Forecasting Demand for services.

Learning Objectives
Learning Objectives
After completing this chapter, you should be able to:
1. Recommend the appropriate forecasting model for a given situation.
2. onduct a !elphi forecasting e"ercise.
#. !escribe the features of e"ponential smoothing that ma$e it an attractive model for
time series forecasting.
%. onduct time series forecasting using the e"ponential smoothing model &ith trend
and seasonal adjustments.
'yper(Active )echnologies is offering fast(food restaurants a &ay to give $itchen
&or$ers a heads(up on &hat orders to e"pect by using rooftop cameras to monitor traffic
entering the par$ing lot and drive(thru. *sing historical data, predictions are made based
on type of vehicle +e.g., a minivan signals many mouths to feed, and occupants +e.g.,
teenagers or adults, to determine order preference +i.e., burger &ith fries or chic$en
sand&ich,. )he $itchen can use this information to prepare food in advance of the actual
order.
-or e"ample, suppose during a .c!onald/s 0ig .ac promotion, five cars accumulate
in the drive(thru during a si" minutes period. 1e $no&, based on historical data, there
is a 122 percent chance that someone &ill order a 0ig .ac &ithin the ne"t three min(
utes. 3n the fast(food business it/s not enough to $no& that you sell 122 burgers during
the lunch hour on &ee$days. .anagers must $no& during &hich 22(minute(&indo& the
$itchen needs to prepare food in anticipation of demand. 3f they underestimate, lines
begin to form and service morphs into slo&(food4 overestimating results in lost profits
from &asted food. 5arly results of this recognition soft&are have sho&n &aste to be cut
in half and &ait times at the drive(thru reduced by 26 to %2 seconds(an eternity in the
fast(food industry.
Chapter preview
)he chapter begins &ith an overvie& of forecasting methods and the criteria for choice.
1e begin our discussion &ith subjective models that are used at the initial planning stage
for a project or mar$eting campaign &hen a long(term hori7on is being considered.
)he !elphi techni8ue is illustrated &ith an application to government policy planning
for nuclear po&er. ausal models use regression analysis to form a linear relationship
bet&een independent variables and a dependent variable of interest. )he selection of a
site for a day care center is used to illustrate causal modeling &hen forecasting
geographic demand.
)he discussion of time series models begins &ith the common 9(period moving
average. A more sophisticated time series model, called e"ponential smoothing, is
introduced &ith the capability to accommodate trends and seasonal data.
The choice of forecasting method
-orecasting techni8ues allo& us to translate the multitude of information available from
databases into strategies that can give a service a competitive advantage. )he particular
techni8ues &e &ill describe are classified into three basic models: subjective, causal, and
time series. 3t must be noted, ho&ever, that &hereas some services may use only one or
another of these models, others &ill use t&o or more depending on the application. -or
e"ample, a fast(food restaurant may be interested in using a time series model to forecast
the daily demand for menu items. )he demand for hospital services, ho&ever, has both
temporal and spatial characteristics, &hich &ill re8uire the use of both time series and
causal models. On occasion, service firms may use subjective models to assess the future
impact of changing demographics, such as the aging of the general population. Overall,
as &e move from subjective to causal to time series models, the forecast time hori7on
becomes shorter. )he models, their characteristics, and their possible applications are
sho&n in )able 1:.1
Subjective models
.ost forecasting techni8ues, such as time series and causal models, are based on data
&hose pattern is relatively stable over time, so &e can e"pect to ma$e reasonably useful
forecasts. 3n some cases, ho&ever, &e may have fe& or no data &ith &hich to &or$, or
&e may have data that e"hibit patterns and relationships only over the short run and,
therefore, are not useful for long(range forecasts.
1hen &e lac$ sufficient or appropriate data, &e must resort to forecast methods that
are subjective or 8ualitative in nature. )hese include the !elphi method, cross(impact
analysis, and historical analogy.
.ethod !ata re8uierd Relative cost -orecast
hori7on
Application
;ubjective
models
!elphi(method ;urvey results 'igh Long )erm )echnological
-orecasting
ross(impact
analysis
orrelation
bet&een events
'igh Long )erm )echnological
-orecasting
'istorical
analogy
;everal years of
data for a
similar situation
'igh .edium a Long
)erm
Life cycle
demand
projection
ausal models
Regression All past data
for all variables
.oderate .edium )erm !emand
forecasting
5conometric All past data
for all variables
.oderate to
high
.edium to long
term
5conomic
conditions
)imer series
models
.oving average 9 most recent
observations
<ery lo& ;hort term !emand
forecasting
5"ponential
smoothing
=revious
smoothed value
and most recent
observation
<ery lo& ;hort term !emand
forecasting
Delphi method
!eveloped at the Rand orporation by Olaf 'elmer, the !elphi method is based on
e"pert opinion. 3n its simplest formn, persons &ith e"pertise in a given area are as$ed
8uestions, and these individuals are not permitted to interact &ith each other. )ypically,
the participants are as$ed to ma$e numerical estimates. -or e"ample, they might be as$ed
to predict the highest !o& >ones average for the coming year.
)he test administrator tabulates the results into 8uartiles and supplies these findings
to the e"perts, &ho then are as$ed to reconsider their ans&ers in light of the ne&
information. Additionally, those &hose opinions fall in the t&o outside 8uartiles are
as$ed to justify their opinions. All the information from this round of 8uestioning is
tabulated and once again returned to the participants. On this occasion, each participant
&ho remains outside the middle t&o 8uartiles +i.e., the inter8uartile range, may be
as$ed to provide an argument as to &hy he or she believes those at the opposite e"treme
are incorrect.
)he process may continue through several more iterations, &ith the intent of eventually
having the e"perts arrive at a consensus that can be used for future planning. )his
rnethod is very labor(intensive and re8uires input from persons &ith e"pert $no&ledge.
Obviously, !elphi is a very e"pensive. time(consuming method and is practical only for
long(term forecasting
5"ample : 9uclear po&er delphi study
An e"ample of the !elphi method can be seen in a study of the nuclear po&er industry
9inety(eight persons agreed to participate in this study. )hese people occupied $ey upper(
level positions &ith architect(engineering firms, reactor manufacturers, and utility
companiesin the industrial sector concerned &ith nuclear po&er as &ell as &ith state
regulatory agencies,state energy commissions, congressional staffs, and nuclear
regulatory agencies in the publicsector.
)he round 1 8uestionnaire contained #: 8uestions, 11 concerning the past evolution of
the nuclear industry and 2? concerning the future. )hese 8uestions &ere to be ans&ered
on a seven(point Li$ert scale, ranging from @strongly agree@ to @uncertain@ to @strongly
disagree,@ as sho&n belo&:.
!ibujar la escala
)he 8uestionnaire also as$ed for open(ended comments.
-or round 2 of this study, the administrator provided a comprehensive summary of the
first(round responses to the 11 8uestions concerning the past and a summary of the open(
ended comments concerning the future. )he number of responses to the 8uestion above
are noted belo&, &ith the median +., and inter8uartile range +designated by the vertical
bars, sho&n belo& the responses:
!ibujar
)he 11 8uestions concerning the past &ere dropped from the round 2 8uestionnaire, and
11 ne& 8uestions prompted by the open(ended comments from round 3 &ere added. )he
participants &ere invited to @defend@ their positions &ith supporting comments if their
opinions fell outside the inter8uartile range.
-or round #, &hich &as the final round in this study, the administrator once again supplied
the participants &ith feedbac$, this time from round 2, and invited the participants to
@vote@ again on the same 8uestions. )he follo&ing illustration of the resulting median and
inter8uartile range after each round of voting demonstrates ho& the opinions shifted and
finally arrived at a consensus for this particular 8uestion:
!ibujar
As noted, some of the 8uestions as$ed for assessments of &here the industry has been
and &here it stands today. Other 8uestions not only as$ed the e"perts &here they thought
it should be headed but also to address issues such as resource allocation and the
political realities affecting the future of nuclear po&er. As sho&n, the !elphi method is a
useful tool in addressing situations for &hich 8uantifiable data are not available.
Cross-lmpact Analysis
ross(impact analysis assumes that some future event is related to the occurrence of an
earlier event. As in the !elphi method, a panel of e"perts studies a set of correlations
bet&een events presented in a matri". )hese correlations form the basis for estimating
the li$elihood of a future event occurring.
-or e"ample, consider a forecast conducted in 222# that assumes A#(per(gallon gasoline
prices by 2212 +event A, and the corresponding doubling of ridership on mass transit
by 2222 +event 0,. 0y initial consensus, it might be determined that given A, the
conditional probability of 0 is .:, and that given 0, the conditional probability of A is .?.
)hese probabilities are sho&n in the matri" belo&:
!ibujar
Assume that the forecasted unconditional probability for doubling mass transit ridership
by 2222 is 1.2 and that the forecasted unconditional probability of A# per galion for
gasoline by 2212 is .B. )hese ne& values are statistically inconsistent &ith the values in
the matri". )he inconsistencies &ould be pointed out to the e"perts on the panel, &ho
then &ould revise their estimates in a series of iterations. As &ith the !elphi method,
an e"perienced administrator is needed to arrive at a satisfactory conditional probability
matri" that can be used for generating a forecast.
istorical Analogy
'istorical analogy assumes that the introduction and gro&th pattern of a ne& service
&ill mimic the pattern of a similar concept for &hich data are available. 'istorical analogy
fre8uently is used to forecast the mar$et penetration or life cycle of a ne& service. )he
concept of a product life cycle as used in mar$eting involves stages, such as introduction,
gro&th, maturity, and decline.
A famous use of historical analogy &as the prediction of the mar$et penetration by
color television based on the e"perience &ith blac$(and(&hite television only a fe& years
earlier. Of course, the appropriate analogy is not al&ays so obvious. -or e"ample, gro&th
in the demand for house$eeping services could follo& the gro&th curve for child(care
services. 0ecause the pattern of previous data can have many interpretations and the
analogy can be 8uestioned, the credibility of any forecast using this method often is
suspect.
)he acceptance of historical analogy forecasts depends on ma$ing a convincing analogy,
3t is fairly easy to ma$e short(term forecasts &hen &e are presented &ith uncomplicated
data. On occasion, ho&ever, a competitive service organi7ation must deal &ith a &ealth
of statistical information, some of &hich may be relevant to ma$ing profitable forecasts
and some of &hich may be e"traneous. 3n these situations, it also is more li$ely that the
forecasts must be made for the ne"t year(or for the ne"t decade(rather than just for the
ne"t day, &ee$, or month. Obviously, a long(term forecast has the potential of spelling
success or devastation for the organi7ation. )herefore, &e need a &ay of separating out
the critical information and processing it to help us ma$e an appropriate forecast.
ausal models ma$e assumptions that are similar to those of time series models +&hich
&e &ill consider later,: that the data follo& an identifiable pattern over time and that an
identifiable relationship e"ists bet&een the information &e &ish to forecast and other
factors. )hese models range from very simple ones, in &hich the forecast is based on a
techni8ue called regression analysis, to those $no&n as econometric models, &hich use
a system of e8uations.
!egression models
A regression model is a relationship bet&een the factor being forecasted, &hich is
designated as the dependent variable +or C,, and the factors that determine the value of C
&hich are designated as the independenf variables or +D,. 3f there are n independent
variables, then the relationship bet&een the dependent variable C and the independent
variables,D is e"pressed as:
C E ao F a1D1 F a2D2 F...F anDn4
)he values a2, a1, a2., etc, are coefficients that are determined by the computer
program being used. 3f calculations are done by hand, values are determined by using
regression e8uations found in elementary statistics te"ts.
5"ample Locating a day care center
)he 8uality of service facility location analysis rests on an accurate assessment of
geographic demand for the service +i.e., demand by geographic area,. )he assessment
re8uires the selection both of some geographic unit that partitions the service area +e.g.,
census tract or 7ipcode, and some method for predicting demand from each of these
partitions +e.g., retailers as$ing customers for their 7ip code,.
)o demonstrate the process of assessing geographic demand, consider the challenge of
locating a day care center. )he target population consists of families &ith children
younger than five years and at least one employable adult. A census tract is selected as the
geographic unit because demographic data on the residents are readily available in digital
form from the *.;. ensus 0ureau. )he dependent variable CG is the percentage of
families from census tract i in need of day care. ;tatistical analysis using readily
available soft&are such as ;A; results in the follo&ing regression model:
&here
C : percentage of families from census tract i in need of day care
D1: pefcentage of families in census trac$ i &ith children underfiveyears old
D2 : perentage of families in census trac$ i &ith a single female head of household
D#: pHrcentage of families in census trac$ i &ith both parents &or$ing
)he percentage, C, estimated for each census trac$, then is multiplied by both number of
families in the census trac$ and the average number of children younger than five years
per family. )he result is the estimate for the number of children that re8uire day care
service from each census trac$ +i.e. geographic demand for day care,.
!evelopment of a regression model re8uires an e"tensive data collection effort to meet
the needs of the individual organi7ation, &hich often involves considerable time and
e"pense. 3t also re8uires e"pertise in the selection of independent and dependent
variables to ensure a relationship that has a logical and meaningful interpretation. -or
these reasons, regression models are appropriate for ma$ing medium( and long(term
forecasts.
"conometric models
5conometric models are versions of regression models that involve a system of e8uations.
)he e8uations are related to each other, and the coefficients are determined as in
the simpler regression models. An econometric model consists of a set of simultaneous
e8uations e"pressing a dependent variable in terms of several different independent
variables. 5conometric models re8uire e"tensive data collection and sophisticated
analysis to create4 thus, they generally are used for long(range forecasts
Time series models.
)ime series models are applicable for ma$ing short(term forecasts &hen the values of
observations occur in an identifiable pattern over time. )hese models range from the
simple 9(period moving average model to the more sophisticated and useful e"ponential
smoothing models.
5"ponential smoothing models are particularly useful because they can be adapted to
trac$ the components of a forecast +i.e., average, trend, and seasonality,. )he average is
an estimate of the underlying mean of a random variable +e.g., customer demand,, trend
is either an increasing or decreasing increment in each period, and seasonality is a
recurring cycle such as daily demand at a restaurant or annual demand at a tourist resort.
9ote that each of these components is stochastic in nature and the underly7ing value can
change over time +e.g., trend could s&itch from positive to negative,. *sing e"ponential
smoothing, each component is trac$ed and the results are combined to obtain a forecast.
1e begin our study of tirne series models &ith the simple 9(period moving average.
#-$eriod %oving Average
;ometimes, observations that are made over a period of time appear to have a random
pattern4 conse8uently, &e do not feel confident in basing forecasts on them. onsider the
data in )able 1: .2 for a 1O2(room hotel in a college to&n. 1e have decided to forecast
only ;aturday occupancy because the demand for each day of the r,vee$ is influenced
by different forces. -or e"ample, on &ee$days, demand is generated by business
travelers, but &ee$end guests often are people on vacation or visiting friends.
)he hotel o&ner has noted increased occupancy for the last t&o ;aturdays and &ishes
to prepare for the coming &ee$end +i.e., ;eptember 32,. perhaps by discontinuing the
practice of offering discount rates. !o the higher occupancy figures indicate a change in
the underlying average occupancyI )o ans&er this 8uestion. &e need a &ay of ta$ing
out the noise of occasional blips in the pattern so that &e do not overreact to a change
that is random rather than permanent and significant.
)he 9(period moving(average method may be used in this simple e"ample to smooth
out random variations and produce a reliable estimate of the underlying average
occupancy. )he method calculates a moving average .A, for period t on the basis of
selecting 9 of the most recent actual observations At as sho&n in e8uation +2,:
if &e select 9 e8ual to #, then &e cannot begin our calculation until period # +i.e.,
August 16,, at &hich time &e add the occupancy figures for the three most recent
;aturdays +i.e., August 1, B, and 16, and divide the sum by # to arrive at a three(period
moving average of J+B# F B% F :K,L#,E B2. 1e use this value to forecast occupancy
for the follo&ing ;aturday +i.e., August 22,. )he moving(average forecast has smoothed
out the random fluctuations to trac$ better the average occupancy, &hich then is used
to forecast the ne"t period. 5ach three(period moving(average forecast
thus involves simply adding the three most recent occupancy values and dividing by #.
-or e"ample, to arrive at the moving average for August 22, &e drop the value for
August 1 , add the value for August 22, and recalculate the average, getting B#.
ontinuing this iterative process for the remaining data, &e see ho& the moving(average
occupancy of appro"imately B2 percent for ;aturday in August has increased recently,
reflecting the near(capacity occupancy of the past t&o &ee$ends. 3f the local college
football team, after playing t&o consecutive home games, is scheduled for an a&ay
game on ;eptember 12, ho& confident are you in forecasting ne"t ;aturday/s occupancy
at K# percentI
Although our 9(period moving average has identified a change in the underlying average
occupancy this method is slo& to react because old data are given the same &eight
+i.e., iL9, as ne& data in calculating the averages. .ore recent data may be better indi(
cators of change4 therefore, &e may &ish to assign more &eight to recent observations.
Rather than arbitrarily assigning &eights to our moving(average data to fi" this
shortcoming, &e instead &ill use a more sophisticated forecasting method that
systematically ages the data. Our ne"t topic, e"ponential smoothing, also can
accommodate trends and seasonality in the data.
Simple "&ponential Smoothing
;imple e"ponential smoothing is the time series method most fre8uently used for
demand forecasting. ;imple e"ponential smoothing also @smooths out@ blips in the data,
but its po&er over the 9(period moving average is threefold: +1, old data are never
dropped or lost, +2, older data are given progressively less &eight, and +#, the
calculation is simple and re8uires only the most recent data.
;imple e"ponential smoothing is based on the concept of feeding bac$ the forecast
error to correct the previous smoothed value. 3n e8uation +#, belo&, ;t is the smoothed
value for period t, At is the actual observed value for period t, and lambda is a smoothing
constant that usually is assigned a value bet&een 2.1 and 2.6:
)he term +At ( ;t(1, represents the forecast error because it is the difference bet&een
the actual observation and the smoothed value that &as calculated in the prior period.
A fraction M of this forecast error is added to the previous smoothed value to obtain the
ne& smoothed value ;,. 9ote ho& self(correcting this method is &hen you consider that
forecast errors can be either positive or negative.
Our moving(average analysis of the occupancy data in )able 1: .2 indicated an actual
increase in average occupancy over the t&o most recent ;aturdays. )hese same
occupancy data are repeated in )able 1: .#, &ith the actual value for each period +At,
sho&n invthe third column. *sing simple e"ponential smoothing, &e &ill demonstrate
again that a significant change in the mean occupancy has occurred.
0ecause &e must start some&here, let the first observed, or actual, value At in a series
of data e8ual the first smoothed value ;t. )herefore, as )able 1:.# sho&s,;1 for August 1
e8uals A1 for August l, or :K.22. )he smoothed value forAugust B +;t, then may be
derived from the actual value for August B +A2, and the previous smoothed value for
August 3 +;1, according to e8uation +#,. 1e have selected an e8ual M to 2.6 because, as
&ill be sho&n later, this results in a forecast that is similar to the one obtained using a
three(period moving average. -or August B:
;imilar calculations then are made to determine the smoothed values +;#, ;%, ;6, ;?,
for successive periods.
;imple e"ponential smoothing assumes that the pattern of data is distributed about a
constant mean. )hus, the smoothed value calculated in period t is used as the forecast
for period +tF 1, rounded to an integer, as sho&n belo&:
Our best estimate for August l6 occupancy &ill be B1.62, the most recent smoothed
value at the end of August B. 9ote that the forecast error +B% ( :K, &as a positive 6 +i.e.,
&e underestimated demand by 6,, and that one(half of this error &as added to the previous
smoothed value to increase the ne& estimate of average occupancy. )his concept of
error feedbac$ to correct an earlier estimate is an idea borro&ed from control theory.
)he smoothed values sho&n in )able 1:.# &ere calculated using an M value of 2.6.
As noted, ho&ever, if &e &ish to ma$e the smoothed values less responsive to the
latest data, &e can assign a smaller value to M. -igure 1:.1 demonstrates graphically ho&
an M of 2.1 and of 2.6 smooth the curve of the actual values. 3t is easily seen in this figure
that the smoothed curve, particularly &ith an M of 2.6, has reduced the e"tremes +i.e., the
dips and pea$, and responded to the increased occupancy in the last t&o ;aturdays.
)herefore, basing forecasts on smoothed data helps to prevent overreacting to the
e"tremes in the actual observed values.
58uation +#, may be re&ritten as follo&s:
)he basis for the name @e"ponential smoothing@ can be observed in the &eights that
are given past data in e8uation +6,. 1e see that At is given a &eight M in determining ;t,
and &e easily can sho& by substitution that At(1 is given a &eight M +l ( M,. 3n general,
actual value At(n, is given a &eight M +l ( M,
n
, as -igure 1:.2 sho&s by graphing the
e"ponential decay of &eights given a series of observations over time. 9ote that older
observations never disappear entirely from the calculation of ;t, as they &ould &hen the
9(period moving average is used, but they do assume progressively decreasing
importance.
!elationship 'etween and #
;electing the value for a is a matter of judgment, often based on the pattern of historical
data, &ith large values giving much &eight to recent data rn anticipation of changes.
)o help select M , a relationship can be made bet&een the number of periods 9 in the
moving(average method and the e"ponential smoothing constant M. 3f &e assume that
the t&o methods are similar &hen the average ages of past data are e8ual, then the
follo&ing relationship results:
As sho&n, the usual assignment of a smoothing value bet&een 2. 1 and 2.6 is reasonable
&hen compared &ith the number of periods in an e8uivalent moving(average forecast.
)he particular value assigned to a is a trade(off bet&een overreacting to random
fluctuations about a constant mean and detecting a change in the mean value. 'igher
values of M are more responsive to change because of the greater &eight that is given to
recent data. 3n practice, the value of a often is selected on the basis of minimi7ing.the
forecast error as measured by the mean absolute deviation +.A!,.
(orecast "rror
Although it is obvious in -igure 1:.l that the smoothed curves have evened out the pea$s
and valleys of the actual curve, ho& do &e measure the accuracy of forecastsI One
common method is calculating the mean absolute deviation +.A!, )his is the calculation
of the average value for the absolute values of forecast errors +At ( -t, sho&n in )able
1:.#. )o calculate the .A! for this e"ample, total the absolute differences and then
divide by the number of observations. -or this case, .A! : +6 F 1 F 1 F 1? F 12,L6 E ?.?
Recall that the forecast values in this e"ample &ere derived from smoothed values
calculated &ith ME 2.6, because this method is similar to a three(period moving(average
method. -or the three(period moving(average forecast developed earlier, the .A!
value is K.: .3n this case, simple e"ponential smoothing resulted in more accurate
forecasts than the corresponding three(period moving(average method. 3f an M of 2.1 is
used, ho&ever, the .A! value is B.B, reflecting the unresponsiveness to change of a small
smoothing constant. 3t should be noted that selecting an M to minimi7e .A! for a set of
data can be accomplished using 5"cel ;olver.
3n any event, &e desire an unbiased forecast &ith respect to its trac$ing of the actual
mean for the data. )hus, the sum of the forecast errors should tend to&ard 7ero, ta$ing
into account both positive and negative differences. 3f it does not, then &e should loo$
for underlying trends or seasonality and account for them e"plicitly. -or the results
sho&n in )able 1:.#,the sum of forecast errors is calculated as
)his high positive sum suggests that an up&ard trend e"ists in the data, and that our
simple e"ponential smoothing forecasts are falling short of actual hotel occupancy. )hus,
&e must incorporate a trend adjustment into our forecast.
"&ponential Smoothing with Trend Adjustment
)he trend in a set of data is the average rate at &hich the observed values change from
one period to the ne"t over time. )he changes created by the trend can be treated using
an e"tension of simple e"ponential smoothing.
)able 1:.% follo&s the e"perience of a ne& commuter airline during its first eight
&ee$s of business. )he average &ee$ly load factors +i.e., percentages of seats sold, sho&
a steady increase, from appro"imately #2 percent for &ee$ 1 to appro"imately :2 percent
for &ee$ B. 3n this e"ample, the smoothed value ;t is calculated using e8uation +?,, &hich
is e8uation +6, modified by the addition of a trend value )t(1 to the previous smoothed
value ;t(1 to account for the &ee$ly rate of increase in the load factor:
)o incorporate a trend adjustment in our calculation, &e &ill use 0 as a smoothing
constant. )his constant usually is assigned a value bet&een 2.1 and 2.6 and may be the
same as, or different from M. )he trend for a given period tis defined by +;t(;t(1,, the rate
of change in smoothed value from one period to the ne"t +i.e., the slope of the demand
curve,. )he smoothed trend )t then is calculated at period t using e8uation +:,, &hich
is a modification of the basic e"ponential smoothing e8uation(e8uation +6,(&ith the
observed trend +;t N ;t(1, used in place of At
)o anticipate cash flo&s during the business startup period, the commuter airline o&ners
are interested in forecasting future &ee$ly load factors. After observing the first t&o
&ee$s of activity, you are as$ed to provide a forecast for &ee$ #. )he smoothed values,
trend figures, and forecasts in )able 1:.% are calculated in a step&ise manner. -or the
first observation in a series, &ee$ 1 in this instance, the smoothed value 61 is e8ual to
the actual value A 1, and the trend f1 is set e8ual to 2.22. )he forecast for &ee$ 2 is
calculated using e8uation +B,. 3n this case, -2 E#1 F 2.22 E #1 rounded to an integer
)o compute the smoothed values use for &ee$ 2 and a forecast for &ee$ # &e &ill M. E 2.6
and 0E 2.#. -irst, the smoothed value ;2 for &ee$ 2 is calculated using e8uation ?
1hen the actual data for the follo&ing &ee$s are received, similar calculations can be
made for the smoothed value, the trend, the forecast, and the forecast error. -or all the
forecasts sho&n in )able l: .%, the .A! is ?.:.
)he sum of the forecast error values +both positive and negative, is a measure of forecast
bias. -or this e"ample ;*.+At ( -t, : K F ? F 12 ( 2 F 11 ( ? F # E #1. )he sum of the
forecast errors for an unbiased forecast should approach 7ero +i.e., the positive and
negative errors cancel out each other,.
3n -igure l: .#, the actual load factors are plotted against the forecasts to illustrate the
trac$ing ability of e"ponential smoothing &ith a trend adjustment.
"&ponential Smoothing with Seasonal Adjustment
)o account for seasonal effects on a set of data, &e can use another e"tension of simple
e"ponential smoothing. 3n simplest terms, &e first remove the seasonality from the data
and then smooth those data as &e already have learned4 finally, &e put the seasonality
bac$ in to determine a forecast.
1e &ill apply this seasonal adjustment to the data in )able 1:.6, &hich reports the
number of passengers per month ta$ing a ferry to a resort island in the aribbean for
the years 222K and 2212. 3n general, &e denote a cycle L as the length of one season.
L may be any length of time, even the 2% hours of a day, but fre8uently, as in this case, it
is 12 months. 9ote that &e must have actual data for at least one full season before &e
can begin smoothing and forecasting calculations.
A seasonality inde" 3t is used to deseasonali7e the data in a given cycle L 3nitially,3t is
estimated by calculating a ratio of the actual value for period t, At divided by the average
value A for all periods in cycle L as sho&n in e8uation +K,:
3n our passenger ferry e"ample, A:1K:1.B#, and by substituting this value into
e8uation +K,, &e can calculate the inde" 3t for each period in the first season of L periods.
)he resulting indices for the months of 222K, &hich are sho&n in column 6 of
)able 1:.6, then are used to deseasonali7e the data for the corresponding months in
2212 according to e8uation +12,, &hich is a minor modification of our basic e"ponential
smoothing e8uation(e8uation +6,(&ith At adjusted to account for seasonality using
inde" 3t(L
-or this e"ample, data for the 12 months in 222K are used to give initial estimates of
the seasonality indices. )herefore, &e cannot begin to calculate ne& smoothed data
until period 1# +i.e., >anuary 2212,. )o begin the process, &e assume that.;12 e8uals A12,
as sho&n in )able 1:.6 &ith a value of 1:K%.22. )he smoothed value for >anuarv 2212
no& can be calculated using e8uation +12,, &ith 3t(LE 2.B#: +i.e., the inde" 3t of 12 months
ago for >anuary 222K, and M. E2.2
)he forecast for -ebruary +period t F l, then is made by seasonali7ing the smoothed value
for >anuary according to the follo&ing formula:
9ote that the seasonali7ing factor 3t.LF1 in this case is the inde" 3t for -ebrury 222K.
)herefore, our forecast for -ebruary 2212 is:
3f the seasonality indices are stable, forecasts that are based on only one cycle, L, &ill
be reliable. 3f, ho&ever, the indices are not stable, they can be adjusted, or smoothed, as
ne& data become available. After calculating the smoothed value ;t for an actual value
At ,at the most recent period t, &e can denote a ne& observation for a seasonality inde"
at period t as +AtL;t,. )o apply the concept of e"ponential smoothing to the inde", &e use
a ne& constant O, &hich usually is assigned a value bet&een 2.1 and 2.6. )he smoothed
estimate of the seasonality inde" then is calculated from the follo&ing formula:
9o& &e can continue the calculations for 2212 in )able 1:.6 by using e8uation +12,
to update the seasonality indices for each month for future use. Remember, ho&ever, that
in actual practice, smoothed values, indices, and forecasts for each period +i.e., month,
in this ne& season of L periods &ould be calculated on a month(to(month basis as the
most recent actual values became available. 'ere, according to e8uation +12,, the ne&
smoothed seasonality inde" for >anuary 2212,31#, using O E 2.# is
)he .A! for -ebruary through !ecember 2212 is 1 12, &hich indicates a very good
fit of forecasts to actual data that e"hibit a definite seasonality. 3s it possible, ho&ever, to
ma$e even more accurate forecastsI
"&ponential Smoothing with Trend and Seasonal Adjustments
)he ans&er to the earlier 8uestion(3s it possible to ma$e even more accurate forecastsI
(is yes +sometimes,. 3n some cases, adjusting only for trend or seasonality &ill provide
the current best estimate of the average4 at others, the forecast can be improved by
considering all factors together. 1e can include both trend and seasonal adjustments in
e"ponential smoothing by &eighting a base smoothed value &ith trend and seasonal
indices to forecast the follo&ing period. )he appropriate e8uations are
)he values in )able 1:.? sho&n in bold are the result of 5"cel formulas. )able 1:.:
contains the formulas for -ebruary 2212 sho&n on line 22 of )able 1:.?. )hese formulas
are automatically repeated for lines 21 through #2 using the copy command in 5"cel.
9ote the use of A0A1, A0A2, and A0A# to free7e the cell reference to the smoothing
parameters +alpha, beta, gamma, &hen the formulas are copied. )his feature allo&s one
to change these parameters and recalculate the forecasts to find the values for alpha,
betha, and gamma that minimi7e .A!. )he resulting .A! of 1?2 tells us that, in this
case, &e have not gained any improvement in our forecast by adding a trend adjustment
to the seasonal adjustment used in )able 1:.6. -igure 1:.% demonstrates graphically the
results of treating the actual data &ith a seasonal adjustment only, and &ith both seasonal
and trend adjustments.
Summary of "&ponential Smoothing
5"ponential smoothing is a relatively easy and straightfor&ard &ay to ma$e short(term
forecasts. 3t has many attributes, including:
. All past data are considered in the smoothing process.
. Recent data are assigned more &eight than older data.
. Only the most recent data are re8uired to update a forecast.
. )he model is easy to implement on a personal computer using spreadsheet soft&are.
. ;moothing constants allo&s us to alter the rate at&hich the model responds to
changes in the underlying pattern in the data.
Summary
!ecisions to embar$ on a ne& service concept often re8uire subjective judgments about
the future needs of customers. ;ubjective models li$e the !elphi method allo& a panel
of e"perts to defend their positions concerning the future, and through a number of
iterations, these e"perts approach a consensus. Regression models have found application
in service location analysis because of the need to account for several independent
variables that contribute to demand generation. 1e ended our discussion of forecasting
&ith an e"amination of time series models. Although the moving(average method is
straightfor&ard, &e discovered that e"ponential smoothing has many superior 8ualities
and has found &ide acceptance in practice. Accounting for trends and seasonality is an
important feature in forecasting service demand and is accommodated easily by means of
e"ponential smoothing.
)ey terms and definitions
ross(impact analysis a technological forecasting method that assumes some future event
is related to an earlier event &ith an estimated probability. p. %62
!elphi method a technological forecasting method that uses a group of e"perts to arrive at
a consensus about the fufure. p. %61
5"ponential smoothing a time series forecast based on the concept of adjusting a previous
forecast by feeding bac$ a percentage of the forecast error. p. %66
-orecast error the difference bet&een the actual observation and the forecasted value. p.
%66
.ean absolute deviation +.A!, a measure of forecasting accuracy calculated as the
average absolute forecast error. p. %6B
.oPng(average forecast a simple time series forecast formed by adding together
the most recent data and dividing by the number of observations. p. %66