30-Jan-16

Outline
What is forecasting?

Forecasting

Types of forecasts
Time-Series forecasting
Nave
Moving Average
Exponential Smoothing
Regression

Good forecasts

Forecasting

What is Forecasting?

Predict the next number in the pattern:

a) 3.7,

3.7,

3.7,

3.7,

3.7,

b) 2.5,

4.5,

6.5,

8.5,

10.5,

c) 5.0, 7.5, 6.0, 4.5, 7.0, 9.5, 8.0, 6.5, ?

Forecasting

Process of predicting a future

event based on historical data
Educated Guessing
Underlying basis of
all business decisions

Production
Inventory
Personnel
Facilities

Importance of Forecasting in OM

Predict the next number in the pattern:

a) 3.7,

3.7,

3.7,

3.7,

3.7, 3.7

b) 2.5,

4.5,

6.5,

8.5,

10.5, 12.5

c) 5.0, 7.5, 6.0, 4.5, 7.0, 9.5, 8.0, 6.5, 9.0

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.

30-Jan-16

Types of Forecasts by Time

Horizon
Quantitative
methods

Short-range forecast
Usually < 3 months
Job scheduling, worker assignments

Detailed
use of
system

Medium-range forecast
Sales/production planning

Long-range forecast
Design
of system

New product planning

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.

3 months to 2 years

> 2 years

Qualitative Methods
Briefly, the qualitative methods are:

Qualitative
Methods

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.

Forecasting During the Life

Cycle
Introduction

Growth

Maturity

Qualitative Methods

Decline

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 models

Qualitative models
- Executive judgment
- Market research
-Survey of sales force
-Delphi method
Sales

- Time series analysis

- Regression analysis

Time

Qualitative Forecasting Methods

Quantitative Forecasting Methods

Qualitative
Forecasting

Executive
Judgement

Sales
Force
Composite

Market
Research/
Survey
Smoothing

Quantitative
Forecasting
Regression
Models

Time Series
Models

Models
Delphi
Method

1. Naive

2. Moving
Average
a) simple
b) weighted

3. Exponential
Smoothing
a) level
b) trend
c) seasonality

30-Jan-16

Product Demand over Time

Quantitative Forecasting Methods

Regression
Models

Time Series
Models

1. Naive

2. Moving
Average
a) simple
b) weighted

3. Exponential
Smoothing
a) level
b) trend
c) seasonality

Demand for product or service

Quantitative
Forecasting

Year
2

Year
1

Year
3

Year
4

Product Demand over Time

Time Series Models

Trend component

Assume that factors influencing the past will

continue to influence the future

Demand for product or service

Try to predict the future based on past

data

Seasonal peaks

Random
variation
Year
1

Year
2

Actual
demand line
Year
3

Year
4

Now lets look at some time series approaches to forecasting

Borrowed from Heizer/Render - Principles of Operations Management, 5e, and Operations Management, 7e

Time Series Models:

Components

Quantitative Forecasting Methods

Quantitative
Time Series
Models

Random

Trend

Models
1. Naive

Seasonal

Composite

2. Moving
Average
a) simple
b) weighted

3. Exponential
Smoothing
a) level
b) trend
c) seasonality

30-Jan-16

1. Naive

2a. Simple Moving Average

Approach

Ft 1 =

Demand in next period is the same as

demand in most recent period
May sales = 48 June forecast = 48

Youre manager in Amazons electronics

department. You want to forecast ipod sales for
months 4-6 using a 3-period moving average.

Month
1
2
3
4
5
6

Usually not good

2a. Simple Moving Average

Assumes an average is a good estimator of
future behavior

Ft 1 =
Ft+1
n
At

A t + A t -1 + A t -2 + ... + A t -n 1
n
= Forecast for the upcoming period, t+1
= Number of periods to be averaged
= Actual occurrence in period t

2a. Simple Moving Average

Ft 1 =

A t + A t -1 + A t -2 + ... + A t -n 1
n

Youre manager in Amazons electronics

department. You want to forecast ipod sales for
months 4-6 using a 3-period moving average.

Month
1
2
3
4
5
6

Sales
(000)
4
6
5
?
?
?

Sales
(000)
4
6
5
?
?
?

Moving Average
(n=3)
NA
NA
NA
(4+6+5)/3=5

2a. Simple Moving Average

What if ipod sales were actually 3

in month 4

Used if little or no trend

Used for smoothing

A t + A t -1 + A t -2 + ... + A t - n 1
n

Month
1
2
3
4
5
6

Sales
(000)
4
6
5
3?
?
?

Moving Average
(n=3)
NA
NA
NA
5

2a. Simple Moving Average

Forecast for Month 5?

Month
1
2
3
4
5
6

Sales
(000)
4
6
5
3
?
?

Moving Average
(n=3)
NA
NA
NA
5
(6+5+3)/3=4.667

30-Jan-16

2a. Simple Moving Average

Actual Demand for Month 5

=7
Month
1
2
3
4
5
6

Sales
(000)
4
6
5
3
?7
?

Moving Average
(n=3)
NA
NA
NA
5
4.667

2b. Weighted Moving Average: 3/6,

2/6, 1/6
Ft 1 = w1A t + w 2 A t -1 + w 3 A t -2 + ... + w n A t -n 1

Month
1
2
3
4
5
6

4
6
5
?
?
?

2b. WeightedF Moving

Average:
3/6,
=w A +w A
+ w A + ... + w
A
2/6, 1/6
t 1

2a. Simple Moving Average

Forecast for Month 6?

Month
1
2
3
4
5
6

Sales
(000)
4
6
5
3
7
?

Moving Average
(n=3)
NA
NA
NA
5
4.667
(5+3+7)/3=5

2b. Weighted Moving Average

Gives more emphasis to recent data

Ft 1 = w1A t + w 2 A t -1 + w 3A t -2 + ... + w n A t -n 1

Month
1
2
3
4
5
6

Sales
(000)
4
6
5
3
7

t -1

t -2

t - n 1

Weighted
Moving
Average
NA
NA
NA
31/6 = 5.167
25/6 = 4.167
32/6 = 5.333

3a. Exponential Smoothing

Assumes the most recent observations have
the highest predictive value
gives more weight to recent time periods

Ft+1 = Ft + (At - Ft)

Weights
decrease for older data
sum to 1.0

Weighted
Moving
Average
NA
NA
NA
31/6 = 5.167

Sales
(000)

et

Simple moving
average models
weight all previous
periods equally

Ft+1 = Forecast value for time t+1

= Actual value at time t
At

= Smoothing constant

Need initial
forecast Ft
to start.

30-Jan-16

3a. Exponential Smoothing

Example 1

Ft+1 = Ft + (At - Ft)

i

Week
1
2
3
4
5
6
7
8
9
10

Ai

Demand
820
775
680
655
750
802
798
689
775

Given the weekly demand

data what are the exponential
smoothing forecasts for
periods 2-10 using =0.10?
Assume F1=D1

Ft+1 = Ft + (At - Ft)

Week
1
2
3
4
5
6
7
8
9
10

Ai

Fi

= 0.1
Demand
0.6
820
820.00
820.00
775
820.00
820.00
= F1+ (A793.00
680 F2815.50
1F1) =820+(820820)
655
801.95
725.20=820
750
787.26
683.08
802
783.53
723.23
798
785.38
770.49
689
786.64
787.00
775
776.88
728.20
776.69
756.28

3a. Exponential Smoothing

Example 1

Ft+1 = Ft + (At - Ft)

i

Week
1
2
3
4
5
6
7
8
9
10

Ai

Ft+1 = Ft + (At - Ft)

i

3a. Exponential Smoothing

Example 1
i

3a. Exponential Smoothing

Example 1

Fi

= 0.1
Demand
0.6
820
820.00
820.00
775
820.00
820.00
680
815.50
793.00
F3 = F2+ (A2F2) =820+(775820)
655
801.95
725.20
750
787.26
683.08=815.5
802
783.53
723.23
798
785.38
770.49
689
786.64
787.00
775
776.88
728.20
776.69
756.28

Week
1
2
3
4
5
6
7
8
9
10

Ai

Demand
820
775
680
655
750
802
798
689
775

Fi

= 0.1

820.00
820.00
815.50
801.95
787.26
783.53
785.38
786.64
776.88
776.69

0.6
820.00
820.00
793.00
725.20
683.08
723.23This process
continues
770.49
through week
787.00
10
728.20
756.28

3a. Exponential Smoothing

Example 1

Ft+1 = Ft + (At - Ft)

i

Week
1
2
3
4
5
6
7
8
9
10

Ai

Demand
820
775
680
655
750
802
798
689
775

Fi

= 0.1

= 0.6

820.00
820.00
815.50
801.95
787.26
783.53
785.38
786.64
776.88
776.69

820.00
820.00
793.00
725.20
683.08
723.23
770.49
787.00
728.20
756.28

What if the
constant
equals 0.6

3a. Exponential Smoothing

Example 2

Ft+1 = Ft + (At - Ft)

i

Ai

Month Demand
January
120
February
90
March
101
April
91
May
115
June
83
July
August
September

Fi

= 0.3

= 0.6

100.00
106.00
101.20
101.14
98.10
103.17
97.12

100.00
112.00
98.80
100.12
94.65
106.86
92.54

What if the
constant
equals 0.6

30-Jan-16

Forecast Effects of
Smoothing Constant

3a. Exponential Smoothing

Example 3
Company A, a personal computer producer
purchases generic parts and assembles them to
final product. Even though most of the orders
require customization, they have many common
components. Thus, managers of Company A need
a good forecast of demand so that they can
purchase computer parts accordingly to minimize
inventory cost while meeting acceptable service
level. Demand data for its computers for the past 5
months is given in the following table.

Ft+1 = Ft + (At - Ft)

Month
January
February
March
April
May
June
July

Ai

= 0.3

= 0.5

84.00
82.80
83.16
82.81
83.47
85.13

84.00
82.00
83.00
82.50
83.75
86.38

??

??

w2

w3

Weights
=

Prior Period

= 0.10

2 periods ago 3 periods ago

(1 - )

(1 - )2

10%

9%

8.1%

90%

9%

0.9%

To Use a Forecasting
Method
Collect historical data

Fi

Demand
80
84
82
85
89

w1

= 0.90

3a. Exponential Smoothing

Example 3
i

or

Ft+1 = Ft + (At - Ft)

Ft+1 = At + (1- ) At - 1 + (1- )2At - 2 + ...

Select a model
Moving average methods
Select n (number of periods)
For weighted moving average: select weights
What if the
constant
equals 0.5

Exponential smoothing
Select

Selections should produce a good forecast

but what is a good forecast?

3a. Exponential Smoothing

How to choose
depends on the emphasis you want to place
on the most recent data

A Good Forecast
Has a small error
Error = Demand - Forecast

Increasing makes forecast more

sensitive to recent data

30-Jan-16

Measures of Forecast Error

Measures of Error

et

1. Mean Absolute Deviation

(MAD)

a. MAD = Mean Absolute Deviation

MAD =

b. MSE = Mean Squared Error

MSE =

c. RMSE = Root Mean Squared Error

- Ft

t=1

Jan

- Ft

At

Ft

et

|et|

et2

120

100

20

20

400

-16

16

256

-1

-10

10

100

Feb

90

106

Mar

101

102

April

91

101

May

115

98

RMSE = MSE

June

83

103

17

17

289

-20

20

400

-10

84

1,446

MSE

MAD Example
MAD =

- Ft

t=1

Month
1
2
3
4
5

At
Ft
Sales Forecast
220
n/a
250
255
210
205
300
320
325
315

= 14

e
t

1,446
= 241
6

RMSE MSE
= SQRT(241)
=15.52

Forecast Bias

= 40 =10
4

What is the MAD value given the

forecast values in the table below?

2b. Root Mean Squared Error

(RMSE)

parameters such as used in the method are wrong.

Note: In the above, n is the number of periods, which is
6 in our example

84
6

et

2a. Mean Squared Error

(MSE)

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

Ideal values =0 (i.e., no forecasting error)

t =1

MAD

How can we tell if a forecast has a positive or

negative bias?

|At Ft|

TS = Tracking Signal
Good tracking signal has low values

5
5
20
10

TS =

(actualt forecastt )
RSFE
= t
MAD Mean absolute
deviation
MAD

= 40

30

- Ft

= 550 =137.5
MSE/RMSE Example
n
4
MSE =

t =1

What is the MSE value?

Quantitative Forecasting Methods

Quantitative
Forecasting

RMSE = 137.5

=11.73
At

Month
1
2
3
4
5

Ft

Sales Forecast
220
n/a
250
255
210
205
300
320
325
315

Regression
Models

Time Series
Models

|At Ft| (At Ft)2

5
5
20
10

25
25
400
100

1. Naive

2. Moving
Average
a) simple
b) weighted

3. Exponential
Smoothing
a) level
b) trend
c) seasonality

= 550

30-Jan-16

Exponential Smoothing
(continued)
We looked at using exponential
smoothing to forecast demand with
only random variations
Ft+1 = Ft + (At - Ft)

Formulas
y=a+bx
where,

xy n x y
x nx

Ft+1 = Ft + At Ft

a y bx

x
y

Exponential Smoothing
(continued)

Regression Example

y = a+ b X

We looked at using exponential

smoothing to forecast demand with
only random variations
What if demand varies due to
randomness and trend?

MonthAdvertising
January
3
February
4
March
2
April
5
May
4
June
2
July

What if we have trend and seasonality

in the data?

TOTAL

xy n x y
x nx

Sales
1
2
1
3
2
1

10

a y bx

X 2 XY
9.00
3.00
16.00
8.00
4.00
2.00
25.00
15.00
16.00
8.00
4.00
2.00

74

38

1.
2.
3.
4.

Forecasts are more accurate for larger groups of items.

Forecasts are more accurate for shorter periods of time.
Every forecast should include an estimate of error.
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

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.

20

General Guiding Principles for

Forecasting

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.

Ft+1 = At + (1-) Ft

Salesof Autos(100,000)

30-Jan-16

FOR JULY 2nd MONDAY

READ THE CHAPTERS ON
Forecasting
Product and service design

10