3-1

Forecasting

Chapter 3

Forecasting

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Operations Management, Seventh Edition, by William J. Stevenson Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.

3-2

Forecasting

FORECAST: A statement about the future Used to help managers

Plan the system Plan the use of the system

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Operations Management, Seventh Edition, by William J. Stevenson Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.

3-3

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

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Operations Management, Seventh Edition, by William J. Stevenson Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.

3-4

Forecasting

Common Features
Assumes causal system past ==> future Forecasts rarely perfect because of randomness I see that you will Forecasts more accurate for get an A this quarter. groups vs. individuals Forecast accuracy decreases as time horizon increases

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Operations Management, Seventh Edition, by William J. Stevenson Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.

3-5

Forecasting

Elements of a Good Forecast

Timely

Reliable

Accurate

Written

McGraw-Hill/Irwin

Operations Management, Seventh Edition, by William J. Stevenson Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.

3-6

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

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Operations Management, Seventh Edition, by William J. Stevenson Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.

3-7

Forecasting

Types 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

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Operations Management, Seventh Edition, by William J. Stevenson Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.

3-8

Forecasting

Consumer surveys Delphi method Executive opinions Sales force.

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Judgmental Forecasts (Qualitative)

Opinions of managers and staff

Operations Management, Seventh Edition, by William J. Stevenson Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.

3-9

Forecasting

Time Series Forecasts (Quantitative)

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

McGraw-Hill/Irwin

3-10

Forecasting

Forecast Variations
Figure 3-1
Irregular variation

Trend cycle Cycles

90 89 88 Seasonal variations
Operations Management, Seventh Edition, by William J. Stevenson Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.

McGraw-Hill/Irwin

3-11

Forecasting

The Forecast of Forecasts

Nave Simple Moving Average Weighted Moving Average Exponential Smoothing ES with Trend and Seasonality

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Operations Management, Seventh Edition, by William J. Stevenson Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.

3-12

Forecasting

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

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Operations Management, Seventh Edition, by William J. Stevenson Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.

3-13

Forecasting

NAVE METHOD
No smoothing of data
Period Demand Forecast change 1 74 2 86 12 3 88 98 2 4 90 5 6 7 8 Average

McGraw-Hill/Irwin

Operations Management, Seventh Edition, by William J. Stevenson Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.

3-14

Forecasting

Techniques for Averaging

Moving average
Weighted moving average

Exponential smoothing

McGraw-Hill/Irwin

Operations Management, Seventh Edition, by William J. Stevenson Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.

3-15

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

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Operations Management, Seventh Edition, by William J. Stevenson Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.

3-16

Forecasting

Points to Know on Moving Averages

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

Moving Average

McGraw-Hill/Irwin

Operations Management, Seventh Edition, by William J. Stevenson Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.

3-17

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

Ft 1
Period Demand Forecast

i t n 1
1 46

a t i 1 A i
Alpha
2 48 3 47 4 23 5 40 32.70

0.6
6 35.60

0.3
7

0.1
8 Average

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Operations Management, Seventh Edition, by William J. Stevenson Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.

3-18

Forecasting

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

Ft Ft 1 a ( At 1 Ft 1 )
a
Period Demand Forecast 1 74 72 2 90 72.2 3 100 73.98 4 60 5 6 7

0.1
8 Average

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Operations Management, Seventh Edition, by William J. Stevenson Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.

3-19

Forecasting

Exponential Smoothing (=0.30)

Ft Ft 1 a ( At 1 Ft 1 )
PERIOD
1 2 3 4 5 6 7 8 9 10 11 12
McGraw-Hill/Irwin

MONTH
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

DEMAND
37 40 41 37 45 50 43 47 56 52 55 54

F2

37 + (0.30)(37-37)

= 37

F3 =37+ (0.30)(40-37) = 37.9

Operations Management, Seventh Edition, by William J. Stevenson Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.

3-20

Forecasting

Exponential Smoothing (cont.)

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

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Operations Management, Seventh Edition, by William J. Stevenson Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.

3-21

Forecasting

Adjusted Exponential Smoothing

AFt +1 = Ft +1 + Tt +1
where T = an exponentially smoothed trend factor Tt +1 = (Ft +1 - Ft) + (1 - ) Tt where Tt = the last period trend factor = a smoothing constant for trend

McGraw-Hill/Irwin

Operations Management, Seventh Edition, by William J. Stevenson Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.

3-22

Forecasting

Adjusted Exponential Smoothing (=0.30)

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

MONTH
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

DEMAND
37 40 41 37 45 50 43 47 56 52 55 54

T3

= (F3 - F2) + (1 - ) T2 = (0.30)(38.5 - 37.0) + (0.70)(0) = 0.45

AF3 = F3 + T3 = 38.5 + 0.45 = 38.95

T13 = (F13 - F12) + (1 - ) T12 = (0.30)(53.61 - 53.21) + (0.70)(1.77)

= 1.36
AF13 = F13 + T13 = 53.61 + 1.36 = 54.96
Operations Management, Seventh Edition, by William J. Stevenson Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.

McGraw-Hill/Irwin

3-23

Forecasting

Adjusted Exponential Smoothing: Example

PERIOD 1 2 3 4 5 6 7 8 9 10 11 12 13
McGraw-Hill/Irwin

MONTH Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan

DEMAND 37 40 41 37 45 50 43 47 56 52 55 54

FORECAST Ft +1 37.00 37.00 38.50 39.75 38.37 38.37 45.84 44.42 45.71 50.85 51.42 53.21 53.61

TREND Tt +1 0.00 0.45 0.69 0.07 0.07 1.97 0.95 1.05 2.28 1.76 1.77 1.36

ADJUSTED FORECAST AFt +1 37.00 38.95 40.44 38.44 38.44 47.82 45.37 46.76 58.13 53.19 54.98 54.96

Operations Management, Seventh Edition, by William J. Stevenson Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.

3-24

Forecasting

Linear Trend Equation

Y

Yt = a + bt
a
0 1 2 3 4 5 t

b is the line slope.

McGraw-Hill/Irwin

Operations Management, Seventh Edition, by William J. Stevenson Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.

3-25

Forecasting

Calculating a and b

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

y - b t a = n

Yes Linear Regression!!

McGraw-Hill/Irwin
Operations Management, Seventh Edition, by William J. Stevenson Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.

3-26

Forecasting

Linear Trend Equation Example

t Week 1 2 3 4 5 t = 15 ( t)2 = 225
t2

y Sales 150 157 162 166 177 y = 812 ty 150 314 486 664 885 ty = 2499 1 4 9 16 25 t2 = 55

McGraw-Hill/Irwin

Operations Management, Seventh Edition, by William J. Stevenson Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.

3-27

Forecasting

Linear Trend Calculation

b = 5 (2499) - 15(812) 5(55) - 225 = 12495 -12180 275 -225 = 6.3

812 - 6.3(15) a = = 143.5 5

y = 143.5 + 6.3t
McGraw-Hill/Irwin

Look on page 85

Operations Management, Seventh Edition, by William J. Stevenson Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.

3-28

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

McGraw-Hill/Irwin

Operations Management, Seventh Edition, by William J. Stevenson Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.

3-29

Forecasting

Forecast Accuracy

Forecast error
difference between forecast and actual demand MAD
mean absolute deviation

MAPD
mean absolute percent deviation

Cumulative error Average error or bias

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Operations Management, Seventh Edition, by William J. Stevenson Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.

3-30

Forecasting

Mean Absolute Deviation (MAD)

At - Ft MAD = n
where t = period number At = demand in period t Ft = forecast for period t n = total number of periods = absolute value
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Operations Management, Seventh Edition, by William J. Stevenson Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.

3-31

Forecasting

MAD Example
PERIOD 1 2 3 4 5 6 7 8 9 10 11 12 DEMAND, At 37 40 41 37 MAD 45 = 50 43 = 47 56 52 = 55 54 557 Ft (a =0.3) (At - Ft) 3.00 3.10 -1.83 6.72 9.69 -0.20 3.86 11.70 4.19 5.94 3.15 49.31 |At - Ft| 3.00 3.10 1.83 6.72 9.69 0.20 3.86 11.70 4.19 5.94 3.15 53.39 37.00 37.00 37.90 At38.83 - Ft 38.28 n 40.29 53.39 43.20 1143.14 44.30 4.85 47.81 49.06 50.84

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Operations Management, Seventh Edition, by William J. Stevenson Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.

3-32

Forecasting

Other Accuracy Measures

Mean absolute percent deviation (MAPD)

|At - Ft| MAPD = At

Cumulative error E = et Average error (E )= n
McGraw-Hill/Irwin

et

Operations Management, Seventh Edition, by William J. Stevenson Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.

3-33

Forecasting

Comparison of Forecasts

FORECAST Exponential smoothing (a = 0.30) Exponential smoothing (a = 0.50) Adjusted exponential smoothing (a = 0.50, = 0.30)

MAD 4.85 4.04 3.81

MAPD 9.6% 8.5% 7.5%

E 49.31 33.21 21.14

(E) 4.48 3.02 1.92

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Operations Management, Seventh Edition, by William J. Stevenson Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.

3-34

Forecasting

Forecast Control Tracking signal

monitors the forecast to see if it is biased high or low (At - Ft) E Tracking signal = = MAD MAD

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Operations Management, Seventh Edition, by William J. Stevenson Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.

3-35

Forecasting

Tracking Signal Values

PERIOD DEMAND At FORECAST, Ft ERROR At - Ft E = (At - Ft) MAD TRACKING SIGNAL

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

37 40 41 37 45 50 43 47 56 52 55 54

37.00 37.00 3.00 3.00 37.90 3.10 6.10 38.83 -1.83 4.27 38.28 6.72 for period 10.99 3 Tracking signal 40.29 9.69 20.68 43.20 -0.20 6.10 20.48 43.14 TS3 = 3.86 = 24.34 2.00 3.05 36.04 44.30 11.70 47.81 4.19 40.23 49.06 5.94 46.17 50.84 3.15 49.32

3.00 3.05 2.64 3.66 4.87 4.09 4.06 5.01 4.92 5.02 4.85

1.00 2.00 1.62 3.00 4.25 5.01 6.00 7.19 8.18 9.20 10.17

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Operations Management, Seventh Edition, by William J. Stevenson Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.

3-36

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.

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Operations Management, Seventh Edition, by William J. Stevenson Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.

3-37

Forecasting

End Notes The two most important factors in choosing a forecasting technique:
Cost Accuracy

Keep it SIMPLE! =FORECAST(70,{23,34,12},{67,76,56}) (if you canlet the computer do it)

McGraw-Hill/Irwin

Operations Management, Seventh Edition, by William J. Stevenson Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.