4 Forecasting

PowerPoint presentation to accompany

Heizer and Render
Operations Management, 10e
Principles of Operations Management, 8e

PowerPoint slides by Jeff Heyl

Modified by Prof. Hesham Bassioni

© 2011 Pearson Education, Inc. publishing as Prentice Hall 4-1

 Outline

Time-Series Forecasting

Moving Averages

Exponential Smoothing

Exponential Smoothing with Trend
Adjustment

Trend Projections

Seasonal Variations in Data

Cyclical Variations in Data

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 Outline – Continued

Associative Forecasting Methods:
Regression and Correlation
Analysis

Using Regression Analysis for
Forecasting

Multiple-Regression Analysis

Monitoring and Controlling
Forecasts

Adaptive Smoothing

Forecasting in the Service Sector
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 Learning Objectives
When you complete this chapter you
should be able to :
1. Understand the three time horizons
and which models apply for each use
2. Explain when to use each of the four
qualitative models
3. Apply the naive, moving average,
exponential smoothing, and trend
methods

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 Learning Objectives
When you complete this chapter you
should be able to :
4. Compute three measures of forecast
accuracy
5. Develop seasonal indexes
6. Conduct a regression and correlation
analysis

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 What is Forecasting?

Process of predicting
a future event

Underlying basis
of all business
??
decisions

Production

Inventory

Personnel

Facilities

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 Strategic Importance of
Forecasting

Human Resources – Hiring, training,
laying off workers

Capacity – Capacity shortages can
result in undependable delivery, loss
of customers, loss of market share

Supply Chain Management – Good
supplier relations and price
advantages

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 Forecasting Time Horizons

Short-range forecast

Up to 1 year, generally less than 3 months

Purchasing, job scheduling, workforce
levels, job assignments, production levels

Medium-range forecast

3 months to 3 years

Sales and production planning, budgeting

Long-range forecast

3+ years

New product planning, facility location,
research and development
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 Types of Forecasts

Economic forecasts

Address business cycle – inflation rate,
money supply, housing starts, etc.

Technological forecasts

Predict rate of technological progress

Impacts development of new products

Demand forecasts

Predict sales of existing products and
services

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 The Realities!

Forecasts are seldom perfect

Most techniques assume an
underlying stability in the system

Product family and aggregated
forecasts are more accurate than
individual product forecasts

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 Forecasting Approaches
Qualitative Methods

Used when situation is vague
and little data exist

New products

New technology

Involves intuition, experience

e.g., forecasting sales on
Internet
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 Forecasting Approaches
Quantitative Methods

Used when situation is ‘stable’ and
historical data exist

Existing products

Current technology

Involves mathematical techniques

e.g., forecasting sales of color
televisions
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 Overview of Qualitative
Methods
1. Jury of executive opinion

Pool opinions of high-level experts,
sometimes augment by statistical
models
2. Delphi method

Panel of experts, queried iteratively

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 Overview of Qualitative
Methods
3. Sales force composite

Estimates from individual
salespersons are reviewed for
reasonableness, then aggregated
4. Consumer Market Survey

Ask the customer

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 Overview of Quantitative
Approaches
1. Naive approach
2. Moving averages
time-series
3. Exponential models
smoothing
4. Trend projection
5. Linear regression associative
model

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 Components of Demand
Trend
component
Demand for product or service

Seasonal peaks

Actual demand
line

Average demand
over 4 years

Random variation
| | | |
1 2 3 4
Time (years)
Figure 4.1
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 Naive Approach

Assumes demand in next
period is the same as
demand in most recent period

e.g., If January sales were 68, then
February sales will be 68

Sometimes cost effective and
efficient

Can be good starting point

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 Moving Average Method

MA is a series of arithmetic means

Used if little or no trend

Used often for smoothing

Provides overall impression of data
over time

∑ demand in previous n periods

Moving average = n

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 Moving Average Example
Actual 3-Month
Month Shed Sales Moving Average
January 10
February 12
March 13
April 16 (10 + 12 + 13)/3 = 11 2/3
May 19 (12 + 13 + 16)/3 = 13 2/3
June 23 (13 + 16 + 19)/3 = 16
July 26 (16 + 19 + 23)/3 = 19 1/3

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 Graph of Moving Average
Moving
30 –
Average
28 –
Forecast
26 – Actual
24 – Sales
Shed Sales

22 –
20 –
18 –
16 –
14 –
12 –
10 –
| | | | | | | | | | | |
J F M A M J J A S O N D

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 Weighted Moving Average

Used when some trend might be
present

Older data usually less important

Weights based on experience and
intuition
∑ (weight for period n )
Weighted x (demand in period n )
moving average = ∑ weights

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 Weights Applied Period
Weighted Moving Average 3 Last month
2 Two months ago
1 Three months ago
6 Sum of weights

Actual 3-Month Weighted

Month Shed Sales Moving Average
January 10
February 12
March 13
April 16 [(3 x 13) + (2 x 12) + (10)]/6 = 121/6
May 19 [(3 x 16) + (2 x 13) + (12)]/6 = 141/3
June 23 [(3 x 19) + (2 x 16) + (13)]/6 = 17
July 26 [(3 x 23) + (2 x 19) + (16)]/6 = 201/2

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 Potential Problems With
Moving Average

Increasing n smooths the forecast
but makes it less sensitive to
changes

Do not forecast trends well

Require extensive historical data

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 Moving Average And
Weighted Moving Average
Weighted
30 – moving
average
25 –
Sales demand

20 – Actual
sales
15 –
Moving
10 – average

5 –
| | | | | | | | | | | |
J F M A M J J A S O N D
Figure 4.2
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 Exponential Smoothing

Form of weighted moving average

Weights decline exponentially

Most recent data weighted most

Requires smoothing constant (α
α)

Ranges from 0 to 1

Subjectively chosen

Involves little record keeping of past
data
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 Exponential Smoothing
New forecast = Last period’s forecast
+ α (Last period’s actual demand
– Last period’s forecast)

Ft = Ft – 1 + α(A t – 1 - Ft – 1)

where Ft = new forecast

Ft – 1 = previous forecast
α = smoothing (or weighting)
constant (0 ≤ α ≤ 1)

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 Exponential Smoothing
Example
Predicted demand = 142 Ford Mustangs
Actual demand = 153
Smoothing constant α = .20

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 Exponential Smoothing
Example
Predicted demand = 142 Ford Mustangs
Actual demand = 153
Smoothing constant α = .20

New forecast = 142 + .2(153 – 142)

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 Exponential Smoothing
Example
Predicted demand = 142 Ford Mustangs
Actual demand = 153
Smoothing constant α = .20

New forecast = 142 + .2(153 – 142)

= 142 + 2.2
= 144.2 ≈ 144 cars

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 Effect of
Smoothing Constants

Weight Assigned to
Most 2nd Most 3rd Most 4th Most 5th Most
Recent Recent Recent Recent Recent
Smoothing Period Period Period Period Period
Constant (α
α) α(1 - α) α(1 - α) 2 α(1 - α) 3 α(1 - α)4

α = .1 .1 .09 .081 .073 .066

α = .5 .5 .25 .125 .063 .031

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 Impact of Different α
225 –

Actual α = .5
200 – demand
Demand

175 –

α = .1
150 – | | | | | | | | |
1 2 3 4 5 6 7 8 9
Quarter

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 Impact of Different α
225 –

Actual α = .5

200
Chose
– high values
demandof α
Demand

when underlying average

is likely to change

175 –
Choose low values of α
when underlying average α = .1
is stable|
150 – | | | | | | | |
1 2 3 4 5 6 7 8 9
Quarter

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 Exponential Smoothing with
Trend Adjustment
When a trend is present, exponential
smoothing must be modified

Forecast Exponentially Exponentially

including (FITt ) = smoothed (Ft ) + smoothed (Tt )
trend forecast trend

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 Exponential Smoothing with
Trend Adjustment

Ft = α(A t - 1) + (1 - α)(Ft - 1 + Tt - 1)

Tt = β(Ft - Ft - 1) + (1 - β)Tt - 1

Step 1: Compute Ft
Step 2: Compute Tt
Step 3: Calculate the forecast FITt = Ft + Tt

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 Exponential Smoothing with
Trend Adjustment Example
Forecast
Actual Smoothed Smoothed Including
Month(t ) Demand (A t ) Forecast, Ft Trend, Tt Trend, FITt
1 12 11 2 13.00
2 17
3 20
4 19
5 24
6 21
7 31
8 28
9 36
10

Table 4.1
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 Exponential Smoothing with
Trend Adjustment Example
Forecast
Actual Smoothed Smoothed Including
Month(t ) Demand (A t ) Forecast, Ft Trend, Tt Trend, FITt
1 12 11 2 13.00
2 17
3 20
4 19
5 24 Step 1: Forecast for Month 2
6 21
7 31 F2 = αA 1 + (1 - α)(F1 + T1)
8 28 F2 = (.2)(12) + (1 - .2)(11 + 2)
9 36
10 = 2.4 + 10.4 = 12.8 units
Table 4.1
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 Exponential Smoothing with
Trend Adjustment Example
Forecast
Actual Smoothed Smoothed Including
Month(t ) Demand (A t ) Forecast, Ft Trend, Tt Trend, FITt
1 12 11 2 13.00
2 17 12.80
3 20
4 19
5 24 Step 2: Trend for Month 2
6 21
7 31 T2 = β(F2 - F1) + (1 - β)T1
8 28 T2 = (.4)(12.8 - 11) + (1 - .4)(2)
9 36
10 = .72 + 1.2 = 1.92 units
Table 4.1
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 Exponential Smoothing with
Trend Adjustment Example
Forecast
Actual Smoothed Smoothed Including
Month(t ) Demand (A t ) Forecast, Ft Trend, Tt Trend, FITt
1 12 11 2 13.00
2 17 12.80 1.92
3 20
4 19
5 24 Step 3: Calculate FIT for Month 2
6 21
7 31 FIT2 = F2 + T2
8 28 FIT2 = 12.8 + 1.92
9 36
10 = 14.72 units

Table 4.1
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 Exponential Smoothing with
Trend Adjustment Example
Forecast
Actual Smoothed Smoothed Including
Month(t ) Demand (A t ) Forecast, Ft Trend, Tt Trend, FITt
1 12 11 2 13.00
2 17 12.80 1.92 14.72
3 20 15.18 2.10 17.28
4 19 17.82 2.32 20.14
5 24 19.91 2.23 22.14
6 21 22.51 2.38 24.89
7 31 24.11 2.07 26.18
8 28 27.14 2.45 29.59
9 36 29.28 2.32 31.60
10 32.48 2.68 35.16

Table 4.1
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 Exponential Smoothing with
Trend Adjustment Example
35 –

30 – Actual demand (A t )
Product demand

25 –

20 –

15 –

10 – Forecast including trend (FITt )

with α = .2 and β = .4
5 –

0 – | | | | | | | | |
1 2 3 4 5 6 7 8 9
Figure 4.3
Time (month)
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 Trend Projections
Fitting a trend line to historical data points
to project into the medium to long-range
Linear trends can be found using the least
squares technique

y^ = a + bx
where y^ = computed value of the variable to
be predicted (dependent variable)
a = y -axis intercept
b = slope of the regression line
x = the independent variable
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 Least Squares Method
Values of Dependent Variable

Actual observation Deviation7

(y -value)

Deviation5 Deviation6

Deviation3

Deviation4

Deviation1
(error) Deviation2
Trend line, y^ = a + bx

Time period Figure 4.4

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 Least Squares Method
Values of Dependent Variable

Actual observation Deviation7

(y -value)

Deviation5 Deviation6

Deviation3 Least squares method

minimizes the sum of the
Deviation
squared errors (deviations)
4

Deviation1
(error) Deviation2
Trend line, y^ = a + bx

Time period Figure 4.4

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 Least Squares Method
Equations to calculate the regression variables

y^ = a + bx

Σxy - nxy
b=
Σx 2 - nx 2

a = y - bx

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 Least Squares Example
Time Electrical Power
Year Period (x ) Demand x2 xy
2003 1 74 1 74
2004 2 79 4 158
2005 3 80 9 240
2006 4 90 16 360
2007 5 105 25 525
2008 6 142 36 852
2009 7 122 49 854
∑x = 28 ∑y = 692 ∑x 2 = 140 ∑xy = 3,063
x=4 y = 98.86
∑xy - nxy 3,063 - (7)(4)(98.86)
b= = = 10.54
∑x 2 - nx 2 140 - (7)(42)

a = y - bx = 98.86 - 10.54(4) = 56.70

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 Least Squares Example
Time Electrical Power
Year Period (x ) Demand x2 xy
2003 1 74 1 74
2004 2 79 4 158
2005The trend
3 line is 80 9 240
2006 4 90 16 360
2007 y^ 5= 56.70 + 10.54
105 x 25 525
2008 6 142 36 852
2009 7 122 49 854
∑x = 28 ∑y = 692 ∑x 2 = 140 ∑xy = 3,063
x=4 y = 98.86
∑xy - nxy 3,063 - (7)(4)(98.86)
b= = = 10.54
∑x 2 - nx 2 140 - (7)(42)

a = y - bx = 98.86 - 10.54(4) = 56.70

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 Least Squares Example
160 –
Trend line,
150 – y^ = 56.70 + 10.54x
140 –
Power demand

130 –
120 –
110 –
100 –
90 –
80 –
70 –
60 –
50 –
| | | | | | | | |
2003 2004 2005 2006 2007 2008 2009 2010 2011
Year
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 Least Squares Requirements

1. We always plot the data to insure a

linear relationship
2. We do not predict time periods far
beyond the database
3. Deviations around the least
squares line are assumed to be
random

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 Seasonal Variations In Data

The multiplicative
seasonal model
can adjust trend
data for seasonal
variations in
demand

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 Seasonal Variations In Data
Steps in the process:
1. Find average historical demand for each season
2. Compute the average demand over all seasons
3. Compute a seasonal index for each season
4. Estimate next year’s total demand
5. Divide this estimate of total demand by the
number of seasons, then multiply it by the
seasonal index for that season

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 Seasonal Index Example
Demand Average Average Seasonal
Month 2007 2008 2009 2007-2009 Monthly Index
Jan 80 85 105 90 94
Feb 70 85 85 80 94
Mar 80 93 82 85 94
Apr 90 95 115 100 94
May 113 125 131 123 94
Jun 110 115 120 115 94
Jul 100 102 113 105 94
Aug 88 102 110 100 94
Sept 85 90 95 90 94
Oct 77 78 85 80 94
Nov 75 72 83 80 94
Dec 82 78 80 80 94
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 Seasonal Index Example
Demand Average Average Seasonal
Month 2007 2008 2009 2007-2009 Monthly Index
Jan 80 85 105 90 94 0.957
Feb 70 85 85 80 94
Mar 80 93 Average
82 85 monthly 94
2007-2009 demand
Seasonal90index95= 115
Apr 100 94
Average monthly demand
May 113 125 131 123 94
= 90/94 = .957
Jun 110 115 120 115 94
Jul 100 102 113 105 94
Aug 88 102 110 100 94
Sept 85 90 95 90 94
Oct 77 78 85 80 94
Nov 75 72 83 80 94
Dec 82 78 80 80 94
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 Seasonal Index Example
Demand Average Average Seasonal
Month 2007 2008 2009 2007-2009 Monthly Index
Jan 80 85 105 90 94 0.957
Feb 70 85 85 80 94 0.851
Mar 80 93 82 85 94 0.904
Apr 90 95 115 100 94 1.064
May 113 125 131 123 94 1.309
Jun 110 115 120 115 94 1.223
Jul 100 102 113 105 94 1.117
Aug 88 102 110 100 94 1.064
Sept 85 90 95 90 94 0.957
Oct 77 78 85 80 94 0.851
Nov 75 72 83 80 94 0.851
Dec 82 78 80 80 94 0.851
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 Seasonal Index Example
Demand Average Average Seasonal
Month 2007 2008 2009 2007-2009 Monthly Index
Jan 80 85 105 90 94 0.957
Feb 70 85 Forecast
85 for802010 94 0.851
Mar 80 93 82 85 94 0.904
Apr 90Expected
95 115annual demand
100 = 1,200
94 1.064
May 113 125 131 123 94 1.309
Jun 110 115 120 1,200 115 94 1.223
Jul Jan 113
100 102 x .957 = 96 94
105 1.117
12
Aug 88 102 110 100 94 1.064
1,200
Sept 85 90
Feb 95 x90.851 = 85 94 0.957
Oct 77 78 85 12 80 94 0.851
Nov 75 72 83 80 94 0.851
Dec 82 78 80 80 94 0.851
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 Seasonal Index Example
2010 Forecast
140 – 2009 Demand
130 – 2008 Demand
2007 Demand
120 –
Demand

110 –
100 –
90 –
80 –
70 –
| | | | | | | | | | | |
J F M A M J J A S O N D
Time
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 San Diego Hospital
Trend Data
10,200 –

10,000 –
Inpatient Days

9,800 – 9745
9659 9702
9573 9616 9766
9,600 – 9530 9680 9724
9594 9637
9,400 – 9551

9,200 –

9,000 – | | | | | | | | | | | |
Jan Feb Mar Apr May June July Aug Sept Oct Nov Dec
67 68 69 70 71 72 73 74 75 76 77 78
Month
Figure 4.6
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 San Diego Hospital
Seasonal Indices
1.06 –
1.04
Index for Inpatient Days

1.04
1.04 – 1.03
1.02
1.02 – 1.01
1.00
1.00 – 0.99
0.98
0.98 – 0.99
0.96 – 0.97 0.97
0.96
0.94 –
0.92 – | | | | | | | | | | | |
Jan Feb Mar Apr May June July Aug Sept Oct Nov Dec
67 68 69 70 71 72 73 74 75 76 77 78
Month
Figure 4.7
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 San Diego Hospital
Combined Trend and Seasonal Forecast
10,200 –
10068
10,000 – 9911 9949
Inpatient Days

9,800 – 9764 9724

9691
9,600 – 9572

9,400 – 9520 9542

9411
9265 9355
9,200 –

9,000 – | | | | | | | | | | | |
Jan Feb Mar Apr May June July Aug Sept Oct Nov Dec
67 68 69 70 71 72 73 74 75 76 77 78
Month
Figure 4.8
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 Associative Forecasting
Used when changes in one or more
independent variables can be used to predict
the changes in the dependent variable

Most common technique is linear

regression analysis

We apply this technique just as we did

in the time series example

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 Associative Forecasting
Forecasting an outcome based on
predictor variables using the least squares
technique
y^ = a + bx

where y^ = computed value of the variable to

be predicted (dependent variable)
a = y -axis intercept
b = slope of the regression line
x = the independent variable though to
predict the value of the dependent
variable
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 Associative Forecasting
Example
Sales Area Payroll
($ millions), y ($ billions), x
2.0 1
3.0 3
2.5 4 4.0 –
2.0 2
2.0 1 3.0 –

Sales
3.5 7
2.0 –

1.0 –

| | | | | | |
0 1 2 3 4 5 6 7
Area payroll
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 Associative Forecasting
Example
Sales, y Payroll, x x2 xy
2.0 1 1 2.0
3.0 3 9 9.0
2.5 4 16 10.0
2.0 2 4 4.0
2.0 1 1 2.0
3.5 7 49 24.5
∑y = 15.0 ∑x = 18 ∑x 2 = 80 ∑xy = 51.5

∑xy - nxy 51.5 - (6)(3)(2.5)

x = ∑x /6 = 18/6 = 3 b =
∑x 2 - nx 2
= 80 - (6)(32) = .25

y = ∑y /6 = 15/6 = 2.5 a = y - b x = 2.5 - (.25)(3) = 1.75

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 Associative Forecasting
Example
y^ = 1.75 + .25x Sales = 1.75 + .25(payroll)

If payroll next year

4.0 –
is estimated to be
$6 billion, then: 3.25
3.0 –

Nodel’s sales
2.0 –
Sales = 1.75 + .25(6)
Sales = $3,250,000 1.0 –

| | | | | | |
0 1 2 3 4 5 6 7
Area payroll

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 Multiple Regression
Analysis
If more than one independent variable is to be
used in the model, linear regression can be
extended to multiple regression to
accommodate several independent variables

y^ = a + b 1x 1 + b 2x 2 …
Computationally, this is quite
complex and generally done on the
computer
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 Multiple Regression
Analysis
In the Nodel example, including interest rates in
the model gives the new equation:

y^ = 1.80 + .30x 1 - 5.0x 2

An improved correlation coefficient of r = .96
means this model does a better job of predicting
the change in construction sales

Sales = 1.80 + .30(6) - 5.0(.12) = 3.00

Sales = $3,000,000
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 Adaptive Forecasting

It’s possible to use the computer to
continually monitor forecast error
and adjust the values of the α and β
coefficients used in exponential
smoothing to continually minimize
forecast error

This technique is called adaptive
smoothing

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 Forecasting in the Service
Sector

Presents unusual challenges

Special need for short term records

Needs differ greatly as function of
industry and product

Holidays and other calendar events

Unusual events

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