Operations Management

BU 385

Roadmap

Last Class

Today

Forecasting Part 2 (Ch 3)

Forecasting Part 3 (Ch 3)

Next class

Product Design (Ch 4)

Reliability (Supplement to Ch 4 Connect)

Participation (5%) Dropbox Quizzes

Answer the assigned problem (see handout)

Individually or in a group max of 3 students from

your section
All work will be automatically submitted to turnitin,
to detect plagiarism

There will be three levels of grades for each quiz

0%: If you do not submit or your work is of very
poor quality
50%: If you make a good attempt but have some
serious errors
100%: If it is right or mostly right

Quiz 1 due Wednesday, October 5, midnight

I will post solutions after the due date

Components of Demand
Average

demand for a
period of time
Trend
Seasonal element
Cyclical elements
Random variation
Today

Forecasting accuracy &

control

Solving problems

Forecasting Accuracy
The

degree of correctness of the

forecasts generated through the
forecasting process

Why

do we need it?

To choose a forecasting technique

To prepare for probable values of
demand
To monitor performance over time and
take corrective actions if necessary

Accuracy and Control of Forecasts

Error = Actual value - Forecast value

Three measures to evaluate forecasts:

plot errors to see if within pre-set control limits

Tracking signal [exclusion]

Mean absolute deviation (MAD)

Mean squared error (MSE)
Mean absolute percent error (MAPE)

Control charts

+ve = forecast too low, -ve = too high

Ratio of cumulative error and MAD

Evaluating Forecasts
How far off is the forecast?
Forecasts

Demands

What do we do with this information?

Three ways to measure error

Mean absolute deviation (MAD)

Mean squared error (MSE)

Average absolute error

Similar to standard deviation

Average of squared error

Similar to variance

Mean absolute percent error (MAPE)

Error, MAD, MSE and MAPE

Error e Actual Forecast At Ft
Actual Forecast

MAD
n

MSE

Actual

Forecast

Actual Forecast

Actual

%
MAPE 100
n

MAD, MSE and MAPE

MAD

Easy
Easy to
to compute
compute
Weights
Weights errors
errors
linearly
linearly

MSE

Squares
Squares error
error

MAPE

perspective
perspective

More
More weight
weight to
to
large
large errors
errors

Puts
Puts errors
errors in
in

Accuracy
Accuracy above
above 70%
70%
satisfactory
satisfactory

Ex 1: Error, MAD, MSE and MAPE

Compute MAD, MSE, and MAPE for the

following data
2

100

Period

Actual

Forecast

217

215

A
0.92%

2
3

213
216

216
215

3
1

3
1

9
1

1.41%
0.46%

210

214

4
10

16
30

1.90%
4.69%

Error, MAD, MSE and MAPE

e

100

Period

Actual

Forecast

e2

217

215

A
0.92%

2
3

213
216

216
215

3
1

3
1

9
1

1.41%
0.46%

210

214

4
10

16
30

1.90%
4.69%

MAD
MSE

n
e2
n

MAPE

2.5
7.5
e

100
A

1.17%

Can we compare MAD, MSE and

MAPE?

MAD & MSE are dependent on the scale

of data

Can be used to compare different forecasts

on the same time series, but not across
different time series variables
Lower value of MAD or MSE = more accurate
forecast

MAPE expressed as percentage,

independent of scale of data

Can be used to make comparisons across

different time series variables

Bias
bias

= the sum of the forecast

errors

+ve bias = frequent underestimation

-ve bias = frequent overestimation
Use of MAD, MSE, or MAPE assumes
negligible bias

Possible

include

sources of error

Model may be inadequate (things have

changed)

Incorrect use of forecasting

technique

Forecast Control
It is necessary to monitor forecast errors to
ensure that the forecast is performing
adequately over time. This is generally
accomplished by comparing forecast errors
to predefined values, or action limits

Error

Upper limit
Range of

acceptable

variation

Lower limit

Time
Need for
corrective
action

Control Chart

A visual tool for monitoring forecast

errors

Used to detect non-randomness in errors

Set limits that are multiples of the MSE

Forecasting errors are in control

when only random errors occur i.e. no
errors from identifiable causes

All errors are within control limits

No patterns (e.g. trends or cycles) are present

Errors

outside limit = need

corrective action

Controlling Forecasts: Control Limits

Standard
deviation of error =

Control Limits

MSE
=

0 2 (or 3) s

95% of all errors should be within 2s

97.7% of all errors should be within 3s

e
n

Control Chart

The control chart sets the limits

as multiples of the squared root
of MSE

Example: Control Chart

A
Month (Sales)

A-F

(Forecast) Error

MSE

90

100

-10

100

95

100

-5

25

115

100

+15

225

100

110

-10

100

125

110

+15

225

140

110

+30

900
1575

1575

262.5 16.2

Errors should be within 2(16.2).

Lower limit = -32.4 Upper limit = 32.4

Example: Control Chart(contd)

All the errors are within the control limits

20

Example Forecast Control

Below is a sports nutrition stores actual sales and demand forecasts for a specific protein
supplement for 5 months.
How accurate is their forecast?
Calculate MAD and MSE and create a control chart

Month
1
2
3
4
5

Sales
350
390
330
420
450

Forecast
N/A
400
375
400
440

Example Forecast Control

Month Sales Forecast

1

350

N/A

2
3
4
5

390
330
420
450

400
375
400
440

S=?
Upper Limit = ?
Lower Limit = ?

Error

Abs.
Error

Squared
Error

Example Forecast Control

Month Sales Forecast

Error

Abs.
Error

Squared
Error

1
2

350
390

N/A
400

-10

10

100

3
4
5

330
420
450

375
400
440

-45
20
10
-25

45
20
10
85

2025
400
100
2625

Bias?
S = MSE = (2625/4) = 25.6
Upper Limit = 2*25.6 = 51.2
Lower Limit = -2*25.6 = -51.2

Why Do We Need Forecast Control?

Incorrect use of forecasting method
The omission of an important variable
Appearance of a new variable
A sudden or unexpected change in the
variable (causing by severe weather
or other nature phenomena,
temporary shortage or breakdown,
catastrophe, or similar events)
Data being misinterpreted
Random variation
Trend which cannot go on forever
[Nortel]

Choosing a Forecasting Technique

No single technique works in every

situation
Two most important factors

Cost
Accuracy

Other factors include availability of:

Historical data
Computers
Time needed to gather and analyze the data
Forecast horizon

Matching Forecasting Techniques with the phases of the Life Cycle of the
Product or Service

Maturity/Saturation

Moving Averages
Simple Exponential Smoothing

Decline

Judgmental
techniques

Growth

Demand

Incubation

Judgmental techniques

Linear Trend
Double Exponential Smoothing

Time

Next Class
Product

Design Ch 4
Reliability (Supplement to
Chapter 4)

Find it on Connect