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.
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 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 Quantitative
methods
Up to 1 year

E.g. Job scheduling, worker assignments

Detailed
Medium-range forecast use of
system
3 months to 3 years
Sales/production planning, budgeting
Long-range forecast
> 3 years
New product planning, facility location, Design
of system
research and development Qualitative
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
Best period to Practical to change Poor time to change Cost control
Company Strategy/Issues

increase market price or quality image, price, or critical

share image quality
Competitive costs
R&D engineering Strengthen niche become critical
is critical Defend market
position

Figure
Product Life Cycle
Introduction Growth Maturity Decline
Product design and Forecasting critical Standardization Little product
development Product and process Less rapid product differentiation
critical reliability changes – more Cost
Frequent product minor changes minimization
OM Strategy/Issues

Competitive product
and process design improvements and Optimum capacity Overcapacity in
changes options the industry
Increasing stability
Short production Increase capacity of process Prune line to
runs eliminate items
Shift toward Long production
High production product focus runs not returning
costs good margin
Enhance Product
Limited models distribution improvement and Reduce capacity
Attention to quality cost cutting

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 of new products and services..
Qualitative Methods …con’d
Delphi Method: As opposed to regular panels where
the individuals involved 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.
The above steps are repeated until a consensus is reached.
 Quantitative Methods
Time 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

Trend Cyclical

Seasonal Random
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 = 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
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 = 121/6
May 19 [(3 x 16) + (2 x 13) + (12)]/6 = 141/3
June 23 [(3 x 19) + (2 x 16) + (13)]/6 = 17
July 26 [(3 x 23) + (2 x 19) + (16)]/6 = 201/2
 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
25 –
Sales demand

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

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

t= 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
Giventhe
theweekly
weeklydemand
demand
2 775 data
datawhat
whatare
arethe
theexponential
exponential
3 680 smoothing
smoothingforecasts
forecastsfor
for
4 655 periods
periods2-10 using a=0.10?
2-10using a=0.10?
5 750
6 802 Assume
AssumeFF11=D
=D11
7 798
8 689
9 775
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
3 680 815.50 793.00
F3 = F2+ a(A2–F2) =820+.1(775–820)
4 655 801.95 725.20
=815.5
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
3 680 815.50 793.00
4 655 801.95 725.20
5 750 787.26 683.08
6 802 783.53 723.23 This process
7 798 785.38 770.49 continues
8 689 786.64 787.00through week 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 Most 3rd Most 4th Most 5th 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
demand
200 –
Demand

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
MADActual
= 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 = 84/8 = 10.50 8
176 178 10
3 159 175 16 173 14
4 For a175
= .50 173 2 166 9
5 190 173 17 170 20
6 205 = 100/8
175 = 12.5030 180 25
7 180 178 2 193 13
8 182 178 4 186 4
84 100
Comparison of Forecast Error
∑ (forecast
Rounded
errors) 2
Absolute Rounded Absolute
MSE = Actual Forecast Deviation Forecast Deviation
Tonage n
with for with for
Quarter Unloaded a = .10 a = .10 a = .50 a = .50
1
For a180
= .10 175 5 175 5
2 = 1,558/8176= 194.75 8
168 178 10
3 159 175 16 173 14
4 For a175
= .50 173 2 166 9
5 190 173 17 170 20
6 = 1,612/8175=
205 201.5030 180 25
7 180 178 2 193 13
8 182 178 4 186 4
84 100
MAD 10.50 12.50
Comparisonn of Forecast Error
100 ∑ |deviation
Rounded i|/actualiRounded
Absolute Absolute
MAPE =Actual i = 1Forecast Deviation Forecast Deviation
Tonage with for with for
Quarter Unloaded a = .10 n a = .10 a = .50 a = .50
1
a = .10 175
For 180 5 175 5
2 168 = 45.62/8
176 = 5.70%
8 178 10
3 159 175 16 173 14
4 a=
For 175 .50 173 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