Forecasting

By 3rd Batch
Roll No. :14ME21
– 14ME30
Course
Structure Introduction

Operations Strategy & Competitiveness

Quality Management
Strategic Decisions (some)
Design of Products Process Selection Capacity and
and Services and Design Facility Decisions

Forecasting

Tactical & Operational Decisions

Forecasting

■ Predict the next number in the pattern:

a) 3.7, 3.7, 3.7, 3.7, 3.7, ?

b) 2.5, 4.5, 6.5, 8.5, 10.5, ?

c) 5.0, 7.5, 6.0, 4.5, 7.0, 9.5, 8.0, 6.5, ?

Forecasting

■ Predict the next number in the pattern:

a) 3.7, 3.7, 3.7, 3.7, 3.7, 3.

7
b) 2.5, 4.5, 6.5, 8.5, 10.5, 12.
5
c) 5.0, 7.5, 6.0, 4.5, 7.0, 9.5, 8.0, 6.5, 9.
0
Outline

■ What is forecasting?
■ Types of forecasts
■ Time-Series forecasting
✔ Naïve
✔ Moving Average
✔ Exponential Smoothing
✔ Regression
■ Good forecasts
 What is Forecasting?

■ Process of predicting a
future event based on
historical data
■ Educated Guessing
■ Underlying basis of
all business decisions
✔ Production
✔ Inventory
✔ Personnel
✔ Facilities
 Why do we need to forecast?

In general, forecasts are almost always wrong.

So,
Throughout the day we forecast very different
things such as weather, traffic, stock market,
state of our company from different
perspectives.

Virtually every business attempt is based on

forecasting. Not all of them are derived from
sophisticated methods. However, “Best"
educated guesses about future are more
valuable for purpose of Planning than no
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.
Types of Forecasts by Time Horizon
Quantitative
■ Short-range forecast methods

✔ Usually < 3 months

■ Job scheduling, worker assignments Detailed
use of
■ Medium-range forecast system

✔ 3 months to 2 years
■ Sales/production planning

■ Long-range forecast
✔ > 2 years Design
of system
■ New product planning Qualitative
Methods
Forecasting During the Life Cycle

Introduction Growth Maturity Decline

Qualitative models Quantitative models

- Executive judgment
- Time series analysis
- Market research
- Regression analysis
- Survey of sales force
- Delphi method
Sales

Time
Qualitative Forecasting Methods

Qualitative
Forecasting

Models
Sales Delphi
Executive Market
Force Method
Judgement Research/
Composite
Survey

Smoothing
 Qualitative
Methods
Briefly, the qualitative methods are:

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
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 Forecasting Methods

Quantitative
Forecasting

Time Series Regression

Models Models

2. Moving 3. Exponential
1. Naive
Average Smoothing
a) simple a) level
b) weighted b) trend
c) seasonality
Time Series Models

■ Try to predict the future based on past data

✔ Assume that factors influencing the past

will continue to influence the future
Time Series Models: Components

Random Trend

Seasonal Composite
Product Demand over Time
Demand for product or service

Year Year Year Year

1 2 3 4
 Product Demand over Time
Trend component
Seasonal peaks
Demand for product or service

Actual
Random demand line
variation
Year Year Year Year
1 2 3 4
Now let’s look at some time series approaches to forecasting…
Borrowed from Heizer/Render - Principles of Operations Management, 5e, and Operations Management, 7e
Quantitative Forecasting Methods

Quantitative
Time Series
Models

Models

2. Moving 3. Exponential
1. Naive
Average Smoothing
a) simple a) level
b) weighted b) trend
c) seasonality
1. Naive Approach

■ Demand in next period is the same as

demand in most recent period
✔ May sales = 48 →June forecast =
48

■ Usually not good

2a. Simple Moving Average

■ Assumes an average is a good estimator of future

behavior
✔ Used if little or no trend
✔ Used for smoothing

Ft+1 = Forecast for the upcoming

period, t+1
n = Number of periods to be averaged
At = Actual occurrence in period t
2a. Simple Moving Average
You’re manager in Amazon’s electronics
department. You want to forecast ipod sales
for months 4-6 using a 3-period moving
average. Sale
Mont s
h1 (000)
4
2 6
3 5
4 ?
5 ?
6 ?
2a. Simple Moving Average
You’re manager in Amazon’s electronics
department. You want to forecast ipod sales
for months 4-6 using a 3-period moving
average. Sale Moving
Mont s (n=3
Average
h1 (000)
4 )N
2 6 A
N
3 5 A
N
4 ? (4+6+5)/3=5
A
5 ?
6 ?
2a. Simple Moving Average

What if ipod sales were actually 3 in month 4

Sale Moving
Mont s (n=3
Average
h1 (000)
4 )N
2 6 A
N
3 5 A
N
4 3? A
5 ? 5
6 ?
2a. Simple Moving Average

Forecast for Month 5?

Sale Moving
Mont s (n=3
Average
h1 (000)
4 )N
2 6 A
N
3 5 A
N
4 3 A
5 ? (6+5+3)/3=4.667
5
6 ?
2a. Simple Moving Average

Actual Demand for Month 5 = 7

Sale Moving
Mont s (n=3
Average
h1 (000)
4 )N
2 6 A
N
3 5 A
N
4 3 A
5 ?7 5 4.667
6 ?
2a. Simple Moving Average

Forecast for Month 6?

Sale Moving
Mont s (n=3
Average
h1 (000)
4 )N
2 6 A
N
3 5 A
N
4 3 A
5 7 5 4.667
6 ? (5+3+7)/3=5
2b. Weighted Moving Average
■ Gives more emphasis to recent data

■ Weights
✔ decrease for older data
✔ sum to 1.0 Simple moving
average models
weight all previous
periods equally
2b. Weighted Moving Average: 3/6, 2/6, 1/6

Mont Sale Weighted

h s(000) Moving
Average
1 4 N
2 6 A
N
3 5 A
N
4 ? 31/6 =A5.167
5 ?
6 ?
2b. Weighted Moving Average: 3/6, 2/6, 1/6

Mont Sale Weighted

h s(000) Moving
Average
1 4 N
2 6 A
N
3 5 A
N
4 3 31/6 =A5.167
5 7 25/6 = 4.167
6 32/6 = 5.333
3a. Exponential Smoothing

■ Assumes the most recent observations have

the highest predictive value
✔ gives more weight to recent time periods

Ft+1 = Ft + α(At -
Ft) e
t
Ft+1 = Forecast value for time t+1 Need initial
At = Actual value at time t forecast Ft
α = Smoothing constant to start.
3a. Exponential Smoothing – Example 1
Ft+1 = Ft + α(At -
Ft)
i Ai

Given the weekly demand

data what are the exponential
smoothing forecasts for
periods 2-10 using α=0.10?

Assume F1=D1
3a. Exponential Smoothing – Example 1
Ft+1 = Ft + α(At -
Ft)
i Ai
α=
Fi

F 2 = F 1+
α(A1–F1) =820+.1(820–820)
=820
3a. Exponential Smoothing – Example 1
Ft+1 = Ft + α(At -
Ft)
i Ai
α=
Fi

F 3 = F 2+
α(A2–F2) =820+.1(775–820)
=815.5
3a. Exponential Smoothing – Example 1
Ft+1 = Ft + α(At -
Ft)
i Ai
α=
Fi

This process
continues
through week 10
3a. Exponential Smoothing – Example 1
Ft+1 = Ft + α(At -
Ft)
i Ai
α=
Fi
α=

What if the
α constant
equals 0.6
3a. Exponential Smoothing – Example 2
Ft+1 = Ft + α(At -
Ft)
i Ai
α=
Fi
α=

What if the
α constant
equals 0.6
 3a. Exponential Smoothing – Example 3

Company A, a personal computer producer

purchases generic parts and assembles them
to final product. Even though most of the
orders require customization, they have
many common components. Thus, managers
of Company A need a good forecast of
demand so that they can purchase computer
parts accordingly to minimize inventory cost
while meeting acceptable service level.
Demand data for its computers for the past 5
months is given in the following table.
3a. Exponential Smoothing – Example 3
Ft+1 = Ft + α(At -
Ft)
i Ai
α=
Fi
α=

What if the
α constant
equals 0.5
3a. Exponential Smoothing

■ How to choose α
✔ depends on the emphasis you want to
place on the most recent data

■ Increasing α makes forecast more

sensitive to recent data
Forecast Effects of
Smoothing Constant α
Ft+1 = Ft + α (At - Ft)
or Ft+1 = α At + α(1- α) At - 1 + α(1- α)2At - 2 + ...
w1 w2 w3

Weights
α= Prior Period 2 periods ago 3 periods ago
α α(1 - α) α(1 - α)2

α= 0.10
10 9 8.1
% % %
α= 0.90 90 9 0.9
% % %
To Use a Forecasting Method

■ Collect historical data

■ Select a model
✔ Moving average methods
■ Select n (number of periods)
■ For weighted moving average: select weights
✔ Exponential smoothing
■ Select α

■ Selections should produce a good

forecast
…but what is a good forecast?
A Good Forecast

♦ Has a small error

♦ Error = Demand - Forecast
Measures of Forecast Error
e
t

a. MAD = Mean Absolute Deviation

b. MSE = Mean Squared Error

c. RMSE = Root Mean Squared Error

■ Ideal values =0 (i.e., no forecasting error)

 = =1
MAD Example 40 0
4
What is the MAD value given the
forecast values in the table below?
At Ft
Month Sales Forecast |At – Ft|
1 22 n/
2 0
25 a
25 5
3 0
21 5
20 5
4 0
30 5
32 2
5 0
32 0
31 0
1
5 5 0
=
 = 550 =137.
MSE/RMSE Example 4 5

What is the MSE RMSE √137.

value? = 5
=11.7
At Ft 3
Month Sales Forecast |At – Ft| (At – Ft)2
1 22 n/
2 0
25 a
25 5 2
3 0
21 5
20 5 2
5
4 0
30 5
32 2 5
40
5 0
32 0
31 0
1 0
10
5 5 0 0
=
 Measures of Error
1. Mean Absolute Deviation
(MAD)
t At Ft et |et| e t2
8 =
Jan 120 100 20 20 400
46 14
-1 1
Feb 90 106 6 6
256 2a. Mean Squared Error
- 1 1 (MSE)
Mar 101 102 1
-1 1 10
April 91 101 0 0 0 1,44
1 1 28 =
6 6
May 115 98 7
-2
7
2
9
40 241
0 0 0 2b. Root Mean Squared Error
June 83 103 (RMSE)
-1 8 1,44
An accurate forecasting system will have small MAD, MSE
0equal to zero.
and RMSE; ideally 4 A large 6error may
indicate that either the forecasting method used or the =
parameters such as α used in the method are wrong.
Note: In the above, n is the number of periods, which is 6 in
SQRT(241)
Forecast Bias

■ How can we tell if a forecast has a positive

or negative bias?

■ TS = Tracking Signal
✔ Good tracking signal has low values

MAD
30
Quantitative Forecasting Methods

Quantitative
Forecasting

Time Series Regression

Models Models

2. Moving 3. Exponential
1. Naive
Average Smoothing
a) simple a) level
b) weighted b) trend
c) seasonality
Exponential Smoothing (continued)

■ We looked at using exponential

smoothing to forecast demand with only
random variations
Ft+1 = Ft +
Ft+1α=(AFtt -+
α Ft)– α
A
Ft+1 = αt At
Ft
+ (1-α)
Ft
Exponential Smoothing (continued)

■ We looked at using exponential

smoothing to forecast demand with only
random variations
■ What if demand varies due to
randomness and trend?

■ What if we have trend and seasonality in

the data?
 Regression Analysis as a Method for
Forecasting
Regression analysis takes
advantage of the relationship
between two variables.
Demand is then forecasted
based on the knowledge of this
relationship and for the given
value of the related variable.

Ex: Sale of Tires (Y), Sale of Autos

(X) are obviously related

If we analyze the past data of these

two variables and establish a
relationship between them, we
may use that relationship to
forecast the sales of tires given
the sales of automobiles.

The simplest form of the

relationship is, of course, linear,
hence it is referred to as a
regression line.
Formulas

y=a+bx

where,
Regression – Example
y = a+ b
X
 General Guiding Principles for
Forecasting

1. Forecasts are more accurate for larger groups of items.

2. Forecasts are more accurate for shorter periods of

time.
3. Every forecast should include an estimate of error.
4. Before applying any forecasting method, the total
system should be understood.
5. Before applying any forecasting method, the method
should be tested and evaluated.
6. Be aware of people; they can prove you wrong very
easily in forecasting