Forecasting

Forecasting is the art and science of

Month Demand
predicting future events. Forecasting may
Jan 110
Feb 89
involve taking historical data and projecting
Mar 90 them in to the future with some sort of
Apr 100 mathematical model.
May 78
June ??? It may be subjective or intuitive prediction. Or it may
involve a combination of these – that is a mathematical
model adjusted by manager’s good judgment.
 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
 Types of Forecasts
 
1. Economic forecasts ( Medium to long range forecast)
Address business cycle – inflation rate, money supply, housing starts, etc.
2. Technological forecasts ( Long term forecast)
Predict rate of technological progress, Impacts development of new products
3. Demand forecasts (Projection of a company’s sales for each time
period in the planning horizon)
a Predict sales of existing products and services
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
6. Make the forecast
7. Validate and implement results
 Forecasting Approaches
There are two general approaches to forecasting, just as there are two ways to
tackle all decision modeling.
One is a quantitative analysis; the other is a qualitative approach.

Quantitative forecasts use a variety of mathematical models that rely on historical data and/or associative
variables to forecast demand.

Subjective or qualitative forecasts incorporate such factors as the decision maker’s intuition, emotions,
personal experiences, and value system in reaching a forecast. Some firms use one approach and some use the
other.

In practice, a combination of the two is usually most effective.

 Forecasting Approaches

Qualitative Methods Quantitative Methods

• Used when situation is vague and
little data exist 1.Naive approach Time-Series
– New products 2. Moving averages models
– New technology 3. Exponential smoothing
• Involves intuition, experience 4. Trend projection
– e.g., forecasting sales on Internet
Associative
1. Linear regression
model
 Overview of Qualitative Methods
1. Jury of executive opinion
Pool opinions of high-level experts, sometimes augment by statistical
models

2. Delphi method
Panel of experts, queried iteratively

3. Sales force Polling

Estimates from individual salespersons are reviewed for reasonableness,
then aggregated

4. Consumer Survey
Ask the customer
 Time-Series Forecasting
Day No. of Packets of Year Population (in
► Set of evenly spaced numerical milk sold Million)

data Monday 90 1921 251

► Obtained by observing response Tuesday 88 1931 279
variable at regular time periods
Wednesday 85 1941 319
► Forecast based only on past values,
no other variables important Thursday 75 1951 361
► Assumes that factors influencing Friday 72 1961 439
past and present will continue
Saturday 90 1971 548
influence in future
Sunday 102 1981 685

From example 1 it is clear that the sale of milk packets is

decrease from Monday to Friday then again its start to
increase. Same thing in example 2 the population is
continuously increase.
 Components of Demand
Trend
Demand for product or service

component
Seasonal peaks

Actual demand
line

Average demand
over 4 years
Random variation
| | | |
1 2 3 4
Time (years)
 Trend Component Seasonal Component
Persistent, overall upward or downward Regular pattern of up and down fluctuations
pattern. Due to weather, customs, etc.
Changes due to population, technology, age, Occurs within a single year
culture, etc.
Typically several years duration
PERIOD “SEASON” NUMBER OF
For example, LENGTH LENGTH “SEASONS” IN
• population increases over a period of PATTERN
time Week Day 7
• price increases over a period of years
• production of goods on the capital Month Week 4 – 4.5
market of the country increases over a
Month Day 28 – 31
period of years.
These are the examples of upward trend. Year Quarter 4

• The sales of a commodity may decrease Year Month 12

over a period of time because of better Year Week 52
products coming to the market.
This is an example of declining trend or
downward.
 Definitions
Cyclical Component A seasonal pattern exists when a series is influenced by
seasonal factors (e.g., the quarter of the year, the month, or
Repeating up and down movements
day of the week). Seasonality is always of a fixed and known
Affected by business cycle, political, and
period. Hence, seasonal time series are sometimes
economic factors
called periodic time series.
Multiple years duration
A cyclic pattern exists when data exhibit rises and falls that
Often causal or associative relationships
are not of fixed period. The duration of these fluctuations is
usually of at least 2 years. Think of business cycles which
usually last several years, but where the length of the current
cycle is unknown beforehand.
Many people confuse cyclic behaviour with seasonal
behaviour, but they are really quite different. If the
fluctuations are not of fixed period then they are cyclic; if
the period is unchanging and associated with some aspect of
the calendar, then the pattern is seasonal.
In general, the average length of cycles is longer than the
length of a seasonal pattern, and the magnitude of cycles
tends to be more variable than the magnitude of seasonal
patterns.

0 5 10 15 20 Source: https://robjhyndman.com/hyndsight/cyclicts/
 Random Component
► Erratic, unsystematic,
‘residual’ fluctuations
► Due to random variation
or unforeseen events
► Short duration
and nonrepeating

M T W T
F
 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
Month Demand Naive Month Demand Naive
January 110 January 35
Feb 98 110 Feb 36 35
March 89 98 March 34 36
April 100 89 April 33 34
May 112 100 May 35 33
June 89 112 June 36 35
July 90 89 July 37 36
August 90 August 37

Forecast Error = Actual - Forecast

 Students
35

Semester No of students
1 35

2 35
Semester
3 35

4 35

5 35
Moving Averages
 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
Weighted Moving Average
MONTH ACTUAL SHED 3-MONTH WEIGHTED MOVING
SALES AVERAGE
January 10
February 12
March 13 = 10+12+13/3 = Moving average
April 16 = (10×1+ 12×2+ 13×3)/6= Weighted
moving average
May 19
WEIGHTS APPLIED PERIOD
June 23
3 Last month
July 26
2 Two months ago
August 30
1 Three months ago
September 28
6 Sum of the weights
October 18
Forecast for this month =
November 16
3 x Sales last mo. + 2 x Sales 2 mos. ago + 1 x Sales 3 mos. ago
December 14
Sum of the weights
Potential Problems With
Moving Average

► Increasing n smooths the

forecast but makes it less
sensitive to changes
► Does not forecast trends
well
► Requires extensive
historical data
 Sales of hair dryers at the Walgreens stores in Youngstown, Ohio, over the past 4
months have been 100, 110, 120, and 130 units (with 130 being the most recent sales).
Develop a moving-average forecast for next month, using
these three techniques:

a) 3-month moving average.

b) 4-month moving average.
c) Weighted 4-month moving average with the most recent
month weighted 4, the preceding month 3, then 2, and the
oldest month weighted 1.
d) If next month’s sales turn out to be 140 units, forecast the
following month’s sales (months) using a 4-month moving
average.

Month Data
1 100
2 110
3 120
4 130
 374 + 368 + 381
4.1 (a)  374.33 pints
3
Weighted
Week of Pints Used Moving Average
August 31 360
September 7 389 381  .1 = 38.1
September 14 410 368  .3 = 110.4
September 21 381 374  .6 = 224.4
September 28 368 372.9
October 5 374
Forecast 372.9
 c) Starting in year 4 and going to year 12,
forecast demand using a 3-year moving
average with weights of .1, .3, and .6,
using .6 for the most recent year.

  Year 1 2 3 4 5 6 7 8 9 10 11 Forecast
 
Demand 7 9 5 9.0 13.0  8.0 12.0 13.0  9.0 11.0  7.0  

(b) 3-year moving       7.0  7.7  9.0 10.0 11.0 11.0 11.3 11.0 9.0

(c) 3-year weighted       6.4  7.8 11.0  9.6 10.9 12.2 10.5 10.6 8.4
  Year 1 2 3 4 5 6 7 8 9 10 11 Forecast
 
Demand 7 9 5 9.0 13.0  8.0 12.0 13.0  9.0 11.0  7.0  

(b) 3-year moving       7.0  7.7  9.0 10.0 11.0 11.0 11.3 11.0 9.0

(c) 3-year weighted       6.4  7.8 11.0  9.6 10.9 12.2 10.5 10.6 8.4
• • 4.5 The Carbondale Hospital is considering the purchase of a new ambulance. The decision will rest
partly on the anticipated mileage to be driven next year. The miles driven during the past 5 years are
as follows:
a) Forecast the mileage for next year (6th year) using a 2-year
moving average.
Forecast for 6th Year = 3800+3700/2 = 3750

b) Use a weighted 2-year moving average with weights of .4

and .6 to forecast next year’s mileage. (The weight of .6 is
for the most recent year.)
Forecast for 6th Year = 3800*4+3700*.6 /2 = 3740
 b) Forecast January sales using each of the following:
i) Naive method.
ii) A 3-month moving average.
iii) A 6-month weighted average using .1, .1, .1, .2, .2, and .3,
with the heaviest weights applied to the most recent months.
iv) Exponential smoothing using an a = .3 and a September
forecast of 18.
v) A trend projection.
c) With the data given, which method would allow you to
forecast
next March’s sale
 [i] Naive The coming January = December = 23
 
 [ii] 3-month moving   (20 + 21 + 23)/3 = 21.33
 
 [iii] 6-month weighted
 
[(0.1  17) + (.1  18)+ (0.1  20) + (0.2  20) + (0.2  21) + (0.3 

23)]/1.0
 
= 20.6
4.7 The actual demand for the patients at Omaha Emergency Medical Clinic for the first 6 weeks of this year
follows:
Clinic administrator Marc Schniederjans wants you to forecast patient
demand at the clinic for week 7 by using this data. You decide to use a
weighted moving average method to find this forecast. Your method
uses four actual demand levels, with weights of 0.333 on the present
period, 0.25 one period ago, 0.25 two periods ago, and 0.167 three
periods ago.
a) What is the value of your forecast?
b) If instead the weights were 20, 15, 15, and 10, respectively, how
would the forecast change? Explain why.
c) What if the weights were 0.40, 0.30, 0.20, and 0.10, respectively?
Now what is the forecast for week 7?
Week Actual no
of Patients
a) 52*0.333+63*0.25+48*.25+70*0.167/0.333+.25+.25+.167
1 65
=(17.36+15.75+12+11.69/1=56.8
2 62
b) 52*20+63*15+48*15+70*10/20+15+15+10
3 70 =(1040+945+720+700/60=56.75
4 48
5 63 c) 52*.40+63*0.30+48*0.20+70*0.10/0.40+.30+.20+0.10
=(20.8+18.9+9.6+7/1=56.3
6 52