5

Forecasting
 LEARNING OBJECTIVES
After completing this chapter, students will be able to:

1. Understand and know when to use various families

of forecasting models.
2. Compare moving averages, exponential
smoothing, and other time-series models.
3. Seasonally adjust data.
4. Understand Delphi and other qualitative decision-
making approaches.
5. Compute a variety of error measures.

5–2
 CHAPTER OUTLINE
5.1 Introduction
5.2 Types of Forecasting Models
5.3 Components of a Time Series
5.4 Measures of Forecast Accuracy
5.5 Forecasting Models – Random Variations Only
5.6 Forecasting Models – Trend and Random
Variations
5.7 Adjusting for Seasonal Variations
5.8 Forecasting Models – Trend, Seasonal, and
Random Variations
5.9 Monitoring and Controlling Forecasts

5–3
 Introduction
• Main purpose of forecasting
– Reduce uncertainty and make better
estimates of what will happen in the future
• Subjective methods
– Seat-of-the pants methods, intuition,
experience
• More formal quantitative and qualitative
techniques

5–4
 Forecasting Models
FIGURE 5.1
Forecasting
Techniques

Qualitative Time-Series Causal

Models Methods Methods

Delphi Moving Regression

Methods Average Analysis

Jury of Executive Exponential Multiple

Opinion Smoothing Regression

Sales Force Trend

Composite Projections

Consumer
Market Survey Decomposition

5–5
 Qualitative Models
• Incorporate judgmental or subjective
factors
– Useful when subjective factors are
important or accurate quantitative data is
difficult to obtain
• Common qualitative techniques
1. Delphi method
2. Jury of executive opinion
3. Sales force composite
4. Consumer market surveys
5–6
 Qualitative Models
• Delphi Method
– Iterative group process
– Respondents provide input to decision
makers
– Repeated until consensus is reached
• Jury of Executive Opinion
– Collects opinions of a small group of high-
level managers
– May use statistical models for analysis

5–7
 Qualitative Models
• Sales Force Composite
– Allows individual salespersons estimates
– Reviewed for reasonableness
– Data is compiled at a district or national
level
• Consumer Market Survey
– Information on purchasing plans solicited
from customers or potential customers
– Used in forecasting, product design, new
product planning
5–8
 Time-Series Models
• Predict the future based on the past
• Uses only historical data on one variable
• Extrapolations of past values of a series
• Ignores factors such as
– Economy
– Competition
– Selling price

5–9
Components of a Time Series
• Sequence of values recorded at
successive intervals of time
• Four possible components
– Trend (T)
– Seasonal (S)
– Cyclical (C)
– Random (R)

5 – 10
 Components of a Time Series
FIGURE 5.2 – Series 4: Trend, Seasonal and Random Variations
Scatter Diagram
for Four Time
Series of Quarterly
Data
Series 3: Trend and Random Variations
Sales

Series 2: Seasonal Variations Only

Series 1: Random Variations Only

| | | | | | | | | | | | | | | |
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16
Time Period (Quarters)
5 – 11
Components of a Time Series
FIGURE 5.3 – Scatter Diagram of Times Series with Cyclical and Random Components
Sales

| | | | | | | | | |
0 2 4 6 8 10 12 14 16 18
Time Period (Years)

5 – 12
 Time-Series Models
• Two basic forms
– Multiplicative
Demand = T x S x C x R

– Additive
Demand = T + S + C + R

– Combinations are possible

5 – 13
Measures of Forecast Accuracy
• Compare forecasted values with actual values
– See how well one model works
– To compare models
Forecast error = Actual value – Forecast value
• Measure of accuracy
– Mean absolute deviation (MAD):

MAD =
å forecast error
n

5 – 14
 Measures of Forecast Accuracy
TABLE 5.1 – Computing the Mean Absolute Deviation (MAD)

ACTUAL
SALES OF ABSOLUTE VALUE OF
WIRELESS FORECAST ERRORS (DEVIATION),
YEAR SPEAKERS SALES (ACTUAL – FORECAST)
1 110 —
2 100 110
3 120 100
4 140 120
5 170 140
6 150 170
7 160 150
8 190 160
9 200 190
10 190 200
11 — 190

5 – 15
 Measures of Forecast Accuracy
TABLE 5.1 – Computing the Mean Absolute Deviation (MAD)

ACTUAL
SALES OF
WIRELESS FORECAST
• ABSOLUTE
Forecast based
VALUE OF
ERRORS (DEVIATION),
on
YEAR SPEAKERS SALES naïve– FORECAST)
(ACTUAL model
1 110 —
2 100 110
• No attempt to adjust
3 120 100 for time series
4 140 120 components
5 170 140
6 150 170
7 160 150
8 190 160
9 200 190
10 190 200
11 — 190

5 – 16
 Measures
MAD =
å forecastof Forecast
error
=
160
=17.8
Accuracy
n 9
TABLE 5.1 – Computing the Mean Absolute Deviation (MAD)

ACTUAL
SALES OF ABSOLUTE VALUE OF
WIRELESS FORECAST ERRORS (DEVIATION),
YEAR SPEAKERS SALES (ACTUAL – FORECAST)
1 110 — —
2 100 110 |100 – 110| = 10
3 120 100 |120 – 110| = 20
4 140 120 |140 – 120| = 20
5 170 140 |170 – 140| = 30
6 150 170 |150 – 170| = 20
7 160 150 |160 – 150| = 10
8 190 160 |190 – 160| = 30
9 200 190 |200 – 190| = 10
10 190 200
|190 – 200| = 10
11 — 190
—
Sum of |errors| = 160
MAD = 160/9 = 17.8
5 – 17
Measures of Forecast Accuracy
• Other common measures
– Mean squared error (MSE)

MSE =
å (error) 2

n
– Mean absolute percent error (MAPE)

error
å actual
MAPE = 100%
n

– Bias is the average error

5 – 18
Forecasting Random Variations
• No other components are present
• Averaging techniques smooth out
forecasts
– Moving averages
– Weighted moving averages
– Exponential smoothing

5 – 19
 Moving Averages
• Used when demand is relatively steady
over time
– The next forecast is the average of the
most recent n data values from the time
series
– Smooths out short-term irregularities in the
data series
Sum of demands in
previous n periods
Moving average forecast =
n

5 – 20
 Moving Averages
• Mathematically
Y t +Y t- 1 +... +Y t- n+1
Ft+1 =
n

ere
Ft+1 = forecast for time period t + 1
Yt = actual value in time period t
n = number of periods to average

5 – 21
 Wallace Garden Supply
• Wallace Garden Supply wants to
forecast demand for its Storage Shed
– Collected data for the past year
– Use a three-month moving average (n = 3)

5 – 22
 Wallace Garden Supply
TABLE 5.2

MONTH ACTUAL SHED SALES 3-MONTH MOVING AVERAGE

January 10
February 12
March 13
April 16 (10 + 12 + 13)/3 = 11.67
May 19 (12 + 13 + 16)/3 = 13.67
June 23 (13 + 16 + 19)/3 = 16.00
July 26 (16 + 19 + 23)/3 = 19.33
August 30 (19 + 23 + 26)/3 = 22.67
September 28 (23 + 26 + 30)/3 = 26.33
October 18 (26 + 30 + 28)/3 = 28.00
November 16 (30 + 28 + 18)/3 = 25.33
December 14 (28 + 18 + 16)/3 = 20.67
January — (18 + 16 + 14)/3 = 16.00

5 – 23
 Weighted Moving Averages
• Weighted moving averages use weights to put
more emphasis on previous periods
– Often used when a trend or other pattern is
emerging

Ft+1 =
å (Weight in period i)(Actual value in period)
å (Weights)
– Mathematically
w1Y t + w2Y t- 1 +... + wnY t- n+1
Ft+1 =
w1 + w2 +... + wn
where
wi = weight for the ith observation
5 – 24
 Wallace Garden Supply
• Use a 3-month weighted moving average
model to forecast demand
– Weighting scheme

WEIGHTS APPLIED PERIOD

3 Last month
2 Two months ago
1 Three months ago
3 x Sales last month + 2 x Sales two months ago + 1 X Sales three months ago
6
Sum of the weights

5 – 25
 Wallace Garden Supply
TABLE 5.3

3-MONTH WEIGHTED
MONTH ACTUAL SHED SALES MOVING AVERAGE
January 10
February 12
March 13
April 16 [(3 X 13) + (2 X 12) + (10)]/6 = 12.17
May 19 [(3 X 16) + (2 X 13) + (12)]/6 = 14.33
June 23 [(3 X 19) + (2 X 16) + (13)]/6 = 17.00
July 26 [(3 X 23) + (2 X 19) + (16)]/6 = 20.50
August 30 [(3 X 26) + (2 X 23) + (19)]/6 = 23.83
September 28 [(3 X 30) + (2 X 26) + (23)]/6 = 27.50
October 18 [(3 X 28) + (2 X 30) + (26)]/6 = 28.33
November 16 [(3 X 18) + (2 X 28) + (30)]/6 = 23.33
December 14 [(3 X 16) + (2 X 18) + (28)]/6 = 18.67
January — [(3 X 14) + (2 X 16) + (18)]/6 = 15.33

5 – 26
 Exponential Smoothing
• Exponential smoothing
– A type of moving average
– Easy to use
– Requires little record keeping of data

orecast = Last period’s forecast

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

 is a weight (or smoothing constant) with a

value 0 ≤  ≤ 1
5 – 27
 Exponential Smoothing
• Mathematically

Ft+1 =Ft + a (Y t - Ft )
where
Ft+1 = new forecast (for time period t + 1)
Ft = pervious forecast (for time period t)
 = smoothing constant (0 ≤  ≤ 1)
Yt = pervious period’s actual demand

The idea is simple – the new estimate is the old

estimate plus some fraction of the error in the
last period
5 – 28
 Exponential Smoothing Example
• In January, February’s demand for a certain car
model was predicted to be 142
• Actual February demand was 153 autos
• Using a smoothing constant of  = 0.20, what is the
forecast for March?

New forecast (for March demand) = 142 + 0.2(153 – 142)

= 144.2 or 144 autos

• If actual March demand = 136

New forecast (for April demand) = 144.2 + 0.2(136 – 144.2)

= 142.6 or 143 autos

5 – 29
 Selecting the Smoothing Constant
• Selecting the appropriate value for  is key to
obtaining a good forecast
• The objective is always to generate an
accurate forecast
• The general approach is to develop trial
forecasts with different values of  and select
the  that results in the lowest MAD
• Chose high values of  when underlying
average is likely to change
• Choose low values of  when underlying
average is stable

5 – 30
 Port of Baltimore Example
TABLE 5.4 – Exponential Smoothing Forecast for  = 0.1 and  = 0.5

ACTUAL FORECAST
TONNAGE FORECAST USING
QUARTER UNLOADED USING  = 0.10  = 0.50
1 180 175 175
2 168 175.5 = 175.00 + 0.10(180 – 175) 177.5
3 159 174.75 = 175.50 + 0.10(168 – 175.50) 172.75
4 175 173.18 = 174.75 + 0.10(159 – 174.75) 165.88
5 190 173.36 = 173.18 + 0.10(175 – 173.18) 170.44
6 205 175.02 = 173.36 + 0.10(190 – 173.36) 180.22
7 180 178.02 = 175.02 + 0.10(205 – 175.02) 192.61
8 182 178.22 = 178.02 + 0.10(180 – 178.02) 186.30
9 ? 178.60 = 178.22 + 0.10(182 – 178.22) 184.15

5 – 31
 Port of Baltimore Example
TABLE 5.5 – Absolute Deviations and MADs

ABSOLUTE
ACTUAL FORECAST DEVIATIONS ABSOLUTE
TONNAGE WITH  = FOR  = FORECAST DEVIATIONS
QUARTER UNLOADED 0.10 0.10 WITH  = 0.50 FOR  = 0.50

1 180 175 175

5 5….

2 168 175.5 177.5

7.5.. 9.5..

3 159 174.75 172.75

15.75 13.75

4 175 173.18 165.88

1.82 9.12

5 190 173.36 170.44

16.64 19.56

6 205 175.02 180.22

29.98 24.78

7 180 178.02 192.61

1.98 12.61

8 182 178.22 186.30

3.78 Best choice5 – 32
4.3..

Sum of absolute deviations 82.45

 Using Software
PROGRAM 5.1A – Selecting the Forecasting Model

5 – 33
 Using Software
PROGRAM 5.1B – Initializing Excel QM

5 – 34
 Using Software
PROGRAM 5.1C – Excel QM Output

5 – 35
 Using Software
PROGRAM 5.2A – Selecting Time-Series Analysis in QM for Windows

5 – 36
 Using Software
PROGRAM 5.2B – Entering Data

5 – 37
 Using Software
PROGRAM 5.2C – Selecting the Model and Entering Data

5 – 38
 Using Software
PROGRAM 5.2D – Output for Port of Baltimore Example

5 – 39
Forecasting – Trend and Random
• Exponential smoothing does not respond to
trends
• A more complex model can be used
• The basic approach
– Develop an exponential smoothing forecast
– Adjust it for the trend

Forecast including Smoothed forecast (Ft+1)

trend (FITt+1) + Smoothed Trend (Tt+1)

5 – 40
 Exponential Smoothing
with Trend
• The equation for the trend correction uses a
new smoothing constant 
• Ft and Tt must be given or estimated
• Three steps in developing FITt

Step 1: Compute smoothed forecast Ft+1

Smoothed Previous forecast
= + a(Last error)
forecast including trend

Ft+1 =FITt + a (Y t - FITt )

5 – 41
 Exponential Smoothing
with Trend
Step 2: Update the trend (Tt +1) using
Smoothed Previous forecast b(Error or
= +
forecast including trend excess in trend)

Tt+1 =Tt + b (Ft+1 - FITt )

Step 3: Calculate the trend-adjusted exponential

smoothing forecast (FITt +1) using
Forecast including Smoothed Smoothed
= +
trend (FITt+1) forecast (Ft+1) trend (Tt+1)

FITt+1 =Ft+1 +Tt+1

5 – 42
Selecting a Smoothing Constant
• A high value of  makes the forecast more
responsive to changes in trend
• A low value of  gives less weight to the
recent trend and tends to smooth out the
trend
• Values are often selected using a trial-and-
error approach based on the value of the
MAD for different values of 

5 – 43
 Midwestern Manufacturing
• Demand for electrical generators from 2007 – 2013
– Midwest assumes F1 is perfect, T1 = 0, a = 0.3, b = 0.4

FIT1 =F1 +T1 =74 +0 =74

TABLE 5.6 – YEAR ELECTRICAL GENERATORS SOLD

Demand 2007 74
2008 79
2009 80
2010 90
2011 105
2012 142
2013 122

5 – 44
 Midwestern Manufacturing
For 2008 (time period 2)
Step 1: Compute Ft+1
F2 = FIT1 + a(Y1 – FIT1)
= 74 + 0.3(74 – 74) = 74
Step 2: Update the trend
T2 = T1 + b(F2 – FIT1)
= 0 + .4(74 – 74) = 0

5 – 45
 Midwestern Manufacturing
Step 3: Calculate the trend-adjusted
exponential smoothing forecast (Ft+1) using
FIT2 = F2 + T2
= 74 + 0 = 74

5 – 46
 Midwestern Manufacturing
For 2009 (time period 3)
Step 1: F3 = FIT2 + a(Y2 – FIT2)
= 74 + 0.3(79 – 74) = 75.5
Step 2: T3 = T2 + .4(F3 – FIT2)
= 0 + .4(75.5 – 74) = 0.6
Step 3: FIT3 = F3 + T3
= 75.5 + 0.6 = 76.1

5 – 47
 Midwestern Manufacturing
TABLE 5.7 – Exponential Smoothing with Trend Forecasts

TIME DEMAND
(t) (Yt) Ft+1 = FITt + 0.3(Yt – FITt) Tt+1 = Tt + 0.4(Ft+1 – FITt) FITt+1 = Ft+1 + Tt+1
1 74 74 0 74

2 79 74 0 74
= 74 + 0.3(74 – 74) = 0 + 0.4(74 – 74) = 74 + 0

3 80 75.5 0.6 76.1

= 74 + 0.3(79 – 74) = 0 + 0.4(75.5 – 74) = 75.5 + 0.6

4 90 77.270 1.068 78.338

= 76.1 + 0.3(80 – 76.1) = 0.6 + 0.4(77.27 – 76.1) = 77.270 + 1.068

5 105 81.837 2.468 84.305

= 78.338 + 0.3(90 – 78.338) = 1.068 + 0.4(81.837 – 78.338) = 81.837 + 2.468

6 142 90.514 4.952 95.466

= 84.305 + 0.3(105 – 84.305) = 2.468 + 0.4(90.514 – 84.305) = 90.514 + 4.952

7 122 109.426 10.536 119.962

= 95.446 + 0.3(142 – 95.466) = 4.952 + 0.4(109.426 – 95.466) = 109.426 + 10.536

8 120.573 10.780 131.353

= 119.962 + 0.3(122 – 119.962) = 10.536 + 0.4(120.573 – 119.962) = 120.573 + 10.780

5 – 48
Exponential Smoothing with
Trend Adjustment(Other Ex.)

Ft = (At - 1) + (1 - )(Ft - 1 + Tt - 1)

Tt = (Ft - Ft - 1) + (1 - )Tt - 1

Step 1: Compute Ft
Step 2: Compute Tt
Step 3: Calculate the forecast FITt = Ft + Tt
 Exponential Smoothing with
Trend Adjustment Example
Forecast
Actual Smoothed Smoothed Including
Month(t) Demand (At) Forecast, Ft Trend, Tt Trend, FITt
1 12 11 2 13.00
2 17
3 20
4 19
5 24
6 21
7 31
8 28
9 36
10
Table 4.1
 Exponential Smoothing with
Trend Adjustment Example
Forecast
Actual Smoothed Smoothed Including
Month(t) Demand (At) Forecast, Ft Trend, Tt Trend, FITt
1 12 11 2 13.00
2 17
3 20
4 19
Step 1: Forecast for Month 2
5 24
6 21
F2 = A1 + (1 - )(F1 + T1)
7 31
8 28 F2 = (.2)(12) + (1 - .2)(11 + 2)
9 36 = 2.4 + 10.4 = 12.8 units
10
Table 4.1
 Exponential Smoothing with
Trend Adjustment Example
Forecast
Actual Smoothed Smoothed Including
Month(t) Demand (At) Forecast, Ft Trend, Tt Trend, FITt
1 12 11 2 13.00
2 17 12.80
3 20
4 19
Step 2: Trend for Month 2
5 24
6 21
T2 = (F2 - F1) + (1 - )T1
7 31
8 28 T2 = (.4)(12.8 - 11) + (1 - .4)(2)
9 36 = .72 + 1.2 = 1.92 units
10
Table 4.1
 Exponential Smoothing with
Trend Adjustment Example
Forecast
Actual Smoothed Smoothed Including
Month(t) Demand (At) Forecast, Ft Trend, Tt Trend, FITt
1 12 11 2 13.00
2 17 12.80 1.92
3 20
4 19
Step 3: Calculate FIT for Month 2
5 24
6 21
FIT2 = F2 + T2
7 31
8 28 FIT2 = 12.8 + 1.92
9 36 = 14.72 units
10
Table 4.1
 Exponential Smoothing with
Trend Adjustment Example
Forecast
Actual Smoothed Smoothed Including
Month(t) Demand (At) Forecast, Ft Trend, Tt Trend, FITt
1 12 11 2 13.00
2 17 12.80 1.92 14.72
3 20 15.18 2.10 17.28
4 19 17.82 2.32 20.14
5 24 19.91 2.23 22.14
6 21 22.51 2.38 24.89
7 31 24.11 2.07 26.18
8 28 27.14 2.45 29.59
9 36 29.28 2.32 31.60
10 32.48 2.68 35.16
Table 4.1
 Midwestern Manufacturing
PROGRAM 5.3 – Output from Excel QM Trend-Adjusted Exponential Smoothing

5 – 55
 Trend Projections
• Fits a trend line to a series of historical
data points
• Projected into the future for medium- to
long-range forecasts
• Trend equations can be developed
based on exponential or quadratic
models
• Linear model developed using
regression analysis is simplest

5 – 56
 Trend Projections
• Mathematical formula

Yˆ =b0 + b1 X

where
Yˆ
= predicted value
b0 = intercept
b1 = slope of the line
X = time period (i.e., X = 1, 2, 3, …, n)

5 – 57
 Midwestern Manufacturing
• Based on least squares regression, the
forecast equation is
Yˆ =56.71+10.54X
• Year 2014 is coded as X = 8
(sales in 2014) = 56.71 + 10.54(8)
= 141.03, or 141 generators
• For X = 9
(sales in 2015) = 56.71 + 10.54(9)
= 151.57, or 152 generators
5 – 58
 Midwestern Manufacturing
PROGRAM 5.4 – Output from Excel QM for Trend Line

5 – 59
 Midwestern Manufacturing
PROGRAM 5.5 – Output from QM for Trend Line

5 – 60
 Midwestern Manufacturing
FIGURE 5.4 – Generator Demand Based on Trend Line

180 –
Trend Line
160 – Yˆ =56.71+10.54X x
x
140 – x
Generator Demand

120 – Projected demand for

next 3 years is shown on
100 – the trend line
80 –

60 –

40 –

20 –
| | | | | | | | | | | |
0–
0 1 2 3 4 5 6 7 8 9 10 11
Time Period

5 – 61