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Forecasting

Forecasting
 Demand Management

 Qualitative Forecasting Methods

 Simple & Weighted Moving Average Forecasts

 Exponential Smoothing

 Simple Linear Regression


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Demand Management
Independent Demand

A Dependent Demand

B(4) C(2)

D(2) E(1) D(3) F(2)

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Independent Demand

 Take an active role to influence demand

 Takea passive role and simply respond to


demand

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Types of Forecasts

 Qualitative (Judgmental)

 Quantitative
– Time Series Analysis
– Causal Relationships
– Simulation

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Components of Demand

What’s going on here?

x
x x
x x
x x
x x
Sales

x x x
x
x
xx
x xx x x
x
x
x x x x x x
x x x x x x
x x x
x xxxxx
x
x x

1 2 3 4
Year 6
A Trend is Worth Noting

 Start by identifying the trend

 Whatis the trend in the sales of personal


computers?

 Are there any seasonal effects, cyclical factors or


other predicted events that might affect the sales
of personal computers?
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Qualitative Methods

 Grass Roots

 Market Research

 Panel Consensus

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Qualitative Methods

 Executive Judgment

 Historical Analogy

 Delphi Method

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Delphi Method
l. Choose the experts to participate. There should be a
variety of knowledgeable people in different areas.

2. Through a questionnaire (or E-mail), obtain forecasts


(and any premises or qualifications for the forecasts)
from all participants.

3. Summarize the results and redistribute them to the


participants along with appropriate new questions.
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Delphi Method

4. Summarize again, refining forecasts and conditions, and


again develop new questions.

5. Repeat Step 4 if necessary. Distribute the final results to


all participants.

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Judgmental Forecasting Applications
Small and Large Firms

Low High
Sales Sales
Technique < $100M > $500M
Manager’s opinion 40.7% 39.6%
Jury of executive opinion 40.7% 41.6%
Sales force composite 29.6% 35.4%
Number of Firms 27 48

Source: Nada Sanders and Karl Mandrodt (1994) “Practitioners Continue to Rely on Judgmental Forecasting
Methods Instead of Quantitative Methods,” Interfaces, vol. 24, no. 2, pp. 92-100.

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Quantitative Forecasting Applications
Small and Large Firms
Low High
Sales Sales
Technique < $100M > $500M
Moving average 29.6% 29.2%
Straight line projection 14.8% 14.6%
Naive 18.5% 14.6%
Exponential smoothing 14.8% 20.8%
Regression 22.2% 27.1%
Simulation 3.7% 10.4%
Classical decomposition 3.7% 8.3%
Box-Jenkins 3.7% 6.3%
Number of Firms 27 48
Source: Nada Sanders and Karl Mandrodt (1994) “Practitioners Continue to Rely on Judgmental Forecasting
Methods Instead of Quantitative Methods,” Interfaces, vol. 24, no. 2, pp. 92-100.

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Time Series Analysis

Pick a model based on:

1. Time horizon to forecast


2. Data availability
3. Accuracy required
4. Size of forecasting budget
5. Availability of qualified personnel

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Simple Moving Average
A t-1 + A t-2 + A t-3 +...+A t- n
Week Demand Ft =
1 650
n
2 678
3 720  Let’sdevelop 3-week and 6-
4 785
5 859 week moving average
6 920 forecasts for demand.
7 850
8 758  Assume you only have 3
9 892
10 920
weeks and 6 weeks of
11 789 actual demand data for the
12 844
respective forecasts
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Week Demand 3-Week 6-Week
1 650
2 678
3 720
4 785 682.67
5 859 727.67
6 920 788.00
7 850 854.67 768.67
8 758 876.33 802.00
9 892 842.67 815.33
10 920 833.33 844.00
11 789 856.67 866.50
12 844 867.00 854.83
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1000

900
Demand

800 Demand
3-Week
700
6-Week
600

500
1 2 3 4 5 6 7 8 9 10 11 12
Week

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In-Class Exercise

 Develop 3-week and


Week Demand
1 820 5-week moving
2 775 average forecasts for
3 680 demand.
4 655
5 620  Assume you only
6 600 have 3 weeks and 5
7 575
weeks of actual
demand data for the
respective forecasts
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In-Class Exercise (Solution)

Week Demand 3-Week 5-Week


1 820
2 775
3 680
4 655 758.33
5 620 703.33
6 600 651.67 710.00
7 575 625.00 666.00

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Weighted Moving Average
Ft = w 1 A t -1 + w 2 A t - 2 + w 3 A t -3 + ...+ w n A t - n
n

w
i=1
i =1

Determine the 3-period


Week Demand
1 650
weighted moving average
2 678 forecast for period 4.
3 720
4 Weights:
t-1 .5
t-2 .3
t-3 .2
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Solution

Week Demand Forecast


1 650
2 678
3 720
4 693.4

F4 = .5(720)+.3(678)+.2(650)
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In-Class Exercise

Determine the 3-period


weighted moving average
Week Demand
forecast for period 5.
1 820
2 775 Weights:
3 680 t-1 .7
4 655 t-2 .2
t-3 .1

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Solution

Week Demand Forecast


1 820
2 775
3 680
4 655
5 672

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Exponential Smoothing

Ft = Ft-1 + a(At-1 - Ft-1)

 Premise--The most recent observations might


have the highest predictive value.
 Therefore, we should give more weight to the
more recent time periods when forecasting

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Exponential Smoothing Example
 Determine
Week Demand exponential
1 820
2 775
smoothing forecasts
3 680 for periods 2-10
4 655 using a=.10 and
5 750 a=.60.
6 802
7 798
8 689
9 775  Let F1=D1
10
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Week Demand 0.1 0.6
1 820 820.00 820.00
2 775 820.00 820.00
3 680 815.50 820.00
4 655 801.95 817.30
5 750 787.26 808.09
6 802 783.53 795.59
7 798 785.38 788.35
8 689 786.64 786.57
9 775 776.88 786.61
10 776.69 780.77

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Effect of a on Forecast

900
800
Demand

Demand
700 0.1
600 0.6

500
1 2 3 4 5 6 7 8 9 10
Week

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In-Class Exercise

Week Demand
Determine exponential
1 820 smoothing forecasts for
2 775 periods 2-5 using a =.50
3 680
4 655
5 Let F1=D1

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In-Class Exercise (Solution)

Week Demand 0.5


1 820 820.00
2 775 820.00
3 680 797.50
4 655 738.75
5 696.88

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Forecast Errors
n
1 MAD  0.8 standard deviation
A
t=1
t - Ft
1 standard deviation  1.25 MAD
MAD =
n

 Study the formula for a moment

 Now, what does MAD tell you?

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Example--MAD

Month Sales Forecast


1 220 n/a
2 250 255
3 210 205
4 300 320
5 325 315

Determine the MAD for the four forecast periods

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Solution

Month Sales Forecast Abs Error


1 220 n/a
2 250 255 5
3 210 205 5
4 300 320 20
5 325 315 10

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A
t=1
t - Ft
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MAD = = = 10
n 4
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Tracking Signal

RSFE Running sum of forecast errors


TS = =
MAD Mean absolute deviation

 Isthe forecast average keeping pace with any


genuine upward or downward changes?

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What do you notice?

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Sales

30

25

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0 1 2 3 4 5 6 7 8 9 10
Period

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Simple Linear Regression Model

Yt = a + bx Y

0 1 2 3 4 5 x (weeks)

b is similar to the slope. However, since it is


calculated with the variability of the data in
mind, its formulation is not as straight-
forward as our usual notion of slope
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Calculating a and b

a = y - bx

 xy - n(y)(x)
b= 2 2
 x - n(x )

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Regression Equation Example

Week Sales
1 150
2 157
3 162
4 166
5 177

Develop a regression equation to predict sales


based on these five points.
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Week Week*Week Sales Week*Sales
1 1 150 150
2 4 157 314
3 9 162 486
4 16 166 664
5 25 177 885
3 55 162.4 2499
Average Sum Average Sum

b=
 xy - n( y)(x) 2499 - 5(162.4)(3) 63
=  = 6.3
 x - n(x )
2 2
55  5(9 ) 10

a = y - bx = 162.4 - (6.3)(3) = 143.5


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y = 143.5 + 6.3t
180
175
170
165
160 Sales
Sales

155 Forecast
150
145
140
135
1 2 3 4 5

Period
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