Forecasting

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Production and Operations Management

Rajesh Tyagi

Policies
Cell phone, laptop use in class
Late assignment Professional behavior: side conversation, late to class, ethics

2-508-97 Production and Operations Management

Copyright 2006 John Wiley & Sons, Inc.

Forecasting

Predicting the future demand Qualitative forecast methods

Subjective

Quantitative forecast methods

based on mathematical formulas

2-508-97 Production and Operations Management

Copyright 2006 John Wiley & Sons, Inc.

Forecastings Importance
Forecasting is important for: Finance uses the long term forecast to evaluate capital investment needs.

Human Resources uses forecasts to evaluate personnel needs.

IT designs and implements systems that generate forecasts.

Marketing develops sales forecasts used for mid-term to long term planning.
Operations develops and uses forecasts to make decisions such as: scheduling, inventory management and long term capacity planning.

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Forecasts by Time Horizon

Short-range forecast
Up to 1 year; usually less than 3 months Job scheduling, worker assignments

Medium-range forecast
3 months to 3 years
Sales & production planning, budgeting

Long-range forecast
3+ years
New product planning, facility location

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Demand Behaviors
Trend
a gradual, long-term up or down movement of demand

Seasonal pattern
an up-and-down repetitive movement in demand occurring periodically (short term: often annually)

Cycle
an up-and-down repetitive movement in demand (long term)

Special events
promotion, stock outs

Random variations
movements in demand that do not follow a pattern

2-508-97 Production and Operations Management

Copyright 2006 John Wiley & Sons, Inc.

Trend Component
Persistent, overall upward or downward pattern

Linear, exponential
Several years duration

Response

Mo., Qtr., Yr.

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1984-1994 T/Maker Co.

2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458

Seasonal Component
Regular pattern of up & down fluctuations

Due to weather, habits etc.

Occurs within a predefined period: year, month, week, day

Summer Response
1984-1994 T/Maker Co.

Mo., Qtr.
2-508-97 Production and Operations Management 2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458

Cyclical Component
Repeating up & down movements

Due to interactions of factors influencing economy

Usually 2-10 years duration

Cycle Response

Mo., Qtr., Yr.

2-508-97 Production and Operations Management 2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458

Forecasting Methods
Judgmental (Qualitative)
use management judgment, expertise, and opinion to predict future demand

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

Associative models (Regression methods)

attempt to develop a mathematical relationship between demand and factors that cause its behavior

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Copyright 2006 John Wiley & Sons, Inc.

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Overview of Qualitative Methods

Jury of executive opinion
Pool opinions of high-level executives, sometimes augment by statistical models

Delphi method
Panel of experts, queried iteratively

Sales force composite

Estimates from individual salespersons are reviewed for reasonableness, then aggregated

Consumer Market Survey

Ask the customer

2-508-97 Production and Operations Management

2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458

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Jury of Executive Opinion

Involves small group of high-level managers
Group estimates demand by working together

Combines managerial experience with statistical models Relatively quick Group-think disadvantage

2-508-97 Production and Operations Management

2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458

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Sales Force Composite

Each salesperson projects his or her sales

Combined at district & national levels

Sales reps know customers needs Tends to be overly optimistic

Sales

1995 Corel Corp.

2-508-97 Production and Operations Management 2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458

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Delphi Method
Iterative group process Reduces group-think

Answer

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2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458

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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
How many hours will you use the Internet next week?

1995 Corel Corp.

2-508-97 Production and Operations Management

2004 by Prentice Hall, Inc., Upper Saddle River, N.J. 07458

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Qualitative Methods : Advantages & Disadvantages

Advantages : Take intangible factors into consideration. Useful when there are little data available (new product, new market, new business unit). Disadvantages : Long consultation process High risk of getting a biased forecast Expensive Usually not precise

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Quantitative Methods : Advantages & Disadvantages

Advantages : Easy to use once the right model has been developed. Data collection is quick and easy since most of the required information is already in the business systems (ex. previous sales) or readily available (ex. consumer price index). Disadvantages : Do not take new information into consideration :

Its like driving a car by looking in the rear-view mirror.

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Forecasting Approaches
Qualitative Methods
Used when situation is vague & little data exist New products New technology Involves intuition, experience

Quantitative Methods
Used when situation is stable & historical data exist Existing products Current technology Involves mathematical techniques

Considerations:
Planning horizon Availability and value of historical data Needs (precision and reliability) Time and budget constraints
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Realities of Forecasting
1. Forecasts are seldom perfect: almost always wrong by some amount 2. Aggregated forecasts are more accurate than individual forecasts 3. More accurate for shorter time periods 4. Most forecasting methods assume that there is some underlying stability in the system: watch out for special events!

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Quantitative Forecasting Methods

(Non-Naive)

Quantitative Forecasting
Time Series Models Associative Models

Moving Average

Exponential Smoothing

Trend Projection

Multiple Regression

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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
naive forecast

simple average
moving average exponential smoothing linear trend analysis

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Moving Averages
Naive forecast
Demand of 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

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Naive forecast
ORDERS PER MONTH 120 90 100 75 110 50 75 130 110 90 -

MONTH Jan Feb Mar Apr May June July Aug Sept Oct Nov

FORECAST 120 90 100 75 110 50 75 130 110 90

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Simple Moving Average

i=1

Di

MAn =
where

n = number of periods in the moving average Di = demand in period i

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3-month Simple Moving Average

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 -

MOVING AVERAGE 103.3 88.3 95.0 78.3 78.3 85.0 105.0 110.0
3

1 Di i=
MA3 = 3 90 + 110 + 130 3

= 110 orders for Nov

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Weighted Moving Average

Adjusts moving average method to more closely reflect data fluctuations

WMAn =
where

i=1

Wi Di

Wi = the weight for period i,

between 0 and 100 percent

Wi = 1.00
Copyright 2006 John Wiley & Sons, Inc.

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Weighted Moving Average Example

MONTH August September October November Forecast WEIGHT 17% 33% 50% DATA 130 110 90
3

WMA3 =

1 Wi Di i=

= (0.50)(90) + (0.33)(110) + (0.17)(130) = 103.4 orders

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Copyright 2006 John Wiley & Sons, Inc.

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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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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

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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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Exponential Smoothing Example

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

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Exponential Smoothing Example

Predicted demand = 142 Ford Mustangs Actual demand = 153 Smoothing constant = .20 New forecast = 142 + .2(153 142) = 142 + 2.2 = 144.2 144 cars

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Common Measures of Error

Mean Absolute Deviation (MAD)

MAD =
|actual - forecast| n

Mean Squared Error (MSE)

MSE =
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(forecast errors)2 n
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MAD example
Absolute Forecast Error
10 5 15 10 15 30

Qtr
1 2 3 4 5 6

Actual Demand
90 95 115 100 125 140

Forecast Demand Error

100 100 100 110 110 110 -10 -5 +15 -10 +15 +30

RSFE
-10 -15 0 -10 +5 +35

Cumulative Absolute Forecast Error MAD

10 15 30 40 55 85 10.0 7.5 10.0 10.0 11.0 14.2

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Trend analysis
Many trends are possible:
Linear Exponential Logarithmic S-growth curve

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Linear Trend Analysis

Demand
6000

5000

4000

3000

2000

1000

0 0 5 10 15 20 25 30

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Discussion points
Ideally, forecast should not only include point estimates, but also a range of outcomes. Think about the cost of a wrong decision based on the forecast:
You have too much production

You have not enough production

Forecasts based on previous demand versus previous sales. Choosing a forecast horizon:
Goals Flexibility Lead times

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Elements of a good forecast

1. Appropriate forecast horizon

2. Degree of accuracy should be taken into account

3. Reliable 4. Choose meaningful units (dollars versus units)

5. Use same forecast throughout organization

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Reading List
Chapter 3 Stevenson and Hojati
Page 59 - 69 (including exponential smoothing) Page 81 (explanation of associate methods) Page 90 - 94

Learning goals-

Define forecasting behaviors

Difference between qualitative and quantitative forecasting techniques Learn forecasting methods such as moving averages, exponential smoothing. Learn to calculate and evaluate forecasting errors using MAD and MSE (and importance of bias)
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