Forecasting

3
PowerPoint presentation to accompany
Heizer, Render, Munson
Operations Management, Thirteenth Edition, Global Edition
Principles of Operations Management, Eleventh Edition

PowerPoint slides by Jeff Heyl

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 Outline
▶ Global Company Profile:
Walt Disney Parks & Resorts

▶ What Is Forecasting?
▶ The Strategic Importance of Forecasting
▶ Seven Steps in the Forecasting System
▶ Forecasting Approaches

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 Outline - Continued

▶ Time-Series Forecasting
▶ Associative Forecasting Methods:
Regression and Correlation Analysis
▶ Monitoring and Controlling Forecasts
▶ Forecasting in the Service Sector

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 Forecasting Provides a Competitive
Advantage for Disney

►Global portfolio includes parks in Shanghai,

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 Provides a Competitive
Advantage for Disney

►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 Provides a Competitive
Advantage for Disney

►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 Provides a Competitive
Advantage for Disney

► 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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 Learning Objectives

When you complete this chapter you should

be able to :
4.1 Understand the three time horizons and
which models apply for each
4.2 Explain when to use each of the four
qualitative models
4.3 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 :
4.4 Compute three measures of forecast
accuracy
4.5 Develop seasonal indices
4.6 Conduct a regression and correlation
analysis
4.7 Use a tracking signal

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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
1. Short-range forecast
► Up to 1 year, generally less than 3 months
► Purchasing, job scheduling, workforce levels,
job assignments, production levels
2. Medium-range forecast
► 3 months to 3 years
► Sales and production planning, budgeting
3. Long-range forecast
► 3+ years
► New product planning, facility location, capital
expenditures, research and development

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 Distinguishing Differences

1. Medium/long range forecasts deal with more

comprehensive issues and support
management decisions regarding planning
and products, plants and processes
2. Short-term forecasting usually employs
different methodologies than longer-term
forecasting
3. 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

increase market price or quality change image, critical
share image price, or quality
Company Strategy/Issues

R&D engineering is Strengthen niche Competitive costs

critical become critical

Defend market
position
Hybrid engine vehicles Xbox One
Boeing 787
3D printers
Boeing 747

Life Cycle Curve Electric vehicles

DVDs
Autonomous Video
vehicles Virtual reality physical
rentals

Figure 2.5
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 Product Life Cycle
Introduction Growth Maturity Decline
Product design Forecasting critical Standardization Little product
and development Product and Fewer rapid differentiation
critical process reliability product changes, Cost
Frequent product Competitive more minor minimization
and process changes
Strategy/Issues

product Overcapacity in
OMStrategy/Issues

design changes improvements and Optimum capacity the industry

Short production options Increasing stability Prune line to
runs Increase capacity of process eliminate items
High production Shift toward not returning
costs product focus good margin
Limited models Enhance Reduce
Long production capacity
Attention to quality distribution runs
OM

Product
improvement and
cost cutting

Figure 2.5
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 Types of Forecasts

1. Economic forecasts
► Address business cycle – inflation rate, money
supply, housing starts, etc.
2. Technological forecasts
► Predict rate of technological progress
► Impacts development of new products
3. Demand forecasts
► Predict sales of existing products and services

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 Strategic Importance of Forecasting

► Supply Chain Management – Good supplier

relations, advantages in product innovation,
cost and speed to market
► Human Resources – Hiring, training, laying off
workers
► Capacity – Capacity shortages can result in
undependable delivery, loss of customers,
loss of market share

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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 needed to make the
forecast
6. Make the forecast
7. Validate and implement the results

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 The Realities!

► Forecasts are seldom perfect,

unpredictable outside factors may
impact the forecast
► 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 augmented 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. 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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 Delphi Method
► Iterative group process,
continues until consensus is
reached Decision Makers
(Evaluate responses
► Three types of participants
and make decisions)
► Decision makers
► Staff
Staff
► Respondents (Administering
survey)

Respondents
(People who can make
valuable judgments)
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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
► May be overly optimistic

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 Market Survey

► Ask customers about purchasing plans

► Useful for demand and product design
and planning
► What consumers say and what they
actually do may be different
► May be overly optimistic

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 Overview of Quantitative Approaches

1. Naive approach
2. Moving averages
3. Exponential smoothing
4. Trend projection Time-series
5. Linear regression models

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

PERIOD LENGTH “SEASON” LENGTH NUMBER OF “SEASONS” IN PATTERN

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
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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 Averages

► MA is a series of arithmetic means

► Used if little or no trend
► Used often for smoothing
► Provides overall impression of data over time

Moving average =
å demand in previous n periods
n

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 Moving Average Example

MONTH ACTUAL SHED SALES 3-MONTH 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
August 30 (19 + 23 + 26)/3 = 22 2/3
September 28 (23 + 26 + 30)/3 = 26 1/3
October 18 (26 + 30 + 28)/3 = 28
November 16 (30 + 28 + 18)/3 = 25 1/3
December 14
(28 + 18 + 16)/3 = 20 2/3

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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

Weighted å ( ( Weight for period n) ( Demand in period n) )

moving =
average å Weights

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 Weighted Moving Average

MONTH ACTUAL SHED SALES 3-MONTH WEIGHTED MOVING AVERAGE

January 10
February 12
March 13
April 16 [(3 x 13) + (2 x 12) + (10)]/6 = 12 1/6
May 19
June WEIGHTS
23 APPLIED PERIOD

July 26 3 Last month

August 30 2 Two months ago

September 28 1 Three months ago

October 18 6 Sum of the weights

November Forecast for

16this month =
December 3 x 14
Sales last mo. + 2 x Sales 2 mos. ago + 1 x Sales 3 mos. ago
Sum of the weights

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 Weighted Moving Average

MONTH ACTUAL SHED SALES 3-MONTH WEIGHTED MOVING AVERAGE

January 10
February 12
March 13
April 16 [(3 x 13) + (2 x 12) + (10)]/6 = 12 1/6
May 19 [(3 x 16) + (2 x 13) + (12)]/6 = 14 1/3
June 23 [(3 x 19) + (2 x 16) + (13)]/6 = 17
July 26 [(3 x 23) + (2 x 19) + (16)]/6 = 20 1/2
August 30 [(3 x 26) + (2 x 23) + (19)]/6 = 23 5/6
September 28 [(3 x 30) + (2 x 26) + (23)]/6 = 27 1/2
October 18
[(3 x 28) + (2 x 30) + (26)]/6 = 28 1/3
November 16
[(3 x 18) + (2 x 28) + (30)]/6 = 23 1/3
December 14
[(3 x 16) + (2 x 18) + (28)]/6 = 18 2/3

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 Potential Problems With
Moving Average

1. Increasing n smooths the forecast but makes it less

sensitive to changes
2. Does not forecast trends well
3. Requires extensive historical data

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 Graph of Moving Averages
Weighted moving average (from Example 2)

30 –

25 –
Sales demand

20 –
Actual sales
15 –

Moving average
10 –
(from Example 1)

5–
| | | | | | | | | | | |

J F M A M J J A S O N D
Figure 4.2 Month

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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

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

Ft = Ft – 1 + a(At – 1 – Ft – 1)

where Ft = new forecast

Ft – 1 = previous period’s forecast
a = smoothing (or weighting) constant (0 ≤ a ≤ 1)
At – 1 = previous period’s actual demand

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 Exponential Smoothing Example

Predicted demand = 142 Ford Mustangs

Actual demand = 153
Smoothing constant a = .20

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 Exponential Smoothing Example

Predicted demand = 142 Ford Mustangs

Actual demand = 153
Smoothing constant a = .20

New forecast = 142 + .2(153 – 142)

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 Exponential Smoothing Example

Predicted demand = 142 Ford Mustangs

Actual demand = 153
Smoothing constant a = .20

New forecast = 142 + .2(153 – 142)

= 142 + 2.2
= 144.2 ≈ 144 cars

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 Effect of
Smoothing Constants
▶Smoothing constant generally .05 ≤ a ≤ .50
▶As a increases, older values become less
significant

WEIGHT ASSIGNED TO
MOST 2ND MOST 3RD MOST 4th MOST 5th MOST
RECENT RECENT RECENT RECENT RECENT
SMOOTHING PERIOD PERIOD PERIOD PERIOD PERIOD
CONSTANT (a ) a (1 – a ) a (1 – a )2 a (1 – a )3 a (1 – a )4
a = .1 .1 .09 .081 .073 .066
a = .5 .5 .25 .125 .063 .031

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 Impact of Different 

225 –
Actual a = .5
demand
200 –
Demand

175 –
a = .1
| | | | | | | | |
150 –
1 2 3 4 5 6 7 8 9
Quarter
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 Impact of Different 

225 –
Actual a = .5
► Choose high of  values
demand
when
200 – underlying average
Demand

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

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
according to one of three preferred measures:

► Mean Absolute Deviation (MAD)

► Mean Squared Error (MSE)
► Mean Absolute Percent Error (MAPE)

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 Common Measures of Error

Mean Absolute Deviation (MAD)

MAD =
å Actual - Forecast
n

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 Determining the MAD
ACTUAL
TONNAGE FORECAST WITH
QUARTER UNLOADED FORECAST WITH a = .10 a = .50
1 180 175 175
2 168 175.50 = 175.00 + .10(180 – 175) 177.50
3 159 174.75 = 175.50 + .10(168 – 175.50) 172.75
4 175 173.18 = 174.75 + .10(159 – 174.75) 165.88
5 190 173.36 = 173.18 + .10(175 – 173.18) 170.44
6 205 175.02 = 173.36 + .10(190 – 173.36) 180.22
7 180 178.02 = 175.02 + .10(205 – 175.02) 192.61
8 182 178.22 = 178.02 + .10(180 – 178.02) 186.30
9 ? 178.59 = 178.22 + .10(182 – 178.22) 184.15

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 Determining the MAD
ACTUAL FORECAST ABSOLUTE FORECAST ABSOLUTE
TONNAGE WITH DEVIATION WITH DEVIATION
QUARTER UNLOADED a = .10 FOR a = .10 a = .50 FOR a = .50
1 180 175 5.00 175 5.00
2 168 175.50 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
Sum of absolute deviations: 82.45 98.62

Σ|Deviations|
MAD = 10.31 12.33
n

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 Common Measures of Error

Mean Squared Error (MSE)

2

MSE =
å ( Forecast errors)
n

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 Determining the MSE
ACTUAL
TONNAGE FORECAST FOR
QUARTER UNLOADED a = .10 (ERROR)2
1 180 175 52 = 25
2 168 175.50 (–7.5)2 =
56.25
3 159 174.75 (–15.75)2 =
248.06
4 175 173.18 (1.82)2 =
3.31
5 190 173.36 (16.64)2 =
276.89
6 205 175.02 (29.98)2 =
898.80
7 180 178.02 (1.98)2 =
3.92
2
8
MSE =
å ( Forecast errors)
182 178.22 (3.78)2
14.29 / 8 =190.8
=1,526.52
=

n Sum of errors squared = 1,526.52

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 Common Measures of Error

Mean Absolute Percent Error (MAPE)

n

å 100 Actual - Forecast i i

/ Actuali
MAPE = i=1
n

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 Determining the MAPE
ACTUAL
TONNAGE FORECAST FOR ABSOLUTE PERCENT ERROR
QUARTER UNLOADED a = .10 100(|ERROR|/ACTUAL)
1 180 175.00 100(5/180) = 2.78%
2 168 175.50 100(7.5/168) = 4.46%
3 159 174.75 100(15.75/159) = 9.90%
4 175 173.18 100(1.82/175) = 1.05%
5 190 173.36 100(16.64/190) = 8.76%
6 205 175.02 100(29.98/205) = 14.62%
7 180 178.02 100(1.98/180) = 1.10%
8 182 178.22 100(3.78/182) = 2.08%
Sum of % errors = 44.75%

MAPE =
å absolute percent error 44.75%
= =5.59%
n 8
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Comparison of Measures

TABLE 4.1 Comparison of Measures of Forecast Error

MEASURE MEANING APPLICATION TO CHAPTER EXAMPLE
Mean absolute How much the forecast For a = .10 in Example 4, the forecast for grain
deviation (MAD) missed the target unloaded was off by an average of 10.31 tons.
Mean squared The square of how much For a = .10 in Example 5, the square of the forecast
error (MSE) the forecast missed the error was 190.8. This number does not have a
target physical meaning, but is useful when compared to
the MSE of another forecast.
Mean absolute The average percent For a = .10 in Example 6, the forecast is off by 5.59%
percent error error on average. As in Examples 4 and 5, some forecasts
(MAPE) were too high, and some were low.

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 Comparison of Forecast Error
Rounded Absolute Rounded Absolute
Actual Forecast Deviation Forecast Deviation
Tonnage with for with for
Quarter Unloaded a = .10 a = .10 a = .50 a = .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
Rounded Absolute Rounded Absolute
Actual ∑ |deviations|
Forecast Deviation Forecast Deviation
MADTonnage
= with for with for
a = .10 a = .10 a = .50 a = .50
Quarter Unloaded
n
1 180 175 5.00 175 5.00
2 For a 168
= .10 175.5 7.50 177.50 9.50
3 159 = 82.45/8
174.75 = 10.31
15.75 172.75 13.75
4 175 173.18 1.82 165.88 9.12
5 For a 190
= .50 173.36 16.64 170.44 19.56
6 205 175.02 29.98 180.22 24.78
7 180 = 98.62/8
178.02 = 12.33
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
Rounded Absolute Rounded Absolute
∑ (forecast
Actual errors)Deviation
Forecast 2 Forecast Deviation
MSE = Tonnage with for with for
Quarter Unloaded an
= .10 a = .10 a = .50 a = .50
1 180 175 5.00 175 5.00
2 For a 168
= .10 175.5 7.50 177.50 9.50
3 159= 1,526.52/8
174.75 = 190.8
15.75 172.75 13.75
4 175 173.18 1.82 165.88 9.12
5 For a 190
= .50 173.36 16.64 170.44 19.56
6 205 175.02 29.98 180.22 24.78
7 = 1,561.91/8
180 178.02 = 195.24
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 Error
nRounded Absolute Rounded Absolute
∑
Actual 100|deviation
Forecast
i|/actuali
Deviation Forecast Deviation
MAPE
Quarter
=Unloaded
Tonnage
i=1 with
a = .10
for
a = .10
with
a = .50
for
a = .50
1 180 175 5.00
n 175 5.00
2 For a
168= .10 175.5 7.50 177.50 9.50
3 159 = 174.75
44.75%/8 =15.75
5.59% 172.75 13.75
4 175 173.18 1.82 165.88 9.12
5 For a
190= .50 173.36 16.64 170.44 19.56
6 205 175.02 29.98 180.22 24.78
7 180 = 178.02
54.00%/8 =1.98
6.75% 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 a = .10 a = .10 a = .50 a = .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% 6.75%
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 Exponential Smoothing with Trend
Adjustment

When a trend is present, exponential

smoothing must be modified
MONTH ACTUAL DEMAND FORECAST (Ft) FOR MONTHS 1 – 5

1 100 F1 = 100 (given)

2 200 F2 = F1 + a(A1 – F1) = 100 + .4(100 – 100) = 100

3 300 F3 = F2 + a(A2 – F2) = 100 + .4(200 – 100) = 140
4 400 F4 = F3 + a(A3 – F3) = 140 + .4(300 – 140) = 204
5 500 F5 = F4 + a(A4 – F4) = 204 + .4(400 – 204) = 282

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 Exponential Smoothing with Trend
Adjustment

Forecast Exponentially Exponentially

including (FITt) = smoothed (Ft) + smoothed (Tt)
trend forecast trend
Ft = a(At − 1) + (1 − a)(Ft − 1 + Tt − 1)
Tt = b(Ft − Ft − 1) + (1 − b)Tt − 1
where Ft = exponentially smoothed forecast average
Tt = exponentially smoothed trend
At = actual demand
a = smoothing constant for average (0 ≤ a ≤ 1)
b = smoothing constant for trend (0 ≤ b ≤ 1)
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 Exponential Smoothing with Trend
Adjustment

Step 1: Compute Ft
Step 2: Compute Tt
Step 3: Calculate the forecast FITt = Ft + Tt

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Exponential Smoothing with Trend
Adjustment Example

MONTH (t) ACTUAL DEMAND (At) MONTH (t) ACTUAL DEMAND (At)

1 12 6 21

2 17 7 31

3 20 8 28

4 19 9 36

5 24 10 ?

a = .2 b = .4

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Exponential Smoothing with Trend
Adjustment Example
TABLE 4.2 Forecast with a = .2 and b = .4
SMOOTHED FORECAST
FORECAST SMOOTHED INCLUDING TREND,
MONTH ACTUAL DEMAND AVERAGE, Ft TREND, Tt FITt
1 12 11 2 13.00
2 17 12.80
3 20
4 19
5 24
Step 1: Average for Month 2
6 21
7 31 F2 = aA1 + (1 – a)(F1 + T1)
8 28
9 36
F2 = (.2)(12) + (1 – .2)(11 + 2)
10 — = 2.4 + (.8)(13) = 2.4 + 10.4
= 12.8 units
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Exponential Smoothing with Trend
Adjustment Example
TABLE 4.2 Forecast with a = .2 and b = .4
SMOOTHED FORECAST
FORECAST SMOOTHED INCLUDING TREND,
MONTH ACTUAL DEMAND AVERAGE, Ft TREND, Tt FITt
1 12 11 2 13.00
2 17 12.80 1.92
3 20
4 19
5 24 Step 2: Trend for Month 2
6 21
7 31
T2 = b(F2 − F1) + (1 − b)T1
8 28
9 36 T2 = (.4)(12.8 − 11) + (1 − .4)(2)
10 —
= .72 + 1.2 = 1.92 units
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Exponential Smoothing with Trend
Adjustment Example
TABLE 4.2 Forecast with a = .2 and b = .4
SMOOTHED FORECAST
FORECAST SMOOTHED INCLUDING TREND,
MONTH ACTUAL DEMAND AVERAGE, Ft TREND, Tt FITt
1 12 11 2 13.00
2 17 12.80 1.92 14.72
3 20
4 19
5 24
Step 3: Calculate FIT for Month 2
6 21
7 31
FIT2 = F2 + T2
8 28
9 36 FIT2 = 12.8 + 1.92
10 —
= 14.72 units
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Exponential Smoothing with Trend
Adjustment Example
TABLE 4.2 Forecast with a = .2 and b = .4
SMOOTHED FORECAST
FORECAST SMOOTHED INCLUDING TREND,
MONTH ACTUAL DEMAND AVERAGE, Ft TREND, Tt FITt
1 12 11 2 13.00
2 17 12.80 1.92 14.72
3 20 15.18 2.10 17.28
4 19 17.82 2.32 20.14
5 24 19.91 2.23 22.14
6 21 22.51 2.38 24.89
7 31 24.11 2.07 26.18
8 28 27.14 2.45 29.59
9 36 29.28 2.32 31.60
10 — 32.48 2.68 35.16

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Exponential Smoothing with Trend
Adjustment Example

40 – Figure 4.3

35 – Actual demand (At)

30 –
Product demand

25 –
20 –
15 –
10 – Forecast including trend (FITt)
5 – with  = .2 and  = .4

0 –
| | | | | | | | |
1 2 3 4 5 6 7 8 9
Time (months)
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 Trend Projections

Fitting a trend line to historical data points to

project into the medium to long-range
Linear trends can be found 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

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 Least Squares Method
Values of Dependent Variable (y-values)

Actual observation Deviation7

(y-value)

Deviation5 Deviation6

Deviation3
Least squares method minimizes the
sum of Deviation
the squared
4
errors (deviations)

Deviation1
(error) Deviation2
Trend line, ^y = a + bx

| | | | | | |
1 2 3 4 5 6 7
Figure 4.4
Time period
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 Least Squares Method

Equations to calculate the regression variables

ŷ =a + bx

b=
å xy - nxy
å x - nx 2 2

a =y - bx
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 Least Squares Example

ELECTRICAL ELECTRICAL
YEAR POWER DEMAND YEAR POWER DEMAND
1 74 5 105
2 79 6 142
3 80 7 122
4 90

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 Least Squares Example

ELECTRICAL POWER
YEAR (x) DEMAND (y) x2 xy
1 74 1 74
2 79 4 158
3 80 9 240
4 90 16 360
5 105 25 525
6 142 36 852
7 122 49 854
Σx = 28 Σy = 692 Σx2 = 140 Σxy = 3,063

x=
å x 28
= =4 y=
å y 692
= =98.86
n 7 n 7

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 Least Squares Example
å xy - nxy 3,063 - ( 7) ( 4) ( 98.86) 295
b = ELECTRICAL
= POWER = =10.54
YEAR (x) å x - nx2
DEMAND (y)2
140 - ( 7) ( 4 ) x 28
2 2
xy
1 74 1 74
2 79 4 158
3 80 - 10.54 4 =56.70
a =y - bx =98.86 ( ) 9 240
4 90 16 360
5 105 25 525
Thus, ŷ =56.70 +10.54x
6 142 36 852
7 122 49 854
Σx = 28 Σy = 692 Σx2 = 140 Σxy = 3,063

x=
å
Demandx 28
= =4 y=
å
in year 8 = 56.70y + 10.54(8)
=
692
=98.86
n 7 = 141.02,
n or
7 141 megawatts

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 Least Squares Example
Trend line,
160 – ^ y = 56.70 + 10.54x

150 –
Power demand (megawatts)

140 –
130 –
120 –
110 –
100 –
90 –
80 –
70 –
60 –
50 –
| | | | | | | | |
1 2 3 4 5 6 7 8 9
Year Figure 4.5
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 Least Squares Requirements

1. We always plot the data to insure a linear relationship

2. We do not predict time periods far beyond the database
3. Deviations around the least squares line are assumed to
be random

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 Seasonal Variations In Data

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

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 Seasonal Variations In Data

Steps in the process for monthly seasons:

1. Find average historical demand for each month

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

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 Seasonal Index Example
DEMAND
AVERAGE AVERAGE
PERIOD MONTHLY SEASONAL
MONTH YEAR 1 YEAR 2 YEAR 3 DEMAND DEMAND INDEX
Jan 80 85 105 90
Feb 70 85 85 80
Mar 80 93 82 85
Apr 90 95 115 100
May 113 125 131 123
June 110 115 120 115
July 100 102 113 105
Aug 88 102 110 100
Sept 85 90 95 90
Oct 77 78 85 80
Nov 75 82 83 80
Dec 82 78 80 80
Total average annual demand = 1,128
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 Seasonal Index Example
DEMAND
AVERAGE AVERAGE
PERIOD MONTHLY SEASONAL
MONTH YEAR 1 YEAR 2 YEAR 3 DEMAND DEMAND INDEX
Jan 80 85 105 90 94
Feb 70 85 85 80 94
Mar 80 93 82 85 94
Apr
Average
90 95 1,128
115 100 94
May
monthly
113
=125 131
= 94 123 94
demand 12 months
June 110 115 120 115 94
July 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 82 83 80 94
Dec 82 78 80 80 94
Total average annual demand = 1,128
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 Seasonal Index Example
DEMAND
AVERAGE AVERAGE
PERIOD MONTHLY SEASONAL
MONTH YEAR 1 YEAR 2 YEAR 3 DEMAND DEMAND INDEX
Jan 80 85 105 90 94 .957 ( = 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
Seasonal110
June Average
115 monthly
120 demand
115 for past 394
years
=
July index 100 102 Average
113 monthly
105 demand 94
Aug 88 102 110 100 94
Sept 85 90 95 90 94
Oct 77 78 85 80 94
Nov 75 82 83 80 94
Dec 82 78 80 80 94
Total average annual demand = 1,128
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 Seasonal Index Example
DEMAND
AVERAGE AVERAGE
PERIOD MONTHLY SEASONAL
MONTH YEAR 1 YEAR 2 YEAR 3 DEMAND DEMAND INDEX
Jan 80 85 105 90 94 .957 ( = 90/94)
Feb 70 85 85 80 94 .851 ( = 80/94)
Mar 80 93 82 85 94 .904 ( = 85/94)
Apr 90 95 115 100 94 1.064 ( = 100/94)
May 113 125 131 123 94 1.309 ( = 123/94)
June 110 115 120 115 94 1.223 ( = 115/94)
July 100 102 113 105 94 1.117 ( = 105/94)
Aug 88 102 110 100 94 1.064 ( = 100/94)
Sept 85 90 95 90 94 .957 ( = 90/94)
Oct 77 78 85 80 94 .851 ( = 80/94)
Nov 75 82 83 80 94 .851 ( = 80/94)
Dec 82 78 80 80 94 .851 ( = 80/94)
Total average annual demand = 1,128
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 Seasonal Index Example
Seasonal forecast for Year 4
MONTH DEMAND MONTH DEMAND

Jan 1,200 July 1,200

× .957 = 96 × 1.117 = 112
12 12
Feb 1,200 Aug 1,200
× .851 = 85 × 1.064 = 106
12 12
Mar 1,200 Sept 1,200
× .904 = 90 × .957 = 96
12 12
Apr 1,200 Oct 1,200
× 1.064 = 106 × .851 = 85
12 12
May 1,200 Nov 1,200
× 1.309 = 131 × .851 = 85
12 12
June 1,200 Dec 1,200
× 1.223 = 122 × .851 = 85
12 12

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 Seasonal Index Example

Year 4 Forecast
140 – Year 3 Demand
130 – Year 2 Demand
Year 1 Demand
120 –
Demand

110 –
100 –
90 –
80 –
70 –
| | | | | | | | | | | |
J F M A M J J A S O N D
Time
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 San Diego Hospital
Trend Data Figure 4.6

10,200 –

10,000 –
Inpatient Days

9745
9,800 – 9659 9702
9573 9616 9766
9,600 – 9530 9680 9724
9594 9637
9551
9,400 –

9,200 –
| | | | | | | | | | | |
9,000 –
Jan Feb Mar Apr May June July Aug Sept Oct Nov Dec
67 68 69 70 71 72 73 74 75 76 77 78
Month
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San Diego Hospital

Seasonality Indices for Adult Inpatient Days at San Diego Hospital

MONTH SEASONALITY INDEX MONTH SEASONALITY INDEX

January 1.04 July 1.03

February 0.97 August 1.04

March 1.02 September 0.97

April 1.01 October 1.00

May 0.99 November 0.96

June 0.99 December 0.98

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San Diego Hospital
Seasonal Indices Figure 4.7

1.06 –
1.04 1.04
Index for Inpatient Days

1.04 – 1.03
1.02
1.02 – 1.01
1.00
1.00 – 0.99
0.98
0.98 – 0.99
0.96 – 0.97 0.97
0.96
0.94 –
| | | | | | | | | | | |
0.92 –
Jan Feb Mar Apr May June July Aug Sept Oct Nov Dec
67 68 69 70 71 72 73 74 75 76 77 78
Month
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San Diego Hospital

Period 67 68 69 70 71 72

Month Jan Feb Mar Apr May June

Forecast with 9,911 9,265 9,764 9,691 9,520 9,542

Trend &
Seasonality
Period 73 74 75 76 77 78

Month July Aug Sept Oct Nov Dec

Forecast with 9,949 10,068 9,411 9,724 9,355 9,572

Trend &
Seasonality

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 San Diego Hospital
Combined Trend and Seasonal Forecast Figure 4.8

10,200 – 10,068
9,949
10,000 – 9,911
Inpatient Days

9,764 9,724
9,800 – 9,691
9,572
9,600 –
9,520 9,542
9,400 –
9,411
9,265 9,355
9,200 –
| | | | | | | | | | | |
9,000 –
Jan Feb Mar Apr May June July Aug Sept Oct Nov Dec
67 68 69 70 71 72 73 74 75 76 77 78
Month
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 Adjusting Trend Data

ŷseasonal =Index ´ ŷtrend forecast

Quarter I: ŷI =(1.30)($100,000) =$130,000

Quarter II: ŷII =(.90)($120,000) =$108,000
Quarter III: ŷIII =(.70)($140,000) =$98,000
Quarter IV: ŷIV =(1.10)($160,000) =$176,000

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 Cyclical Variations

• Cycles – patterns in the data that occur every several years

• Forecasting is difficult
• Wide variety of factors

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 Associative Forecasting

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

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 Associative Forecasting

Forecasting an outcome based on predictor

variables using the least squares technique

ŷ =a +bx

where ŷ = value of the dependent variable (in our example,

sales)
a = y - axis intercept
b = slope of the regression line
x = the independent variable

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 Associative Forecasting Example

NODEL’S SALES AREA PAYROLL NODEL’S SALES AREA PAYROLL

(IN $ MILLIONS), y (IN $ BILLIONS), x (IN $ MILLIONS), y (IN $ BILLIONS), x
2.0 1 2.0 2
3.0 3 2.0 1
2.5 4 3.5 7

4.0 –
Nodel’s sales
(in $ millions)

3.0 –

2.0 –

1.0 –

| | | | | | |

0 1 2 3 4 5 6 7
Area payroll (in $ billions)
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 Associative Forecasting Example
SALES, y PAYROLL, x x2 xy
2.0 1 1 2.0
3.0 3 9 9.0
2.5 4 16 10.0
2.0 2 4 4.0
2.0 1 1 2.0
3.5 7 49 24.5
Σy = 15.0 Σx = 18 Σx2 = 80 Σxy = 51.5

x=
å x =18 =3 y=
å y =15 =2.5
6 6 6 6

b=
å xy - nxy 51.5 - (6)(3)(2.5)
= =.25 a =y - bx =2.5 - (.25)(3) =1.75
å x - nx
2 2
80 - (6)(3 ) 2

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 Associative Forecasting Example
SALES, y PAYROLL, x x2 xy
2.0 1 1 2.0
3.0 3 9 9.0
2.5 4
ŷ =1.75
16
+.25x 10.0
2.0 2 Sales =1.754 +.25(payroll)
4.0
2.0 1 1 2.0
3.5 7 49 24.5
Σy = 15.0 Σx = 18 Σx2 = 80 Σxy = 51.5

x=
å x =18 =3 y=
å y =15 =2.5
6 6 6 6

b=
å xy - nxy 51.5 - (6)(3)(2.5)
= =.25 a =y - bx =2.5 - (.25)(3) =1.75
å x - nx
2 2
80 - (6)(3 ) 2

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 Associative Forecasting Example
SALES, y PAYROLL, x x2 xy
2.0 1 1 2.0
3.0 3 9 9.0
2.5
4.0 –
4
ŷ =1.75
16
+.25x 10.0
Nodel’s sales
(in $ millions)

2.0
3.0 –
2 Sales =1.754 +.25(payroll)
4.0
2.0 1 1 2.0
3.5 2.0 – 7 49 24.5
Σy = 15.0 Σx = 18 Σx2 = 80 Σxy = 51.5
1.0 –

x=
å x 18 |
= =3
|
y=
|å y | 15 |
= =2.5
| |
0 1 2 3 4 5 6 7
6 6 6 6
Area payroll (in $ billions)

b=
å xy - nxy 51.5 - (6)(3)(2.5)
= =.25 a =y - bx =2.5 - (.25)(3) =1.75
å x - nx
2 2
80 - (6)(3 ) 2

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 Associative Forecasting Example

If payroll next year is estimated to be $6 billion,

then:

Sales (in $ millions) = 1.75 + .25(6)

= 1.75 + 1.5 = 3.25

Sales = $3,250,000

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 Associative Forecasting Example

If payroll next4.0year
–
is estimated to be $6 billion,
then: 3.25
Nodel’s sales
(in $ millions)

3.0 –

2.0 –
Sales (in$ millions) = 1.75 + .25(6)
1.0 – = 1.75 + 1.5 = 3.25
| | | | | | |
0 1 2 3 4 5 6 7
Sales
Area = $3,250,000
payroll (in $ billions)

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 Standard Error of the Estimate
► A forecast is just a point estimate of a future
value
► This point is
actually the
mean or 4.0 –
3.25
Nodel’s sales
expected (in $ millions) 3.0 –
Regression line,
value of a 2.0 –
ŷ =1.75 +.25x

probability 1.0 –
distribution | | | | | | |
0 1 2 3 4 5 6 7
Figure 4.9 Area payroll (in $ billions)

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 Standard Error of the Estimate

S y,x =
å ( y - yc ) 2
n- 2

where y = y-value of each data point

yc = computed value of the dependent
variable, from the regression equation
n = number of data points

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 Standard Error of the Estimate

Computationally, this equation is

considerably easier to use
  2
∑ 𝑦 − 𝑎 ∑ 𝑦 −𝑏 ∑ 𝑥𝑦
𝑆 𝑦 , 𝑥=
√ 𝑛 −2
We use the standard error to set up
prediction intervals around the point
estimate
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 Standard Error of the Estimate
 

3.6 –
Nodel’s sales
3.5 – + .306
(in $ millions)
3.4 –
3.3 –
The standard error of 3.2 –
3.1 –
the estimate is 3.0 –
– .306
$306,000 in sales 2.9 –

5 6
Area payroll (in $ billions)

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 Correlation

► 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

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 Correlation Coefficient
Figure 4.10
y y

x x
(a) Perfect negative (e) Perfect positive
correlation, r = –1 y correlation, r = 1
y

y
x x
(b) Negative correlation (d) Positive correlation

x
(c) No correlation, r = 0

High Moderate Low Low Moderate High

| | | | | | | | |

–1.0 –0.8 –0.6 –0.4 –0.2 0 0.2 0.4 0.6 0.8 1.0
Correlation coefficient values

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 Correlation Coefficient

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 Correlation Coefficient
y x x2 xy y2
2.0 1 1 2.0 4.0
3.0 3 9 9.0 9.0
2.5 4 16 10.0 6.25
2.0 2 4 4.0 4.0
2.0 1 1 2.0 4.0
3.5 7 49 24.5 12.25
Σy = 15.0 Σx = 18 Σx2 = 80 Σxy = 51.5 Σy2 = 39.5

309  270 39 39
    .901
(156)(12) 1,872 43.3

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 Correlation
► 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

For the Nodel Construction example:

r = .901
r2 = .81
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 Multiple-Regression Analysis

If more than one independent variable is to be used

in the model, linear regression can be extended to
multiple regression to accommodate several
independent variables

ŷ =a + b1x1 + b2 x2

Computationally, this is quite complex and

generally done on the computer

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 Multiple-Regression Analysis
In the Nodel example, including interest rates in the
model gives the new equation:

ŷ =1.80 +.30x1 - 5.0x2

An improved correlation coefficient of r = .96 suggests this

model does a better job of predicting the change in
construction sales

Sales = 1.80 + .30(6) − 5.0(.12) = 3.00

Sales = $3,000,000

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 Monitoring and Controlling Forecasts

Tracking Signal
► Measures how well the forecast is predicting
actual values
► Ratio of cumulative forecast errors to mean
absolute deviation (MAD)
► Good tracking signal has low values
► If forecasts are continually high or low, the
forecast has a bias error

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 Monitoring and Controlling Forecasts

Tracking Cumulative error

signal =
MAD

  ∑ ( 𝐴𝑐𝑡𝑢𝑎𝑙 𝑑𝑒𝑚𝑎𝑛𝑑 𝑖𝑛 𝑝𝑒𝑟𝑖𝑜𝑑 𝑖 − 𝐹𝑜𝑟𝑒𝑐𝑎𝑠𝑡 𝑑𝑒𝑚𝑎𝑛𝑑 𝑖𝑛 𝑝𝑒𝑟𝑖𝑜𝑑 𝑖 )

¿
∑ | 𝐴𝑐𝑡𝑢𝑎𝑙 − 𝐹𝑜𝑟𝑒𝑐𝑎𝑠𝑡|
𝑛

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 Tracking Signal

Signal exceeding limit

Tracking signal
Upper control limit
+

Acceptable
0 MADs range

– Lower control limit

Time
Figure 4.11

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 Tracking Signal Example
ABSOLUTE CUM ABS TRACKING
ACTUAL FORECAST CUM FORECAST FORECAST SIGNAL (CUM
QTR DEMAND DEMAND ERROR ERROR ERROR ERROR MAD ERROR/MAD)
1 90 100 –10 –10 10 10 10.0 –10/10 = –1
2 95 100 –5 –15 5 15 7.5 –15/7.5 = –2
3 115 100 +15 0 15 30 10.0 0/10 = 0
4 100 110 –10 –10 10 40 10.0 10/10 = –1
5 125 110 +15 +5 15 55 11.0 +5/11 = +0.5
6 140 110 +30 +35 30 85 14.2 +35/14.2 = +2.5

At the end of quarter 6, MAD =

å Forecast errors
=
85
=14.2
n 6
Cumulative error 35
Tracking signal = = =2.5 MADs
MAD 14.2
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 Adaptive Smoothing

► It’s possible to use the computer to

continually monitor forecast error and
adjust the values of the a and b
coefficients used in exponential
smoothing to continually minimize
forecast error
► This technique is called adaptive
smoothing

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 Focus Forecasting
► Developed at American Hardware Supply, based
on two principles:
1. Sophisticated forecasting models are not always
better than simple ones
2. There is no single technique that should be used
for all products or services

► Uses historical data to test multiple forecasting

models for individual items
► Forecasting model with the lowest error used to
forecast the next demand

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 Forecasting in the Service Sector

► Presents unusual challenges

► Special need for short-term records
► Needs differ greatly as function of industry and product
► Holidays and other calendar events
► Unusual events

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 Fast Food Restaurant Forecast
Percentage of sales by hour of day

20% – Figure 4.12

15% –

10% –

5% –

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

12-1 2-3 4-5 6-7 8-9 10-11
(Lunchtime) (Dinnertime)
Hour of day
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 FedEx Call Center Forecast

Figure 4.12
12% –

10% –

8% –

6% –

4% –

2% –

0% – 2 4 6 8 10 12 2 4 6 8 10 12
A.M. P.M.
Hour of day

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