4-2

Learning Objectives
When you complete this chapter, you should be
able to :
Identify or Define:
+ Forecasting
+ Types of forecasts
+ Time horizons
+ Approaches to forecasts
4-3
Learning Objectives - continued
When you complete this chapter, you should
be able to :
Describe or Explain:
Moving averages
Exponential smoothing
Trend projections
Regression and correlation analysis
Measures of forecast accuracy
Demand Management
A
B(4) C(2)
D(2) E(1) D(3) F(2)
Dependent Demand:
Raw Materials,
Component parts,
Sub-assemblies, etc.
Independent Demand:
Finished Goods
Independent Demand:
What a firm can do to manage it?
Can take an active role to influence
demand
Can take a passive role and simply respond
to demand
What is Forecasting?
+ Process of predicting a
future event
+ Underlying basis of
all business decisions
+ Production
+ Inventory
+ Personnel
+ Facilities
Sales will be
$200 Million!
4-7
Short-range forecast
Up to 1 year; usually less than 3 months
Job scheduling, worker assignments
Medium-range forecast
3 months to 3 years
Sales & production planning, budgeting
Long-range forecast
3
+
years
New product planning, facility location
Types of Forecasts by Time Horizon
4-8
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
Types of Forecasts
Qualitative (Judgmental)
Quantitative
Time Series Analysis
Causal Relationships
Simulation
Forecasting Approaches
+ Used when situation is
stable & historical
data exist
+ Existing products
+ Current technology
+ Involves mathematical
techniques
+ e.g., forecasting sales of
color televisions
Quantitative Methods
+ Used when situation is
vague & little data exist
+ New products
+ New technology
+ Involves intuition,
experience
+ e.g., forecasting sales on
Internet
Qualitative Methods
Overview of Qualitative Methods
Jury of executive opinion
Pool opinions of high-level executives,
sometimes augment by statistical models
Delphi method
Panel of experts.
Sales force composite
Estimates from individual salespersons are
reviewed for reasonableness, then aggregated
Consumer Market Survey
Ask the customer
+ Involves small group of high-level managers
+ Group estimates demand by working together
+ Combines managerial experience with
statistical models
+ Relatively quick

Jury of Executive Opinion
Sales Force Composite
+ Each salesperson
projects his or her sales
+ Combined at district &
national levels
+ Sales reps know
customers wants
+ Tends to be overly
optimistic
Sales
1995 Corel Corp.
Delphi Method
Iterative group
process
3 types of people
Decision makers
Staff
Respondents
Reduces group-
think
Respondents
(Sales?)
(Sales will be 45, 50,
55)
(Sales will be
50!)
(What
will
sales
be?
survey)
Staff

Decision Makers

Consumer Market Survey
+ Ask customers
about purchasing
plans
+ What consumers
say, and what they
actually do are
often different
+ Sometimes difficult
to answer
How many hours will you use
the Internet next week?
1995 Corel
Corp.
Components of Demand
Average demand for a period of time
Trend
Seasonal element
Cyclical elements
Random variation
Autocorrelation
Product Demand Charted over 4 Years
with Trend and Seasonality
Year
1
Year
2
Year
3
Year
4
Seasonal peaks Trend component
Actual
demand line
Average demand
over four years
D
e
m
a
n
d

f
o
r

p
r
o
d
u
c
t

o
r

s
e
r
v
i
c
e

Random
variation
Overview of Quantitative Approaches
Nave approach
Moving averages
Exponential smoothing
Trend projection

Linear regression
Time-series Models
Associative
models
Quantitative Forecasting Methods
(Non-Naive)
Associative
Quantitative
Forecasting
Linear
Regression
Associative
Models
Exponential
Smoothing
Moving
Average
Time Series
Models
Trend
Projection

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
What is a Time Series?
Trend
Seasonal
Cyclical
Random
Time Series Components
Persistent, overall upward or downward
pattern
Due to population, technology etc.
Several years duration
Mo., Qtr., Yr.
Response
Trend Component
Regular pattern of up & down fluctuations
Due to weather.
Occurs within 1 year
Mo., Qtr.
Response
Summer
Seasonal Component
Repeating up & down movements
Due to interactions of factors influencing
economy
Usually 2-10 years duration
Mo., Qtr., Yr.
Response
Cycle
Cyclical Component
Erratic (tidak menentu), unsystematic,
residual fluctuations
Due to random variation or unforeseen events
Union strike
Tornado
Short duration &
nonrepeating
1984-1994 T/Maker Co.
Random Component
Time Series Analysis
Time series forecasting models try to predict the
future based on past data
You can pick models based on:
1. Time horizon to forecast
2. Data availability
3. Accuracy required
4. Size of forecasting budget
5. Availability of qualified personnel
Actual Demand, Moving Average,
Weighted Moving Average
0
5
10
15
20
25
30
35
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec
Month
S
a
l
e
s

D
e
m
a
n
d
Actual sales
Moving average
Weighted moving average
Simple Moving Average Formula
F =
A + A + A +...+A
n
t
t -1 t -2 t -3 t - n
The simple moving average model assumes an
average is a good estimator of future behavior
The formula for the simple moving average is:
F
t
= Forecast for the coming period
N = Number of periods to be averaged
A
t-1
= Actual occurrence in the past period for
up to n periods

Simple Moving Average Problem (1)
Week Demand
1 650
2 678
3 720
4 785
5 859
6 920
7 850
8 758
9 892
10 920
11 789
12 844
F =
A + A + A +...+A
n
t
t -1 t -2 t -3 t - n
Question: What are the 3-
week and 6-week moving
average forecasts for
demand?
Assume you only have 3
weeks and 6 weeks of
actual demand data for the
respective forecasts
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
F
4
=(650+678+720)/3
=682.67
F
7
=(650+678+720
+785+859+920)/6
=768.67
Calculating the moving averages gives us:
The McGraw-Hill Companies, Inc., 2004
30
Plotting the moving averages and comparing them shows how
the lines smooth out to reveal the overall upward trend in this
example
Note how the 3-
Week is smoother
than the Demand,
and 6-Week is even
smoother
Simple Moving Average Problem (2) Data
Week Demand
1 820
2 775
3 680
4 655
5 620
6 600
7 575
Question: What is the 3
week moving average
forecast for this data?
Assume you only have 3
weeks and 5 weeks of
actual demand data
for the respective
forecasts
Simple Moving Average Problem (2)
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
F
4
=(820+775+680)/3
=758.33
F
6
=(820+775+680
+655+620)/5
=710.00
Weighted Moving Average Formula
F = w A + w A + w A +...+w A
t 1 t -1 2 t - 2 3 t -3 n t - n
w = 1
i
i=1
n

While the moving average formula implies an equal

weight being placed on each value that is being averaged,
the weighted moving average permits an unequal
weighting on prior time periods
w
t
= weight given to time period t
occurrence (weights must add to one)
The formula for the moving average is:
Weighted Moving Average Problem (1) Data
Weights:
t-1 .5
t-2 .3
t-3 .2
Week Demand
1 650
2 678
3 720
4
Question: Given the weekly demand and weights, what is the forecast for the 4
th

period or Week 4?
Note that the weights place more emphasis on the most recent data,
that is time period t-1
Weighted Moving Average Problem (1) Solution
Week Demand Forecast
1 650
2 678
3 720
4 693.4
F
4
= 0.5(720)+0.3(678)+0.2(650)=693.4
Weighted Moving Average Problem (2) Data
Weights:
t-1 .7
t-2 .2
t-3 .1
Week Demand
1 820
2 775
3 680
4 655
Question: Given the weekly demand information and weights, what is the
weighted moving average forecast of the 5
th
period or week?
Weighted Moving Average Problem (2) Solution
Week Demand Forecast
1 820
2 775
3 680
4 655
5 672
F
5
= (0.1)(755)+(0.2)(680)+(0.7)(655)= 672
Exponential Smoothing Model
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
F
t
= F
t-1
+ o(A
t-1
- F
t-1
)
constant smoothing Alpha
period e past t tim in the occurance Actual A
period past time 1 in alue Forecast v F
period t time coming for the lue Forcast va F
: Where
1 - t
1 - t
t
=
=
=
=
o
Exponential Smoothing Problem (1) Data
Week Demand
1 820
2 775
3 680
4 655
5 750
6 802
7 798
8 689
9 775
10
Question: Given the weekly
demand data, what are the
exponential smoothing
forecasts for periods 2-10
using o=0.10 and o=0.60?
Assume F
1
=D
1
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
Answer: The respective alphas columns denote the forecast values. Note that
you can only forecast one time period into the future.
Exponential Smoothing Problem (1)
Plotting
Note how that the smaller alpha results in a smoother line in this example
Exponential Smoothing Problem (2) Data
Question: What are the
exponential smoothing
forecasts for periods 2-5
using a =0.5?
Assume F
1
=D
1
Week Demand
1 820
2 775
3 680
4 655
5
Exponential Smoothing Problem (2) Solution
Week Demand 0.5
1 820 820.00
2 775 820.00
3 680 797.50
4 655 738.75
5 696.88
F
1
=820+(0.5)(820-820)=820
F
3
=820+(0.5)(775-820)=797.75
The MAD Statistic to Determine Forecasting
Error
MAD =
A - F
n
t t
t=1
n

1 MAD 0.8 standard deviation

1 standard deviation 1.25 MAD
~
~
The ideal MAD is zero which would mean
there is no forecasting error

The larger the MAD, the less the accurate
the resulting model
MAD Problem Data
Month Sales Forecast
1 220 n/a
2 250 255
3 210 205
4 300 320
5 325 315
Question: What is the MAD value given
the forecast values in the table below?
MAD Problem Solution
MAD =
A - F
n
=
40
4
=10
t t
t=1
n

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
40
Note that by itself, the MAD
only lets us know the mean
error in a set of forecasts
Tracking Signal Formula
The Tracking Signal or TS adalah ukuran apakah
ramalan rata-rata terjaga perubahan naik dan
turunnya.
Depending on the number of MADs selected, the TS
can be used like a quality control chart indicating
when the model is generating too much error in its
forecasts.
The TS formula is:
TS =
RSFE
MAD
=
Running sum of forecast errors
Mean absolute deviation
Simple Linear Regression Model
Y
t
= a + bx
0 1 2 3 4 5 x (Time)
Y
The simple linear regression
model seeks to fit a line
through various data over time
Is the linear regression model
a
Yt is the regressed forecast value or dependent variable
in the model, a is the intercept value of the the
regression line, and b is similar to the slope of the
regression line. 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.
Simple Linear Regression Formulas for
Calculating a and b
a = y- bx
b =
xy- n(y)(x)
x - n(x
2 2

)
Simple Linear Regression Problem Data
Week Sales
1 150
2 157
3 162
4 166
5 177
Question: Given the data below, what is the simple linear regression model that can be
used to predict sales in future weeks?
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)
x - n(x
=
2499- 5(162.4)(3)
=
a = y- bx =162.4 - (6.3)(3) =
2 2

=
) ( ) 55 5 9
63
10
6.3
143.5
Answer: First, using the linear regression formulas, we can compute a
and b
52
Y
t
= 143.5 + 6.3x
180
Period
135
140
145
150
155
160
165
170
175
1 2 3 4 5
S
a
l
e
s

Sales
Forecast
The resulting regression model
is:
Now if we plot the regression generated forecasts against the actual sales we obtain
the following chart:
53
4-54
Tracking Signal Equation
( )
MAD
error forecast

MAD
y y

MAD
RSFE
TS
n
i
i i

=
=
1 =
Mo Fcst Act Error RSFE Abs
Error
Cum MAD TS
1 100 90
2 100 95
3 100 115
4 100 100
5 100 125
6 100 140
|Error|
Tracking Signal Computation
Mo Forc Act Error RSFE Abs
Error
Cum MAD TS
1 100 90
2 100 95
3 100 115
4 100 100
5 100 125
6 100 140
-10
Error = Actual - Forecast
= 90 - 100 = -10
|Error|
Tracking Signal Computation
Mo Forc Act Error RSFE Abs
Error
Cum MAD TS
1 100 90
2 100 95
3 100 115
4 100 100
5 100 125
6 100 140
-10 -10
RSFE = E Errors
= NA + (-10) = -10
|Error|
Tracking Signal Computation
Mo Forc Act Error RSFE Abs
Error
Cum MAD TS
1 100 90
2 100 95
3 100 115
4 100 100
5 100 125
6 100 140
-10 -10 10
Abs Error = |Error|
= |-10| = 10
|Error|
Tracking Signal Computation
Mo Forc Act Error RSFE Abs
Error
Cum MAD TS
1 100 90
2 100 95
3 100 115
4 100 100
5 100 125
6 100 140
-10 -10 10 10
Cum |Error| = E |Errors|
= NA + 10 = 10
|Error|
Tracking Signal Computation
Mo Forc Act Error RSFE Abs
Error
Cum
|Error|
MAD TS
1 100 90
2 100 95
3 100 115
4 100 100
5 100 125
6 100 140
-10 -10 10 10 10.0
MAD = E |Errors|/n
= 10/1 = 10
Tracking Signal Computation
Mo Forc Act Error RSFE Abs
Error
Cum MAD TS
1 100 90
2 100 95
3 100 115
4 100 100
5 100 125
6 100 140
-10 -10 10 10 10.0 -1
TS = RSFE/MAD
= -10/10 = -1
|Error|
Tracking Signal Computation
Mo Forc Act Error RSFE Abs
Error
Cum MAD TS
1 100 90
2 100 95
3 100 115
4 100 100
5 100 125
6 100 140
-10 -10 10 10 10.0 -1
-5
Error = Actual - Forecast
= 95 - 100 = -5
|Error|
Tracking Signal Computation
Mo Forc Act Error RSFE Abs
Error
Cum MAD TS
1 100 90
2 100 95
3 100 115
4 100 100
5 100 125
6 100 140
-10 -10 10 10 10.0 -1
-5 -15
RSFE = E Errors
= (-10) + (-5) = -15
|Error|
Tracking Signal Computation
Mo Forc Act Error RSFE Abs
Error
Cum MAD TS
1 100 90
2 100 95
3 100 115
4 100 100
5 100 125
6 100 140
-10 -10 10 10 10.0 -1
-5 -15 5
Abs Error = |Error|
= |-5| = 5
|Error|
Tracking Signal Computation
Mo Forc Act Error RSFE Abs
Error
Cum MAD TS
1 100 90
2 100 95
3 100 115
4 100 100
5 100 125
6 100 140
-10 -10 10 10 10.0 -1
-5 -15 5 15
Cum Error = E |Errors|
= 10 + 5 = 15
|Error|
Tracking Signal Computation
Mo Forc Act Error RSFE Abs
Error
Cum MAD TS
1 100 90
2 100 95
3 100 115
4 100 100
5 100 125
6 100 140
-10 -10 10 10 10.0 -1
-5 -15 5 15 7.5
MAD = E |Errors|/n
= 15/2 = 7.5
|Error|
Tracking Signal Computation
Mo Forc Act Error RSFE Abs
Error
Cum MAD TS
1 100 90
2 100 95
3 100 115
4 100 100
5 100 125
6 100 140
-10 -10 10 10 10.0 -1
-5 -15 5 15 7.5 -2
|Error|
TS = RSFE/MAD
= -15/7.5 = -2
Tracking Signal Computation
Plot of a Tracking Signal
Time
Lower control limit
Upper control
limit
Signal exceeded limit
Tracking signal
Acceptable range
+
0
-
Tracking Signals
0
20
40
60
80
100
120
140
160
0 1 2 3 4 5 6 7
Time
A
c
t
u
a
l

D
e
m
a
n
d
-3
-2
-1
0
1
2
3
T
r
a
c
k
i
n
g

S
i
n
g
a
l
Tracking Signal
Forecast
Actual demand