Forecasting Outlines

Forecasting in Operations Management

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Science and Art of Forecasting

Seven Steps in the Forecasting
Categories and Models of Forecasting (Focus
on Time-Series Forecasting)
Measure the Forecast Accuracy
Selecting the Best Forecasting Techniques
Forecasting in service sector; forecasting and
IT
 Learning Objectives
When you complete this chapter, you should be
able to :
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Identify or Define:
Forecasting
Categories of forecasts
Time horizons
Approaches to measure forecasts
Explain and Apply:
Moving averages
Exponential smoothing
Trend and seasonal projections
Measures of forecast accuracy
 Why Forecasting?
Forecasting lays a ground for reducing the risk in
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all decision making because many of the decisions

need to be made under uncertainty.
In business applications, forecasting serves as a
starting point of major decisions in finance,
marketing, productions, and purchasing.

Under what condition there is no value for

forecasting?
 Decisions Relevant to Demand
Forecasts
Select product portfolio
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Predicting new facility location

Anticipating capacity needs
Identifying labor requirements
Projecting material requirements
Developing production schedules
Creating maintenance schedules
 Forecasting at Tupperware
Via forecasting, managers make important
decisions
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Each of 50 profit centers around the world is

responsible for computerized monthly, quarterly,
and 12-month sales projections
These projections are aggregated by product
family and region, then globally, at
Tupperwares World Headquarters
Tupperware uses all techniques discussed in text
 Successful Forecasting
= Science + Art
"Science" implies that the body of the forecasting
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knowledge lies on the solid ground of quantitative

forecasting methods and their correct utilization for
various business situations.
"Art" represents a combination of a decision
maker's experience, logic, and intuition to
supplement the forecasting quantitative analysis.
Both the science and art of forecasting are essential
in developing accurate forecasts.
All managers are forecasters!
 Forecast Categories
TYPES
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Qualitative Executive opinions

Sales force surveys
Delphi method
Consumer surveys

Quantitative Times series methods

Associative (causal)
methods
 Forecast Categories

TIME HORIZON
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Long-term For duration of 3-5

years or more (on
annual basis)
Medium-term For duration of up to three
years (usually on quarterly
or monthly basis)
Short-term Up to one year, usually less
than three months (on
daily, weekly)
 Facts in Forecasting
Main assumption: Past pattern repeats itself into the
future.
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Forecasts are rarely perfect: Don't expect forecasts to

be exactly equal to the actual data.
The science and art of forecasting try to minimize, but
not to eliminate, forecast errors. Forecast errors mean
the difference between actual and forecasted values.
Forecasts for a group of products are usually more
accurate than these for individual products; a shorter
period tend to be more accurate.
Computer and IT are critical parts of the modern
forecasting in large corporations.
 Seven Steps in Forecasting
(Demands)
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Determine the use of the forecast

Select the items to be forecast
Determine the time horizon of the forecast
Select the forecasting model(s)
Gather the data
Make the forecast
Validate and implement results
 Quantitative Methods
A time series is an uninterrupted set of data
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observations that have been ordered in

equally spaced intervals (units of time).
Associative (causal) forecasting is based on
identification of variables (factors) that can
predict values of the variable in question.
 Quantitative Forecasting Models

Time Series Models Associative (Causal)

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Models
Naive Forecast
Simple Moving Averages Simple Linear Regression
Weighted Moving Averages Multiple Linear Regression
Simple Exponential Smoothing Nonlinear Regression
Exponential Smoothing with
Trend
Linear Trend Projection
Time Series Decomposition
 Time Series Pattern: Stationary
The result of many
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influences that act

independently so as to
yield nonsystematic
and non-repeating
patterns about some
average value.
Forecasting methods:
naive, moving average,
exponential smoothing
 Time Series Pattern: Trend
It represents a general
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increase or decrease in
a time series over
several consecutive
periods (some sources
present six-seven or
more periods).
Forecasting methods:
linear trend projection,
exponential smoothing
with trend, etc.
 Time Series Pattern: Seasonal
Seasonal Patterns
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represent patterns that

are periodic and
recurrent (usually on a
quarterly, monthly, or
annual basis).
Forecasting methods:
exponential smoothing
with trend and
seasonality, time series
decomposition, etc.
 Time Series Pattern: Cyclical
The result of economic and
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business expansions (increasing

demand) and contractions
(recessions and depressions)
and usually repeat every two-
five years. Cyclical influences
are difficult to forecast because
cyclical demands are recurrent
but not periodic (they happen in
different intervals of time with
great variability of demands).
Forecasting methods: time
series decomposition, multiple
regression
 Product Demand Charted over 4
Years with Trend and Seasonality
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Seasonal peaks Trend component

Demand for product or service

Actual
demand line

Average demand
over four years
Random
variation
Year Year Year Year
1 2 3 4
 What is a Time Series?
Set of evenly spaced numerical data
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Obtained by observing response variable at

regular time periods

Forecast based only on past values
Assumes that factors influencing past and

present will continue influence in future

Example
Year: 1993 1994 1995 1996 1997
Sales: 78.7 63.5 89.7 93.2 92.1
 Nave Approach
Assumes demand in next period is the same as
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demand in most recent period

e.g., If May sales were 48, then June sales will be
around 48
Sometimes it is effective & cost efficient
e.g. when the demand is steady or changes slowly
when inventory cost is low
when unmet demand will not lose
 Moving Average Method
MA is a series of arithmetic means
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Used if little or no trend, seasonal, and cyclical

patterns
Used often for smoothing
Provides overall impression of data over time

Equation

MA Demand in Previous n Periods

n
 Moving Average Example
Youre manager of a museum store that sells
historical replicas. You want to forecast sales
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of item (123) for 2000 using a 3-period moving

average.
1995 4
1996 6
1997 5
1998 3
1999 7

1995 Corel Corp.

 Moving Average Solution
Time Response Moving Moving
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Yi Total Average
(n=3) (n=3)
1995 4 NA NA
1996 6 NA NA
1997 5 NA NA
1998 3 4+6+5=15 15/3 = 5
1999 7
2000 NA
 Moving Average Solution

Time Response Moving Moving

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Yi Total Average
(n=3) (n=3)
1995 4 NA NA
1996 6 NA NA
1997 5 NA NA
1998 3 4+6+5=15 15/3 = 5
1999 7 6+5+3=14 14/3=4 2/3
2000 NA
 Moving Average Solution

Time Response Moving Moving

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Yi Total Average
(n=3) (n=3)
1995 4 NA NA
1996 6 NA NA
1997 5 NA NA
1998 3 4+6+5=15 15/3=5.0
1999 7 6+5+3=14 14/3=4.7
2000 NA 5+3+7=15 15/3=5.0
 Moving Average Graph
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Sales
8 Actual
6
Forecast
4
2
95 96 97 98 99 00
Year
 Weighted Moving Average
Method
Used when trend is present
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Older data usually less important

Weights based on intuition
Often lay between 0 & 1, & sum to 1.0

Equation

(Weight for period n) (Demand in period n)

WMA =
Weights
 Actual Demand, Moving Average,
Weighted Moving Average
35 Weighted moving average
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30
Actual sales
25
Sales Demand

20
15

10
Moving average
5

0
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec
Month
 Disadvantages of Moving
Average Methods
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Increasing n makes forecast less sensitive

to changes
Do not forecast trend well due to the delay
between actual outcome and forecast
Difficult to trace seasonal and cyclical
patterns
Require much historical data
Weighted MA may perform better
 Exponential Smoothing Method
Form of weighted moving average
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Weights decline exponentially

Most recent data weighted most

Requires smoothing constant ()

Ranges from 0 to 1

Subjectively chosen

Involves little record keeping of past data

 Exponential Smoothing
Equations
Ft = Ft-1 + (At-1 - Ft-1)
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= At-1 + (1 - ) Ft-1
Ft = Forecast value
A = Actual value
t
= Smoothing constant

Ft = At - 1 + (1-)At - 2 + (1- )2At - 3

+ (1- )3At - 4 + ... + (1- )t-1A0
Use for computing forecast
 Exponential Smoothing
Example
Youre organizing a Kwanza meeting. You
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want to forecast attendance for 2000 using

exponential smoothing ( = .10). The
1995 (made in 1994) forecast was 175.
Actual data:
1995 180
1996 168
1997 159
1998 175 1995 Corel Corp.

1999 190
 Exponential Smoothing Solution
Ft = Ft-1 + ( At-1 - Ft-1)
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Forecast, F t
Time Actual
( = .10)
1995 180 175.00 (Given)
1996 168 175.00 +
1997 159
1998 175
1999 190
2000 NA
 Exponential Smoothing Solution
Ft = Ft-1 + ( At-1 - Ft-1)
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Forecast, F t
Time Actual
( = .10)
1995 180 175.00 (Given)
1996 168 175.00 + .10(
1997 159
1998 175
1999 190
2000 NA
 Exponential Smoothing Solution
Ft = Ft-1 + ( At-1 - Ft-1)
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Forecast, Ft
Time Actual
( = .10)
1995 180 175.00 (Given)
1996 168 175.00 + .10(180 -
1997 159
1998 175
1999 190
2000 NA
 Exponential Smoothing Solution
Ft = Ft-1 + ( At-1 - Ft-1)
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Forecast, Ft
Time Actual
( = .10)
1995 180 175.00 (Given)
1996 168 175.00 + .10(180 - 175.00)
1997 159
1998 175
1999 190
2000 NA
 Exponential Smoothing Solution
Ft = Ft-1 + ( At-1 - Ft-1)
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Forecast, Ft
Time Actual
( = .10)
1995 180 175.00 (Given)
1996 168 175.00 + .10(180 - 175.00) = 175.50
1997 159
1998 175
1999 190
2000 NA
 Exponential Smoothing Solution
Ft = Ft-1 + ( At-1 - Ft-1)
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Forecast, F t
Time Actual
( = .10)
1995 180 175.00 (Given)
1996 168 175.00 + .10(180 - 175.00) = 175.50
1997 159 175.50 + .10(168 - 175.50) = 174.75
1998 175
1999 190
2000 NA
 Exponential Smoothing Solution
Ft = Ft-1 + ( At-1 - Ft-1)
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Forecast, F t
Time Actual
( = .10)
1995 180 175.00 (Given)
1996 168 175.00 + .10(180 - 175.00) = 175.50
1997 159 175.50 + .10(168 - 175.50) = 174.75
1998 175 174.75 + .10(159 - 174.75)= 173.18
1999 190
2000 NA
 Exponential Smoothing Solution
Ft = Ft-1 + ( At-1 - Ft-1)
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Forecast, F t
Time Actual
( = .10)
1995 180 175.00 (Given)
1996 168 175.00 + .10(180 - 175.00) = 175.50
1997 159 175.50 + .10(168 - 175.50) = 174.75
1998 175 174.75 + .10(159 - 174.75) = 173.18
1999 190 173.18 + .10(175 - 173.18) = 173.36
2000 NA
 Exponential Smoothing Solution
Ft = Ft-1 + ( At-1 - Ft-1)
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Forecast, F t
Time Actual
( = .10)
1995 180 175.00 (Given)
1996 168 175.00 + .10(180 - 175.00) = 175.50
1997 159 175.50 + .10(168 - 175.50) = 174.75
1998 175 174.75 + .10(159 - 174.75) = 173.18
1999 190 173.18 + .10(175 - 173.18) = 173.36
2000 NA 173.36 + .10(190 - 173.36) = 175.02
 Exponential Smoothing Graph

Sales
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190 Actual
180
170 Forecast
160
150
140
93 94 95 96 97 98
Year
 Forecast Effects of
Smoothing Constant
Ft = At - 1 + (1- )At - 2 + (1- )2At - 3 + ...
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Weights
= Prior Period 2 periods ago 3 periods ago
(1 - ) (1 - )2

= 0.10 10%
= 0.90
 Forecast Effects of
Smoothing Constant
Ft = At - 1 + (1- ) At - 2 + (1- )2At - 3 + ...
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Weights
= Prior Period 2 periods ago 3 periods ago
(1 - ) (1 - )2

= 0.10 10% 9%
= 0.90
 Forecast Effects of
Smoothing Constant
Ft = At - 1 + (1- )At - 2 + (1- )2At - 3 + ...
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Weights
= Prior Period 2 periods ago 3 periods ago
(1 - ) (1 - )2

= 0.10 10% 9% 8.1%

= 0.90
 Forecast Effects of
Smoothing Constant
Ft = At - 1 + (1- )At - 2 + (1- )2At - 3 + ...
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Weights
= Prior Period 2 periods ago 3 periods ago
(1 - ) (1 - )2

= 0.10 10% 9% 8.1%

= 0.90 90%
 Forecast Effects of
Smoothing Constant
Ft = At - 1 + (1- ) At - 2 + (1- )2At - 3 + ...
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Weights
= Prior Period 2 periods ago 3 periods ago
(1 - ) (1 - )2

= 0.10 10% 9% 8.1%

= 0.90 90% 9%
 Forecast Effects of
Smoothing Constant
Ft = At - 1 + (1- ) At - 2 + (1- )2At - 3 + ...
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Weights
= Prior Period 2 periods ago 3 periods ago
(1 - ) (1 - )2

= 0.10 10% 9% 8.1%

= 0.90 90% 9% 0.9%
 Guidelines for Selecting
Forecasting Model
You want to achieve:
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Smallest forecast error

^
Mean square error (MSE)

Mean absolute deviation (MAD)

No pattern or direction in forecast

error
Error = (Y - Y ) = (Actual - Forecast)
i i
Seen in plots of errors over time
 How to Choose
Seek to minimize the Mean Absolute Deviation (MAD)
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If: Forecast error = demand - forecast

forecast errors
Then: MAD
n
Note that the sum of all weights in exponential
smoothing equals to 1. It is popular because of the
simplicity of data keeping.
 Measuring Forecast Accuracy
Mean Squared Error (MSE)
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represents the variance of errors in a forecast. This criterion

is most useful if you want to minimize the occurrence of a
major error(s).

n n
2
(A t - F t ) e2t
MSE = t = 1 = t =1
n n
 Exponential Smoothing with
Trend Adjustment
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Forecast including trend (FITt)

= exponentially smoothed forecast (Ft)
+ exponentially smoothed trend (Tt)
 Exponential Smoothing with
Trend Adjustment - continued
Ft = (Actual demand this period)
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or + (1- )(Forecast last period+Trend estimate last period)

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

Tt = (Forecast this period - Forecast last period)

or + (1-)(Trend estimate last period

Tt = (Ft - Ft-1) + (1- )Tt-1
 Exponential Smoothing with
Trend Adjustment - continued
Ft = exponentially smoothed forecast of the
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data series in period t

Tt = exponentially smoothed trend in period t
At = actual demand in period t
= smoothing constant for the average
= smoothing constant for the trend
 Comparison of Forecasts

40
Exponential smoothing +
Actual Demand Trend
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35
Product Demand

30
25
20
15
10
5
Exponential smoothing
0
Jan Feb Mar Apr May Jun Jul Aug Sep
Month
 Linear Trend Projection
Used for forecasting linear trend line
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Assumes relationship between response

variable, Y, and time, X, is a linear
function
Yi a bX i

Estimated by least squares method

Minimizes sum of squared errors
 Linear Trend Projection Model

Yi a bX i
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Y b>0
a

b<0

a
Time, X
 Interpretation of Coefficients
Slope (b)
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Estimated Y changes by b for each 1 unit

increase in X
If b = 2, then sales (Y) is expected to increase

by 2 for each 1 unit increase in advertising

(X)
Y-intercept (a)
Average value of Y when X = 0

If a = 4, then average sales (Y) is expected to

be 4 when advertising (X) is 0

 How to Find a and b: Least
Squares Equations
Criteria of finding a and b:
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Equation: i a bx i
Y
n
x i y i nx y
Slope: b in
x i nx
i

Y-Intercept: a y bx
 Measuring Forecast Accuracy
Mean Absolute Deviation (MAD)
measures the average absolute error of a forecast. A sign of
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an error, which represents over- or underestimation, is

really not important in most cases; we are rather concerned
with the value of deviation.
n n

| A
t =1
t - Ft | | e |
t =1
t

MAD = =
n n
where:
At = actual value in period t,
Ft = forecasted value in period t,
et = forecast error in period t,
n = number of periods.
 Measuring Forecast Accuracy
Mean Squared Error (MSE)
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represents the variance of errors in a forecast. This criterion

is most useful if you want to minimize the occurrence of a
major error(s).

n n
2
(A t - F t ) e2t
MSE = t = 1 = t =1
n n
 General Description of TS Models:
Time Series Decomposition
Include seasonal and cyclical patterns
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In decomposition, a time series is described as a function of

four components:
Y = T*C*S*I multiplicative model (commonly used)
Y = T+C+S+I additive model
where:
Y= actual value of time series
T= trend component
C= cyclical component
S= seasonal component
I = irregular (random) component
 Multiplicative Seasonal Model

Find average historical demand for each

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season by summing the demand for

that season in each year, and dividing by
the number of years for which you have
data.
Compute the average demand over all
seasons by dividing the total average
annual demand by the number of seasons.
 Multiplicative Seasonal Model
Compute a seasonal index by dividing
that seasons historical demand (from
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step 1) by the average demand over all

seasons.
Estimate next years total demand by
using smoothed linear trend projection
model
Divide this estimate of total demand by
the number of seasons, then multiply it
by the seasonal index for that season.
This provides the seasonal forecast.
 Example of Multiplicative
Seasonal Model
The following trend projection is used to predict quarterly
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demand: Y = 350 - 2.5t, where t = 1 in the first quarter of

1998. Seasonal (quarterly) relatives are Quarter 1 = 1.5;
Quarter 2 = 0.8; Quarter 3 = 1.1; and Quarter 4 = 0.6. What is
the seasonally adjusted forecast for the four quarters of 2000?
(10%)
Period Projection Adjusted
9 327.5 491.25
10 325 260
11 322.5 354.75
12 320 192
 Seven Steps in Forecasting
(Demands)
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Determine the use of the forecast

Select the items to be forecast
Determine the time horizon of the forecast
Select the forecasting model(s)
Gather the data
Make the forecast
Validate and implement results
 Past Data of Nurse Demand: What
patterns can be observed?
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20
Number of Nurses

15

Number of
10
Nurses

0
1

11
Time Period
 Forecasting Issues During a
Products Life
Introduction Growth Maturity Decline
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Best period to Practical to change Poor time to change Cost control

increase market price or quality image image, price, or quality critical
share
Strengthen niche Competitive costs
R&D product become critical
Company Strategy/Issues

engineering
critical Defend market position
Drive-thru restaurants Fax machines
3 1/2
CD-ROM Floppy
disks
Sales
Internet Station
Color copiers wagons

HDTV

Product design and Forecasting critical Standardization Little product

development critical
Frequent product and
OM Strategy/Issues
Less rapid product differentiation
Product and process
reliability changes - more minor Cost minimization
changes

process design changes Competitive product

improvements and
Short production runs
options
High production costs
Increase capacity
Limited models Shift toward product
focused
Attention to quality
Enhance distribution
Over capacity in the
Optimum capacity
industry
Increasing stability of
process Prune line to eliminate
items not returning
Long production runs
good margin
Product improvement
and cost cutting Reduce capacity
 Tracking Signal
Measures how well the forecast is predicting
actual values
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Ratio of running sum of forecast errors

(RSFE) to mean absolute deviation (MAD)
Good tracking signal has low values

Should be within upper and lower control

limits
n

RSFE y i y i
forecast error
TS i 1

MAD MAD MAD
 Plot of a Tracking Signal
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Signal exceeded limit

Tracking signal
Upper control limit
+

0
MAD

Acceptable range

-
Lower control limit

Time
 Pattern of Forecast Error:
Identified Only by Observation
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Trend Not Fully

Accounted for Desired Pattern
Error Error

0 0

Time (Years) Time (Years)

 Predicting Cyclical Factors

Leading indicators
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Investment (public/private)
Export
Business purchasing
Consumer confidence
Government expending
 Advanced Forecasting Methods
To improve the accuracy, more complicated
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models might be required. For example,

Adaptive smoothing

Focus forecasting
 Application in Wholesale/Retail
Sectors
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 Applications in Marketing
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 Applications in Finance and
Accounting
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 Seven Steps in Forecasting
Determine the use of the forecast
Select the items to be forecast (e.g. type of
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nurse)
Determine the time horizon of the forecast (why
quarterly)
Select the forecasting models (among both
qualitative and quantitative)
Gather the data
Make the forecast
Validate and implement results
 Assignment: Forecasting inventory
and Warehouse Expansion
May apply any material you have learned
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about forecasting
Please answer ALL questions in a clear
format
It is not necessary to print out the detailed
result form POM
It is desirable to describe and justify your
decisions in a precise and concise way (e.g.
using charts or figures)