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FUNDAMENTALS OF PRODUCTION AND OPERATION MANAGEMENT

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Module II: Forecasting Techniques

Coverage

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Forecasting as a planning tool Qualitative Forecasting Methods (Educated Guess, Consensus, Delphi Method, Historical Analogy, Market Research) Quantitative Forecasting (Linear Regression, Moving Average, Weighted Moving Average, Exponential Smoothing with Numerical) Measurement of forecasting errors (Running sum of forecast errors, Mean forecast errors, Mean absolute deviation, Mean squared error, Mean absolute percentage error, Tracking - signal).

Forecasting

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The art and science of predicting future events. Forecasts are estimates of timing and magnitude of the occurrence of future events. Forecasting is used as a planning tool. An organization uses forecasting as a starting point to the annual business planning exercise. A good forecasting system will be able to predict the occurrence of short term fluctuations in demand.

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Forecasting Approaches

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Quantitative forecasts - Forecasts that employ one or more mathematical models that rely on historical data and/or causal variables to forecast demand. Qualitative forecasts Forecasts that incorporate such factors as the decision makers intuition , emotions , personal experiences.

Qualitative Forecasting Methods

Educated Guess Consensus Delphi Method Historical Analogy Market Research

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Educated Guess

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An estimate, a guess value based on experience or theoretical knowledge.

Consensus

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Consensus decision-making is a group decision making process that seeks the consent of all participants. It as an acceptable resolution, one that can be supported, even if not the "favourite" of each individual. It has its origin in the Latin word cnsnsus (agreement), which is from cnsenti meaning literally feel together. It is used to describe both the decision and the process of reaching a decision. Consensus decision-making is thus concerned with the process of deliberating and finalizing a decision.

Delphi Method

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A forecasting technique using a group process that allows experts to make forecasts. Experts give their opinion and a moderator moderates the discussion till a consensus is reached.

Historical Analogy

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Forecasts made on previous years data, experience, judgement and intuition.

Market Research

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A forecasting method that solicits input from customers or potential customers regarding future purchasing plans.

Quantitative Forecasting
Moving Average Weighted Moving Average Exponential Smoothing Linear Regression

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Moving Average

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A forecasting method that uses an average of the n most recent periods of data to forecast the next period. This method tends to smooth out shortterm irregularities in the data series.

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1. Donnas Garden supply wants a 3-month moving average forecast , including a forecast for next January, for shed sales

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Month Jan

Actual Shed Sales 10

Feb
Mar Apr May Jun July Aug Sep Oct Nov Dec

12
13 16 19 23 26 30 28 18 16 14

Weighted Moving Average

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When a detectable trend or pattern is present, weights can be used to place more emphasis on recent values. This practice makes forecasting techniques more responsive to changes because most recent periods may be more heavily weighted.

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2. Donnas Garden supply wants to forecast storage shed sales by weighting the past 3 months, with more weight given to most recent data to make them more significant.

Month
Jan Feb

Actual Shed Sales

10 12

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Weights Applied

Period

Mar
Apr May Jun July Aug Sep Oct Nov Dec

13
16 19 23 26 30 28 18 16 14

3
2 1

Last Month
Two Months Ago Three Months Ago

Measuring Forecast Error

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The forecast error tells us how well the model performed against itself using past data.

Mean Absolute Deviation

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A measure of the overall forecast error for a model

Mean Squared Error

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The average of the squared differences between the forecasted and observed values.

Practice Problem
A manufacturing company has monthly demand for one of its products as follows: Develop a 3-month moving average forecast and a three month weighted moving average forecast with weights of 0.50, 0.30 and 0.20 for the most recent demand values in that order. Calculate MAD , MSE for each forecast.
Month Feb Mar Apr May Jun

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Demand 260 245 275 290 300

July
Aug Sep

210
255 305

Exponential Smoothing

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A weighted moving average forecasting technique in which data points are weighted by an exponential function.

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1. A firm has experienced the following demand. Develop an exponential smoothing forecast using = 0.40

Period 1 2 3 4 5

Units 100 200 300 400 500

Practice Problem
A firm has experienced the following demand Develop an exponential smoothing forecast using = 0.30

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Period 1 2 3 4 5 6 7 8

Units 28 31 28 35 33 32 36 38

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Regression Analysis
Regression analysis is a forecasting technique that establishes a relationship between variables. One variable is known, which is used to forecast the value of an unknown variable.

Factors to be Considered in the Selection of Forecasting Method

the nature of the business the nature of data forecast granularity forecast horizon shelf life of the model and the expected accuracy of the forecasts.

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Forecast granularity is the unit of time of each forecast. Forecast horizon is the number of time units into the future for which forecasts are required. For example, weekly forecasts for the next 2 months have a granularity of a week and a horizon of 8 weeks. Shelf life is the time after which a model becomes useless and there is a need to switch to another model.

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Long-Range Capacity Planning

Definitions of Capacity

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In general, production capacity is the maximum production rate of an organization. Capacity can be difficult to quantify due to
Day-to-day uncertainties such as employee absences, equipment breakdowns, and materialdelivery delays Products and services differ in production rates (so product mix is a factor) Different interpretations of maximum capacity

Definitions of Capacity

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The Federal Reserve Board defines sustainable practical capacity as the greatest level of output that a plant can maintain
within the framework of a realistic work schedule taking account of normal downtime assuming sufficient availability of inputs to operate the machinery and equipment in place

Definition of Production Capacity

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Volume of products that can be generated by a production plant or enterprise in a given period by using current resources.

Steps in the Capacity Planning Process

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Estimate the capacity of the present facilities. Forecast the long-range future capacity needs. Identify and analyze sources of capacity to meet these needs. Select from among the alternative sources of capacity.