Chapter 2

FORECASTING
(metrology, population, price, growth, demand forecast
etc….)
 What is forecasting?
 Predictions, projections or estimates of future events

 usually as a result of rational study or analysis of relevant data.

 Objective of forecasting: predicting future by reducing the forecast error.

The purpose of forecasting is to guide organizational goals such as:
 Production
 Inventory
 Personnel
 Facilities
 Forecasting
Forecasting time
time horizons
horizons
 Short-range forecast
 generally less than 3 months
 Forecast Purchasing, job scheduling, workforce levels, job assignments,
production levels
 Short-term forecasts tend to be more accurate than longer-term forecasts
 Medium-range forecast
 From 3 months to 3 years
 Forecast sales and production planning, budgeting
 Long-range forecast
 3+ years
 New product planning, facility location, research and development(R&D)
 Medium/long range forecasts deal with more comprehensive issues and support
management decisions regarding planning and products, plants and processes
 Influence
Influence of
of product
product life
life cycle
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
Product life
life cycle
cycle ((the
the life
life of
of a
a product
product in
in the
the market
market with
with
respect
respect to
to business/commercial
business/commercial costs
costs and
and sales
sales measures)
measures)

Introduction Growth Maturity Decline

 Product design and  Forecasting critical  Product  Little product

development Standardization differentiation
OM Strategy/Issues

 Product and process

critical reliability  Optimum capacity  Cost
 Frequent product  Competitive product  Increasing stability minimization
process design improvements of process  reduce line to
changes eliminate items
 Increase capacity  Long production
 High production runs not returning
costs good margin
 Product
 Attention to quality improvement and  Reduce capacity
cost cutting
 Stage Characteristics
1. investment costs are very high
2. slow sales volumes to start
3. little or no competition
1. Market introduction stage
4. demand has to be created
5. customers have to be prompted to try the product
6. makes little money at this stage

1.sales volume increases significantly

2.profitability begins to rise
3.public awareness increases
2. Growth stage
4.competition begins to increase with a few new players
in establishing market
5.increased competition leads to price decreases
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 Stage Characteristics
1.costs are decreased as a result of production volumes
increasing and experience curve effects
2.sales volume peaks and market saturation is reached
3.increase in competitors entering the market
3. Maturity stage 4.prices tend to drop due to the proliferation of
competing products
5.brand differentiation and feature diversification is
emphasized to maintain or increase market share
6.industrial profits go down

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 Types
Types of
of forecasts.
forecasts.

Economic forecasts

 Address business cycle –by predicting inflation rate, money supply, housing
start etc.

Technological forecasts

 Predict rate of technological progress

 Impacts development of new products

Demand forecasts

 Predict sales of existing products and services

 The
The realities!
realities!
 Forecasts are seldom perfect(can be higher or lower than the realization).
 Product family and aggregated forecasts are more accurate than individual product
forecasts
 We usually prefer simple models than complex ones in forecasting

Reasons for preferring simple models:

 Easier to estimate precisely
 Easier to interpret, understand
 Easier to communicate
 Forecasting
Forecasting approaches
approaches
1. Qualitative Methods

 spontaneous, largely educated guesses involves

 Incorporate such factor as the decision makers emotion , personal experience,
 Used when situation is unclear and little data exist about
• New products
• New technology
 Usually cannot be reproduced by someone else
 Not a precise approach
 May be quite appropriate in certain situations
Classifications
Classifications of
of qualitative
qualitative methods
methods

1. Jury of executive opinion

2. Delphi method

3. Sales force composite

4. Consumer Market Survey

 1.
1. Jury
Jury of
of executive
executive opinion
opinion
 Involves opinion of small group of high-level experts
 Group estimates demand by working together
 Combines managerial experience with statistical models
 Relatively quick

2. Delphi method
 Iterative group process, continues until
consensus is reached
 3 types of participants
 Staff
 Respondents
 Decision makers
 3.
3. Sales
Sales force
force composite
composite
 Each salesperson projects his or her sales at their region
 Combined at district and national levels
 Tends to be overly optimistic

4. Consumer market survey

 Ask customers about purchasing plans.

 What consumers say, and what they actually do are

often different.

 Sometimes difficult to answer.

Forecasting
Forecasting approaches
approaches
2. Quantitative Methods

 Uses variety of mathematical model or statistical models

 Used when situation is ‘stable’ and historical data exist about
• Existing products
• Current technology
 Have underlying model or technique
 Results produced automatically from the model
 Fully reproducible by any forecaster
Overview
Overview of
of quantitative
quantitative approaches
approaches

1. Naive approach
2. Moving averages Time-series models
3. Exponential smoothing
4. Trend projection
Associative
5. Linear regression model
 Time
Time series
series forecasting
forecasting
Forecast based only on past values, no other variables important
* Assumes that factors influencing past and present will continue influence in future
Set of evenly spaced numerical data
* Obtained by observing response variable at regular time periods
Associated model
 incorporate (Assumes ) the variable or factors that may influencing the quantity being
forecasts. Such as housing start, advertising , competitors price etc.
Time Series
The forecast statement of time series can be:
 Point forecast: a single number
 Interval forecast: an interval
 Density forecast: the probability density
1.
1. Naive
Naive approach
approach

2. Moving average method

∑ demand in previous n periods

Moving average =
n
Simple moving Average Example

Actual 3-Month
Month Shed Sales Moving Average

January 10
February 12
March 13
April 16 (10 + 12 + 13)/3
13 = 11.67
May 19 (12 + 13 + 16)/3 = 13.67
June 23 (13 + 16 + 19)/3 = 16
July 26 (16 + 19 + 23)/3 = 19.33
 Moving Average - example
MONTH Demand Month Demand
3 month MA:
January 89 July 223 =(oct+nov+dec)/3=258.33

February 57 August 286

6 month MA:
March 144 September 212
=(jul+aug+…+dec)/6=249.33
April 221 October 275

May 177 November 188 12 month MA:

June 280 December 312

=(Jan+feb+…+dec)/12=205.33

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Graph of Moving Average

30 –
28 – Moving
26 – Average
24 –
Forecast
Actual
22 – Sales
Sales

20 –
18 –
16 –
14 –
12 –
10 –
| | | | | | | | | | | |
J F M A M J J A S O N D
2b.
2b. Weighted
Weighted moving
moving average
average
• Used when some trend might be present
• Older data usually less important
• Weights based on experience and intuition
Weighted ∑ (Weight for period n) x
Moving Average = (Demand in period n)
∑ Weights

This method looks at past data and tries to logically attach importance to certain data over other
data. Can weight recent higher than older. For example:
If forecasting staffing, we could use data from the last four weeks where Tuesdays are to be
forecast.
Weighting on Tuesdays is: T-1 is .25; T-2 is .20; T-3 is .15; T-4 is .10 and Average of all other
days is weighed .30.
WEIGHTED
WEIGHTED MOVING
MOVING AVERAGE
AVERAGE Weights Applied Period
3 Last month
2 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)
13 + (2 x 12) 12 + (10)]/6
10
May1/6
=12 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/
Potential
Potential problems
problems with
with moving
moving average
average
 Increasing n, smoothed the forecast but makes it less sensitive to changes.
 Do not forecast trends well.
 Require extensive historical data.
Moving average and weighted moving average
 3.
3. Exponential
Exponential smoothing
smoothing
 Form of sophisticated weighted moving average
 Involves little record keeping of past data
• Weights decline exponentially
• Most recent data weighted most
 Requires smoothing constant (α)
• Ranges from 0 to 1
• Subjectively chosen by forecaster
Exponential
Exponential smoothing
smoothing

New forecast = Last period’s forecast + α (Last period’s actual demand– Last period’s forecast)

Ft = Ft – 1 + α(At – 1 - Ft – 1)

Where:- Ft = new forecast

At – 1 = previous actual demand
Ft – 1 = previous forecast
α = smoothing (or weighting) constant
(0 ≤ a ≤ 1)
 Exponential smoothing example

 Predicted demand = 142 Ford

 Actual demand = 153
 Smoothing constant a = 0.20
New forecast = 142 + 0.2(153 – 142)
= 142 + 2.2
= 144.2 ≈ 144 cars
Ft = Ft – 1 + α(At – 1 - Ft – 1)

New forecast = Last period’s forecast + α (Last period’s actual demand– Last period’s forecast)
 Impact of ’s
Impact of ’s

225 –

Actual
200 –
demand a = 0.5
Demand

175 –

a = 0.1
150 –

| | | | | | | | |
1 2 3 4 5 6 7 8 9
Quarter
 Impact of ’s
Impact of ’s

225 –

Actual
200 –
deman  = 0.5
Demand

d
175 –

 = 0.1
150 –

| | | | | | | | |
1 2 3 4 5 6 7 8 9
Quarter
 Choosing 
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.
error

Forecast error = Actual demand - Forecast value

= At - Ft
 Common
Common measures
measures of
of error
error

Mean Absolute Deviation (MAD)

MAD = ∑ |Actual - Forecast|
n

Mean Squared Error (MSE)

∑ (Forecast Errors)2
MSE =
n
COMMON
COMMON MEASURES
MEASURES OF
OF ERROR
ERROR

 Mean Absolute Percent Error (MAPE)

MAPE =∑[100|Actuali - Forecasti|]/Actuali

n
COMPARISON
COMPARISON OF
OF FORECAST
FORECAST ERROR
ERROR
Rounded Absolute Rounded Absolute
Actual Forecast Deviation Forecast Deviation
Tonnage with for with for
Quarter Unloaded  = 0.10  = 0.10  = 0.50  = 0.50

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
COMPARISON
COMPARISON OF
OF FORECAST
FORECAST ERROR
ERROR
Rounded Absolute Rounded Absolute
Actual Forecast Deviation Forecast Deviation
MAD =∑ |deviations|
Tonnage with for with for
Quarter Unloaded a = .10 a = .10  = 0.50 = 0.50
n
1For 180 0.10
= 175 5.00 175 5.00
2 = 82.45/8
168 175.5 = 10.31
7.50 177.50 9.50
3For 159 0.50
= 174.75 15.75 172.75 13.75
4 175 173.18 1.82 165.88 9.12
5
=
190
98.62/8
173.36
= 12.33
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
COMPARISON
COMPARISON OF
OF FORECAST
FORECAST ERROR
ERROR
Rounded Absolute Rounded Absolute

MSE = ∑ (forecast
Actual
Tonnage
Forecast errors)
with
Deviation2 Forecast Deviation
for with for
Quarter Unloaded a = .10 a = .10  = 0.50  = 0.50
n
1 180 175 5.00 175 5.00
For
2  = 0.10 175.5
168 7.50 177.50 9.50
3 =159
1,526.54/8
174.75 = 15.75
190.82 172.75 13.75
4  =
For 175
0.50 173.18 1.82 165.88 9.12
5 190 173.36
6
= 1,561.91/8
205 175.02
= 16.64
195.24
29.98
170.44
180.22
19.56
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
COMPARISON
COMPARISON OF
OF FORECAST
FORECAST ERROR
ERROR
Rounded Absolute Rounded Absolute
n
Actual Forecast Deviation Forecast Deviation
∑ 100|deviation
Tonnage with for|/actual
i
with
i
for
MAPEUnloaded
Quarter = i = 1 a = .10 a = .10 a = .50  = 0.50
1 180 175 5.00 175 5.00
2 For168 175.5
 = 0.10 n 7.50 177.50 9.50
3 159 174.75
4 175
= 44.75/8
173.18
=15.75
5.59%
1.82
172.75
165.88
13.75
9.12
5 For190
 = 0.50
173.36 16.64 170.44 19.56
6 205= 54.05/8
175.02 =29.98
6.76% 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
COMPARISON
COMPARISON OF
OF FORECAST
FORECAST ERROR
ERROR
Actual Rounded Absolute Rounded Absolute
Tonnage Forecast Deviation Forecast Deviation
Quarter Unloaded  = 0.10  = 0.10  = 0.50  = 0.50
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% 6.76%
THANK YOU

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