PRODUCTION PLANNING & CONTROL

FORECASTING
 OUTLINE

1.0 Introduction
2.0 Types of Forecasts by Time Horizon
3.0 Steps in the Forecasting Process
4.0 Qualitative Forecasting Methods
5.0 Quantitative Forecasting Methods
1.0 INTRODUCTION
DEFINITION OF FORECASTING

A statement about the future value of a variable of

interest such as demand (Stevenson, 2005).

Process (art and science) of predicting a future
event (Heizer & Render, 2004)

Forecasts affect decisions and activities throughout
an organization

Accounting, finance

Human resources

Marketing

MIS

Operations

Product / service design

Forecasts
rarely perfect because of
randomness

Forecasts more accurate for
groups vs. individuals

Forecast accuracy decreases
as time horizon increases
I see that you will
get an A this semester.
 Usage of Forecasting

Accounting Cost/profit estimates

Finance Cash flow and funding
Human Resources Hiring/recruiting/training
Marketing Pricing, promotion, strategy
MIS IT/IS systems, services
Operations Schedules, MRP, workloads
Product/service New products and services
design
Elements of a Good Forecast

Timely

Reliable Accurate

Written
 Realities of Forecasting

Forecasts are seldom perfect

Most forecasting methods assume that
there is some underlying stability in the
system

Both product family and aggregated
product forecasts are more accurate
than individual product forecasts
2.0 TYPES OF FORECASTS
BY TIME HORIZON
 Types of Forecasts by Time Horizon

Short-range forecast
Short-

Up to 1 year; usually less than 3 months

Job scheduling, worker assignments

Medium--range forecast
Medium

3 months to 3 years

Sales & production planning, budgeting

Long--range forecast
Long

3+ years

New product planning, facility location
Short--term vs. Longer
Short Longer--term Forecasting

Medium/long range forecasts deal with

more comprehensive issues and
support management decisions
regarding planning and products,
plants and processes.

Short
Short--term forecasting usually employs
different methodologies than longer-
longer-
term forecasting

Short
Short--term forecasts tend to be more
accurate than longer-
longer-term forecasts.
 Influence of Product Life
Cycle
Introduction, Growth, Maturity, Decline

Stages of introduction and growth require
longer forecasts than maturity and decline

Forecasts useful in projecting

staffing levels,

inventory levels, and

factory capacity
as product passes through life cycle stages
 Strategy and Issues During a
Products Life
Introduction Growth Maturity Decline
Best period to Practical to change Poor time to change image, Cost control
increase market price or quality image price, or quality critical
share
Strengthen niche Competitive costs become
Company Strategy/Issues

R&D product critical

engineering critical
Defend market position
Drive-thru restaurants Fax machines
3 1/2
CD-ROM Floppy
disks
Sales
Station
Internet wagons
Color copiers

HDTV

Product design and Forecasting critical Standardization Little product

development critical Product and process differentiation
Less rapid product
Frequent product and process reliability changes - more minor
OM Strategy/Issues

design changes
Short production runs
High production costs
Limited models
Attention to quality
Cost minimization
Competitive product changes
improvements and options Over capacity in the
Optimum capacity
industry
Increase capacity Increasing stability of
Shift toward product process Prune line to eliminate
focused items not returning good
Long production runs
Enhance distribution margin
Product improvement and
cost cutting Reduce capacity
3.0 STEPS IN FORECASTING
PROCESS
Steps in the Forecasting Process

The forecast

Step 6 Monitor the forecast

Step 5 Prepare the forecast
Step 4 Gather and analyze data
Step 3 Select a forecasting technique
Step 2 Establish a time horizon
Step 1 Determine purpose of forecast
FORECASTING APPROACHES
 Forecasting Approaches
Qualitative Methods Quantitative Methods

Used when situation
Used when situation
is vague/uncertain & is stable & historical
little data exist data exist

New products
Existing products

New technology
Current technology

Involves intuition,
Involves
experience mathematical
techniques
4.0 QUALITATIVE FORECASTING
METHODS
 Overview of Qualitative/Judgmental
Forecasting Methods

Executive opinions

Pool opinions of high-
high-level executives,
sometimes augment by statistical models

Sales force opinions

Estimates from individual salespersons are
reviewed for reasonableness, then
aggregated

Consumer Surveys

Ask the customer

Delphi method

Panel of experts, queried iteratively
5.0 QUANTITATIVE FORECASTING
METHODS
Overview of Quantitative Approaches

1. Nave approach
2. Simple Moving Averages
3. Weighted Moving Time-series
Models
Average
4. Exponential smoothing
5. Trend Projections
Associative
models
1. Linear regression (Causal)
5.0 QUANTITATIVE FORECASTING
METHODS
(TIME SERIES MODEL)
 What is a Time Series?

Set of evenly spaced numerical data
(weekly, monthly etc)

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
 1. 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
1995 Corel Corp.
Naive Forecasts
Uh, give me a minute....
We sold 250 wheels last
week.... Now, next week
we should sell....

The forecast for any period equals

the previous periods actual value.
 Nave Forecasts

Simple to use

Virtually no cost

Quick and easy to prepare

Data analysis is nonexistent

Easily understandable

Cannot provide high accuracy
 2. Simple Moving Average

Used if little or no trend

Equation:

MA = Demand in Previous n Periods

n
n

Ai
MAn = i=1

n
 Simple Moving Average Example
Youre manager of a museum store that
sells historical replicas. You want to
forecast sales for 2003 using a 3-period
moving average.
1998 4
1999 6
2000 5
2001 3
2002 7
 Moving Average Solution
Time Response Moving Moving
Yi Total Average
(n=3) (n=3)
1998 4 NA NA
1999 6 NA NA
2000 5 NA NA
2001 3 4+6+5=15 15/3 = 5
2002 7
2003 NA
 Moving Average Solution
Time Response Moving Moving
Yi Total Average
(n=3) (n=3)
1998 4 NA NA
1999 6 NA NA
2000 5 NA NA
2001 3 4+6+5=15 15/3 = 5
2002 7 6+5+3=14 14/3=4 2/3
2003 NA
 Moving Average Solution
Time Response Moving Moving
Yi Total Average
(n=3) (n=3)
1998 4 NA NA
1999 6 NA NA
2000 5 NA NA
2001 3 4+6+5=15 15/3=5.0
2002 7 6+5+3=14 14/3=4.7
2003 NA 5+3+7=15 15/3=5.0
3. Weighted Moving Average Method

Used when trend is present

Older data usually less important

Weights based on intuition

Often lay between 0 & 1, & sum to 1.0

Equation

(Weight for period n) (Demand in period n)

WMA =
Weights
 Weighted Moving Average: Example

Period 1 2 3 4 5
Demand 42 40 43 40 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.
next.

b. If the actual demand for period 6 is 39, forecast demand for

period 7 using the same weights as in part a.

Solution:
a. F6 = [(0.4(41)
[(0.4(41) + 0.3(40) + 0.2(43) + 0.1(40
0.1(40)]
)] / 1 = 41.0

b. F7 = [0.4(39)
[0.4(39) + 0.3(41) + 0.2(40) + 0.1(43
0.1(43)]
)] / 1 = 40.2
Actual Demand, Moving Average, Weighted
Moving Average
35 Weighted moving average
30
Actual sales
25
Sales Demand

20
15
10
Moving average
5
0
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec
Month
 Disadvantages of
Techniques for Averaging Methods

Increasing n makes forecast less
sensitive to real changes in the data

Cannot pickup trends very well.
Because they are averages, they
will always stay within past levels
and will not predict changes to
either higher or lower levels.

Require much historical
data
 3. Exponential Smoothing
Ft = Ft-1 + (At-1 - Ft-1)

The most recent observations might

have the highest predictive value.

Therefore, we should give more weight to
the more recent time periods when
forecasting.
 Exponential Smoothing
Equations

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

Where,

Ft = Forecast value for period t

Ft-1 = Forecast value for the previous period

At = Actual value for period t

At-1= Actual value for the previous period

= Smoothing constant
 Exponential Smoothing

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

Weighted averaging method based on previous
forecast plus a percentage of the forecast error

A-F is the error term, is the % feedback

If closer to 0 = less responsiveness, greater
smoothing

If closer to 1 = greater responsiveness, less
smoothing
 Exponential Smoothing Example
During the past 8 quarters, the Port of Baltimore has unloaded
large quantities of grain. ( = .10).
.10). The first quarter forecast
was 175
175..
Quarter Actual
1 180 Find the forecast
2 168 for the 9th quarter.
3 159
4 175
5 190
6 205
7 180
8 182
9 ?
 Exponential Smoothing Solution
Ft = Ft-1 + 0.1(At-1 - Ft-1)
Forecast, F t
Quarter Actual
= .10)
( .10)
1 180 175.00 (Given)
2 168 175.00 +
3 159
4 175
5 190
6 205
 Exponential Smoothing Solution
Ft = Ft-1 + 0.1(At-1 - Ft-1)
Forecast, F t
Quarter Actua
Actual
= .10)
( .10)
1 180 175.00 (Given)
2 168 175.00 + .10(
.10(
3 159
4 175
5 190
6 205
 Exponential Smoothing Solution
Ft = Ft-1 + 0.1(At-1 - Ft-1)
Forecast, Ft
Quarter Actual
( = .10)
.10)
1 180 175.00 (Given)
2 168 175.00 + .10(180
.10(180 -
3 159
4 175
5 190
6 205
 Exponential Smoothing Solution

Ft = Ft-1 + 0.1(At-1 - Ft-1)

Forecast, Ft
Quarter Actual
(
= .10)
.10)
1 180 175.00 (Given)
2 168 175.00 + .10(180
.10(180 - 175.00
175.00))
3 159
4 175
5 190
6 205
 Exponential Smoothing Solution

Ft = Ft-1 + 0.1(At-1 - Ft-1)

Forecast, Ft
Quarter Actual
( = .10)
.10)
1 180 175.00 (Given)
2 168 175.00 + .10(180
.10(180 - 175.00
175.00)) = 175.50
3 159
4 175
5 190
6 205
 Exponential Smoothing Solution
Ft = Ft-1 + 0.1(At-1 - Ft-1)
Forecast, F t
Quarter Actual
= .10)
( .10)
1 180 175.00 (Given)
2 168 175.00 + .10(180 - 175.00) = 175.50
3 159 175.50 + .10(168
.10(168 - 175.50
175.50)) = 174.75
4 175
5 190
6 205
 Exponential Smoothing Solution
Ft = Ft-1 + 0.1(At-1 - Ft-1)
Forecast, F t
Quarter Actual
( = .10)
1 180 175.00 (Given)
2 168 175.00 + .10(180 - 175.00) = 175.50
3 159 175.50 + .10(168 - 175.50) = 174.75
4 175 174.75 + .10(159 - 174.75)= 173.18
5 190
6 205
 Exponential Smoothing Solution
Ft = Ft-1 + 0.1(At-1 - Ft-1)
Forecast, F t
Quarter Actual
( = .10)
1 180 175.00 (Given)
2 168 175.00 + .10(180 - 175.00) = 175.50
3 159 175.50 + .10(168 - 175.50) = 174.75
4 175 174.75 + .10(159 - 174.75) = 173.18
5 190 173.18 + .10(175 - 173.18) = 173.36
6 205
 Exponential Smoothing Solution
Ft = Ft-1 + 0.1(At-1 - Ft-1)
Forecast, F t
Quarter Actual
( = .10)
1 180 175.00 (Given)
2 168 175.00 + .10(180 - 175.00) = 175.50
3 159 175.50 + .10(168 - 175.50) = 174.75
4 175 174.75 + .10(159 - 174.75) = 173.18
5 190 173.18 + .10(175 - 173.18) = 173.36
6 205 173.36 + .10(190 - 173.36) = 175.02
Exponential Smoothing Solution
Ft = Ft-1 + 0.1(At-1 - Ft-1)
Forecast, F t
Time Actual
( = .10)
4 175 174.75 + .10(159 - 174.75) = 173.18
5 190 173.18 + .10(175 - 173.18) = 173.36
6 205 173.36 + .10(190 - 173.36) = 175.02
7 180 175.02 + .10(205 - 175.02) = 178.02
8
9
Exponential Smoothing Solution
Ft = Ft-1 + 0.1(At-1 - Ft-1)
Forecast, F t
Time Actual
( = .10)
4 175 174.75 + .10(159 - 174.75) = 173.18
5 190 173.18 + .10(175 - 173.18) = 173.36
6 205 173.36 + .10(190 - 173.36) = 175.02
7 180 175.02 + .10(205 - 175.02) = 178.02
8 182 178.02 + .10(180 - 178.02) = 178.22
9 ? 178.22 + .10(182 - 178.22) = 178.58
 Impact of
250

200 Forecast (0.5)

A c tu a l T o n a g e

150 Forecast (0.1)

Actual

100

50

0
1 2 3 4 5 6 7 8 9
Quarter
 4. TREND PROJECTIONS

A time-
time-series forecasting method that fits a
trend line to a series of historical data
points and then projects the line into the
future for forecasts.

Several mathematical trend equations can
be developed (e.g. linear, exponential,
quadratic)

We will focus on linear trend only
 Linear Trend Projection

Used for forecasting linear trend line

Assumes relationship between
response variable, Y, and time, X, is a
linear function
Yi = a + bX i

Estimated by least squares method

Minimizes sum of squared errors
Least Squares Method for finding the best-
best-
fitting straight line
Actual
observation Deviation
Values of Dependent Variable

Deviation Deviation

Deviation
Deviation Point on
regression
Deviation line
Deviation

Y = a + bx
Time
Linear Trend Projection Model

Y$i = a + bX i
Y b>0
a

b<0

a
Time, X
 Equations
Equation: Yi = a + bx i

n
x i y i nx y
Slope: b = i =1n
x i2 nx 2
i =1

Y-Intercept: a = y bx
 Computation Table

2 2
Xi Yi Xi Yi X iY i
2 2
X1 Y1 X1 Y1 X 1Y 1
2 2
X2 Y2 X2 Y2 X 2Y 2
: : : : :
2 2
Xn Yn Xn Yn X nY n
2 2
Xi Yi Xi Yi X iY i
 Using a Trend Line
The demand for
Year Demand
electrical power at
1997 74 N.Y.Edison over the
1998 79 years 1997 2003 is
1999 80 given at the left. Find
the overall trend.
2000 90
2001 105
2002 142
2003 122
 Finding a Trend Line
Year Time Power x2 xy
Period Demand
(x) (y)
1997 1 74 1 74
1998 2 79 4 158
1999 3 80 9 240
2000 4 90 16 360
2001 5 105 25 525
2002 6 142 36 852
2003 7 122 49 854
x=28 y=692 x2=140 xy=3,063
 The Trend Line Equation
x 28 y 692
x= = =4 y= = = 98.86
n 7 n 7

xy - n x y 3,063 (7)(4)(98. 86) 295

b= 2 2
= 2
= = 10.54
x n x 140 (7)(4) 28

a = y - b x = 98.86 - 10.54(4) = 56.70

Demand in 2004 = 56.70 + 10.54(8) = 141.02 megawatts

Demand in 2005 = 56.70 + 10.54(9) = 151.56 megawatts

 Actual and Trend Forecast
Electric Power Demand

160
Trend line
150
Y = 56.70 + 10.54x
140

130

120

110

100

90

80

70

60
1997 1998 1999 2000 2001 2002 2003 2004 2005
Year
Linear Trend Equation (2nd Technique)

y = a + bx

0 1 2 3 4 5 x

y = Forecast for period x

x = Specified number of time periods

a = Value of Ft at t = 0

b = Slope of the line
Calculating a and b

n (xy) - x y
b =
2 2
n x - ( x)

y - b x
a =
n
Linear Trend Equation Example
t y
2
Week t Sales ty
1 1 150 150
2 4 157 314
3 9 162 486
4 16 166 664
5 25 177 885

2
t = 15 t = 55 y = 812 ty = 2499
2
( t) = 225
 Linear Trend Calculation

5 (2499) - 15(812) 12495-12180

b = = = 6.3
5(55) - 225 275 -225

812 - 6.3(15)
a = = 143.5
5

y = 143.5 + 6.3x
5.0 QUANTITATIVE FORECASTING
METHODS
(ASSOCIATIVE / CAUSAL MODEL)
 ASSOCIATIVE MODEL

Unlike time-
time-series method, associative
model usually consider several variables
that are related to the quantity being
predicted

E.g.: the sale of IBM PCs might be related
to IBMs advertising budget, the
companys prices, competitors prices etc.

PC sales = dependent variable;
other variables = independent variables

Main technique: Linear Regression
 Linear Regression Model

Shows linear relationship between
dependent & explanatory variables

Example: Sales & advertising (not
(not time)

Y-intercept Slope

Y^ i = a + b X i
Dependent Independent (explanatory)
(response) variable variable
Example:
Expenditure on advertising is expected to cause
an increase in sales volume, or
Sales Volume = A + B x advertising expenditure
Where :
A = Sales volume without advertising
B = The amount by which one unit of advertising
expenditure can increase sales volume.
 Linear Regression Model
Y Y i = a + b X i +Error

Error
Regression line

Y^i = a + b X i
X
Observed value
 Equations
Equation: Yi = a + bx i

n
x i y i nx y
Slope: b = i =1n
x i2 nx 2
i =1

Y-Intercept: a = y bx
 or

n (xy) - x y
b =
2 2
n x - ( x)

y - b x
a =
n
 Scatter Diagram

Sales versus Payroll

4
S a le s ( in $ h u n d r e d s o f

3
th o u s a n d s )

0
0 1 2 3 4 5 6 7 8
Area Payroll (in $ hundreds of millions)
EXAMPLE
Data shows sales of 20 TV and unemployment. Derive
predictive equation for sales based on unemployment
levels.
Period Unit Sold Unemployment (%)
1 20 7.2
2 41 4.0
3 17 7.3
4 35 5.5
5 25 6.8
6 31 6.0
7 38 5.4
8 50 3.6
9 15 8.4
10 19 7.0
11 14 9.0
Solution:
a ) Plot a graph data

Unit Sold vs Level of Unemployment (%)

60
50
Unit Sold

40
Unit Sold vs Level of
30
Unemployment
20
10
0
0.0 2.0 4.0 6.0 8.0 10.0
Level of Unemployment (%)
b) Calculate x, y, xy, x2, y2

Unemployment (x) Unit Sold (y) xy x2 y2

7.2 20 144 51.84 400
4.0 41 164 16 1681
7.3 17 124.1 53.29 289
5.5 35 192.5 30.25 1225
6.8 25 170 46.24 625
6.0 31 186 36 961
5.4 38 205.2 29.16 1444
3.6 50 180 12.96 2500
8.4 15 126 70.56 225
7.0 19 133 49 361
9.0 14 126 81 196
Total 70.2 305.0 1750.8 476.3 9907.0
b) Calculate value of a and b:

b = 11 (1750.8) 70.2(305)
11 (476.4) 70.2 (70.2)
= -2152.2 / 312.36 = -6.89

a = 305 (- 6.91)(70.2) = 71.85

11

c) Make the general equation:

y = 71.85 - 6.89x
Additional exercises

National Mixer, Inc., sells can openers. Monthly sales

for a seven-month period were as follows:

Month Sales (000 units)

Feb 19
Mar 18
Apr 15
May 20
Jun 18
July 22
Aug. 20
a. Plot the monthly data
b. Forecast September sales using:
i. A linear trend equation
ii. A five-month moving average
iii. Exponential smoothing, = 0.2, assume March forecast
of 19 (000).
iv. The nave approach.
v. A weighted moving average using 0.6 for Aug., 0.3 for
July, and 0.1 for June.
 REFERENCES

Heizer, J. and Render, B. (2004).
Principles of Operations Management.
Management.
5th Edition. New Jersey: Prentice Hall.

Stevenson, W.J. (2005). Operations
Management.. 8th Edition. New York:
Management
McGraw--Hill.
McGraw