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Forecasting

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What is Forecasting?
 The art and science of
predicting a future
events
 Underlying basis ??
of all business decisions
 Production
 Inventory
 Personnel
 Facilities

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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
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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

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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

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Seven Steps in Forecasting

 Determine the use of the forecast
 Select the items to be forecasted
 Determine the time horizon of the
forecast
 Select the forecasting model(s)
 Gather the data
 Make the forecast
 Validate and implement results
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Forecasting Techniques
Qualitative Approach:
 Delphi Methods (Expert's Subjective Rating)
 Marketing Research and Analysis (Customer Survey)
 Historical Analogy (Knowledge of similar products)
Quantitative Approach: (Two General Techniques)
 Time Series Models:
- Simple Moving Average
- Weighted Moving Average
- Exponential Smoothing (Simple/Adaptive/....)
 Causal Relationship Models:
- Regression Analysis
- Linear vs. Non-Linear
- Single vs. Multi-variable
- Econometric
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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

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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

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Overview of Qualitative Methods

 Jury of executive opinion

 Pool opinions of high-level experts,
sometimes augment by statistical models
 Delphi method
 Panel of experts, queried iteratively

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Overview of Qualitative Methods

 Sales force composite

 Estimates from individual salespersons
are reviewed for reasonableness, then
aggregated
 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

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Jury of Executive Opinion

 Jury of executive opinion: senior managers draw
upon their collective wisdom to map out future
events. These discussions are carried out in open
meeting, and may be subject to the drawbacks of
group think and personality dominance.

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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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Consumer Market Survey

 Ask customers about
purchasing plans How many hours will you
use the Internet next
week?
 What consumers say,
and what they actually
do are often different
 Sometimes difficult to
answer
© 1995Corel
Corp.

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Delphi Method
 Iterative group Decision Makers
process, continues (Evaluate
responses and
until consensus is make decisions)
reached
 3 types of Staff
(Administering
participants survey)
 Decision makers
 Staff
 Respondents Respondents
(People who can
make valuable
judgments)
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Delphi Method
 The Delphi Method drawing upon the
group’s expertise by getting individual
submissions, without the drawback of face
to face meetings.

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Using Expert Opinion

 Output from the group techniques is
sorted into scenarios.
 These scenarios are further reviewed by
the group.
 A final ‘consensus of opinion’ forecast is
accepted by the group.

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Qualitative Methods
Advantages & Disadvantages
• Take intangible factors into Disadvantages :
consideration. • Long consultation process
• Useful when there are little data • High risk of getting a biased
available (new product, new
forecast
market, new business unit).
• Easy to use once the right model • Expensive
has been developed. • Usually not precise
• Data collection is quick and easy • Do not take « new
since most of the required information » into
information is already in the consideration
business’ systems (ex. previous • « It’s like driving a car by
sales) or readily available (ex. looking in the rear-view
consumer price index). mirror. »

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Overview of Quantitative
Approaches
1. Naive approach
2. Moving averages
time-series
3. Exponential models
smoothing
4. Trend projection
5. Linear regression associative
model

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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

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Time Series Components

Trend Cyclical

Seasonal Random

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Time Series Patterns

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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 3 4
Time (years)
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
Number of
Period Length Seasons
Week Day 7
Month Week 4-4.5
Month Day 28-31
Year Quarter 4
Year Month 12
Year Week 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 5 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 T W T F
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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

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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

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Moving Average Example

• Donna’s Garden Supply wants a 3 months moving
average forecast:

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Weighted Moving Average

 Used when trend is present

 Older data usually less important
 Weights based on experience and
intuition

∑ (weight for period n)

Weighted x (demand in period n)
moving average = ∑ weights

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Weights Applied Period

Weighted Moving
3 Average
Last month
2 Two months ago
1 Three months ago
6 Sum of weights

Actual 3-Month Weighted

Month Shed Sales Moving Average
January 10 10
February 12 12
March 13 13
April 16 [(3 x 13) + (2 x 12) + (10)]/6 = 121/6
May 19 [(3 x 16) + (2 x 13) + (12)]/6 = 141/3
June 23 [(3 x 19) + (2 x 16) + (13)]/6 = 17
July 26 [(3 x 23) + (2 x 19) + (16)]/6 = 201/2

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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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Moving Average And

Weighted Moving Average
Weighted
30 – moving
average
25 –
Sales demand

20 – Actual
sales
15 –
Moving
10 – average

5 –
| | | | | | | | | | | |
J F M A M J J A S O N D
Figure 4.2
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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 period’s forecast
+  (Last period’s actual demand
– Last period’s 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

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Common Measures of Error

Mean Absolute Deviation (MAD)

∑ |Actual - Forecast|
MAD = n

Mean Squared Error (MSE)

∑ (Forecast Errors)2
MSE = n

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Common Measures of Error

Mean Absolute Percent Error (MAPE)

n
∑100|Actuali - Forecasti|/Actuali
MAPE = i=1
n

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Exponential smoothing with

MAD

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Trend Projections
Fitting a trend line to historical data points
to project into the medium to long-range
Linear trends can be found using the least
squares technique

y^= a + bx
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

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Trend Projections

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Seasonal Variations In Data

The multiplicative
seasonal model
can adjust trend
data for seasonal
variations in
demand

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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 year’s total demand
5. Divide this estimate of total demand by the number of
seasons, then multiply it by the seasonal index for that
season

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Seasonal Index Example

Demand Average Average Seasonal
Month 2005 2006 2007 2005-2007 Monthly Index
Jan 80 85 105 90 94
Feb 70 85 85 80 94
Mar 80 93 82 85 94
Apr 90 95 115 100 94
May 113 125 131 123 94
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
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Seasonal Index Example

Demand Average Average Seasonal
Month 2005 2006 2007 2005-2007 Monthly Index
Jan 80 85 105 90 94 0.957
Feb 70 85 85 80 94
Mar 80 93 average
82 2005-2007
85 monthly demand
94
Seasonal index = average monthly demand
Apr 90 95 115 100 94
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
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Seasonal Index Example

Demand Average Average Seasonal
Month 2005 2006 2007 2005-2007 Monthly Index
Jan 80 85 105 90 94 0.957
Feb 70 85 85 80 94 0.851
Mar 80 93 82 85 94 0.904
Apr 90 95 115 100 94 1.064
May 113 125 131 123 94 1.309
Jun 110 115 120 115 94 1.223
Jul 100 102 113 105 94 1.117
Aug 88 102 110 100 94 1.064
Sept 85 90 95 90 94 0.957
Oct 77 78 85 80 94 0.851
Nov 75 72 83 80 94 0.851
Dec 82 78 80 80 94 0.851
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Seasonal Index Example

Demand Average Average Seasonal
Month 2005 2006 2007 2005-2007 Monthly Index
Jan 80 85 105 90 94 0.957
Feb 70 85 Forecast
85 for 2008
80 94 0.851
Mar 80 93 82 85 94 0.904
Apr
Expected annual demand = 1,200 1.064
90 95 115 100 94
May 113 125 131 123 94 1.309
Jun 110 115 120 1,200 115 94 1.223
Jul Jan x .957 = 96 1.117
100 102 113 12 105 94
Aug 88 102 110 1,200 100 94 1.064
Sept Feb 0.957
12 x .851 = 85
85 90 95 90 94
Oct 77 78 85 80 94 0.851
Nov 75 72 83 80 94 0.851
Dec 82 78 80 80 94 0.851
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