MD 021 - Management and Operations

Forecasting
Outline

 Components of demand

 Judgment methods

 Linear regression

 Time series methods

 Forecast errors

1
Judgment Methods

Sales force estimates

Executive opinion

Market research

Delphi method

2
 Linear Regression

Yi  a  bX i

where:

Y = dependent variable

X = independent variable

a = Y-intercept of the line

b = slope of the line

3
Measures of Forecast Accuracy in Linear
Regression

Coefficient of correlation

Coefficient of determination

Standard error of the estimate

4
 Regression Analysis Example

The manager of Al’s Diner is interested in forecasting the number

of potato skin appetizers sold each week. He believes that the
number sold has a linear relationship to the price and uses linear
regression to determine if this is the case.

X Y
Week (Price) (Appetizers
)
1. $2.70 760
2. 3.50 510
3. 2.00 980
4. 4.20 250
5. 3.10 320
6. 4.05 480

The Excel output is below:

Regression Statistics
Multiple R 0.843
R Square 0.711
Adjusted R Square 0.639
Standard Error 165.257
Observations 6

ANOVA
df SS MS F Significance
F
Regression 1 269160 269160 9.856 0.035
Residual 4 109239 27309
Total 5 378400

Coefficients Standard t Stat P-

Error value
Intercept 1454.604 295.939 4.915 0.008
Price ($) -277.628 88.434 -3.139 0.035

5
 Linear Regression Example

A professor is interested in determining whether average study hours per week is a good
predictor of test scores. The results of her study are:
Hours Score
3.0 90
2.1 95
5.8 65
3.8 80
4.2 95
3.2 60
5.3 85
4.6 70

A student says: "Professor, what can I do to get a B on the next

test. The professor asks, "On average, how many hours do you
spend studying for this course per week?" The student responds,
"About 2 hours." Use linear regression to forecast the student's
test score.

Regression Statistics
Multiple R 0.391
R Square 0.153
Adjusted R Square 0.0121
Standard Error 13.544
Observations 8

ANOVA
df SS MS FSignificance
F
Regression 1 199.246 199.246 1.0861 0.3375
Residual 6 1100.753 183.458
Total 7 1300

Coefficients Standard Error t Stat P-value

Intercept 97.325 17.301 5.625 0.0013
Study hours -4.331 4.156 -1.042 0.3375

6
 Time Series Methods

Naive forecasts

Moving averages

Weighted moving averages

Exponential smoothing

Trend-adjusted exponential smoothing

Regression Method

Multiplicative seasonal method

7
 Moving Average Method

Customer
Month arrivals
n
 At  i 1 800
Ft  MAn  i 1
2 740
n
3 810
4 790

 Use a 3-month moving average to forecast customer

arrivals for month 5.

F5 

 If the actual demand for month 5 is 805 customers, what

is the forecast for month 6?

F6 

8
 Weighted Moving Average Method

Customer
Month arrivals
1 800
Ft  wn At  n  wn 1 At  ( n 1)  ...  w1 At 1
2 740
3 810
4 790

 Let W1  0.50, W2  0.30, and W3  0.20.

Calculate the forecast for month 5.
F5 

 If the actual demand for month 5 is 805 customers, what

is the forecast for month 6?
F6 

9
 Exponential Smoothing

Customer
Month arrivals
1 800
Ft  (1   ) Ft 1  At 1 2 740
3 810
4 790

 Suppose F3  783 customers and   0.20.

What is the forecast for month 5?
F4 

F5 

 If D5  805, what is the forecast for month 6?

F6 

10
 Trend-Adjusted Exponential Smoothing

St  TAFt   ( At  TAFt )
Month Patients
Tt  Tt 1   (TAFt  TAFt 1  Tt 1 )
TAFt 1  St  Tt
1 48
2 52
3 50
4 54
5 55

 Using months 1-4, an initial estimate of the trend is 2

[(4-2+4)/3 = 2]. The starting forecast for month 5 is
54+2 = 56. Using   0.3 and   0.4 , forecast the number
of patients in month 6.
S5 

T5 

TAF6 

 If the actual number of patients in month 6 is 58, what is

the forecast for month 7?
S6 

T6 

TAF7 

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 Regression Method
Example: Garcia Garage
Month (t) Number of Number of Oil
time periods Changes (Y)
from t = 0
Jan. 1 41
Feb. 2 46
Mar. 3 57
Apr. 4 52
May 5 59
Jun. 6 51
Jul. 7 60
Aug. 8 62
1. Forecast the numbers of oil changes in September, October,
and November.
2. What is the average value of the trend?

Regression Statistics
Multiple R 0.817
R Square 0.668
Adjusted R
Square 0.613
Standard
Error 4.572
Observations 8.000

ANOVA
Significanc
  df SS MS F eF
252.59 12.08
Regression 1.000 252.595 5 5 0.013
Residual 6.000 125.405 20.901
Total 7.000 378.000      

Coefficient Standard P- Upper

  s Error t Stat value Lower 95% 95%
Intercept 42.464 3.562 11.921 0.000 33.748 51.181
X Variable 1 2.452 0.705 3.476 0.013 0.726 4.179

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 Multiplicative Seasonal Method

Step 1: Calculate the trend line based on the

available data using regression.
Step 2: Calculate the centered moving average,
with the number of periods equal to the
number of seasons.
Step 3: Calculate the seasonal relative for a
period by dividing the actual demand for
the period by the corresponding centered
moving average.
Step 4: Calculate the overall estimated seasonal
relative by averaging the seasonal
relatives from the same periods over the
cycle.
Step 5: Calculate the trend values for each of the
periods to be forecast based on the trend
line determined in Step 1.
Step 4: To get a forecast for a given period in a
future cycle, multiply the seasonal factor
by the trend values.

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 Multiplicative Seasonal Method Application
Quarter Demand CMA (4 seasons) MA (2 periods) Seasonal Relatives Normalized S.R.
1 100

2 400
250
3 300 261.5 1.147227533 1.171002862
273
4 200 274 0.729927007 0.745054133
275
5 192 285.5 0.672504378 0.686441468
296
6 408 298 1.369127517 1.397501537
300
7 384 Total 3.918786436 4

8 216

9 331 (trend value*) 227 (forecast)

10 344 (trend value*) 480 (forecast)
11 356 (trend value*) 417 (forecast)
12 369 (trend value*) 275 (forecast)

* Using regression, the trend line is 218.86 + 12.48t.

Forecast Errors

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  Bias--- systematic errors
 Random Errors --- variability
Example:
Day 1 Day 2 Day 3 Day 4
Actual 100 100 100 100
Demand
Forecast 105 105 105 105
1
Forecast 50 150 50 150
2

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 Forecast Error Measures

Bias:
n
 et
Average error  t 1
n

Variability:
n 2
 et
Mean squared error MSE  t 1
n 1

Standard deviation s  MSE

n
 et
Mean absolute error MAD  t 1
n

n et
[ (100)]
Mean percent absolute error MAPE 
t 1 At
n

Control Chart for Forecast Errors

Upper Control Limit: UCL  0  z MSE

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Lower Control Limit: LCL  0  z MSE

Z = the number of standard deviations from the mean

*Where to find “z” given the percentage of

the control chart, P ? Where to find “z” given
0

the probability for type I error,  ?

Normal Distribution Table (page 850, Table
B.2)
Look for “z” corresponds to the probability:
 p
P{Z<= z} = 1  2 = 0.5+ 2 , 0

P =1- 
0

e.g. A 95% control chart has  = 1-95% = 5%,

which means its probability for type I error is
5%. Thus probability in the table should be
0.975 (P = 1-0.025 or P = 0.5+ 0.475), which
corresponds to z = 1.96.

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 Summarizing Forecast Accuracy

Period Actual (A) Forecast (F) Error (E=A-F) Abs Error Error Sq [(Abs E)/A] x 100
1 113 95 18 18 324 15.93
2 85 80 5 5 25 5.88
3 96 103 -7 7 49 7.29
4 86 119 -33 33 1089 38.37
5 121 117 4 4 16 3.31
6 100 125 -25 25 625 25.00
7 142 67 75 75 5625 52.82
8 92 96 -4 4 16 4.35
9 72 116 -44 44 1936 61.11

Total -11 215 9705 214.06

MAD = 23.9
MSE = 1213.1
s= 34.8
MAPE = 23.8%

Tracking and Analyzing Forecast Errors

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Period Actual (A) Forecast (F) Error (E=A-F)
10 102 130 -28
11 107 102 5
12 112 89 23
13 118 97 21 Average error (periods 1-18)= -0.39
14 89 115 -26 Standard deviation (periods 1-9) = 34.8
15 142 82 60
2s control limits: 0 +/- 2(34.8) = 0 +/- 69.6
16 100 130 -30
17 94 137 -43
18 111 89 22

Total 4
80
60 UCL = 69.6
40
20
0
-20 10 11 12 13 14 15 16 17 18

-40
-60 LCL = -69.6
-80

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 Forecasting Summary Notes
Choosing a Forecasting Method

General considerations:
Method Pros
Judgment · Can be used in the absence of
historical data (e.g. new product)
· Helpful in identifying turning
points and preparing medium- and
long-term forecasts
Causal · Most sophisticated method
· Very good for predicting turning
points and preparing medium- and
long-term forecasts
Time series · Easy to implement
· Work well when demand is
relatively stable
Cons
· Subjective estimates are subject to
the biases and motives of the
estimators
· Must have historical data on
independent and dependent
variables
· Relationships can be difficult to
specify
· Rely exclusively on past demand
data
· Only useful for short-term
estimates

Specific considerations for time series methods:

Method Pros Cons
Naive forecast · Easiest method, low cost · Results in highly variable
· Works well when random forecasts if the random
errors are small errors are large
Simple moving average · Easiest moving average · Data must be retained for
method n periods
· To some extent, controls · Forecast lags changes in
for random error the underlying average of
demand
Weighted moving average · Weights can be varied to · Data must be retained for
be responsive to demand n periods
pattern · Forecast lags changes in
· To some extent, controls the underlying average of
for random error demand
Exponential smoothing · Requires little data · Forecast lags changes in
·  can be varied to be the underlying average of
responsive to demand demand
pattern
· To some extent, controls
for random error
In general, emphasize recent demand (i.e. small n, large weights for recent observations,
large  ) for dynamic (i.e. uncertain) demand patterns. Emphasize historical experience
for stable demand patterns. If a trend is present, simple moving average, weighted
moving average, and exponential smoothing estimates will always lag actual demand.

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 Forecasting Notes
Choosing a Time Series Forecasting Method

Evaluating forecast performance: Forecast errors can be classified as either bias errors or
random errors. Bias errors are the results of systematic over- or underestimation.
Random errors are unpredictable. Ideally, a forecast should minimize both bias and
random errors.
Method Purpose
Mean forecast Measures bias
errors
Mean squared error (MSE) Measures the dispersion of forecast errors; large errors get
more weight than when using MAD
Mean absolute deviation Measures the dispersion of forecast errors; method is
(MAD) intuitive
Mean absolute percent Measures the dispersion of forecast errors relative to the
error (MAPE) level of demand
Forecast error control chart Determines whether the method of forecasting is
accurately predicting actual changes in demand

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