Manufacturing Management

K S Sangwan
BITS Pilani
Pilani Campus
 BITS Pilani
Pilani Campus

Forecasting
Forecasting

 What is forecasting?
 Why forecasting is needed?
 What kind of strategic role play the forecasting in
supply chain management?
 Which forecasting method is best suited for various
type of organization?
 How much accurate is the given forecast?

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Forecasting
Forecast is a prediction of what will occur in the future.
Hopefully, the forecast will reduce uncertainty about the future
as much as possible, but it will never eliminate uncertainty.
A forecast of product demand is the basis for most important
planning decisions.
Planning decisions regarding—
scheduling,
inventory,
production,
facility layout and design,
workforce,
distribution,
purchasing, etc.
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 Why forecasting is important?

• Forecasts serve as a basis for

planning
• Enable managers to anticipate
the future to plan the system
and plan the use of that
system
• Forecasting is more than
predicting demand
• It is not an exact science;
one must blend experience,
judgment, and technical
expertise

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Strategic role of forecasting
In today’s global business environment, strategic planning and design
tend to focus on supply chain management and quality management.
Supply chain management
Forecasts of product demand determine how much inventory is
needed, how much product to make, and how much material to
purchase from suppliers to meet forecasted customer needs.
The distortion of information (bullwhip effect) about product demand
(including forecasts) as it is transmitted up the supply chain back
toward suppliers is serious problem with respect to demand forecast.
Ideally, a single forecast of demand for the final customer in the supply
chain would drive the development of subsequent forecasts for each
supply chain member back up through the supply chain.
One trend in supply chain design is continuous replenishment, wherein
continuous updating of data is shared between suppliers and
customers.
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Strategic role of forecasting

An inaccurate forecast causes service to break down,

resulting in poor quality.
For manufacturing operations, especially for suppliers,
customers expect parts to be provided when demanded.
Accurately forecasting customer demand is a crucial part of
providing the high-quality service.
Example: When customers walk into a McDonald’s to order
a meal, they do not expect to wait long to place orders.

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Types of Forecasting

Depend on
– time frame
– demand behavior

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 Time Frame

Indicates how far into the future

is forecast
– Short- to mid-range
forecast
• typically encompasses
the immediate future
• daily up to some months
– Long-range forecast
• usually encompasses a
period of time longer in
years

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 Demand Behavior

Trend
– a gradual, long-term up or
down movement of demand
Random variations
– movements in demand that do
not follow a pattern
Cycle
– an up-and-down repetitive
movement in demand
Seasonal pattern
– an up-and-down repetitive
movement in demand
occurring periodically

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Common features for All
forecasts
• Errors occur-- actual differs from predicted; presence of
randomness
• Assumption that past continues into future
• Forecasts of group of items (aggregate) tends to be
more accurate than individual items
• Forecast accuracy decreases as time horizon increases

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Characteristics of a Good
Forecast
• Timely

• Reliable

• Accurate

• Meaningful units

• Easy to use

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Forecasting Process
1. Identify the purpose 2. Collect historical data 3. Plot data and identify
of forecast 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 adjust
acceptable? parameters of existing
model
Yes
9. Adjust forecast based on 10. Monitor results and
8a. Forecast over
additional qualitative measure forecast
planning horizon
information and insight accuracy

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Forecasting Methods

Forecasting methods are classified into two groups:

Qualitative methods Quantitative methods
Characteristics Based on human judgement, Based on mathematical
opinions; subjective in nature formulas

Strengths Can incorporate latest changes Consistent and objective; able

in the business environment and to consider much information
“inside information” and data at one time

Weaknesses Can bias the forecast and Often quantifiable data are not
reduce forecast accuracy available. Only as the data on
which they are based

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Qualitative methods

• Executive opinions Decision Makers

(Evaluate
• Sales-force opinions responses and
• Consumer surveys make decisions)
• Delphy method
Staff
(Administering
survey)

Respondents
(People who can
make valuable
judgments)
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Quantitative Methods

Time Series Models:

– Assumes information needed to generate a forecast is contained in a
time series of data
– Relate the forecast to only one factor - time
 Naive method
 Simple moving average
 Weighted moving average
 exponential smoothing
 linear trend line
Causal Models or Associative Models
– Explores cause-and-effect relationships
 Regression Methods
 Correlation

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Naive method

Demand in current period is used as next period’s forecast

ORDERS
MONTH PER MONTH FORECAST
Jan 120 -
120
Feb 90 90
100
Mar 100 75
110
Apr 75 50
75
May 110 130
110
Nov
June - 50 90

July 75 BITS Pilani, Pilani Campus

Simple Moving Average

– uses average demand for a fixed sequence of periods

– stable demand with no pronounced behavioral
patterns
n
Di
i=1
MAn =
n
where

n = number of periods
in the moving average
Di = demand in period i

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3-month Simple Moving
Average

ORDERS MOVING
AVERAGE 3
MONTH
Jan
PER MONTH
120 –  Di
i=1
– MA3 =
Feb 90 – 3
103.3
Mar 100 88.3 90 + 110 + 130
95.0
= 3
Apr 75 78.3
78.3
= 110 orders for Nov
May 110 85.0
105.0
June 50 110.0

July 75

Aug 130 BITS Pilani, Pilani Campus

5-month Simple Moving
Average

ORDERS MOVING
AVERAGE 5
MONTH
Jan
PER MONTH
120 – 
i=1
Di
– MA5 =
Feb 90 – 5
–
Mar 100 – 90 + 110 + 130+75+50
= 5
99.0
Apr 75 85.0
82.0 = 91 orders for Nov
May 110 88.0
95.0
June 50 91.0

July 75

Aug 130 BITS Pilani, Pilani Campus

Smoothing Effects

150 –

5-month
125 –

100 –
Orders

75 –

3-month
50 –

Actual
25 –

| | | | | | | | | | |
0–
Jan Feb Mar Apr May June July Aug Sept Oct Nov
Month

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Weighted Moving Average

Adjusts moving average method to more closely reflect

data fluctuations
n
WMAn =  Wi Di
i=1
where
Wi = the weight for period i,
between 0 and 100 percent
 W = 1.00
i

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Weighted Moving Average

MONTH WEIGHT DATA

August 17% 130
September 33% 110
October 50% 90
3
November Forecast WMA3 =  Wi Di
i=1
= (0.50)(90) + (0.33)(110) + (0.17)(130)

= 103.4 orders

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Exponential Smoothing

• Weights most recent data more strongly

• Reacts more to recent changes
• Widely used, accurate method
Ft +1 = Dt + (1 - )Ft

where:
Ft +1 = forecast for next period
Dt = actual demand for present period
Ft = previously determined forecast for
present period
= weighting factor, smoothing constant
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Effect of Smoothing Constant

0.0  1.0

If = 0.20, then Ft +1 = 0.20Dt + 0.80 Ft

If = 0, then Ft +1 = 0Dt + 1 Ft = Ft

Forecast does not reflect recent data
If = 1, then Ft +1 = 1Dt + 0 Ft =Dt
Forecast based only on most recent data
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Exponential smoothing
(α=0.30)

PERIOD MONTH DEMAND F2 = D1 + (1 - )F1

= (0.30)(37) + (0.70)(37)
1 Jan 37
= 37
2 Feb 40 F3 = D2 + (1 - )F2
= (0.30)(40) + (0.70)(37)
3 Mar 41
= 37.9
4 Apr 37 F13 = D12 + (1 - )F12
5 May 45 = (0.30)(54) + (0.70)(50.84)
= 51.79
6 Jun 50

7 Jul 43
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Exponential smoothing

FORECAST, Ft + 1
PERIOD MONTH DEMAND ( = 0.3) ( = 0.5)
1 Jan 37 – –
2 Feb 40 37.00 37.00
3 Mar 41 37.90 38.50
4 Apr 37 38.83 39.75
5 May 45 38.28 38.37
6 Jun 50 40.29 41.68
7 Jul 43 43.20 45.84
8 Aug 47 43.14 44.42
9 Sep 56 44.30 45.71
10 Oct 52 47.81 50.85
11 Nov 55 49.06 51.42
12 Dec 54 50.84 53.21
13 Jan – 51.79 53.61

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Exponential smoothing

70 –

60 –
Actual  = 0.50

50 –
Orders

40 –
 = 0.30
30 –

20 –

10 –

| | | | | | | | | | | | |
0–
1 2 3 4 5 6 7 8 9 10 11 12 13
Month
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Adjusted Exponential
Smoothing

AFt +1 = Ft +1 + Tt +1
where
T = an exponentially smoothed trend factor

Tt +1 = (Ft +1 - Ft) + (1 - ) Tt
where
Tt = the last period trend factor
= a smoothing constant for trend
0≤ ≤ 1

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Adjusted Exponential
Smoothing (β=0.30)
T3 = (F3 - F2) + (1 - ) T2
PERIOD MONTH DEMAND = (0.30)(38.5 - 37.0) + (0.70)(0)
= 0.45
1 Jan 37 AF3 = F3 + T3 = 38.5 + 0.45
= 38.95
2 Feb 40
T13 = (F13 - F12) + (1 - ) T12
3 Mar 41
= (0.30)(53.61 - 53.21) + (0.70)(1.77)
4 Apr 37 = 1.36

5 May 45
AF13 = F13 + T13 = 53.61 + 1.36 = 54.97
6 Jun 50

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7 Jul 43
Adjusted Exponential
Smoothing
FORECAST TREND ADJUSTED
PERIOD MONTH DEMAND Ft +1 Tt +1 FORECAST AFt +1

1 Jan 37 37.00 – –
2 Feb 40 37.00 0.00 37.00
3 Mar 41 38.50 0.45 38.95
4 Apr 37 39.75 0.69 40.44
5 May 45 38.37 0.07 38.44
6 Jun 50 38.37 0.07 38.44
7 Jul 43 45.84 1.97 47.82
8 Aug 47 44.42 0.95 45.37
9 Sep 56 45.71 1.05 46.76
10 Oct 52 50.85 2.28 58.13
11 Nov 55 51.42 1.76 53.19
12 Dec 54 53.21 1.77 54.98
13 Jan – 53.61 1.36 54.96
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Adjusted Exponential
Smoothing Forecasts
70 –
Adjusted forecast ( = 0.30)
60 –
Actual

50 –
Demand

40 –

Forecast ( = 0.50)
30 –

20 –

10 –

| | | | | | | | | | | | |
0–
1 2 3 4 5 6 7 8 9 10 11 12 13
Period

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Linear Trend Line

xy - nxy
y = a + bx b =
x2 - nx2
where a = y-bx
a = intercept
b = slope of the line where
x = time period n = number of periods
y = forecast for x
demand for period x x = = mean of the x values
n
y
y = n = mean of the y values

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Least Squares Example

x(PERIOD) y(DEMAND) xy x2
1 73 37 1
2x 78 40 80 4
= = 6.5
3 12 41 123 9
4 557 37 148 16
5y = = 45
46.42 225 25
12
6 50 300 36
7b = xy - 43
nxy =3013867 - (12)(6.5)(46.42)
49 =1.72
8 x2 - 47
nx2 376 650 64
- 12(6.5)2
9 56 504 81
10 a = y - bx 52 520 100
11 = 46.42 - 55 605= 35.2 121
(1.72)(6.5)
12 54 648 144
78 557 3867 650

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Least Squares Example

Linear trend line y = 35.2 + 1.72x

70 –
Forecast for period 13 y = 35.2 + 1.72(13) = 57.56 units
60 – Actual

50 –
Demand

40 –
Linear trend line
30 –

20 –

10 – | | | | | | | | | | | | |
1 2 3 4 5 6 7 8 9 10 11 12 13
Period

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Seasonal Adjustments

Repetitive increase/ decrease in demand

Use seasonal factor to adjust forecast

Di
Seasonal factor = Si =
D

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Seasonal Adjustment

DEMAND (1000’S PER QUARTER)

YEAR 1 2 3 4 Total

2002 12.6 8.6 6.3 17.5 45.0

2003 14.1 10.3 7.5 18.2 50.1
2004 15.3 10.6 8.1 19.6 53.6
Total 42.0 29.5 21.9 55.3 148.7

D1 42.0 D3 21.9
S1 = = = 0.28 S3 = = = 0.15
D 148.7 D 148.7
D2 29.5 D4 55.3
S2 = = = 0.20 S4 = = = 0.37
D 148.7 D 148.7

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Seasonal Adjustment

For 2005

y = 40.97 + 4.30x = 40.97 + 4.30(4) = 58.17

SF1 = (S1) (F5) = (0.28)(58.17) = 16.28

SF2 = (S2) (F5) = (0.20)(58.17) = 11.63
SF3 = (S3) (F5) = (0.15)(58.17) = 8.73
SF4 = (S4) (F5) = (0.37)(58.17) = 21.53

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Forecasting accuracy

A forecast is never completely accurate; forecasts will always deviate

from the actual demand.
This difference between the forecast and the actual is the forecast
error.
A large degree of error may indicate that either the forecasting
technique is the wrong one or it needs to be adjusted by changing its
parameters (for example, α in the exponential smoothing forecast).
There are different measures of forecast error. Like—
• Mean absolute deviation (MAD),
• Mean absolute percent deviation (MAPD),
• Cumulative error, and
• Average error or bias (Ē)

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Mean absolute deviation (MAD)

MAD is an average of the difference between the forecast

and actual demand, as computed by the following
formula:
S Dt - Ft 
MAD = n
Where,
t = the period number
Dt = demand in period t
Ft = the forecast for period t
n = the total number of periods
 = the absolute value

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MAD Example
PERIOD DEMAND, Dt Ft ( =0.3) (Dt - Ft) |Dt - Ft|
1 37 37.00 – –
2 40 37.00 3.00 3.00
3 41 37.90 3.10 3.10
4 37 38.83S Dt-1.83
- Ft  1.83
5 45 MAD38.28
= n6.72 6.72
6 50 40.29 9.69 9.69
7 43 43.20 53.39
-0.20 0.20
8 47 =
43.14 3.86 3.86
9 56 44.30
11 11.70 11.70
10 52 = 4.854.19
47.81 4.19
11 55 49.06 5.94 5.94
12 54 50.84 3.15 3.15
557 49.31 53.39

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 Mean absolute percent
deviation (MAPD)
The mean absolute percent deviation (MAPD) measures the
absolute error as a percentage of demand rather than per
period.
As a result, it eliminates the problem of interpreting the measure
of accuracy relative to the magnitude of the demand and
forecast values, as MAD does.
The mean absolute percent deviation is computed according to
the following formula:

|Dt - Ft|
MAPD =
Dt

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Cumulative error

Cumulative error is computed simply by summing the

forecast errors, as shown in the following formula.
 Cumulative error
E = et
= 49.31
A large positive value indicates that the forecast is
probably consistently lower than the actual demand, or
is biased low.
 Average error
et
E=
n BITS Pilani, Pilani Campus
Comparison of errors

FORECAST MAD MAPD E (E)

Exponential smoothing (= 0.30) 4.85 9.6% 49.31 4.48
Exponential smoothing (= 0.50) 4.04 8.5% 33.21 3.02
Adjusted exponential smoothing 3.81 8.1% 21.14 1.92
(= 0.50, = 0.30)
Linear trend line 2.29 4.9% – –

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Forecast control

There are several ways to monitor forecast error over time

to make sure that the forecast is performing correctly—
that is, the forecast is in control.
 Reasons for out-of-control forecasts
 Change in trend
 Appearance of cycle
 Weather changes
 Promotions
 Competition
 Politics

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Forecast control

A tracking signal indicates if the forecast is consistently

biased high or low. It is computed by dividing the
cumulative error by MAD, according to the formula—
 Compute each period
 Compare to control limits
 Forecast is in control if within limits

(Dt - Ft) E
Tracking signal = =
MAD MAD
Use control limits of +/- 2 to +/- 5 MAD

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Example

DEMAND FORECAST, ERROR E = TRACKING

PERIOD Dt Ft Dt - Ft (Dt - Ft) MAD SIGNAL

1 37 37.00 – – – –
2 40 37.00 3.00 3.00 3.00 1.00
3 41 37.90 3.10 6.10 3.05 2.00
4 37 38.83 -1.83 4.27 2.64 1.62
5 45 38.28 6.72for period
Tracking signal 10.993 3.66 3.00
6 50 40.29 9.69 20.68 4.87 4.25
7 43 43.20 -0.20
6.10 20.48 4.09 5.01
8 47 TS3 =
43.14 3.05 = 2.00
3.86 24.34 4.06 6.00
9 56 44.30 11.70 36.04 5.01 7.19
10 52 47.81 4.19 40.23 4.92 8.18
11 55 49.06 5.94 46.17 5.02 9.20
12 54 50.84 3.15 49.32 4.85 10.17

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Regression methods

Regression is used for forecasting by establishing a

mathematical relationship between two or more variables.
For example, there is a relationship between increased
demand in new housing and lower interest rates.
There are two basic regression methods—
• Linear regression method
• Multiple regression method

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Linear regression method

Linear regression is a mathematical technique that relates

one variable, called an independent variable, to another,
the dependent variable, in the form of an equation for a
straight line.
A linear equation has the following general form:

y = a + bx

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Linear regression method

a = y-bx

b = xy - nxy
x2 - nx2
where
a = intercept (at period 0)
b = slope of the line

x = x = mean of the x data

n

y = y = mean of the y data

n

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 Linear regression example
The State University athletic department wants to develop its budget for the
coming year using a forecast for football attendance. Football attendance
accounts for the largest portion of its revenues, and the athletic director believes
attendance is directly related to the number of wins by the team. The business
manager has accumulated total annual average attendance figures for the past
eight years.

Given the number of returning starters and the strength of the schedule,
the athletic director believes the team will win at least seven games next
year. Develop a simple regression equation for this data to forecast
attendance for this level of success.
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Linear regression example

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Correlation
Correlation in a linear regression equation is a measure of
the strength of the relationship between the independent
and dependent variables. The formula for the correlation
coefficient is

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 Correlation example

This value for the correlation coefficient is very close to 1.00,

indicating a strong linear relationship between the number of
wins and home attendance.
Another measure of the strength of the relationship between
the variables in a linear regression equation is the coefficient
of determination.
It is computed by squaring the value of r.

This value for the coefficient of determination means that 89.7% of the
amount of variation in attendance can be attributed to the number of wins by
the team
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Thank You

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