Forecasting

 Predicting future events

 Usually demand behavior
over a time frame
 Qualitative methods
 Based on subjective methods
 Quantitative methods
 Based on mathematical formulas
 Types of Forecasts by Time
Horizon
• Short-range forecast
– Up to 1 year; usually less than 3 months
– Job scheduling, worker assignments
• Medium-range forecast
– 3 months to 3 years
– Sales & production planning, budgeting
• Long-range forecast
– 3+ years
– New product planning, facility location
 Forecasting Approaches
Qualitative Methods
• Used when situation is
vague & little data exist
– New products
– New technology
• Involves intuition,
experience
– e.g., forecasting sales on
Internet
Quantitative Methods
• Used when situation is
‘stable’ & historical
data exist
– Existing products
– Current technology
• Involves mathematical
techniques
– e.g., forecasting sales of
color televisions
Overview of Qualitative Methods
• Jury of executive opinion
– Pool opinions of high-level executives,
sometimes augment by statistical models
• Delphi method
– Panel of experts, queried iteratively
• Sales force composite
– Estimates from individual salespersons are
reviewed for reasonableness, then aggregated
• Consumer Market Survey
– Ask the customer
Overview of Quantitative Approaches

• Naïve approach
• Moving averages Time-series
• Exponential smoothing Models

• Trend projection
Associative
• Linear regression models
 What is a Time Series?
• Set of evenly spaced numerical data
– Obtained by observing response variable at regular time
periods
• Forecast based only on past values
– Assumes that factors influencing past and present will
continue influence in future
• Example
Year: 1998 1999 2000 2001 2002
Sales: 78.7 63.5 89.7 93.2 92.1
 Time Series Components
Trend Cyclical

Seasonal Random
 Trend Component
• Persistent, overall upward or downward
pattern
• Due to population, technology etc.
• Several years duration
 Seasonal Component
• Regular pattern of up & down fluctuations
• Due to weather, customs etc.
• Occurs within 1 year
Common Seasonal Patterns
Period of “Season” Number of
Pattern Length “Seasons” in
Pattern
Week Day 7
Month Week 4–4½
Month Day 28 – 31
Year Quarter 4
Year Month 12
Year Week 52
 Cyclical Component
• Repeating up & down movements
• Due to interactions of factors influencing
economy
• Usually 2-10 years duration
 Random Component
• Erratic, unsystematic, ‘residual’ fluctuations
• Due to random variation or unforeseen events
– Union strike
– Tornado

• Short duration &

nonrepeating
 Naive Approach
• Assumes demand in next
period is the same as
demand in most recent
period
– e.g., If May sales were 48,
then June sales will be 48
• Sometimes cost effective &
efficient
 Moving Average
 Average several
periods of data
 Dampen, smooth out
changes
 Use when demand is
stable with no trend
or seasonal pattern
 Moving Average
 Average several n
periods of data 
i=1
Di
MAn =
 Dampen, smooth out n
changes where

 Use when demand is n = number of periods in

the moving average
stable with no trend Di = demand in period i
or seasonal pattern
 Simple Moving Average
ORDERS THREE-MONTH FIVE-MONTH
MONTH PER MONTH MOVING AVERAGE MOVING AVERAGE
Jan 120 – –
Feb 90 – –
Mar 100 – –
Apr 75 103.3 –
May 110 88.3 –
June 50 95.0 99.0
July 75 78.3 85.0
Aug 130 78.3 82.0
Sept 110 85.0 88.0
Oct 90 105.0 95.0
Nov – 110.0 91.0
 Smoothing Effects
150 –

5-month
125 –

100 –
Orders

75 –

50 – 3-month

Actual
25 –

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

 Adjusts WMAn =  Wi Di
i=1
moving
average where
method to Wi = the weight for period i,
more closely between 0 and 100
percent
reflect data
fluctuations  W = 1.00
i
Weighted Moving Average Example

MONTH WEIGHT DATA

August 17% 130
September 33% 110
October 50% 90
Weighted Moving Average Example

MONTH WEIGHT DATA

August 17% 130
September 33% 110
October 50% 90
3
November forecast WMA3 = 
i=1
Wi Di

= (0.50)(90) + (0.33)(110) + (0.17)(130)

= 103.4 orders
 Exponential Smoothing
Ft +1 = Dt + (1 - )Ft
 Averaging method where
 Weights most Ft +1 = forecast for next
recent data more period
strongly Dt = actual demand for
 Reacts more to present period
recent changes Ft = previously
determined forecast
 Widely used, for present period
accurate method
= weighting factor,
smoothing constant
 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 0 = Ft

Forecast does not reflect recent data

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

Forecast based only on most recent data
 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
 Exponential Smoothing Forecasts
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
 Forecast Accuracy
 Error = Actual - Forecast
 Find a method which minimizes error
 Mean Absolute
Deviation (MAD)
 Mean Absolute
Percent Deviation (MAPD)
 Cumulative Error (E)
 The MAD Statistic to Determine
Forecasting Error
n
1 MAD  0.8 standard deviation
A
t=1
t - Ft
1 standard deviation  1.25 MAD
MAD =
n

• The ideal MAD is zero which would mean

there is no forecasting error

• The larger the MAD, the less the accurate

the resulting model
 Tracking Signal Formula
• The Tracking Signal or TS is a measure that
indicates whether the forecast average is keeping
pace with any genuine upward or downward
changes in demand.
• Depending on the number of MAD’s selected, the
TS can be used like a quality control chart
indicating when the model is generating too much
error in its forecasts.
• The TS formula is:
RSFE Running sum of forecast errors
TS = =
MAD Mean absolute deviation
 Tracking Signal
 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