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Forecasting Forecasting
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Copyright 2010 Pearson Education, Inc. Publishing as Prentice Hall.
For For Operations Management, 9e Operations Management, 9e by by
Krajewski/Ritzman/Malhotra Krajewski/Ritzman/Malhotra
2010 Pearson Education 2010 Pearson Education
PowerPoint Slides PowerPoint Slides
by Jeff Heyl by Jeff Heyl
Forecasting Forecasting
Forecasts are critical inputs to business plans,
annual plans, and budgets
Finance, human resources, marketing, operations,
and supply chain managers need forecasts to
plan: output levels, purchases of services and
materials, workforce and output schedules,
inventories, and long-term capacities
Forecasts are made on many different variables
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Forecasts are important to managing both
processes and managing supply chains
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Demand Patterns Demand Patterns
A time series is the repeated observations
of demand for a service or product in their p
order of occurrence
There are five basic time series patterns
Horizontal
Trend
Seasonal
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Seasonal
Cyclical
Random
Demand Patterns Demand Patterns
Figure 13.1 Patterns of Demand
Q
u
a
n
t
i
t
y
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Time
(a) Horizontal: Data cluster about a horizontal line
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Demand Patterns Demand Patterns
Figure 13.1 Patterns of Demand
Q
u
a
n
t
i
t
y
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Time
(b) Trend: Data consistently increase or decrease
Demand Patterns Demand Patterns
Figure 13.1 Patterns of Demand
Q
u
a
n
t
i
t
y
Year 1
Year 2
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| | | | | | | | | | | |
J F M A M J J A S O N D
Months
(c) Seasonal: Data consistently show peaks and valleys
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Demand Patterns Demand Patterns
Figure 13.1 Patterns of Demand
Q
u
a
n
t
i
t
y
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1 2 3 4 5 6
Years
(d) Cyclical: Data reveal gradual increases and
decreases over extended periods
Key Decisions Key Decisions
Deciding what to forecast
Level of aggregation
U i f Units of measure
Choosing a forecasting system
Choosing the type of forecasting technique
Judgment and qualitative methods
Causal methods
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Time-series analysis
Key factor in choosing the proper
forecasting approach is the time horizon
for the decision requiring forecasts
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Judgment Methods Judgment Methods
Other methods (casual and time-series) require an
adequate history file, which might not be available
Judgmental forecasts use contextual knowledge
gained through experience
Salesforce estimates
Executive opinion is a method in which opinions,
experience, and technical knowledge of one or
more managers are summarized to arrive at a
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g
single forecast
Delphi method
Judgment Methods Judgment Methods
Market research is a systematic approach to
determine external customer interest through
d t th i data-gathering surveys
Delphi method is a process of gaining consensus
from a group of experts while maintaining their
anonymity
Useful when no historical data are available
Can be used to develop long-range forecasts and
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p g g
technological forecasting
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Linear Regression Linear Regression
A dependent variable is related to one or more
independent variables by a linear equation
Th i d d t i bl d t The independent variables are assumed to
cause the results observed in the past
Simple linear regression model is a straight line
Y = a + bX
where
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Y = dependent variable
X = independent variable
a = Y-intercept of the line
b = slope of the line
Linear Regression Linear Regression
Y
Estimate of
Regression
equation:
Y = a + bX
Deviation,
or error
D
e
p
e
n
d
e
n
t

v
a
r
i
a
b
l
e
Estimate of
Y from
regression
equation
Actual
value
of Y
Value of X used
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Independent variable
X
Value of X used
to estimate Y
Figure 13.2 Linear Regression Line Relative to Actual Data
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Linear Regression Linear Regression
The sample correlation coefficient, r
Measures the direction and strength of the relationship
between the independent variable and the dependent between the independent variable and the dependent
variable.
The value of r can range from 1.00 r 1.00
The sample coefficient of determination, r
2
Measures the amount of variation in the dependent
variable about its mean that is explained by the
regression line
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The values of r
2
range from 0.00 r
2
1.00
The standard error of the estimate, s
yx
Measures how closely the data on the dependent variable
cluster around the regression line
Using Linear Regression Using Linear Regression
EXAMPLE 13.1
The supply chain manager seeks a better way to forecast the
demand for door hinges and believes that the demand is related g
to advertising expenditures. The following are sales and
advertising data for the past 5 months:
Month Sales (thousands of units) Advertising (thousands of $)
1 264 2.5
2 116 1.3
3 165 1.4
4 101 1 0
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4 101 1.0
5 209 2.0
The company will spend $1,750 next month on advertising for
the product. Use linear regression to develop an equation and
a forecast for this product.
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Using Linear Regression Using Linear Regression
SOLUTION
We used POM for Windows to determine the best values of a, b,
the correlation coefficient, the coefficient of determination, and , ,
the standard error of the estimate
a =
b =
r =
r
2
=
s
yx
=
8.135
109.229X
0.980
0.960
15.603
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The regression equation is
Y = 8.135 + 109.229X
Using Linear Regression Using Linear Regression
The regression line is shown in Figure 13.3. The r of 0.98
suggests an unusually strong positive relationship between
sales and advertising expenditures. The coefficient of
determination
2
implies that 96 percent of the variation in determination, r
2
, implies that 96 percent of the variation in
sales is explained by advertising expenditures.
250
200
150
(
0
0
0

u
n
i
t
s
)
Brass Door Hinge
X
X
X
X
Data
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| |
1.0 2.0
Advertising ($000)
100
50
0
S
a
l
e
s

X
X
Data
Forecasts
Figure 13.3 Linear Regression Line for the Sales and Advertising Data
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Time Series Methods Time Series Methods
In a naive forecast the forecast for the next
period equals the demand for the current
period (Forecast = D) period (Forecast = D
t
)
Estimating the average: simple moving
averages
Used to estimate the average of a demand time
series and thereby remove the effects of
random fluctuation
Most useful when demand has no pronounced
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Most useful when demand has no pronounced
trend or seasonal influences
The stability of the demand series generally
determines how many periods to include
450
430
Time Series Methods Time Series Methods
430
410
390
370
350
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a
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n
t

a
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v
a
l
s
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0 5 10 15 20 25 30
Week
Figure 13.4 Weekly Patient Arrivals at a Medical Clinic
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Simple Moving Averages Simple Moving Averages
Specifically, the forecast for period t + 1 can be
calculated at the end of period t (after the actual
demand for period t is known) as demand for period t is known) as
F
t+1
= =
Sum of last n demands
n
D
t
+ D
t-1
+ D
t-2
+ + D
t-n+1
n
where
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D
t
= actual demand in period t
n = total number of periods in the average
F
t+1
= forecast for period t + 1
Simple Moving Averages Simple Moving Averages
For any forecasting method, it is important to
measure the accuracy of its forecasts. Forecast
error is simply the difference found by subtracting error is simply the difference found by subtracting
the forecast from actual demand for a given
period, or
where
E
t
= D
t
F
t
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where
E
t
= forecast error for period t
D
t
= actual demand in period t
F
t
= forecast for period t
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Using the Moving Average Method Using the Moving Average Method
EXAMPLE 13.2
a. Compute a three-week moving average forecast for the
arrival of medical clinic patients in week 4. The numbers of arrival of medical clinic patients in week 4. The numbers of
arrivals for the past three weeks were as follows:
Week Patient Arrivals
1 400
2 380
3 411
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b. If the actual number of patient arrivals in week 4 is 415,
what is the forecast error for week 4?
c. What is the forecast for week 5?
Using the Moving Average Method Using the Moving Average Method
SOLUTION
a. The moving average forecast at
the end of week 3 is
Week Patient Arrivals
1 400
2 380
3 411
the end of week 3 is
b. The forecast error for week 4 is
F
4
= = 397.0
411 + 380 + 400
3
E
4
= D
4
F
4
= 415 397 = 18
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c. The forecast for week 5 requires the actual arrivals from
weeks 2 through 4, the three most recent weeks of data
F
5
= = 402.0
415 + 411 + 380
3
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Application 13.1a Application 13.1a
Estimating with Simple Moving Average using the following
customer-arrival data
Month Customer arrival
1 800
2 740
3 810
4 790
Use a three-month moving average to forecast customer
arrivals for month 5
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arrivals for month 5
F
5
= = 780
D
4
+ D
3
+ D
2
3
790 + 810 + 740
3
=
Forecast for month 5 is 780 customer arrivals
Application 13.1a Application 13.1a
If the actual number of arrivals in month 5 is 805, what is the
forecast for month 6?
F = = 801 667
D
5
+ D
4
+ D
3
805 + 790 + 810
=
Month Customer arrival
1 800
2 740
3 810
4 790
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F
6
= = 801.667
3 3
=
Forecast for month 6 is 802 customer arrivals
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Application 13.1a Application 13.1a
Forecast error is simply the difference found by subtracting the
forecast from actual demand for a given period, or
Given the three-month moving average forecast for month 5,
and the number of patients that actually arrived (805), what is
the forecast error?
E
t
= D
t
F
t
E
5
= 805 780 = 25
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Forecast error for month 5 is 25
In the weighted moving average method, each
historical demand in the average can have its own
weight provided that the sum of the weights equals
Weighted Moving Averages Weighted Moving Averages
weight, provided that the sum of the weights equals
1.0. The average is obtained by multiplying the
weight of each period by the actual demand for that
period, and then adding the products together:
F
t+1
= W
1
D
1
+ W
2
D
2
+ + W
n
D
t-n+1
A three-period weighted moving average model with
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the most recent period weight of 0.50, the second
most recent weight of 0.30, and the third most
recent might be weight of 0.20
F
t+1
= 0.50D
t
+ 0.30D
t1
+ 0.20D
t2
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Application 13.1b Application 13.1b
Revisiting the customer arrival data in Application 13.1a. Let
W
1
= 0.50, W
2
= 0.30, and W
3
= 0.20. Use the weighted moving
average method to forecast arrivals for month 5.
= 0.50(790) + 0.30(810) + 0.20(740)
F
5
= W
1
D
4
+ W
2
D
3
+ W
3
D
2
= 786
Forecast for month 5 is 786 customer arrivals
Given the number of patients that actually arrived (805), what
is the forecast error?
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is the forecast error?
Forecast error for month 5 is 19
E
5
= 805 786 = 19
Application 13.1b Application 13.1b
If the actual number of arrivals in month 5 is 805, compute
the forecast for month 6
= 0.50(805) + 0.30(790) + 0.20(810)
F
6
= W
1
D
5
+ W
2
D
4
+ W
3
D
3
= 801.5
Forecast for month 6 is 802 customer arrivals
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15
Exponential Smoothing Exponential Smoothing
A sophisticated weighted moving average that
calculates the average of a time series by giving
recent demands more weight than earlier demands recent demands more weight than earlier demands
Requires only three items of data
The last periods forecast
The demand for this period
A smoothing parameter, alpha (), where 0 1.0
The equation for the forecast is
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F
t+1
= (Demand this period) + (1 )(Forecast calculated last period)
= D
t
+ (1 )F
t
F
t+1
= F
t
+ (D
t
F
t
)
or the equivalent
Exponential Smoothing Exponential Smoothing
The emphasis given to the most recent demand
levels can be adjusted by changing the smoothing
parameter parameter
Larger values emphasize recent levels of
demand and result in forecasts more responsive
to changes in the underlying average
Smaller values treat past demand more
uniformly and result in more stable forecasts
E ti l thi i i l d i
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Exponential smoothing is simple and requires
minimal data
When the underlying average is changing, results
will lag actual changes
16
450 3-week MA
6-week MA
forecast
Exponential Smoothing and Exponential Smoothing and
Moving Average Moving Average
430
410
390
370
a
t
i
e
n
t

a
r
r
i
v
a
l
s
forecast
forecast
Exponential
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P
a
Week
| | | | | |
0 5 10 15 20 25 30
Exponential
smoothing
= 0.10
Using Exponential Smoothing Using Exponential Smoothing
EXAMPLE 13.3
a. Reconsider the patient arrival data in Example 13.2. It is
now the end of week 3. Using = 0.10, calculate the now the end of week 3. Using 0.10, calculate the
exponential smoothing forecast for week 4.
Week Patient Arrivals
1 400
b. What was the forecast error for week 4 if the actual demand
turned out to be 415?
c. What is the forecast for week 5?
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2 380
3 411
4 415
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Using Exponential Smoothing Using Exponential Smoothing
SOLUTION
a. The exponential smoothing method requires an initial
forecast. Suppose that we take the demand data for the first pp
two weeks and average them, obtaining (400 + 380)/2 = 390
as an initial forecast. (POM for Windows and OM Explorer
simply use the actual demand for the first week as a default
setting for the initial forecast for period 1, and do not begin
tracking forecast errors until the second period). To obtain
the forecast for week 4, using exponential smoothing with
and the initial forecast of 390, we calculate the average at
the end of week 3 as
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F
4
=
Thus, the forecast for week 4 would be 392 patients.
0.10(411) + 0.90(390) = 392.1
Using Exponential Smoothing Using Exponential Smoothing
b. The forecast error for week 4 is
E 415 392 23
c. The new forecast for week 5 would be
E
4
=
F
5
=
or 394 patients Note that we used F not the integer value
415 392 = 23
0.10(415) + 0.90(392.1) = 394.4
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or 394 patients. Note that we used F
4
, not the integer-value
forecast for week 4, in the computation for F
5
. In general, we
round off (when it is appropriate) only the final result to
maintain as much accuracy as possible in the calculations.
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Application 13.1c Application 13.1c
Suppose the value of the customer arrival series average in
month 3 was 783 customers (let it be F
4
). Use exponential
smoothing with = 0.20 to compute the forecast for month 5.
F
t+1
= F
t
+ (D
t
F
t
) = 783 + 0.20(790 783) = 784.4
Forecast for month 5 is 784 customer arrivals
Given the number of patients that actually arrived (805),
what is the forecast error?
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E
5
=
Forecast error for month 5 is 21
805 784 = 21
Application 13.1c Application 13.1c
Given the actual number of arrivals in month 5, what is the
forecast for month 6?
F
t+1
= F
t
+ (D
t
F
t
) = 784.4 + 0.20(805 784.4) = 788.52
Forecast for month 6 is 789 customer arrivals
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19
Including a Trend Including a Trend
A trend in a time series is a systematic
increase or decrease in the average of the increase or decrease in the average of the
series over time
The forecast can be improved by
calculating an estimate of the trend
Trend-adjusted exponential smoothing
requires two smoothing constants
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requires two smoothing constants
Including a Trend Including a Trend
For each period, we calculate the average and the
trend:
A = (Demand this period) A
t
= (Demand this period)
+ (1 )(Average + Trend estimate last period)
= D
t
+ (1 )(A
t1
+ T
t1
)
T
t
= (Average this period Average last period)
+ (1 )(Trend estimate last period)
= (A
t
A
t1
) + (1 )T
t1
F A + T
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F
t+1
= A
t
+ T
t
where
A
t
= exponentially smoothed average of the series in period t
T
t
= exponentially smoothed average of the trend in period t
= smoothing parameter for the average, with a value between 0 and 1
= smoothing parameter for the trend, with a value between 0 and 1
F
t+1
= forecast for period t + 1
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Using Trend Using Trend--Adjusted Exponential Adjusted Exponential
Smoothing Smoothing
EXAMPLE 13.4
Medanalysis, Inc., provides medical laboratory services
M i t t d i f ti th b f bl d Managers are interested in forecasting the number of blood
analysis requests per week
There has been a national increase in requests for standard
blood tests
Medanalysis recently ran an average of 28 blood tests per
week and the trend has been about three additional patients
per week
Thi k d d f 27 bl d t t
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This weeks demand was for 27 blood tests
We use = 0.20 and = 0.20 to calculate the forecast for
next week
Using Trend Using Trend--Adjusted Exponential Adjusted Exponential
Smoothing Smoothing
SOLUTION
A
0
= 28 patients and T
0
= 3 patients
30.2 + 2.8 = 33 blood tests
If the actual number of blood tests requested in week 2
proved to be 44, the updated forecast for week 3 would be
The forecast for week 2 (next week) is
A
1
=
T
1
=
F
2
=
0.20(27) + 0.80(28 + 3) = 30.2
0.20(30.2 28) + 0.80(3) = 2.8
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p , p
A
2
=
F
3
= 35.2 + 3.2 = 38.4 or 38 blood tests
0.2(35.2 30.2) + 0.80(2.8) = 3.2
0.20(44) + 0.80(30.2 + 2.8) = 35.2
T
2
=
21
Using Trend Using Trend--Adjusted Exponential Adjusted Exponential
Smoothing Smoothing
TABLE 13.1 | FORECASTS FOR MEDANALYSIS USING THE TREND-ADJUSTED EXPONENTIAL
| SMOOTHING MODEL
Calculations to Forecast Arrivals for Next Week
Week Arrivals
Smoothed
Average
Trend
Average
Forecast for This Week Forecast Error
g g
0 28 28.00 3.00
1 27
2 44
3 37
4 35
5 53
6 38
7 57
8 61
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9 39
10 55
11 54
12 52
13 60
14 60
15 75
Using Trend Using Trend--Adjusted Exponential Adjusted Exponential
Smoothing Smoothing
TABLE 13.1 | FORECASTS FOR MEDANALYSIS USING THE TREND-ADJUSTED EXPONENTIAL
| SMOOTHING MODEL
Calculations to Forecast Arrivals for Next Week
Week Arrivals
Smoothed
Average
Trend
Average
Forecast for This Week Forecast Error
30.20 + 2.84 = 33.04
4 30.20
35.23
2.84
3.28
28.00 + 3.00 = 31.00
35.23 + 3.28 = 38.51
38.21 + 3.22 = 41.43
40.14 + 2.96 = 43.10
45.08 + 3.36 = 48.44
46.35 + 2.94 = 49.29
50.83 + 3.25 = 54.08
10.96
1.51
6.43
9.90
10.44
7.71
6.92
38.21
40.14
45.08
46.35
50.83
55.46
3.22
2.96
3.36
2.94
3.25
3.52
g g
0 28 28.00 3.00
1 27
2 44
3 37
4 35
5 53
6 38
7 57
8 61
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55.46 + 3.52 = 58.98
54.99 + 2.72 = 57.71
57.17 + 2.62 = 59.79
58.63 + 2.38 = 61.01
59.21 + 2.02 = 61.23
60.99 + 1.97 = 62.96
62.37 + 1.86 = 64.23
19.98
2.71
5.79
9.01
1.23
2.96
10.77
55 6
54.99
57.17
58.63
59.21
60.99
62.37
66.38
3 5
2.72
2.62
2.38
2.02
1.97
1.86
2.29
9 39
10 55
11 54
12 52
13 60
14 60
15 75
22
80
70
Trend-adjusted
forecast
Using Trend Using Trend--Adjusted Exponential Adjusted Exponential
Smoothing Smoothing
70
60
50
40
30
P
a
t
i
e
n
t

a
r
r
i
v
a
l
s
Actual blood
test requests
forecast
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| | | | | | | | | | | | | | | |
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15
30
Week
Figure 13.5 Trend-Adjusted Forecast for Medanalysis
Application 13.2 Application 13.2
The forecaster for Canine Gourmet dog breath fresheners
estimated (in March) the sales average to be 300,000 cases sold
per month and the trend to be +8,000 per month. The actual
l f A il 330 000 Wh t i th f t f M sales for April were 330,000 cases. What is the forecast for May,
assuming = 0.20 and = 0.10?
A
Apr
= D
t
+ (1 )(A
Mar
+ T
Mar
)
T
Apr
= (A
Apr
A
Mar
) + (1 )T
Mar
= 0.20(330,000) + 0.80(300,000 + 8,000) = 312,400 cases
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Forecast for May = A
Apr
+ pT
Apr
= 0.10(312,400 300,000) + 0.90(8,000) = 8,440 cases
= 312,400 + (1)(8,440) = 320,840 cases
23
Application 13.2 Application 13.2
Suppose you also wanted the forecast for July, three months
ahead. To make forecasts for periods beyond the next period,
we multiply the trend estimate by the number of additional
i d th t t i th f t d dd th lt t th periods that we want in the forecast and add the results to the
current average.
Forecast for July = A
Apr
+ pT
Apr
= 312,400 + (3)(8,440) = 337,720 cases
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Seasonal Patterns Seasonal Patterns
Seasonal patterns are regularly repeated
upward or downward movements in
demand measured in periods of less than demand measured in periods of less than
one year
Account for seasonal effects by using one
of the techniques already described but to
limit the data in the time series to those
periods in the same season
Thi h t f l
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This approach accounts for seasonal
effects but discards considerable
information on past demand
24
Multiplicative Seasonal Method Multiplicative Seasonal Method
Multiplicative seasonal method, whereby seasonal
factors are multiplied by an estimate of the average
demand to arrive at a seasonal forecast
1. For each year, calculate the average demand for
each season by dividing annual demand by the
number of seasons per year
2. For each year, divide the actual demand for each
season by the average demand per season,
resulting in a seasonal index for each season
demand to arrive at a seasonal forecast
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Copyright 2010 Pearson Education, Inc. Publishing as Prentice Hall.
resulting in a seasonal index for each season
3. Calculate the average seasonal index for each
season using the results from Step 2
4. Calculate each seasons forecast for next year
Using the Multiplicative Seasonal Using the Multiplicative Seasonal
Method Method
EXAMPLE 13.5
The manager of the Stanley Steemer carpet cleaning company
needs a quarterly forecast of the number of customers needs a quarterly forecast of the number of customers
expected next year. The carpet cleaning business is seasonal,
with a peak in the third quarter and a trough in the first quarter.
Following are the quarterly demand data from the past 4 years:
Quarter Year 1 Year 2 Year 3 Year 4
1 45 70 100 100
2 335 370 585 725
3 520 590 830 1160
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The manager wants to forecast customer demand for each
quarter of year 5, based on an estimate of total year 5 demand
of 2,600 customers
3 520 590 830 1160
4 100 170 285 215
Total 1000 1200 1800 2200
25
Using the Multiplicative Seasonal Using the Multiplicative Seasonal
Method Method
SOLUTION
Figure 13.6 shows the solution using the Seasonal Forecasting
Solver in OM Explorer. For the Inputs the forecast for the total Solver in OM Explorer. For the Inputs the forecast for the total
demand in year 5 is needed. The annual demand has been
increasing by an average of 400 customers each year (from
1,000 in year 1 to 2,200 in year 4, or 1,200/3 = 400). The
computed forecast demand is found by extending that trend,
and projecting an annual demand in year 5 of 2,200 + 400 =
2,600 customers.
The Results sheet shows quarterly forecasts by multiplying the
seasonal factors by the average demand per quarter For
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seasonal factors by the average demand per quarter. For
example, the average demand forecast in year 5 is 650
customers (or 2,600/4 = 650). Multiplying that by the seasonal
index computed for the first quarter gives a forecast of 133
customers (or 650 0.2043 = 132.795).
Using the Multiplicative Seasonal Using the Multiplicative Seasonal
Method Method
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Figure 13.6 Demand Forecasts
Using the Seasonal
Forecast Solver of OM
Explorer
26
Application 13.3 Application 13.3
Suppose the multiplicative seasonal method is being used to
forecast customer demand. The actual demand and seasonal
indices are shown below.
Year 1 Year 2
Average
Index Quarter Demand Index Demand Index
1 100 0.40 192 0.64 0.52
2 400 1.60 408 1.36 1.48
3 300 1.20 384 1.28 1.24
4 200 0.80 216 0.72 0.76
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Average 250 300
Application 13.3 Application 13.3
Quarter Average Index
1 0.52
2 1 48
If the projected demand for Year 3 is 1320
units, what is the forecast for each quarter
of that year?
1320 units 4 quarters = 330 units
2 1.48
3 1.24
4 0.76
y
Forecast for Quarter 1 =
Forecast for Quarter 2 =
0.52(330) 172 units
1.48(330) 488 units
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Forecast for Quarter 3 =
Forecast for Quarter 4 =
1.24(330) 409 units
0.76(330) 251 units
27
(a) Multiplicative pattern
Seasonal Patterns Seasonal Patterns
D
e
m
a
n
d
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Period
| | | | | | | | | | | | | | | |
0 2 4 5 8 10 12 14 16
Seasonal Patterns Seasonal Patterns
(b) Additive pattern
D
e
m
a
n
d
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Period
| | | | | | | | | | | | | | | |
0 2 4 5 8 10 12 14 16
28
Choosing a Time Choosing a Time- -Series Method Series Method
Forecast performance is determined by forecast
errors
F t d t t h thi i i Forecast errors detect when something is going
wrong with the forecasting system
Forecast errors can be classified as either bias
errors or random errors
Bias errors are the result of consistent mistakes
Random error results from unpredictable factors
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p
that cause the forecast to deviate from the actual
demand
CFE = E
Measures of Forecast Error Measures of Forecast Error
(E
t
E)
2
= CFE = E
t
n 1
=
|E
t
|
n
MAD = E =
CFE
n
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E
t
2
n
MSE =
(|E
t
|/D
t
)(100)
n
MAPE =
29
Calculating Forecast Errors Calculating Forecast Errors
EXAMPLE 13.6
The following table shows the actual sales of upholstered
chairs for a furniture manufacturer and the forecasts made for chairs for a furniture manufacturer and the forecasts made for
each of the last eight months. Calculate CFE, MSE, , MAD, and
MAPE for this product.
Month
t
Demand
D
t
Forecast
F
t
Error
E
t
Error
2
E
t
2
Absolute
Error |E
t
|
Absolute % Error
(|E
t
|/D
t
)(100)
1 200 225 25
2 240 220 20
3 300 285 15
4 270 290 20
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4 270 290 20
5 230 250 20 400 20 8.7
6 260 240 20 400 20 7.7
7 210 250 40 1,600 40 19.0
8 275 240 35 1,225 35 12.7
Total 15 5,275 195 81.3%
Calculating Forecast Errors Calculating Forecast Errors
EXAMPLE 13.6
The following table shows the actual sales of upholstered
chairs for a furniture manufacturer and the forecasts made for chairs for a furniture manufacturer and the forecasts made for
each of the last eight months. Calculate CFE, MSE, , MAD, and
MAPE for this product.
Month
t
Demand
D
t
Forecast
F
t
Error
E
t
Error
2
E
t
2
Absolute
Error |E
t
|
Absolute % Error
(|E
t
|/D
t
)(100)
1 200 225 25 625 25 12.5%
2 240 220 20 400 20 8.3
3 300 285 15 225 15 5.0
4 270 290 20 400 20 7 4
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4 270 290 20 400 20 7.4
5 230 250 20 400 20 8.7
6 260 240 20 400 20 7.7
7 210 250 40 1,600 40 19.0
8 275 240 35 1,225 35 12.7
Total 15 5,275 195 81.3%
30
SOLUTION
Using the formulas for the measures, we get
C l ti f t (bi )
Calculating Forecast Errors Calculating Forecast Errors
Cumulative forecast error (bias):
CFE = 15
Average forecast error (mean bias):
CFE
n
E = 1.875 =
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Mean squared error:
MSE =
E
t
2
n
5,275
8
=
Standard deviation:
Calculating Forecast Errors Calculating Forecast Errors
[E ( 1 875)]
2
Mean absolute deviation:
[E
t
(1.875)]
2
n 1
=
|E
t
|
n
MAD =
= 27.4
= = 24.4
195
8
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Mean absolute percent error:
(|E
t
|/ D
t
)(100)
n
MAPE = = = 10.2%
81.3%
8
31
Calculating Forecast Errors Calculating Forecast Errors
A CFE of 15 indicates that the forecast has a slight bias to
overestimate demand. The MSE, , and MAD statistics provide
measures of forecast error variability. A MAD of 24.4 means that easu es o o ecast e o a ab ty o ea s t at
the average forecast error was 24.4 units in absolute value. The
value of , 27.4, indicates that the sample distribution of
forecast errors has a standard deviation of 27.4 units. A MAPE
of 10.2 percent implies that, on average, the forecast error was
about 10 percent of actual demand. These measures become
more reliable as the number of periods of data increases.
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Tracking Signals Tracking Signals
A measure that indicates whether a method of
forecasting is accurately predicting actual
changes in demand changes in demand
Useful when forecast systems are computerized
because it alerts analysts when forecast are
getting far from desirable limits
Tracking signal =
CFE
MAD
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MAD
Each period, the CFE and MAD are updated to
reflect current error, and the tracking signal is
compared to some predetermined limits
32
Tracking Signals Tracking Signals
The MAD can be calculated as a weighted average
determined by the exponential smoothing method
MAD
t
= |E
t
| + (1 )MAD
t-1
If forecast errors are normally distributed with a
mean of 0, the relationship between and MAD is
simple
( /2)(MAD) 1 25(MAD)
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= ( /2)(MAD) 1.25(MAD)
MAD = 0.7978 0.8
+2.0
+1 5
Out of control
Tracking Signals Tracking Signals
Control limit
+1.5
+1.0
+0.5
0
0.5
1.0
T
r
a
c
k
i
n
g

s
i
g
n
a
l
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1.5
| | | | |
0 5 10 15 20 25
Observation number
Control limit
Figure 13.7 Tracking Signal
33
Criteria for Selecting Methods Criteria for Selecting Methods
Criteria to use in making forecast method and
parameter choices include
1 Minimizing bias 1. Minimizing bias
2. Minimizing MAPE, MAD, or MSE
3. Meeting managerial expectations of changes in the
components of demand
4. Minimizing the forecast error last period
Statistical performance measures can be used
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1. For projections of more stable demand patterns, use
lower and values or larger n values
2. For projections of more dynamic demand patterns try
higher and values or smaller n values
Using Multiple Techniques Using Multiple Techniques
Combination forecasts are forecasts that
are produced by averaging independent p y g g p
forecasts based on different methods or
different data or both
Focus forecasting selects the best forecast
from a group of forecasts generated by
individual techniques
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34
Forecasting as a Process Forecasting as a Process
A typical forecasting process
Step 1: Adjust history file Step 1: Adjust history file
Step 2: Prepare initial forecasts
Step 3: Consensus meetings and collaboration
Step 4: Revise forecasts
Step 5: Review by operating committee
Step 6: Finalize and communicate
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Step 6: Finalize and communicate
Forecasting is not a stand-alone activity,
but part of a larger process
Forecasting as a Process Forecasting as a Process
Finalize Review by
R i
Consensus
meetings and
collaboration
3
Prepare
initial
forecasts
2
Adjust
history
file
1
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Finalize
and
communicate
6
Review by
Operating
Committee
5
Revise
forecasts
4
35
Forecasting Principles Forecasting Principles
TABLE 13.2 | SOME PRINCIPLES FOR THE FORECASTING PROCESS
Better processes yield better forecasts
Demand forecasting is being done in virtually every company, either formally
or informally. The challenge is to do it wellbetter than the competition
Better forecasts result in better customer service and lower costs, as well as
better relationships with suppliers and customers
The forecast can and must make sense based on the big picture, economic
outlook, market share, and so on
The best way to improve forecast accuracy is to focus on reducing forecast
error
Bi i th t ki d f f t t i f bi
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Bias is the worst kind of forecast error; strive for zero bias
Whenever possible, forecast at more aggregate levels. Forecast in detail
only where necessary
Far more can be gained by people collaborating and communicating well
than by using the most advanced forecasting technique or model
Solved Problem 1 Solved Problem 1
Chicken Palace periodically offers carryout five-piece chicken
dinners at special prices. Let Y be the number of dinners sold
and X be the price. Based on the historical observations and
l l ti i th f ll i t bl d t i th i calculations in the following table, determine the regression
equation, correlation coefficient, and coefficient of
determination. How many dinners can Chicken Palace expect
to sell at $3.00 each?
Observation Price (X) Dinners Sold (Y)
1 $2.70 760
2 $3.50 510
3 $2 00 980
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3 $2.00 980
4 $4.20 250
5 $3.10 320
6 $4.05 480
Total $19.55 3,300
Average $3.258 550
36
Solved Problem 1 Solved Problem 1
SOLUTION
We use the computer to calculate the best values of a, b, the
correlation coefficient, and the coefficient of determination correlation coefficient, and the coefficient of determination
a =
b =
r =
r
2
= 0.71
0.84
277.63
1,454.60
The regression line is
Y = a + bX = 1 454 60 277 63X
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Y = a + bX = 1,454.60 277.63X
For an estimated sales price of $3.00 per dinner
Y = a + bX = 1,454.60 277.63(3.00)
= 621.71 or 622 dinners
Solved Problem 2 Solved Problem 2
The Polish Generals Pizza Parlor is a small restaurant catering
to patrons with a taste for European pizza. One of its specialties
is Polish Prize pizza. The manager must forecast weekly
d d f th i l i th t h d i demand for these special pizzas so that he can order pizza
shells weekly. Recently, demand has been as follows:
Week Pizzas Week Pizzas
June 2 50 June 23 56
June 9 65 June 30 55
June 16 52 July 7 60
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a. Forecast the demand for pizza for June 23 to July 14 by
using the simple moving average method with n = 3 then
using the weighted moving average method with and
weights of 0.50, 0.30, and 0.20, with 0.50.
b. Calculate the MAD for each method.
37
Solved Problem 2 Solved Problem 2
SOLUTION
a. The simple moving average method and the weighted
moving average method give the following results: moving average method give the following results:
Current
Week
Simple Moving Average
Forecast for Next Week
Weighted Moving Average Forecast
for Next Week
June 16
June 23
= 55.7 or 56
52 + 65 + 50
3
[(0.5 52) + (0.3 65) + (0.2 50)] = 55.5 or 56
= 57.7 or 58
56 + 52 + 65
3
55 + 56 + 52
[(0.5 56) + (0.3 52) + (0.2 65)] = 56.6 or 57
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June 30
July 7
= 54.3 or 54
55 56 52
3
[(0.5 55) + (0.3 56) + (0.2 52)] = 54.7 or 55
= 57.0 or 57
60 + 55 + 56
3
[(0.5 60) + (0.3 55) + (0.2 56)] = 57.7 or 58
Solved Problem 2 Solved Problem 2
b. The mean absolute deviation is calculated as follows:
Simple Moving Average Weighted Moving Average Simple Moving Average Weighted Moving Average
Week
Actual
Demand
Forecast for
This Week Absolute Errors |E
t
|
Forecast for
This Week Absolute Errors |E
t
|
June 23 56 56 56
June 30 55 58 57
July 7 60 54 55
|56 56| = 0
|55 58| = 3
|60 54| = 6
MAD = = 3
0 + 3 + 6
3
MAD = = 2.3
0 + 2 + 2
3
|56 56| = 0
|55 57| = 2
|60 55| = 5
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For this limited set of data, the weighted moving average
method resulted in a slightly lower mean absolute deviation.
However, final conclusions can be made only after analyzing
much more data.
38
Solved Problem 3 Solved Problem 3
The monthly demand for units manufactured by the Acme
Rocket Company has been as follows:
Month Units Month Units Month Units Month Units
May 100 September 105
June 80 October 110
July 110 November 125
August 115 December 120
a. Use the exponential smoothing method to forecast June to
January. The initial forecast for May was 105 units; = 0.2.
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b. Calculate the absolute percentage error for each month
from June through December and the MAD and MAPE of
forecast error as of the end of December.
c. Calculate the tracking signal as of the end of December.
What can you say about the performance of your
forecasting method?
Solved Problem 3 Solved Problem 3
SOLUTION
a.
Current Month, t
Calculating Forecast for Next
Month F
t+1
= D
t
+ (1 )F
t
Forecast for Month t + 1
May June
June July
July August
August September
September October
October November
0.2(100) + 0.8(105) = 104.0 or 104
0.2(80) + 0.8(104.0)
0.2(110) + 0.8(99.2)
= 99.2 or 99
= 101.4 or 101
0.2(115) + 0.8(101.4)
0.2(105) + 0.8(104.1)
0 2(110) + 0 8(104 3)
= 104.1 or 104
= 104.3 or 104
105 4 105
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October November
November December
December January
0.2(110) + 0.8(104.3)
0.2(125) + 0.8(105.4)
0.2(120) + 0.8(109.3)
= 105.4 or 105
= 109.3 or 109
= 111.4 or 111
39
Solved Problem 3 Solved Problem 3
b.
Actual
Absolute
Percent
24 24 30.0%
11 11 10.0
Month, t
Actual
Demand,
Dt
Forecast,
Ft
Error,
Et = Dt Ft
Absolute
Error, |Et|
Percent
Error,
(|Et|/Dt)(100)
June 80 104
July 110 99
August 115 101
September 105 104
October 110 104
November 125 105
14 14 12.0
1 1 1.0
6 6 5.5
20 20 16 0
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November 125 105
December 120 109
Total 765
20 20 16.0
11 11 9.2
39 87 83.7%
|E
t
|
n
MAD =
(|E
t
|/D
t
)(100)
n
MAPE = = = 11.96%
83.7%
7
= = 12.4
87
7
Solved Problem 3 Solved Problem 3
c. As of the end of December, the cumulative sum of forecast
errors (CFE) is 39. Using the mean absolute deviation
calculated in part (b), we calculate the tracking signal:
The probability that a tracking signal value of 3.14 could be
generated completely by chance is small. Consequently, we
Tracking signal =
CFE
MAD
= = 3.14
39
12.4
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g p y y q y,
should revise our approach. The long string of forecasts
lower than actual demand suggests use of a trend method.
40
Solved Problem 4 Solved Problem 4
The Northville Post Office experiences a seasonal pattern of
daily mail volume every week. The following data for two
representative weeks are expressed in thousands of pieces of
il mail:
Day Week 1 Week 2
Sunday 5 8
Monday 20 15
Tuesday 30 32
Wednesday 35 30
Thursday 49 45
Friday 70 70
S t d 15 10
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Saturday 15 10
Total 224 210
a. Calculate a seasonal factor for each day of the week.
b. If the postmaster estimates 230,000 pieces of mail to be
sorted next week, forecast the volume for each day.
Solved Problem 4 Solved Problem 4
SOLUTION
a. Calculate the average daily mail volume for each week. Then
f h d f th k di id th il l b th for each day of the week divide the mail volume by the
weeks average to get the seasonal factor. Finally, for each
day, add the two seasonal factors and divide by 2 to obtain
the average seasonal factor to use in the forecast.
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41
Solved Problem 4 Solved Problem 4
Week 1 Week 2
Mail Seasonal Factor Mail Seasonal Factor
Average
Seasonal Factor
Day
Mail
Volume
Seasonal Factor
(1)
Mail
Volume
Seasonal Factor
(2)
Seasonal Factor
[(1) + (2)]/2
Sunday 5 8
Monday 20 15
Tuesday 30 32
Wednesday 35 30
Thursday 49 45
Friday 70 70
Saturday 15 10
5/32 = 0.15625
20/32 = 0.62500
30/32 = 0.93750
8/30 = 0.26667
15/30 = 0.50000
32/30 = 1.06667
0.21146
0.56250
1.00209
35/32 = 1.09375
49/32 = 1.53125
70/32 = 2.18750
15/32 = 0.46875
30/30 = 1.00000
45/30 = 1.50000
70/30 = 2.33333
10/30 = 0.33333
1.04688
1.51563
2.26042
0.40104
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Total 224 210
Average 224/7 = 32 210/7 = 30
Solved Problem 4 Solved Problem 4
b. The average daily mail volume is expected to be
230,000/7 = 32,857 pieces of mail. Using the average
seasonal factors calculated in part (a), we obtain the
f ll i f t following forecasts:
6,948
18,482
32,926
0.21146(32,857) =
0.56250(32,857) =
1.00209(32,857) =
34,397 1.04688(32,857) =
Day Calculations Forecast
Sunday
Monday
Tuesday
Wednesday
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49,799
74,271
13,177
230,000
1.51563(32,857) =
2.26042(32,857) =
0.40104(32,857) =
y
Thursday
Friday
Saturday
Total
42
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