Forecasting

4
PowerPoint presentation to accompany
Heizer and Render
Operations Management, Eleventh Edition
Principles of Operations Management, Ninth Edition

PowerPoint slides by Jeff Heyl

© 2014
© 2014
Pearson
Pearson
Education,
Education,
Inc.Inc. 4-1
 What is Forecasting?
► Process of predicting a
future event
► Underlying basis
of all business
??
decisions
► Production
► Inventory
► Personnel
► Facilities
© 2014 Pearson Education, Inc. 4-2
 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
© 2014 Pearson Education, Inc. 4-3
 Distinguishing Differences
1. Medium/long range forecasts deal with more
comprehensive issues and support
management decisions regarding planning
and products, plants and processes
2. Short-term forecasting usually employs
different methodologies than longer-term
forecasting
3. Short-term forecasts tend to be more
accurate than longer-term forecasts

© 2014 Pearson Education, Inc. 4-4

 Product Life Cycle
Introduction Growth Maturity Decline

Best period to Practical to change Poor time to Cost control

increase market price or quality change image, critical
share image price, or quality
Company Strategy/Issues

R&D engineering is Strengthen niche Competitive costs

critical become critical
Defend market
position Drive-through
Internet search engines restaurants
DVDs
Xbox 360
iPods
Boeing 787

Sales
3D printers

3-D game Analog

Electric vehicles TVs
players

Figure 2.5
© 2014 Pearson Education, Inc. 4-5
 Product Life Cycle
Introduction Growth Maturity Decline
Product design Forecasting critical Standardization Little product
and development differentiation
Product and Fewer product
critical process reliability changes, more Cost
Frequent product minor changes minimization
Competitive
and process
OM Strategy/Issues

product Optimum capacity Overcapacity in

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

Figure 2.5
© 2014 Pearson Education, Inc. 4-6
 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

© 2014 Pearson Education, Inc. 4-7

 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

© 2014 Pearson Education, Inc. 4-8

 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 results
© 2014 Pearson Education, Inc. 4-9
 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

© 2014 Pearson Education, Inc. 4 - 10

 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 augment 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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 Jury of Executive Opinion
► Involves small group of high-level experts
and managers
► Group estimates demand by working
together
► Combines managerial experience with
statistical models
► Relatively quick
► ‘Group-think’
disadvantage

© 2014 Pearson Education, Inc. 4 - 14

 Delphi Method
► Iterative group
process, continues Decision Makers
(Evaluate responses
until consensus is and make decisions)
reached
► 3 types of Staff
(Administering
participants survey)
► Decision makers
► Staff
► Respondents Respondents
(People who can make
valuable judgments)
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 Sales Force Composite
► Each salesperson projects his or her
sales
► Combined at district and national
levels
► Sales reps know customers’ wants
► May be overly optimistic

© 2014 Pearson Education, Inc. 4 - 16

 Market Survey
► Ask customers about purchasing
plans
► Useful for demand and product
design and planning
► What consumers say, and what they
actually do may be different
► May be overly optimistic

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 Overview of Quantitative
Approaches

1.Moving averages
2.Exponential
smoothing
3.Linear regression

© 2014 Pearson Education, Inc. 4 - 18

 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

© 2014 Pearson Education, Inc. 4 - 19

 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

© 2014 Pearson Education, Inc. 4 - 20

 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 (29 + 30 + 28)/3 = 28
November 16 (30 + 28 + 18)/3 = 25 1/3
December 14
(28 + 18 + 16)/3 = 20 2/3

© 2014 Pearson Education, Inc. 4 - 21

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

Weighted
moving
average

© 2014 Pearson Education, Inc. 4 - 22

 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
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

© 2014 Pearson Education, Inc. 4 - 23

 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

© 2014 Pearson Education, Inc. 4 - 24

 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

© 2014 Pearson Education, Inc. 4 - 25

 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
© 2014 Pearson Education, Inc. 4 - 26
 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

© 2014 Pearson Education, Inc. 4 - 27

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

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

New forecast = 142 + .2(153 – 142)

© 2014 Pearson Education, Inc. 4 - 29

 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 - 30

 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

© 2014 Pearson Education, Inc. 4 - 31

 Common Measures of Error

Mean Absolute Deviation (MAD)

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 Common Measures of Error

Mean Squared Error (MSE)

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 Common Measures of Error

Mean Absolute Percent Error (MAPE)

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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
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 Least Squares Method
Equations to calculate the regression variables

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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

© 2014 Pearson Education, Inc. 4 - 37

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

© 2014 Pearson Education, Inc. 4 - 38

 Least Squares Example
ELECTRICAL POWER
YEAR (x) DEMAND (y) x2 xy
74 1 74
1
79 4 158
2
80 9 240
3
90 16 360
4
105 25 525
5
142 36 852
6 Demand in year 8 = 56.70 + 10.54(8)
122 = 141.02, or 141
49 megawatts 854
7
Σx = 28 Σy = 692 Σx2 = 140 Σxy = 3,063

© 2014 Pearson Education, Inc. 4 - 39

 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
© 2014 Pearson Education, Inc. 4 - 40
 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

© 2014 Pearson Education, Inc. 4 - 41

 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

© 2014 Pearson Education, Inc. 4 - 42

 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

© 2014 Pearson Education, Inc. 4 - 43

 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)
© 2014 Pearson Education, Inc. 4 - 44
 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

© 2014 Pearson Education, Inc. 4 - 45

 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

© 2014 Pearson Education, Inc. 4 - 46

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

2.5 4 16 10.0
3.0 –
2.0 2 4 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
| | | | | | |
0 1 2 3 4 5 6 7
Area payroll (in $ billions)

© 2014 Pearson Education, Inc. 4 - 47

 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

© 2014 Pearson Education, Inc. 4 - 48

 Associative Forecasting
Example

If payroll4.0
next
–
year is estimated to be $6 billion,
then: 3.25
Nodel’s sales
(in$ millions)

3.0 –

2.0 –
Sales (in$ millions) = 1.75 + .25(6)
1.0 –
= 1.75 + 1.5 = 3.25
| | | | | | |
0 1 2 3 4 5 6 7
Sales = $3,250,000
Area payroll (in $ billions)

© 2014 Pearson Education, Inc. 4 - 49

 Standard Error of the Estimate
► A forecast is just a point estimate of a
future value
► This point is
actually the
mean of a 4.0 –
3.25
probability
Nodel’s sales
(in$ millions) 3.0 –
Regression line,
distribution 2.0 –

1.0 –

| | | | | | |
0 1 2 3 4 5 6 7
Figure 4.9 Area payroll (in $ billions)

© 2014 Pearson Education, Inc. 4 - 50

 Standard Error of the Estimate

where y = y-value of each data point

yc = computed value of the
dependent variable, from the regression
equation
n = number of data points

© 2014 Pearson Education, Inc. 4 - 51

 Standard Error of the Estimate

Computationally, this equation is

considerably easier to use

We use the standard error to set up

prediction intervals around the point
estimate
© 2014 Pearson Education, Inc. 4 - 52
 Standard Error of the Estimate

4.0 –
Nodel’s sales 3.25
(in$ millions) 3.0 –
The standard error 2.0 –
of the estimate is
1.0 –
$306,000 in sales
| | | | | | |
0 1 2 3 4 5 6 7
Area payroll (in $ billions)

© 2014 Pearson Education, Inc. 4 - 53

 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

© 2014 Pearson Education, Inc. 4 - 54

 Correlation Coefficient

© 2014 Pearson Education, Inc. 4 - 55

 Correlation Coefficient
Figure 4.10
y y

x x
(a) Perfect negative (e) Perfect positive
correlation y correlation
y

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

x
(c) No correlation

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

© 2014 Pearson Education, Inc. 4 - 56

 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

© 2014 Pearson Education, Inc. 4 - 57

 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
© 2014 Pearson Education, Inc. 4 - 58
 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

Computationally, this is quite

complex and generally done on the
computer
© 2014 Pearson Education, Inc. 4 - 59
 Multiple-Regression Analysis
In the Nodel example, including interest rates in the
model gives the new equation:

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

© 2014 Pearson Education, Inc. 4 - 60

 Forecasting in the Service
Sector
► Presents unusual challenges
► Special need for short term records
► Needs differ greatly as function of
industry and product
► Holidays and other calendar events
► Unusual events

© 2014 Pearson Education, Inc. 4 - 61

 Fast Food Restaurant Forecast
Percentage of sales by hour of day

20% – Figure 4.12

15% –

10% –

5% –

11-12 1-2 3-4 5-6 7-8 9-10

12-1 2-3 4-5 6-7 8-9 10-11
(Lunchtime) (Dinnertime)
Hour of day
© 2014 Pearson Education, Inc. 4 - 62
 FedEx Call Center Forecast
Figure 4.12
12% –

10% –

8% –

6% –

4% –

2% –

0% – 2 4 6 8 10 12 2 4 6 8 10 12
A.M. P.M.
Hour of day

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