FORECASTING METHOD

ACTIVITIES IN PRODUCTION SYSTEM

What Is Forecasting?
Process of predicting
a future event
Underlying basis of
all business decisions

Production
Inventory
Personnel
Facilities

Forecasting Approaches
Qualitative Methods
Used when situation
is vague & little data
exist
New products
New technology

Involve intuition,
experience
e.g., forecasting
sales on Internet

Quantitative Methods

Forecasting Approaches
Qualitative Methods

Quantitative Methods

Used when situation

is vague & little data
exist
New products
New technology

Involve intuition,
experience

Used when situation is stable & historical data

exist

Existing products

Involve mathematical techniques

Quantitative Forecasting
Select several forecasting methods
Forecast the past
Evaluate forecasts
Select best method
Forecast the future
Monitor continuously forecast accuracy

Quantitative Forecasting
Methods
Quantitative
Forecasting
Causal
Models

Time Series
Models

Moving
Average

Exponential
Smoothing

Trend
Models

Regression

What is a Time Series?

Time series data is a sequence of observations
collected from a process
with equally spaced periods of time F
Forecast based only on past values
Example
Year: 19951996199719981999
Sales: 78.7 63.5 89.7 93.2 92.1

Time Series Components

Trend

Cyclical

Seasonal

Irregular

Trend Component
Persistent, overall upward or downward
pattern
Due to population, technology etc.
Several years duration

Response

Mo., Qtr., Yr.

1984-1994 T/Maker Co.

Trend Component

Overall Upward or Downward Movement

Data Taken Over a Period of Years

Sales

end
r
t
d
r
a
Upw

Time

Cyclical Component
Repeating up & down movements
Due to interactions of factors influencing
economy
Usually 2-10 years duration

Cycle
Response

Mo., Qtr., Yr.

Cyclical Component

Upward or Downward Swings

May Vary in Length

Usually Lasts 2 - 10 Years

Sales

Cycle

Time

Seasonal Component
Regular pattern of up & down fluctuations
Due to weather, customs etc.
Occurs within one year

Summer
Response
1984-1994 T/Maker Co.

Mo., Qtr.

Seasonal Component

Upward or Downward Swings

Regular Patterns

Observed Within One Year

Sales

Winter

Time (Monthly or Quarterly)

Irregular Component
Erratic, unsystematic, residual fluctuations
Due to random variation or unforeseen events
Short duration &
nonrepeating

INTRODUCTION TIME SERIES

METHOD
1. Time series are best when applied to short-term
forecasts.
2. Time series models prove most satisfactory when
historical data contain either no systematic data
pattern or when the changes are occurring very slowly
or consistently.
3. Data requirements and easy of implementation are a
function of the specific time series technique selected.

NAVE MODEL
Uses recent past as the best indicator of
the future.

Yt 1 Yt

The error associated with

this model is

computed as: et Yt Yt

Example for the

Nave Model
Week
1
2
3
5
6
7
8
9

Sales (in
$1,000)
9
8
9
12
9
12
11
?

Forecast
9
8
9
12
9
12
11

Example for the Nave

Model
Week

Sales (in
$1,000)

1
2
3
5
6
7
8

9
8
9
12
9
12
11

Forecast

Error

Absolute
Error

Squared
Error

9
8
9
12
9
12
Sum
Mean

1
1
3
3
3
1
2
0.33

1
1
3
3
3
1
12
2

1
1
9
9
9
1
30
5

TIME SERIES METHOD

Also Known as Averaging methods:
The basic premise of these models is that a weightedaverage of past observations can be used to smooth the
fluctuations in the data in the short term
Averaging methods are suitable for stationary time series
data where the series is in equilibrium around a constant
value ( the underlying mean) with a constant variance over
time.

Moving Average Graph

Sales
Actual

Year

Simple Average Model

Similar to the nave model, this model
uses part of the historical data to make a
forecast.

Yt 1

Yt

t 1

Moving Average Model

Recent observations play an important role in
the forecast.
As new observations become available, a new
average is computed.
The choice of using a smaller or larger number
of observations has implications for the
forecast.

The Moving-Average Model

The n-period moving average builds a forecast by
averaging the observations in the most recent n
periods:

where xt represents the observation made in period t,

and At denotes the moving average calculated after
making the observation in period t.

Moving Average
[An
An Example]
Example]

You work for Firestone Tire.

You want to smooth
random fluctuations using
a 3-period moving average.
199520,000
1996 24,000
199722,000
199826,000
199925,000

Moving Average
[Solution]
Year

Sales

MA(3) in 1,000

199520,000 NA
1996

24,000 (20+24+22)/3 = 22

199722,000 (24+22+26)/3 = 24
199826,000 (22+26+25)/3 = 24
199925,000 NA

Moving Average
Year

Response Moving
Ave
Sales
8

1994

NA

1995

1996

1997

3.67

1998

1999

NA

6
4
2
0
94 95 96 97 98 99

Double Moving Average Model

Used when we have a linear trend in the data
Two different moving averages are computed in this model.
The idea is to remove the trend.

Double Moving
Average Model
Week

Sales
(in $1,000)

1
2
3
5
6
7
8

9
11
10
14
18
22
23

Simple
Moving
Average

10
10.5
12
16
20
22.5

Simple
Moving
Average
Forecast

Double
Moving
Average

10
10.5
12
16
20

10.25
11.25
14
18
21.25

Double Moving Average Model

(2)

Exponential Smoothing Methods

This method provides an exponentially weighted moving average of
all previously observed values.
Appropriate for data with no predictable upward or downward trend.
The aim is to estimate the current level and use it as a forecast of
future value.

EXPONENTIAL SMOOTHING METHODS

The simplest exponential smoothing method is the single
smoothing (SES) method where only one parameter needs
to be estimated
Holts method makes use of two different parameters and
allows forecasting for series with trend.
Holt-Winters method involves three smoothing parameters
to smooth the data, the trend, and the seasonal index.

No trend or
seasonal
pattern?

Y
Single
Exponential
Smoothing
Method

Linear trend
and no seasonal
pattern?

Y
Holts Trend
Corrected
Exponential
Smoothing
Method

Both trend
and seasonal
pattern?

Holt-Winters
Methods

Use Other
Methods

SINGLE EXPONENTIAL SMOOTHING METHODS

Holts Exponential smoothing

Holts two parameter exponential smoothing method is an extension of
simple exponential smoothing.
It adds a growth factor (or trend factor) to the smoothing equation as a
way of adjusting for the trend.

Holts Exponential Smoothing

Three equations and two smoothing constants are used in the model.
The exponentially smoothed series or current level estimate.
The trend estimate.
Forecast m periods into the future.

Holts Exponential smoothing

At = Estimate of the level of the series at time t

= smoothing constant for the data.
yt = new observation or actual value of series in period t.
= smoothing constant for trend estimate
Tt = estimate of the slope of the series at time t
m = periods to be forecast into the future.

Holts Exponential smoothing

The weight and can be selected subjectively or by minimizing a
measure of forecast error such as RMSE.
Large weights result in more rapid changes in the component.
Small weights result in less rapid changes.

Holts Exponential smoothing

The initialization process for Holts linear exponential smoothing
requires two estimates:
One to get the first smoothed value for L1
The other to get the trend b1.

One alternative is to set A1 = y1 and

Winters Exponential Smoothing

Winters exponential smoothing model is the second extension of the
basic Exponential smoothing model.
It is used for data that exhibit both trend and seasonality.
It is a three parameter model that is an extension of Holts method.
An additional equation adjusts the model for the seasonal component.

Holts Exponential smoothing

Three equations and two smoothing constants are used in the model.
The exponentially smoothed series or current level estimate.
The trend estimate.
Forecast m periods into the future.
L t yt (1 )( Lt 1 bt 1 )

bt ( Lt Lt 1 ) (1 )bt 1

F t m Lt mbt

Holts Exponential smoothing

Lt = Estimate of the level of the series at time t

= smoothing constant for the data.
yt = new observation or actual value of series in
= smoothing constant for trend estimate
bt = estimate of the slope of the series at time t
m = periods to be forecast into the future.

period t.

Holts Exponential smoothing

The weight and can be selected subjectively or by minimizing a
measure of forecast error such as RMSE.
Large weights result in more rapid changes in the component.
Small weights result in less rapid changes.

Holts Exponential smoothing

The initialization process for Holts linear exponential smoothing
requires two estimates:
One to get the first smoothed value for L1
The other to get the trend b1.

One alternative is to set L1 = y1 and

b1 y 2 y1
or
b1

y 4 y1
3

or
b1 0

Winters Exponential Smoothing

As with Holts linear exponential smoothing, the weights , , and
can be selected subjectively or by minimizing a measure of forecast
error such as RMSE.
As with all exponential smoothing methods, we need initial values for
the components to start the algorithm.
To start the algorithm, the initial values for Lt, the trend bt, and the
indices St must be set.

Winters Exponential Smoothing

To determine initial estimates of the seasonal indices we need to use at least one
complete season's data (i.e. s periods).Therefore,we initialize trend and level at period s.
Initialize level as:
Initialize trend as
Initialize seasonal indices as:

1
Ls ( y1 y2 y s )
s
1 y y y y2
y ys
bs ( s 1 1 s 2
ss
)
s
s
s
s
S1

y1
y
y
, S 2 2 ,, S s s
Ls
Ls
Ls

Winters Exponential Smoothing

We will apply Winters method to Acme Tool company sales. The
value for is .4, the value for is .1, and the value for is .3.
The smoothing constant smoothes the data to eliminate randomness.
The smoothing constant smoothes the trend in the data set.

Winters Exponential Smoothing

The smoothing constant smoothes the seasonality in the data.
The initial values for the smoothed series Lt, the trend bt, and the
seasonal index St must be set.

Measures of Forecast Accuracy

MAD

Actual

forecast
n

MSE

( Actual

forecast)

n -1

MAPE =

Actual

forecast / Actual*100)
n