4 Forecasting

PowerPoint presentation to accompany

Heizer and Render
Operations Management, 10e
Principles of Operations Management, 8e

PowerPoint slides by Jeff Heyl

© 2011 Pearson Education, Inc. publishing as Prentice Hall 4-1

 Learning Objectives
When you complete this chapter you
should be able to :
1. Understand the three time horizons
and which models apply for each use
2. Explain when to use each of the four
qualitative models
3. Apply the naive, moving average,
exponential smoothing, and trend
methods

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 Learning Objectives
When you complete this chapter you
should be able to :
4. Compute three measures of forecast
accuracy
5. Develop seasonal indexes
6. Conduct a regression and correlation
analysis
7. Use a tracking signal

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 Forecasting at Disney World
 Global portfolio includes parks in Hong
Kong, Paris, Tokyo, Orlando, and
Anaheim
 Revenues are derived from people – how
many visitors and how they spend their
money
 Daily management report contains only
the forecast and actual attendance at
each park

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 Forecasting at Disney World
 Disney generates daily, weekly, monthly,
annual, and 5-year forecasts
 Forecast used by labor management,
maintenance, operations, finance, and
park scheduling
 Forecast used to adjust opening times,
rides, shows, staffing levels, and guests
admitted

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 Forecasting at Disney World
 20% of customers come from outside the
USA
 Economic model includes gross
domestic product, cross-exchange rates,
arrivals into the USA
 A staff of 35 analysts and 70 field people
survey 1 million park guests, employees,
and travel professionals each year

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 Forecasting at Disney World
 Inputs to the forecasting model include
airline specials, Federal Reserve
policies, Wall Street trends,
vacation/holiday schedules for 3,000
school districts around the world
 Average forecast error for the 5-year
forecast is 5%
 Average forecast error for annual
forecasts is between 0% and 3%

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 What is Forecasting?
 Process of predicting
a future event
 Underlying basis
of all business
??
decisions
 Production
 Inventory
 Personnel
 Facilities

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 Forecasting Time Horizons
 Short-range forecast
 Up to 1 year, generally less than 3 months
 Purchasing, job scheduling, workforce
levels, job assignments, production levels
 Medium-range forecast
 3 months to 3 years
 Sales and production planning, budgeting
 Long-range forecast
 3+ years
 New product planning, facility location,
research and development
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 Distinguishing Differences
 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

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 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

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 Product Life Cycle
Introduction Growth Maturity Decline
Best period to Practical to change Poor time to Cost control
Company Strategy/Issues

increase market price or quality change image, critical

share image price, or quality

R&D engineering is Strengthen niche Competitive costs

critical become critical
Defend market
position Drive-through
Internet search engines restaurants
CD-ROMs
iPods LCD &
Xbox 360 plasma TVs
Sales
Avatars

Boeing 787 Analog

TVs
Twitter
Figure 2.5
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 Product Life Cycle
Introduction Growth Maturity Decline
Product design Forecasting Standardization Little product
and critical Fewer product differentiation
development Product and changes, more Cost
OM Strategy/Issues

critical process minor changes minimization

Frequent reliability Optimum Overcapacity
product and Competitive capacity in the
process design product industry
changes Increasing
improvements stability of Prune line to
Short production and options process eliminate
runs Increase capacity Long production items not
High production Shift toward runs returning
costs product focus good margin
Product
Limited models Enhance improvement Reduce
Attention to distribution and cost cutting capacity
quality

Figure 2.5
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 Types of Forecasts
 Economic forecasts
 Address business cycle – inflation rate,
money supply, housing starts, etc.
 Technological forecasts
 Predict rate of technological progress
 Impacts development of new products
 Demand forecasts
 Predict sales of existing products and
services

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 Strategic Importance of
Forecasting
 Human Resources – Hiring, training,
laying off workers
 Capacity – Capacity shortages can
result in undependable delivery, loss
of customers, loss of market share
 Supply Chain Management – Good
supplier relations and price
advantages

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 Seven Steps in Forecasting
1. Determine the use of the forecast
2. Select the items to be forecasted
3. Determine the time horizon of the
forecast
4. Select the forecasting model(s)
5. Gather the data
6. Make the forecast
7. Validate and implement results

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 The Realities!

 Forecasts are seldom perfect

 Most techniques assume an
underlying stability in the system
 Product family and aggregated
forecasts are more accurate than
individual product forecasts

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 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
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 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
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 Overview of Qualitative
Methods
1. Jury of executive opinion
 Pool opinions of high-level experts,
sometimes augment by statistical
models
2. Delphi method
 Panel of experts, queried iteratively

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 Overview of Qualitative
Methods
3. Sales force composite
 Estimates from individual
salespersons are reviewed for
reasonableness, then aggregated
4. Consumer Market Survey
 Ask the customer

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 Jury of Executive Opinion
 Involves small group of high-level
experts and managers
 Group estimates demand by working
together
 Combines managerial experience with
statistical models
 Relatively quick
 ‘Group-think’
disadvantage

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 Sales Force Composite

 Each salesperson projects his or

her sales
 Combined at district and national
levels
 Sales reps know customers’ wants
 Tends to be overly optimistic

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 Delphi Method
 Iterative group
Decision Makers
process, (Evaluate
continues until responses and
consensus is make decisions)
reached
Staff
 3 types of (Administering
survey)
participants
 Decision makers
 Staff Respondents
(People who can
 Respondents make valuable
judgments)
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 Consumer Market Survey

 Ask customers about purchasing

plans
 What consumers say, and what
they actually do are often different
 Sometimes difficult to answer

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 Overview of Quantitative
Approaches
1. Naive approach
2. Moving averages
time-series
3. Exponential models
smoothing
4. Trend projection
5. Linear regression associative
model

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 Time Series Forecasting

 Set of evenly spaced numerical data

 Obtained by observing response
variable at regular time periods
 Forecast based only on past values,
no other variables important
 Assumes that factors influencing
past and present will continue
influence in future

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 Time Series Components

Trend Cyclical

Seasonal Random

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 Components of Demand
Trend
component
Demand for product or service

Seasonal peaks

Actual demand
line

Average demand
over 4 years

Random variation
| | | |
1 2 3 4
Time (years)
Figure 4.1
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 Trend Component
 Persistent, overall upward or
downward pattern
 Changes due to population,
technology, age, culture, etc.
 Typically several years
duration

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 Seasonal Component
 Regular pattern of up and
down fluctuations
 Due to weather, customs, etc.
 Occurs within a single year
Number of
Period Length Seasons
Week Day 7
Month Week 4-4.5
Month Day 28-31
Year Quarter 4
Year Month 12
Year Week 52

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 Cyclical Component
 Repeating up and down movements
 Affected by business cycle,
political, and economic factors
 Multiple years duration
 Often causal or
associative
relationships

0 5 10 15 20
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 Random Component
 Erratic, unsystematic, ‘residual’
fluctuations
 Due to random variation or unforeseen
events
 Short duration
and nonrepeating

M T W T F
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 Naive Approach
 Assumes demand in next
period is the same as
demand in most recent period
 e.g., If January sales were 68, then
February sales will be 68
 Sometimes cost effective and
efficient
 Can be good starting point

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 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

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 Moving Average Example
Actual 3-Month
Month Shed Sales Moving Average
January 10
February 12
March 13
April 16 (10 + 12 + 13)/3 = 11 2/3
May 19 (12 + 13 + 16)/3 = 13 2/3
June 23 (13 + 16 + 19)/3 = 16
July 26 (16 + 19 + 23)/3 = 19 1/3

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 Graph of Moving Average
Moving
30 –
Average
28 –
Forecast
26 – Actual
24 – Sales
Shed Sales

22 –
20 –
18 –
16 –
14 –
12 –
10 –
| | | | | | | | | | | |
J F M A M J J A S O N D

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 Weighted Moving Average
 Used when some trend might be
present
 Older data usually less important
 Weights based on experience and
intuition
∑ (weight for period n)
Weighted x (demand in period n)
moving average = ∑ weights

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 Weights Applied Period
Weighted Moving Average 3 Last month
2 Two months ago
1 Three months ago
6 Sum of weights

Actual 3-Month Weighted

Month Shed Sales Moving Average
January 10
February 12
March 13
April 16 [(3 x 13) + (2 x 12) + (10)]/6 = 121/6
May 19 [(3 x 16) + (2 x 13) + (12)]/6 = 141/3
June 23 [(3 x 19) + (2 x 16) + (13)]/6 = 17
July 26 [(3 x 23) + (2 x 19) + (16)]/6 = 201/2

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 Potential Problems With
Moving Average
 Increasing n smooths the forecast
but makes it less sensitive to
changes
 Do not forecast trends well
 Require extensive historical data

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 Moving Average And
Weighted Moving Average
Weighted
30 – moving
average
25 –
Sales demand

20 – Actual
sales
15 –
Moving
10 – average

5 –
| | | | | | | | | | | |
J F M A M J J A S O N D
Figure 4.2
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 Exponential Smoothing
 Form of weighted moving average
 Weights decline exponentially
 Most recent data weighted most
 Requires smoothing constant ()
 Ranges from 0 to 1
 Subjectively chosen
 Involves little record keeping of past
data
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 Exponential Smoothing
New forecast = Last period’s forecast
+  (Last period’s actual demand
– Last period’s forecast)

Ft = Ft – 1 + (At – 1 - Ft – 1)

where Ft = new forecast

Ft – 1 = previous forecast
 = smoothing (or weighting)
constant (0 ≤  ≤ 1)

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 Exponential Smoothing
Example
Predicted demand = 142 Ford Mustangs
Actual demand = 153
Smoothing constant  = .20

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 Exponential Smoothing
Example
Predicted demand = 142 Ford Mustangs
Actual demand = 153
Smoothing constant  = .20

New forecast = 142 + .2(153 – 142)

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 Exponential Smoothing
Example
Predicted demand = 142 Ford Mustangs
Actual demand = 153
Smoothing constant  = .20

New forecast = 142 + .2(153 – 142)

= 142 + 2.2
= 144.2 ≈ 144 cars

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 Effect of
Smoothing Constants

Weight Assigned to
Most 2nd Most 3rd Most 4th Most 5th Most
Recent Recent Recent Recent Recent
Smoothing Period Period Period Period Period
Constant () (1 - ) (1 - ) 2 (1 - ) 3 (1 - )4

 = .1 .1 .09 .081 .073 .066

 = .5 .5 .25 .125 .063 .031

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 Impact of Different 
225 –

Actual  = .5
200 – demand
Demand

175 –

 = .1
150 – | | | | | | | | |
1 2 3 4 5 6 7 8 9
Quarter

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 Impact of Different 
225 –

Actual  = .5
200
Chose
– high values
demandof 
Demand

when underlying average

is likely to change
–
175
Choose low values of 
when underlying average  = .1
is stable|
150 – | | | | | | | |
1 2 3 4 5 6 7 8 9
Quarter

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 Choosing 

The objective is to obtain the most

accurate forecast no matter the
technique
We generally do this by selecting the
model that gives us the lowest forecast
error

Forecast error = Actual demand - Forecast value

= At - Ft

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 Common Measures of Error

Mean Absolute Deviation (MAD)

∑ |Actual - Forecast|
MAD =
n

Mean Squared Error (MSE)

∑ (Forecast Errors)2
MSE =
n

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 Common Measures of Error

Mean Absolute Percent Error (MAPE)

n
∑100|Actuali - Forecasti|/Actuali
MAPE = i=1
n

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 Comparison of Forecast
Error
Rounded Absolute Rounded Absolute
Actual Forecast Deviation Forecast Deviation
Tonnage with for with for
Quarter Unloaded  = .10  = .10  = .50  = .50
1 180 175 5.00 175 5.00
2 168 175.5 7.50 177.50 9.50
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 4.30
82.45 98.62

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 Comparison of Forecast
Error
∑ |deviations|
Rounded Absolute Rounded Absolute
MADActual
= Forecast Deviation Forecast Deviation
Tonnage n
with for with for
Quarter Unloaded  = .10  = .10  = .50  = .50
1
For 180
= .10 175 5.00 175 5.00
2 168 = 82.45/8
175.5 = 10.31
7.50 177.50 9.50
3 159 174.75 15.75 172.75 13.75
4 For 175
= .50 173.18 1.82 165.88 9.12
5 190 173.36 16.64 170.44 19.56
6 205 = 98.62/8
175.02 = 12.33
29.98 180.22 24.78
7 180 178.02 1.98 192.61 12.61
8 182 178.22 3.78 186.30 4.30
82.45 98.62

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 Comparison of Forecast
Error2
∑ (forecast errors)
Rounded Absolute Rounded Absolute
MSE = Actual Forecast Deviation Forecast Deviation
Tonnage
n
with for with for
Quarter Unloaded  = .10  = .10  = .50  = .50
1
For 180
= .10 175 5.00 175 5.00
2 = 1,526.54/8
168 175.5 = 190.82
7.50 177.50 9.50
3 159 174.75 15.75 172.75 13.75
4 For 175
= .50 173.18 1.82 165.88 9.12
5 190 173.36 16.64 170.44 19.56
6 = 1,561.91/8
205 175.02 = 195.24
29.98 180.22 24.78
7 180 178.02 1.98 192.61 12.61
8 182 178.22 3.78 186.30 4.30
82.45 98.62
MAD 10.31 12.33

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 Comparison of Forecast
n Error
∑100|deviation |/actual i i
Rounded Absolute Rounded Absolute
MAPE = i=1
Actual Forecast Deviation Forecast Deviation
Tonnage with n for with for
Quarter Unloaded  = .10  = .10  = .50  = .50
1
 = .10 175
For 180 5.00 175 5.00
2 168 = 44.75/8
175.5 = 7.50
5.59% 177.50 9.50
3 159 174.75 15.75 172.75 13.75
4 =
For 175 .50 173.18 1.82 165.88 9.12
5 190 173.36 16.64 170.44 19.56
6 205 = 54.05/8
175.02 =29.98
6.76% 180.22 24.78
7 180 178.02 1.98 192.61 12.61
8 182 178.22 3.78 186.30 4.30
82.45 98.62
MAD 10.31 12.33
MSE 190.82 195.24
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 Comparison of Forecast
Error
Rounded Absolute Rounded Absolute
Actual Forecast Deviation Forecast Deviation
Tonnage with for with for
Quarter Unloaded  = .10  = .10  = .50  = .50
1 180 175 5.00 175 5.00
2 168 175.5 7.50 177.50 9.50
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 4.30
82.45 98.62
MAD 10.31 12.33
MSE 190.82 195.24
MAPE 5.59% 6.76%
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 EXAMPLE

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SEASONAL

4 - 70
Seasonal Variations In Data

The multiplicative
seasonal model can
adjust trend data for
seasonal variations
in demand

4 - 71
Seasonal Variations In Data
Steps in the process:

1. Find average historical demand for each season

2. Compute the average demand over all seasons
3. Compute a seasonal index for each season
4. Estimate next year’s total demand
5. Divide this estimate of total demand by the
number of seasons, then multiply it by the
seasonal index for that season

4 - 72
 Seasonal Index Example
Demand Average Average Seasonal
Month 2005 2006 2007 2005-2007 Monthly Index
Jan 80 85 105 90 94
Feb 70 85 85 80 94
Mar 80 93 82 85 94
Apr 90 95 115 100 94
May 113 125 131 123 94
Jun 110 115 120 115 94
Jul 100 102 113 105 94
Aug 88 102 110 100 94
Sept 85 90 95 90 94
Oct 77 78 85 80 94
Nov 75 72 83 80 94
4 - 73
Dec 82 78 80 80 94
 Seasonal Index Example
Demand Average Average Seasonal
Month 2005 2006 2007 2005-2007 Monthly Index
Jan 80 85 105 90 94 0.957
Feb 70 85
average852005-2007 monthly
80 94
demand
Seasonal
Mar index
80 = 93 average
82 85demand 94
monthly
Apr 90 95 115 100 94
= 90/94 = .957
May 113 125 131 123 94
Jun 110 115 120 115 94
Jul 100 102 113 105 94
Aug 88 102 110 100 94
Sept 85 90 95 90 94
Oct 77 78 85 80 94
Nov 75 72 83 80 94
Dec 82 78 80 80 94 4 - 74
 Seasonal Index Example
Demand Average Average Seasonal
Month 2005 2006 2007 2005-2007 Monthly Index
Jan 80 85 105 90 94 0.957
Feb 70 85 85 80 94 0.851
Mar 80 93 82 85 94 0.904
Apr 90 95 115 100 94 1.064
May 113 125 131 123 94 1.309
Jun 110 115 120 115 94 1.223
Jul 100 102 113 105 94 1.117
Aug 88 102 110 100 94 1.064
Sept 85 90 95 90 94 0.957
Oct 77 78 85 80 94 0.851
Nov 75 72 83 80 94 0.851
Dec 82 78 80 80 94 0.851 4 - 75
 Seasonal Index Example
Demand Average Average Seasonal
Month 2005 2006 2007 2005-2007 Monthly Index
Jan 80 85 Forecast
105 for 2008
90 94 0.957
Feb 70 85 85 80 94 0.851
Mar
Expected
80
annual
93 82
demand =851,200 94 0.904
Apr 90 95 115 100 94 1.064
May 113 125 131 1,200 123 94 1.309
Jan x .957 = 96
Jun 110 115 120 12 115 94 1.223
Jul 100 102 113 105 94 1.117
Aug Feb 110 1,200
88 102 x .851
100 = 85 94 1.064
Sept 85 90 95 12 90 94 0.957
Oct 77 78 85 80 94 0.851
Nov 75 72 83 80 94 0.851
Dec 82 78 80 80 94 0.851 4 - 76
 Seasonal Index Example
2008 Forecast
2007 Demand
140 –
2006 Demand
130 – 2005 Demand
Demand

120 –
110 –
100 –
90 –
| | | | | | | | | | | |
80 –
J F M A M J J A S O N D
70 – Time
4 - 77
 Components of Demand/
Data Pattern
Trend
Demand for product or service

component
Seasonal peaks

Actual
demand

Average
demand over
Random four years
variation
| | | |
1 2 3 4
Figure 4.1
Year 4 - 78
 Associative Forecasting
(Linear Regression)
Used when changes in one or more independent
variables can be used to predict the changes in
the dependent variable
Most common technique is linear
regression analysis

We apply this technique just as we did in

the time series example

4 - 79
Associative Forecasting

Forecasting an outcome based on

predictor variables using the least
squares
^ technique
y = a + bx
where ^ y = computed value of the variable to be
predicted (dependent variable)
a = y-axis intercept
b = slope of the regression line
x = the independent variable though to predict the
value of the dependent variable

4 - 80
 Associative Forecasting

Equations to calculate the regression variables

^
y = a + bx

Sxy - nxy
b=
Sx2 - nx2
a = y - bx

4 - 81
 Associative
Forecasting (Solved The trend line is
^
Problem 4.3) y = 14.545 + 1.135x
Time Registrants, y
Year Period (x) (in thousand) x2 xy
1999 1 17 1 17
2000 2 16 4 32
2001 3 16 9 48
2002 4 21 16 84
2003 5 20 25 100
2004 6 20 36 120
2005 7 23 49 161
2006 8 25 64 200
2007 9 24 81 216
∑x = 45 ∑y = 182 ∑x2 = 285
∑xy = 978 a = y - bx
∑xy - nxy x=5
978 - (9)(5)(20.22) y = 20.22
= 20.22 – 1.135(5)
b= = = 1.135
∑x2 - nx2 285 – (9)(25) = 14.545 4 - 82
 Correlation Coefficient

 How strong is the linear relationship between the

variables?
 Correlation does not necessarily imply causality!
 Coefficient of correlation, r, measures degree of
association
 Values range from -1 to +1

nSxy - SxSy
r=
[nSx2 - (Sx)2][nSy2 - (Sy)2]

4 - 83
Coefficient of Determination

 Coefficient of Determination, r2, measures

the percent of change in y predicted by the
change in x
 Values range from 0 to 1
 Easy to interpret

4 - 84
EXERCISE

4 - 85
 Exercise
As you can see demand of heart transplant surgery at
Washington General Hospital has increased steadily in the
past few years. The directors of medical services predicted 6
years ago that demand in year 1 would be 41 surgeries.
Year 201 2014 201 2016 201 2018
3 5 7
Heart 45 50 52 56 58
Transplant
a. Use three years weighted moving average using weight
(0.5; 0.2; 0.3)
b. Use trend projection method to forecast demand in years
2013 though 2018
c. Using MAD and MSE, which of these methods is the best?

4 - 86
 Problem 4.27
Mark Cotteleer owns a company that manufactures
sailboats. Actual demand for Mark’s sailboats during
each season in 2006 throughYEAR
2009 was as follows:
Season 2006 2007 2008 2009
Winter 1,400 1,200 1,000 900
Spring 1,500 1,400 1,600 1,500
Summer 1,000 2,100 2,000 1,900
Fall 600 750 650 500

Mark has forecasted that annual demand for his

sailboats in 2011 will equal 5,600 sailboats. Based
on this daata and the multiplicative seasonal model,
what will the demand level be for Mark’s sailboats in
the spring of 2011? 4 - 87
 Problem 4.5

The Carbondale Hospital is considering the purchase

of a new ambulance. The decision will rest partly on
the anticipated mileage to be driven next year. The
miles driven during the past 5 years as follows:

Year Mileage
1 3000
2 4000
3 3400
4 3800
5 3700

4 - 88
 Problem 4.5
a. Forecast the mileage for the next year using a 2-
year moving average
b. Find the MAD based on the 2-year moving average
forecast in part (a). (Hint : You will have only 3
years of matched data)
c. Use a weighted 2-year moving average with weight
of .4 and .6 to forecast next year’s mileage. (The
weight of .6 is for the most recent year.) What MAD
results from using this approach to forecasting?
(Hint: You will have only 3 years of matched data.)
d. Compute the forecast for year 6 using exponential
smoothing, an initial forecast for year 1of 3,000
miles, and  = .5.
4 - 89
 HOMEWORK DG

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