patterns

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Time Series Models


Naive:

Ft 1 At

The forecast is equal to the actual value observed during


the last period good for level patterns
Ft 1 A t / n

Simple Mean:

The average of all available data - good for level patterns

Moving Average:

Ft 1 A t / n

The average value over a set time period


(e.g.: the last four weeks)
Each new forecast drops the oldest data point & adds a
new observation
More responsive to a trend but still lags behind actual data
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Simple Moving Average


Forecast Ft is average of n previous
observations or actuals At :
Note that the n past observations are equally
weighted
Issues with moving average forecasts:
All n past observations treated equally;
Observations older than n are not included at all;

Simple Moving Average


Include n most recent observations
Weight equally
Ignore older observations
weight

1/n

...

3 2 1

today

Time Series Models cont


Weighted Moving Average:

Ft 1 Wt A t

All weights must add to 100% or 1.00


e.g. Wt .5, Wt-1 .3, Wt-2 .2 (weights add to 1.0)
Allows emphasizing one period over others; above
indicates more weight on recent data (Wt=.5)
Differs from the simple moving average that weighs
all periods equally - more responsive to trends

(
A

F
)
n

1
n
n
n
A
1
2
F

(1

)
A

(1

)A

1
n
n

1
n

Exponential Smoothing:
Math

The forecast value for the next period is Fn 1


taken as the sum of
The forecasted value for the current period Fn

Some fraction of the difference between the actual


and forecasted values for the current period
In order to understand graphical representation:

Exponential Smoothing:

0(1)1

Include all past observations


Weight recent observations much more heavily
than very old observations:
weight
Decreasing weight given
to older observations

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Exponential Smoothing:
Thus, new forecast is weighted sum of old forecast
and actual value
Notes:
Only 2 values (An and Fn ) are required, compared with n for
moving average
Parameter determined empirically (whatever works best)
Rule of thumb: < 0.5
Typically, = 0.2 or = 0.3 work well

Dependent
variable

Regression Analysis

Independent variable (x)


Regression is the attempt to explain the variation in a dependent
variable using the variation in independent variables.
Regression is thus an explanation of causation.
If the independent variable(s) sufficiently explain the variation in the
dependent variable, the model can be used for prediction.

Dependent
variable (y)

Simple Linear Regression

y = b0 + b1X

b0 (y intercept)

B1 = slope
= y/ x

Independent variable (x)


To recall think of the equation y=c+mx where m is slope
The output of a regression is a function that predicts
the dependent variable based upon values of the
independent variables.
Simple regression fits a straight line to the data.

Whats Slope?
A slope of 2 means that every 1 unit change in
X yields a 2 unit change in Y.

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Whats Prediction
If you know something about X, this knowledge
helps you predict something about Y.

Simple Linear Regression

Dependent
variable

Observation: y
Prediction: y^

Zero
Independent variable (x)

The function will make a prediction for each observed


data point.
The observation is denoted by y and the prediction is
denoted by ^y.

Simple Linear Regression

Observation: y

Prediction
error:
Prediction: y^
Zero

For each observation, the variation can be described as:


^y = y +
Actual = Explained + Error

Dependent
variable

Regression

Independent variable (x)


A least squares regression selects the line with the
lowest total sum of squared prediction errors.
This value is called the Sum of Squares of Error, or
SSE.

Multiple Linear Regression


More than one independent variable can be used to explain
variance in the dependent variable, as long as they are not
linearly related.

A multiple regression takes the form:

y = A + X + X + + k Xk +
1

where k is the number of variables, or parameters.

Multicollinearity
Multicollinearity is a condition in which at least 2
independent variables are highly linearly correlated. It
will often crash computers.
Example table of
Correlations
Y

X1

1.000

X1

0.802

1.000

X2

0.848

0.578

X2

1.000

A correlations table can suggest which independent


variables may be significant. Generally, an ind. variable
that has more than a .3 correlation with the dependent
variable and less than .7 with any other ind. variable can
be included as a possible predictor.

Nonlinear Regression

Nonlinear functions can also be fit as regressions.


Common choices include Power, Logarithmic,
Exponential, and Logistic, but any continuous
function can be used.

Which Method?
Select a few methods
Make forecasts
Take simple average
No one best answer

Forecasting New Products


First use judgmental
Expert opinions
Consumer intentions

Technological Forecasting
Which technologies will be available in
the future
Part of planning as this is the context in which
plans will operate or be implemented

Delphi Method
Internet
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Demographics
Trends

Strategies for Managing


Technology
Invention and Innovation
Entrepreneurship
Intrapreneurship

Managing Technological Change


E.g. advent of the Internet

Government Regulations