Chapter 4 - Forecasting

Mr. David P. Blain. C.Q.E. Management Department UNLV

Outline
Global Company Profile: Tupperware What is Forecasting? Types of Forecasts Seven Steps in the Forecasting System Forecasting Approaches Overview of Qualitative & Quantitative Methods Time-Series Forecasting Monitoring and Controlling Forecasts
(Principles of Operations Management, Heizer & Render, 5th Edition)

Forecasting at Tupperware
Each of 50 profit centers around the world is

responsible for computerized monthly, quarterly, and 12-month sales projections These projections are aggregated by region, then globally, at Tupperwares World Headquarters Tupperware uses techniques discussed in text
(Principles of Operations Management, Heizer & Render, 5th Edition)

Three Key Factors for Tupperware

The number of registered consultants or

sales representatives The percentage of currently active dealers (this number changes each week and month) Sales per active dealer, on a weekly basis

(Principles of Operations Management, Heizer & Render, 5th Edition)

Tupperware - Forecast by Consensus

Although inputs come from sales,

marketing, finance, and production, final forecasts are the consensus of all participating managers. The final step is Tupperwares version of the jury of executive opinion

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What is Forecasting?
Process of predicting a
Sales will be $200 Million!

future event
Underlying basis of

all business decisions

Production Inventory Personnel Facilities

(Principles of Operations Management, Heizer & Render, 5th Edition)

Forecasting Time Horizons

Process of predicting a future event Short-range forecast
Job

scheduling, worker assignments & production planning, budgeting product planning, facility location

Medium-range forecast
Sales New

Long-range forecast

(Principles of Operations Management, Heizer & Render, 5th Edition)

Types of Forecasts
Economic forecasts Address business cycle, e.g., inflation rate, money supply, etc. Technological forecasts Predict technological change Predict new product sales Demand forecasts Predict existing product sales

(Principles of Operations Management, Heizer & Render, 5th Edition)

Forecasting Approaches
Qualitative Methods
Used when situation is vague & little data exist
New products New technology

Quantitative Methods
Used when situation is stable & historical data exist
Existing products Current technology

Involves intuition, experience e.g., forecasting sales on Internet

Involves mathematical techniques e.g., forecasting sales of color televisions

(Principles of Operations Management, Heizer & Render, 5th Edition)

Overview of Qualitative Methods

Jury of executive opinion Pool opinions of high-level executives, sometimes augment by statistical models Sales force composite Estimates from individual salespersons are reviewed for reasonableness, then aggregated Delphi method Panel of experts, queried iteratively Consumer Market Survey Ask the customer
(Principles of Operations Management, Heizer & Render, 5th Edition)

Overview of Quantitative Approaches

Nave approach Moving averages Exponential smoothing Trend projection Linear regression

Time-series models

Associative models

(Principles of Operations Management, Heizer & Render, 5th Edition)

Time Series Forecasting

Trend

Cyclical

Seasonal

Random

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Naive Approach
Assumes demand in next period is the

same as demand in most recent period

If May sales were

48, then June sales will

be 48
Sometimes can be cost effective &

efficient

(Principles of Operations Management, Heizer & Render, 5th Edition)

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

Equation

Demand in previous n periods MA=

n
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Weighted Moving Average Method

Used when trend is present
Older

data usually less important between 0 & 1, & sum to 1.0

Weights based on intuition

Ranges

Equation
WMA

(Weight for period n) (Demand in period (

=

Weights

(Principles of Operations Management, Heizer & Render, 5th Edition)

Exponential Smoothing Method

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

(Principles of Operations Management, Heizer & Render, 5th Edition)

Exponential Smoothing Equations

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

for computing forecast

Ft = At - 1 + (1-)At - 2 + (1- )2At - 3

+ (1- )3At - 4 + ... + (1- )t-1A0

Ft At

= Forecast value = Actual value

= Smoothing constant

(Principles of Operations Management, Heizer & Render, 5th Edition)

Trend & Linear Regression Model

Shows linear relationship between dependent

& explanatory variables

Example:

Sales & advertising (not time)

Slope

Y-intercept

^ Yi = a +b X i
Dependent (response) variable Independent (explanatory) variable

(Principles of Operations Management, Heizer & Render, 5th Edition)

Linear Regression Model

Y
Yi = a + b X i + Error
Error

^ Yi = a + b X i
Observed value of Operations Management, Heizer & Render, 5 (Principles

Regression line

X
th

Edition)

Linear Regression Equations

Equation:
Yi = a + bx i

Slope:

b = i =1 n 2 x i nx 2
i =1

x i y i nx y

Y-Intercept: a = y bx

(Principles of Operations Management, Heizer & Render, 5th Edition)

Interpretation of Coefficients
Slope (b) Estimated Y changes by b for each 1 unit increase in X
If b = 2, then sales (Y) is expected to increase by 2 for each 1 unit increase in advertising (X)

Y-intercept (a) Average value of Y when X = 0

If a = 4, then average sales (Y) is expected to be 4 when advertising (X) is 0

(Principles of Operations Management, Heizer & Render, 5th Edition)

Selecting a Forecasting Model

You want to achieve:
No

pattern or direction in forecast error

Error = (Yi - Yi) = (Actual - Forecast) Seen in plots of errors over time
Smallest

forecast error

Mean square error (MSE) Mean absolute deviation (MAD)

(Principles of Operations Management, Heizer & Render, 5th Edition)

Forecast Error Equations

Mean Square Error (MSE)
MSE = (y i y i ) 2
i =1 n

forecast =
n

errors

Mean Absolute Deviation (MAD)

MAD = i =1
| yi
n

yi |

| forecast

errors |

(Principles of Operations Management, Heizer & Render, 5th Edition)

Tracking Signal
Measures how well the forecast is predicting

actual values Ratio of running sum of forecast errors (RSFE) to mean absolute deviation (MAD)
Good

tracking signal has low values

Should be within upper and lower control

limits

(Principles of Operations Management, Heizer & Render, 5th Edition)

Chap 4 Forecasting Learning Objectives

Ability to Identify or Define:
Forecasting and types of Time horizons Approaches to forecasts

forecasts

Ability to Describe or Explain:

Moving averages Exponential smoothing Trend projections and regression Measures of forecast accuracy Tracking signal
(Principles of Operations Management, Heizer & Render, 5th Edition)

Ch 4 Forecasting

4.6, 4.7

(Principles of Operations Management, Heizer & Render, 5th Edition)

Problem 4.6 Forecasting methods

Monthly Sales for Telco Batteries were as follows:
Month January February March April May June July August September October November December Sum Average Sales (y) 20 21 15 14 13 16 17 16 20 20 21 23 218 18.17 Period (x) 1 2 3 4 5 6 7 8 9 10 11 12 78 6.5 x2 1 4 9 16 25 36 49 64 81 100 121 144 650

Ch 4 Forecasting
xy 20 42 45 56 65 96 119 144 180 200 231 276 1474

(Principles of Operations Management, Heizer & Render, 5th Edition)

Ch 4 Forecasting
P 4.6 a) Plotting this data:
Sales
25 20 Dollars 15 10 5 0 1 2 3 4 5 6 7 8 9 10 11 12 Month

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Ch 4 Forecasting
P 4.6 b) Forecast January Sales using each of the following : 1) Naive Method
Demand in next period same as last period Therefore January will be 23 since those were Decembers sales

2) 3 month Moving Average

Using the last 3 months Oct, Nov, Dec = (20 + 21 + 23)/3 =21 .33 We would forecast January at 21 based on smoothing of 3 month average

(Principles of Operations Management, Heizer & Render, 5th Edition)

Ch 4 Forecasting
3) 6-month weighted average Using weighting of .1, .1, .1, .2, .2 and .3; with the heavier weights applied to the most recent months ( Oct, Nov, Dec) (0.1 * 17) + (0.1 * 18) + (0.1 * 20) + (0.2 * 20) + ( 0.2 * 21) + (0.3 * 23) = 21.33 which gives us a January forecast of 21

(Principles of Operations Management, Heizer & Render, 5th Edition)

4) Exponential smoothing

Ch 4 Forecasting

sophisticated weighted moving average forecasting method

New forecast = last periods forecast + alpha * (last period's actual demand - last period's forecast)

Therefore with alpha of .3 and Septembers forecast of 18 October forecast = Sept forecast + alpha times (Sept. actual - Sept. forecast) October forecast November forecast December forecast January forecast = 18 + 0.3 (20-18) = 18.6 = 18.6 + 0.3 (20-18.6) = 19.02 = 19.02 + 0.3 (21-19.02) = 19.6 = 19.6 + 0.3 (23-19.6) = 20.6

(Principles of Operations Management, Heizer & Render, 5th Edition)

Ch 4 Forecasting
5) Trend projection is a forecasting method that fits a trend line to a series of = a + b*x
Calculate slope b = xy n x y x - nx historical data points and then projects the line into the future for forecasting:

(equation of the line)

and y-intecept a = y bx

= summation sign = (y hat) computed value of the variable to be predicted (dependant variable) a = y-axis intercept b = slope of regression line (rate of change in y given change in x) x = the independent variable X = known values of the independent variable Y = known values of the dependant variable x = average of value of xs y = average of value of ys n = number of data points or observations (Principles of Operations Management, Heizer & Render, 5th Edition)

Ch 4 Forecasting

5) Trend projection:
Based on earlier data supplied: x X y = 78 = 6.5 = 218 = 18.2

Calculate slope b = xy n x y x - nx b = 1474-(12*6.5*18.2) 650 (12*(6.5)2 ) and y-intercept a = y bx a = 18.2 (0.38*6.5) = 15.73 Forecast is = a + b*x = 15.73 + ( .38*13) = 20.76 , where January is 13th month

= 54.4 = 0.38 143

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Ch 4 Forecasting
P 4.7
Doug Moodie is the president of Garden Products Limited. Over the last 5 tears, he has asked both his vice president of marketing and his vice president of operations to provide sales forecasts. The actual sales and the forecasts are given below. Mkt VP Oper VP VP VP YEAR SALES Marketing Operations Error Error

1 2 3 4 5

167,325 167,325 167,325 167,325 176,325 Totals

170,000 2,675 5,362 170,000 7,464 170,000 23,268 170,000 11,325 165,000 50,094

160,000 7,325 10,322 160,000 2,536 160,000 18,268 160,000 11,325 165,000 49,816

Using MAD which vice president is better at forecasting? MAD VP Marketing = 50,094 /5 = 10,019 MAD VP Operations = 49,816 /5 = 9.963 Therefore, based on past data, the VP of operations has been presenting better forecasts.
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