Forecasting: Operations Management - 5 Edition

Chapter 11
Forecasting
Operations
Operations Management
Management -- 55thth Edition
Edition
Roberta Russell & Bernard W. Taylor, III
Copyright 2006 John Wiley & Sons, Inc.
Beni Asllani
University of Tennessee at Chattanooga
Lecture Outline
Strategic Role of Forecasting in Supply
Chain Management and TQM
Components of Forecasting Demand
Time Series Methods
Forecast Accuracy
Regression Methods
11-2
Forecasting
Predicting the Future
Qualitative forecast methods
subjective
Quantitative forecast
methods
based on mathematical
formulas
11-3
Forecasting and Supply Chain

Management
Accurate forecasting determines how much
inventory a company must keep at various points
along its supply chain
Continuous replenishment
supplier and customer share continuously updated data

typically managed by the supplier
reduces inventory for the company
speeds customer delivery
Variations of continuous replenishment
quick response
JIT (just-in-time)
VMI (vendor-managed inventory)
stockless inventory
11-4
Forecasting and TQM

Accurate forecasting customer demand is a
key to providing good quality service
Continuous replenishment and JIT
complement TQM
eliminates the need for buffer inventory, which, in

turn, reduces both waste and inventory costs, a
primary goal of TQM
smoothes process flow with no defective items
meets expectations about on-time delivery, which is
perceived as good-quality service
11-5
Types of Forecasting Methods

Depend on
time frame
demand behavior
causes of behavior
11-6
Time Frame
Indicates how far into the future is
forecast
Short- to mid-range forecast

typically
encompasses the immediate future

daily up to two years
Long-range forecast
usually
encompasses a period of time longer

than two years
11-7
Demand Behavior
Trend
a gradual, long-term up or down movement of

demand
Random variations
movements in demand that do not follow a pattern
Cycle
an up-and-down repetitive movement in demand
Seasonal pattern
an up-and-down repetitive movement in demand

occurring periodically
11-8
Demand
Demand
Forms of Forecast Movement
Random
movement
Time
(b) Cycle
Demand
Demand
Time
(a) Trend
Time
(c) Seasonal pattern
Time
(d) Trend with seasonal pattern
11-9
Forecasting Methods
Qualitative
use management judgment, expertise, and opinion to

predict future demand
Time series
statistical techniques that use historical demand data to

predict future demand
Regression methods
attempt to develop a mathematical relationship

between demand and factors that cause its behavior
11-10
Qualitative Methods
Management, marketing, purchasing,
and engineering are sources for internal
qualitative forecasts
Delphi method
involves soliciting forecasts about

technological advances from experts
11-11
Forecasting Process
1. Identify the
purpose of forecast
2. Collect historical
data
3. Plot data and identify

patterns
6. Check forecast
accuracy with one or
more measures
5. Develop/compute
forecast for period of
historical data
4. Select a forecast
model that seems
appropriate for data
7.
Is accuracy of
forecast
acceptable?
No
8b. Select new

forecast model or
adjust parameters of
existing model
Yes
8a. Forecast over
planning horizon
9. Adjust forecast based

on additional qualitative
information and insight
10. Monitor results

and measure forecast
accuracy
11-12
Time Series
Assume that what has occurred in the past will
continue to occur in the future
Relate the forecast to only one factor - time
Include
moving average
exponential smoothing
linear trend line
11-13
Moving Average
Naive forecast
demand the current period is used as next

periods forecast
Simple moving average
stable demand with no pronounced

behavioral patterns
Weighted moving average
weights are assigned to most recent data
11-14
Moving Average:
Nave Approach
MONTH
Jan
Feb
Mar
Apr
May
June
July
Aug
Sept
Oct
Nov
ORDERS
PER MONTH
120
90
100
75
110
50
75
130
110
90
-
FORECAST
120
90
100
75
110
50
75
130
110
90
11-15
Simple Moving Average

n
i = 1 Di
MAn =
where
n
Di
= number of
periods in the
moving average
= demand in period
i
11-16
3-month Simple Moving Average

3
ORDERS
MONTH
Jan
MONTH
PER
MOVING
AVERAGE
120
Feb
90
Mar
100
Apr
75
May
110
June
50
July
75
103.3
88.3
95.0
78.3
78.3
85.0
105.0
110.0
i = 1 Di
MA3 =
=
3
90 + 110 + 130
3
= 110 orders
for Nov
11-17
5-month Simple Moving Average

ORDERS
MONTH
Jan
MONTH
PER
MOVING
AVERAGE
120
Feb
90
Mar
100
Apr
75
May
110
June
50
July
75
99.0
85.0
82.0
88.0
95.0
91.0
i = 1 Di
MA5 =
=
90 + 110 + 130+75+50
5
= 91 orders
for Nov
11-18
Smoothing Effects
150
125
5-month
Orders
100
75
50
3-month
25
Actual
0
|
Jan
|
Feb
|
Mar
|
|
Apr May
|
|
June July
|
|
Aug Sept
Month
11-19
|
Oct
|
Nov
Weighted Moving Average

Adjusts
moving
average
method to
more closely
reflect data
fluctuations
WMAn =
Wi Di
i=1
where
Wi = the weight for period i,

between 0 and 100
percent
W = 1.00
i
11-20
Weighted Moving Average Example

MONTH
WEIGHT
DATA
17%
33%
50%
130
110
390
August
September
October
November Forecast
= 1W D
WMA3 = i
i
i
= (0.50)(90) + (0.33)(110) + (0.17)(130)

= 103.4 orders
11-21
Exponential Smoothing
Averaging method
Weights most recent data more strongly
Reacts more to recent changes
Widely used, accurate method
11-22
Exponential Smoothing (cont.)

Ft +1 = Dt + (1 - )Ft
where:
Ft +1 = forecast for next period
Dt =
actual demand for present period
Ft = previously determined forecast for

present period
=weighting factor, smoothing constant
11-23
Effect of Smoothing Constant

0.0 1.0
If = 0.20, then Ft +1 = 0.20Dt + 0.80 Ft
If = 0, then Ft +1 = 0Dt + 1 Ft 0 = Ft
Forecast does not reflect recent data
If = 1, then Ft +1 = 1Dt + 0 Ft =Dt

Forecast based only on most recent data
11-24
Exponential Smoothing (=0.30)

PERIOD
DEMAND
MONTH
Jan
37
Feb
40
Mar
41
Apr
37
May
45
Jun
50
F2 = D1 + (1 - )F1
7
43 Inc.
Copyright
2006Jul
John Wiley & Sons,
= (0.30)(37) + (0.70)(37)
= 37
F3 = D2 + (1 - )F2
= (0.30)(40) + (0.70)(37)
= 37.9
F13 = D12 + (1 - )F12
= (0.30)(54) + (0.70)(50.84)
= 51.79
11-25
Exponential Smoothing
(cont.)
PERIOD
MONTH
DEMAND
1
2
3
4
5
6
7
8
9
10
11
12
13
Jan
Feb
Mar
Apr
May
Jun
Jul
Aug
Sep
Oct
Nov
Dec
Jan
37
40
41
37
45
50
43
47
56
52
55
54
FORECAST, Ft + 1
( = 0.3)
( = 0.5)
37.00
37.90
38.83
38.28
40.29
43.20
43.14
44.30
47.81
49.06
50.84
51.79
37.00
38.50
39.75
38.37
41.68
45.84
44.42
45.71
50.85
51.42
53.21
53.61
11-26
70
Exponential Smoothing (cont.)
60
= 0.50
Actual
50
Orders
40
= 0.30
30
20
10
0
|
1
|
2
|
3
|
4
|
5
|
6
|
7
|
8
|
9
|
10
Month
11-27
|
11
|
12
|
13
Adjusted Exponential Smoothing

AFt +1 = Ft +1 + Tt +1
where
T = an exponentially smoothed trend factor
Tt +1 = (Ft +1 - Ft) + (1 - ) Tt
where
Tt = the last period trend factor
= a smoothing constant for trend
11-28
Adjusted Exponential
Smoothing (=0.30)
T3
PERIOD
DEMAND
MONTH
Jan
37
Feb
40
Mar
41
= (0.30)(38.5 - 37.0) + (0.70)(0)
Apr
37
May
45
Jun
= (F3 - F2) + (1 - ) T2
50
= 0.45
AF3 = F3 + T3 = 38.5 + 0.45
= 38.95
T13
= (F13 - F12) + (1 - ) T12

= (0.30)(53.61 - 53.21) + (0.70)
(1.77)
= 1.36
AF13 = F13 + T13 = 53.61 + 1.36 = 54.96
11-29
Adjusted Exponential Smoothing:

Example
PERIOD
MONTH
DEMAND
FORECAST
Ft +1
1
2
3
4
5
6
7
8
9
10
11
12
13
Jan
Feb
Mar
Apr
May
Jun
Jul
Aug
Sep
Oct
Nov
Dec
Jan
37
40
41
37
45
50
43
47
56
52
55
54
37.00
37.00
38.50
39.75
38.37
38.37
45.84
44.42
45.71
50.85
51.42
53.21
53.61
TREND
Tt +1
ADJUSTED
FORECAST AFt +1
0.00
0.45
0.69
0.07
0.07
1.97
0.95
1.05
2.28
1.76
1.77
1.36
37.00
38.95
40.44
38.44
38.44
47.82
45.37
46.76
58.13
53.19
54.98
54.96
11-30
Adjusted Exponential Smoothing

Forecasts
70
60
Adjusted forecast ( = 0.30)

Actual
Demand
50
40
30
Forecast ( = 0.50)
20
10
0
|
1
|
2
|
3
|
4
|
5
|
|
6
7
Period
|
8
|
9
|
10
11-31
|
11
|
12
|
13
Linear Trend Line

y = a + bx
where
a = intercept
b = slope of the line
x = time period
y = forecast for
demand for period x
xy - nxy
b = x2 - nx2
a = y-bx
where
n = number of periods
x
x = n = mean of the x values
y
y = n = mean of the y values
11-32
Least Squares Example

x(PERIOD)
y(DEMAND)
xy
x2
1
2
3
4
5
6
7
8
9
10
11
12
73
40
41
37
45
50
43
47
56
52
55
54
37
80
123
148
225
300
301
376
504
520
605
648
1
4
9
16
25
36
49
64
81
100
121
144
78
557
3867
650
11-33
Least Squares Example

(cont.)
78
x =
= 6.5
12
557
y =
= 46.42
12
xy - nxy
3867 - (12)(6.5)(46.42)
b =
=
=1.72
2
2
2
x - nx
650 - 12(6.5)
a = y - bx
= 46.42 - (1.72)(6.5) = 35.2
11-34
Linear trend line y = 35.2 + 1.72x

Forecast for period 13 y = 35.2 + 1.72(13) = 57.56 units
70
60
Actual
Demand
50
40
Linear trend line
30
20
10
0
|
1
|
2
|
3
|
4
|
5
|
|
6
7
Period
|
8
|
9
|
10
|
11
11-35
|
12
|
13
Seasonal Adjustments
Repetitive increase/ decrease in demand
Use seasonal factor to adjust forecast
Seasonal factor = Si =
Di
D
11-36
Seasonal Adjustment (cont.)

YEAR
2002
2003
2004
Total
DEMAND (1000S PER QUARTER)

1
2
3
4
Total
12.6
14.1
15.3
42.0
8.6
10.3
10.6
29.5
D1
42.0
S1 =
=
= 0.28
D 148.7
D2
29.5
S2 =
=
= 0.20
148.7
D
6.3
7.5
8.1
21.9
17.5
18.2
19.6
55.3
45.0
50.1
53.6
148.7
D3
21.9
S3 =
=
= 0.15
D 148.7
D4
55.3
S4 =
=
= 0.37
148.7
D
11-37
Seasonal Adjustment (cont.)
For 2005
y = 40.97 + 4.30x = 40.97 + 4.30(4) = 58.17
SF1 = (S1) (F5) = (0.28)(58.17) = 16.28
SF2 = (S2) (F5) = (0.20)(58.17) = 11.63
SF3 = (S3) (F5) = (0.15)(58.17) = 8.73
SF4 = (S4) (F5) = (0.37)(58.17) = 21.53
11-38
Forecast Accuracy
Forecast error
difference between forecast and actual demand

MAD
MAPD
mean absolute deviation
mean absolute percent deviation
Cumulative error
Average error or bias
11-39
Mean Absolute Deviation

(MAD)
Dt - Ft
MAD =
n
where
t = period number
Dt = demand in period t
Ft = forecast for period t
n = total number of periods
= absolute value
11-40
MAD Example
PERIOD
1
2
3
4
5
6
7
8
9
10
11
12
DEMAND, Dt
Ft ( =0.3)
37
37.00
40
37.00
41
37.90
D38.83
t - Ft
37
MAD
=
45
n38.28
50
40.29
53.39
43
43.20
=
47
1143.14
56
44.30
52
= 4.85 47.81
55
49.06
54
50.84
557
(Dt - Ft)
|Dt - Ft|
3.00
3.10
-1.83
6.72
9.69
-0.20
3.86
11.70
4.19
5.94
3.15
3.00
3.10
1.83
6.72
9.69
0.20
3.86
11.70
4.19
5.94
3.15
49.31
53.39
11-41
Other Accuracy Measures

Mean absolute percent deviation (MAPD)
MAPD =
|Dt - Ft|
Dt
Cumulative error
E = et
Average error
et
E= n
11-42
Comparison of Forecasts
FORECAST
MAD
MAPD
(E)
Exponential smoothing (= 0.30)

Exponential smoothing (= 0.50)
Adjusted exponential smoothing
(= 0.50, = 0.30)
Linear trend line
4.85
4.04
3.81
9.6%
8.5%
7.5%
49.31
33.21
21.14
4.48
3.02
1.92
2.29
4.9%
11-43
Forecast Control
Tracking signal
monitors the forecast to see if it is biased

high or low
(Dt - Ft)
E
Tracking signal =
= MAD
MAD
1 MAD 0.8
Control limits of 2 to 5 MADs are used most
frequently
11-44
Tracking Signal Values

PERIOD
DEMAND
Dt
1
2
3
4
5
6
7
8
9
10
11
12
37
40
41
37
45
50
43
47
56
52
55
54
FORECAST,
Ft
ERROR
Dt - Ft
E =
(Dt - Ft)
37.00
37.00
3.00
3.00
37.90
3.10
6.10
38.83
-1.83
4.27
38.28
6.72 for period
10.99 3
Tracking
signal
40.29
9.69
20.68
43.20
-0.20
6.10 20.48
43.14
TS3 = 3.86 =24.34
2.00
3.05
44.30
11.70
36.04
47.81
4.19
40.23
49.06
5.94
46.17
50.84
3.15
49.32
MAD
3.00
3.05
2.64
3.66
4.87
4.09
4.06
5.01
4.92
5.02
4.85
11-45
TRACKING
SIGNAL
1.00
2.00
1.62
3.00
4.25
5.01
6.00
7.19
8.18
9.20
10.17
Tracking Signal Plot

Tracking signal (MAD)
3
2
Exponential smoothing ( = 0.30)
1
0
-1
-2
Linear trend line
-3
|
0
|
1
|
2
|
3
|
4
|
5
|
6
Period
|
7
|
8
|
9
|
10
11-46
|
11
|
12
Statistical Control Charts

=
(Dt - Ft)2
n-1
Using we can calculate statistical

control limits for the forecast error
Control limits are typically set at 3
11-47
Statistical Control Charts

18.39
12.24
UCL = +3
Errors
6.12
0
-6.12
-12.24
-18.39
|
0
LCL = -3
|
1
|
2
|
3
|
4
|
5
|
6
Period
|
7
|
8
|
9
|
10
11-48
|
11
|
12
Regression Methods
Linear regression
a mathematical technique that relates a

dependent variable to an independent
variable in the form of a linear equation
Correlation
a measure of the strength of the relationship

between independent and dependent
variables
11-49
Linear Regression
y = a + bx
a = y-bx
xy - nxy
b = x2 - nx2
where
a = intercept
b = slope of the line
x = x = mean of the x data
n
y
y =
= mean of the y data
n
11-50
Linear Regression Example

x
(WINS)
y
(ATTENDANCE)
xy
x2
4
6
6
8
6
7
5
7
36.3
40.1
41.2
53.0
44.0
45.6
39.0
47.5
145.2
240.6
247.2
424.0
264.0
319.2
195.0
332.5
16
36
36
64
36
49
25
49
49
346.7
2167.7
311
11-51
Linear Regression Example (cont.)

49
= 6.125
8
346.9
y=
= 43.36
8
x=
xy - nxy2
b=
x2 - nx2
(2,167.7) - (8)(6.125)(43.36)
=
(311) - (8)(6.125)2
= 4.06
a = y - bx
= 43.36 - (4.06)(6.125)
= 18.46
11-52
Linear Regression Example (cont.)

Regression equation
Attendance forecast for 7 wins
y = 18.4660,000
+ 4.06x
y = 18.46 + 4.06(7)
= 46.88, or 46,880
50,000
Attendance, y
40,000
30,000
20,000
Linear regression line,

y = 18.46 + 4.06x
10,000
|
0
|
1
|
2
|
3
|
4
|
5
Wins, x
|
6
|
7
|
8
|
9
|
10
11-53
Correlation and Coefficient of

Determination
Correlation, r
Measure of strength of relationship
Varies between -1.00 and +1.00
Coefficient of determination, r2
Percentage of variation in dependent
variable resulting from changes in the
independent variable
11-54
Computing Correlation
r=
n xy - x y
[n x2 - ( x)2] [n y2 - ( y)2]
(8)(2,167.7) - (49)(346.9)
r=
[(8)(311) - (49)2] [(8)(15,224.7) - (346.9)2]

r = 0.947
Coefficient of determination
r2 = (0.947)2 = 0.897
11-55
Multiple Regression
Study the relationship of demand to two or
more independent variables
y = 0 + 1x1 + 2x2 + kxk
where
0 = the intercept
1, , k = parameters for the
independent variables
x1, , xk = independent variables
11-56

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unlawful. Request for further information should
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John Wiley & Sons, Inc. The purchaser may make
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for distribution or resale. The Publisher assumes
no responsibility for errors, omissions, or
damages
caused
byInc.
the use of these programs
Copyright 2006 John
Wiley & Sons,
11-57

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Chapter 11

Copyright 2006 John Wiley & Sons, Inc.

Copyright 2006 John Wiley & Sons, Inc.

Copyright 2006 John Wiley & Sons, Inc.

Forecasting and Supply Chain

supplier and customer share continuously updated data

Variations of continuous replenishment

Copyright 2006 John Wiley & Sons, Inc.

Forecasting and TQM

eliminates the need for buffer inventory, which, in

Copyright 2006 John Wiley & Sons, Inc.

Types of Forecasting Methods

Copyright 2006 John Wiley & Sons, Inc.

Short- to mid-range forecast

encompasses the immediate future

encompasses a period of time longer

Copyright 2006 John Wiley & Sons, Inc.

a gradual, long-term up or down movement of

movements in demand that do not follow a pattern

an up-and-down repetitive movement in demand

an up-and-down repetitive movement in demand

Copyright 2006 John Wiley & Sons, Inc.

Forms of Forecast Movement

Copyright 2006 John Wiley & Sons, Inc.

use management judgment, expertise, and opinion to

statistical techniques that use historical demand data to

attempt to develop a mathematical relationship

Copyright 2006 John Wiley & Sons, Inc.

involves soliciting forecasts about

Copyright 2006 John Wiley & Sons, Inc.

3. Plot data and identify

8b. Select new

9. Adjust forecast based

Copyright 2006 John Wiley & Sons, Inc.

10. Monitor results

Copyright 2006 John Wiley & Sons, Inc.

demand the current period is used as next

Simple moving average

stable demand with no pronounced

Weighted moving average

weights are assigned to most recent data

Copyright 2006 John Wiley & Sons, Inc.

Copyright 2006 John Wiley & Sons, Inc.

Simple Moving Average

Copyright 2006 John Wiley & Sons, Inc.

3-month Simple Moving Average

Copyright 2006 John Wiley & Sons, Inc.

5-month Simple Moving Average

Copyright 2006 John Wiley & Sons, Inc.

Weighted Moving Average

Wi = the weight for period i,

Copyright 2006 John Wiley & Sons, Inc.

Weighted Moving Average Example

= (0.50)(90) + (0.33)(110) + (0.17)(130)

Copyright 2006 John Wiley & Sons, Inc.

Exponential Smoothing (cont.)

actual demand for present period

Ft = previously determined forecast for

Copyright 2006 John Wiley & Sons, Inc.

Effect of Smoothing Constant

If = 1, then Ft +1 = 1Dt + 0 Ft =Dt

Exponential Smoothing (=0.30)

Copyright 2006 John Wiley & Sons, Inc.