Lecture 3

Forecasting
 Forecast
• Forecast- a statement about the future value
of a variable of interest
– We make forecasts about such things as weather,
demand and resource availability
– Forecasts are important to making informed
decisions
 Two Important Aspects of Forecasts
• Expected level of demand
– The level of demand may be a function of some
structural variation such as trend or seasonal
variation
• Accuracy
– Related to the potential size of forecast error
 Forecast Uses
• Plan the system
– Generally involves long-range plans related to:
• Types of products and services to offer
• Facility and equipment levels
• Facility location
• Plan the use of the system
– Generally involves short-and-medium-range plans related to:
• Inventory management
• Workforce levels
• Purchasing
• Production
• Budgeting
• Scheduling
 Forecasts are not perfect
• Forecasts are not perfect:
– Because random variation is always present, there
will always be some residual error, even if all other
factors have been accounted for.
 Elements of a Good Forecast
• The forecast should be
– Timely
– Accurate
– Reliable
– Expressed in meaningful units
– In writing
– Technically simple to understand
– Cost-effective in use
 Steps in the Forecasting Process
1. Determine the purpose of the forecast
2. Establish a time horizon
3. Obtain, clean and analyze appropriate data
4. Select a forecasting technique
5. Make the forecast
6. Monitor the forecast errors
 Forecast Accuracy and Control
• Allowances should be made for forecast errors
– It is importance to provide and indication of the
extent to which the forecast might deviate from
the value of the variable that actually occurs
• Forecast errors should be monitored
– Error= Actual-Forecast
– If errors fall beyond acceptable bounds, corrective
action may be necessary
 Forecast Accuracy Metrics
•
Example calculations
 Forecasting Approaches
• Qualitative Forecasting
– Qualitative techniques permit the inclusion of soft
information such as:
• Human factors
• Personal opinions
• Hunches
– These factors are difficult, or impossible to quantify
• Quantitative Forecasting
– These techniques rely on hard data
– Quantitative techniques involve either the projection of
historical data or the development of associative methods
that attempts to use causal variables to make a forecast
 Qualitative Forecasts
• Forecasts that use subjective inputs such as opinions from
consumer surveys, sales staff, managers, executives and experts
– Executive opinions
• A small group of upper-level managers may meet and collectively develop a
forecast
– Sales force opinions
• Members of the sales or customer service staff can be good sources of
information due to their direct contact with customers and may be aware of
plans customers may be considering for the future
– Consumer surveys
• Since consumers ultimately determine demand, it makes sense to solicit input
from them
– Other approaches
• Managers may solicit opinions from other managers or staff people or outside
experts to help with developing a forecast
• The Delphi method is an iterative process intended to achieve a consensus
 Time-series Forecasts
• Forecasts that project patterns identified in
recent time-series observations
– Time Series: A time-ordered sequence of
observations taken at regular time intervals
• Assume that future values of the time-series
can be estimated from past values of the
time-series
 Trends and Seasonality
• Trend
– A long-term upward or downward movement in
data
• Population shifts
• Changing income
• Seasonality
– Short-term, fairly regular variations related to the
calendar or time of day
– Restaurants, services call centres and theatres all
experience seasonal demand
 Cycles and Variations
• Cycle
– Wavelike variations lasting more than one year
• These are often
• Irregular variation
– Due to unusual circumstances that do not reflect
typical behaviour
• Labour strike
• Weather event
• Random variation
– Residual variation that remains after all other
behaviours have been accounted for
Graphic Examples of Data
 Time-series Forecasting – Naïve
Forecast
• Naïve Forecast
– Uses a single previous value of a time series as the
basis for a forecast
• The forecast for a time period is equal to the previous
time period’s value
– Can be used with
• a stable time series
• seasonal variations
• trend
Time-series Forecasting - Averaging
• These techniques work best when a series
tends to vary about an average
– Average techniques smooth variations in the data
– They can handle step changes or gradual changes
in the level of a series
– Techniques
• Moving average
• Weighted moving average
• Exponential smoothing
 Moving Average (MA)
• Technique that averages a number of the most recent
actual values in generating forecast

where
Ft = Forecast for time period t
MAn= n period moving average
At-i = Actual value in period t-i
n = Number of periods in the moving average
 Moving Average
• As new data become available, the forecast is
updated by adding the newest value and
dropping the oldest and then re-computing
the average
• The number of data points included in the
average determines the model’s sensitivity
– Fewer data points used: more responsive
– More data points used : less responsive
 Weighted Moving Average
• The most recent values in a time series are given more weight in
computing a forecast
– The choice of weights, w, is somewhat arbitrary and involves some trial and
error
Ft= wt(At)+ wt-1(At-1)+ …. + wt-n(At-n)
where,

w =weight for period t,

F =F + ∝(A -F )
t t-1 t-1 t-1
where,

F = Forecast for period t

A = Actual demand or sales from the previous period

Ft = Forecast for period t

a= Value of Ft at t =0
b= Slope of the line
t = Specified number of time periods from t =0
 Techniques for Seasonality
• Seasonality- regularly repeating movements in
series values that can be tied to recurring events
– Expressed in terms of the amount that actual values
deviate from the average value of a series
– Models of seasonality
• Additive
– Seasonality is expressed as a quantity that gets added to or
subtracted from the time series average in order to incorporate
seasonality
• Multiplicative
– Seasonality is expressed as a percentage of the average (or trend)
amount which is them used to multiply the value of a series in
order to incorporate seasonality
Associative Forecasting Techniques
• Associative techniques are based on the
development of an equation that summarizes
the effect of predictor variables
– Predictor variables- variables that can be used to
predict values of the variable of interest
• Home values may be related to such factors as home
and property size, location, number of bedrooms and
number of bathrooms
 Simple Linear Regression
• Regression – a technique for fitting a line to a
set of data points
– Simple linear regression- the simplest form of
regression that involves a linear relationship
between two variables
• The object of simple linear regression is to obtain an
equation of a straight line that minimizes the sum of
squared vertical deviations from the line (i.e., the least
squares criterion)
 Issues to consider
• Always plot the line to verify that a linear
relationship is appropriate
• The data may be time dependent
– If they are
• use analysis of time series
• use time as an independent variable in a multiple
regression
• A small correlation may indicate that order
variables are important
 Monitoring the Forecast
• Tracking forecast errors and analysing them can provide
useful insight into whether forecasts are performing
satisfactorily
• Sources of forecast errors:
– The model may be inadequate due to
a. Omission of an important variable
b. A change or shift in the variable the model cannot handle
c. The appearance of a new variable
– Irregular variations may have occur
– Random variation
• Control charts are useful for identifying the presence of
non-random error in forecasts
• Tracking signals can be used to detect forecast bias
 Choosing a Forecast Technique
• Factors to consider
– Cost
– Accuracy
– Availability of historical data
– Availability of forecasting software
– Time needed to gather and analyze data and
prepare a forecast
– Forecast horizon
 Operations Strategy
• The better forecasts are, the more able
organisations will be to take advantage of future
opportunities and reduce potential risks
– A worthwhile strategy is to work to improve
short-term forecast
• Accurate up-to-date information can have a significant
effect on forecast accuracy:
– Prices
– Demand
– Other important variables
– Reduce the time horizon
– Sharing forecasts or demand data through the supply
chain can improve forecast quality
 Forecasting summary
• Forecast- a statement about the future value
of a variable of interest
• Forecasting Approaches
– Qualitative Forecasting
– Quantitative Forecasting
• Trends and Seasonality