Chapter Two

Forecasting

 Meaning and use of

forecasting
 Forecasting techniques
A forecast is a prediction of what will
occur in the future.
o Meteorologists ---weather,
o sportscasters--- the winners of
football games, and
o companies---how much of their
product will be sold in the future.
Forecasting is an uncertain process.
Management hopes to forecast demand
with as much accuracy as possible,
o which is becoming increasingly difficult to do.
Difficulties raise due to:
consumers have more product
choices and more information
demand receive greater product
diversity, made possible by rapid
technological advances
• Consumers and markets have never
been stationary targets, but they are
??
moving more rapidly now than they ever
have before.
 STRATEGIC ROLE OF FORECASTING
IN SCM
Today’s global business environment focus
on SCM & QM
Supply chain management(SCM)
Encompasses all of the facilities, functions,
and activities involved in producing a
product or service from suppliers (and their
suppliers) to customers (and their
customers).
Supply chain functions include purchasing,
inventory, production, scheduling, facility
location, transportation, and distribution.
Fig. The Effect of Inaccurate Forecasting on the Supply Chain
Importance of Forecasting in OM
Departments throughout the organization
depend on forecasts to formulate and execute
their plans.

Finance needs forecasts to project cash flows

and capital requirements.

Human resources need forecasts to anticipate

hiring needs.

Production needs forecasts to plan production

levels, workforce, material requirements,
inventories, etc.
Importance of Forecasting in OM

Demand is not the only variable of

interest to forecasters.

Manufacturers also forecast worker

absenteeism, machine availability,
material costs, transportation and
production lead times, etc.

Besides demand, service providers are

also interested in forecasts of population,
of other demographic variables, of
weather, etc.
Forecasting Time Horizons
Short-range forecast
Usually < 3 months Quantitati
ve
Up to 1 year
methods
E.g. Job scheduling, worker assignments
Detaile
Medium-range forecast d
use of
3 months to 3 years
system
Sales/production planning, budgeting
Long-range forecast
> 3 years
Design
New product planning, facility location,
of system
Qualitative
research and development
Methods
Medium/long range forecasts deal
with more comprehensive issues and
support management decisions
regarding planning and products,
plants and processes
Short-term forecasting usually
employs different methodologies
than longer-term forecasting
Short-term forecasts tend to be
more accurate than longer-term
forecasts
 Influence of Product Life Cycle

Introduction – Growth – Maturity –

Decline

 Introduction and growth require longer

forecasts than maturity and decline
 As product passes through life cycle,
forecasts are useful in projecting
 Staffing levels
 Inventory levels
 Factory capacity
 Product Life Cycle
Introduction Growth Maturity Decline
Company Strategy/Issues

Best period to Practical to Poor time to Cost control

increase change price change image, critical
market share or quality price, or
image quality
R&D Competitive
engineering is Strengthen costs become
critical niche critical
Defend
market
position

Figure
Product Life Cycle
Introduction Growth Maturity Decline
Product Forecasting Standardizatio Little
design and critical n product
OM Strategy/Issues

development Product and Less rapid differentiat

critical process product ion
Frequent reliability changes – Cost
product and Competitive more minor minimizatio
process product changes n
design improvements Optimum Overcapaci
changes and options capacity ty in the
Short Increase Increasing industry
production capacity stability of Prune line
runs process to
Shift toward
High product focus Long eliminate
production production items not
costs Enhance returning
distribution runs
Limited good
Product margin
models improvement
Attention to and cost Reduce
quality cutting capacity
Figure
 Forecasting
Methods

Quantitative Qualitative
Methods Methods
- Time series analysis - Executive judgment
- Regression analysis - Market research
-Survey of sales force
-Delphi method
Qualitative forecasting methods:
Used when situation is vague and little
data exist
 New products
 New technology
 Involves intuition, judgment,
opinion, past experience, or best
guesses, to make forecasts.
 Qualitative Methods
Executive Judgment: Opinion of a group
of high level experts or managers is pooled
Sales Force Composite: Each regional
salesperson provides his/her sales
estimates. Those forecasts are then
reviewed to make sure they are realistic. All
regional forecasts are then pooled at the
district and national levels to obtain an
overall forecast.
Market Research/Survey: Solicits input
from customers pertaining to their future
purchasing plans. It involves the use of
questionnaires, consumer panels and tests
Delphi Method: As opposed to regular
Qualitative
panels whereMethods
the individuals involved…con’d
are in
direct communication, this method
eliminates the effects of group potential
dominance of the most vocal members.
The group involves individuals from inside
as well as outside the organization.
Typically, the procedure consists of the following
steps:
Each expert in the group makes his/her own
forecasts in form of statements
The coordinator collects all group statements and
summarizes them
The coordinator provides this summary and gives
another set of questions to each group member
including feedback as to the input of other
experts.
 Quantitative Methods
ime Series Forecasting
 Set of evenly spaced numerical data
 Obtained by observing response
variable at regular time periods
 Forecast based only on past values
 Assumes that factors influencing
past and present will continue
influence in future
Time Series Components

Tren Cyclica
d l

Season Rando
al m
Trend Component
 Persistent, overall upward or
downward pattern
 Changes due to population,
technology, age, culture, etc.
 Typically several years duration
 Seasonal Component
 Regular pattern of up and
down fluctuations
 Due to weather, customs,
etc.
 Occurs within a single year
Number of
Period Length Seasons
Week Day 7
Month Week 4-4.5
Month Day 28-31
Year Quarter 4
Year Month 12
Year Week 52
 Cyclical Component
 Repeating up and down movements
 Affected by business cycle, political,
and economic factors
 Multiple years duration
 Often causal or associative
relationships

0 5 10 15 20
 Random Component
 Erratic, unsystematic,
‘residual’ fluctuations
 Due to random variation or
unforeseen events
 Short duration and
nonrepeating

M T W T F
 1. Naive Approach
 Assumes demand in next
period is the same as
demand in most recent
period
 e.g., If May sales were 48,
then June sales will be 48
 Sometimes cost effective
and efficient
 2. 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
Example
Actual 3-Month
Month Shed Sales Moving Average
January 10
February 12
March 13
April 16 (10 + 12 + 13)/3 =
May
11 2
/3 19 (12 + 13 + 16)/3 =
June
13 2
/3 23
July 26 (13 + 16 + 19)/3 =
16
(16 + 19 + 23)/3 =
19 1/3
Graph of Moving Average
Moving
Average
30 –
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
Weighted Moving Average
 Used when trend is 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
 Weights Applied Period
Weighted Moving Average
3
2
Last month
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
May = 121/19
6 [(3 x 16) + (2 x 13) +
(12)]/6
June = 141/23
3
July 26 [(3 x 19) + (2 x 16) +
(13)]/6 = 17
[(3 x 23) + (2 x 19) +
1
 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
 Moving Average And
Weighted Moving Average
Weighted
moving
30 – average
Sales demand

25 –

20 – Actual
sales
15 –
Moving
10 – average

5 –
| | | | | | | | | | | |
Figure 4.2
J F M A M J J A S O N D
3. Exponential Smoothing
Assumes the most recent
observations have the highest
predictive value
gives more weight to recent time periods
FFt+1
t+1
=
= F
F tt
+
+ a(A
a(A tt
-
- F
Ft)
t)
et

Ft+1 = Forecast value for time t+1

Need initial
Need initial
At = Actual value at time tforecast
forecastFFt t
to
tostart.
start.
 = Smoothing constant
 Exponential Smoothing

= last period’s forecast

+ a (last period’s actual demand
– last period’s forecast)

Ft = Ft – 1 + a(At – 1 - Ft – 1)

where Ft = new forecast

Ft – 1 = previous forecast
a = smoothing (or weighting)
constant (0  a  1)
 Example 1

If:
Predicted demand = 142
Actual demand = 153
Smoothing constant a = .20
New forecast = 142 + .2(153 – 142)
= 142 + 2.2
= 144.2 ≈ 144
Example 2
FFt+1
t+1
=
= F
F tt
+
+ a(A
a(A tt
-
- F
Ft)
t)
i Ai
Week Demand
1 820 Given
Given the
the weekly
weekly
2 775 demand
demand
3 680 data
data what
what are
are the
the
4 655 exponential
exponential
5 750 smoothing
smoothing forecasts
forecasts for
for
6 802 periods
periods 2-10
2-10 using
using
7 798 a=0.10?
a=0.10?
8 689
9 775 Assume
Assume FF11=D
=D11
10
 Example 2 ………con’d
FFt+1
t+1
=
= F
F tt
+
+ a(A
a(A tt
-
- F
Ft)
t)
i Ai Fi
Week Demand a = 0.1 0.6
1 820 820.00 820.00
2 775 820.00 820.00
F2 = F1+ a(A1–F1)
3 680 815.50 793.00 =820+.1(820–820)
4 655 801.95 725.20 =820
5 750 787.26 683.08
6 802 783.53 723.23
7 798 785.38 770.49
8 689 786.64 787.00
9 775 776.88 728.20
10 776.69 756.28
 Example 2 ………con’d
FFt+1
t+1
=
= F
F tt
+
+ a(A
a(A tt
-
- F
Ft)
t)
i Ai Fi
Week Demand a = 0.1 0.6
1 820 820.00 820.00
2 775 820.00 820.00
3 680 815.50
F3 = F2+ a(A2793.00
–F2) =820+.1(775–820)
4 655 801.95 725.20
5 750 787.26 683.08 =815.5
6 802 783.53 723.23
7 798 785.38 770.49
8 689 786.64 787.00
9 775 776.88 728.20
10 776.69 756.28
 Example 2 ………con’d
FFt+1
t+1
=
= F
F tt
+
+ a(A
a(A tt
-
- F
Ft)
t)
i Ai Fi
Week Demand a = 0.1 0.6
1 820 820.00 820.00
2 775 820.00 820.00
3 680 815.50 793.00
4 655 801.95 725.20
5 750 787.26 683.08
6 802 783.53 723.23This process
7 798 785.38 770.49 continues
through week
8 689 786.64 787.00
10
9 775 776.88 728.20
10 776.69 756.28
 Example 2 ………con’d
FFt+1
t+1
=
= F
F tt
+
+ a(A
a(A tt
-
- F
Ft)
t)
i Ai Fi
Week Demand a = 0.1 a = 0.6
1 820 820.00 820.00
2 775 820.00 820.00
3 680 815.50 793.00
4 655 801.95 725.20
5 750 787.26 683.08 What if the
6 802 783.53 723.23 a constant
7 798 785.38 770.49 equals 0.5
8 689 786.64 787.00
9 775 776.88 728.20
10 776.69 756.28
 Effect of Smoothing Constants

Weight Assigned to
Most 2nd Most3rd Most4th Most5th Most
Recent Recent Recent Recent Recent
Smoothing Period Period Period Period Period
Constant (a) a(1 - a) a(1 - a)2 a(1 - a)3 a(1 - a)4

a = .1 .1 .09 .081 .073 .066

a = .5 .5 .25 .125 .063 .031

 Impact of Different 

225 –
Actual a = .5
deman
Demand

200 – d

175 –
a = .1
| | | | | | | | |
150 –
1 2 3 4 5 6 7 8 9
Quarter
 Choosing 
The objective is to obtain the
most accurate forecast no
matter the technique
We generally do this by selecting
the model that gives us the lowest
forecast error

Forecast error = Actual demand - Forecast value

= At - Ft
Common Measures of Error

Mean Absolute Deviation (MAD)

∑ |actual - forecast|
MAD =
n

Mean Squared Error (MSE)

∑ (forecast errors)2
MSE =
n
 Common Measures of Error

Mean Absolute Percent Error (MAPE)

n
100 ∑ |actuali - forecasti|/actuali
MAPE = i=1
n
 Comparison of Forecast Error
Rounded Absolute Rounded Absolute
Actual Forecast Deviation Forecast Deviation
Tonnage with for with for
Quarter Unloaded a = .10 a = .10 a = .50 a = .50
1 180 175 5 175 5
2 168 176 8 178 10
3 159 175 16 173 14
4 175 173 2 166 9
5 190 173 17 170 20
6 205 175 30 180 25
7 180 178 2 193 13
8 182 178 4 186 4
84 100
 Comparison of Forecast Error
∑ |deviations|
Rounded Absolute Rounded Absolute
MAD =
Actual Forecast Deviation Forecast Deviation
Tonage n
with for with for
Quarter Unloaded a = .10 a = .10 a = .50 a = .50
1
For a =
180
.10 175 5 175 5
2 168= 84/8176= 10.50 8 178 10
3 159 175 16 173 14
For
4 = .50 173
a175 2 166 9
5 190 173 17 170 20
6 = 100/8
205 175 = 12.50
30 180 25
7 180 178 2 193 13
8 182 178 4 186 4
84 100
 Comparison of Forecast Error
∑ (forecast errors) 2
MSE =Actual Rounded Absolute
Forecast Deviation
Rounded
Forecast
Absolute
Deviation
Tonage n
with for with for
Quarter Unloaded a = .10 a = .10 a = .50 a = .50
For
1
a =
180
.10 175 5 175 5
2 =168
1,558/8176= 194.75
8 178 10
3 159 175 16 173 14
For
4 = .50 173
a175 2 166 9
5 190 173 17 170 20
6 =205
1,612/8
175= 201.50
30 180 25
7 180 178 2 193 13
8 182 178 4 186 4
84 100
MAD 10.50 12.50
 Comparison
n of Forecast Error
100 ∑Rounded
|deviation i|/actual
Absolute Rounded
i Absolute
MAPE Actual
= i= 1
Forecast Deviation Forecast Deviation
Tonage with for with for
Quarter Unloaded a = .10 n a = .10 a = .50 a = .50
1
For a =
180
.10175 5 175 5
2 168 = 45.62/8
176 = 5.70%
8 178 10
3 159 175 16 173 14
4 For a = .50173
175 2 166 9
5 190 173 17 170 20
6 205 = 54.8/8
175 = 6.85%
30 180 25
7 180 178 2 193 13
8 182 178 4 186 4
84 100
MAD 10.50 12.50
MSE 194.75 201.50
 Comparison of Forecast Error
Rounded Absolute Rounded Absolute
Actual Forecast Deviation Forecast Deviation
Tonnage with for with for
Quarter Unloaded a = .10 a = .10 a = .50 a = .50
1 180 175 5 175 5
2 168 176 8 178 10
3 159 175 16 173 14
4 175 173 2 166 9
5 190 173 17 170 20
6 205 175 30 180 25
7 180 178 2 193 13
8 182 178 4 186 4
84 100
MAD 10.50 12.50
MSE 194.75 201.50
MAPE 5.70% 6.85%
A Good Forecast

¨ Has a small error

¨ Error = Demand - Forecast