3-1 Forecasting

Chapter 2: FORECASTING

Chapter contents:
• Features of forecast
• Steps in forecasting process
• Approaches to forecasting

Operations Management, Seventh Edition, by William J. Stevenson

McGraw-Hill/Irwin Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
3-2 Forecasting

Forecasting
FORECAST:
A statement about the
future value of a variable of
interest

Operations Management, Seventh Edition, by William J. Stevenson

McGraw-Hill/Irwin Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
3-3 Forecasting

Introduction

• People make and use forecasts all the time,

both in their jobs and in everyday life.
• In everyday life, they forecast answers to
questions and then make decisions based on
their forecasts.
• Forecasts are basis for budgeting, planning
capacity, sales, production and inventory,
personnel ,purchasing and more

Operations Management, Seventh Edition, by William J. Stevenson

McGraw-Hill/Irwin Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
3-4 Forecasting

• Forecasting play an important role in the

planning process because they enable
managers to anticipate the future so they can
plan accordingly.
• Used to help managers
– Plan the system
– Plan the use of the system

Operations Management, Seventh Edition, by William J. Stevenson

McGraw-Hill/Irwin Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
3-5 Forecasting

Forecast Uses
• Plan the system
– Generally involves long-range plans related to:
• Types of products and services to offer
• Facility and equipment levels
• Facility location
• Plan the use of the system
– Generally involves short- and medium-range
plans related to:
• Inventory management
• Workforce levels
• Purchasing
• Budgeting
Operations Management, Seventh Edition, by William J. Stevenson
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3-6 Forecasting

Discuss how forecast affects decisions

and activities of:
• Accounting?
• Finance?
• HR?
• Marketing?
• MIS?
• Operations?
• Product/Service design?
Operations Management, Seventh Edition, by William J. Stevenson
McGraw-Hill/Irwin Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
3-7 Forecasting

Uses of Forecasts

Accounting Cost/profit estimates

Finance Cash flow and funding

Human Resources Hiring/recruiting/training

Marketing Pricing, promotion, strategy

MIS IT/IS systems, services

Operations Schedules, MRP, workloads

Product/service design New products and services

Operations Management, Seventh Edition, by William J. Stevenson

McGraw-Hill/Irwin Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
3-8 Forecasting

Common Features of forecast

• Assumes causal system
past ==> future
• Forecasts are rarely perfect because of
randomness (Actual results usually differ from
predicted values) I see that you will
• Forecasts more accurate for get an A in this subject.

groups than individuals

• Forecast accuracy decreases
as time horizon increases

Operations Management, Seventh Edition, by William J. Stevenson

McGraw-Hill/Irwin Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
3-9 Forecasting

Elements of a Good Forecast

Timely

e
it v
c
ff e
Reliable Accurate t e
o s
C

Written

Operations Management, Seventh Edition, by William J. Stevenson

McGraw-Hill/Irwin Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
3-10 Forecasting

Steps in the Forecasting Process

“The forecast”

Step 6 Monitor the forecast

Step 5 Make the forecast
Step 4 Gather and analyze data
Step 3 Select a forecasting technique
Step 2 Establish a time horizon
Step 1 Determine purpose of forecast

Operations Management, Seventh Edition, by William J. Stevenson

McGraw-Hill/Irwin Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
3-11 Forecasting

Types/Approaches of Forecasts
• Judgmental - uses subjective inputs
(qualitative)
• Time series - uses historical data
assuming the future will be like the past
(quantitative)
• Associative models - uses explanatory
variables to predict the future

Operations Management, Seventh Edition, by William J. Stevenson

McGraw-Hill/Irwin Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
3-12 Forecasting

Judgmental Forecasts

• Executive opinions
• Sales force opinions
• Consumer surveys
• Outside opinion
• Delphi method
– Opinions of managers and staff
– Achieves a consensus forecast

Operations Management, Seventh Edition, by William J. Stevenson

McGraw-Hill/Irwin Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
3-13 Forecasting

Time Series Forecasts

(Behaviors)
• Trend - long-term movement in data
• Seasonality - short-term regular variations in
data
• Irregular variations - caused by unusual
circumstances
• Random variations - caused by chance

• CYCLE- wave like variations lasting more

than one year

Operations Management, Seventh Edition, by William J. Stevenson

McGraw-Hill/Irwin Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
3-14 Forecasting

Forecast Variations

Irregular
variation

Trend

cycle
Cycles

90
89
88
Seasonal variations

Operations Management, Seventh Edition, by William J. Stevenson

McGraw-Hill/Irwin Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
3-15 Forecasting

Types of Time Series Forecasts

• Naïve
• Simple Moving Average
• Weighted Moving Average
• Exponential Smoothing
• ES with Trend and Seasonality

Operations Management, Seventh Edition, by William J. Stevenson

McGraw-Hill/Irwin Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
3-16 Forecasting

Naive Forecasts

Uh, give me a minute....

We sold 250 wheels last
week.... Now, next week
we should sell....

The forecast for any period equals

the previous period’s actual value.

Operations Management, Seventh Edition, by William J. Stevenson

McGraw-Hill/Irwin Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
3-17 Forecasting

Uses for Naïve Forecasts

• Stable time series data

F(t) = A(t-1)
• Seasonal variations
F(t) = A(t-n)
• Data with trends
F(t) = A(t-1) + (A(t-1) – A(t-2))

Operations Management, Seventh Edition, by William J. Stevenson

McGraw-Hill/Irwin Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
3-18 Forecasting

NAÏVE METHOD
• No smoothing of data

Period 1 2 3 4 5 6 7 8 Average
Demand 74 86 88
Forecast 98 90
change 12 2

Operations Management, Seventh Edition, by William J. Stevenson

McGraw-Hill/Irwin Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
3-19 Forecasting

Naïve Forecast
• Simple to use
• Virtually no cost
• Data analysis is nonexistent
• Easily understandable
• Cannot provide high accuracy

Operations Management, Seventh Edition, by William J. Stevenson

McGraw-Hill/Irwin Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
3-20 Forecasting

Techniques for Averaging

• Moving average
• Weighted moving average
• Exponential smoothing

Operations Management, Seventh Edition, by William J. Stevenson

McGraw-Hill/Irwin Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
3-21 Forecasting

Moving Averages

• Moving average – A technique that averages a

number of recent actual values, updated as new
values become available.
n

 A i
MAn = i=1

Operations Management, Seventh Edition, by William J. Stevenson

McGraw-Hill/Irwin Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
3-22 Forecasting

Simple Moving Average

• Smoothes out randomness by averaging positive and
negative random elements over several periods
• n - number of periods (this example uses 4)

Period 1 2 3 4 5 6 7
Demand 74 90 100 60 80 90
Forecast 81 82.5 82.5

Operations Management, Seventh Edition, by William J. Stevenson

McGraw-Hill/Irwin Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
3-23 Forecasting

Points to Know on Moving Averages

• Pro: Easy to compute and understand
• Con: All data points were created equal….

…. Weighted Moving Average

Operations Management, Seventh Edition, by William J. Stevenson

McGraw-Hill/Irwin Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
3-24 Forecasting

Weighted Moving Average

• Similar to a moving average methods except that it
assigns more weight to the most recent values in a time
series.
• n -- number of periods
ai – weight applied to period t-i+1
t
Ft 1    t  i 1 A i 1 2 3
i  t  n 1 Alpha 0.6 0.3 0.1

Period 1 2 3 4 5 6 7 8 Average
Demand 46 48 47 23 40
Forecast 32.70 35.60

Operations Management, Seventh Edition, by William J. Stevenson

McGraw-Hill/Irwin Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
3-25 Forecasting

Exponential Smoothing

Ft = Ft-1 + (At-1 - Ft-1)

• Ft = Next Period
• Ft-1= Previous Period
•  = Smoothing Constant
• At-1 = Actual Result Previous Period

Operations Management, Seventh Edition, by William J. Stevenson

McGraw-Hill/Irwin Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
3-26 Forecasting

Exponential Smoothing
• Simpler equation, equivalent to WMA
a – exponential smoothing parameter (0< a<1)

• Ft  Ft1 ( At1  Ft1)

 0.1

Period 1 2 3 4 5 6 7 8 Average
Demand 74 90 100 60
Forecast 72 72.2 73.98

Operations Management, Seventh Edition, by William J. Stevenson

McGraw-Hill/Irwin Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
3-27 Forecasting

Exponential Smoothing (α=0.30)

Ft  Ft1 (At1  Ft1)
PERIOD MONTH F2 37 + (0.30)(37-37)
=
DEMAND
= 37
1 Jan 37

2 Feb 40
F3 =37+ (0.30)(40-37)

3 Mar 41 = 37.9

4 Apr 37

5 May 45

6 Jun 50
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3-28 Forecasting

Exponential Smoothing (cont.)

FORECAST, Ft + 1
PERIOD MONTH DEMAND ( = 0.3) ( = 0.5)
1 Jan 37 – –
2 Feb 40 37.00 37.00
3 Mar 41 37.90 38.50
4 Apr 37 38.83 39.75
5 May 45 38.28 38.37
6 Jun 50 40.29 41.68
7 Jul 43 43.20 45.84
8 Aug 47 43.14 44.42
9 Sep 56 44.30 45.71
10 Oct 52 47.81 50.85
11 Nov 55 49.06 51.42
12 Dec 54 50.84 53.21
13 Jan – 51.79 53.61

Operations Management, Seventh Edition, by William J. Stevenson

McGraw-Hill/Irwin Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
3-29 Forecasting

Associative /Linear Trend Equation

Y

Yt = a + bt
a
0 1 2 3 4 5 t
• b is the line slope.

Operations Management, Seventh Edition, by William J. Stevenson

McGraw-Hill/Irwin Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
3-30 Forecasting

Calculating a and b

n  (ty) -  t  y
b =
2
n t - (  t) 2

 y - b t
a =
n

Operations Management, Seventh Edition, by William J. Stevenson

McGraw-Hill/Irwin Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
3-31 Forecasting

Linear Trend Equation Example

t y
Week t2 Sales ty
1 1 150 150
2 4 157 314
3 9 162 486
4 16 166 664
5 25 177 885

 t = 15 t2 = 55  y = 812  ty = 2499

(t)2 = 225

Operations Management, Seventh Edition, by William J. Stevenson

McGraw-Hill/Irwin Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
3-32 Forecasting

Linear Trend Calculation

5 (2499) - 15(812) 12495-12180

b = = = 6.3
5(55) - 225 275 -225

812 - 6.3(15)
a = = 143.5
5

y = 143.5 + 6.3t
Operations Management, Seventh Edition, by William J. Stevenson
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3-33 Forecasting

Disadvantage of simple linear regression

1-apply only to linear relationship with an

independent variable.
2-one needs a considerable amount of data to
establish the relationship (at least 20).
3-all observations are weighted equally

Operations Management, Seventh Edition, by William J. Stevenson

McGraw-Hill/Irwin Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
3-34 Forecasting

Sources of forecast errors

• The model may be inadequate.

• Irregular variation may be occur.
• The forecasting technique may be used
incorrectly or the results misinterpreted.
• There are always random variation in the
data.

Operations Management, Seventh Edition, by William J. Stevenson

McGraw-Hill/Irwin Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
3-35 Forecasting

End Notes

• The two most important factors in choosing

a forecasting technique:
– Cost
– Accuracy
• Keep it SIMPLE!

Operations Management, Seventh Edition, by William J. Stevenson

McGraw-Hill/Irwin Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.