Chapter III: Forecasting

Delivered by: Dr. Bui Cong Son

Learning Objectives
1. LO3.1 List features common to all forecasts.
2. LO3.2 Explain why forecasts are generally wrong.
3. LO3.3 List the elements of a good forecast.
4. LO3.4 Outline the steps in the forecasting process.
5. LO3.5 Summarize forecast errors and use summaries to make decisions.
6. LO3.6 Describe four qualitative forecasting techniques.
7. LO3.7 Use a naive method to make a forecast.
8. LO3.8 Prepare a moving average forecast.
9. LO3.9 Prepare a weighted-average forecast.
10.LO3.10 Prepare an exponential smoothing forecast.
11.LO3.11 Prepare a linear trend forecast.
12.LO3.12 Prepare a trend-adjusted exponential smoothing forecast.
13.LO3.13 Compute and use seasonal relatives.
14.LO3.14 Compute and use regression and correlation coefficients.
15.LO3.15 Construct control charts and use them to monitor forecast errors.
16.LO3.16 Describe the key factors and trade-offs to consider when choosing a forecasting technique.
 3.1 INTRODUCTION
• The primary goal of operations management is to match supply to demand.
Having a forecast of demand is essential for determining how much
capacity or supply will be needed to meet demand.
• Forecasts are a basic input in the decision processes of operations
management because they provide information on future demand.
• Anticipated demand is derived from two possible sources, actual customer
orders and forecasts.
• Two aspects of forecasts are important.
• 1 - The expected level of demand;
• 2 - The degree of accuracy that can be assigned to a forecast.
=> Forecasts play an important role in the planning process because they
enable managers to anticipate the future so they can plan accordingly

Can you give us the example of uses of forecasts

in business organizations?
(based on the decisions and activities throughout organization)
3.2 FEATURES COMMON TO ALL FORECASTS

Forecasts are not

Forecasting perfect; actual
techniques generally results usually differ
assume that the from predicted
same underlying values; the presence
causal system in the of randomness
past will continue to precludes a perfect
exist in the future forecast.

Forecast accuracy
Forecasts for groups
decreases as the
of items tend to be
time period covered
more accurate than
by the forecast—the
forecasts for
time
individual
horizon—increases
items
ELEMENTS OF A GOOD FORECAST
Timely

Cost effective Accurate

Simple to use
and Reliable
understand

Meaningful
In writing
Units
 STEPS IN THE FORECASTING PROCESS

Monitor the
forecast
Make the errors
forecast
Select a
forecasting
Obtain, clean, technique\
and analyze
Establish a appropriate
time horizon. data
Determine
the purpose
of the
forecast.
 FORECAST ACCURACY
• Accuracy and control of forecasts is a vital aspect of forecasting, so
forecasters want to minimize forecast errors.
• Random variation is always present, there will always be some
residual error, even if all other factors have been accounted for.
Consequently, it is important to include an indication of the extent to
which the forecast might deviate from the value of the variable that
actually occurs.
• Forecast error is the difference between the value that occurs and the
value that was predicted for a given time period. Hence, Error =
Actual - Forecast:
 FORECAST ACCURACY
Summarizing Forecast Accuracy

• Three commonly used measures for summarizing historical errors are

the mean absolute deviation (MAD), the mean squared error (MSE),
and the mean absolute percent error (MAPE). MAD is the average
absolute error, MSE is the average of squared errors, and MAPE is the
average absolute percent error. The formulas used to compute MAD,1
MSE, and MAPE are as follows:
APPROACHES TO FORECASTING
QUALITATIVE FORECASTS
Executive Opinions
• This approach is often used as a part of long-range planning and new product
development

Salesforce Opinions
• Members of the sales staff or the customer service staff are often good sources of
information because of their direct contact with consumers.

Consumer Surveys
• Organizations seeking consumer input usually resort to consumer surveys, which
enable them to sample consumer opinions

Delphi method
• An iterative process in which managers and staff complete a series of questionnaires,
each developed from the previous one, to achieve a consensus forecast.
QUANTATIVE FORECASTS
FORECAST BASED ON TIME-SERIES DATA

Trend refers to a long-term upward or downward movement in the data

Seasonality refers to short-term, fairly regular variations generally related

to factors such as the calendar or time of day.

Cycles are wavelike variations of more than one year’s duration

Irregular variations are due to unusual circumstances

Random variations are residual variations that remain after all other behaviors
have been accounted for
 QUANTATIVE FORECASTS
FORECAST BASED ON TIME-SERIES DATA - Naive

• A naive forecast uses a single previous value of a time series as the basis of a forecast.
The naive approach can be used with a stable series (variations around an average),
with seasonal variations, or with trend.

• Although at first glance the naive approach may appear too simplistic, it is nonetheless
a legitimate forecasting tool.

• It has virtually no cost, it is quick and easy to prepare because data analysis is
nonexistent, and it is easily understandable.

• The main objection to this method is its inability to provide highly accurate forecasts.
QUANTATIVE FORECASTS
FORECAST BASED ON TIME-SERIES DATA - Techniques for Averaging

• A moving average forecast uses a number of the most recent

actual data values in generating a forecast. The moving
average forecast can be computed using the following

equation:
 QUANTATIVE FORECASTS
FORECAST BASED ON TIME-SERIES DATA - Techniques for Averaging

• A weighted average is similar to a moving average, except

that it typically assigns more weight to the most recent values

in a time series.
 QUANTATIVE FORECASTS
FORECAST BASED ON TIME-SERIES DATA - Techniques for Averaging

• Exponential smoothing is a sophisticated weighted averaging method that

is still relatively easy to use and understand. Each new forecast is based on
the previous forecast plus a percentage of the difference between that
forecast and the actual value of the series at that point. That is:
Next forecast = Previous forecast + α(Actual – Previous forecast)

where (Actual – Previous forecast) represents the forecast error and α is a

percentage of the
error. More concisely,
 QUANTATIVE FORECASTS
FORECAST BASED ON TIME-SERIES DATA - Techniques for Averaging

• An alternate form of Formula 3–7a reveals the weighting of the previous

forecast and the latest actual demand:
 COMPARING FORECAST ERRORS

Compare the error

performance of these
three forecasting
techniques using MAD,
MSE, and MAPE: a
naive forecast, a two-
period moving
average, and
exponential smoothing
with α = .10
 QUANTATIVE FORECASTS
FORECAST BASED ON TIME-SERIES DATA - Other Forecasting Methods

Trend Equation. A linear trend equation has the form

Obtaining and Using a Trend
Equation
Cell phone sales for a California-
based firm over the last 10 weeks
are shown in the following table.
Plot the data, and visually check to
see if a linear trend line would be
appropriate. Then determine the
equation of the trend line, and
predict sales for weeks 11 and 12.
 QUANTATIVE FORECASTS
FORECAST BASED ON TIME-SERIES DATA - Trend-Adjusted Exponential Smoothing
• A variation of simple exponential smoothing can be used when a time series exhibits a
linear trend. It is called trend-adjusted exponential smoothing or, sometimes, double
smoothing, to differentiate it from simple exponential smoothing, which is
appropriate only when data vary around an average or have step or gradual changes.
• The trend-adjusted forecast (TAF) is composed of two elements—a smoothed error
and a trend factor
 MONITORING FORECAST ERROR
• Tracking the forecast errors and analyzing them can provide useful insight on whether
forecasts are performing satisfactorily
• There are a variety of possible sources of forecast errors, including the following:
• The model may be inadequate due to (a) the omission of an important variable, (b) a
change or shift in the variable that the model cannot deal with (e.g., sudden appearance of a trend or
cycle), or (c) the appearance of a new variable (e.g., new competitor).
• Irregular variations may occur due to severe weather or other natural phenomena, temporary
shortages or breakdowns, catastrophes, or similar events.
• Random variations. Randomness is the inherent variation that remains in the data after all causes
of variation have been accounted for. There are always random variations.
MONITORING FORECAST ERROR