Forecasting

The Starting Point for All Planning

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Overview

Introduction
Qualitative Forecasting Methods
Quantitative Forecasting Models
How to Have a Successful Forecasting System
Computer Software for Forecasting
Forecasting in Small Businesses and Start-Up
Ventures
Wrap-Up: What World-Class Producers Do

Slide 2 of 56

Demand Management

Independent demand items are the only

items demand for which needs to be
forecast
These items include:

Finished goods and

Spare parts

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Demand Management
Independent Demand
(finished goods and spare parts)

Dependent Demand

(components)

C(2)

B(4)

D(2)

E(1)

D(3)

F(2)

Slide 4 of 56

Introduction

Demand estimates for independent demand products

and services are the starting point for all the other
forecasts in POM.
Management teams develop sales forecasts based in
part on demand estimates.
Sales forecasts become inputs to both business
strategy and production resource forecasts.

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Forecasting is an Integral Part

of Business Planning
Inputs:
Market,
Economic,
Other

Forecast
Method(s)

Sales
Forecast

Business
Strategy

Demand
Estimates

Management
Team

Production Resource
Forecasts
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Examples of Production Resource Forecasts

Forecast
Horizon

Time Span

Item Being Forecast

Units of
Measure

Product lines
Factory capacities
Planning for new products
Capital expenditures
Facility location or expansion
R&D

Dollars, tons, etc.

Product groups
Department capacities
Sales planning
Production planning and
budgeting

Dollars, tons, etc.

Specific product quantities

Machine capacities
Planning
Purchasing
Scheduling
Workforce levels
Production levels
Job assignments

Physical units of
products

Long-Range

Years

MediumRange

Months

Short-Range

Weeks

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Forecasting Methods

Qualitative Approaches
Quantitative Approaches

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Qualitative Forecasting Applications

Small and Large Firms

Technique

Low Sales

High Sales

(less than $100M)

(more than $500M)

Managers Opinion

40.7%

39.6%

Executives
Opinion

40.7%

41.6%

Sales Force
Composite

29.6%

35.4%

Number of Firms

27

48

Source: Nada Sanders and Karl Mandrodt (1994) Practitioners Continue to Rely on Judgmental Forecasting
Methods Instead of Quantitative Methods, Interfaces, vol. 24, no. 2, pp. 92-100.
Note: More than one response was permitted.

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Qualitative Approaches

Usually based on judgments about causal factors that

underlie the demand of particular products or services
Do not require a demand history for the product or
service, therefore are useful for new products/services
Approaches vary in sophistication from scientifically
conducted surveys to intuitive hunches about future
events

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Qualitative Methods

Executive committee consensus

Delphi method
Survey of sales force
Survey of customers
Historical analogy
Market research

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Quantitative Forecasting Approaches

Based on the assumption that the forces that

generated the past demand will generate the future
demand, i.e., history will tend to repeat itself
Analysis of the past demand pattern provides a good
basis for forecasting future demand
Majority of quantitative approaches fall in the
category of time series analysis

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Quantitative Forecasting Applications

Small and Large Firms

Technique

Low Sales

High Sales

(less than $100M)

(more than $500M)

Moving Average

29.6%

29.2

Simple Linear
Regression

14.8%

14.6

Naive

18.5%

14.6

Single Exponential
Smoothing

14.8%

20.8

Multiple Regression

22.2%

27.1

Simulation

3.7%

10.4

Classical Decomposition

3.7%

8.3

Box-Jenkins

3.7%

6.3

Number of Firms

27

48

Source: Nada Sanders and Karl Mandrodt (1994) Practitioners Continue to Rely on Judgmental Forecasting
Methods Instead of Quantitative Methods, Interfaces, vol. 24, no. 2, pp. 92-100.
Note: More than one response was permitted.

Slide 13 of 56

Time Series Analysis

A time series is a set of numbers where the order or

sequence of the numbers is important, e.g., historical
demand
Analysis of the time series identifies patterns
Once the patterns are identified, they can be used to
develop a forecast

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Components of Time Series

Whats going on here?

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

Year

x
x

x
x x
x
x

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Components of Time Series

Trends are noted by an upward or downward sloping

line
Seasonality is a data pattern that repeats itself over
the period of one year or less
Cycle is a data pattern that repeats itself... may take
years
Irregular variations are jumps in the level of the series
due to extraordinary events
Random fluctuation from random variation or
unexplained causes
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Actual Data & the Regression Line

160

Power Demand

140
120

Actual Data
Linear (Actual Data)

100
80

60
40
1988 1989 1990 1991 1992 1993 1994 1995 1996 1997
Year

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Seasonality
Length of Time
Before Pattern
Is Repeated
Year Quarter
Year Month
Year
Week
Month Week
Month Day
Week Day 7

Number of
Length of
Seasons
Season
in Pattern
4
12
52
4
28-31

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Eight Steps to Forecasting

Determining the use of the forecast--what are the

objectives?
Select the items to be forecast
Determine the time horizon of the forecast
Select the forecasting model(s)
Collect the data
Validate the forecasting model
Make the forecast
Implement the results
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Quantitative Forecasting Approaches

Linear Regression
Simple Moving Average
Weighted Moving Average
Exponential Smoothing (exponentially weighted
moving average)
Exponential Smoothing with Trend (double
smoothing)

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Simple Linear Regression

Relationship between one independent variable, X,

and a dependent variable, Y.
Assumed to be linear (a straight line)
Form: Y = a + bX
Y = dependent variable
X = independent variable
a = y-axis intercept
b = slope of regression line

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Simple Linear Regression Model

Yt = a + bx

0 1 2 3 4 5

(weeks)

b is similar to the slope. 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
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Calculating a and b

a = y - bx

b=

xy - n(y)(x)
2

x - n(x )

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Regression Equation Example

Week
1
2
3
4
5

Sales
150
157
162
166
177

Develop a regression equation to predict sales

based on these five points.
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Regression Equation Example

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

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Regression Equation Example

Sales

y = 143.5 + 6.3t
180
175
170
165
160
155
150
145
140
135

Sales
Forecast

Period
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Forecast Accuracy

Accuracy is the typical criterion for judging the

performance of a forecasting approach
Accuracy is how well the forecasted values match the
actual values

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Monitoring Accuracy

Accuracy of a forecasting approach needs to be

monitored to assess the confidence you can have in
its forecasts and changes in the market may require
reevaluation of the approach
Accuracy can be measured in several ways
Mean absolute deviation (MAD)
Mean squared error (MSE)

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Mean Absolute Deviation (MAD)

n

MAD =

Actual demand - Forecast demand

i =1

n
nn

(A -- FF ))
(A
ii

MAD
MAD

ii11

ii

nn

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Mean Squared Error (MSE)

MSE = (Syx)2
Small value for Syx means data points tightly
grouped around the line and error range is small.
The smaller the standard error the more accurate
the forecast.
MSE = 1.25(MAD)
When the forecast errors are normally distributed

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Example--MAD
Month
1
2
3
4
5

Sales
220
250
210
300
325

Forecast
n/a
255
205
320
315

Determine the MAD for the four forecast periods

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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

MAD =

t=1

- Ft

40
=
= 10
4
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Simple Moving Average

An averaging period (AP) is given or selected

The forecast for the next period is the arithmetic
average of the AP most recent actual demands
It is called a simple average because each period
used to compute the average is equally weighted
. . . more

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Simple Moving Average

It is called moving because as new demand data

becomes available, the oldest data is not used
By increasing the AP, the forecast is less responsive
to fluctuations in demand (low impulse response)
By decreasing the AP, the forecast is more responsive
to fluctuations in demand (high impulse response)

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Simple Moving Average

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

Lets develop 3-week and 6week moving average forecasts

for demand.
Assume you only have 3 weeks
and 6 weeks of actual demand
data for the respective forecasts

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Simple Moving Average

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

Demand 3-Week 6-Week

650
678
720
785
682.67
859
727.67
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
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Simple Moving Average

1000

Demand

900
Demand

800

3-Week

700

6-Week

600
500
1

3 4

9 10 11 12

Week

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Weighted Moving Average

This is a variation on the simple moving average

where instead of the weights used to compute the
average being equal, they are not equal
This allows more recent demand data to have a
greater effect on the moving average, therefore the
forecast
. . . more

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Weighted Moving Average

The weights must add to 1.0 and generally decrease

in value with the age of the data
The distribution of the weights determine impulse
response of the forecast

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Weighted Moving Average

Ft = w1A t-1 + w 2 A t-2 + w 3A t-3 +...+w n A t-n
Week
1
2
3
4

Demand
650
678
720

Determine
n the 3-period
w i = 1 average
weightedmoving
i=1
forecast for
period 4
Weights (adding up to 1.0):
t-1: .5
t-2: .3
t-3: .2
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Solution
Week
1
2
3
4

Demand
650
678
720

Forecast

693.4

F4 = .5(720)+.3(678)+.2(650)
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Exponential Smoothing

The weights used to compute the forecast (moving

average) are exponentially distributed
The forecast is the sum of the old forecast and a
portion of the forecast error
Ft = Ft-1 + (At-1-Ft-1)
. . . more

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Exponential Smoothing

The smoothing constant, , must be between 0.0 and

1.0 (excluding 0.0 and 1.0)
A large provides a high impulse response forecast
A small provides a low impulse response forecast

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Exponential Smoothing Example

Week
1
2
3
4
5
6
7
8
9
10

Demand
820
775
680
655
750
802
798
689
775

Determine exponential
smoothing forecasts for
periods 2 through 10
using =.10 and =.60.

Let F1=D1

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Exponential Smoothing Example

Week
1
2
3
4
5
6
7
8
9
10

Demand
820
775
680
655
750
802
798
689
775

0.1
820.00
820.00
815.50
801.95
787.26
783.53
785.38
786.64
776.88
776.69

0.6
820.00
820.00
820.00
817.30
808.09
795.59
788.35
786.57
786.61
780.77
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Effect of on Forecast

Demand

900
800

Demand

700

0.1

600

0.6

500
1

10

Week

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Criteria for Selecting

a Forecasting Method

Cost
Accuracy
Data available
Time span
Nature of products and services
Impulse response and noise dampening

Slide 47 of 56

Reasons for Ineffective Forecasting

Not involving a broad cross section of people

Not recognizing that forecasting is integral to
business planning
Not recognizing that forecasts will always be wrong
(think in terms of interval rather than point forecasts)
Not forecasting the right things
(forecast independent demand only)
Not selecting an appropriate forecasting method
(use MAD to evaluate goodness of fit)
Not tracking the accuracy of the forecasting models
Slide 48 of 56

How to Monitor and

Control a Forecasting Model

Tracking Signal
nn

(Actual demand
demand -- Forecast
Forecast demand)
demand)
(Actual

ii

Tracking signal =

ii11

MAD
MAD
nn

(A -- FF ))
(A
ii

ii

ii11

MAD
MAD

Slide 49 of 56

Tracking Signal: What do you notice?

40
Sales

35
30
25
20
0

9 10 11

Period

Slide 50 of 56

Sources of Forecasting Data

Consumer Confidence Index

Consumer Price Index
Housing Starts
Index of Leading Economic Indicators
Personal Income and Consumption
Producer Price Index
Purchasing Managers Index
Retail Sales

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Wrap-Up: World-Class Practice

Predisposed to have effective methods of forecasting

because they have exceptional long-range business
planning
Formal forecasting effort
Develop methods to monitor the performance of their
forecasting models
Use forecasting software with automated model
fitting features, which is readily available today
Do not overlook the short run.... excellent short range
forecasts as well
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