Project Planning and

Management (EG853ME)
Ram C. Poudel
Pulchowk Campus
November 1, 2009
Forecasting Horizons
Long Term
5+ years into the future
R&D, plant location, product planning
Principally judgement-based
Medium Term
1 season to 2 years
Aggregate planning, capacity planning, sales forecasts
Mixture of quantitative methods and judgement
Short Term
1 day to 1 year, less than 1 season
Demand forecasting, staffing levels, purchasing,
inventory levels
Quantitative methods
Short Term Forecasting:
Needs and Uses
Scheduling existing resources
NEA for Load Dispatch Center
Acquiring additional resources
How much power stations needs to be
added?
Determining what resources are needed
Renewable Energy
Nuclear Energy
 Types of Forecasting
Models
Types of Forecasts
 Qualitative --- based on experience, judgement, knowledge;
 Quantitative --- based on data, statistics;

Methods of Forecasting
 Naive Methods --- eye-balling the numbers;
 Formal Methods --- systematically reduce forecasting errors;
 time series models (e.g. exponential smoothing);
 causal models (e.g. regression).
Focus here on Time Series Models
Assumptions of Time Series Models
There is information about the past;
This information can be quantified in the form of data;
The pattern of the past will continue into the future.
 Methods of demand forecasting
1. Jury of expert’s opinion
2. Delphi method: Individual experts act separately
3. Consumer’s Survey
4. Sales forecast composite
5. Naïve models
6. Smoothing techniques
a. Moving average
b. Exponential smoothing
7. Analysis of time series and trend projections
8. Use of economic indicators
9. Controlled experiments
10. Judgemental approach
 Approach to forecasting
1. Identify and clearly state the objectives of forecasting.
2. Select appropriate method of forecasting.
3. Identify the variables.
4. Gather relevant data.
5. Determine the most probable relationship.
6. For forecasting the company’s share in the demand, two different
assumptions may be made:
(a) Ratio of company sales to the total industry sales will continue as in
the past.
(b) On the basis of an analysis of likely competition and industry trends,
the company may assume a market share different from that of the
past. (alternative / rolling forecasts)
7. Forecasts may be made either in terms of units or sales in rupees.
8. May be made in terms of product groups and then broken for
individual products.
9. May be made on annual basis and then divided month-wise, etc.
Statistical Methods
Trend Analysis
Curve fitting
Moving Average method
Weighted moving average method
Exponential smoothing method (w/ Trend and
Seasonality)
Time Series decomposition method
Curve Fitting
Method of Least Squares:
Principle of maxima and
minima

 Find the value of m and b that minimize the sum of square of

residuals.
How do we know how good the
fit is?
Correlation Coefficient, R2
60

50
y = 9x - 17.333
R2 = 0.9743
40

30

20

10

0
0 2 4 6 8
Simple Moving Average
Forecast Ft is average of n previous observations or actuals
Dt :
Note that the n past observations are equally weighted.
1
Ft +1 = ( Dt + Dt −1 + + Dt +1−n )
Issues with moving average forecasts:
n
All n past observations treated equally;
Observations older than n are not included at all;
t
Requires that1
∑
n past observations be retained;
Problem = 1000's
Ft +1 when Ditems
of i are being forecast.
n i =t +1−n
 Simple Moving Average
Include n most recent observations
Weight equally
Ignore older observations

weight

1/n

n ... 3 2 1
today
Moving Average

n=
3
 Exponential Smoothing I
Include all past observations
Weight recent observations much more
heavily than very old observations:

weight
Decreasing weight given
to older observations

today
 Exponential Smoothing:
Concept
Include all past observations
Weight recent observations much more
heavily than very old observations:
0<α <1
weight
Decreasing weight given α
to older observations
α (1 − α )
α (1 − α ) 2

α (1 − α ) 3

today 
 Exponential Smoothing:
Math
Ft =αDt +α(1 −α) Dt −1 +α(1 −α) Dt −2 +
2

Ft =αDt + (1 −α)[αDt −1 +α(1 − a ) Dt −2 +]

Ft = aD t + (1 − a ) Ft −1
 Exponential Smoothing:
Math
Ft = aD t + a (1 − a ) Dt −1 + a (1 − a ) Dt −2 +2

Ft = aD t + (1 − a ) Ft −1
Thus, new forecast is weighted sum of old forecast and
actual demand
Notes:
Only 2 values (Dt and Ft-1 ) are required, compared with n for
moving average
Parameter a determined empirically (whatever works best)
Rule of thumb: α < 0.5
Typically, α = 0.2 or α = 0.3 work well
Forecast for k periods into future is:

Ft +k = Ft
Exponential Smoothing

α = 0.2
Complicating Factors
Simple Exponential Smoothing works
well with data that is “moving
sideways” (stationary)
Must be adapted for data series
which exhibit a definite trend
Must be further adapted for data
series which exhibit seasonal and
cyclic patterns
Time Series Decomposition
Approach
Y = f(Xt) where Xt = f(Tt, St, Ct, Rt).
The trend component (Tt) and
Cyclic component (Ct)
Seasonal Componet (St)
Random component (Rt) of the series.

Attached Lecture Video from IIT,Delhi: Prof

Arun Kunda
De-seasonalizing Time Series
If the time series represents a seasonal
pattern of L period, then by taking moving
average Mt of L periods, we could get mean
value for the year
Thus Mt = Tt ×Ct, Tt by regression or
inspection, linear, quadratic, exponential or
other function
Seasonality = Xt/Mt = St × Rt
Averaging over same month removes Rt.
Put them together and get the forecast.
there is a way out...
 Forecasting Performance
How good is the forecast?
Mean Forecast Error (MFE or Bias): Measures
average deviation of forecast from actuals.

Mean Absolute Deviation (MAD): Measures

average absolute deviation of forecast from
actuals.
Mean Absolute Percentage Error (MAPE):
Measures absolute error as a percentage of
the forecast.
Standard Squared Error (MSE): Measures
variance of forecast error
Forecasting Performance
Measures
1 n
MFE = ∑( Dt − Ft )
n t =1
1 n
MAD = ∑ Dt − Ft
n t =1
100 n Dt − Ft
MAPE = ∑
n t =1 Dt
1 n
MSE = ∑( Dt − Ft ) 2

n t =1
 Mean Forecast Error (MFE or
Bias)
1 n
MFE = ∑( Dt − Ft )
n t =1

Want MFE to be as close to zero as possible -- minimum bias

A large positive (negative) MFE means that the forecast is
undershooting (overshooting) the actual observations
Note that zero MFE does not imply that forecasts are perfect (no
error) -- only that mean is “on target”
Also called forecast BIAS
Mean Absolute Deviation
(MAD)
1 n
MAD = ∑ Dt − Ft
n t =1

Measures absolute error

Positive and negative errors thus do not cancel out
(as with MFE)
Want MAD to be as small as possible
No way to know if MAD error is large or small in
relation to the actual data
Mean Absolute Percentage Error
(MAPE)

100 n Dt − Ft
MAPE = ∑
n t =1 Dt

Same as MAD, except ...

Measures deviation as a percentage of actual
data
 Mean Squared Error (MSE)

1 n
MSE = ∑( Dt − Ft ) 2
n t =1

Measures squared forecast error -- error variance

Recognizes that large errors are disproportionately more “expensive”
than small errors
But is not as easily interpreted as MAD, MAPE -- not as intuitive
Suggested Readings
Lecture - 35 The Analysis of Time
Series
Prof. Arun Kanda ITT/Delhi Available at:
Youtube.com
Chapter 3 : Textbook (Page 60 ~ 76).