4

Forecasting Demand

4-1

Outline Continued
Forecasting Approaches
Overview of Qualitative Methods
Overview of Quantitative Methods

Time-Series Forecasting
Decomposition of a Time Series

Naive Approach

4-2

Outline Continued
Time-Series Forecasting (cont.)
Moving Averages
Exponential Smoothing
Exponential Smoothing with Trend
Adjustment
Trend Projections
Seasonal Variations in Data
Cyclical Variations in Data
4-3

Forecasting at Disney World

Global portfolio includes parks in Hong
Kong, Paris, Tokyo, Orlando, and
Anaheim
Revenues are derived from people how
many visitors and how they spend their
money

Daily management report contains only

the forecast and actual attendance at
each park
4-4

Forecasting at Disney World

Disney generates daily, weekly, monthly,
annual, and 5-year forecasts
Forecast used by labor management,
maintenance, operations, finance, and
park scheduling
Forecast used to adjust opening times,
rides, shows, staffing levels, and guests
admitted

4-5

Forecasting at Disney World

20% of customers come from outside the
USA
Economic model includes gross
domestic product, cross-exchange rates,
arrivals into the USA
A staff of 35 analysts and 70 field people
survey 1 million park guests, employees,
and travel professionals each year

4-6

Forecasting at Disney World

Inputs to the forecasting model include
airline specials, Federal Reserve
policies, Wall Street trends,
vacation/holiday schedules for 3,000
school districts around the world
Average forecast error for the 5-year
forecast is 5%
Average forecast error for annual
forecasts is between 0% and 3%
4-7

What is Forecasting?
Process of predicting
a future event
Underlying basis
of all business
decisions

??

Production
Inventory
Personnel
Facilities
4-8

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
4-9

Distinguishing Differences
Medium/long range forecasts deal with
more comprehensive issues and support
management decisions regarding
planning and products, plants and
processes
Short-term forecasting usually employs
different methodologies than longer-term
forecasting
Short-term forecasts tend to be more
accurate than longer-term forecasts
4 - 10

Influence of Product Life

Cycle
Introduction Growth Maturity Decline
Introduction and growth require longer
forecasts than maturity and decline
As product passes through life cycle,
forecasts are useful in projecting
Staffing levels
Inventory levels
Factory capacity
4 - 11

Product Life Cycle

Introduction

OM Strategy/Issues

Product design
and
development
critical
Frequent
product and
process design
changes
Short production
runs
High production
costs
Limited models
Attention to
quality

Growth
Forecasting
critical
Product and
process
reliability
Competitive
product
improvements
and options

Maturity
Standardization
Fewer product
changes, more
minor changes
Optimum
capacity

Increasing
stability of
process

Increase capacity Long production

Shift toward
runs
product focus
Product
Enhance
improvement
distribution
and cost cutting

Decline
Little product
differentiation
Cost
minimization
Overcapacity
in the
industry
Prune line to
eliminate
items not
returning
good margin
Reduce
capacity

Figure 2.5

4 - 12

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 - 13

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 - 14

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 - 15

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 - 16

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 - 17

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 - 18

Overview of Qualitative
Methods

Jury of executive opinion

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

Delphi method
Panel of experts, queried iteratively

4 - 19

Overview of Qualitative
Methods

Sales force composite

Estimates from individual
salespersons are reviewed for
reasonableness, then aggregated

Consumer Market Survey

Ask the customer

4 - 20

Jury of Executive Opinion

Involves small group of high-level
experts and managers
Group estimates demand by working
together
Combines managerial experience with
statistical models

Relatively quick
Group-think
disadvantage
4 - 21

Sales Force Composite

Each salesperson projects his or
her sales
Combined at district and national
levels
Sales reps know customers wants
Tends to be overly optimistic

4 - 22

Delphi Method
Iterative group
process,
continues until
consensus is
reached
3 types of
participants

Decision Makers
(Evaluate
responses and
make decisions)

Staff
(Administering
survey)

Decision makers
Staff

Respondents

Respondents
(People who can
make valuable
judgments)

4 - 23

Consumer Market Survey

Ask customers about purchasing
plans
What consumers say, and what
they actually do are often different
Sometimes difficult to answer

4 - 24

Overview of Quantitative
Approaches
Naive approach
Moving averages

Exponential
smoothing

time-series
models

Trend projection

Linear regression

associative
model
4 - 25

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 - 26

Time Series Components

Trend

Cyclical

Seasonal

Random
4 - 27

Components of Demand
Trend
component
Demand for product or service

Seasonal peaks

Actual demand
line

Average demand
over 4 years
Random variation
| |
1 2

|
3

Time (years)

|
4
Figure 4.1

4 - 28

Trend Component
Persistent, overall upward or
downward pattern

Changes due to population,

technology, age, culture, etc.
Typically several years
duration

4 - 29

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

Number of
Length

Seasons

Day
Week
Day
Quarter
Month
Week

7
4-4.5
28-31
4
12
52
4 - 30

Cyclical Component
Repeating up and down movements
Affected by business cycle,
political, and economic factors
Multiple years duration
Often causal or
associative
relationships
0

10

15

20
4 - 31

Random Component
Erratic, unsystematic, residual
fluctuations

Due to random variation or unforeseen

events
Short duration
and nonrepeating

F
4 - 32

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 - 33

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
demand in previous n periods
Moving average =
n
4 - 34

Moving Average Example

Actual
Month
January
February
March
April
May
June
July

3-Month
Shed Sales
10
12
13
16
19
23
26

Moving Average

10
12
13
(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 - 35

Graph of Moving Average

Shed Sales

30
28
26
24
22
20
18
16
14
12
10

Moving
Average
Forecast

| |
J F

Actual
Sales

|
M

|
A

|
M

|
J

|
J

|
A

|
S

|
O

|
N

|
D
4 - 36

Weighted Moving Average

Used when some trend might be
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 - 37

Weights Applied

Period

3 Last month
Weighted Moving
Average
2Two months ago
1Three months ago
6Sum of weights
Actual3-Month Weighted
Month
Shed Sales
January
February
March
April
May
June
July

10
12
13
16
19
23
26

Moving Average

10
12
13
[(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

4 - 38

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 - 39

Moving Average And

Weighted Moving Average
Weighted
moving
average

30
Sales demand

25
20

Actual
sales

15
Moving
average

10
5

Figure 4.2

||
J

|
F

|
M

|
A

|
M

|
J

|
J

|
A

|
S

|
O

|
N

D
4 - 40

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 - 41

Exponential Smoothing
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)
4 - 42

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

4 - 43

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

4 - 44

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 - 45

Effect of
Smoothing Constants
Weight Assigned to
Most
2nd Most 3rd Most 4th Most 5th Most
Recent
Recent
Recent
Recent
Recent
Smoothing
Period
Period
Period
Period
2
Constant
()
(1 - ) (1 - )
(1 - )3

Period
(1 - )4

= .1

.1

.09

.081

.073

.066

= .5

.5

.25

.125

.063

.031

4 - 46

Impact of Different
225
200

= .5

Demand

Actual
demand

175
150

= .1
||
12

|
3

|
4

|
5

|
6

|
7

|
8

|
9

Quarter
4 - 47

Impact of Different
225

= .5

Actual
Chose high values
of
demand
200

Demand

when underlying average

175
is likely to change

Choose low values of

150
when underlying average
is stable
||
|
|
|
|
12

= .1
|
7

|
8

|
9

Quarter
4 - 48

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 - 49

Common Measures of Error

Mean Absolute Deviation (MAD)
MAD =

|Actual - Forecast|
n

Mean Squared Error (MSE)

MSE =

(Forecast Errors)2
n
4 - 50

Common Measures of Error

Mean Absolute Percent Error (MAPE)
n

i = 1100|Actuali

MAPE =

- Forecasti|/Actuali
n

4 - 51

Comparison of Forecast
Error
Quarter

1
2
3
4
5
6
7
8

Actual
Tonnage
Unloaded

180
168
159
175
190
205
180
182

Rounded
Forecast
with
= .10

175
175.5
174.75
173.18
173.36
175.02
178.02
178.22

Absolute
Deviation
for
= .10

5.00
7.50
15.75
1.82
16.64
29.98
1.98
3.78
82.45

Rounded
Forecast
with
= .50

175
177.50
172.75
165.88
170.44
180.22
192.61
186.30

Absolute
Deviation
for
= .50

5.00
9.50
13.75
9.12
19.56
24.78
12.61
4.30
98.62

4 - 52

Comparison of Forecast
Error
|deviations|
Absolute
Rounded

Rounded
MAD
=
Actual
Forecast
Tonnage
with
Quarter
Unloaded

Deviation
n
for
= .10

Forecast
with
= .10

For 180
= .10 175
5.00
168 = 82.45/8
175.5 = 10.31
7.50

1
2
3
4 For
5
6
7
8

159
174.75
175
= .50 173.18
190
173.36
205 = 98.62/8
175.02
180
178.02
182
178.22
82.45

15.75
1.82
16.64
12.33
29.98
1.98
3.78

Absolute
Deviation
for
= .50

175
177.50
172.75
165.88
170.44
180.22
192.61
186.30
98.62

= .50

5.00
9.50
13.75
9.12
19.56
24.78
12.61
4.30

4 - 53

Comparison of Forecast
Error2
(forecast errors)

Rounded
MSE
=
Actual
Forecast
Tonnage
Quarter

with
Unloaded

Absolute
Deviation
n
for
= .10

Rounded
Forecast
with
= .10

Absolute
Deviation
for
= .50

15.75
1.82
16.64
195.24
29.98
1.98
3.78

175
177.50
172.75
165.88
170.44
180.22
192.61
186.30
98.62
12.33

For 180
= .10 175
5.00
168
175.5 = 190.82
7.50
= 1,526.54/8

1
2
3
4 For
5
6
7
8

159
174.75
175
= .50 173.18
190
173.36
= 1,561.91/8
205
175.02
180
178.02
182
178.22
82.45
MAD
10.31

= .50

5.00
9.50
13.75
9.12
19.56
24.78
12.61
4.30

4 - 54

Comparison of Forecast
n
Error
100|deviation |/actual

i=1
Rounded
MAPEForecast
=
Actual
Tonnage
with
Quarter
Unloaded

1
2
3
4
5
6
7
8

i
Absolute
Rounded
Deviation
Forecast
n with
for
= .10
= .10

For 180
= .10 175
5.00
168
175.5
= 44.75/8
= 7.50
5.59%
159
For 175
=
190
205
180
182

174.75
15.75
1.82
.50 173.18
173.36
16.64
= 54.05/8
=29.98
6.76%
175.02
178.02
1.98
178.22
3.78
82.45
MAD
10.31
MSE
190.82

i
Absolute
Deviation
for
= .50

175
177.50
172.75
165.88
170.44
180.22
192.61
186.30
98.62
12.33
195.24

= .50

5.00
9.50
13.75
9.12
19.56
24.78
12.61
4.30

4 - 55

Comparison of Forecast
Error
Tonnage
Quarter

Actual
with
Unloaded

Rounded
Forecast
for
= .10

1
2
3
4
5
6
7
8

180
168
159
175
190
205
180
182

175
175.5
174.75
173.18
173.36
175.02
178.02
178.22
MAD
MSE
MAPE

Absolute
Deviation
with
= .10

5.00
-7.50
-15.75
1.82
16.64
29.98
1.98
3.78
82.45
10.31
190.82
5.59%

Rounded
Forecast
for
= .50

175
177.50
172.75
165.88
170.44
180.22
192.61
186.30

Absolute
Deviation
= .50

5.00
-9.50
-13.75
9.12
19.56
24.78
-12.61
-4.30
98.62
12.33
195.24
6.76%

4 - 56

Exponential Smoothing with

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

4 - 57

Exponential Smoothing with

Trend Adjustment
Ft = (At - 1) + (1 - )(Ft - 1 + Tt - 1)
Tt = (Ft - Ft - 1) + (1 - )Tt - 1
Step 1: Compute Ft
Step 2: Compute Tt

Step 3: Calculate the forecast FITt = Ft + Tt

4 - 58

Exponential Smoothing with

Trend Adjustment Example
Month(t)
1
2
3
4
5
6
7
8
9
10

Actual
Demand (At)
12
17
20
19
24
21
31
28
36

Smoothed
Forecast, Ft
11

Forecast
Smoothed
Trend, Tt
2

Including
Trend, FITt
13.00

Table 4.1

4 - 59

Exponential Smoothing with

Trend Adjustment Example
Month(t)
1
2
3
4
5
6
7
8
9
10

Forecast
Smoothed
Trend, Tt
2

Actual
Smoothed
Including
Demand (At) Forecast, Ft
Trend, FITt
12
11
13.00
17
20
19
Step 1: Forecast for Month 2
24
21
F2 = A1 + (1 - )(F1 + T1)
31
28
F2 = (.2)(12) + (1 - .2)(11 + 2)
36

= 2.4 + 10.4 = 12.8 units

Table 4.1

4 - 60

Exponential Smoothing with

Trend Adjustment Example
Month(t)
1
2
3
4
5
6
7
8
9
10

Forecast
Smoothed
Trend, Tt
2

Actual
Smoothed
Including
Demand (At) Forecast, Ft
Trend, FITt
12
11
13.00
17
12.80
20
19
Step 2: Trend for Month 2
24
21
T2 = (F2 - F1) + (1 - )T1
31
28
T2 = (.4)(12.8 - 11) + (1 - .4)(2)
36

= .72 + 1.2 = 1.92 units

Table 4.1

4 - 61

Exponential Smoothing with

Trend Adjustment Example
Month(t)
1
2
3
4
5
6
7
8
9
10

Forecast
Smoothed
Trend, Tt
2
1.92

Actual
Smoothed
Including
Demand (At) Forecast, Ft
Trend, FITt
12
11
13.00
17
12.80
20
19
Step 3: Calculate FIT for Month 2
24
21
FIT2 = F2 + T2
31
28
FIT2 = 12.8 + 1.92
36

= 14.72 units

Table 4.1

4 - 62

Exponential Smoothing with

Trend Adjustment Example
Actual
Month(t)
1
2
3
4
5
6
7
8
9
10

Smoothed
Demand (At)
12
17
20
19
24
21
31
28
36

Smoothed
Forecast, Ft
11
12.80
15.18
17.82
19.91
22.51
24.11
27.14
29.28
32.48

Forecast
Including
Trend, Tt
2
1.92
2.10
2.32
2.23
2.38
2.07
2.45
2.32
2.68

Trend, FITt
13.00
14.72
17.28
20.14
22.14
24.89
26.18
29.59
31.60
35.16

Table 4.1

4 - 63

Exponential Smoothing with

Trend Adjustment Example
35
30

Actual demand (At)

Product demand

25
20
15

Forecast including trend (FITt)

with = .2 and = .4

10
5
0 | |
1 2

|
3

|
4

|
5

|
6

|
7

Time (month)

|
8

|
9
Figure 4.3

4 - 64

Trend Projections
Fitting a trend line to historical data points
to project into the medium to long-range
Linear trends can be found using the least
squares technique
y^ = a + bx
^

where y
= computed value of
the variable to be predicted
(dependent variable)
a
= y-axis intercept
b
= slope of the regression line
x
= the independent variable
4 - 65

Least Squares Method

Values of Dependent Variable

Actual observation
(y-value)

Deviation7

Deviation5
Deviation3

Deviation6

Least squares method

minimizes the sum of the
Deviation
squared
errors (deviations)
4

Deviation1
(error)

Deviation2

Trend line, y^ = a + bx

Time period

Figure 4.4

4 - 66

Least Squares Method

Equations to calculate the regression variables
y^ = a + bx

b=

xy - nxy
x2 - nx2

a = y - bx
4 - 67

Least Squares Example

Time Electrical Power
Year
Period (x)
2003
2004
2005
2006
2007
2008
2009

1
2
3
4
5
6
7
x = 28
x = 4 y = 98.86

x2

xy

1
4
9
16
25
36
49
x2 = 140

74
158
240
360
525
852
854
xy = 3,063

Demand
74
79
80
90
105
142
122
y = 692

3,063 - (7)(4)(98.86)
xy - nxy
b=
=
= 10.54
2)
2
2
140
(7)(4
x - nx
a = y - bx = 98.86 - 10.54(4) = 56.70
4 - 68

Least Squares Example

Time Electrical Power
Year
Period (x)

x2

xy

2003
1
74
1
2004
2
79
4
line is 80
2005The trend
3
9
2006
4
90
16
2007
105
25
y^ 5= 56.70 + 10.54x
2008
6
142
36
2009
7
122
49
x = 28y = 692
x2 = 140
xy = 3,063
x = 4 y = 98.86

74
158
240
360
525
852
854

Demand

3,063 - (7)(4)(98.86)
xy - nxy
b=
=
= 10.54
2)
2
2
140
(7)(4
x - nx
a = y - bx = 98.86 - 10.54(4) = 56.70
4 - 69

Least Squares Example

Power demand

160
150
140
130
120
110
100
90
80
70
60
50

Trend line,
y^ = 56.70 + 10.54x

| |
2003

|
2004

|
2005

|
2006

|
2007
Year

|
2008

|
2009

|
2010

2011
4 - 70

Seasonal Index Example

Demand
Average
Month 2007 2008 2009

Average
2007-2009

Seasonal
Monthly

Jan
80
85 105
90
94
Feb
70
85
85
80
94
Mar
80
93 Average
82
85 monthly 94
2007-2009
demand
Seasonal
Apr
90index95= 115 Average monthly
100
94
demand
May
113 125 131
123
94
= 90/94 = .957
Jun
110 115 120
115
94
Jul
100 102 113
105
94
Aug
88 102 110
100
94
Sept
85
90
95
90
94
Oct
77
78
85
80
94
Nov
75
72
83
80
94
Dec
82
78
80
80
94

Index
0.957

4 - 72

Seasonal Index Example

Demand
Average
Month 2007 2008 2009
Jan
Feb
Mar
Apr
May
Jun
Jul
Aug
Sept
Oct
Nov
Dec

80
70
80
90
113
110
100
88
85
77
75
82

85
85
93
95
125
115
102
102
90
78
72
78

105
85
82
115
131
120
113
110
95
85
83
80

Average
2007-2009

Seasonal
Monthly

Index

90
80
85
100
123
115
105
100
90
80
80
80

94
94
94
94
94
94
94
94
94
94
94
94

0.957
0.851
0.904
1.064
1.309
1.223
1.117
1.064
0.957
0.851
0.851
0.851
4 - 73

Seasonal Index Example

Demand
Average
Month 2007 2008 2009
Jan
Feb
Mar
Apr
May
Jun
Jul
Aug
Sept
Oct
Nov
Dec

Average
2007-2009

Seasonal
Monthly

80
85 105
90
94
for802010
70
85 Forecast
85
94
80
93
82
85
94
annual demand
= 1,200
90Expected
95 115
100
94
113 125 131
123
94
110 115 120 1,200 115
94
Jan 113
x105
.957 = 96 94
100 102
12
88 102 110
100
94
1,200
85
90
Feb 95
x90
.851 = 85 94
77
78
85 12
80
94
75
72
83
80
94
82
78
80
80
94

Index
0.957
0.851
0.904
1.064
1.309
1.223
1.117
1.064
0.957
0.851
0.851
0.851
4 - 74

Seasonal Index Example

2010 Forecast
2009 Demand
2008 Demand
2007 Demand

140
130
120
Demand

110
100
90
80
70
||
JF

|
M

|
A

|
M

|
J

|
J

|
A

|
S

|
O

|
N

|
D

Time
4 - 75

Associative Forecasting
Used when changes in one or more
independent variables can be used to predict
the changes in the dependent variable
Most common technique is linear
regression analysis
We apply this technique just as we did
in the time series example

4 - 76

Associative Forecasting
Forecasting an outcome based on predictor
variables using the least squares technique

y^ = a + bx
^

where y
= computed value of
the variable to be predicted
(dependent variable)
a
= y-axis intercept
b
= slope of the regression line
x
= the independent variable
though to predict the value of the
dependent variable
4 - 77

Associative Forecasting
Example

Sales

SalesArea Payroll
($ millions), y
($ billions), x
2.0
1
3.0
3
2.5
4
4.0
2.0
2
3.0
2.0
1
3.5
7
2.0
1.0

|
0 1

|
2

|
3

|
|
|
|
4
5
6
7
Area payroll
4 - 78

Associative Forecasting
Example
Sales, y

2.0
1
3.0
3
2.5
4
2.0
2
2.0
1
3.5
7
y = 15.0

Payroll, x

1
9
16
4
1
49
x = 18

x = x/6 = 18/6 = 3
y = y/6 = 15/6 = 2.5

x2

2.0
9.0
10.0
4.0
2.0
24.5
x2 = 80

xy

xy = 51.5

51.5 - (6)(3)(2.5)
xy - nxy
b=
=
= .25
80 - (6)(32)
x2 - nx2

a = y - bx = 2.5 - (.25)(3) = 1.75

4 - 79

Associative Forecasting
Example
y^ = 1.75 + .25x

Sales = 1.75 + .25(6)

Sales = $3,250,000

4.0
Nodels sales

If payroll next year

is estimated to be
$6 billion, then:

Sales = 1.75 + .25(payroll)

3.25
3.0
2.0

1.0

|
0 1

|
2

|
3

|
|
|
|
4
5
6
7
Area payroll
4 - 80

Correlation
How strong is the linear
relationship between the variables?
Correlation does not necessarily
imply causality!
Coefficient of correlation, r,
measures degree of association
Values range from -1 to +1

4 - 81

Correlation Coefficient
r=

nxy - xy

[nx2 - (x)2][ny2 - (y)2]

4 - 82

Correlation Coefficient
nxy - xy

r=

2 - (x)2][ny2 - (y)2]
[nx
(a) Perfect positive x

(b) Positive
correlation:
0<r<1

correlation:
r = +1

(c) No correlation:
r=0

(d) Perfect negative x

correlation:
r = -1
4 - 83

Correlation
Coefficient of Determination, r2,
measures the percent of change in
y predicted by the change in x
Values range from 0 to 1
Easy to interpret

For the Nodel Construction example:

r = .901

r2 = .81
4 - 84

Monitoring and Controlling

Forecasts
Tracking Signal
Measures how well the forecast is
predicting actual values
Ratio of cumulative forecast errors to
mean absolute deviation (MAD)
Good tracking signal has low values
If forecasts are continually high or low, the
forecast has a bias error
4 - 85

Forecasting in the Service

Sector
Presents unusual challenges
Special need for short term records
Needs differ greatly as function of
industry and product
Holidays and other calendar events
Unusual events

4 - 86