Operations Management

Topic 6 Forecasting
UiTM Shah Alam Lecturer: Pn. Noriah Yusoff T1-A16-6C

4/21/2012

NY - KJP 585 2009

What is Forecasting?
Process of predicting a future event
Hmm. you gonna get an A for this subject

Underlying basis of all business decisions

Production Inventory

Personnel
Facilities

4/21/2012

NY - KJP 585 2009

Forecasting Time Horizons

Short-range forecast
Up to 1 year, generally less than 3 months Purchasing, job scheduling, workforce levels, job assignments, production levels

Medium-range forecast
3 months to 3 years Sales and production planning, budgeting

Long-range forecast
3+ years New product planning, facility location, research and development

4/21/2012

NY - KJP 585 2009

Seven Steps in Forecasting

Determine the use of the forecast Select the items to be forecasted Determine the time horizon of the forecast Select the forecasting model(s) Gather the data Make the forecast Validate and implement results
4/21/2012 NY - KJP 585 2009 4

Types of Forecasts
Economic forecasts
Address business cycle inflation rate, money supply, housing starts, etc.

Technological forecasts
Predict rate of technological progress Impacts development of new products

Demand forecasts
Predict sales of existing products and services

4/21/2012

NY - KJP 585 2009

Strategic Importance of Forecasting

Human Resources Hiring, training, laying off workers

Capacity Capacity shortages can result in undependable delivery, loss of customers, loss of market share
Supply Chain Management Good supplier relations and price advantages
4/21/2012 NY - KJP 585 2009 6

The Realities!
Forecasts are seldom perfect Most techniques assume an underlying stability in the system Product family and aggregated forecasts are more accurate than individual product forecasts

4/21/2012

NY - KJP 585 2009

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
4/21/2012 NY - KJP 585 2009 8

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
4/21/2012 NY - KJP 585 2009 9

Overview of Quantitative Approaches

1. Naive approach 2. Moving averages 3. Exponential smoothing 4. Trend projection 5. Linear regression
4/21/2012 NY - KJP 585 2009

Time-Series Models

Associative Model
10

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

4/21/2012

NY - KJP 585 2009

11

Components of Demand
Trend component
Seasonal peaks
Demand for product or service

Actual demand Average demand over four years

| 3 Year
NY - KJP 585 2009

Random variation
| 1 | 2

| 4
Figure 4.1
12

4/21/2012

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

4/21/2012

NY - KJP 585 2009

13

Seasonal Component
Regular pattern of up and down fluctuations Due to weather, customs, etc. Occurs within a single year
Period Week Month Month Year Year Year Length Day Week Day Quarter Month Week Number of Seasons 7 4-4.5 28-31 4 12 52

4/21/2012

NY - KJP 585 2009

14

Cyclical Component
Repeating up and down movements Affected by business cycle, political, and economic factors Multiple years duration Often causal or associative relationships
4/21/2012 NY - KJP 585 2009

10

15

20

15

Random Component
Erratic, unsystematic, residual fluctuations Due to random variation or unforeseen events Short duration and nonrepeating

4/21/2012

NY - KJP 585 2009

16

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 Can be good starting point

4/21/2012 NY - KJP 585 2009 17

Techniques for Averaging

Moving average Weighted moving average Exponential smoothing

4/21/2012

NY - KJP 585 2009

18

Moving Average Method

MA is a series of arithmetic means Used if little or no trend Used often for smoothing
Provides overall impression of data over time
Moving average = demand in previous n periods n

4/21/2012

NY - KJP 585 2009

19

Moving Average Example

Month January February March April May June July Actual Shed Sales 10 12 13 16 19 23 26 3-Month Moving Average

(10 + 12 + 13)/3 = 11 2/3 (12 + 13 + 16)/3 = 13 2/3 (13 + 16 + 19)/3 = 16 (16 + 19 + 23)/3 = 19 1/3

4/21/2012

NY - KJP 585 2009

20

Graph of Moving Average

30 28 26 24 22 20 18 16 14 12 10 | | |

Moving Average Forecast Actual Sales

Shed Sales

J
4/21/2012

D
21

NY - KJP 585 2009

Weighted Moving Average

Used when trend is present
Older data usually less important

Weights based on experience and intuition

Weighted moving average = (weight for period n) x (demand in period n)

weights

4/21/2012

NY - KJP 585 2009

22

Last month Weighted 3 Moving Average 2 1 6

Weights Applied

Period

Two months ago Three months ago Sum of weights

Month
January February March April May June July
4/21/2012

Actual Shed Sales

10 12 13 16 19 23 26

3-Month Weighted Moving Average

[(3 x 13) + (2 x 12) + (10)]/6 = 121/6 [(3 x 16) + (2 x 13) + (12)]/6 = 141/3 [(3 x 19) + (2 x 16) + (13)]/6 = 17 [(3 x 23) + (2 x 19) + (16)]/6 = 201/2
NY - KJP 585 2009 23

Moving Average And Weighted Moving Average

30 Sales demand
25 20 15 10 5 |
Figure 4.2
4/21/2012

Weighted moving average

Actual sales
Moving average

| F

| M

| A

| M

| J

| J

| A

| S

| O

| N

| D
24

NY - KJP 585 2009

Potential Problems With Moving Average

Increasing n smooths the forecast but makes it less sensitive to changes Do not forecast trends well Require extensive historical data

4/21/2012

NY - KJP 585 2009

25

Exponential Smoothing
Form of weighted moving average
Weights decline exponentially Most recent data weighted most

Requires smoothing constant ()

Ranges from 0 to 1 Subjectively chosen

Involves little record keeping of past data

4/21/2012 NY - KJP 585 2009 26

Exponential Smoothing
Remember This!!!!!!!!

New forecast = Last periods forecast + (Last periods actual demand Last periods forecast)

Ft = Ft 1 + (At 1 - Ft 1)
where Ft = new forecast Ft 1 = previous forecast = smoothing (or weighting) constant (0 1)
NY - KJP 585 2009 27

4/21/2012

Choosing
The objective is to obtain the most accurate forecast no matter the technique
We generally do this by selecting the model that gives us the lowest forecast error
Forecast error = Actual demand - Forecast value

= At - Ft
4/21/2012 NY - KJP 585 2009 28

Common Measures of Error

Mean Absolute Deviation (MAD)
MAD =
|Actual - Forecast| n

Mean Squared Error (MSE)

MSE =
4/21/2012

(Forecast Errors)2 n
NY - KJP 585 2009 29

Exponential Smoothing Example

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

4/21/2012

NY - KJP 585 2009

30

Exponential Smoothing Example

Predicted demand = 142 Ford Mustangs Actual demand = 153 Smoothing constant = .20 New forecast = 142 + .2(153 142)

4/21/2012

NY - KJP 585 2009

31

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
4/21/2012 NY - KJP 585 2009 32

Exponential Smoothing Example 2

Demand for the last four months was:

Predict demand for July using each of these methods: (A) 1) A 3-period moving average 2) exponential smoothing with alpha equal to .20 (use nave to begin). (B) 3) If the naive approach had been used to predict demand for April through June, what would MAD have been for those months?
4/21/2012 NY - KJP 585 2009 33

Exponential Smoothing Example 2

A) 1. 2. (8+10+8)/3 = 8.33 (July Forecast) Use nave to begin
Month March Demand 6 Forecast

April
May June

8
10 8

6
6 + 0.2(8 6) = 6.4 6.4 + 0.2(10 6.4) = 7.12 7.12 + 0.2(8 7.12) = 7.296

B)

Month Demand Nave Error MAD

March 6 6/3

April 8 6 +2 = 2.0
NY - KJP 585 2009

May 10 8 +2

June 8 10 -2

4/21/2012

34

Exponential Smoothing with Trend Adjustment

When a trend is present, exponential smoothing must be modified
Forecast Exponentially Exponentially including (FITt) = smoothed (Ft) + (Tt) smoothed trend forecast trend

4/21/2012

NY - KJP 585 2009

35

Exponential Smoothing with Trend Adjustment

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

Tt = b(Ft - Ft - 1) + (1 - b)Tt - 1
Step 1: Compute Ft Step 2: Compute Tt Step 3: Calculate the forecast FITt = Ft + Tt
4/21/2012 NY - KJP 585 2009 36

Other Examples
Moving Average

Weekly sales of ten-grain bread at the local organic food market are in the table below. Based on this data, forecast week 9 using a five-week moving average.
Week Sales 1 415 2 389 3 420 4 382 5 410 6 432 7 405 8 421

(382+410+432+405+421)/5 = 410.0

4/21/2012

NY - KJP 585 2009

37

Other Examples
Exponential Smoothing & MAD
Jim's department at a local department store has tracked the sales of a product over the last ten weeks. Forecast demand using exponential smoothing with an alpha of 0.4, and an initial forecast of 28.0. Calculate MAD. Period 1 2 3 4 5 6 7 8 9 10
4/21/2012

Demand 24 23 26 36 26 30 32 26 25 28
NY - KJP 585 2009 38

Other Examples
Exponential Smoothing
Period 1 2 3 4 5 6 7 8 9 10 Demand 24 23 26 36 26 30 32 26 25 28 Forecast 28.00 26.40 25.04 25.42 29.65 28.19 28.92 30.15 28.49 27.09 Total Average Error -3.40 0.96 10.58 -3.65 1.81 3.08 -4.15 -3.49 0.91 2.64 0.29 Bias Absolute 3.40 0.96 10.58 3.65 1.81 3.08 4.15 3.49 0.91 32.03 3.56 MAD
39

4/21/2012

NY - KJP 585 2009