ForecastIng

Pirzada
October 2, 2012

Statistics: Few terms

Dependent variable:
Independent variable:
Mean Absolute Deviation: The average forecast error
using absolute values of the error of each past forecast.

Statistics: Few more terms

Regression: Y = a + b x1
Multiple regression: Y = a + b x1 + b x2 + b x3 +
Least square fitting: Sum of the residuals is least
Time series analysis: A type of forecast in which
data relating to past demand are used to
predict future demand.

Linear Regression
Y a bx
Y= Value of dependent variable from
regression equation.
a : Y intercept
b: Slope of the line.

a y bx
xy n x. y
b
x 2 n x x

y : Average of all ys

x : Average of all xs
x: x value of each data point
y: y value of each data point
n: number od data points.

S yx

2
(
y

Y
)
i i
i 1

n2

Forecasts: Need and importance

Basis of corporate planning
Basis of budgetary planning
Operations planning
Capacity planning

Demand Management
Independent demand e.g. cars
Dependent demand e.g. Wheels of the cars
Influencing demand
Active role: Incentives, campaigns, price cuts etc.
Passive role: Simply accept because
Firm is running to full capacity,
market is fixed and static, funding issues etc.

Types of Forecasting
Qualitative
Time series analysis
Casual relationship
Simulation

See Exhibit 13.1, Page 540

Components of Demand
Average demand
Trends

linear
S-curve
asymptotic
exponential

Seasonal elements
Cyclic elements
Random variation
Auto correction

Qualitative Techniques -I
Grass Roots
- The person closest to customers knows future needs best.
Forecasts of bottom level +
safety stocks +
order size corrections

To next level

Qualitative Techniques-II
Panel Consensus
Panel of people from variety of position
Open meeting & free exchange

Historical Analogy
Modeling a generic product

Qualitative Techniques-III
Delphi Method
1.
2.
3.
4.
5.

Choose experts (variety of knowledgeable persons).

Obtain forecast through a questionnaire ((e-mails etc.).
Summarize the results/ redistribute with new questionnaire.
Summarize again develop new questions.
Repeat step 4.
Usually 3 rounds required!

Time Series Analysis

Selection of Method:

1.
2.
3.
4.
5.

Time horizon
Data availability
Accuracy required
Size of forecasting budget
Availability of qualified personnel

Simple Moving Average

At 1 At 2 At 3 ....At n
ft
n
Ft: Forecast for the coming period
n: No. of periods to be averaged
At-1: Actual occurrence in the past period
At-2, At-3, At-n : Actual occurrence in 2
periods ago, 3 periods ago, n periods ago,

Good for cases where demand is stable

and does not have seasonal characteristics

Weighted Moving Average

Allows placing of weights, e.g. most recent more weight

Ft w1 At 1 w2 At 2 w3 At 3 .... wn At n
n

w
i 1

W1: Weight to be given to the actual occurrence for the period t-1
W2: Weight to be given to the actual occurrence for the period t-2

Wn: Weight to be given to the actual occurrence for the period t-n
n: Total number of periods in the forecast.

Exponential Smoothening
Only 3 pieces of data required:

i. Most recent forecast (Ft-1)

ii. The actual demand (At-1)
iii. Smoothening constant ()

Ft Ft 1 ( At 1 Ft 1 )

Premise:
Most recent
occurrences

are most
indicative.

Here Ft is the exponentially smoothed forecast for period t.

Exponential Smoothening
Smoothening constant ()
The value is determined by nature of the product and a
judgment on response rate.
Smaller values

Larger values

Standard items

Fashion items

Stable demand

Growing demand

Small reaction rate

Higher reaction rate

More lagging*

Less lagging*
See Exhibit 13.7 page 550

Trend Effects in Exponential Smoothening

Forecast including trend =
Exponentially Smoothed forecast + Exponentially Smoothed Trend

: Smoothing constant
: Smoothing constant

FITt Ft Tt
Ft FITt 1 ( At 1 FITt 1 )
Tt Tt 1 ( Ft FITt 1 )

FITt: The forecast including trend for period t.

Ft: Forecast for the coming period
Tt: The exponentially smoothed trend for period t.

Forecast Errors
Types and Sources
The confidence band of regression line
does nor work satisfactorily for future values
Bias Errors: making a consistent mistake: Because of :
Failure to include right variables
Using wrong relationships
Wrong trend lines
Undetected trends
Random Errors: Errors that cannot be explained.

Measurement of Errors
Degree of error measured as standard deviation, variance, mean
absolute deviation (MAD)
n
At Ft

MAD i 1
n
1 MAD = 0.8 Standard deviation
3.75 MAD = 3 Standard deviation

An exponentially smoothed MAD is used as error range for next

periods forecast.

Tracking Signal- Measure of Error

Tracking signal is a measurement that indicated whether the
forecast averages keep in pace with any genuine upward or
downward changes in demand. As used in forecasting, the
tracking signal is the number of mean absolute deviations that
the forecast value is above or below the actual occurrence.

RSFE: Running sum of forecast errors

MAD: the average of absolute forecast errors.

RSFE
TS
MAD

Follow exhibit 13.9 1nd 13.10, page 555

Linear Regression Analysis

Discussed earlier. The formulae including
those of standard error were also given.

Follow exhibit 13.9 1nd 13.10, page 555

Decomposition of Time Series

Time series is a chronologically ordered data set.
Trend, seasonal, cyclic, autocorrelation, random.
Decomposition: Identifying and separating into components
Easy to identify

Trend, Seasonal
Difficult to identify

Cyclic, autocorrelation, random

Seasonal Variation
Additive seasonal variation
Forecast including trend and seasonal = Trend + seasonal factor

Multiplicative seasonal variation

Forecast including trend and seasonal = Trend x seasonal factor
See Exhibit 13.15 B, Page 561

Seasonal Factor (or Index)

Seasonal Factor (or Index)
Amount of correction needed in a time series to adjust for the
season of the year.
Let us follow examples 13.3 and 13.13.14 page 562

Forecast including trend and seasonal

factor for period t (FITSt):
FITSt = Trend . seasonal factor

Decomposing Time Series

Decomposing using Least Square Regression
I.

Decompose the time series into its components

a.
b.
c.

Find seasonal components

Deseasonalize the demand
Find Trend component

II. Forecast future values of each component

a.
b.

Project trend component into the future

Multiply trend component by seasonal component.

Scheme for Decomposition

Step 1: Determine the seasonal factor
Step 2: Deseasonalize the original data

Step 3: Develop regression line for deseasonalized data

Step 4: Project for the period of forecast
Step 5: Create final forecast using seasonal factor.

Casual Relationship Forecast

Where one occurrence causes another.
1. Find causes
2. Develop a relation ship

3. Make forecast

Follow Example 13.5 page 567

Multiple Regression Analysis

S B Bm ( M ) Bh ( H ) Bi ( I ) Bt (T )
S= Gross sale for the year
B= Base sales (starting point)
M= Marriages during the year
H= Housing starts during the year
I= Annual disposable personal income
T= Time trend

Focused Forecasting
1.
2.

3.
4.

5.

Whatever we sold in the past three month is what we will

probably sell in the next three months.
What we sold in the same three month period last year, we will
probably sell in that three month period this year. (This would
account for seasonal effects.)
We will probably sell ten percent more in the next three months
than we sold in the past three months.
We will probably sell fifty percent more over the next three
months than we did for the same three months of last year.
Whatever percentage chance we had for the past three months
this year compared to the same three months last year will
probably be the same percentage change that we will have for the
next three months of this year.

Web-Based Forecasting
Collaborative Planning, Forecasting and Replenishment
(CPFR)
Web-based tool for trading partners (food, apparel etc.)
Step 1: Creation of a front-end partnership agreement.
Step 2: Joint business planning.
Step 3: Development of demand forecast.

Step 4: Sharing forecasts.

Step 5: Inventory replenishment.

Home Work 3
Due Date April 11, 2010

Problem Nos. 4, 5, 6