Stevenson

Forecasting
 Learning Objectives
 List the elements of a good forecast.
 Outline the steps in the forecasting process.
 Compare and contrast qualitative and quantitative
approaches to forecasting.
 Briefly describe averaging techniques, trend and
seasonal techniques, and regression analysis,
and solve typical problems.
 Describe measure(s) of forecast accuracy.
 Describe evaluating and controlling forecasts.

3-2
FORECAST:
 A statement about the future value of a
variable of interest such as demand.
 Forecasting is used to make informed
decisions
 Match supply to demand.
 Two important aspects:
 Level of demand
 Degree of accuracy
 Long-range – plan the system (strategic)
 Short-range – plan to use the system (on-
going operations)

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 Forecasts
 Forecasts affect decisions and activities
throughout an organization
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, workloads

Product/service design New products and services

3-4
 Features of Forecasts
 Assumes causal system
past ==> future
 Forecasts are rarely perfect
 Forecast accuracy decreases
as time horizon increases

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Elements of a Good Forecast

Timely

Reliable Accurate

Written

Cost Effective
3-6
Steps in the Forecasting Process

“The forecast”

Step 6 Monitor the forecast

Step 5 Make the forecast
Step 4 Obtain, clean and analyze data
Step 3 Select a forecasting technique
Step 2 Establish a time horizon
Step 1 Determine purpose of forecast

3-7
 Forecasting Process
1. Identify the 2. Collect historical 3. Plot data and identify
purpose of forecast data patterns

6. Check forecast 5. Develop/compute 4. Select a forecast

accuracy with one or forecast for period of model that seems
more measures historical data appropriate for data

7.
Is accuracy of No 8b. Select new
forecast forecast model or
acceptable? adjust parameters of
existing model
Yes
9. Adjust forecast based 10. Monitor results
8a. Forecast over
on additional qualitative and measure forecast
planning horizon
information and insight accuracy

12-8
 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
 Judgmental Forecasts
 Executive opinions
 Sales force opinions
 Consumer surveys
 Outside opinion
 Delphi method
 Opinions of managers and staff
 Achieves a consensus forecast

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 Time Series Forecasts
 Trend - long-term movement in data
 Seasonality - short-term regular
variations in data
 Cycle – wavelike variations of more than
one year’s duration
 Irregular variations - caused by unusual
circumstances
 Random variations - caused by chance

3-11
 Forecast Variations

Irregular
variation

Trend

Cycles

90
89
88
Seasonal variations

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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.

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 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 of comparison

3-14
 Techniques for Averaging

 Moving average
 Weighted moving average
 Exponential smoothing

3-15
 Moving Averages
 Moving average – A technique that averages a
number of recent actual values, updated as
new values become available.
At-n + … At-2 + At-1
Ft = MAn=
n
 Weighted moving average – More recent
values in a series are given more weight in
computing the forecast.
wnAt-n + … wn-1At-2 + w1At-1
Ft = WMAn=

3-16
 Moving Average Example
Calculate a three-period moving average forecast for demand in period 6

If the actual demand in period 6 is 38, then the moving average forecast for
period 7 is:

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 Simple Moving Average

At-n + … At-2 + At-1

Ft = MAn=
n
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Weighted Moving Average Example
Period Demand Weight

1 42

2 40 10%

3 43 20%

4 40 30%

5 41 40%

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 Exponential Smoothing

Ft = Ft-1 + (At-1 - 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.
 Uses most recent period’s actual and forecast data
 Weighted averaging method based on previous
forecast plus a percentage of the forecast error
 A-F is the error term,  is the % of error

3-20
Exponential Smoothing Example

F3  F2   ( A2  F2 )
  0.10, F3  42  0.10(40  42)  42  0.10  (2)  42  0.2  41.8
If actual is 43…
F4  F3   ( A3  F3 )
  0.10, F4  41.8  0.10(43  41.8)  41.8  0.10 1.2  41.8  0.12  41.92

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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

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Common Nonlinear Trends

Parabolic

Exponential

Growth

3-23
 Linear Trend Equation
y

Ft = a + bt

0 1 2 3 4 5 t
 Ft = Forecast for period t
 t = Specified number of time periods
 a = Value of Ft at t = 0
 b = Slope of the line

3-24
Calculating a and b

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

 y - b t
a =
n

3-25
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

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 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

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 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

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 Regression Methods
 Linear regression
 mathematical technique that relates a
dependent variable to an independent
variable in the form of a linear equation
 Primary method for Associative Forecasting
 Correlation
 a measure of the strength of the relationship
between independent and dependent
variables

12-29
 Linear Regression Assumptions
 Variations around the line are random
 Deviations around the line normally
distributed
 Predictions are being made only within the
range of observed values
 For best results:
 Always plot the data to verify linearity
 Check for data being time-dependent
 Small correlation may imply that other variables
are important
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Linear Model Seems Reasonable
X Y Computed
7 15
relationship
2 10
6 13 50

4 15 40

14 25 30

15 27 20

10
16 24
0
12 20 0 5 10 15 20 25

14 27
20 44
15 34
7 17
A straight line is fitted to a set of sample points.

3-31
 Linear Regression
y = a + bx a = y-bx
xy - nxy
b =
x2 - nx2
where
a = intercept
b = slope of the line
x
x = = mean of the x data
n
y
y = n = mean of the y data

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Linear Regression Example
x y
(WINS) (ATTENDANCE) xy x2
4 36.3 145.2 16
6 40.1 240.6 36
6 41.2 247.2 36
8 53.0 424.0 64
6 44.0 264.0 36
7 45.6 319.2 49
5 39.0 195.0 25
7 47.5 332.5 49
49 346.7 2167.7 311

12-33
Linear Regression Example
49
x= = 6.125
8
346.9
y= = 43.36
8

xy - nxy
b=
x2 - nx2
(2,167.7) - (8)(6.125)(43.36)
= (311) - (8)(6.125)2
= 4.06

a = y - bx
= 43.36 - (4.06)(6.125)
= 18.46

12-34
 Linear Regression Example
60,000 –

50,000 –

40,000 –
Attendance, y

30,000 – Linear regression line, y

= 18.46 + 4.06x

20,000 – Attendance forecast for 7 wins

y = 18.46 + 4.06(7)
10,000 – = 46.88, or 46,880

| | | | | | | | | | |
0 1 2 3 4 5 6 7 8 9 10
Wins, x

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 Correlation and Coefficient of
Determination
 Correlation, r
 Measure of strength of relationship between the
dependent variable (demand) and the independent
variable
 Varies between -1.00 and +1.00
 Coefficient of determination, r2
 Percentage of variation in dependent variable that
is explained by changes in the independent
variable

12-36
 Computing Correlation
n xy -  x y
r=
[n x2 - ( x)2] [n y2 - ( y)2]

(8)(2,167.7) - (49)(346.9)
r=
[(8)(311) - (49)2] [(8)(15,224.7) - (346.9)2]

r = 0.947

Coefficient of determination
r2 = (0.947)2 = 0.897

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 Forecast Accuracy
 Error - difference between actual value and predicted value
 Mean Absolute Deviation (MAD)
 Average absolute error
 Weights errors linearly.
 Mean Squared Error (MSE)
 Average of squared error
 Gives more weight to larger errors, which typically cause more problems
 Mean Absolute Percent Error (MAPE)
 Average absolute percent error
 MAPE should be used when there is a need to put errors in perspective. For
example, an error of 10 in a forecast of 15 is huge. Conversely, an error of 10 in
a forecast of 10,000 is insignificant. Hence, to put large errors in perspective,
MAPE would be used.

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 MAD, MSE, and MAPE

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

( Actual  forecast / Actual*100)

MAPE =
n

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Forecast Accuracy Example

3-40
 MAD, MSE, and MAPE
 MAD – easiest to compute, but weighs
errors linearly.
 MSE – Gives more weight to larger
errors; larger errors cause more
problems.
 MAPE – Puts errors in perspective: e.g.,
error of 10 in a forecast of 15 is huge, but
error of 10 in a forecast of 10,000 is
perhaps negligible.

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 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

3-42
 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.

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 Forecast Control

 Tracking signal
 monitors the forecast to see if it
is biased high or low
(Dt - Ft) E
Tracking signal = =
MAD MAD

 1 MAD ≈ 0.8 б
 Control limits of 2 to 5 MADs are
used most frequently
Tracking Signal Values

3-45
Tracking Signal Plot

3-46
 Sources of Forecast errors
 Model may be inadequate
 Irregular variations
 Incorrect use of forecasting technique

3-47
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
3-48
 Operations Strategy
 Forecasts are the basis for many decisions
 Work to improve short-term forecasts
 Accurate short-term forecasts improve
 Profits
 Lower inventory levels
 Reduce inventory shortages
 Improve customer service levels
 Enhance forecasting credibility

3-49
 Supply Chain Forecasts
 Sharing forecasts with supply can
 Improve forecast quality in the supply chain
 Lower costs
 Shorter lead times

3-50