Forecasting
Introduction
Operations Strategy & Competitiveness
Quality Management
Strategic Decisions (some)
Design of Products Process Selection Capacity and
and Services and Design Facility Decisions
Forecasting
Tactical & Operational Decisions
What is Forecasting?
■ Process of predicting a future
event based on historical data
■ Educated Guessing
■ Underlying basis of
all business decisions
✓ Production
✓ Inventory
✓ Personnel
✓ Facilities
Why do we need to forecast?
In general, forecasts are almost always wrong.
So,
Throughout the day we forecast very different
things such as weather, traffic, stock market, state
of our company from different perspectives.
Virtually every business attempt is based on
forecasting. Not all of them are derived from
sophisticated methods. However, “Best" educated
guesses about future are more valuable for
purpose of Planning than no forecasts and hence
no planning.
Importance of Forecasting in OM
Departments throughout the organization depend on
forecasts to formulate and execute their plans.
Finance needs forecasts to project cash flows and
capital requirements.
Human resources need forecasts to anticipate hiring
needs.
Production needs forecasts to plan production
levels, workforce, material requirements,
inventories, etc.
Importance of Forecasting in OM
Demand is not the only variable of interest to
forecasters.
Manufacturers also forecast worker
absenteeism, machine availability, material
costs, transportation and production lead
times, etc.
Besides demand, service providers are also
interested in forecasts of population, of other
demographic variables, of weather, etc.
Types of Forecasts by Time Horizon
Quantitativ
■ Short-range forecast e
methods
✓ Usually < 3 months
■ Job scheduling, worker assignments
Detailed
use of
■ Medium-range forecast system
✓ 3 months to 2 years
■ Sales/production planning
■ Long-range forecast
✓ > 2 years Design
■ New product planning of system
Qualitative
Methods
Forecasting During the Life Cycle
Introduction Growth Maturity Decline
Qualitative models Quantitative models
- Executive judgment
- Time series analysis
- Market research
-Survey of sales force - Regression analysis
-Delphi method
Sales
Time
Qualitative Forecasting Methods
Qualitative
Forecasting
Models
Sales Delphi
Executive Market
Force Method
Judgement Research/
Composite
Survey
Smoothing
Qualitative Methods
Briefly, the qualitative methods are:
Executive Judgment: Opinion of a group of high level
experts or managers is pooled
Sales Force Composite: Each regional salesperson
provides his/her sales estimates. Those forecasts are then
reviewed to make sure they are realistic. All regional
forecasts are then pooled at the district and national levels
to obtain an overall forecast.
Market Research/Survey: Solicits input from customers
pertaining to their future purchasing plans. It involves the
use of questionnaires, consumer panels and tests of new
products and services.
Qualitative Methods
Delphi Method: As opposed to regular panels where the individuals
involved are in direct communication, this method eliminates the
effects of group potential dominance of the most vocal members.
The group involves individuals from inside as well as outside the
organization.
Typically, the procedure consists of the following steps:
Each expert in the group makes his/her own forecasts in form of
statements
➢The coordinator collects all group statements and
summarizes them
➢The coordinator provides this summary and gives another
set of questions to each
group member including feedback as to the input of other
experts.
➢The above steps are repeated until a consensus is reached.
.
Quantitative Forecasting Methods
Quantitative
Forecasting
Time Series Regression
Models Models
2. Moving 3. Exponential
1. Naive
Average Smoothing
a) we
a) tre so
sim igh
b)
lev nd na
b) sea
pl ted
el
c)
e
li
Quantitative Forecasting Methods
Quantitative
Forecasting
Time Series Regression
Models Models
2. Moving 3. Exponential
1. Naive
Average Smoothing
a) we
a) tre so
sim igh
b)
lev nd na
b) sea
pl ted
el
c)
e
li
Time Series Models
■ Try to predict the future based on past
data
✓ Assume that factors influencing the past will
continue to influence the future
Time Series Models: Components
Random Trend
Seasonal Composite
Product Demand over Time
Demand for product or service
Year Year Year Year
1 2 3 4
Product Demand over Time
Trend component
Seasonal peaks
Demand for product or service
Actual
Random demand line
variation
Year Year Year Year
1 2 3 4
Now let’s look at some time series approaches to
Borrowed from Heizer/Render - Principles of Operations Management, 5e, and Operations Management, 7e
Quantitative Forecasting Methods
Quantitative
Time Series
Models
Models
2. Moving 3. Exponential
1. Naive
Average Smoothing
a) we
a) tre so
sim igh
b)
lev nd na
b) sea
pl ted
el
c)
e
lit
y
1. Naive Approach
■ Demand in next period is the same as
demand in most recent period
✓ May sales = 48 → June forecast = 48
■ Usually not good
2a. Simple Moving Average
■ Assumes an average is a good estimator of
future behavior
✓ Used if little or no trend
✓ Used for smoothing
Ft+1 = Forecast for the upcoming period, t+1
n = Number of periods to be averaged
At = Actual occurrence in period t
2a. Simple Moving Average
You’re manager in Amazon’s electronics
department. You want to forecast ipod sales for
months 4-6 using a 3-period moving average.
Sales
Month (000)
1 4
2 6
3 5
4 ?
5 ?
6 ?
2a. Simple Moving Average
You’re manager in Amazon’s electronics
department. You want to forecast ipod sales for
months 4-6 using a 3-period moving average.
Sales Moving Average
Month (000) (n=3)
1 4 NA
2 6 NA
3 5 NA
4 ? (4+6+5)/3=5
5 ?
6 ?
2a. Simple Moving Average
What if ipod sales were actually 3 in month 4
Sales Moving Average
Month (000) (n=3)
1 4 NA
2 6 NA
3 5 NA
4 3? 5
5 ?
6 ?
2a. Simple Moving Average
Forecast for Month 5?
Sales Moving Average
Month (000) (n=3)
1 4 NA
2 6 NA
3 5 NA
4 3 5
5 ? (6+5+3)/3=4.667
6 ?
2a. Simple Moving Average
Actual Demand for Month 5 = 7
Sales Moving Average
Month (000) (n=3)
1 4 NA
2 6 NA
3 5 NA
4 3 5
5 ?7 4.667
6 ?
2a. Simple Moving Average
Forecast for Month 6?
Sales Moving Average
Month (000) (n=3)
1 4 NA
2 6 NA
3 5 NA
4 3 5
5 7 4.667
6 ? (5+3+7)/3=5
2b. Weighted Moving Average
■ Gives more emphasis to recent data
■ Weights
✓decrease for older data
✓sum to 1.0
Simple moving
average models
weight all previous
periods equally
2b. Weighted Moving Average: 3/6, 2/6, 1/6
Month Sales Weighted
(000) Moving
Average
1 4 NA
2 6 NA
3 5 NA
4 ? 31/6 = 5.167
5 ?
6 ?
2b. Weighted Moving Average: 3/6, 2/6, 1/6
Month Sales Weighted
(000) Moving
Average
1 4 NA
2 6 NA
3 5 NA
4 3 31/6 = 5.167
5 7 25/6 = 4.167
6 32/6 = 5.333
3a. Exponential Smoothing
■ Assumes the most recent observations have
the highest predictive value
✓ gives more weight to recent time periods
FFt+1
t+1
=
= F
F tt
+
+ a(A
a(A tt
-
- F
Ft)
t)
et
Ft+1 = Forecast value for time t+1
Need initial
At = Actual value at time t forecast Ft
a = Smoothing constant to start.
3a. Exponential Smoothing – Example 1
FFt+1
t+1
=
= F
F tt
+
+ a(A
a(A tt
-
- F
Ft)
t)
i Ai
Given
Given the
the weekly
weekly demand
demand
data
data what
what are
are the
the exponential
exponential
smoothing
smoothing forecasts
forecasts for
for
periods
periods 2-10 using a=0.10?
2-10 using a=0.10?
Assume
Assume FF11=D
=D11
3a. Exponential Smoothing – Example 1
FFt+1
t+1
=
= F
F tt
+
+ a(A
a(A tt
-
- F
Ft)
t)
i Ai Fi
a=
F2 = F1+ a(A1–F1) =820+.1(820–820)
=820
3a. Exponential Smoothing – Example 1
FFt+1
t+1
=
= F
F tt
+
+ a(A
a(A tt
-
- F
Ft)
t)
i Ai Fi
a=
F3 = F2+ a(A2–F2) =820+.1(775–820)
=815.5
3a. Exponential Smoothing – Example 1
FFt+1
t+1
=
= F
F tt
+
+ a(A
a(A tt
-
- F
Ft)
t)
i Ai Fi
a=
This process
continues
through week
10
3a. Exponential Smoothing – Example 1
FFt+1
t+1
=
= F
F tt
+
+ a(A
a(A tt
-
- F
Ft)
t)
i Ai Fi
a= a=
What if the
a constant
equals 0.6
3a. Exponential Smoothing – Example 2
FFt+1
t+1
=
= F
F tt
+
+ a(A
a(A tt
-
- F
Ft)
t)
i Ai Fi
a= a=
What if the
a constant
equals 0.6
3a. Exponential Smoothing – Example 3
Company
CompanyA, A, aa personal
personal computer
computer producer
producer
purchases
purchases generic
generic parts
parts and
and assembles
assembles themthem toto
final
final product.
product. Even
Even though
though mostmost ofof the
the orders
orders
require
require customization,
customization, theythey have
have many
many common
common
components.
components. Thus,
Thus, managers
managers of of Company
CompanyA Aneed
need
aa good
good forecast
forecast of of demand
demand so so that
that they
they can
can
purchase
purchase computer
computer parts
parts accordingly
accordingly to to minimize
minimize
inventory
inventory cost
cost while
while meeting
meeting acceptable
acceptable service
service
level.
level. Demand
Demand data data for
for its
its computers
computers for for the
the past
past 55
months
months isis given
given in
in the
the following table..
following table
3a. Exponential Smoothing – Example 3
FFt+1
t+1
=
= F
F tt
+
+ a(A
a(A tt
-
- F
Ft)
t)
i Ai Fi
a= a=
What if the
a constant
equals 0.5
3a. Exponential Smoothing
■ How to choose α
✓depends on the emphasis you want to place
on the most recent data
■ Increasing α makes forecast more
sensitive to recent data
Forecast Effects of
Smoothing Constant a
Ft+1 = Ft + a (At - Ft)
or Ft+1 = a At + a(1- a) At - 1 + a(1- a)2At - 2 + ...
w1 w2 w3
Weights
a= Prior Period 2 periods ago 3 periods ago
a a(1 - a) a(1 - a)2
a= 0.10
10% 9% 8.1%
a= 0.90 90% 9% 0.9%
To Use a Forecasting Method
■ Collect historical data
■ Select a model
✓ Moving average methods
■ Select n (number of periods)
■ For weighted moving average: select weights
✓ Exponential smoothing
■ Select a
■ Selections should produce a good forecast
…but what is a good forecast?
A Good Forecast
¨ Has a small error
¨ Error = Demand - Forecast
Measures of Forecast Error
et
a. MAD = Mean Absolute Deviation
b. MSE = Mean Squared Error
c. RMSE = Root Mean Squared Error
■ Ideal values =0 (i.e., no forecasting error)
= 40 =10
MAD Example 4
What
What isis the
the MAD
MAD value
value given
given the
the forecast
forecast
values
values in
in the
the table
table below?
below?
At Ft
Month Sales Forecast |At – Ft|
1 220 n/a
2 250 255 5
3 210 205 5
4 300 320 20
5 325 315 10
= 40
= 550 =137.5
MSE/RMSE Example 4
What
What isis the
the MSE
MSE value?
value? RMSE = √137.5
=11.73
At Ft
Month Sales Forecast |At – Ft| (At – Ft)2
1 220 n/a
2 250 255 5 25
3 210 205 5 25
4 300 320 20 400
5 325 315 10 100
= 550
Measures of Error
1. Mean Absolute Deviation
(MAD)
t At Ft et |et| et2
84 = 14
Jan 120 100 20 20 400
6
-16 16
Feb 90 106 256 2a. Mean Squared Error
-1 1 1 (MSE)
Mar 101 102
-10 10 100
April 91 101 1,446
17 17 289 = 241
May 115 98 6
-20 20 400
2b. Root Mean Squared Error
June 83 103 (RMSE)
-10 84 1,446
An accurate forecasting system will have small MAD,
MSE and RMSE; ideally equal to zero. A large error may
indicate that either the forecasting method used or the = SQRT(241)
parameters such as α used in the method are wrong.
Note: In the above, n is the number of periods, which is
=15.52
Forecast Bias
■ How can we tell if a forecast has a positive or
negative bias?
■ TS = Tracking Signal
✓Good tracking signal has low values
MAD
30
Quantitative Forecasting Methods
Quantitative
Forecasting
Time Series Regression
Models Models
2. Moving 3. Exponential
1. Naive
Average Smoothing
a) we
a) tre so
sim igh
b)
lev nd na
b) sea
pl ted
el
c)
e
li
Exponential Smoothing (continued)
■ We looked at using exponential
smoothing to forecast demand with
only random variations
Ft+1 = Ft + a (At - Ft)
Ft+1 = Ft + a At – a Ft
Ft+1 = a At + (1-a) Ft
Exponential Smoothing (continued)
■ We looked at using exponential
smoothing to forecast demand with
only random variations
■ What if demand varies due to
randomness and trend?
■ What if we have trend and seasonality
in the data?
Regression Analysis as a Method for Forecasting
Regression analysis takes advantage
of the relationship between two
variables. Demand is then
forecasted based on the knowledge
of this relationship and for the given
value of the related variable.
Ex: Sale of Tires (Y), Sale of Autos (X)
are obviously related
If we analyze the past data of these two
variables and establish a
relationship between them, we may
use that relationship to forecast the
sales of tires given the sales of
automobiles.
The simplest form of the relationship is,
of course, linear, hence it is referred
to as a regression line.
Formulas
yy == aa++ bb xx
where,
where,
Regression – Example
yy == aa++ bb X
X
General Guiding Principles for Forecasting
1. Forecasts are more accurate for larger groups of items.
2. Forecasts are more accurate for shorter periods of time.
3. Every forecast should include an estimate of error.
4. Before applying any forecasting method, the total system
should be understood.
5. Before applying any forecasting method, the method should
be tested and evaluated.
6. Be aware of people; they can prove you wrong very easily in
forecasting
FOR JULY 2nd MONDAY
■ READ THE CHAPTERS ON
✓ Forecasting
✓ Product and service design
