Operations Management

William J. Stevenson

8th edition
CHAPTER
3

Forecasting

Operations Management, Eighth Edition, by William J. Stevenson

McGraw-Hill/Irwin Copyright © 2005 by The McGraw-Hill Companies, Inc. All rights reserved.
3-3 Forecasting

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
3-4 Forecasting

USES OF FORECASTS
Accounting Cost/profit estimates

Finance Cash flow and funding

Human Resources Hiring/recruiting/training

Marketing Pricing, promotion, strategy

MIS IT/IS systems, services

Operations Schedules, MRP, workloads

Product/service design New products and services

3-5 Forecasting

Assumes causal system

past ==> future
Forecasts are rarely perfect because of
randomness
Forecasts are more accurate for
groups vs. individuals
Forecast accuracy decreases I see that you will
as time horizon increases get an A this semester.

FEATURES COMMON TO ALL

FORECASTS
3-6 Forecasting

ELEMENTS OF A GOOD FORECAST

Timely

Reliable Accurate

Written
3-7 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
3-8 Forecasting

APPROACHES TO FORECASTING
Qualitative- uses subjective inputs; permit inclusion of soft information
(e.g. human factors, personal opinions and hunches).
Quantitative– involve either the projection of historical data or the
development of associative models; analyzing objective or hard
data.

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
3-9 Forecasting

JUDGMENTAL FORECASTS
Executive opinions – often used as a part of long-range planning and new
product development.
Sales force opinions – good source of information
Consumer surveys
Outside opinion
Delphi method
 Opinions of managers and staff
 Achieves a consensus forecast
3-10 Forecasting

TIME SERIES FORECASTS

Trend - long-term upward or downward movement in data (e.g.
populations shifts, changing incomes and cultural changes)
Seasonality - short-term regular variations in data related to
factors such as calendar or time of day.
Cycle – wavelike variations of more than one year’s duration
related to variety of economic, political or agricultural conditions.
Irregular variations - caused by unusual circumstances such as
severe weather conditions, strikes or a major change in a product
or service.
Random variations - caused by chance; residual variations that
remain after all other behaviors have been accounted for.
3-11 Forecasting

FORECAST VARIATIONS
Figure 3.1

Irregular
variatio
n
Trend

Cycles

90
89
88
Seasonal variations
3-12 Forecasting

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 period’s actual value.
3-13 Forecasting

NAÏVE 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
3-14 Forecasting

TECHNIQUES FOR AVERAGING

Moving average
Weighted moving average
Exponential smoothing
3-15 Forecasting

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


i=1
Ai
MAn =
n
Man = n period moving average
Weighted moving average – More recent values in a
series are given more weight in computing the
forecast.
3-16 Forecasting

Period Demand
1 42
2 40
3 43
4 40
5 41

F6 = 43 + 40 + 41 = 41.33
3

If actual demand for F6 turns out to be 38, the moving average for
period 7 is
F7 = 40 + 41 + 38 = 39.67
3
3-17 Forecasting

SIMPLE MOVING AVERAGE

Actual
MA5
47
45
43
41
39
37 MA3
35
1 2 3 4 5 6 7 8 9 10 11 12
n


i=1
Ai
MAn =
n
3-18 Forecasting

WEIGHTED MOVING AVERAGE

It is similar to a moving average, except that it assigns more weight to the most
recent values in the time series.
Example.
A. Compute a weighted average forecast using a weight of .40 for the most
recent period, .30 for the next most recent, .20 for the next, and .10 for the
next.
B. If the actual demand for the period 6 is 39, forecast demand for period 7
using the same weights as in A.
Period Demand
1 42
2 40
3 43
4 40
5 41
3-19 Forecasting

A. F6 = .10(40) + .20(43) + .30(40) + .40(41) = 41.00

B. F7 = .10(43) + .20(40) + .30(41) + .40(39) = 40.20

The advantage of weighted MA over a simple moving average is that

the weighted average is more reflective of the most recent
occurrences.
3-20 Forecasting

EXPONENTIAL SMOOTHING

Ft = Ft-1 + (At-1 - Ft-1)

Next forecast = Previous forecast + (actual – previous forecast)

•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.

A weighted averaging method based on a

previous forecast plus a percentage of the
forecast error.
3-21 Forecasting

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
3-22 Forecasting

Suppose the previous forecast was 42 units, actual

demand was 40 units, and  = .10. The new forecast
would be computed as follows:
Ft = 42 + .10 (40 – 42) = 41.8

Then if the actual demand turns out to be 43, the next

forecast would be:
Ft = 41.8 + .10 (43-41.8) = 41.92
3-23 Forecasting

ALTERNATE FORMULA: Ft = (1- ) Ft-1 + At-1

Ft = .90(42) + .10(40)
= 37.8 + 4 = 41.8

Ft = .90(41.8) + .10(43)
= 37.62 + 4.3 = 41.92
The quickness of forecast adjustment to error is determined by the
smoothing constant. The closer its value to zero, the slower the
forecast will be to adjust to errors (the greater the smoothing).

The closer the value is to 1.00, the greater the responsiveness

and the less the smoothing.
3-24 Forecasting

PICKING A SMOOTHING CONSTANT

Actual
50
.4
 .1
Demand

45

40

35
1 2 3 4 5 6 7 8 9 10 11 12
Period
 3-25 Forecasting

LINEAR TREND EQUATION

Ft

Ft = a + bt

Ft = Forecast for period t

0 1 2 3 4 5 t
t = Specified number of time periods
a = Value of Ft at t = 0
b = Slope of the line
3-26 Forecasting

CALCULATING A AND B

n  (ty) -  t  y
b =
2
n t - (  t) 2

 y - b t
a =
n
3-27 Forecasting

LINEAR TREND EQUATION EXAMPLE

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

 t = 15 t = 55  y = 812  ty = 2499

2
2
(t) = 225
3-28 Forecasting

LINEAR TREND CALCULATION

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

812 - 6.3(15)
a = = 143.5
5

y = 143.5 + 6.3t
3-29 Forecasting

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
3-30 Forecasting

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
3-31 Forecasting

ACCURACY AND CONTROL OF FORECASTS

-Necessary for the success of daily activities of every
organization
FORECAST ERROR – The difference between the actual value
and the value that was predicted for a given period.
-Significant factor when deciding among forecasting
alternatives
Mean Absolute Deviation (MAD) – the average absolute
forecast error; easiest to compute but weighs all errors evenly
Mean Squared Error (MSE) – The average of squatted forecast
errors; squares errors, thereby giving weight to larger errors
Mean Absolute Percent Error (MAPE) – The average absolute
percent error; weighs according to relative error; to put large
errors in perspective, MAPE would be used.
3-32 Forecasting

MAD, MSE, AND MAPE

 Actual  forecast
MAD =
n
2
 ( Actual  forecast)
MSE =
n -1

( Actual  forecast / Actual*100)

MAPE =
n
3-33 Forecasting

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
3-34 Forecasting

SOURCES OF FORECAST ERRORS

Model may be inadequate
Irregular variations
Incorrect use of forecasting technique
3-35 Forecasting

TRACKING SIGNAL
•Tracking signal
–Ratio of cumulative error to MAD

Tracking signal =
(Actual-forecast)
MAD
Bias – Persistent tendency for forecasts to be
Greater or less than actual values.
3-36 Forecasting

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