Types of Forcasting

Operations Management
For Competitive Advantage
Chapter 11
Forecasting
Iba Almajzoub www.almajzoub.net
Forecasting
Educated Demand
Guessing Game
Management Forecasting Methods
Qualitative Simple
& Weighted Moving Average Forecasts Smoothing
Exponential Simple
Linear Regression
Characteristics of Forecasts
Guessing
at the future
No
perfect forecast
are more accurate in aggregation
Forecasts
Objective
Long-term
is to minimize forecast error
forecasts are less accurate than short-term forecasts is only a tool used to set:
Production plan and budgets Work schedules
It
Forecasting Time Horizons

Short-range
forecasts
Generally less than 3 months: could be up to a year Used for purchase planning, work force scheduling and job assignment
Medium-range
forecasts
Varies from 3 months to 3 years Used for sales planning, production planning, budgeting and operating plan analysis
Long-range
forecasts
Varies from 5 years and up Used for new products planning, capital expenditures facility location, research and development
Types of Demand
Independent
Demand Dependent Demand

A
Independent Demand: Finished Goods Dependent Demand: Raw Materials, Component parts, Sub-assemblies, etc.
B(4)
C(2)
D(2)
E(1)
D(3)
F(2)
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Types of Forecasts
Qualitative
(Judgmental)
- Forecasts based on subjective estimates and opinions

Quantitative
- Forecasts based on historical data

Time
Series Analysis Fundamental Relationships Simulation

Components of Demand
Average Trend Seasonal
demand for a period of time
element Cyclical elements Random variation Autocorrelation
Iba Almajzoub
www.almajzoub.net
Finding Components of Demand

Seasonal variation
x x x x x
Linear
x x x
Sales
x x x
xx x x xx x x x x x x x xxx x x x x x xxxx
x x x x x x x
x x
Trend
Year
Qualitative Methods
Executive Judgment
Grass Roots
Historical analogy
Qualitative Methods
Market Research
Delphi Method
Panel Consensus
Iba Almajzoub
www.almajzoub.net
10
Qualitative Methods
Grass
Roots
Builds forecast by adding successively from bottom Those closest to customer knows better
Market
Research
Consumer surveys and interviews Used to improve existing products

Panel
Consensus
Open meetings with free exchange of ideas Power play possibilities

11
Qualitative Methods
Executive
Judgment
Used for new products introduction Decisions are broader and at a higher level
Historical
Analogy (similarity)
Existing product used as a model for another

Delphi
Method
Is a method used to conceal the identity of the person participating in the study.
12
Judgmental Forecasting Applications

Small and Large Firms
Low Sales Technique Manageropinion s Jury of executive opinion Sales force composite Number of Firms
< $100M
High Sales
> $500M
40.7% 40.7% 29.6% 27
39.6% 41.6% 35.4% 48
Iba Almajzoub
www.almajzoub.net
13
Time Series Analysis

Time
series forecasting models try to predict the future based on past data. Choosing a forecasting models is based on: 1. Time horizon to forecast 2. Data availability 3. Accuracy required 4. Size of forecasting budget 5. Availability of qualified personnel
14
Simple Moving Average

Assumes Average Longer Longer
steady market demand
of known demand series, n
periods tend to be more stable periods tend to be less sensitive large databases
Maintains Equal
weights given to all data
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15
Simple Moving Average Formula

The
simple moving average model assumes an average is a good estimator of future behavior. The formula for the simple moving average is:
A t-1 + A t-2 + A t-3 +...+A t- n n Ft = Forecast for the coming period N = Number of periods to be averaged A t-1 = Actual occurrence in the past period for up to periods n Ft =
16
Simple Moving Average Problem

Week 1 2 3 4 5 6 7 8 9 10 11 12 Demand 650 678 720 785 859 920 850 758 892 920 789 844
Ft =
A t-1 + A t-2 + A t-3 +...+A t- n n Question: What are the 3-week and 6-week moving average forecasts for demand? Assume you only have 3 weeks and 6 weeks of actual demand data for the respective forecasts
Calculating the moving averages gives us:
17
Week 1 2 3 4 5 6 7 8 9 10 11 12
Demand 3-Week 6-Week 650 F4=(650+678+720)/3 678 =682.67 720 F7=(650+678+720 785 682.67 +785+859+920)/6 859 727.67 =768.67 920 788.00 850 854.67 768.67 758 876.33 802.00 892 842.67 815.33 920 833.33 844.00 789 856.67 866.50 844 867.00 854.83
The McGraw-Hill Companies, Inc., 2001
Operations Management Plotting the moving averages and comparing them shows how the lines smooth out to reveal the overall upward trend in this example.
1000 900
Demand
18
800 700 600 500 1 2 3 4 5 6 7 8 9 10 11 12 Week
Demand 3-Week 6-Week
Iba Almajzoub
www.almajzoub.net
19
Weighted Moving Average

More
flexible than simple moving average each data differently to vary their
Weights
effect
Sum
of weights=1 if fractions
Otherwise,
weights can be real number. If so divide by sum of weights

- Ft =
w w D /
i t 1 i
Removes
masking effect of moving average

20
Weighted Moving Average Formula

While the moving average formula implies an equal weight being placed on each value that is being averaged, the weighted moving average permits an unequal weighting on prior time periods. The formula for the moving average is:
Ft = w 1 A t-1 + w 2 A t- 2 + w 3 A t -3 + ...+ w n A t - n
wt = weight given to time period t occurrence. (Weights must add to one.)
w
i=1
=1
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Iba Almajzoub
21
Weighted Moving Average Problem Data

Question: Given the weekly demand and weights, what is the forecast for the 4th period or Week 4?
Week 1 2 3 4 Demand 650 678 720
Weights: t-1 .5 t-2 .3 t-3 .2
Note that the weights place more emphasis on the most recent data, that is time period . t-1
22
Weighted Moving Average Problem (1) Solution
Week 1 2 3 4
Demand Forecast 650 678 720 693.4
F4 = 0.5(720)+0.3(678)+0.2(650)=693.4
23
Exponential Smoothing Model
Ft = Ft-1 + t-1 - Ft-1) (A = smoothing constant

Premise
(assumption): The most recent observations might have the highest predictive value. Therefore, we should give more weight to the more recent time periods when forecasting.
24
Exponential Smoothing
This
is a form of moving average easy to use minimal amount of data storage
Relatively Requires
Most recent forecast Most recent demand A smoothing constant

Most They
widely used forecasting method are relatively accurate

25
Exponential Smoothing Problem Data

Week 1 2 3 4 5 6 7 8 9 10 Demand 820 775 680 655 750 802 798 689 775
Question:
Given the weekly demand data, what are the exponential smoothing forecasts for periods 2-10 using =0.10 and =0.60? Assume F1=D1
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You can only forecast one time period into the future.
26
Week 1 2 3 4 5 6 7 8 9 10
Demand 820 775 680 655 750 802 798 689 775
Iba Almajzoub
0.1 820.00 820.00 815.50 801.95 787.26 783.53 785.38 786.64 776.88 776.69
0.6 820.00 820.00 793.00 725.20 683.08 723.23 770.49 787.00 728.20 756.28
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27
Exponential Smoothing Problem (1) Plotting

Note how that the smaller alpha the smoother the line in this example.
900
Demand
800 700 600 500 1 2 3 4 5 6 7 8 9 10 Week
Demand 0.1 0.6
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www.almajzoub.net
28
Quantitative Forecasting Applications

Small and Large Firms
Low Sales Technique Moving average Straight line projection Naive Exponential smoothing Regression Simulation Classical decomposition Box-Jenkins Number of Firms
< $100M
High Sales
> $500M
29.6% 14.8% 18.5% 14.8% 22.2% 3.7% 3.7% 3.7% 27
29.2% 14.6% 14.6% 20.8% 27.1% 10.4% 8.3% 6.3% 48
Iba Almajzoub
www.almajzoub.net
29
Forecast Errors
Sources
of errors
Projecting past into future Wrong relationships Errors outside of our control
Iba Almajzoub
www.almajzoub.net

Types of Forcasting

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Operations Management

Management Forecasting Methods

& Weighted Moving Average Forecasts Smoothing

is to minimize forecast error

Forecasting Time Horizons

Demand Dependent Demand

- Forecasts based on subjective estimates and opinions

- Forecasts based on historical data

Series Analysis Fundamental Relationships Simulation

demand for a period of time

element Cyclical elements Random variation Autocorrelation

Finding Components of Demand

Consumer surveys and interviews Used to improve existing products

Open meetings with free exchange of ideas Power play possibilities

Existing product used as a model for another

Judgmental Forecasting Applications

40.7% 40.7% 29.6% 27

39.6% 41.6% 35.4% 48

Time Series Analysis

Simple Moving Average

steady market demand

of known demand series, n

weights given to all data

Simple Moving Average Formula

Simple Moving Average Problem

Calculating the moving averages gives us:

800 700 600 500 1 2 3 4 5 6 7 8 9 10 11 12 Week

Demand 3-Week 6-Week

Weighted Moving Average

weights can be real number. If so divide by sum of weights

masking effect of moving average

Weighted Moving Average Formula

Weighted Moving Average Problem Data

Weights: t-1 .5 t-2 .3 t-3 .2

Weighted Moving Average Problem (1) Solution

Demand Forecast 650 678 720 693.4

Exponential Smoothing Model

Ft = Ft-1 + t-1 - Ft-1) (A = smoothing constant

is a form of moving average easy to use minimal amount of data storage

Most recent forecast Most recent demand A smoothing constant

widely used forecasting method are relatively accurate

Exponential Smoothing Problem Data

Exponential Smoothing Problem (1) Plotting

800 700 600 500 1 2 3 4 5 6 7 8 9 10 Week

Demand 0.1 0.6

Quantitative Forecasting Applications

29.6% 14.8% 18.5% 14.8% 22.2% 3.7% 3.7% 3.7% 27

29.2% 14.6% 14.6% 20.8% 27.1% 10.4% 8.3% 6.3% 48

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