Chapter 8-

Forecasting
March 5, 2001
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Forecasting

Planning
Forecasting is a prelude to planning
Most firms cannot wait until orders are
received to plan what is going to be produced
Most firms must have saleable goods on hand
or materials and subassemblies
Customers usually demand delivery in a
reasonable time

Forecasting

Demand
Major factors that influence demand include:

Business and economic conditions

Competitive factors

Market trends

A firms plans related to product planning and

design

Forecasting

Demand Management
Is the function of recognizing and managing all demands
for products
A firm must include long, medium and short term planning
DM includes four major activities;

Forecasting
Order processing
Making delivery promises
Interfacing between MP&C and the market

Forecasting

Order Processing
A product is usually either delivered from finished
goods inventory or assembled to order.
When an item is sold from finished goods inventory a
sales order authorizes the item to be shipped.
If an item is assembled to order a sales order is
issued that specifies the product.

Forecasting

Demand Forecasting
Forecasts are made for three levels of plans:

The strategic business plan

The production plan

The master production schedule

Forecasting

Characteristics of Demand*
Demand shows the need for an item
Sales is what is actually sold

This chapter uses the term demand rather than

sales

Forecasting

Characteristics of Demand
Demand Patterns

A pattern is the general shape of a time series

Trend
Overall direction of the demand over the time series

Seasonality
How demand fluctuates over the course of a year
May include some other time frame...week, month

Forecasting

Characteristics of Demand
Demand Patterns

Random variation
Fluctuations in the demand that occur on a random
basis due to various factors

Cycle
Influences on demand due to long term (a span of
several years and even decades) fluctuations of the
overall economy

Forecasting

Characteristics of Demand
Stable and dynamic patterns

Stable patterns are those that retain the same general

shape over time
Dynamic patterns are those that do not follow the same
general shape over time
The more stable the demand, the easier it is to forecast
demand

Dependent and independent demand

Only independent demand items are forecast

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Forecasting

Principles of Forecasting
Forecasts are usually wrong!
Every forecast usually includes an estimate of
error
Forecasts are more accurate for groups or families
Forecasts are more accurate for near time

Lead time issues

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Forecasting

Forecast Data
Forecasts are only as good as the data upon
which they are based

GIGO (Garbage In, Garbage Out)

Forecasts are usually based on historical

data using statistical techniques

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Forecasting

Data Collection and Preparation

Record data in the same terms as needed for the
forecast

What is the purpose of the forecast?

What is to be forecast?
Forecast period should match the schedule period

Items forecast should match those as controlled by

manufacturing

Record the circumstances relating to the data

Particular events, factors and conditions

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Forecasting

Data Collection and Preparation

Record the demand separately for different
customer groups

Take into account differing distribution channels

Each set of demands should be forecast

separately

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Forecasting

Forecasting Techniques
Qualitative techniques

Projections based on judgement, intuition, and informed

options

Subjective projections

Used to project long term trends and demand

Generally NOT used for production and inventory

forecasting

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Forecasting

Forecasting Techniques
Extrinsic Techniques

Projections based on external indicators which relate to

demand for a product

The theory is that the demand for a product group is

directly related or correlates for activity in another field

Mainly used for forecasting total demand for a firms

products or families of products.
Not used for individual end items

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Forecasting

Forecasting Techniques
Intrinsic techniques

Use historical data to forecast

Data usually available from company records
Based on the assumption that the future will be
similar to the past
Used as the input for the MPS

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Forecasting

Intrinsic Techniques
Rule based methods

Demand in a future period will be the same as the last

period

Demand this period will be the same as demand during

the same period last year

May be applicable if demand is seasonal and there is

little fluctuation in the trend

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Forecasting

Intrinsic Techniques
Average Demand

Averages are used rather than attempting to assess

what the random fluctuations might be

Should include an estimate of error applied to the

forecast

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Forecasting

Intrinsic Techniques
Moving Averages

A forecast created by taking an average over a previous

period
The forecast will be based on the average of the actual
demand over the specified period
The fewer periods included in the forecast the more
weight will be given to recent information
The forecast will react quicker to trends
The forecast will always lag behind the trend

Best used for forecasting products with stable demand

with little trend or seasonality

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Example (pg. 204)

Q: Demand over the past three months has been 120, 135, and 114
units. Using a three month moving average, calculate the forecast
for the fourth month.
A: Forecast for month 4 = (120 + 135 + 114)/3 = 369/3
= 123 units
Q: Demand for the fourth month turned out to be 129. Calculate
the forecast for the fifth month.
A: Forecast for month 5 = (135 + 114 + 129)/3 = 378/3
= 126 units

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Forecasting

Intrinsic Techniques
Exponential Smoothing

A technique that utilizes the most recent demand data

and the previous forecast to arrive at a forecast for the
next period.

Uses a weight called a smoothing constant () to control

how much emphasis is to be placed on recent data

A routine for updating item forecasts

Works best with stable items and short range forecasts

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Forecasting

Intrinsic Techniques
Exponential Smoothing

Method will detect trends

Forecast will lag actual demand

The larger the smoothing constant the more closely the

forecast will follow actual demand
The forecast may become erratic, however, if there exists
large amounts of random fluctuations
Simulation may assist in the selection of

New forecast =()(latest demand) + (l-)(previous forecast)

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Example 8.5, pg. 221Q: If the old forecast is 100 and the latest actual demand is 85,
what is the exponentially smoothed forecast for the next period?
Alpha is 0.2.
A: New Forecast = Alpha(Latest Demand) + (1-Alpha)(Previous Forecast)
New Forecast = (0.2)(85) + (1 - 0.2)(100)
= 97

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Forecasting

Seasonality
Many products have a seasonal or periodic demand
pattern

Period may be day, week, month

A measure of the degree of seasonal variation for a

product is the seasonal index.

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Forecasting

Seasonal Forecasts
If a company forecasts average demand for all
period, the seasonal indices can be used to calculate
the seasonal forecasts.

Seasonal demand = (Seasonal index)(deseasonalized

demand)

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Forecasting

Deseasonalized Demand

Forecasts are made for average demand and do not consider

random variation.
Historical data are of actual seasonal demand and must be
deseasonalized before they can be used to develop a
forecast of average demand.
Comparisons of data between different periods
deseasonalized data must be used.

Deseasonalized Demand = actual seasonal demand/seasonal index

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Forecasting

Rules for Forecasting with Seasonality

Only use deseasonalized data to forecast
Forecast deseasonalized demand, not seasonal
demand
Calculate the seasonal forecast by applying the
seasonal index to the base forecast.

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Forecasting

Tracking the Forecast

The process of comparing actual demand with the
forecast

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Forecasting

Forecast Error
The difference between actual demand and forecast
demand.
Bias

Exists when the cumulative actual demand varies from

the cumulative forecast

Random variation

Actual demand will vary about the average demand

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Forecasting

Forecast Error
Mean Absolute Deviation (MAD)

A measurement of forecast error

Calculate the total error ignoring the plus and minus
signs and then take the average

MAD = sum of absolute deviation/# of

observations

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Forecasting

Using MAD
Normal distribution

+/-1MAD of the average about 60% of the time

+/-2MAD of the average about 90% of the time
+/-3MAD of the average about 98% of the time

Tracking Signal

If error is due to bias the forecast should be connected

Under normal conditions the actual period demand should
be within +/-3 MAD of the average 98% of the time

Tracking signal = sum of forecast errors/MAD

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Forecasting

Using MAD
Contingency planning
Safety stock

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For Next Week. . .

Do Problems:

8.1
8.2
8.4
8.9
8.10
8.14
8.16

PREPARE for Test #2. . . 15% of the final grade

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