Opm Mba Week 3

Forecasting
Lecture 3
2011 Pearson Education, Inc. publishing as Prentice Hall
4-1
Learning Objectives
When you complete this chapter you should be able to :
1. Understand the three time horizons and which models apply for each use
2. Explain when to use each of the four qualitative models

3. Apply the naive, moving average, exponential smoothing, and trend methods
2011 Pearson Education, Inc. publishing as Prentice Hall 4-2
Learning Objectives
When you complete this chapter you should be able to :
4. Compute three measures of forecast accuracy
5. Develop seasonal indices

6. Conduct a regression and correlation analysis
7. Use a tracking signal

What is Forecasting?
Process of predicting a future event
Underlying basis of all business decisions
Production Inventory Personnel Facilities
??
Forecasting Time Horizons

Short-range forecast
Up to 1 year, generally less than 3 months Purchasing, job scheduling, workforce levels, job assignments, production levels
Medium-range forecast
3 months to 3 years Sales and production planning, budgeting
Long-range forecast
3+ years New product planning, facility location, research and development
Distinguishing Differences
Medium/long range forecasts deal with more comprehensive issues and support management decisions regarding planning and products, plants and processes
Short-term forecasting usually employs different methodologies than longer-term forecasting Short-term forecasts tend to be more accurate than longer-term forecasts
Influence of Product Life Cycle

Introduction Growth Maturity Decline Introduction and growth require longer forecasts than maturity and decline As product passes through life cycle, forecasts are useful in projecting
Staffing levels
Inventory levels Factory capacity
Product Life Cycle

Introduction Company Strategy/Issues
Best period to increase market share R&D engineering is critical
Growth
Practical to change price or quality image Strengthen niche
Maturity
Poor time to change image, price, or quality
Decline
Cost control critical
Competitive costs become critical Defend market position Drive-through
Internet search engines iPods Xbox 360 Sales Avatars Boeing 787 LCD & plasma TVs
restaurants CD-ROMs
Analog TVs Figure 2.5
Twitter
4-8
Product Life Cycle

Introduction
Product design and development critical
Growth
Forecasting critical Product and process reliability Competitive product improvements and options
Maturity
Standardization Fewer product changes, more minor changes Optimum capacity Increasing stability of process
Decline
Little product differentiation Cost minimization Overcapacity in the industry Prune line to eliminate items not returning good margin Reduce capacity
OM Strategy/Issues
Frequent product and process design changes

Short production runs
High production costs

Limited models Attention to quality
Increase capacity Long production Shift toward runs product focus Product Enhance distribution improvement and cost cutting
Figure 2.5
Types of Forecasts
Economic forecasts
Address business cycle inflation rate, money supply, housing starts, etc.
Technological forecasts
Predict rate of technological progress Impacts development of new products
Demand forecasts
Predict sales of existing products and services
2011 Pearson Education, Inc. publishing as Prentice Hall 4 - 10
Strategic Importance of Forecasting

Human Resources Hiring, training, laying off workers Capacity Capacity shortages can result in undependable delivery, loss of customers, loss of market share Supply Chain Management Good supplier relations and price advantages
Seven Steps in Forecasting

1. Determine the use of the forecast 2. Select the items to be forecasted 3. Determine the time horizon of the forecast 4. Select the forecasting model(s) 5. Gather the data 6. Make the forecast 7. Validate and implement results
The Realities!
Forecasts are seldom perfect
Most techniques assume an underlying stability in the system

Product family and aggregated forecasts are more accurate than individual product forecasts
4 - 13
Forecasting Approaches
Qualitative Methods
Used when situation is vague and little data exist
New products New technology
Involves intuition, experience

e.g., forecasting sales on Internet
Forecasting Approaches
Quantitative Methods Used when situation is stable and historical data exist
Existing products
Current technology
Involves mathematical techniques

e.g., forecasting sales of color televisions
Overview of Qualitative Methods

1. Jury of executive opinion
Pool opinions of high-level experts, sometimes augment by statistical models
2. Delphi method
Panel of experts, queried iteratively
4 - 16
Overview of Qualitative Methods

3. Sales force composite
Estimates from individual salespersons are reviewed for reasonableness, then aggregated
4. Consumer Market Survey

Ask the customer
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Jury of Executive Opinion

Involves small group of high-level experts and managers
Group estimates demand by working together Combines managerial experience with statistical models
Relatively quick
Group-think disadvantage
Sales Force Composite

Each salesperson projects his or her sales Combined at district and national levels Sales reps know customers wants Tends to be overly optimistic
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Delphi Method
Iterative group process, continues until consensus is reached
3 types of participants
Staff
Decision Makers (Evaluate responses and make decisions)
Staff (Administering survey)
Decision makers
Respondents
Respondents (People who can make valuable judgments)

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Consumer Market Survey

Ask customers about purchasing plans
What consumers say, and what they actually do are often different
Sometimes difficult to answer
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Overview of Quantitative Approaches

1. Naive approach 2. Moving averages 3. Exponential smoothing 4. Trend projection
time-series models
5. Linear regression
associative model
4 - 22
Time Series Forecasting

Set of evenly spaced numerical data
Obtained by observing response variable at regular time periods
Forecast based only on past values, no other variables important

Assumes that factors influencing past and present will continue influence in future
Time Series Components

Trend Cyclical
Seasonal
Random
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Components of Demand
Trend component Demand for product or service Seasonal peaks
Actual demand line Average demand over 4 years Random variation | 1 | 2 Time (years) | 3 | 4 Figure 4.1
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Trend Component
Persistent, overall upward or downward pattern Changes due to population, technology, age, culture, etc. Typically several years duration
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Seasonal Component
Regular pattern of up and down fluctuations
Due to weather, customs, etc.

Occurs within a single year
Period Week Month Month Year Year Year
Length Day Week Day Quarter Month Week
Number of Seasons 7 4-4.5 28-31 4 12 52

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Cyclical Component
Repeating up and down movements Affected by business cycle, political, and economic factors
Multiple years duration

Often causal or associative relationships
0
10
15
20
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Random Component
Erratic, unsystematic, residual fluctuations Due to random variation or unforeseen events Short duration and nonrepeating
M
F
4 - 29
Naive Approach
Assumes demand in next period is the same as demand in most recent period
e.g., If January sales were 68, then February sales will be 68
Sometimes cost effective and efficient Can be good starting point

Moving Average Method

MA is a series of arithmetic means Used if little or no trend Used often for smoothing
Provides overall impression of data over time
demand in previous n periods Moving average = n
Moving Average Example

Month January February March April May June July Actual Shed Sales 10 12 13 16 19 23 26 3-Month Moving Average
(10 + 12 + 13)/3 = 11 2/3 (12 + 13 + 16)/3 = 13 2/3 (13 + 16 + 19)/3 = 16 (16 + 19 + 23)/3 = 19 1/3
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Graph of Moving Average

30 28 26 24 22 20 18 16 14 12 10 | J | F
Moving Average Forecast
Shed Sales
Actual Sales
| M
| A
| M
| J
| J
| A
| S
| O
| N
| D
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Weighted Moving Average

Used when some trend might be present
Older data usually less important
Weights based on experience and intuition

Weighted moving average = (weight for period n) x (demand in period n)
weights
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3 Last month Weighted Moving Average 2 1 6 Month

January February March April May June July
Weights Applied
Period
Two months ago Three months ago Sum of weights
Actual Shed Sales

10 12 13 16 19 23 26
3-Month Weighted Moving Average
[(3 x 13) + (2 x 12) + (10)]/6 = 121/6 [(3 x 16) + (2 x 13) + (12)]/6 = 141/3 [(3 x 19) + (2 x 16) + (13)]/6 = 17 [(3 x 23) + (2 x 19) + (16)]/6 = 201/2
4 - 35
Potential Problems With Moving Average

Increasing n smooths the forecast but makes it less sensitive to changes Do not forecast trends well
Require extensive historical data
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Moving Average And Weighted Moving Average

30 Sales demand
25 20 15 10 5 |
Figure 4.2
Weighted moving average
Actual sales
Moving average
| F
| M
| A
| M
| J
| J
| A
| S
| O
| N
| D
4 - 37
Exponential Smoothing
Form of weighted moving average
Weights decline exponentially Most recent data weighted most
Requires smoothing constant ()

Ranges from 0 to 1
Subjectively chosen
Involves little record keeping of past data

Exponential Smoothing
New forecast = Last periods forecast + (Last periods actual demand Last periods forecast)
Ft = Ft 1 + (At 1 - Ft 1)
where Ft = new forecast Ft 1 = previous forecast = smoothing (or weighting) constant (0 1)
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Exponential Smoothing Example

Predicted demand = 142 Ford Mustangs Actual demand = 153 Smoothing constant = .20
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Predicted demand = 142 Ford Mustangs Actual demand = 153 Smoothing constant = .20 New forecast = 142 + .2(153 142)
4 - 41

Predicted demand = 142 Ford Mustangs Actual demand = 153 Smoothing constant = .20 New forecast = 142 + .2(153 142) = 142 + 2.2 = 144.2 144 cars
4 - 42
Effect of Smoothing Constants

Weight Assigned to
Most Recent Period () .1 .5 2nd Most 3rd Most 4th Most 5th Most Recent Recent Recent Recent Period Period Period Period 2 3 (1 - ) (1 - ) (1 - ) (1 - )4 .09 .25 .081 .125 .073 .063 .066 .031
Smoothing Constant = .1 = .5
4 - 43
Impact of Different
225
Demand
200
Actual demand
= .5
175
= .1
150 | 1 | 2 | 3 | 4 | 5 Quarter
| 6
| 7
| 8
| 9
Impact of Different
225
Demand
Actual Chose high values of demand 200
= .5
when underlying average is likely to change

= .1
| 6 | 7 | 8 | 9
175 Choose low values of when underlying average is stable| | | | 150 | 1 2 3 4 5 Quarter
4 - 45
Choosing
The objective is to obtain the most accurate forecast no matter the technique
We generally do this by selecting the model that gives us the lowest forecast error
Forecast error = Actual demand - Forecast value
= At - Ft
Common Measures of Error

Mean Absolute Deviation (MAD)
MAD = |Actual - Forecast|
Mean Squared Error (MSE)

MSE = (Forecast Errors)2
n
4 - 47
Common Measures of Error

Mean Absolute Percent Error (MAPE)
100|Actuali - Forecasti|/Actuali
MAPE =
i=1
4 - 48
Comparison of Forecast Error

Quarter Actual Tonnage Unloaded Rounded Forecast with = .10 Absolute Deviation for = .10 Rounded Forecast with = .50 Absolute Deviation for = .50
1 2 3 4 5 6 7 8
180 168 159 175 190 205 180 182
175 175.5 174.75 173.18 173.36 175.02 178.02 178.22
5.00 7.50 15.75 1.82 16.64 29.98 1.98 3.78 82.45
175 177.50 172.75 165.88 170.44 180.22 192.61 186.30
5.00 9.50 13.75 9.12 19.56 24.78 12.61 4.30 98.62
4 - 49

MAD = Actual
Quarter
|deviations| Rounded Absolute

Forecast n with = .10
1 2 3 4 For 5 6 7 8
For 180 = .10 175 5.00 168 = 82.45/8 175.5 = 10.31 7.50
159 174.75 175 = .50 173.18 190 173.36 205 = 98.62/8 175.02 180 178.02 182 178.22
Tonnage Unloaded
Deviation for = .10
Rounded Forecast with = .50
Absolute Deviation for = .50
15.75 1.82 16.64 12.33 29.98 1.98 3.78 82.45
175 177.50 172.75 165.88 170.44 180.22 192.61 186.30
5.00 9.50 13.75 9.12 19.56 24.78 12.61 4.30 98.62
4 - 50
Comparison of Forecast Error2

MSE = Actual
Quarter
(forecast errors)
Rounded Forecast n with = .10
1 2 3 4 For 5 6 7 8
For 180 = .10 175 5.00 168 175.5 = 190.82 7.50 = 1,526.54/8
159 174.75 175 = .50 173.18 190 173.36 = 1,561.91/8 205 175.02 180 178.02 182 178.22 MAD
Tonnage Unloaded
15.75 1.82 16.64 195.24 29.98 1.98 3.78 82.45 10.31
175 177.50 172.75 165.88 170.44 180.22 192.61 186.30
5.00 9.50 13.75 9.12 19.56 24.78 12.61 4.30 98.62 12.33
4 - 51
Comparison of Forecast n Error 100|deviation |/actual

i=1 MAPE = Actual Quarter Tonnage Unloaded
1 2 3 4 5 6 7 8
For 180 = .10 175 5.00 168 175.5 = 44.75/8 = 7.50 5.59%
159 For 175 = 190 205 180 182 174.75 15.75 1.82 .50 173.18 173.36 16.64 = 54.05/8 = 6.76% 175.02 29.98 178.02 1.98 178.22 3.78 82.45 MAD 10.31 MSE 190.82
i Absolute Deviation for = .10
i Rounded Forecast with = .50
175 177.50 172.75 165.88 170.44 180.22 192.61 186.30
5.00 9.50 13.75 9.12 19.56 24.78 12.61 4.30 98.62 12.33 195.24
4 - 52

Quarter Actual Tonnage Unloaded Rounded Forecast with = .10 Absolute Deviation for = .10 Rounded Forecast with = .50 Absolute Deviation for = .50
1 2 3 4 5 6 7 8
180 168 159 175 190 205 180 182
175 175.5 174.75 173.18 173.36 175.02 178.02 178.22 MAD MSE MAPE
5.00 7.50 15.75 1.82 16.64 29.98 1.98 3.78 82.45 10.31 190.82 5.59%
175 177.50 172.75 165.88 170.44 180.22 192.61 186.30
5.00 9.50 13.75 9.12 19.56 24.78 12.61 4.30 98.62 12.33 195.24 6.76%
4 - 53
Exponential Smoothing with Trend Adjustment

When a trend is present, exponential smoothing must be modified
Forecast Exponentially Exponentially including (FITt) = smoothed (Ft) + smoothed (Tt) trend forecast trend
4 - 54
Exponential Smoothing with Trend Adjustment

Ft = (At - 1) + (1 - )(Ft - 1 + Tt - 1)
Tt = b(Ft - Ft - 1) + (1 - b)Tt - 1
Step 1: Compute Ft Step 2: Compute Tt Step 3: Calculate the forecast FITt = Ft + Tt
Seasonal Variations In Data

Steps in the process:
1. Find average historical demand for each season 2. Compute the average demand over all seasons
3. Compute a seasonal index for each season

4. Estimate next years total demand 5. Divide this estimate of total demand by the number of seasons, then multiply it by the seasonal index for that season
4 - 56
Seasonal Index Example

Month Jan Feb Mar Apr May Jun Jul Aug Sept Oct Nov Dec Demand 2007 2008 2009 80 70 80 90 113 110 100 88 85 77 75 82 85 85 93 95 125 115 102 102 90 78 72 78 105 85 82 115 131 120 113 110 95 85 83 80 Average 2007-2009 90 80 85 100 123 115 105 100 90 80 80 80 Average Monthly 94 94 94 94 94 94 94 94 94 94 94 94
4 - 57
Seasonal Index

Month Demand 2007 2008 2009 Average 2007-2009 Average Monthly Seasonal Index 0.957 Jan 80 85 105 90 94 Feb 70 85 85 80 94 Mar 80 93 Average 82 85 monthly 94 2007-2009 demand Seasonal index = 115 Apr 90 95 100 94 Average monthly demand May 113 125 131 123 94 = 90/94 = .957 Jun 110 115 120 115 94 Jul 100 102 113 105 94 Aug 88 102 110 100 94 Sept 85 90 95 90 94 Oct 77 78 85 80 94 Nov 75 72 83 80 94 Dec 82 78 80 80 94
4 - 58

Month Jan Feb Mar Apr May Jun Jul Aug Sept Oct Nov Dec Demand 2007 2008 2009 80 70 80 90 113 110 100 88 85 77 75 82 85 85 93 95 125 115 102 102 90 78 72 78 105 85 82 115 131 120 113 110 95 85 83 80 Average 2007-2009 90 80 85 100 123 115 105 100 90 80 80 80 Average Monthly 94 94 94 94 94 94 94 94 94 94 94 94 Seasonal Index 0.957 0.851 0.904 1.064 1.309 1.223 1.117 1.064 0.957 0.851 0.851 0.851
4 - 59

Month Jan Feb Mar Apr May Jun Jul Aug Sept Oct Nov Dec Demand 2007 2008 2009 Average 2007-2009 Average Monthly Seasonal Index 0.957 0.851 0.904 1.064 1.309 1.223 1.117 1.064 0.957 0.851 0.851 0.851
4 - 60
80 85 105 90 94 for 2010 70 85 Forecast 85 80 94 80 93 82 85 94 Expected annual demand = 1,200 90 95 115 100 94 113 125 131 123 94 110 115 120 1,200 115 94 Jan 113 x .957 = 96 94 100 102 105 12 88 102 110 100 94 1,200 85 90 95 Feb x90 .851 = 85 94 77 78 85 12 80 94 75 72 83 80 94 82 78 80 80 94

140 130 120 Demand 110 100
2010 Forecast 2009 Demand 2008 Demand 2007 Demand
90
80 70 | J | F | M | A | M | J | J | A | S | O | N | D
Time
San Diego Hospital

Trend Data
10,200
10,000
Inpatient Days 9,800 9,600 9530 9573 9551 9594 9616 9637 9659
9702 9680
9724
9745 9766
9,400
9,200 9,000
| | | | | | | | | | | | Jan Feb Mar Apr May June July Aug Sept Oct Nov Dec 67 68 69 70 71 72 73 74 75 76 77 78 Month
Figure 4.6
4 - 62
San Diego Hospital

Seasonal Indices
1.06
Index for Inpatient Days
1.04 1.02 1.00 0.98 0.96 0.94 0.92
1.04 1.02 1.01 0.99 0.99 0.97
1.03
1.04
1.00 0.98 0.97 0.96
Figure 4.7
4 - 63
San Diego Hospital

Combined Trend and Seasonal Forecast
10,200 10068 9949 9764 9691 9520 9542 9411 9724 9572
Inpatient Days
10,000 9911
9,800 9,600
9,400
9,200 9,000
9265
9355
Figure 4.8
4 - 64
Associative Forecasting
Used when changes in one or more independent variables can be used to predict the changes in the dependent variable Most common technique is linear regression analysis We apply this technique just as we did in the time series example
4 - 65
Associative Forecasting
Forecasting an outcome based on predictor variables using the least squares technique
^ = a + bx y
^ where y = computed value of the variable to be predicted (dependent variable) a = y-axis intercept b = slope of the regression line x = the independent variable though to predict the value of the dependent variable
Forecasting in the Service Sector

Presents unusual challenges
Special need for short term records Needs differ greatly as function of industry and product
Holidays and other calendar events

Unusual events
4 - 67
Fast Food Restaurant Forecast

20%
Percentage of sales
15% 10% 5%
11-12
1-2 2-3
3-4 4-5
5-6
7-8 8-9
9-10 10-11
Figure 4.12
4 - 68
12-1 (Lunchtime)
6-7 (Dinnertime) Hour of day
FedEx Call Center Forecast

12%
10%
8% 6% 4% 2% 0%
2 4 6 8 A.M. 10 12 2 4 6 8 P.M. 10 12
Hour of day
Figure 4.12

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Forecasting

2011 Pearson Education, Inc. publishing as Prentice Hall

2. Explain when to use each of the four qualitative models

5. Develop seasonal indices

7. Use a tracking signal

Forecasting Time Horizons

Influence of Product Life Cycle

Product Life Cycle

Competitive costs become critical Defend market position Drive-through

Analog TVs Figure 2.5

2011 Pearson Education, Inc. publishing as Prentice Hall

Product Life Cycle

Frequent product and process design changes

High production costs

Strategic Importance of Forecasting

Seven Steps in Forecasting

Most techniques assume an underlying stability in the system

2011 Pearson Education, Inc. publishing as Prentice Hall

Involves intuition, experience

Involves mathematical techniques

Overview of Qualitative Methods

2011 Pearson Education, Inc. publishing as Prentice Hall

Overview of Qualitative Methods

4. Consumer Market Survey

2011 Pearson Education, Inc. publishing as Prentice Hall

Jury of Executive Opinion

Sales Force Composite

2011 Pearson Education, Inc. publishing as Prentice Hall

Staff (Administering survey)

Respondents (People who can make valuable judgments)

Consumer Market Survey

2011 Pearson Education, Inc. publishing as Prentice Hall

Overview of Quantitative Approaches

Time Series Forecasting

Forecast based only on past values, no other variables important

Time Series Components

2011 Pearson Education, Inc. publishing as Prentice Hall

2011 Pearson Education, Inc. publishing as Prentice Hall

2011 Pearson Education, Inc. publishing as Prentice Hall

Due to weather, customs, etc.

Length Day Week Day Quarter Month Week

Number of Seasons 7 4-4.5 28-31 4 12 52

Multiple years duration

Sometimes cost effective and efficient Can be good starting point

Moving Average Method

Moving Average Example

2011 Pearson Education, Inc. publishing as Prentice Hall

Graph of Moving Average

Moving Average Forecast

2011 Pearson Education, Inc. publishing as Prentice Hall

Weighted Moving Average

Weights based on experience and intuition

2011 Pearson Education, Inc. publishing as Prentice Hall

3 Last month Weighted Moving Average 2 1 6 Month

Two months ago Three months ago Sum of weights

Actual Shed Sales

3-Month Weighted Moving Average

2011 Pearson Education, Inc. publishing as Prentice Hall

Potential Problems With Moving Average

2011 Pearson Education, Inc. publishing as Prentice Hall

Moving Average And Weighted Moving Average

Weighted moving average

2011 Pearson Education, Inc. publishing as Prentice Hall