2/25/2019

Forecasting
4
PowerPoint presentation to accompany
Heizer, Render, Munson
Operations Management, Twelfth Edition, Global Edition
Principles of Operations Management, Tenth Edition, Global Edition

PowerPoint slides by Jeff Heyl

Copyright © 2017 Pearson Education, Ltd. 4-1

Outline
▶Global Company Profile:
Walt Disney Parks & Resorts
▶What Is Forecasting?
▶The Strategic Importance of
Forecasting
▶Seven Steps in the Forecasting
System
▶Forecasting Approaches

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Outline - Continued
▶Time-Series Forecasting
▶Associative Forecasting Methods:
Regression and Correlation Analysis
▶Monitoring and Controlling Forecasts
▶Forecasting in the Service Sector

Copyright © 2017 Pearson Education, Ltd. 4-3

Forecasting Provides a
Competitive Advantage for Disney

► Global portfolio includes parks in Shanghai,

Hong Kong, Paris, Tokyo, Orlando, and
Anaheim
► Revenues are derived from people – how
many visitors and how they spend their
money
► Daily management report contains only the
forecast and actual attendance at each park
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Forecasting Provides a
Competitive Advantage for Disney

► Disney generates daily, weekly, monthly,

annual, and 5-year forecasts
► Forecast used by labor management,
maintenance, operations, finance, and park
scheduling
► Forecast used to adjust opening times, rides,
shows, staffing levels, and guests admitted

Copyright © 2017 Pearson Education, Ltd. 4-5

Forecasting Provides a
Competitive Advantage for Disney

► 20% of customers come from outside the

USA
► Economic model includes gross domestic
product, cross-exchange rates, arrivals into
the USA
► A staff of 35 analysts and 70 field people
survey 1 million park guests, employees, and
travel professionals each year
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Forecasting Provides a
Competitive Advantage for Disney

► Inputs to the forecasting model include airline

specials, Federal Reserve policies, Wall
Street trends, vacation/holiday schedules for
3,000 school districts around the world
► Average forecast error for the 5-year forecast
is 5%
► Average forecast error for annual forecasts is
between 0% and 3%

Copyright © 2017 Pearson Education, Ltd. 4-7

Learning Objectives
When you complete this chapter you
should be able to :
4.1 Understand the three time horizons and
which models apply for each
4.2 Explain when to use each of the four
qualitative models
4.3 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 :
4.4 Compute three measures of forecast
accuracy
4.5 Develop seasonal indices
4.6 Conduct a regression and correlation
analysis
4.7 Use a tracking signal

Copyright © 2017 Pearson Education, Ltd. 4-9

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

1. Short-range forecast
► Up to 1 year, generally less than 3 months
► Purchasing, job scheduling, workforce levels,
job assignments, production levels
2. Medium-range forecast
► 3 months to 3 years
► Sales and production planning, budgeting
3. Long-range forecast
► 3+ years
► New product planning, facility location,
research and development
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Types of Forecasts
1. Economic forecasts
► Address business cycle – inflation rate, money
supply, housing starts, etc.
2. Technological forecasts
► Predict rate of technological progress
► Impacts development of new products
3. Demand forecasts
► Predict sales of existing products and services

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Strategic Importance of
Forecasting
► Supply-Chain Management – Good
supplier relations, advantages in product
innovation, cost and speed to market
► Human Resources – Hiring, training,
laying off workers
► Capacity – Capacity shortages can result
in undependable delivery, loss of
customers, loss of market share

Copyright © 2017 Pearson Education, Ltd. 4 - 13

Seven Steps in Forecasting

1. Determine the use of the forecast
2. Select the items to be forecasted
3. Determine the time horizon of the
forecast
4. Select the forecasting model(s)
5. Gather the data needed to make the
forecast
6. Make the forecast
7. Validate and implement the results
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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 augmented 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. Market Survey
► Ask the customer

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Overview of Quantitative
Approaches
1. Naive approach
2. Moving averages
3. Exponential Time-series
smoothing models
4. Trend projection
5. Linear regression 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 3 4
Time (years)
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 LENGTH “SEASON” LENGTH NUMBER OF “SEASONS” IN PATTERN
Week Day 7
Month Week 4 – 4.5
Month Day 28 – 31
Year Quarter 4
Year Month 12
Year Week 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 5 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 T W T
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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 Averages

► MA is a series of arithmetic means

► Used if little or no trend
► Used often for smoothing
► Provides overall impression of data
over time

Moving average =
å demand in previous n periods
n

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Moving Average Example

MONTH ACTUAL SHED SALES 3-MONTH 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
August 30 (19 + 23 + 26)/3 = 22 2/3
September 28 (23 + 26 + 30)/3 = 26 1/3
October 18 (26 + 30 + 28)/3 = 28
November 16 (30 + 28 + 18)/3 = 25 1/3
December 14 (28 + 18 + 16)/3 = 20 2/3

Copyright © 2017 Pearson Education, Ltd. 4 - 29

Weighted Moving Average

► Used when some trend might be
present
► Older data usually less important
► Weights based on experience and
intuition

(( )(
Weighted å Weight for period n Demand in period n
moving =
))
average å Weights

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Weighted Moving Average

MONTH ACTUAL SHED SALES 3-MONTH WEIGHTED MOVING AVERAGE
January 10
February 12
March 13
April 16 [(3 x 13) + (2 x 12) + (10)]/6 = 12 1/6
May 19
June WEIGHTS
23 APPLIED PERIOD

July 26 3 Last month

August 30 2 Two months ago

September 28 1 Three months ago

October 18 6 Sum of the weights

November Forecast for

16this month =

December 3 x14Sales last mo. + 2 x Sales 2 mos. ago + 1 x Sales 3 mos. ago
Sum of the weights

Copyright © 2017 Pearson Education, Ltd. 4 - 31

Weighted Moving Average

MONTH ACTUAL SHED SALES 3-MONTH WEIGHTED MOVING AVERAGE
January 10
February 12
March 13
April 16 [(3 x 13) + (2 x 12) + (10)]/6 = 12 1/6
May 19 [(3 x 16) + (2 x 13) + (12)]/6 = 14 1/3
June 23 [(3 x 19) + (2 x 16) + (13)]/6 = 17
July 26 [(3 x 23) + (2 x 19) + (16)]/6 = 20 1/2
August 30 [(3 x 26) + (2 x 23) + (19)]/6 = 23 5/6
September 28 [(3 x 30) + (2 x 26) + (23)]/6 = 27 1/2
October 18 [(3 x 28) + (2 x 30) + (26)]/6 = 28 1/3
November 16 [(3 x 18) + (2 x 28) + (30)]/6 = 23 1/3
December 14 [(3 x 16) + (2 x 18) + (28)]/6 = 18 2/3

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Potential Problems With

Moving Average
1. Increasing n smooths the forecast but
makes it less sensitive to changes
2. Does not forecast trends well
3. Requires extensive historical data

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Graph of Moving Averages

Weighted moving average (from Example 2)
30 –

25 –
Sales demand

20 –

15 – Actual sales

10 – Moving average
(from Example 1)
5–
| | | | | | | | | | | |

J F M A M J J A S O N D
Figure 4.2 Month

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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 period’s forecast
+  (Last period’s actual demand
– Last period’s forecast)

Ft = Ft – 1 + (At – 1 – Ft – 1)

where Ft = new forecast

Ft – 1 = previous period’s forecast
 = smoothing (or weighting) constant (0 ≤  ≤ 1)
At – 1 = previous period’s actual demand

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

© 2014 Pearson Education, Inc. 4 - 37

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

New forecast = 142 + .2(153 – 142)

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

New forecast = 142 + .2(153 – 142)

= 142 + 2.2
= 144.2 ≈ 144 cars

© 2014 Pearson Education, Inc. 4 - 39

Effect of
Smoothing Constants
▶Smoothing constant generally .05 ≤  ≤ .50
▶As  increases, older values become less
significant

WEIGHT ASSIGNED TO
MOST 2ND MOST 3RD MOST 4th MOST 5th MOST
RECENT RECENT RECENT RECENT RECENT
SMOOTHING PERIOD PERIOD PERIOD PERIOD PERIOD
CONSTANT () (1 – ) (1 – )2 (1 – )3 (1 – )4
 = .1 .1 .09 .081 .073 .066

 = .5 .5 .25 .125 .063 .031

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Impact of Different 
225 –

Actual  = .5
demand
200 –
Demand

175 –

 = .1
150 – | | | | | | | | |
1 2 3 4 5 6 7 8 9
Quarter
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Impact of Different 
225 –

Actual  = .5
►200 – demand of 
Choose high values
when underlying average
Demand

is likely to change
175 –
► Choose low values of 
when underlying average  = .1
is stable|
150 – | | | | | | | |
1 2 3 4 5 6 7 8 9
Quarter
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Selecting the Smoothing

Constant
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 according to one of three preferred
measures:
► Mean Absolute Deviation (MAD)
► Mean Squared Error (MSE)
► Mean Absolute Percent Error (MAPE)
Copyright © 2017 Pearson Education, Ltd. 4 - 43

Common Measures of Error

Mean Absolute Deviation (MAD)

MAD =
å Actual - Forecast
n

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Determining the MAD

ACTUAL
TONNAGE FORECAST WITH
QUARTER UNLOADED FORECAST WITH  = .10  = .50
1 180 175 175

2 168 175.50 = 175.00 + .10(180 – 175) 177.50

3 159 174.75 = 175.50 + .10(168 – 175.50) 172.75

4 175 173.18 = 174.75 + .10(159 – 174.75) 165.88

5 190 173.36 = 173.18 + .10(175 – 173.18) 170.44

6 205 175.02 = 173.36 + .10(190 – 173.36) 180.22

7 180 178.02 = 175.02 + .10(205 – 175.02) 192.61

8 182 178.22 = 178.02 + .10(180 – 178.02) 186.30

9 ? 178.59 = 178.22 + .10(182 – 178.22) 184.15

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Determining the MAD

ACTUAL FORECAST ABSOLUTE FORECAST ABSOLUTE
TONNAGE WITH DEVIATION WITH DEVIATION
QUARTER UNLOADED  = .10 FOR a = .10  = .50 FOR a = .50
1 180 175 5.00 175 5.00

2 168 175.50 7.50 177.50 9.50

3 159 174.75 15.75 172.75 13.75

4 175 173.18 1.82 165.88 9.12

5 190 173.36 16.64 170.44 19.56

6 205 175.02 29.98 180.22 24.78

7 180 178.02 1.98 192.61 12.61

8 182 178.22 3.78 186.30 4.30

Sum of absolute deviations: 82.45 98.62

Σ|Deviations|
MAD = 10.31 12.33
n

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Common Measures of Error

Mean Squared Error (MSE)

å(Forecast errors)
2

MSE =
n

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Determining the MSE

ACTUAL
TONNAGE FORECAST FOR
QUARTER UNLOADED  = .10 (ERROR)2
1 180 175 52 = 25
2 168 175.50 (–7.5)2 = 56.25
3 159 174.75 (–15.75)2 = 248.06
4 175 173.18 (1.82)2 = 3.31
5 190 173.36 (16.64)2 = 276.89
6 205 175.02 (29.98)2 = 898.80
7 180 178.02 (1.98)2 = 3.92
8 182 178.22 (3.78)2 = 14.29
Sum of errors squared = 1,526.52

å(Forecast errors)
2

MSE = = 1,526.52 / 8 = 190.8

n
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Common Measures of Error

Mean Absolute Percent Error (MAPE)

n

å100 Actual -Forecast i i

/ Actuali
MAPE = i=1
n

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Determining the MAPE

ACTUAL
TONNAGE FORECAST FOR ABSOLUTE PERCENT ERROR
QUARTER UNLOADED  = .10 100(|ERROR|/ACTUAL)
1 180 175.00 100(5/180) = 2.78%
2 168 175.50 100(7.5/168) = 4.46%
3 159 174.75 100(15.75/159) = 9.90%
4 175 173.18 100(1.82/175) = 1.05%
5 190 173.36 100(16.64/190) = 8.76%
6 205 175.02 100(29.98/205) = 14.62%
7 180 178.02 100(1.98/180) = 1.10%
8 182 178.22 100(3.78/182) = 2.08%
Sum of % errors = 44.75%

MAPE =
åabsolute percent error = 44.75% = 5.59%
n 8
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Comparison of Forecast Error

Rounded Absolute Rounded Absolute
Actual Forecast Deviation Forecast Deviation
Tonnage with for with for
Quarter Unloaded  = .10  = .10  = .50  = .50
1 180 175 5.00 175 5.00
2 168 175.5 7.50 177.50 9.50
3 159 174.75 15.75 172.75 13.75
4 175 173.18 1.82 165.88 9.12
5 190 173.36 16.64 170.44 19.56
6 205 175.02 29.98 180.22 24.78
7 180 178.02 1.98 192.61 12.61
8 182 178.22 3.78 186.30 4.30
82.45 98.62

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Comparison of Forecast Error

Rounded Absolute Rounded Absolute
Actual ∑ |deviations|
Forecast Deviation Forecast Deviation
MAD
Quarter
=
Tonnage
Unloaded
with
 =n.10
for
 = .10
with
 = .50
for
 = .50
1 180 175 5.00 175 5.00
2 For  168
= .10 175.5 7.50 177.50 9.50
3 159 = 82.45/8
174.75 = 15.75
10.31 172.75 13.75
4 175 173.18 1.82 165.88 9.12
5 For  = .50 173.36
190 16.64 170.44 19.56
6 205 175.02 29.98 180.22 24.78
7 180 = 98.62/8
178.02 = 12.33
1.98 192.61 12.61
8 182 178.22 3.78 186.30 4.30
82.45 98.62

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Comparison of Forecast Error

Rounded Absolute Rounded Absolute
∑ (forecast
Actual Forecasterrors) 2
Deviation Forecast Deviation
MSE =Tonnage with for with for
Quarter Unloaded  =n.10  = .10  = .50  = .50
1 180 175 5.00 175 5.00
2 For  168
= .10 175.5 7.50 177.50 9.50
3 159 174.75
= 1,526.52/8 = 15.75
190.8 172.75 13.75
4 175 173.18 1.82 165.88 9.12
5 For  = .50 173.36
190 16.64 170.44 19.56
6 205 175.02 29.98 180.22 24.78
7 = 1,561.91/8
180 178.02 = 195.24
1.98 192.61 12.61
8 182 178.22 3.78 186.30 4.30
82.45 98.62
MAD 10.31 12.33

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Comparison of Forecast Error

n
Rounded
∑ Absolute
Actual 100|deviation
Forecast
Rounded
i|/actualiForecast
Deviation
Absolute
Deviation
MAPEUnloaded
Quarter
= i = 1  with
Tonnage
= .10
for
 = .10
with
 = .50
for
 = .50
n
1 180 175 5.00 175 5.00
2 For 
168= .10 175.5 7.50 177.50 9.50
3 159 174.75
= 44.75%/8 15.75
= 5.59% 172.75 13.75
4 175 173.18 1.82 165.88 9.12
5 For 
190= .50 173.36 16.64 170.44 19.56
6 205 175.02 29.98 180.22 24.78
7 180 = 54.00%/8
178.02 =1.98
6.75% 192.61 12.61
8 182 178.22 3.78 186.30 4.30
82.45 98.62
MAD 10.31 12.33
MSE 190.82 195.24

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Comparison of Forecast Error

Rounded Absolute Rounded Absolute
Actual Forecast Deviation Forecast Deviation
Tonnage with for with for
Quarter Unloaded  = .10  = .10  = .50  = .50
1 180 175 5.00 175 5.00
2 168 175.5 7.50 177.50 9.50
3 159 174.75 15.75 172.75 13.75
4 175 173.18 1.82 165.88 9.12
5 190 173.36 16.64 170.44 19.56
6 205 175.02 29.98 180.22 24.78
7 180 178.02 1.98 192.61 12.61
8 182 178.22 3.78 186.30 4.30
82.45 98.62
MAD 10.31 12.33
MSE 190.82 195.24
MAPE 5.59% 6.75%
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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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Values of Dependent Variable (y-values)

Least Squares Method
Actual observation Deviation7
(y-value)

Deviation5 Deviation6

Deviation3
Least squares method minimizes the
sum of Deviation
the squared
4
errors (deviations)

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

| | | | | | |
1 2 3 4 5 6 7
Figure 4.4
Time period
© 2014 Pearson Education, Inc. 4 - 57

Least Squares Method

Equations to calculate the regression variables

ŷ = a+ bx

b=
å xy - nxy
å x - nx 2 2

a = y - bx
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Least Squares Example

ELECTRICAL ELECTRICAL
YEAR POWER DEMAND YEAR POWER DEMAND
1 74 5 105
2 79 6 142
3 80 7 122
4 90

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Least Squares Example

ELECTRICAL POWER
YEAR (x) DEMAND (y) x2 xy
1 74 1 74
2 79 4 158
3 80 9 240
4 90 16 360
5 105 25 525
6 142 36 852
7 122 49 854
Σx = 28 Σy = 692 Σx2 = 140 Σxy = 3,063

x=
å x = 28 = 4 y=
å y = 692 = 98.86
n 7 n 7

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Least Squares Example

- nxy 3,063 - ( 7) ( 4) (98.86) 295
å xyELECTRICAL
b= = POWER = = 10.54
YEAR (x)
1
å x - nx
2 2

74
( ) x 28
DEMAND (y) 140 - ( 7) 42 2

1
xy
74

()
2 79 4 158
3
a = y - bx = 98.8680
-10.54 4 = 56.70 9 240
4 90 16 360
5 105 ŷ = 56.70 +10.54x25
Thus, 525
6 142 36 852
7 122 49 854
Σx = 28 Σy = 692 Σx2 = 140 Σxy = 3,063

x=
å x =in28year
Demand
=4 y=
å y+=10.54(8)
8 = 56.70 692
= 98.86
n 7 = 141.02,
n or 7141 megawatts

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Least Squares Example

Trend line,
160 – y^ = 56.70 + 10.54x
150 –
Power demand (megawatts)

140 –
130 –
120 –
110 –
100 –
90 –
80 –
70 –
60 –
50 –
| | | | | | | | |
1 2 3 4 5 6 7 8 9
Year Figure 4.5
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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 for monthly seasons:

1. Find average historical demand for each month

2. Compute the average demand over all months
3. Compute a seasonal index for each month
4. Estimate next year’s total demand
5. Divide this estimate of total demand by the
number of months, then multiply it by the
seasonal index for that month

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Seasonal Index Example

DEMAND
AVERAGE AVERAGE
YEARLY MONTHLY SEASONAL
MONTH YEAR 1 YEAR 2 YEAR 3 DEMAND DEMAND INDEX
Jan 80 85 105 90
Feb 70 85 85 80
Mar 80 93 82 85
Apr 90 95 115 100
May 113 125 131 123
June 110 115 120 115
July 100 102 113 105
Aug 88 102 110 100
Sept 85 90 95 90
Oct 77 78 85 80
Nov 75 82 83 80
Dec 82 78 80 80
Total average annual demand = 1,128
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Seasonal Index Example

DEMAND
AVERAGE AVERAGE
YEARLY MONTHLY SEASONAL
MONTH YEAR 1 YEAR 2 YEAR 3 DEMAND DEMAND INDEX
Jan 80 85 105 90 94
Feb 70 85 85 80 94
Mar 80 93 82 85 94
Apr
Average
90 95 1,128
115 100 94
monthly = = 94
May 113
demand 12 months
125 131 123 94
June 110 115 120 115 94
July 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 82 83 80 94
Dec 82 78 80 80 94
Total average annual demand = 1,128
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Seasonal Index Example

DEMAND
AVERAGE AVERAGE
YEARLY MONTHLY SEASONAL
MONTH YEAR 1 YEAR 2 YEAR 3 DEMAND DEMAND INDEX
Jan 80 85 105 90 94 .957( = 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
Seasonal110
June Average
115 monthly
120 demand
115 for past 394
years
=
July index 100 102 Average
113 monthly
105 demand 94
Aug 88 102 110 100 94
Sept 85 90 95 90 94
Oct 77 78 85 80 94
Nov 75 82 83 80 94
Dec 82 78 80 80 94
Total average annual demand = 1,128
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Seasonal Index Example

DEMAND
AVERAGE AVERAGE
YEARLY MONTHLY SEASONAL
MONTH YEAR 1 YEAR 2 YEAR 3 DEMAND DEMAND INDEX
Jan 80 85 105 90 94 .957( = 90/94)
Feb 70 85 85 80 94 .851( = 80/94)
Mar 80 93 82 85 94 .904( = 85/94)
Apr 90 95 115 100 94 1.064( = 100/94)
May 113 125 131 123 94 1.309( = 123/94)
June 110 115 120 115 94 1.223( = 115/94)
July 100 102 113 105 94 1.117( = 105/94)
Aug 88 102 110 100 94 1.064( = 100/94)
Sept 85 90 95 90 94 .957( = 90/94)
Oct 77 78 85 80 94 .851( = 80/94)
Nov 75 82 83 80 94 .851( = 80/94)
Dec 82 78 80 80 94 .851( = 80/94)
Total average annual demand = 1,128
Copyright © 2017 Pearson Education, Ltd. 4 - 69

Seasonal Index Example

Seasonal forecast for Year 4
MONTH DEMAND MONTH DEMAND

Jan 1,200 July 1,200

x .957 = 96 x 1.117 = 112
12 12
Feb 1,200 Aug 1,200
x .851 = 85 x 1.064 = 106
12 12
Mar 1,200 Sept 1,200
x .904 = 90 x .957 = 96
12 12
Apr 1,200 Oct 1,200
x 1.064 = 106 x .851 = 85
12 12
May 1,200 Nov 1,200
x 1.309 = 131 x .851 = 85
12 12
June 1,200 Dec 1,200
x 1.223 = 122 x .851 = 85
12 12

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Seasonal Index Example

Year 4 Forecast
140 – Year 3 Demand
130 – Year 2 Demand
Year 1 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 Figure 4.6

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
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San Diego Hospital

Seasonality Indices for Adult Inpatient Days at San Diego Hospital

MONTH SEASONALITY INDEX MONTH SEASONALITY INDEX

January 1.04 July 1.03

February 0.97 August 1.04

March 1.02 September 0.97

April 1.01 October 1.00

May 0.99 November 0.96

June 0.99 December 0.98

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San Diego Hospital

Seasonal Indices Figure 4.7

1.06 –
1.04 1.04
Index for Inpatient Days

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
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San Diego Hospital

Period 67 68 69 70 71 72

Month Jan Feb Mar Apr May June

Forecast with 9,911 9,265 9,764 9,691 9,520 9,542

Trend &
Seasonality
Period 73 74 75 76 77 78

Month July Aug Sept Oct Nov Dec

Forecast with 9,949 10,068 9,411 9,724 9,355 9,572

Trend &
Seasonality

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San Diego Hospital

Combined Trend and Seasonal Forecast Figure 4.8

10,200 –
10,068
10,000 – 9,911 9,949
Inpatient Days

9,800 – 9,764 9,724

9,691
9,600 – 9,572

9,400 – 9,520 9,542

9,411
9,265 9,355
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
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Adjusting Trend Data

ŷseasonal = Index ´ ŷtrend forecast

Quarter I: ŷI = (1.30)($100,000) = $130,000

Quarter II: ŷII = (.90)($120,000) = $108,000
Quarter III: ŷIII = (.70)($140,000) = $98,000
Quarter IV: ŷIV = (1.10)($160,000) = $176,000

© 2014 Pearson Education, Inc. 4 - 77

Cyclical Variations

▶Cycles – patterns in the data that

occur every several years
▶Forecasting is difficult
▶Wide variety of factors

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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 = value of the dependent variable (in our example,

sales)
a = y-axis intercept
b = slope of the regression line
x = the independent variable

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Associative Forecasting
Example
NODEL’S SALES AREA PAYROLL NODEL’S SALES AREA PAYROLL
(IN $ MILLIONS), y (IN $ BILLIONS), x (IN $ MILLIONS), y (IN $ BILLIONS), x
2.0 1 2.0 2
3.0 3 2.0 1
2.5 4 3.5 7

4.0 –
Nodel’s sales
(in $ millions)

3.0 –

2.0 –

1.0 –

| | | | | | |

0 1 2 3 4 5 6 7
Area payroll (in $ billions)
Copyright © 2017 Pearson Education, Ltd. 4 - 81

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
Σy = 15.0 Σx = 18 Σx2 = 80 Σxy = 51.5

x=
å x = 18 = 3 y=
å y = 15 = 2.5
6 6 6 6

b=
å xy - nxy = 51.5 - (6)(3)(2.5) = .25 a = y - bx = 2.5 - (.25)(3) = 1.75
å x - nx
2 2
80 - (6)(3 ) 2

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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
ŷ = 1.75 + .25x
2.5 4 16 10.0
2.0 2 Sales = 1.75
4 + .25(payroll)
4.0
2.0 1 1 2.0
3.5 7 49 24.5
Σy = 15.0 Σx = 18 Σx2 = 80 Σxy = 51.5

x=
å x = 18 = 3 y=
å y = 15 = 2.5
6 6 6 6

b=
å xy - nxy = 51.5 - (6)(3)(2.5) = .25 a = y - bx = 2.5 - (.25)(3) = 1.75
å x - nx
2
80 - (6)(3 )
2 2

Copyright © 2017 Pearson Education, Ltd. 4 - 83

Associative Forecasting
Example
SALES, y PAYROLL, x x2 xy
2.0 1 1 2.0
4.0 –
3.0 3 9 9.0
ŷ = 1.75 + .25x
(in $ millions)
Nodel’s sales

2.5 3.0 – 4 16 10.0

2.0 2 Sales = 1.75
4 + .25(payroll)
4.0
2.0 2.0 – 1 1 2.0
3.5 7 49 24.5
1.0 –
Σy = 15.0 Σx = 18 Σx2 = 80 Σxy = 51.5
| | | | | | |

x=
0å x1= 18 =2 3 3 å
4 y 5 15 6
y =(in $ billions)
= = 2.5
7
Area payroll
6 6 6 6

b=
å xy - nxy = 51.5 - (6)(3)(2.5) = .25 a = y - bx = 2.5 - (.25)(3) = 1.75
å x - nx
2
80 - (6)(3 )
2 2

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Associative Forecasting
Example

If payroll next year is estimated to be $6 billion,

then:

Sales (in $ millions) = 1.75 + .25(6)

= 1.75 + 1.5 = 3.25

Sales = $3,250,000

Copyright © 2017 Pearson Education, Ltd. 4 - 85

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
Figure 4.10
y y

x x
(a) Perfect negative (e) Perfect positive
correlation, r = –1 y y correlation, r = 1

y
x x
(b) Negative correlation (d) Positive correlation

x
(c) No correlation, r = 0

High Moderate Low Low Moderate High

| | | | | | | | |

–1.0 –0.8 –0.6 –0.4 –0.2 0 0.2 0.4 0.6 0.8 1.0
Correlation coefficient values

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Correlation Coefficient

nå xy - å xå y
r=
é 2 ùé 2ù

êë nå x2
- ( ) å úûêënå y2 -
x ( å úû
y )

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Correlation Coefficient
y x x2 xy y2
2.0 1 1 2.0 4.0
3.0 3 9 9.0 9.0
2.5 4 16 10.0 6.25
2.0 2 4 4.0 4.0
2.0 1 1 2.0 4.0
3.5 7 49 24.5 12.25
Σy = 15.0 Σx = 18 Σx2 = 80 Σxy = 51.5 Σy2 = 39.5

(6)(51.5) – (18)(15.0)
r=
é(6)(80) – (18) 2 ùé(16)(39.5) – (15.0)2 ù
ë ûë û

309 - 270 39 39
= = = = .901
(156)(12) 1,872 43.3

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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

ŷ = a + b1x1 + b2 x2

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:

ŷ = 1.80 + .30x1 - 5.0x2

An improved correlation coefficient of r = .96 suggests

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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