ETE 329 B i Business System S t Engineering E i i Part-1: Part 1: Forecasting

Sonia Sultana Senior Lecturer Daffodil International University

Sonia Sultana, Lecturer, Daffodil International University

Presented by

ForecastingForecasting - Introduction

Forecasting is an estimate of what is likely to happen in the future. Forecasts are concerned with determining what the future will look like; planning is concerned with what it should look like. Forecasting provides a basis for coordinating activities in various parts of the company. company Forecasts are important input to both long-term, strategic decision-making, dec so a g, as we well as for o s short-term o t te p planning a g for o day-to-day operations.

Forecasting- Importance

Finance uses long-term forecasts for capital planning l i and d short-term h tt f forecasts t for f budgeting. b d ti Marketing produces sales forecasts for market planning l i and d market k t strategy. t t Operations develops and uses forecasts for scheduling, h d li i inventory management, and d long-term l capacity planning. Human Resource Management uses forecasts to estimate the need for employees.

Forecasting- Types
1. Demand Forecasts these are estimates of demand

for a companys goods or services. 2. Technological Forecasts These are forecasts concerned with the rate of change in technology and the impact on a companys revenues and/or costs. 3. Economic Forecasts predict inflation rates, employment rates, money supply, housing starts, and other measures of the performance of an economy.

Features of Forecasts
Forecasting techniques assume that the same basic

or original system that existed in the past will exist in the future.
Forecasts are rarely perfect. Forecast accuracy decreases as the time horizon

increases.
Forecasts F t for f groups of f items it are more accurate t

than forecasts for individual items.

Forecasting Process
1. Identify the purpose of forecast 2. Collect historical data 3. Plot data and identify patterns

6. Check forecast accuracy with one or more measures 7. I accuracy Is of forecast acceptable?

5. Develop/compute forecast for period of historical data

4. Select a forecast model that seems appropriate for data

No

8b. Select new forecast model or adjust parameters of existing model

Y Yes
8a. Forecast over planning horizon 9. Adjust forecast based on additional qualitative information 10. Monitor results and measure forecast accuracy y

Forecasts by Time Horizon

Short-range forecast

Up to 1 year; usually less than 3 months Job scheduling, worker assignments

Medium-range di f forecast

3 months to 3 years Sales & production planning, planning budgeting

Long-range Long range forecast

3+ years New p product p planning, g, facility y location

Demand behavior

Trend A gradual, long-term up or down movement of demand Linear, exponential, several year duration Seasonal pattern An up-and-down repetitive movement in demand occurring periodically short term: often annually) Due D t to weather, th habits h bit etc. t Occurs within a predefined period: year, month, week, day Cycle An up-and-down repetitive movement in demand (long term) Repeating up & down movements Due to interactions of factors influencing economy Usually y 2-10 y years duration Random variations Movements in demand that do not follow a pattern

Graphical representation of Demand Behavior

Deman nd Deman nd Random movement Time (a) Trend Time (b) Cycle Time (c) Seasonal pattern Demand D Time (d) Trend with seasonal pattern

Demand

Forecasting Techniques
Type I: Qualitative forecasting It is based on opinion and intuition. intuition Generally used when data are limited, unavailable, or not currently relevant. Forecast depends on skill & experience of forecaster & available information. Used when situation is vague g and little data exist. exist. It is applied pp for New products and New technology Qualitative models are: 1.1 Four Q Jury of executive opinion Sales force composite Consumer survey Delphi method

Four Qualitative Models

1.Jury of executive opinion collect opinions of high-level executives, sometimes augment by statistical models Involves small group of high-level managers Combines managerial experience with statistical models Relatively quick 2.Sales Force Composite Each salesperson projects his or her sales Combined at district and national levels Tends to be overly optimistic 3.Consumer /Market Survey Ask A k customers t about b t purchasing h i plans l What consumers say, and what they actually do are often different Sometimes difficult to answer

Four Qualitative Models

4.Delphi Method Iterative group process, continues until consensus is reached Steps involved in Delphi Method: 1. Choose the experts to participate. 2. Through h h a questionnaire (or ( Email), l) obtain b f forecasts f from all ll participants. 3. Summarize the results and redistribute them to the 3 participants along with appropriate new questions. 4. Summarize again, refining forecasts and conditions, and again develop new questions. questions 5. Repeat Step 4 if necessary. Distribute the final results to all participants.

Qualitative Methods : Advantages & Disadvantages

Advantages : Take intangible factors into consideration. consideration Useful when there are little data available (new product, new market, new business unit). ) Disadvantages g : Long consultation process High risk of getting a biased forecast Expensive Usually not precise

Type II: Quantitative Forecasting

Type II: Quantitative Q i i forecasting f i It is used when situation is stable and historical data exist Existing products Current technology Involves vo ves mathematical at e at ca tec techniques. ques. e.g., forecasting o ecast g sa sales es o of color televisions OverviewofQuantitativeForecasting
1. 2. 3 3. 4. 5.

Naive N i approach h Moving averages Exponential smoothing Trend projection Linear regression g

TimeTime -Series Models Associative Model

Quantitative Methods : Advantages & Disadvantages

Advantages : Easy to use once the right model has been developed. Data collection is quick and easy since i most t of f the th required information is already in the business systems (ex. previous sales) or readily available (ex. consumer price index).

Disadvantages : Do not take new information into consideration

Realities of Forecasting
1.

Forecasts are seldom perfect: almost always wrong g by y some amount Aggregated forecasts are more accurate than individual forecasts More o e accu accurate ate for o s shorter o te t time e pe periods ods Most forecasting methods assume that there is some underlying stability in the system: watch out for special events.

2.

3. 4.

Naive Forecasts
A forecast that assumes that demand in the next period will be equal to demand in the most recent period. Characteristics:

Simple to use Virt all no cost Virtually Quick and easy to prepare Easily understandable Can be a standard for accuracy Cannot p provide high g accuracy y

Naive Forecasts
ORDERS PER MONTH 120 90 100 75 110 50 75 130 110 90 -

Assumes demand in
FORECAST 120 90 100 75 110 50 75 130 110 90

MONTH Jan Feb M Mar Apr May June July Aug Sept Oct Nov

next period is the same as demand in most recent period If May sales were 48, then June sales will ill be b 48 Sometimes can be cost effective & efficient

Techniques for Averaging

These are techniques that are useful for data that has only random variation. These techniques smooth fluctuations in a time series. Forecasts that are based on an average are more stable than the original data. There are three popular averaging techniques:

Simple Si l moving i average Weighted moving average Simple exponential smoothing

Moving Average

A technique that uses a number of historical data values to generate a forecast. Involves l fi di a series finding i of f successive i averages by b dropping d i the first data value in the series and adding the last data value. Useful for data without trend, seasonality, or cycles.
Weekly Patient Arrivals at a Medical Clinic
475 Patient Arrivals 450 425 400 375 350 1 4 7 10 13 16 19 22 2 25 28 Week

Sonia Sultana, Lecturer, Daffodil International University

Simple Moving Average Formula

The simple moving average model assumes an average is a good estimator of future behavior. A technique q that averages g a number of recent actual values, , updated as new values become available The formula for the simple moving average is:

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

Ft = Forecast for the coming period
N = Number N b of f periods i d to be b averaged d A t-1 = Actual occurrence in the past period for up to n periods

Simple Moving Average

A key decision involves selecting the number of periods that will be included in the average. The larger the number of periods, the greater the smoothing; the smaller the number of periods, the quicker the forecast reacts to changes in the data.
Example of Three- and Five-Period Moving Average
3-Period MA Forecast 5-Period MA Forecast

100 90 Demand d 80 70 60

Period 1 2 3 4 5 6 7 8 9 10

Demand 53 62 84 78 95 75 66 82 71 83

66.3 74.7 85.7 82 7 82.7 78.7 74.3 73.0 78.7

74.4 78 8 78.8 79.6 79.2 77.8 75.4

50 1 2 3 4 5 6 Period Demand 3-Period MA 5-Period MA 7 8 9 10

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Example 1 Simple Moving Average Illustration Market Mixer, Inc. sells can openers. Monthly sales for an eight-month period were as follows: Month 1 2 3 4 Sales 450 425 445 435 Month 5 6 7 8 Sales 460 455 430 420

Forecast next months sales using a 3-month moving average. Solution: Period 1 2 3 4 5 6 7 8 9 Sales 450 425 445 435 460 455 430 420 Moving Average Forecast Comments:
1. Any y forecasts beyond y Period 9 will have the same value as the Period 9 forecast; i.e., 435. 2. As a new actual value becomes available, the forecast will be updated by adding the newest value and dropping the oldest one. 3. SMA gives equal weight to all values in the average. Hence, the oldest value has the same weight, or importance as the newest. importance, newest

(450 + 425 + 445) / 3 = 440 (425 + 445 + 435) / 3 = 435 (445 + 435 + 460) / 3 = 447 (435 + 460 + 455) / 3 = 450 (460 + 455 + 430) /3 = 448 (455 + 430 + 420) / 3 = 435

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Simple Moving Average Problem (2)

W eek 1 2 3 4 5 6 7 Demand 820 775 680 655 620 600 575

Question: What is the 3 week moving i average forecast f f for this data? A Assume you only l have h 3 weeks k and 5 weeks of actual demand data for the respective forecasts

Simple Moving Average Problem (2) Solution

W eek 1 2 3 4 5 6 7 Demand 820 775 680 655 620 600 575 3-W eek 5-W eek

Weighted Moving Average

A model that applies pp different weights g to each value in the moving average calculation. Theformulaforthemovingaverageis:

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

wt = weight given to time period t occurrence. (Weights must add to one.)

w
i=1

=1

Example 1 Weighted Moving Average Illustration (Let us continue with the same p problem as we had in Example p 1.) Market Mixer, , Inc. sells can openers. Monthly sales for an eight-month period were as follows: Month 1 2 3 4 Sales 450 425 445 435 Month 5 6 7 8 Sales 460 455 430 420

Forecast next months sales using a 3-month weighted moving average, where the weight for the most recent data value is 0.60; the next most recent, 0.30; and the earliest, 0.10. Solution: Period 1 2 3 4 5 6 7 8 9 Sales 450 425 445 435 460 455 430 420 Weighted Moving Average Forecast Comments:
1. Any y forecasts beyond y Period 9 will have the same value as the Period 9 forecast, i.e., 427. 3. WMA gives greater weight to more recent values in the moving average and is more responsive to recent changes in the data.

(450*.10) + (425*.30) + (445*.60) = 440 (425*.10) + (445*.30) + (435*.60) = 437 (445* (445 .10) 10) + (435 (435*.30) 30) + (460 (460*.60) 60) = 451 (435*.10) + (460*.30) + (445*.60) = 455 (460*.10) + (455*.30) + (430*.60) = 441 (445*.10) + (430*.30) + (420*.60) = 427

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Weighted Moving Average Problem (2)

Question: Given the weekly demand information and weights, what is the weighted moving average forecast of the 5th period or week?
W eek 1 2 3 4 5 Demand 820 775 680 655 Forecast

Weights: t-1 .7 t-2 .2 t-3 .1

Simple Exponential Smoothing

This is a variation of the weighted moving average model. W i ht are determined Weights d t i d by b an exponential ti l function f ti which hi h declines as the data gets older. The most recent observations might g have the highest g predictive value. Therefore, we should give more weight to the more recent time i periods i d when h forecasting. f i Theformula: Ft+1 =aAt +(1 a)Ft
Where Ft+1 =forecastfornextperiod a=smoothingconstant(0<a<1) At =currentperiodsactualdemand Ft =currentperiodsforecast
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Advantages of Simple Exponential Smoothing model over other forecasting approaches

Exponential models are surprisingly accurate Formulating Exponential model is relatively easy The user can understand how the model works Little computation is required to use the model Computer p storage g requirements q are small because of the limited use of historical data Tests for accuracy y as to how well the model is performing are easy to compute

Example 1 Simple Exponential Smoothing Illustration (Let us continue with the same problem as we had in Example 1.) Market Mixer, Inc. sells can openers. Monthly sales for an eight-month period were as follows: Sales Month Sales Month 1 450 5 460 2 425 6 455 3 445 7 430 4 435 8 420 Forecast next months sales using exponential smoothing with alpha () = 0.30 and the first ( (starting) g) forecast = 450. Solution: Period 1 2 3 4 5 6 7 8 9 Sales 450 425 445 435 460 455 430 420 Exponential Smoothing Forecast 450 ( 30*450) (.30 450) + (1 - .30) 30)*450 450 = 450 (.30*425) + (1 - .30)*450 = 443 (.30*445) + (1 - .30)*443 = 443 (.30*435) + (1 - .30)*443 = 441 ( 30*460) + (1 - .30)*441 (.30*460) 30)*441 = 447 (.30*455) + (1 - .30)*447 = 449 (.30*430) + (1 - .30)*449 = 443 (.30*420) + (1 - .30)*443 = 436

Comments:
1. Any forecasts beyond Period 9 will have the same value as the Period 9 forecast, i.e., 436. 3. The higher the value of , the quicker the reaction to changes in the data and the less the smoothing.

Exponential Smoothing Problem (1)

W eek 1 2 3 4 5 6 7 8 9 10 Demand 820 775 680 655 750 802 798 689 775

Question: Given the weekly Q y

demand data, what are the exponential smoothing f forecasts f periods for i d 210 using i a=0.10 and a=0.60? Assume F1=D1

Answer: The respective alphas columns denote the forecast values. Note that you can only forecast one time period into the future.

Week 1 2 3 4 5 6 7 8 9 10

Demand 820 775 680 655 750 802 798 689 775

0.1 820.00 820.00 815.50 801.95 787.26 783 53 783.53 785.38 786 64 786.64 776.88 776 69 776.69

0.6 820.00 820.00 793.00 725.20 683.08 723 23 723.23 770.49 787 00 787.00 728.20 756 28 756.28

Exponential Smoothing Problem (1) Plotting

900 De emand 800 700 600 500 1 2 3 4 5 6 7 8 9 10 W eek D em and 0.1 0.6

Exponential Smoothing Problem (2)

Question: What are the exponential smoothing forecasts for periods 25 using a =0.5?Assume F1=D1
Week 1 2 3 4 5 Demand 820 775 680 655

W eek 1 2 3 4 5

Dem and 820 775 680 655

0.5

Picking a Smoothing Constant

Exponential Smoothing
Actual Alpha=0.10 Alpha=0.40

100 95 De emand 90 85 80 75 70 2 3 4 5 6 7 8 9 10 11 Period

Problem 1

National Mixer Inc. sells can openers. Monthly sales for a seven-month period were as follows: Forecast September sales volume using each h of f the h following: f ll i

Month Feb Mar Apr May Jun Jul Aug

Sales (1000) 19 18 15 20 18 22 20

A five-month moving average Exponential smoothing with a smoothing constant equal to .20, assuming a March forecast of 19. The naive approach A weighted average using .60 for August, .30 30 for July, July and .10 10 for June. June

Problem 2

A dry cleaner uses exponential smoothing to forecast equipment usage at its main plant. plant August usage was forecast to be 88% of capacity. Actual usage was 89.6%. 89 6% A smoothing constant of 0.1 0 1 is used.

Prepare a forecast for September Assuming actual September usage of 92%, prepare a forecast f t of f October O t b usage

Problem 3

An electrical contractors records during the last five weeks indicate the number of job requests: Week: 1 2 3 4 5 Requests: 20 22 18 21 22 Predict the number of requests for week 6 using each of these methods:

Nave A four-period four period moving average Exponential smoothing with a smoothing constant of .30. Use 20 for week 2 forecast.

Forecast Accuracy

Source of forecast errors:

Model may y be inadequate q Irregular variations Incorrect use of forecasting technique R d Random variation i ti

Key to validity is randomness

Accurate models: random errors Invalid models: nonrandom errors

Key question: How to determine if forecasting errors are random?

Error measures

Error - difference between actual value and predicted value Mean Absolute Deviation (MAD)

Average absolute error

Mean Squared Error (MSE)

Average of squared error Average absolute percent error

Mean Absolute Percent Error (MAPE)

MAD, MSE, and MAPE

MAD = Actual forecast n MSE = ( Actual forecast) n -1
2

MAPE =

Actual Forecast 100 Actual n

Example
Period 1 2 3 4 5 6 7 8 Actual 217 213 216 210 213 219 216 212 Forecast 215 216 215 214 211 214 217 216 (A-F) 2 -3 1 -4 4 2 5 -1 -4 -2 |A-F| 2 3 1 4 2 5 1 4 22 (A-F)^2 4 9 1 16 4 25 1 16 76 (|A-F|/Actual)*100 0.92 1.41 0.46 1 90 1.90 0.94 2.28 0 46 0.46 1.89 10.26

MAD= MSE= MAPE=

2.75 10.86 1.28