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3-1 Forecasting

Operations Management
PRDN & OPRN

Forecasting
Learning Objectives
• Explore the nature of forecasting.
• Describe the common features of all forecasts.
• Examine the elements of a good forecast.
• Understand the basic steps in the forecasting process.
• Be able to familiarize with the basic forecasting
techniques and solve practical problems.
3-3 Forecasting

Is demand forecasting important?


Why is it important?
3-4 Forecasting

You’ll never get it right.


But, you can always get it less
wrong.
3-5 Forecasting

FORECAST:

• A process of predicting a future event


3-6 Forecasting

Nature of
FORECAST
▪ Forecasts are basic input in the decision process
▪ Forecast is used for planning the system and
planning the use of system
▪ Forecasts are made with reference
to a specific time horizon
3-7 Forecasting

• Forecasts affect decisions and activities throughout


an organization

• Forecasting is more than predicting demand


3-8 Forecasting

This chapter provides a survey of


business forecasting. It describes
the elements of good forecasts,
the necessary steps in preparing
Features Common to All Forecasts
a forecast, basic forecasting
techniques, and how to monitor a
forecast.
• Assumption of a stable underlying causal system
• Actual results will differ somewhat from predicted
values
• Forecasts for group of items tend to be more accurate
than forecast for individual items
• Accuracy decreases as time horizon increases
3-9 Forecasting

Elements of a Good Forecast


3-10 Forecasting

Steps in the Forecasting Process

“The forecast”

Step 6 Monitor the forecast


Step 5 Prepare the forecast
Step 4 Select a forecasting technique
Step 3 Gather, clean and analyze data
Step 2 Establish a time horizon
Step 1 Determine purpose of forecast
3-11 Forecasting

Approaches to Forecasting

This chapter provides a survey of


business forecasting. It describes
the elements of good forecasts,
the necessary steps in preparing
a forecast, basic forecasting
techniques, and how to monitor a
forecast.

Qualitative Quantitative

▪ subjective inputs ▪ historical data/associative model


▪ soft information ▪ hard data
Forecasting Approaches
Qualitative Methods

► Used when situation is vague and


little data exist
► New products
► New technology
► Involves intuition, experience
► e.g., forecasting sales on Internet

© 2014 Pearson Education Exponential Smoothing 4 - 12


Forecasting Approaches
Quantitative Methods

► Used when situation is ‘stable’ and


historical data exist
► Existing products
► Current technology
► Involves mathematical techniques
► e.g., forecasting sales of color
televisions
© 2014 Pearson Education Exponential Smoothing 4 - 13
Overview of Qualitative Methods

1. Jury of executive opinion


► Pool opinions of high-level experts,
sometimes augment by statistical
models
2. Delphi method
► Panel of experts, queried iteratively

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Overview of Qualitative Methods

3. Sales force composite


► Estimates from individual salespersons
are reviewed for reasonableness, then
aggregated
4. Market Survey
► Ask the customer

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Jury of Executive Opinion
► Involves small group of high-level experts
and managers
► Group estimates demand by working
together
► Combines managerial experience with
statistical models

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Delphi Method
► Iterative group
process, continues Decision Makers
(Evaluate responses
until consensus is and make decisions)
reached
► 3 types of Staff
(Administering
participants survey)

► Decision makers
► Staff
► Respondents Respondents
(People who can make
valuable judgments)
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Sales Force Composite

► Each salesperson projects his or her


sales
► Combined at district and national
levels
► Sales reps know customers’ wants
► May be overly optimistic

© 2014 Pearson Education Exponential Smoothing 4 - 18


Market Survey
► Ask customers about purchasing
plans
► Useful for demand and product
design and planning
► What consumers say, and what they
actually do may be different
► May be overly optimistic

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Qualitative Methods
Type Characteristics Strengths Weaknesses
Executive A group of managers Good for strategic or One person's opinion
opinion meet & come up with new-product can dominate the
a forecast forecasting forecast

Market Uses surveys & Good determinant of It can be difficult to


research interviews to identify customer preferences develop a good
customer preferences questionnaire

Delphi Seeks to develop a Excellent for Time consuming to


method consensus among a forecasting long-term develop
group of experts product demand,
technological
changes, and
© 2014 Pearson Education Exponential Smoothing 4 - 20
Overview of Quantitative
Approaches
1. Naive approach
2. Moving averages
3. Exponential Time-series
smoothing models
4. Trend projection
5. Linear regression Associative
model

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Time-Series Forecasting

► Set of evenly spaced numerical data


► Obtained by observing response variable at
regular time periods
► Forecast based only on past values, no
other variables important
► Assumes that factors influencing past and
present will continue influence in future

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Time-Series Patterns

Trend Cyclical

Seasonal Random

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Trend Pattern
► Persistent, overall upward or downward
pattern
► Changes due to population, technology,
age, culture, etc.
► Typically several years duration

© 2014 Pearson Education Exponential Smoothing 4 - 24


Seasonal Variation
► Regular pattern of up and down
fluctuations
► Due to weather, customs, etc.
► Occurs within a single year
PERIOD LENGTH “SEASON” LENGTH NUMBER OF “SEASONS” IN PATTERN
Week Day 7
Month Week 4 – 4.5
Month Day 28 – 31
Year Quarter 4
Year Month 12
Year Week 52

© 2014 Pearson Education Exponential Smoothing 4 - 25


Cyclical Pattern
► Repeating up and down movements
► Affected by business cycle, political,
and economic factors
► Multiple years duration

0 5 10 15 20
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Exponential Smoothing
Random Variation
► Erratic, unsystematic, ‘residual’
fluctuations
► Due to random variation or unforeseen
events
► Short duration
and nonrepeating

M T W T
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Exponential Smoothing
Demand Patttern

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Naive Approach

► Assumes demand in next


period is the same as
demand in most recent period
► e.g., If January sales were 68, then
February sales will be 68
► Sometimes cost effective and efficient

© 2014 Pearson Education Exponential Smoothing 4 - 29


Moving Average Method
▶ A technique that averages a number of recent
actual values, updated as new values
become available

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3-31 Forecasting

Moving Average
Sample Problem
Compute a three-period moving average forecast given demand
for shopping carts for the last five periods.

If the actual demand in period 6 turns out to be 38, the 3-period


moving average forecast for period 7 would be:
Moving Average Example
Donna’s Garden Supply wants a 3-month moving-average forecast,
including a forecast for next January, for shed sales.

MONTH ACTUAL SHED SALES 3-MONTH MOVING AVERAGE


January 10
10
February 12
March 13
April 16 (10 + 12 + 13)/3 = 11 2/3
May 19 (12 + 13 + 16)/3 = 13 2/3
June 23 (13 + 16 + 19)/3 = 16
July 26 (16 + 19 + 23)/3 = 19 1/3
August 30 (19 + 23 + 26)/3 = 22 2/3
September 28 (23 + 26 + 30)/3 = 26 1/3
October 18 (29 + 30 + 28)/3 = 28
November 16 (30 + 28 + 18)/3 = 25 1/3
December 14 (28 + 18 + 16)/3 = 20 2/3

© 2014 Pearson Education Exponential Smoothing 4 - 32


Weighted Moving Average

► Used when some trend might be present


► Older data usually less important
► assigns more weight to the most recent values
in a time series.
► Example: The most recent value is assigned
.40, the next most recent .30, next .20 and last
value with weight of .10

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Formula of Weighted
Moving Average

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Sample Problem
Given the following demand data:
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 period 6 is 39, forecast demand
for period 7 using the same weights as in part a.

a. F 6= .10(40) + .20(43) + .30(40) + .40(41) = 41.0

b. F 7 = .10(43) + .20(40) + .30(41) + .40(39) = 40.2

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Learning Exercise
Actual
Period Demand
2001 58
2002 47
2003 52
2004 64
2005 41
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 period 6 is 39, forecast demand
for period 7 using the same weights as in part a.
© 2014 Pearson Education Exponential Smoothing 4 - 36
Potential Problems With
Moving Average

► Increasing n smooths the forecast but


makes it less sensitive to changes

► Does not forecast trends well

► Requires extensive historical data

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Exponential Smoothing

► Form of weighted moving average


► Most recent data weighted most

► Three data needed


► Last period’s forecast (Ft)
► Last period’s actual value / demand (At)
► Smoothing constant ()

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Exponential Smoothing
New forecast = Last period’s forecast
+  (Last period’s actual demand
– Last period’s forecast)

Ft = Ft – 1 + (At – 1 - Ft – 1)

where Ft = new forecast


Ft – 1 = previous period’s forecast
 = smoothing (or weighting) constant (0 ≤  ≤ 1)
At – 1 = previous period’s actual demand

© 2014 Pearson Education Exponential Smoothing 4 - 39


Exponential Smoothing
Example

In January, a car dealer predicted February


demand for 142 Ford Mustangs. Actual
February demand was 153 autos. Using a
smoothing constant chosen by management
of a = .20, the dealer wants to forecast
March demand using the exponential
smoothing model.

© 2014 Pearson Education Exponential Smoothing 4 - 40


Exponential Smoothing
Example
Predicted demand = 142 Ford Mustangs
Actual demand = 153
Smoothing constant  = .20

New forecast = 142 + .2(153 – 142)


= 142 + 2.2
= 144.2 ≈ 144 cars

© 2014 Pearson Education Exponential Smoothing 4 - 41


Learning Exercises 1 & 2:
Suppose the previous forecast was 42 units,
actual demand was 40 units, and  .10.

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


the next
t
forecast would be:

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Learning Exercise 3
Given the following data compute the exponential
smoothing forecasts for the periods 2010 through
2012 with smoothing constant  .of .40.

Actual
Period No. of Forecast Calculations
Orders
2008 60
2009 65 60
2010 55
2011 58
2012 64
© 2014 Pearson Education Exponential Smoothing 4 - 43
Learning Exercise
Given the following data compute the exponential
smoothing forecasts for the periods 2010 through
2012 with smoothing constant  .of .40.

Actual
Period No. of Forecast Calculations
Orders
2008 60
2009 65 60
2010 55 62 60+.40(65-60) = 62
2011 58 59.2 62+.40(55-62) = 59.2
2012 64 58.72 59.2+.40(58-59.2) = 58.72
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Measuring Forecast Error

• difference between the value that occurs and the


value that was predicted for a given time period

Error = Actual - Forecast


et = At - Ft

Where
t = Any given time period

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Forecast Error
Example:
(cont’n)

• Positive errors result when the forecast is too low,


negative errors when the forecast is too high

if actual demand for a week is 100 units and forecast


demand was 90 units, the forecast was too low

et = 100 - 90
et = +10

© 2014 Pearson Education Exponential Smoothing 4 - 46


Common Measures of Error

Mean Absolute Deviation (MAD)


Mean Squared Error (MSE)
Mean Absolute Percent Error (MAPE)

© 2014 Pearson Education Exponential Smoothing 4 - 47

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