[email protected].

pk
Advanced class this week

Next classes:

December 7 (9th),
December 14 (report),
December 21*,
Manage 2 MSPM make-up classes
December 28*,
Forecasting

Pirzada
November 28, 2021
Forecasting

• Foretell
• Predict,
• Project,
• Estimate,
• Guess
Forecasts: Need and importance

• Basis of corporate planning

• Basis of budgetary planning

• Operations planning
• Capacity planning
Types of Forecasts

1. Economic forecasts
Inflation rates, money supplies, housing starts, and other
planning indicators.
2. Technological forecasts
Rates of technological progress, requiring new plants and
equipment.
3. Demand forecasts
Accurate information about real demand. drive a company’s
production, capacity, marketing, and personnel planning.
Forecasting Time Horizons

1. Short-range forecast:
Span: < 3 months - 1 year.
Use: purchasing, job assignments and scheduling,
2. Medium-range forecast: Span: 3 months - 3 years.
Use: Sales planning, production planning and budgeting,
3. Long-range forecast:
Span: 3 years or more,
Use: New products, capital expenditures, facility location or
expansion, and research and development.
Demand Management: Influencing Demand
Active role:
• Incentives, • Campaigns, • Price cuts etc.

Passive role:
Simply accept because:
• Firm is running to full capacity,
• Market is fixed and static, and
• Funding issues etc.
 Types of Forecasting

 Qualitative
 Time series analysis
 Casual relationship
 Simulation

See Exhibit 13.1, Page 540

 Qualitative Methods

1. Panel Consensus: The opinions of a group of high-level

experts or managers.

2. Market survey: Input from customers or potential customers

regarding future purchasing plans.

3. Grass root method: Salespersons estimates for their region.

4. Delphi method: Different types of participants.
Qualitative Techniques-I

Panel Consensus
Panel of people from variety of position
Open meeting & free exchange

Historical Analogy
Modeling a generic product
Qualitative Techniques -II

Grass Roots
- The person closest to customers knows future needs best.

Forecasts of bottom level +

safety stocks +
order size corrections To next level …
Qualitative Techniques-III

Delphi Method

1. Choose experts (variety of knowledgeable persons).

2. Obtain forecast through a questionnaire ((e-mails etc.).
3. Summarize the results/ redistribute with new questionnaire.
4. Summarize again develop new questions.
5. Repeat step 4.

Usually 3 rounds required!

Quantitative Forecasting Models
Time Series Analysis

A forecast in which past demand data is used to predict future

demand.
Components of Demand

 Average demand
 Trends
• Linear • S-curve • Asymptotic • Exponential

 Seasonal elements
 Cyclic elements
 Random variation
 Auto correction

See Exhibit 13.2, Page 541

Time Series Analysis

Selection of method of forecasting depends on:

1. Time horizon
2. Data availability
3. Accuracy required
4. Size of forecasting budget
5. Availability of qualified personnel
Simple Moving Average

At 1  At  2  At 3  .... At  n
ft 
n
Ft: Forecast for the coming period
n: No. of periods to be averaged
At-1: Actual occurrence in the past period
At-2, At-3, At-n : Actual occurrence in 2
periods ago, 3 periods ago, n periods ago,

Good for cases where demand is stable

and does not have seasonal characteristics
Weighted Moving Average

Allows placing of weights, e.g. most recent more weight

Ft  w1 At 1  w2 At  2  w3 At 3  ....wn At  n
n

w
i 1
i 1

W1: Weight to be given to the actual occurrence for the period t-

1
W2: Weight to be given to the actual occurrence for the period t-
2
Wn: Weight to be given to the actual occurrence for the period t-
Exponential Smoothening

Ft  Ft 1   ( At 1  Ft 1 ) Premise
Most recent
i. Most recent forecast: (Ft-1)
occurrences
ii. The actual demand (At-1)
are most
iii. Smoothening constant (α)
iv. Forecast for period t: (Ft) indicative.

Exponential models are surprisingly accurate, relatively easy

(little computation), limited use of historical data, easy tests
for accuracy.
Exponential Smoothening
Smoothening constant (α)
The value is determined by nature of the product and a judgment
on response rate.

Smaller α values Larger α values

Standard items Fashion items

Stable demand Growing demand

Small reaction rate Higher reaction rate

More lagging* Less lagging*

See Exhibit 13.7 page 550

Statistics: Few more terms

Regression Residuals
Y = a + b x1
The difference between
an observed value of the
Least square fitting response variable and
Sum of the residuals is least the value of the
response variable
predicted from the
regression line.
Linear Regression

Y  a  bx
Y= Value of dependent variable from a  y  bx
regression equation.
xy  n x. y
a : Y –intercept b
b: Slope of the line. x 2  n x x
n
y : Average of all ys
 i i
( y  Y ) 2

x : Average of all xs S yx  i 1

x: x value of each data point n2

y: y value of each data point
n: number od data points.
Linear Regression Analysis
Casual Relationship Forecast

Where one occurrence causes another.

1. Find causes
2. Develop a relation ship
3. Make forecast

Follow Example 13.5 page 567

Statistics: Few more terms

Regression: Y = a + b x1

Multiple regression: Y = a + b x1 + b x2 + b x3 + …
Least square fitting: Sum of the residuals is least
Multiple Regression Analysis

S  B  Bm ( M )  Bh ( H )  Bi ( I )  Bt (T )

S= Gross sale for the year

B= Base sales (starting point)
M= Marriages during the year
H= Housing starts during the year
I= Annual disposable personal income
T= Time trend
Focused Forecasting

1. Whatever we sold in the past three month is what we will probably

sell in the next three months.
2. What we sold in the same three month period last year, we will
probably sell in that three month period this year. (This would
account for seasonal effects.)
3. We will probably sell ten percent more in the next three months
than we sold in the past three months.
4. We will probably sell fifty percent more over the next three months
than we did for the same three months of last year.
5. Whatever percentage chance we had for the past three months this
year compared to the same three months last year will probably be
the same percentage change that we will have for the next three
months of this year.
Web-Based Forecasting

Collaborative Planning, Forecasting and Replenishment (CPFR)

Web-based tool for trading partners (food, apparel etc.)

Step 1: Creation of a front-end partnership agreement.

Step 2: Joint business planning.
Step 3: Development of demand forecast.
Step 4: Sharing forecasts.
Step 5: Inventory replenishment.
 Reading Assignment
Forecasting at Hard Rock Café
Page 193 of Jay Heizer

Discussion: Next week

Forecast Errors: Types and Sources

Bias Errors:
Making a consistent mistake:
Because of :
• Failure to include right variables,
• Using wrong relationships
• Wrong/ undetected trends

Random Errors:
Errors that cannot be explained.
Measurement of Errors

Degree of error measured as standard deviation, variance, mean

absolute deviation (MAD) n

 At  Ft
MAD  i 1
n
1 MAD = 0.8 Standard deviation
3.75 MAD = 3 Standard deviation

An exponentially smoothed MAD is used as error range for next

period’s forecast.
Tracking Signal- Measure of Error

Tracking signal is a measurement that indicated whether the

forecast averages keep in pace with any genuine upward or
downward changes in demand. As used in forecasting, the
tracking signal is the number of mean absolute deviations that
the forecast value is above or below the actual occurrence.

RSFE
TS 
MAD
RSFE: Running sum of forecast errors
MAD: the average of absolute forecast errors.

Follow exhibit 13.9 1nd 13.10, page 555

Linear Regression Analysis

Discussed earlier. The formulae including

those of standard error were also given.

Follow exhibit 13.9 1nd 13.10, page 555

Decomposition of Time Series

Time series is a chronologically ordered data set.

Trend, seasonal, cyclic, autocorrelation, random.

Decomposition: Identifying and separating into components

Easy to identify: Trend, Seasonal

Difficult to identify: Cyclic, autocorrelation, random

Seasonal Variation

Additive seasonal variation

Forecast including trend and seasonal = Trend + seasonal factor

Multiplicative seasonal variation

Forecast including trend and seasonal = Trend x seasonal factor

See Exhibit 13.15 B, Page 561

Seasonal Factor (or Index)

Seasonal Factor (or Index)

Amount of correction needed in a time series to adjust for the
season of the year.

Let us follow examples 13.3 and 13.13.14 page 562

(FITSt): Forecast including trend and seasonal factor for period t

FITSt = Trend . seasonal factor

Decomposing Time Series

Decomposing using Least Square Regression

I. Decompose the time series into its components
a. Find seasonal components
b. Deseasonalize the demand
c. Find Trend component

II. Forecast future values of each component

a. Project trend component into the future
b. Multiply trend component by seasonal component.
Scheme for Decomposition

Step 1: Determine the seasonal factor

Step 2: Deseasonalize the original data
Step 3: Develop regression line for deseasonalized data
Step 4: Project for the period of forecast
Step 5: Create final forecast using seasonal factor.
 Home Work 3
Due Date April 11, 2010

Problem Nos. 4, 5, 6
Statistics: Few terms

Mean Absolute Deviation: The average forecast error using

absolute values of the error of each past forecast.