Chapter 5

Forecasting
 Chapter Outline

5.1 Introduction
5.2 Types of Forecasts
5.3 Scatter Diagrams and Time Series
5.4 Measures of Forecast Accuracy
5.5 Time-Series Forecasting Models
5.6 Monitoring and Controlling Forecasts
5.7 Using the Computer to Forecast
 Introduction

 Managers are always trying to reduce

uncertainty and make better estimates of what
will happen in the future
 This is the main purpose of forecasting
 Some firms use subjective methods
 Seat-of-the pants methods, intuition,
experience
 There are also several quantitative techniques
 Moving averages, exponential smoothing,
trend projections, least squares regression
analysis
 Forecasting Procedure

“The forecast”

Step 8 Implement
Step 7 Make the forecast
Step 6 Validate the model
Step 5 Gather the data
Step 4 Select the forecasting model
Step 3 Determine the time horizon
Step 2 Select the items to be forecasted
Step 1 Determine purpose of forecast
 Introduction
 These steps are a systematic way of initiating,
designing, and implementing a forecasting
system
 When used regularly over time, data is
collected routinely and calculations performed
automatically
 There is seldom one superior forecasting
system
 Different organizations may use different
techniques
 Whatever tool works best for a firm is the one
they should use
 Forecasting Models
Forecasting
Techniques

Qualitative Time-Series Causal

Models Methods Methods

Delphi Moving Regression

Methods Average Analysis

Jury of Executive Exponential Multiple

Opinion Smoothing Regression

Sales Force Trend

Composite Projections

Figure 5.1
Consumer
Decomposition
Market Survey
 Time-Series Models

 Time-series models attempt to predict

the future based on the past
 Common time-series models are
 Moving average
 Exponential smoothing
 Trend projections
 Decomposition
 Regression analysis is used in trend
projections and one type of
decomposition model
 Causal Models

 Causal models use variables or factors

that might influence the quantity being
forecasted
 The objective is to build a model with
the best statistical relationship between
the variable being forecast and the
independent variables
 Regression analysis is the most
common technique used in causal
modeling
 Qualitative Models
 Qualitative models incorporate judgmental or subjective
factors
 Useful when subjective factors are thought to be important
or when accurate quantitative data is difficult to obtain
Common qualitative techniques are
 Delphi Method – an iterative group process where (possibly
geographically dispersed) respondents provide input to decision
makers
 Jury of Executive Opinion – collects opinions of a small group of
high-level managers, possibly using statistical models for
analysis
 Sales Force Composite – individual salespersons estimate the
sales in their region and the data is compiled at a district or
national level
 Consumer Market Survey – input is solicited from customers or
potential customers regarding their purchasing plans
 Scatter Diagrams
 Wacker Distributors wants to forecast sales for
three different products
YEAR TELEVISION SETS RADIOS COMPACT DISC PLAYERS
1 250 300 110
2 250 310 100
3 250 320 120
4 250 330 140
5 250 340 170
6 250 350 150
7 250 360 160
8 250 370 190
9 250 380 200
10 250 390 190

Table 5.1
 Scatter Diagrams

Scatter diagrams are helpful when forecasting time-series

data because they depict the relationship between variables.

450
400
350
Annual Sales

300
250
Televisions
200
150
100
50
0
0 2 4 6 8 10 12
Time (Years)
 Evaluating Forecasts

Forecast is always wrong, isn’t it?

Forecasts

Demands

What do we do with this information?

 Measures of Forecast Accuracy

 We compare forecasted values with actual values

to see how well one model works or to compare
models
Forecast error = Actual value – Forecast value

 One measure of accuracy is the mean absolute

deviation (MAD)

MAD 
 forecast error
n
 Measures of Forecast Accuracy
 Using a naïve forecasting model: Ft = At-1

ACTUAL ABS(OLUTE VALUE OF

SALES OF CD FORECAST ERRORS (DEVIATION),
YEAR PLAYERS (At) SALES (Ft) (ACTUAL – FORECAST)
1 110 — —
2 100 110 |100 – 110| = 10
3 120 100 |120 – 110| = 20
4 140 120 |140 – 120| = 20
5 170 140 |170 – 140| = 30
6 150 170 |150 – 170| = 20
7 160 150 |160 – 150| = 10
8 190 160 |190 – 160| = 30
9 200 190 |200 – 190| = 10
10 190 200 |190 – 200| = 10
11 — 190 —
Sum of |errors| = 160
MAD = 160/9 = 17.8

Table 5.2
 Measures of Forecast Accuracy
 Using a naïve forecasting model

MAD
YEAR
 SALES
ACTUAL
forecast error
OF CD
PLAYERS
160 ABSOLUTE VALUE OF
SALES  17.8 (ACTUAL – FORECAST)
FORECAST ERRORS (DEVIATION),

1 n
110 —9 —
2 100 110 |100 – 110| = 10
3 120 100 |120 – 110| = 20
4 140 120 |140 – 120| = 20
5 170 140 |170 – 140| = 30
6 150 170 |150 – 170| = 20
7 160 150 |160 – 150| = 10
8 190 160 |190 – 160| = 30
9 200 190 |200 – 190| = 10
10 190 200 |190 – 200| = 10
11 — 190 —
Sum of |errors| = 160
MAD = 160/9 = 17.8

Table 5.2
 Measures of Forecast Accuracy
 There are other popular measures of forecast accuracy
 The mean squared error

MSE 
 ( error) 2

n
 The mean absolute percent error

error
 actual
MAPE  100%
n
 And bias is the average error

bias 
 error
n
Time-Series Forecasting Models

 A time series is a sequence of evenly

spaced events
 Time-series forecasts predict the future
based solely of the past values of the
variable
 Other variables are ignored
 Decomposition of a Time-Series

 A time series typically has four components

1. Trend (T) is the gradual upward or downward
movement of the data over time
2. Seasonality (S) is a pattern of demand
fluctuations above or below trend line that
repeats at regular intervals
3. Cycles (C) are patterns in annual data that
occur every several years
4. Random variations (R) are “blips” in the data
caused by chance and unusual situations
 Decomposition of a Time-Series
Demand for Product or Service

Trend
Component

Seasonal Peaks

Actual
Demand
Line
Average Demand
over 4 Years

| | | |
Year Year Year Year
1 2 3 4
Time
Figure 5.3
Decomposition of a Time-Series

 There are two general forms of time-series

models
 The multiplicative model
Demand = T x S x C x R

 The additive model

Demand = T + S + C + R

 Models may be combinations of these two

forms
 Forecasters often assume errors are
normally distributed with a mean of zero
 Moving Averages

 Moving averages can be used when demand is

relatively steady over time

 The next forecast is the average of the most

recent n data values from the time series

 This methods tends to smooth out short-term

irregularities in the data series

Sum of demands in previous n periods

Moving average forecast 
n
 Moving Averages
 Mathematically

Yt  Yt 1  ...  Yt  n1
Ft 1 
n

where
Ft 1 = forecast for time period t + 1
Yt = actual value in time period t
n = number of periods to average
 Wallace Garden Supply’s Three-
Month Moving Average
MONTH ACTUAL SHED SALES THREE-MONTH MOVING AVERAGE
January 10
Forecasted
February 12
values
March 13
April 16 (10 + 12 + 13)/3 = 11.67
May 19 (12 + 13 + 16)/3 = 13.67
June 23 (13 + 16 + 19)/3 = 16.00
July 26 (16 + 19 + 23)/3 = 19.33
August 30 (19 + 23 + 26)/3 = 22.67
September 28 (23 + 26 + 30)/3 = 26.33
October 18 (26 + 30 + 28)/3 = 28.00
November 16 (30 + 28 + 18)/3 = 25.33
December 14 (28 + 18 + 16)/3 = 20.67
January — (18 + 16 + 14)/3 = 16.00

Table 5.3
 Weighted Moving Averages
 Weighted moving averages use weights to put
more emphasis on recent periods
 Often used when a trend or other pattern is
emerging

Ft 1 
 ( Weight in period i )( Actual value in period)
 ( Weights)
 Mathematically
w1Yt  w2Yt 1  ...  wnYt  n1
Ft 1 
w1  w2  ...  wn
where
wi = weight for the ith observation
 Wallace Garden Supply Example

 Wallace Garden Supply decides to try a

weighted moving average model to forecast
demand for its Storage Shed
 They decide on the following weighting
scheme
WEIGHTS APPLIED PERIOD
3 Last month
2 Two months ago
1 Three months ago
3 x Sales last month + 2 x Sales two months ago + 1 X Sales three months ago
6
Sum of the weights
 Wallace Garden Supply Example
THREE-MONTH WEIGHTED
MONTH ACTUAL SHED SALES MOVING AVERAGE
January 10 Forecasted
February 12 values
March 13
April 16 [(3 X 13) + (2 X 12) + (10)]/6 = 12.17
May 19 [(3 X 16) + (2 X 13) + (12)]/6 = 14.33
June 23 [(3 X 19) + (2 X 16) + (13)]/6 = 17.00
July 26 [(3 X 23) + (2 X 19) + (16)]/6 = 20.50
August 30 [(3 X 26) + (2 X 23) + (19)]/6 = 23.83
September 28 [(3 X 30) + (2 X 26) + (23)]/6 = 27.50
October 18 [(3 X 28) + (2 X 30) + (26)]/6 = 28.33
November 16 [(3 X 18) + (2 X 28) + (30)]/6 = 23.33
December 14 [(3 X 16) + (2 X 18) + (28)]/6 = 18.67
January — [(3 X 14) + (2 X 16) + (18)]/6 = 15.33
Table 5.4
 Wallace Garden Supply Example

Program 5.1A
 Wallace Garden Supply Example

Program 5.1B
 Exponential Smoothing
 Exponential smoothing is easy to use and
requires little record keeping of data
 It is a type of moving average

New forecast = Last period’s forecast

+ (Last period’s actual demand
– Last period’s forecast)

Where  is a weight (or smoothing constant)

with a value between 0 and 1 inclusive
 Exponential Smoothing
 Mathematically

Ft 1  Ft   (Yt  Ft )

where
Ft+1 = new forecast (for time period t + 1)
Ft = pervious forecast (for time period t)
 = smoothing constant (0 ≤  ≤ 1)
Yt = pervious period’s actual demand

 The idea is simple – the new estimate is the

old estimate plus some fraction of the error in
the last period
Selecting the Smoothing Constant

 Selecting the appropriate value for  is

key to obtaining a good forecast
 The objective is always to generate an
accurate forecast
 The general approach is to develop trial
forecasts with different values of  and
select the  that results in the lowest MAD
 Port of Baltimore Example
 Exponential smoothing forecast for two values of 
ACTUAL
TONNAGE FORECAST FORECAST
QUARTER UNLOADED USING  =0.10 USING  =0.50
1 180 175 (Any reasonable starting figure) 175
2 168 175.5 = 175.00 + 0.10(180 – 175) 177.5
3 159 174.75 = 175.50 + 0.10(168 – 175.50) 172.75
4 175 173.18 = 174.75 + 0.10(159 – 174.75) 165.88
5 190 173.36 = 173.18 + 0.10(175 – 173.18) 170.44
6 205 175.02 = 173.36 + 0.10(190 – 173.36) 180.22
7 180 178.02 = 175.02 + 0.10(205 – 175.02) 192.61
8 182 178.22 = 178.02 + 0.10(180 – 178.02) 186.30
9 ? 178.60 = 178.22 + 0.10(182 – 178.22) 184.15

Table 5.5
 Selecting the Best Value of 
ACTUAL ABSOLUTE ABSOLUTE
TONNAGE FORECAST DEVIATIONS FORECAST DEVIATIONS
QUARTER UNLOADED WITH  = 0.10 FOR  = 0.10 WITH  = 0.50 FOR  = 0.50
1 180 175 5….. 175 5….
2 168 175.5 7.5.. 177.5 9.5..
3 159 174.75 15.75 172.75 13.75
4 175 173.18 1.82 165.88 9.12
5 190 173.36 16.64 170.44 19.56
6 205 175.02 29.98 180.22 24.78
7 180 178.02 1.98 192.61 12.61
8 182 178.22 3.78 186.30 4.3..
Sum of absolute deviations 82.45 98.63
Σ|deviations|
MAD = = 10.31 MAD = 12.33
n

Table 5.6
Best choice
 Port of Baltimore Example

Program 5.2A
Port of Baltimore Example

Program 5.2B
 Exponential Smoothing with Trend
Adjustment
Forecast including trend (FITt+1) = new forecast (Ft+1) + trend correction (Tt+1)
FITt 1  Ft 1  Tt 1
Ft 1  Ft   Yt  Ft 

 Tt is computed by

Tt 1  (1   )Tt   ( Ft 1  Ft )
where
Tt+1 = smoothed trend for period t + 1
Tt = smoothed trend for preceding period
= trend smooth constant that we select
Ft+1 = simple exponential smoothed forecast for period t + 1
Ft = forecast for pervious period
 Selecting a Smoothing Constant
 As with exponential smoothing, a high value of 
makes the forecast more responsive to changes in
trend
 A low value of  gives less weight to the recent trend
and tends to smooth out the trend
 Values are generally selected using a trial-and-error
approach based on the value of the MAD for different
values of 
 Simple exponential smoothing is often referred to as
first-order smoothing
 Trend-adjusted smoothing is called second-order,
double smoothing, or Holt’s method
 Exponential Smoothing With Trend Adjustment -Example
An electronics company is selling portable CD players and estimated the demand for the first period and
forecasted the next three periods' adjusted demand using the Adjusted Exponential Smoothing model.
The first periods demand is 50 players and 54 players was used to start the forecast. α= 0.2 and β = 0.7

Step 1: Any reasonable starting

figure to start the process
Step 2:Calculate Ft+1 for period 2 Step 3: Calculate the trend Tt+1 for period 2:
F t+1 = αDt + (1- α)Ft T t+1 = β(F t+1 -Ft) + (1- β)Tt
F2 = 0.2*54+(1-0.2)*50 = 50.8 T2 = 0.7(50.8-50)+(1-0.7)*0 = 0.56

Unadjusted Adjusted
Period Demand Forecast Ft Trend Tt Forecast FITt

1 54 50 0 -
2 57 50.8 0.56 51.36
3 44 - - -

Step 4: Calculate the Adjusted FITt:

* α value is 0.2 FITt+1 = F t+1 + Tt+1
** β value is 0.7 FIT2 = 50.8 + 0.56 = 51.36
 Trend Projection
 Trend projection fits a trend line to a series of historical data
points
 The line is projected into the future for medium- to long-range
forecasts
 The simplest is a linear model developed using regression
analysis
 The mathematical form is

Yˆ  b0  b1 X
where
Ŷ = predicted value
b0 = intercept
b1 = slope of the line
X = time period (i.e., X = 1, 2, 3, …, n)
 Trend Projection

Yˆ  b0  b1 X *
Dist7
b1 
 ( X  X )(Y  Y )
(X  X )
Value of Dependent Variable

Dist5 * Dist6

* Dist3 * b0  Y  b1 X
Dist4
 X  average (mean) of X values
Dist1 * Dist2
* X
n

* Y
 Y  average (mean) of Y values
n

Time
 Midwestern Manufacturing
Company Example
 Midwestern Manufacturing Company has
experienced the following demand for it’s electrical
generators over the period of 2001 – 2007

YEAR ELECTRICAL GENERATORS SOLD

2001 74
2002 79
2003 80
2004 90
2005 105
2006 142
2007 122

Table 5.7
 Midwestern Manufacturing
Company Example

Notice code
instead of
actual years

Program 5.3A
 Midwestern Manufacturing
Company Example

r2 says model predicts

about 80% of the
variability in demand

Significance level for

F-test indicates a
definite relationship

Program 5.3B
 Midwestern Manufacturing
Company Example

160 –
150 – 
140 – 
Trend Line
130 –
Generator Demand

Yˆ  56.71  10.54 X
120 – 
110 –

100 –
90 – 
80 –  
70 –  Actual Demand Line
60 –
50 –
| | | | | | | | |

2001 2002 2003 2004 2005 2006 2007 2008 2009

Figure 5.5 Year
 Midwestern Manufacturing
Company Example

Program 5.4A
 Midwestern Manufacturing
Company Example

Program 5.4B
 Seasonal Variations
 A seasonal index indicates how a
particular season compares with an
average season
 When no trend is present, the seasonal
index can be found by dividing the
average value for a particular season by
the average of all the data
 Eichler Supplies:
Seasonal Index Example
AVERAGE AVERAGE AVERAGE
SALES DEMAND
TWO- YEAR MONTHLY SEASONAL
MONTH YEAR 1 YEAR 2 DEMAND DEMAND INDEX
January 80 100 90 94 0.957
February 85 75 80 94 0.851
March 80 90 85 94 0.904
April 110 90 100 94 1.064
May 115 131 123 94 1.309
June 120 110 115 94 1.223
July 100 110 105 94 1.117
August 110 90 100 94 1.064
September 85 95 90 94 0.957
October 75 85 80 94 0.851
November 85 75 80 94 0.851
December 80 80 80 94 0.851
Total average demand = 1,128
1,128 Average two-year demand
Average monthly demand = = 94 Seasonal index =
12 months Average monthly demand
Table 5.8
 Seasonal Variations
We then use the seasonal indices to adjust future forecast. For example,
suppose we expected the third year’s annual demand for answering machines
to be 1,200 units (one year)
1,200 1,200
Jan.  0.957  96 July  1.117  112
12 12
1,200 1,200
Feb.  0.851  85 Aug.  1.064  106
12 12
1,200 1,200
Mar.  0.904  90 Sept.  0.957  96
12 12
1,200 1,200
Apr.  1.064  106 Oct.  0.851  85
12 12
1,200 1,200
May  1.309  131 Nov.  0.851  85
12 12
1,200 1,200
June  1.223  122 Dec.  0.851  85
12 12
 Seasonal Variations with Trend
 When both trend and seasonal components are present,
the forecasting task is more complex
 Seasonal indices should be computed using a centered
moving average (CMA) approach
 There are four steps in computing seasonal indices

1. Compute the CMA for each observation (where possible)

2. Compute the seasonal ratio = Observation/CMA for that
observation
3. Average seasonal ratios to get seasonal indices
4. If seasonal indices do not add to the number of seasons,
multiply each index by (Number of seasons)/(Sum of
indices)
 Turner Industries Example
 The following are Turner Industries’ sales figures
for the past three years

QUARTER YEAR 1 YEAR 2 YEAR 3 AVERAGE

1 108 116 123 115.67
2 125 134 142 133.67
3 150 159 168 159.00
4 141 152 165 152.67
Average 131.00 140.25 149.50 140.25

Table 5.9
Seasonal
Definite trend pattern
 Turner Industries Example
 To calculate the CMA for quarter 3 of year 1 we compare the
actual sales with an average quarter centered on that time
period

 We will use 1.5 quarters before quarter 3 and 1.5 quarters

after quarter 3 – that is we take quarters 2, 3, and 4 and one
half of quarters 1, year 1 and quarter 1, year 2

0.5(108) + 125 + 150 + 141 + 0.5(116)

CMA(q3, y1) = = 132.00
4
 We compare the actual sales in quarter 3 to the CMA to find
the seasonal ratio

Sales in quarter 3 150

Seasonal ratio    1.136
CMA 132
 Turner Industries Example
YEAR QUARTER SALES CMA SEASONAL RATIO
1 1 108
2 125
3 150 132.000 1.136
4 141 134.125 1.051
2 1 116 136.375 0.851
2 134 138.875 0.965
3 159 141.125 1.127
4 152 143.000 1.063
3 1 123 145.125 0.848
2 142 147.875 0.960
3 168
4 165

 There are two seasonal Index for quarter 1 = I1 = (0.851 + 0.848)/2 = 0.85
ratios for each quarter so Index for quarter 2 = I2 = (0.965 + 0.960)/2 = 0.96
these are averaged to get Index for quarter 3 = I3 = (1.136 + 1.127)/2 = 1.13
the seasonal index
Index for quarter 4 = I4 = (1.051 + 1.063)/2 = 1.06
 Turner Industries Example
 Scatter plot of Turner Industries data and CMAs

200 – CMA

  
150 –   
 
  
Sales

100 – 

50 –
Original Sales Figures
0– | | | | | | | | | | | |

1 2 3 4 5 6 7 8 9 10 11 12
Time Period
Figure 5.6
 The Decomposition Method of
Forecasting
 Decomposition is the process of isolating linear
trend and seasonal factors to develop more
accurate forecasts
 There are five steps to decomposition
1. Compute seasonal indices using CMAs
2. Deseasonalize the data by dividing each number by
its seasonal index
3. Find the equation of a trend line using the
deseasonalized data
4. Forecast for future periods using the trend line
5. Multiply the trend line forecast by the appropriate
seasonal index
 Turner Industries –
Decomposition Method
SALES SEASONAL DESEASONALIZED
($1,000,000s) INDEX SALES ($1,000,000s)
108 0.85 127.059
125 0.96 130.208
150 1.13 132.743
141 1.06 133.019
116 0.85 136.471
134 0.96 139.583
159 1.13 140.708
152 1.06 143.396
123 0.85 144.706
142 0.96 147.917
168 1.13 148.673
165 1.06 155.660
Table 5.11
 Turner Industries –
Decomposition Method
 Find a trend line using the deseasonalized data

b1 = 2.34 b0 = 124.78

 Develop a forecast using this trend a multiply the

forecast by the appropriate seasonal index
Ŷ = 124.78 + 2.34X
= 124.78 + 2.34(13)
= 155.2 (forecast before adjustment for
seasonality)

Ŷ x I1 = 155.2 x 0.85 = 131.92

 Regression with Trend and
Seasonal Components
 Multiple regression can be used to forecast both
trend and seasonal components in a time series
 One independent variable is time
 Dummy independent variables are used to represent the
seasons
 The model is an additive decomposition model

Yˆ  a  b1 X 1  b2 X 2  b3 X 3  b4 X 4
where
X1 = time period
X2 = 1 if quarter 2, 0 otherwise
X3 = 1 if quarter 3, 0 otherwise
X4 = 1 if quarter 4, 0 otherwise
 Regression with Trend and
Seasonal Components

Program 5.6A
 Regression with Trend and
Seasonal Components

Program 5.6B (partial)

 Regression with Trend and
Seasonal Components
 The resulting regression equation is

Yˆ  104.1  2.3 X 1  15.7 X 2  38.7 X 3  30.1X 4

 Using the model to forecast sales for the first two

quarters of next year

Ŷ  104.1 2.3(13)  15.7(0)  38.7(0)  30.1(0)  134

Ŷ  104.1 2.3(14)  15.7(1)  38.7(0)  30.1(0)  152

 These are different from the results obtained

using the multiplicative decomposition method
 Use MAD and MSE to determine the best model
 Monitoring and Controlling Forecasts
 Tracking signals can be used to monitor the
performance of a forecast
 Tracking signals are computed using the following
equation
Running Sum of Forecast Errors RSFE
Tracking signal  
Mean of Absolute Deviation MAD

 Actual Demand in period i  Forecast Demand in period i

 i
MAD

where MAD 
 forecast error
n
 Monitoring and Controlling Forecasts

Signal Tripped
Upper Control Limit Tracking Signal
+

Acceptable
0 MADs Range

–
Lower Control Limit

Time

Figure 5.7
 Monitoring and Controlling Forecasts

 Positive tracking signals indicate demand is

greater than forecast
 Negative tracking signals indicate demand is less
than forecast
 Some variation is expected, but a good forecast
will have about as much positive error as
negative error
 Problems are indicated when the signal trips
either the upper or lower predetermined limits
 This indicates there has been an unacceptable
amount of variation
 Limits should be reasonable and may vary from
item to item
 Kimball’s Bakery Example
 Tracking signal for quarterly sales of croissants

TIME FORECAST ACTUAL |FORECAST | CUMULATIVE TRACKING

PERIOD DEMAND DEMAND ERROR RSFE | ERROR | ERROR MAD SIGNAL
1 100 90 –10 –10 10 10 10.0 –1
2 100 95 –5 –15 5 15 7.5 –2
3 100 115 +15 0 15 30 10.0 0
4 110 100 –10 –10 10 40 10.0 –1
5 110 125 +15 +5 15 55 11.0 +0.5
6 110 140 +30 +35 35 85 14.2 +2.5

MAD 
 forecast error 85
  14.2
n 6
RSFE 35
Tracking signal    2.5MADs
MAD 14.2
 Adaptive Smoothing

 Adaptive smoothing is the computer

monitoring of tracking signals and self-
adjustment if a limit is tripped
 In exponential smoothing, the values of 
and  are adjusted when the computer
detects an excessive amount of variation
 Using The Computer to Forecast
 Spreadsheets can be used by small and
medium-sized forecasting problems
 More advanced programs (SAS, SPSS,
Minitab) handle time-series and causal
models
 May automatically select best model
parameters
 Dedicated forecasting packages may be
fully automatic
 May be integrated with inventory planning
and control
 Controlling the quality of forecast

 Necessary to monitor forecast to ensure that the forecast is

performing adequately
 This is accomplished by comparing forecast errors to
predetermined values
 Errors that fall within the limits are considered acceptable

 Errors outside either limit indicates that corrective action is

needed.
 Tracking signal values are compared to predetermined limits
(+4,-4) based on judgment and experience
 Upper and lower limits for individual forecast errors are
calculated using control chart techniques. We will learn about
control charts in quality chapters.
 Choosing a Forecasting Technique

 No single technique works best in every situation

 The forecast horizon
 Forecasting frequency
 Forecasting is not free
 Consider cost and accuracy
 Weigh cost-accuracy trade-offs carefully
 Forecast detail, part / product level?
 Availability of
 historical data
 computers
 able users / decision makers
 Choosing a Forecasting Technique
(cont.)

 Moving Averages and Exponential Smoothing are

short range techniques. They produce forecast for the
next period

 Trend equations are used for much longer time

horizons.

 More than one forecasting techniques might be used

to increase confidence.
 Summary

 We studied the steps of forecasting

 We examined the Time Series forecasting
techniques
 We learned about seasonality, trend, cyclical
data
 Discussed monitoring forecast accuracy
 Summary
Moving Average:
Yt  Yt 1  ...  Yt  n1 Where: Ft 1 = forecast for time period t + 1
Ft 1  Yt = actual value in time period t
n
n = number of periods to average

Weighted Moving Average:

w Y  w2Yt 1  ...  wnYt  n1
Ft 1  1 t where wi = weight for the ith observation
w1  w2  ...  wn

Exponetial Smoothing: Ft+1 = new forecast (for time period t + 1)

Ft 1  Ft   (Yt  Ft ) where Ft = pervious forecast (for time period t)
 = smoothing constant (0 ≤  ≤ 1)
Yt = pervious period’s actual demand
 Summary
Exponetial Smoothing with trend adjustment:
where
FITt 1  Ft 1  Tt 1 Tt+1 =smoothed trend for period t + 1
Tt =smoothed trend for preceding period
Ft 1  Ft   Yt  Ft   =trend smooth constant that we select
Ft+1 =simple exponential smoothed forecast
Tt 1  (1   )Tt   ( Ft 1  Ft ) for period t + 1
Ft =forecast for pervious period

Trend Projection:
Yˆ  b0  b1 X where
Ŷ = predicted value
X = time period (i.e., X = 1, 2, 3, …, n)
b1 
 ( X  X )(Y  Y )
 X  average (mean) of X values
(X  X ) 2
X
n
b0  Y  b1 X Y
 Y  average (mean) of Y values
n
 Summary
four steps in computing seasonal indices
1. Compute the CMA for each observation (where possible)
2. Compute the seasonal ratio = Observation/CMA for that observation
3. Average seasonal ratios to get seasonal indices
4. If seasonal indices do not add to the number of seasons, multiply each
index by (Number of seasons)/(Sum of indices)
five steps to decomposition
1. Compute seasonal indices using CMAs
2. Deseasonalize the data by dividing each number by its seasonal index
3. Find the equation of a trend line using the deseasonalized data
4. Forecast for future periods using the trend line
5. Multiply the trend line forecast by the appropriate seasonal index

additive decomposition model X1 = time period

X2, X3, X4 = 1 if quarter 2,3, 4;
Yˆ  a  b1 X 1  b2 X 2  b3 X 3  b4 X 4 0 otherwise
 Example
Weighted
Moving Exponential
Sale Moving Smoothed Trend T Exp. Smoothing
Periods Average Smoothing
s Average (β=0.7) with Trend Adj.
(n=2) (α=0.3)
(w1=1;w2=2)
Q1/2008 236 230 0 230
231.8= 1.3= 0*(1-
Q2/2008 189 233.1 = 1.3+231.8
230+0.3*(236-230) 0.7)+0.7*(231.8-230)
Q3/2008 245 212.5 204.7 219 -8.6 210.4
Q4/2008 208 217 226.3 226.8 2.9 229.7
Q1/2009 245 226.5 220.3 221.2 -3.1 218.1
Q2/2009 199 226.5 232.7 228.3 4 232.3
Q3/2009 253 222 214.3 219.5 -5 214.5
Q4/2009 213 226 235 229.6 5.6 235.2
Q1/2010 267 233 226.3 224.6 -1.8 222.8
Q2/2010 210 240 249 237.3 8.4 245.7
Q3/2010 273 238.5 229 229.1 -3.2 225.9
Q4/2010 234 241.5 252 242.3 8.3 250.6
Q1/2011 253.5 247 239.8 0.7 240.5
MAD = 23.75 31.94 26.56 30.91
MSE = 667 1112 855 1098
 Example
Periods Sales CMAs Seasonal ratios Seasonal Indices

Q1/2008 236

Q2/2008 189
220.6=0.5*236+189+245
Q3/2008 245 1.111= 245/220.6 1.105=(1.111+1.099)/2
+208+0.5*245
Q4/2008 208 223 0.933 0.921
Q1/2009 245 225.3 1.087 1.1035
Q2/2009 199 226.9 0.877 0.87
Q3/2009 253 230.3 1.099 1.105
Q4/2009 213 234.4 0.909 0.921
Q1/2010 267 238.3 1.12 1.1035
Q2/2010 210 243.4 0.863 0.87
Q3/2010 273 1.105
Q4/2010 234 0.921
Q1/2011 1.1035
 Example
Additive
Seaso
Forecasted Decom.Model
Sale nal Deseasonalize Forecasted
Periods Base Values (Y=232.8+3.313X1-
s Indice d Sales Sales
(Y=3.351X+209) 53.313X2+1.042X3-
s
40.938X4)
1.Q1/2008 236 1.1035 213.9=236/1.1035 212.4=3.351*1+209 234.4=212.4*1.1035 236.1
2.Q2/2008 189 0.87 217.2 215.7=3.351*2+209 187.7 186.1
3.Q3/2008 245 1.105 221.7 219.1 242.1 243.8
4.Q4/2008 208 0.921 225.8 222.4 204.8 205.1
5.Q1/2009 245 1.1035 222 225.8 249.2 249.4
6.Q2/2009 199 0.87 228.7 229.1 199.3 199.4
7.Q3/2009 253 1.105 229 232.5 256.9 257
8.Q4/2009 213 0.921 231.3 235.8 217.2 218.4
9.Q1/2010 267 1.1035 242 239.2 264 262.6
10.Q2/2010 210 0.87 241.4 242.5 211 212.6
11.Q3/2010 273 1.105 247.1 245.9 271.7 270.3
12.Q4/2010 234 0.921 254.1 249.2 229.5 231.6
13.Q1/2011 1.1035 252.6 278.7 275.9

MAD = 2.62 2.78

MSE = 9 10
 Homework 05

 Prob. 4.15, 4.19

 Prob. 5.13, 5.14, 5.15, 5.16, 5.23, 5.25