Tutorial 2

FORECASTING
OPERATIONS MANAGEMENT

What is Forecasting?

Process of predicting
a future event
Underlying basis
of all business
decisions

Production
Inventory
Personnel
Facilities

??

Forecasting Time Horizons

1.

Short-range forecast

2.

Medium-range forecast

3.

Up to 1 year, generally less than 3 months

Purchasing, job scheduling, workforce levels,
job assignments, production levels
3 months to 3 years
Sales and production planning, budgeting

Long-range forecast

3+ years
New product planning, facility location,
research and development

Distinguishing Differences
1.

2.

3.

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

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

Company Strategy/Issues

Product Life Cycle

Introduction

Growth

Best period to
increase market
share

Practical to
change price or
quality image

Poor time to
change image,
price, or quality

R&D
engineering is
critical

Strengthen
niche

Competitive
costs become
critical
Defend market
position

Internet search
engines
Xbox 360
Boeing 787
Sales
3-D
game
players

3D
printers
Electric
vehicles

Maturity

Decline
Cost control
critical

Drivethrough
restaurants
DVDs

iPods

Analog
TVs

Figure 2.5

Types of Forecasts
1.

Economic forecasts

2.

Technological forecasts

3.

Address business cycle inflation rate, money

supply, housing starts, etc.
Predict rate of technological progress
Impacts development of new products

Demand forecasts

Predict sales of existing products and services

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

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

15-10

Demand Management

Independent Demand:
Finished Goods
Dependent Demand:
Raw Materials,
Component parts,
Sub-assemblies, etc.

C(2)

B(4)

D(2)

E(1)

D(3)

F(2)

15-11

Components of Demand

Average

demand for a
period of time
Trend
Seasonal element
Cyclical elements
Random variation
Autocorrelation

15-12

Finding Components of Demand

Seasonal
Seasonal
variation
variation

Sales

x
x x

xx
x
x xx
x
x x
x
x
x
x
x
x
x
x
x
x
x
x
xxxx

x x

x
x

3
Year

x
x

x
x x
x
x

Linear
Linear
Trend
Trend
x

15-13

Types of Forecasts

Qualitative (Judgmental)

Quantitative
Time

Series Analysis
Causal Relationships
Simulation

15-14

Qualitative Methods

Executive
Judgment

Historical
analogy

Grass Roots

Qualitativ
e

Market
Research

Methods
Delphi Method

Panel
Consensus

15-15

Delphi Method

l. Choose the experts to participate representing a variety of

knowledgeable people in different areas
2. Through a questionnaire (or E-mail), obtain forecasts (and
any premises or qualifications for the forecasts) from all
participants
3. Summarize the results and redistribute them to the
participants along with appropriate new questions
4. Summarize again, refining forecasts and conditions, and
again develop new questions
5. Repeat Step 4 as necessary and distribute the final results
to all participants

15-16

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

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

15-18

Simple Moving Average Formula

The simple moving average model assumes an

average is a good estimator of future
behavior
The formula for the simple moving average is:

A t-1 + A t-2 + A t-3 +...+A t- n

Ft =
n
Ft = 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

Moving Average Example

MONTH

ACTUAL SHED SALES

January

10
10

3-MONTH MOVING AVERAGE

March

12
12
13
13

(10 + 12 + 13)/3 = 11 2/3

April

16

(12 + 13 + 16)/3 = 13 2/3

May

19

June

23

(19 + 23 + 26)/3 = 22 2/3

July

26

(23 + 26 + 30)/3 = 26 1/3

February

August

30

September

28

October

18

November

16

(13 + 16 + 19)/3 = 16
(16 + 19 + 23)/3 = 19 1/3

(29 + 30 + 28)/3 = 28
(30 + 28 + 18)/3 = 25 1/3
(28 + 18 + 16)/3 = 20 2/3

15-20

Simple Moving Average Problem (1)

Week
1
2
3
4
5
6
7
8
9
10
11
12

Demand
650
678
720
785
859
920
850
758
892
920
789
844

A t-1 + A t-2 + A t-3 +...+A t- n

Ft =
n
Question:
Question: What
What are
are the
the 33week
week and
and 6-week
6-week
moving
moving average
average
forecasts
forecasts for
for demand?
demand?
Assume
Assume you
you only
only have
have 33
weeks
weeks and
and 66 weeks
weeks of
of
actual
actual demand
demand data
data for
for
the
the respective
respective forecasts
forecasts

Calculating the moving averages gives

us:

Week
1
2
3
4
5
6
7
8
9
10
11
12

15-21

Demand 3-Week 6-Week

650 F4=(650+678+720)/3
678
=682.67
720
F7=(650+678+720
785
682.67
+785+859+920)/6
859
727.67
=768.67
920
788.00
850
854.67
768.67
758
876.33
802.00
892
842.67
815.33
920
833.33
844.00
789
856.67
866.50
844
867.00
854.83
The McGraw-Hill Companies, Inc.,

15-22

Plotting
Plotting the
the moving
moving averages
averages and
and
comparing
comparing them
them shows
shows how
how the
the lines
lines
smooth
smooth out
out to
to reveal
reveal the
the overall
overall upward
upward
trend
trend in
in this
this example
example

Note
Notehow
howthe
the
3-Week
3-Weekisis
smoother
smootherthan
than
the
theDemand,
Demand,
and
and6-Week
6-Weekisis
even
evensmoother
smoother

15-23

Simple Moving Average Problem (2) Data

Week
1
2
3
4
5
6
7

Demand
820
775
680
655
620
600
575

Question:
Question: What
What is
is
the
the 33 week
week
moving
moving average
average
forecast
forecast for
for this
this
data?
data?
Assume
Assume you
you only
only
have
have 33 weeks
weeks
and
and 55 weeks
weeks of
of
actual
actual demand
demand
data
data for
for the
the
respective
respective
forecasts
forecasts

15-24

Simple Moving Average Problem (2) Solution

Week
1
2
3
4
5
6
7

Demand
820
775
680
655
620
600
575

3-Week

5-Week

F4=(820+775+680)/3
=758.33

758.33
703.33
651.67
625.00

F6=(820+775+680
+655+620)/5
=710.00

710.00
666.00

Potential Problems With

Moving Average

Increasing n smooths the forecast but makes it

less sensitive to changes
Does not forecast trends well
Requires extensive historical data

Weighted Moving Average

Used when some trend might be present

Older data usually less important

Weights based on experience and intuition

Weighted Weight for period n Demand in period n

moving
Weights
average

Weighted Moving Average

MONTH

ACTUAL SHED SALES

January

10
10

February
March
April

12
12
13
13

3-MONTH WEIGHTED MOVING AVERAGE

[(3 x 13) + (2 x 12) + (10)]/6 = 12 1/6

16
WEIGHTS APPLIED

PERIOD

May

19

Last month

June

23

Two months ago

July

26

Three months ago

August

30

Sum of the weights

September
October
November

28this month =
Forecast for
3 x Sales last mo. + 2 x Sales 2 mos. ago + 1 x Sales 3 mos. ago
18
Sum of the weights
16

Weighted Moving Average

MONTH

ACTUAL SHED SALES

January

10
10

3-MONTH WEIGHTED MOVING AVERAGE

March

12
12
13
13

[(3 x 13) + (2 x 12) + (10)]/6 = 12 1/6

April

16

[(3 x 16) + (2 x 13) + (12)]/6 = 14 1/3

May

19

June

23

[(3 x 26) + (2 x 23) + (19)]/6 = 23 5/6

July

26

[(3 x 30) + (2 x 26) + (23)]/6 = 27 1/2

February

August

30

September

28

October

18

November

16

[(3 x 19) + (2 x 16) + (13)]/6 = 17

[(3 x 23) + (2 x 19) + (16)]/6 = 20 1/2

[(3 x 28) + (2 x 30) + (26)]/6 = 28 1/3

[(3 x 18) + (2 x 28) + (30)]/6 = 23 1/3
[(3 x 16) + (2 x 18) + (28)]/6 = 18 2/3

15-29

Weighted Moving Average Formula

While
Whilethe
themoving
movingaverage
averageformula
formulaimplies
impliesan
anequal
equalweight
weightbeing
beingplaced
placedon
oneach
each
value
valuethat
thatisisbeing
beingaveraged,
averaged,the
theweighted
weightedmoving
movingaverage
averagepermits
permitsan
anunequal
unequal
weighting
weightingon
onprior
priortime
timeperiods
periods
The
Theformula
formulafor
forthe
themoving
movingaverage
averageis:
is:

Ft = w1A t-1 + w 2 A t-2 + w 3A t-3 +...+w n A t-n

w
wtt=
= weight
weight given
given to
to time
time period
period
t
t occurrence
occurrence (weights
(weights must
must
add
add to
to one)
one)

w
i=1

=1

15-30

Weighted Moving Average Problem (1) Data

Question:
Question:Given
Giventhe
theweekly
weeklydemand
demandand
andweights,
weights,what
whatisis
th
the
theforecast
forecastfor
forthe
the44thperiod
periodor
orWeek
Week4?
4?
Week
1
2
3
4

Demand
650
678
720

Weights:
t-1 .5
t-2 .3
t-3 .2

Note
Notethat
thatthe
theweights
weightsplace
placemore
moreemphasis
emphasison
onthe
the
most
mostrecent
recentdata,
data,that
thatisistime
timeperiod
periodt-1
t-1

15-31

Weighted Moving Average Problem (1) Solution

Week
1
2
3
4

Demand Forecast
650
678
720
693.4

F4 = 0.5(720)+0.3(678)+0.2(650)=693.4

15-32

Weighted Moving Average Problem (2) Data

Question:
Question:Given
Giventhe
theweekly
weeklydemand
demandinformation
informationand
and
weights,
weights,what
whatisisthe
theweighted
weightedmoving
movingaverage
averageforecast
forecast
thth
of
ofthe
the55 period
periodor
orweek?
week?
Week
1
2
3
4

Demand
820
775
680
655

Weights:
t-1 .7
t-2 .2
t-3 .1

15-33

Weighted Moving Average Problem (2) Solution

Week
1
2
3
4
5

Demand Forecast
820
775
680
655
672

F5 = (0.1)(755)+(0.2)(680)+(0.7)(655)= 672

15-34

Exponential Smoothing Model

FFtt == FFt-1
+
(A
F
)
+
(A
F
t-1
t-1
t-1
t-1
t-1)
Where :
Ft Forcast value for the coming t time period
Ft - 1 Forecast value in 1 past time period
At - 1 Actual occurance in the past t time period
Alpha smoothing constant

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

15-35

Exponential Smoothing Problem (1) Data

Week
1
2
3
4
5
6
7
8
9
10

Demand
820
775
680
655
750
802
798
689
775

Question:
Question: Given
Given
the
the weekly
weekly
demand
demand data,
data,
what
what are
are the
the
exponential
exponential
smoothing
smoothing
forecasts
forecasts for
for
periods
periods 2-10
2-10
using
using =0.10
=0.10 and
and
=0.60?
=0.60?
Assume
Assume FF11=D
=D11

15-36

Answer:
Answer:The
Therespective
respectivealphas
alphascolumns
columnsdenote
denotethe
theforecast
forecastvalues.
values. Note
Note
that
thatyou
youcan
canonly
onlyforecast
forecastone
onetime
timeperiod
periodinto
intothe
thefuture.
future.

15-37

Exponential Smoothing Problem (1) Plotting

Note
Notehow
howthat
thatthe
thesmaller
smalleralpha
alpharesults
resultsin
inaa smoother
smootherline
linein
in
this
thisexample
example

15-38

Exponential Smoothing Problem (2) Data

Question: What
What are
are
Week Demand Question:
the exponential
exponential
1
820 the
smoothing forecasts
forecasts
2
775 smoothing
for periods
periods 2-5
2-5 using
using
3
680 for
=0.5?
4
655 aa =0.5?
5
Assume
Assume FF11=D
=D11

15-39

Exponential Smoothing Problem (2) Solution

F1=820+(0.5)(820-820)=820

Week
1
2
3
4
5

Demand
820
775
680
655

F3=820+(0.5)(775-820)=797.75

0.5
820.00
820.00
797.50
738.75
696.88

15-40

The MAD Statistic to Determine Forecasting Error

n

MAD =

t=1

- Ft

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

15-41

MAD Problem Data

Question:
Question: What
What isis the
the MAD
MAD value
value given
given
the
the forecast
forecast values
values in
in the
the table
table below?
below?
Month

Sales

Forecast

220

n/a

250

255

210

205

300

320

325

315

15-42

MAD Problem Solution

Month
1
2
3
4
5

Sales
220
250
210
300
325

Forecast Abs Error

n/a
255
5
205
5
320
20
315
10

40
n

MAD =

t=1

- Ft

40
=
= 10
4

Note
Notethat
thatby
byitself,
itself,the
theMAD
MAD
only
onlylets
letsus
usknow
knowthe
themean
mean
error
errorin
inaaset
setof
offorecasts
forecasts

15-43

Tracking Signal Formula

The Tracking Signal or TS is a measure

that indicates whether the forecast
average is keeping pace with any genuine
upward or downward changes in demand.
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:

RSFE Running sum of forecast errors

TS =
=
MAD
Mean absolute deviation

15-44

Simple Linear Regression Model

The
Thesimple
simplelinear
linearregression
regression
model
modelseeks
seeksto
tofit
fitaaline
line
through
throughvarious
variousdata
dataover
over
time
time

Yt = a + bx

a
0 1 2 3 4 5

(Time)

Is
Is the
the linear
linear regression
regression
model
model

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.

15-45

Simple Linear Regression Formulas for Calculating a and b

a = y - bx

b=

xy - n(y)(x)
2

x - n(x )

15-46

Simple Linear Regression Problem Data

Question:
Question:Given
Giventhe
thedata
databelow,
below,what
whatisisthe
thesimple
simplelinear
linear
regression
regressionmodel
modelthat
thatcan
canbe
beused
usedto
topredict
predictsales
salesin
infuture
future
weeks?
weeks?

Week
1
2
3
4
5

Sales
150
157
162
166
177

15-47

Answer:
Answer: First,
First, using
using the
the linear
linear regression
regression
formulas,
formulas, we
we can
can compute
compute a
a and
and b
b

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
xy - n(y)(x) 2499 - 5(162.4)(3) 63

b=
=

= 6.3
55 5(9 )
10
x - n(x )
2

a = y - bx = 162.4 - (6.3)(3) = 143.5

15-48

The resulting regression model

is:

Yt = 143.5 + 6.3x

Sales

Now if we plot the regression generated forecasts against the

actual sales we obtain the following chart:
180
175
170
165
160
155
150
145
140
135

Sales
Forecast

3
Perio
d