3-1 Forecasting

Chapter 3

Forecasting

Operations Management, Seventh Edition, by William J. Stevenson

McGraw-Hill/Irwin Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
3-2 Forecasting

FORECAST:
A statement about the future

Used to help managers

Plan the system
Plan the use of the system

Operations Management, Seventh Edition, by William J. Stevenson

McGraw-Hill/Irwin Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
3-3 Forecasting

Forecast Uses

Plan the system

Generally involves long-range plans related to:
Types of products and services to offer
Facility and equipment levels
Facility location
Plan the use of the system
Generally involves short- and medium-range plans related to:
Inventory management
Workforce levels
Purchasing
Budgeting

Operations Management, Seventh Edition, by William J. Stevenson

McGraw-Hill/Irwin Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
3-4 Forecasting

Common Features
Assumes causal system
past ==> future
Forecasts rarely perfect because of randomness
Forecasts more accurate for
groups vs. individuals I see that you will
Forecast accuracy decreases get an A this quarter.

as time horizon increases

Operations Management, Seventh Edition, by William J. Stevenson

McGraw-Hill/Irwin Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
3-5 Forecasting

Elements of a Good Forecast

Timely

e
it v
ec
Reliable Accurate eff
st
Co
l se
f u Written u
i ng y
to
n s
ea Ea
M
Operations Management, Seventh Edition, by William J. Stevenson
McGraw-Hill/Irwin Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
3-6 Forecasting

Steps in the Forecasting Process

The forecast

Step 6 Monitor the forecast

Step 5 Make the forecast
Step 4 Gather and analyze data
Step 3 Select a forecasting technique
Step 2 Establish a time horizon
Step 1 Determine purpose of forecast

Operations Management, Seventh Edition, by William J. Stevenson

McGraw-Hill/Irwin Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
3-7 Forecasting

Types of Forecasts
Judgmental - uses subjective inputs (qualitative)
Time series - uses historical data assuming the
future will be like the past (quantitative)
Associative models - uses explanatory variables
to predict the future

Operations Management, Seventh Edition, by William J. Stevenson

McGraw-Hill/Irwin Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
3-8 Forecasting

Judgmental Forecasts
(Qualitative)

Consumer surveys
Delphi method
Executive opinions
Opinions of managers and staff

Sales force.

Operations Management, Seventh Edition, by William J. Stevenson

McGraw-Hill/Irwin Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
3-9 Forecasting

Time Series Forecasts

(Quantitative)

Trend - long-term movement in data

Seasonality - short-term regular variations in data
Irregular variations - caused by unusual circumstances
Random variations - caused by chance

CYCLE- wave like variations lasting more than one year

Operations Management, Seventh Edition, by William J. Stevenson

McGraw-Hill/Irwin Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
3-10 Forecasting

Forecast Variations
Figure 3-1

Irregular
variation

Trend

cycle
Cycles

90
89
88
Seasonal variations

Operations Management, Seventh Edition, by William J. Stevenson

McGraw-Hill/Irwin Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
3-11 Forecasting

The Forecast of Forecasts

Nave
Simple Moving Average
Weighted Moving Average
Exponential Smoothing
ES with Trend and Seasonality

Operations Management, Seventh Edition, by William J. Stevenson

McGraw-Hill/Irwin Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
3-12 Forecasting

Nave Forecast
Simple to use
Virtually no cost
Data analysis is nonexistent
Easily understandable
Cannot provide high accuracy

Operations Management, Seventh Edition, by William J. Stevenson

McGraw-Hill/Irwin Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
3-13 Forecasting

NAVE METHOD
No smoothing of data

Operations Management, Seventh Edition, by William J. Stevenson

McGraw-Hill/Irwin Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
3-14 Forecasting

Techniques for Averaging

Moving average
Weighted moving average
Exponential smoothing

Operations Management, Seventh Edition, by William J. Stevenson

McGraw-Hill/Irwin Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
3-15 Forecasting

Simple Moving Average

Smoothes out randomness by averaging positive and
negative random elements over several periods
n - number of periods (this example uses 4)

Operations Management, Seventh Edition, by William J. Stevenson

McGraw-Hill/Irwin Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
3-16 Forecasting

Points to Know on Moving Averages

Pro: Easy to compute and understand
Con: All data points were created equal.

. Weighted Moving Average

Operations Management, Seventh Edition, by William J. Stevenson

McGraw-Hill/Irwin Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
3-17 Forecasting

Weighted Moving Average

Similar to a moving average methods except that it assigns
more weight to the most recent values in a time series.
n -- number of periods
i weight applied to period t-i+1

t
Ft 1 t i 1 A i 1 2 3
i t n 1 Alpha 0.6 0.3 0.1

Operations Management, Seventh Edition, by William J. Stevenson

McGraw-Hill/Irwin Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
3-18 Forecasting

Exponential Smoothing
Simpler equation, equivalent to WMA
exponential smoothing parameter (0<

Ft Ft 1 ( At 1 Ft 1 )
0.1

Operations Management, Seventh Edition, by William J. Stevenson

McGraw-Hill/Irwin Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
3-19 Forecasting

Exponential Smoothing (=0.30)

Ft Ft 1 ( At 1 Ft 1 )
PERIOD MONTH F2 37 + (0.30)(37-37)
=
DEMAND
= 37
1 Jan 37

2 Feb 40
F3 =37+ (0.30)(40-37)
3 Mar 41 = 37.9

4 Apr 37

5 May 45

6 Jun 50

Operations Management, Seventh Edition, by William J. Stevenson

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McGraw-Hill/Irwin
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3-20 Forecasting

Exponential Smoothing (cont.)

FORECAST, Ft + 1
PERIOD MONTH DEMAND ( = 0.3) ( = 0.5)
1 Jan 37
2 Feb 40 37.00 37.00
3 Mar 41 37.90 38.50
4 Apr 37 38.83 39.75
5 May 45 38.28 38.37
6 Jun 50 40.29 41.68
7 Jul 43 43.20 45.84
8 Aug 47 43.14 44.42
9 Sep 56 44.30 45.71
10 Oct 52 47.81 50.85
11 Nov 55 49.06 51.42
12 Dec 54 50.84 53.21
13 Jan 51.79 53.61

Operations Management, Seventh Edition, by William J. Stevenson

McGraw-Hill/Irwin Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
3-21 Forecasting

Adjusted Exponential Smoothing

AFt +1 = Ft +1 + Tt +1
where
T = an exponentially smoothed trend factor

Tt +1 = (Ft +1 - Ft) + (1 - ) Tt
where
Tt = the last period trend factor
= a smoothing constant for trend

Operations Management, Seventh Edition, by William J. Stevenson

McGraw-Hill/Irwin Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
 3-22 Forecasting

Adjusted Exponential Smoothing

(=0.30)
T3 = (F3 - F2) + (1 - ) T2
PERIOD MONTH
DEMAND
= (0.30)(38.5 - 37.0) + (0.70)(0)
= 0.45
1 Jan 37
AF3 = F3 + T3 = 38.5 + 0.45
2 Feb 40 = 38.95

3 Mar 41 T13 = (F13 - F12) + (1 - ) T12

= (0.30)(53.61 - 53.21) + (0.70)(1.77)
4 Apr 37
= 1.36
5 May 45
AF13 = F13 + T13 = 53.61 + 1.36 = 54.96
6 Jun 50
Operations Management, Seventh Edition, by William J. Stevenson
McGraw-Hill/Irwin Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
3-23 Forecasting

Adjusted Exponential Smoothing:

Example
FORECAST TREND ADJUSTED
PERIOD MONTH DEMAND Ft +1 Tt +1 FORECAST AFt +1

1 Jan 37 37.00
2 Feb 40 37.00 0.00 37.00
3 Mar 41 38.50 0.45 38.95
4 Apr 37 39.75 0.69 40.44
5 May 45 38.37 0.07 38.44
6 Jun 50 38.37 0.07 38.44
7 Jul 43 45.84 1.97 47.82
8 Aug 47 44.42 0.95 45.37
9 Sep 56 45.71 1.05 46.76
10 Oct 52 50.85 2.28 58.13
11 Nov 55 51.42 1.76 53.19
12 Dec 54 53.21 1.77 54.98
13 Jan 53.61 1.36 54.96
Operations Management, Seventh Edition, by William J. Stevenson
McGraw-Hill/Irwin Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
3-24 Forecasting

Linear Trend Equation

Yt = a + bt
a
0 1 2 3 4 5 t

b is the line slope.

Operations Management, Seventh Edition, by William J. Stevenson

McGraw-Hill/Irwin Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
3-25 Forecasting

Calculating a and b

n (ty) - t y
b =
2
n t - ( t) 2

y - b t
a =
n

Yes Linear Regression!!

Operations Management, Seventh Edition, by William J. Stevenson
McGraw-Hill/Irwin Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
3-26 Forecasting

Linear Trend Equation Example

Operations Management, Seventh Edition, by William J. Stevenson

McGraw-Hill/Irwin Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
3-27 Forecasting

Linear Trend Calculation

5 (2499) - 15(812) 12495-12180

b = = = 6.3
5(55) - 225 275 -225

812 - 6.3(15)
a = = 143.5
5

y = 143.5 + 6.3t
Operations Management, Seventh Edition, by William J. Stevenson
McGraw-Hill/Irwin Look on page 85 Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
3-28 Forecasting

Disadvantage of simple linear regression

1-apply only to linear relationship with an

independent variable.
2-one needs a considerable amount of data to
establish the relationship ( at least 20).
3-all observations are weighted equally

Operations Management, Seventh Edition, by William J. Stevenson

McGraw-Hill/Irwin Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
3-29 Forecasting

Forecast Accuracy

Forecast error
difference between forecast and actual demand
MAD
mean absolute deviation
MAPD
mean absolute percent deviation
Cumulative error
Average error or bias

Operations Management, Seventh Edition, by William J. Stevenson

McGraw-Hill/Irwin Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
3-30 Forecasting

Mean Absolute Deviation (MAD)

At - Ft
MAD = n
where
t = period number
At = demand in period t
Ft = forecast for period t
n = total number of periods
= absolute value
Operations Management, Seventh Edition, by William J. Stevenson
McGraw-Hill/Irwin Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
3-31 Forecasting

MAD Example
PERIOD DEMAND, At Ft ( =0.3) (A t - F t ) |At - Ft|
1 37 37.00
2 40 37.00 3.00 3.00
3 41 37.90 3.10 3.10
4 37 At38.83
- Ft -1.83 1.83
5 MAD
45 = n38.28 6.72 6.72
6 50 40.29 9.69 9.69
7 43 53.39
43.20 -0.20 0.20
=
8 47 1143.14 3.86 3.86
9 56 44.30 11.70 11.70
10 52
= 4.85 47.81 4.19 4.19
11 55 49.06 5.94 5.94
12 54 50.84 3.15 3.15
557 49.31 53.39

Operations Management, Seventh Edition, by William J. Stevenson

McGraw-Hill/Irwin Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
3-32 Forecasting

Other Accuracy Measures

Mean absolute percent deviation (MAPD)

|At - Ft|
MAPD =
At
Cumulative error
E = et
Average error
et
(E )=
n
Operations Management, Seventh Edition, by William J. Stevenson
McGraw-Hill/Irwin Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
3-33 Forecasting

Comparison of Forecasts

FORECAST MAD MAPD E (E)

Exponential smoothing ( = 0.30) 4.85 9.6% 49.31 4.48
Exponential smoothing ( = 0.50) 4.04 8.5% 33.21 3.02
Adjusted exponential smoothing 3.81 7.5% 21.14 1.92
( = 0.50, = 0.30)

Operations Management, Seventh Edition, by William J. Stevenson

McGraw-Hill/Irwin Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
3-34 Forecasting

Forecast Control

Tracking signal
monitors the forecast to see if it is biased high
or low
(At - Ft) E
Tracking signal = = MAD
MAD

Operations Management, Seventh Edition, by William J. Stevenson

McGraw-Hill/Irwin Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
3-35 Forecasting

Tracking Signal Values

DEMAND FORECAST, ERROR E = TRACKING
PERIOD At Ft At - Ft (At - Ft) MAD SIGNAL

1 37 37.00
2 40 37.00 3.00 3.00 3.00 1.00
3 41 37.90 3.10 6.10 3.05 2.00
4 37 38.83 -1.83 4.27 2.64 1.62
5 45 38.28
Tracking 6.72 for period
signal 10.99 3 3.66 3.00
6 50 40.29 9.69 20.68 4.87 4.25
7 43 43.20 -0.20
6.10 20.48 4.09 5.01
8 47 43.14TS = 3.86 = 24.34
2.00 4.06 6.00
9 56 44.30
3
3.05
11.70 36.04 5.01 7.19
10 52 47.81 4.19 40.23 4.92 8.18
11 55 49.06 5.94 46.17 5.02 9.20
12 54 50.84 3.15 49.32 4.85 10.17

Operations Management, Seventh Edition, by William J. Stevenson

McGraw-Hill/Irwin Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
3-36 Forecasting

Sources of forecast errors

The model may be inadequate.

Irregular variation may be occur.
The forecasting technique may be used
incorrectly or the results misinterpreted.
There are always random variation in the
data.

Operations Management, Seventh Edition, by William J. Stevenson

McGraw-Hill/Irwin Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
3-37 Forecasting

End Notes

The two most important factors in choosing

a forecasting technique:
Cost
Accuracy
Keep it SIMPLE!
=FORECAST(70,{23,34,12},{67,76,56})
(if you canlet the computer do it)

Operations Management, Seventh Edition, by William J. Stevenson

McGraw-Hill/Irwin Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.