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Outline
What is forecasting?
Types of forecasts
Qualitative
quantitative
Time-Series forecasting
Nave
Moving Average
Exponential Smoothing
Regression
Good forecasts
What is Forecasting?
Forecasts are estimates of occurrence, timing
, or magnitude of uncertain future events.
It is the process of predicting a future event
based on historical data
Forecasting is Educated Guessing
Underlying basis of all business decisions
v
v
v
v
Production
Inventory
Personnel
Facilities
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.
Short-range forecast
e
methods
Medium-range forecast
3
Sales/production planning
Long-range forecast
> 2 years
New product planning
Design
of system
Qualitative
Methods
Qualitative models
- Executive judgment
- Market research
-Survey of sales force
-Delphi method
Sales
Growth
Maturity
Quantitative models
- Time series analysis
- Regression analysis
Time
Decline
Types of forecasting
techniques
I.
Qualitative Methods
Time Series
Models
1. Naive
2. Moving
Average
a) simple
b) weighted
3. Exponential
Smoothing
a) level
b) trend
c) seasonality
Trend
Seasonal
cyclical
Year
2
Year
3
Year
4
Random
variation
Year
1
Year
2
Actual demand
line
Year
3
Year
4
Trend Component
Persistent, overall upward or
downward pattern
Changes due to population,
technology, age, culture, etc.
Typically several years duration
Seasonal Component
Regular pattern of up and
down fluctuations
Due to weather, customs, etc.
Occurs within a single year
Period
Length
Number of
Seasons
Week
Month
Month
Year
Year
Year
Day
Week
Day
Quarter
Month
Week
7
4-4.5
28-31
4
12
52
Cyclical Component
Repeating up and down movements
Affected by business cycle, political,
and economic factors
Multiple years duration
Often causal or
associative
relationships
0
10
15
20
Random Component
Erratic, unsystematic, residual
fluctuations
Due to random variation or
unforeseen events
Short duration and
nonrepeating
M
F
Quantitative Forecasting
Methods
Quantitative
Time Series
Models
Models
1. Naive
2. Moving
Average
a) simple
b) weighted
3. Exponential
Smoothing
a) level
b) trend
c) seasonality
1.
Naive Approach
n
Usually not good
2. Simple Moving
Average
A + A + A + ... + A
FF == A + A + A + ... + A
t t 11
tt
t -t1-1
t -t2- 2
nn
t -tn- n11
Month
1
2
3
4
5
6
(000)
4
6
5
?
?
?
Month
1
2
3
4
5
6
Sales
(000)
4
6
5
?
?
?
Moving Average
(n=3)
NA
NA
NA
(4+6+5)/3=5
Sales
(000)
4
6
5
3?
?
?
Moving Average
(n=3)
NA
NA
NA
5
Month
1
2
3
4
5
6
Sales
(000)
4
6
5
3
?
?
Moving Average
(n=3)
NA
NA
NA
5
(6+5+3)/3=4.667
Sales
(000)
4
6
5
3
?7
?
Moving Average
(n=3)
NA
NA
NA
5
4.667
Month
1
2
3
4
5
6
Sales
(000)
4
6
5
3
7
?
Moving Average
(n=3)
NA
NA
NA
5
4.667
(5+3+7)/3=5
Weights
decrease for older data
sum to 1.0
Simple
Simplemoving
moving
average
averagemodels
models
weight
weightall
allprevious
previous
periods
periodsequally
equally
Sales
(000)
4
6
5
?
?
?
Weighted
Moving
Average
NA
NA
NA
31/6 = 5.167
Sales
(000)
4
6
5
3
7
Weighted
Moving
Average
NA
NA
NA
31/6 = 5.167
25/6 = 4.167
32/6 = 5.333
3. Exponential Smoothing
Assumes the most recent observations
have the highest predictive value
gives more weight to recent time periods
FFt+1
=
F
+
(A
F
)
=
F
+
(A
F
t
t
t
t+1
t
t
t)
et
Ft+1
At
Need initial
forecast
forecastFFt t
totostart.
start.
3. Exponential Smoothing
1
FF == FFExample
++ (A
F
(A - F ))
t+1
t+1
tt
tt
tt
Ai
Given
Given the
the weekly
weekly demand
demand
data
data what
what are
are the
the
exponential
exponential
smoothing
smoothing forecasts
forecasts for
for
periods
periods 2-10
2-10 using
using =0.10?
=0.10?
Assume
Assume FF11=D
=D11
3. Exponential Smoothing
1
FF == FFExample
++ (A
F
(A - F ))
t+1
t+1
tt
Ai
tt
tt
Fi
F2 = F1+ (A1F1)
=820+(820820)
=820
3. Exponential Smoothing
1
FF == FFExample
++ (A
F
(A - F ))
t+1
t+1
tt
Ai
tt
tt
Fi
F3 = F2+ (A2F2)
=820+(775820)
=815.5
3. Exponential Smoothing
1
FF == FFExample
++ (A
F
(A - F ))
t+1
t+1
tt
Ai
tt
Fi
tt
3. Exponential Smoothing
1
FF == FFExample
++ (A
F
(A - F ))
t+1
t+1
tt
Ai
tt
tt
Fi
3. Exponential Smoothing
2
FF == FFExample
++ (A
F
(A - F ))
t+1
t+1
tt
Ai
tt
tt
Fi
What if the
constant
equals 0.6
3. Exponential Smoothing
Example 3
Company
Company A,
A, aa personal
personal computer
computer producer
producer
purchases
purchases generic
generic parts
parts and
and assembles
assembles them
them to
to
final
final product.
product. Even
Even though
though most
most of
of the
the orders
orders
require
require customization,
customization, they
they have
have many
many common
common
components.
components. Thus,
Thus, managers
managers of
of Company
Company A
A need
need
aa good
good forecast
forecast of
of demand
demand so
so that
that they
they can
can
purchase
purchase computer
computer parts
parts accordingly
accordingly to
to minimize
minimize
inventory
inventory cost
cost while
while meeting
meeting acceptable
acceptable service
service
level.
level. Demand
Demand data
data for
for its
its computers
computers for
for the
the past
past 55
months
months isis given
given in
in the
the following
following table
table..
tt
Ai
tt
tt
Fi
What if the
constant
equals 0.5
3. Exponential
Smoothing
How to choose
depends on the emphasis you want to
place on the most recent data
Forecast Effects of
Smoothing Constant
Ft+1 = F + (At - Ft)
Ft+1 = At + (1- ) At - 1 + (1- )2At - 2 + ...
t
or
w1
w2
w3
Weights
Prior Period
2 periods ago
3 periods ago
(1 - )
(1 - )2
= 0.10
10%
9%
8.1%
= 0.90
90%
9%
0.9%
Regression analysis
/Trend Projections
Fitting a trend line to historical data
points to project into the medium-tolong-range
Linear trends can be found using the
least squares technique
^
y = a + bx
^
Deviation7
Deviation5
Deviation6
Deviation3
Deviation4
Deviation1
Deviation2
Trend line, ^
y = a + bx
Time period
Figure 4.4
Deviation7
Deviation5
Deviation3
Deviation6
Deviation1
Deviation2
Trend line, ^
y = a + bx
Time period
Figure 4.4
y = a + bx
xy - nxy
b=
x2 - nx2
a = y - bx
Time
Period (x)
1
2
3
4
5
6
7
x = 28
x=4
Electrical Power
Demand
74
79
80
90
105
142
122
y = 692
y = 98.86
x2
xy
1
4
9
16
25
36
49
x2 = 140
74
158
240
360
525
852
854
xy = 3,063
= 10.54
Electrical Power
Demand
x2
xy
1999
1
74
1
2000
2
79
4
line is 80
2001The trend
3
9
2002
4
90
16
^
2003
y 5= 56.70 +10510.54x 25
2004
6
142
36
2005
7
122
49
x = 28
y = 692
x2 = 140
x=4
y = 98.86
74
158
240
360
525
852
854
xy = 3,063
Year
xy nx y 3,063 - (7)(4)(98.86)
b=
= - (7)(42)
140
x2 - nx2
a = y - bx = 98.86 - 10.54(4) = 56.70
160
150
140
130
120
110
100
90
80
70
60
50
Trend line,
y^= 56.70 + 10.54x
|
1999
|
2000
|
2001
|
2002
|
2003
Year
|
2004
|
2005
|
2006
|
2007
Formulas
yy== aa++bbxx
where,
where,
x
xy n x y
b
x nx
2
x
y
a y bx
Regression Example 2
yy == aa ++ bb X
X
xy n x y
b
x nx
2
a y bx
To Use a Forecasting
Method
Collect historical data
Select a model
Moving average methods
Exponential smoothing
Select
A Good Forecast
Has a small error
Error = Demand - Forecast
Measures of Forecast
Error
a. MAD = Mean Absolute Deviation
et
nn
MAD
MAD==
AA --FF
t=1
t=1
tt
tt
nn
nn
22
A
F
At t - Ft t
t=
t =11
MSE
=
MSE =
nn
RMSE
RMSE == MSE
MSE
nn
MAD
A --FF
Example
MAD
MAD==
t=1
t=1
tt
tt
nn
What
What isis the
the MAD
MAD value
value given
given the
the forecast
forecast
values
values in
in the
the table
table below?
below?
At
Month
1
2
3
4
5
Ft
= 40=10
4
nn
22
A
F
At t - Ft t
= 550=137.5
4
MSE/RMSE Example
nn
t=
t =11
MSE
=
MSE =
What
What isis the
the MSE
MSE value?
value?
RMSE = 137.5
=11.73
At
Month
1
2
3
4
5
Ft
Sales Forecast
220
n/a
250
255
210
205
300
320
325
315
25
25
400
100
= 550
Measures of Error
1. Mean Absolute Deviation
(MAD)
n
MAD
-16
16
-1
-10
84
6
= 14
10
100
17
17
289
-20
20
400
-10
84
1,446
MSE
2
e
t
1
1,446
= 241
6
RMSE MSE
= SQRT(241)
=15.52
Forecast Bias
How can we tell if a forecast has a
positive or negative bias?
TS = Tracking Signal
Good tracking signal has low values
(actual
forecastt )
RSFE
TS =
= t
MAD
MAD Mean absolute
deviation
30