Operational Management

POMG2710
Chapter (3) Forecasting

CHAPTER OUTLINE
 What is Forecasting
 Types of Forecasting Models
 Time series Forecasting Models
 Measures of Forecast Accuracy

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Forecast
 To forecast = To predict (or estimate)
 Forecast: a statement about the future value of a variable of interest (e.g. weather,
demand, resource availability, .. etc.)

 Inoperations management, forecasts are

important for the decision process as they
provide information on future demand.
 Commonly demand is unknown  a forecast of
demand is essential for determining how much
capacity will be needed to meet demand.

Forecasting based on time horizon

Long-range forecasts:
important for decisions that have long-term consequences (e.g. capacity of power plant operate 20 yrs.)
 Medium-range forecasts:
(e.g. profit potential for a new service\product)
Short-range forecasts:
covering a day or a week (e.g. scheduling day-to-day operations)

Forecast – Cont.
 Two aspects of forecasts are important:
1. Expected level of demand
 (can be a function of some structural variation: e.g. Trend or seasonal variation).
2. Forecast accuracy
 (isa function of the ability of the forecasters to correctly model demand, random
variation, and sometimes unforeseen events).
 Forecasts rarely perfect because of randomness
 Main purpose of forecasting
 Reduce uncertainty
 Better estimates of what would happen in the future
 Subjective methods
 Seat-of-the pants methods, intuition, experience
 More formal quantitative and qualitative techniques

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 Features Common to All Forecasts

1. Techniques assume some underlying causal system

Past  Future
that existed in the past will persist into the future

2. Forecasts are not

perfect Forecasts are JUST forecasts

3. Forecasts for groups of items

are more accurate than those of Forecasting errors among items in a group
individual items usually have a canceling effects

4. Forecast accuracy decreases as the forecasting horizon

increases

Video: http://www.youtube.com/watch?v=kKm8noEnl5w
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Elements of a Good Forecast

Forecasting horizons must cover the time necessary to
Timely
implement possible changes

The degree of accuracy should be stated  to provide the

Accurate
basis for comparing forecast alternatives

Reliable It should work consistently over different forecasted scenarios

Meaning To express the forecast results in meaningful units (e.g. RO, production
ful Units units, machines) so that all concerns have similar understanding

Written Increase the likelihood that all concerns are using the same information

Simple to Fairly simple forecasting techniques enjoy widespread popularity because

Understand users are more comfortable working with them.
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 Eight steps to forecasting:
Determine the use of the forecast.
1.
2. Select the items or quantities to be forecasted.
3. Determine the time horizon of the forecast.
4. Select the forecasting model or models.
5. Gather the data needed to make the forecast.
6. Validate the forecasting model.
7. Make the forecast.
8. Implement the results.
 These steps provide a systematic way of initiating, designing,
and implementing a forecasting system.
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Forecasting Models
 Forecasting is Art and Science!!!
Forecasting
Qualitative Quantitative Techniques Techniques
Techniques
Permit the inclusion of Involve either the Qualitative Time-Series Causal
soft information (e.g. projection of historical data Models Methods Methods
Human factors, or the development of
Personal opinions, associative methods that Delphi Naive
Hunches) attempt to use causal Methods
variables to make a forecast Moving
Jury of
Executive Average
These factors are These techniques rely on
difficult, or impossible, hard data Opinion Weighted
to quantify Sales Force Moving Average
Composite
Associative models: uses explanatory variables to Exponential
predict the future (e.g. demand for paint might be Consumer Smoothing
related to variables such as, price and advertising Market Survey
expenditure, as well as to specific characteristics of Time series: uses
historical data
the paint (e.g. drying time, ease of cleanup). Judgmental: uses assuming the future
subjective inputs
will be like the past
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 Forecasting Models
Qualitative Models
 Incorporate judgmental or subjective factors (e.g. opinion, experience, best guesses
 Usefulwhen subjective factors are important or accurate quantitative data is difficult to obtain
 Help managers to evaluate trends and causal relationships

 Common qualitative techniques

 Jury of Executive Opinion
 Delphi Method  Collects opinions of a small (focus) group of high-level
 Bestknown, yet Iterative group process managers
 Respondents provide input to decision  Called panel approach (football pundits, politicians, stock
makers anonymously – questionnaire market analysis etc.)
 Repeated until consensus is reached  May use statistical models for analysis or scenario planning

 Sales Force Composite  Consumer Market Survey

 Allows individual salespersons estimates  Information on purchasing plans solicited
 Reviewed for reasonableness from customers or potential customers
 Data is compiled at a district or national level  Used in forecasting, product design, new
product planning

Forecasting Models
Time-Series Models
 Time-series - a time-ordered sequence of observations taken at regular time intervals (e.g. hourly,
daily, .. etc.)
 Assume that future values of the time-series can be estimated from past values of the time-
series – Thus:
 Predict the future based on the past

 Uses only historical data on one variable

 Ignores factors such as Economy, Competition, Selling price

 Analysis of time-series data requires the analyst to identify the underlying behavior of the
series  Plot the data over time.
 Possible patterns: trends, seasonal variation, cycles, or variation around the average.

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Forecasting Models Trend (T): A long-
term, gradual upward
Four possible components or downward
movement in data

Cycles (C): Wavelike

Irregular variation: caused by unusual variations lasting
circumstances, not reflective of typical behavior. more than one year

Random variation: Residual variations after Seasonality (S): Short-

all other behaviors are accounted for. term, fairly regular
variations related to
the calendar or time
of day

Random Variation (R):

“blips” in the data
caused by chance &
unusual situations

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Measures of Forecast Accuracy

• Compare forecasted values with actual values
– See how well one model works
– To compare models

Forecast error = Actual value – Forecast value

– Measure of accuracy

Mean absolute deviation Mean absolute percent error

MAD  
actual - forecast error
MAPE  
actual
n 100%
n
Mean squared error
Bias is the average error
MSE  
(error) 2
n 1
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Measures of Forecast Accuracy
TABLE 5.1 – Computing the Mean Absolute Deviation (MAD)
ACTUAL
SALES OF ABSOLUTE VALUE OF
WIRELESS FORECAST ERRORS (DEVIATION),
YEAR SPEAKERS SALES (ACTUAL – FORECAST)
1 110 —
2 100 110
3 120 100 • Forecast based on naïve model
4 140 120 • No attempt to adjust for time
5 170 140 series components
6 150 170
7 160 150
8 190 160
9 200 190
10 190 200
11 — 190

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Measures of Forecast Accuracy

MAD 
 forecast error

160
 17.8
TABLE 5.1 – Computing the Mean Absolute Deviation (MAD) n 9
ACTUAL
SALES OF ABSOLUTE VALUE OF
WIRELESS FORECAST ERRORS (DEVIATION),
YEAR SPEAKERS SALES (ACTUAL – FORECAST)
1 110 — —
2 100 110 |100 – 110| = 10
3 120 100 |120 – 110| = 20
4 140 120 |140 – 120| = 20
5 170 140 |170 – 140| = 30
6 150 170 |150 – 170| = 20
7 160 150 |160 – 150| = 10
8 190 160 |190 – 160| = 30
9 200 190 |200 – 190| = 10
10 190 200 |190 – 200| = 10
11 — 190 —
Sum of |errors| = 160
MAD = 160/9 = 17.8
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Measures of Forecast Accuracy

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Time Series Forecasting

 ForecastingRandom Variations
 No other components are present
 Averaging techniques smooth out forecasts
 NaïveMethods
 Movingaverages
 Weighted moving averages

 Exponential smoothing

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 Time Series Forecasting- Naïve Methods
 Naïve methods: uses a single previous value of a time series as the basis for a forecast
 Can be used when
 The time series is stable Example: suppose the demand of a product in last month
 There is a trend is 100 units, what is the forecasted demand of this month?
 There is seasonality

 But, for data with trend:

Advantages Disadvantages
The forecast is equal to the last value of the series plus or o Too simple and o Inability to provide
minus the difference between the last two values of the series. with no cost highly accurate
o Quick and easy to forecasts
 Example 1: Suppose the last two values were 50 and 53. prepare o Forecast are just
What is the next forecast? o Easily traces the actual
understandable data, with a lag of
one period

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Moving Averages
 Used when demand is relatively steady over time
 Thenext forecast is the average of the most recent n
data values from the time series
 Smooths out short-term irregularities in the data series

 The number of data points included in the average

determines the model’s sensitivity n

 Fewer data points used-- more responsive A t i

 More data points used-- less responsive Ft  M At  i1

n
where
Ft  Forecast for time period t
Sum of demands in previous n periods
Moving average forecast = MA t  n period moving average
n At 1  Actual value in period t 1
n  Number of periods in the moving average

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Moving Averages
Advantages Disadvantages
o Easy to compute o All values in the average are weighted equally – oldest
o Easy to understand value has the same weight as the recent value.
o If the change occurs in the series, this technique can be
slow to react

 Example 1 : A service organization has a complaint

center. The number of complaints of previous periods
were recorded. Using a three-period moving average:
1. Computed the forecasted number of complaints for the
corresponding periods
2. Prepare a forecast for period 6.

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Moving Averages
MONTH ACTUAL 3-MONTH MOVING
SHED AVERAGE
SALES
 Example 2 : Wallace January 10
Garden Supply wants to February 12
forecast demand for its March 13
Storage Shed April 16 (10 + 12 + 13)/3 = 11.67
 Collected data for the past year May 19 (12 + 13 + 16)/3 = 13.67
 Use a three-month moving average June 23 (13 + 16 + 19)/3 = 16.00
(n = 3) July 26 (16 + 19 + 23)/3 = 19.33
August 30 (19 + 23 + 26)/3 = 22.67
September 28 (23 + 26 + 30)/3 = 26.33
October 18 (26 + 30 + 28)/3 = 28.00
November 16 (30 + 28 + 18)/3 = 25.33
December 14 (28 + 18 + 16)/3 = 20.67

January — (18 + 16 + 14)/3 = 16.00

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Weighted Moving Averages
 Weighted moving averages use weights to put more emphasis on previous periods
 Often used when a trend or other pattern is emerging
 The most recent values in a time series are given more weight in computing a forecast
 The choice of weights, w, is somewhat arbitrary and involves some trial and error

Ft  wn At n  wn1 At (n1)  ...  w1 At 1

where
wt  weight for period t, wt 1  weight for period t 1, etc.
At  the actual value for period t, At1  the actual value for period t 1, etc.

Advantages Disadvantages

o Compared with simple moving o The choice of weights, w, is

average, this technique is more somewhat arbitrary and involves
reflective of the most recent some trial and error
occurrences

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Weighted Moving Averages

 Example 1:
A service organization has a complaint center. The number of complaints of previous periods
were recorded. Using a weighted average of 0.5 (most recent), 0.3, and 0.2:
1. Computed the forecasted number of complaints for the corresponding periods
2. Prepare a forecast for period 6.
 Exponential Smoothing
 Exponential smoothing
A weighted averaging method that is based on the previous forecast plus a percentage of the
forecast error
A type of moving average, Easy to use, Requires little record keeping of data

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

 is a weight (or smoothing constant) with a value 0 ≤  ≤ 1

The idea is simple – the new estimate is the old estimate plus some fraction of the error in the last period
Ft  Ft1   ( At1  Ft1 ) Advantages Disadvantages
where
Ft  Forecast for period t o One of the most o Selecting a smoothing
widely used forecasting constant is a matter of
Ft 1  Forecast for the previous period judgment or trial and
techniques
 = Smoothing constant (i.e. percentage of the forecast error) o Ease of calculation error (but commonly
At 1  Actual demand or sales from the previous period o Ease of use between 0.05 and 0.5).

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Exponential Smoothing Example1

 Example 1:
A service organization has a complaint center. The number of complaints of previous periods
were recorded. Using exponential smoothing with a smoothing constant of 0.4:
1. Computed the forecasted number of complaints for the corresponding periods
2. Prepare a forecast for period 6

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Exponential Smoothing Example2
 In January, February’s demand for a certain car model was predicted to be 142
 Actual February demand was 153 autos
 Using a smoothing constant of  = 0.20, what is the forecast for March?

New forecast (for March demand) = 142 + 0.2(153 – 142)

= 144.2 or 144 autos

• If actual March demand = 136

New forecast (for April demand) = 144.2 + 0.2(136 – 144.2)

= 142.6 or 143 autos

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Selecting the Smoothing Constant

 Selecting the appropriate value for alpha is key to obtaining a good forecast
 The objective is always to generate an accurate forecast
 The general approach is to develop trial forecasts with different values of alpha and
select the alpha that results in the lowest MAD

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Example 2 Port of Baltimore Example
TABLE 5.4 – Exponential Smoothing Forecast for  = 0.1 and  = 0.5

ACTUAL FORECAST
TONNAGE FORECAST USING
QUARTER UNLOADED USING  = 0.10  = 0.50
1 180 175 175
2 168 175.5 = 175.00 + 0.10(180 – 175) 177.5
3 159 174.75 = 175.50 + 0.10(168 – 175.50) 172.75
4 175 173.18 = 174.75 + 0.10(159 – 174.75) 165.88
5 190 173.36 = 173.18 + 0.10(175 – 173.18) 170.44
6 205 175.02 = 173.36 + 0.10(190 – 173.36) 180.22
7 180 178.02 = 175.02 + 0.10(205 – 175.02) 192.61
8 182 178.22 = 178.02 + 0.10(180 – 178.02) 186.30
9 ? 178.60 = 178.22 + 0.10(182 – 178.22) 184.15

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Port of Baltimore Example 2

TABLE 5.5 – Absolute Deviations and MADs

ACTUAL ABSOLUTE ABSOLUTE

TONNAGE FORECAST DEVIATIONS FORECAST DEVIATIONS
QUARTER UNLOADED WITH  = 0.10 FOR  = 0.10 WITH  = 0.50 FOR  = 0.50
1 180 175 5 175 5
2 168 175.5 7.5 177.5 9.5
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 4.3
Sum of absolute deviations 82.45 98.63
Σ|deviations|
MAD = = 10.31 MAD = 12.33
n

29 Best choice
 PM Computer: Moving Average Example
PM Computer assembles customized personal
computers from generic parts. The owners
purchase generic computer parts in volume at a Period month actual demand
discount from a variety of sources whenever they 1 Jan 37
see a good deal. It is important that they develop a 2 Feb 40
good forecast of demand for their computers so 3 Mar 41
they can purchase component parts efficiently. 4 Apr 37
5 May 45
 Compute a 2-month moving average
6 June 50
 Compute a 3-month weighted average using 7 July 43
weights of 4,2,1 for the past three months of 8 Aug 47
data 9 Sept 56
 Compute an exponential smoothing forecast
using alpha = 0.7
 Using MAD, what forecast is most accurate?
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Solved Example1: Forecasts based on averages. Given the following data:

a.Plot the data to see if there is a pattern.Variations
around an average (i.e., no trend or cycles).Therefore,
the most recent value of the series becomes the next
forecast: 64.
70
No. of Complaints

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Prepare a forecast for period 6 using each of these approaches:

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a.The appropriate naive approach. 0 1 2 3 4 5
Period
b.A three-period moving average.
c.A weighted average using weights of .50 (most recent), .30, and .20.
d.Exponential smoothing with a smoothing constant of .40. a.Use the latest values.

c. F = .20(55) + .30(58) + .50(64) = 60.4

d. Start with period 2. Use the data in period 1 as the forecast for period 2, and then use exponential smoothing
for successive forecasts.

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 1. Given your answers to the solved example (1), compare the error performance using MAD, MSE, and
MAPE.
2. Which of the forecasting techniques is better? Justify your answer.

No. 2 National Scan, Inc., sells radio frequency inventory tags. Monthly sales for a seven-month period were

• Plot the monthly data on a sheet of graph paper.

• Forecast September sales volume using each of the following:
• A five-month moving average.
• Exponential smoothing with a smoothing constant equal to .20, assuming a March forecast
of 19(000).
• The naive approach.
• A weighted average using .60 for August, .30 for July, and .10 for June.
• Which method seems least appropriate? Why?
• What does use of the term sales rather than demand presume?
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4) An electrical contractor's records during the last five weeks indicate the number of job requests:

 Predict the number of requests for week 6 using each of these methods:
 Naive.
A four-period moving average.
 Exponential smoothing with α = .30. Use 20 for week 2 forecast.

22) Two independent methods of forecasting based on

judgment and experience have been prepared each month for
the past 10 months.The forecasts and actual sales are as
follows:
 Compute the MSE and MAD for each forecast. Does either
forecast seem superior? Explain.
 Compute MAPE for each forecast.
 Prepare a naive forecast for periods 2 through 11 using the
given sales data. Compute each of the following; (1) MSE, (2)
MAD, (3) tracking signal at month 10, and (4) 2s control
limits. How do the naive results compare with the other two
forecasts?

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 Exercise
Consider the following data:
1. Plot the time series and comment on the pattern.
2. Using naïve approach, provide the forecasted sales of auto battery for
next January.
3. Compute the forecasted sales for the corresponding months using: (a) 2-
moving average, (b) 3-moving average, and (c) 4-moving average. Plot all
values, which forecast is better?
4. Using a weighted moving average (weights are 0.4 most recent, 0.4, and 0.2),
what is the forecast for next Jan? If weights are changed to 0.5 most recent,
0.3, and 0.2, would the forecast improve?
5. In exponential smoothing, decide which of the following smoothing
constants provide better forecast: 0.3, 0.4, 0.5.
6. How can you find the optimal smoothing constant value that provides
the lowest amount of error?

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