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PowerPoint slides by Jeff Heyl

Forecasting

PowerPoint presentation to accompany Heizer and Render Operations Management, 10e Principles of Operations Management, 8e

2011 Pearson Education, Inc. publishing as Prentice Hall

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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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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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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 Quantitative Approaches

1. Naive approach 2. Moving averages 3. Exponential smoothing 4. Trend projection
time-series models

5. Linear regression
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associative model
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Time Series Forecasting

Set of evenly spaced numerical data
Obtained by observing response variable at regular time periods

Forecast based only on past values, no other variables important

Assumes that factors influencing past and present will continue influence in future
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Time Series Components

Trend Cyclical

Seasonal

Random

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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 Time (years) | 3 | 4 Figure 4.1
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Trend Component
Persistent, overall upward or downward pattern Changes due to population, technology, age, culture, etc. Typically several years duration

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Seasonal Component
Regular pattern of up and down fluctuations

Due to weather, customs, etc.

Occurs within a single year
Period Week Month Month Year Year Year
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Length Day Week Day Quarter Month Week

Number of Seasons 7 4-4.5 28-31 4 12 52

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Cyclical Component
Repeating up and down movements Affected by business cycle, political, and economic factors

Multiple years duration

Often causal or associative relationships
0
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10

15

20
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Random Component
Erratic, unsystematic, residual fluctuations Due to random variation or unforeseen events Short duration and nonrepeating

M
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F
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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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Exponential Smoothing
Form of weighted moving average
Weights decline exponentially Most recent data weighted most

Requires smoothing constant ()

Ranges from 0 to 1
Subjectively chosen

Involves little record keeping of past data

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Exponential Smoothing
New forecast = Last periods forecast + (Last periods actual demand Last periods forecast)
Ft = Ft 1 + (At 1 - Ft 1)
where Ft = new forecast Ft 1 = previous forecast = smoothing (or weighting) constant (0 1)
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2011 Pearson Education, Inc. publishing as Prentice Hall

Common Measures of Error

Mean Absolute Deviation (MAD)
MAD = |Actual - Forecast|

Mean Squared Error (MSE)

MSE = (Forecast Errors)2

n
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2011 Pearson Education, Inc. publishing as Prentice Hall

Common Measures of Error

Mean Absolute Percent Error (MAPE)

100|Actuali - Forecasti|/Actuali
MAPE =
i=1

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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

^ = a + bx y
^ = computed value of the variable to where y be predicted (dependent variable) a = y-axis intercept b = slope of the regression line x = the independent variable
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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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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
^ = a + bx y
^ 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 ($ millions), y 2.0 3.0 2.5 2.0 2.0 3.5 Area Payroll ($ billions), x 1 3 4 4.0 2 1 3.0 7
Sales 2.0 1.0 0
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| 1

| 2

| | | | 3 4 5 6 Area payroll

| 7
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Associative Forecasting Example

Sales, y
2.0 3.0 2.5 2.0 2.0 3.5 y = 15.0

Payroll, x
1 3 4 2 1 7 x = 18

x2
1 9 16 4 1 49 x2 = 80

xy
2.0 9.0 10.0 4.0 2.0 24.5 xy = 51.5

x = x/6 = 18/6 = 3

51.5 - (6)(3)(2.5) xy - nxy b= = 80 - (6)(32) = .25 x2 - nx2

y = y/6 = 15/6 = 2.5

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a = y - bx = 2.5 - (.25)(3) = 1.75

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Associative Forecasting Example

^ = 1.75 + .25x y If payroll next year is estimated to be $6 billion, then: Sales = 1.75 + .25(6) Sales = $3,250,000

Sales = 1.75 + .25(payroll)

4.0 Nodels sales 3.25 3.0 2.0 1.0 0 | 1 | 2 | | | | 3 4 5 6 Area payroll | 7

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Standard Error of the Estimate

A forecast is just a point estimate of a future value This point is actually the mean of a probability distribution
4.0 Nodels sales 3.25 3.0 2.0 1.0 0
Figure 4.9
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| 1

| 2

| | | | 3 4 5 6 Area payroll

| 7

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Standard Error of the Estimate

Sy,x = (y - yc)2 n-2

where y = y-value of each data point yc = computed value of the dependent variable, from the regression equation n = number of data points

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Correlation
How strong is the linear relationship between the variables?

Correlation does not necessarily imply causality!

Coefficient of correlation, r, measures degree of association
Values range from -1 to +1

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Correlation Coefficient
r= nSxy - SxSy
[nSx2 - (Sx)2][nSy2 - (Sy)2]

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Correlation Coefficient
2 - (Sx)2][nSy2 - (Sy)2] [ n S x (a) Perfect positive x
correlation: r = +1

r=

nSxy - SxSy
(b) Positive correlation: 0<r<1

(c) No correlation: r=0

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(d) Perfect negative x correlation: r = -1

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Correlation
Coefficient of Determination, r2, measures the percent of change in y predicted by the change in x
Values range from 0 to 1

Easy to interpret

For the Nodel Construction example:

r = .901
r2 = .81
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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 ^=a+b x +b x y 1 1 2 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:
^ = 1.80 + .30x - 5.0x y 1 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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