Adjusted Exponential Smoothing

Paul Mendenhall BusM 361 Professor Foster

Outline
Tool defined Equation Explained Illustrated step by step problem Practice Problem Summary

Definition
Times Series Forecasting model Adjusts for trends in information

Trends
What are trends?
Long term movements in a time series.

Why are trends a problem?

Cause lags in forecasts.

Smoothing and Alpha

Alpha () If randomness is great than is closer to 0.
More weight on past data.

If randomness is small than is closer to 1.

Greater weight on recent data.

Why the Model is Used

Smoothes random information. Works with trends in information. Provides a more accurate forecast.

Equation
The equation is:

AFt+1 = F t+1 + Tt+1

Equation Explained
The equation is: where: AFt+1 = F t+1 + Tt+1

F t+1 = Dt + (1- )Ft T t+1 = (F t+1 -Ft) + (1- )Tt

Tt=1 = trend factor for the next period. Tt = trend factor for the current period = smoothing constant for the trend adjustment factor.

Equation Illustrated
An electronics company is selling portable CD players and estimated the demand for the first period and forecasted the next three periods' adjusted demand using the Adjusted Exponential Smoothing model. The first periods demand is 50 players and 54 players was used to start the forecast. = 0.7 and = 0.2 (see Table 1)

Equation Illustrated cont

Period 1 2 3 Demand 54 57 44 Unadjusted Forecast Ft 50 Trend Tt Adjusted Forecast AFt -

* value is 0.2 ** value is 0.7

Table 1

Step 1
Create a table in Excel and enter the figures for the first period. Demand was 54. Unadjusted Forecast is any reasonable starting figure to start the process, in this case 50 players.
Period 1 Demand 54 Unadjusted Forecast Ft 50 Trend Tt Adjusted Forecast AFt -

Step 2
Calculate Ft+1 for period 2: F t+1 = Dt + (1- )Ft F2 = 0.2*57+(1-0.2)*50 = 50.8

Period 1 2

Demand 54 57

Unadjusted Forecast Ft 50 50.8

Trend Tt -

Adjusted Forecast AFt -

Step 3
Calculate the trend adjustment factor for period 2: T t+1 = (F t+1 -Ft) + (1- )Tt T2 = 0.7(50.8-50)+(1-0.7)*0 = 0.56

Period 1 2

Demand 54 57

Unadjusted Forecast Ft 50 50.8

Trend Tt 0 0.56

Adjusted Forecast AFt -

Step 4
Calculate the Adjusted Forecast AFt: AFt+1 = F t+1 + Tt+1 AF2 = 50.8 + 0.56 = 51.36

Period 1 2

Demand 54 57

Unadjusted Forecast Ft 50 50.8

Trend Tt 0 0.56

Adjusted Forecast AFt 51.36

Complete the table

Now calculate the Adjusted Forecast for period 3.

Period 1 2 3

Demand 54 57 44

Unadjusted Forecast Ft 50 50.8 -

Trend Tt 0 0.56 -

Adjusted Forecast AFt 50 51.36 -

Steps 1-4 Completed

Now calculate the Adjusted Forecast for period 3. Forecast table completed.

Period 1 2 3

Demand 54 57 44

Unadjusted Forecast Ft 50 50.8 52.04

Trend Tt 0 0.56 1.036

Adjusted Forecast AFt 50 51.36 53.08

Real World Example

Concise Co. is considering purchasing new equipment to improve productivity, but must first do some financial analysis. To provide accurate information for the analysis, an accurate forecast of demand must be produced to determine the estimated profit and cash flows for the next year. Concise Co. is concerned about the accuracy of the forecast due to dramatic movements is demand the last few years. Top management has asked you, the financial analysis, to create the forecasted report for 2005.

Real World Ex. Continued

You decide, after looking at the trends of the information, that the adjusted exponential smoothing model would work best for the forecast. Alpha is .3 and beta is .6. Use the last five years to create next years forecasted demand

Real World Ex. Continued

Top management has asked you, the financial analysis, to create the forecasted report for 2005. Use the last five years to create next years forecasted demand. The last five years demand is provided in the graph below.
Year 2000 2001 2002 2003 2004 Demand 1376 1189 1122 1306 1213

Practice Problem Answer

Year 2000 2001 2002 2003 2004 Demand 1376 1189 1122 1306 1213 Unadjusted Forecast Ft 1200 1253 1234 1200 1232 Trend Tt 0 32 1 -20 11 Adjusted Forecast AFt 1200 1284 1235 1181

Summary
Times series Smoothing Trends Accurate forecasting

Additional Readings
http://www.duke.edu/~rnau/411outbd.htm Introduction to Operations and Supply Chain Management Bozarth, Cecil C., Handfield, Robert B. 1st ed. 2005