Unit08 - Demand Forecasting

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Dr. Rameez Khal i d, PMP
Associ at e Professor
NED Uni ver si t y of Engi neer i ng and Technol ogy
What i s For ecast i ng?
Process of predicting a future
event
Underlying basis of
all business decisions
Production
Inventory
Personnel
Facilities
Timely
Accurate Reliable
Written
I see that you will
get an A this semester.
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Short -range forecast
Up t o 1 year, general l y l ess t han 3 mont hs
Pur chasi ng, j ob schedul i ng, wor kf orce l evel s, j ob
assi gnment s, product i on l evel s
Medi um-range f orecast
3 mont hs t o 3 years
Sal es and pr oduct i on pl anni ng, budget i ng
Long-range forecast
3
+
years
New product pl anni ng, f aci l i t y l ocat i on, resear ch and
devel opment
For ecast i ng Ti me Hor i zons
Inf l uence of Pr oduct Li f e Cycl e
Int roduct i on and gr owt h r equi r e l onger f or ecast s
t han mat ur i t y and decl i ne
As pr oduct passes t hrough l i f e cycl e, f or ecast s
ar e usef ul i n proj ect i ng
St af f i ng l evel s
Invent or y levels
Fact or y capacit y
Introduction Growth Maturity Decline
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Pr oduct Li f e Cycl e
Best period to
increase market
share

R&D engineering is
critical
Practical to change
price or quality
image

Strengthen niche
Poor time to change
image, price, or
quality

Competitive costs
become critical
Defend market
position
Cost control
critical
Introduction Growth Maturity Decline
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Internet search engines
Sales
Xbox 360
Drive-through
restaurants
CD-ROMs
3 1/2
Floppy
disks
LCD & plasma TVs
Analog TVs
iPods
Types of For ecast s
Economi c forecast s
Address business cycle inf lat i on rat e, money
supply, housing st ar t s, et c.
Technol ogi cal forecast s
Predict rat e of t echnologi cal progress
Impact s devel opment of new product s
Demand f orecast s
Predi ct sal es of exi st i ng product s and ser vi ces
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Seven St eps i n For ecast i ng
Det er mine t he use of t he f or ecast
Sel ect t he i t ems t o be f or ecast ed
Det er mine t he t i me hor i zon of t he f or ecast
Sel ect t he f or ecast i ng model(s)
Gat her t he dat a
M ake t he f or ecast
Val i dat e and i mpl ement resul t s
For ecast i ng Approaches
Used when situation is vague and
little data exist
New products
New technology
Involves intuition, experience
e.g., forecasting sales on Internet
Qualitative Methods
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For ecast i ng Approaches
Used when situation is stable and
historical data exist
Existing products
Current technology
Involves mathematical techniques
e.g., forecasting sales of color
televisions
Quantitative Methods
Over vi ew of Qual i t at i ve Met hods
Jur y of execut i ve opi ni on
Po o l o p i n i o n s o f h i g h - l evel exp er t s, so m et i m es
a u g m en t b y st a t i st i ca l m o d el s
Del phi met hod
Pa n el o f exp er t s, q u er i ed i t er a t i v el y
Sales f orce composi t e
Est i m a t es f r o m i n d i v i d u a l sa l esp er so n s a r e
r evi ew ed f o r r ea so n a b l en ess, t h en a g g r eg a t ed
Consumer M ar ket Sur vey
Ask t h e cu st o m er
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Over vi ew of Quant i t at i ve Appr oaches
1. Nai ve approach
2. M ovi ng averages
3. Exponent i al
smoot hi ng
4. Trend proj ect i on
5. Li near r egr essi on
Time-Series
Models
Associative
Model
Set of evenl y spaced numer i cal dat a
Ob t a i n ed b y o b ser v i n g r esp o n se v a r i a b l e a t
r eg u l a r t i m e p er i o d s
For ecast based onl y on past val ues, no ot her
var i abl es i mpor t ant
Assu m es t h a t f a ct o r s i n f l u en ci n g p a st a n d
p r esen t w i l l co n t i n u e i n f l u en ce i n f u t u r e
Ti me Ser i es For ecast i ng
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Trend
Seasonal
Cyclical
Random
Ti me Ser i es Component s
Component s of Demand
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| | | |
1 2 3 4
Year
Average
demand over
four years
Seasonal peaks
Trend
component
Actual
demand
Random
variation
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Nave Appr oach
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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St abl e t i me seri es dat a
F(t ) = A(t -1)
Seasonal vari at i ons
F(t ) = A(t -n)
Dat a wi t h t rends
F(t ) = A(t -1) + (A(t -1) A(t -2))
Uses f or Nave For ecast s
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M A i s a ser i es of ar i t hmet i c means
Used i f l i t t l e or no t rend
Used of t en f or smoot hi ng
Pr o vi d es o ver a l l i m p r essi o n o f d a t a o ver t i m e
Movi ng Average M et hod
Moving average =
demand in previous n periods
n
January 10
February 12
March 13
April 16
May 19
June 23
July 26

Actual 3-Month
Month Shed Sales Moving Average

(12 + 13 + 16)/3 = 13
2
/
3

(13 + 16 + 19)/3 = 16
(16 + 19 + 23)/3 = 19
1
/
3
M ovi ng Average
10
12
13
(10 + 12 + 13)/3 = 11
2
/
3
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Used when t r end i s pr esent
Ol der dat a usual l y l ess i mpor t ant
Wei ght s based on exper i ence and i nt ui t i on
Wei ght ed M ovi ng Average
Weighted
moving average
=
(weight for period n)
x (demand in period n)
weights
January 10
February 12
March 13
April 16
May 19
June 23
July 26

Actual 3-Month Weighted
Month Shed Sales Moving Average

[(3 x 16) + (2 x 13) + (12)]/6 = 14
1
/
3

[(3 x 19) + (2 x 16) + (13)]/6 = 17
[(3 x 23) + (2 x 19) + (16)]/6 = 20
1
/
2
10
12
13
[(3 x 13) + (2 x 12) + (10)]/6 = 12
1
/
6

Wei ght s Appl i ed Per i od
3 Last mont h
2 Two mont hs ago
1 Three mont hs ago
6 Sum of w eight s
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M ovi ng Average And
30
25
20
15
10
5
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| | | | | | | | | | | |
J F M A M J J A S O N D
Actual
sales
Moving
average
Weighted
moving
average
Figure 4.2
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For m of wei ght ed movi ng average
W ei g h t s d ecl i n e exp o n en t i a l l y
M o st r ecen t d a t a w ei g h t ed m o st
Requi r es smoot hi ng const ant (o)
Ra n g es f r o m 0 t o 1
Su b j ect i v el y ch o sen
Invol ves l i t t l e r ecor d keepi ng of past dat a
Exponent i al Smoot hi ng
New forecast = Last periods forecast
+ o (Last periods actual demand
Last periods forecast)
F
t
= F
t 1
+ o(A
t 1
- F
t 1
)
Where, F
t
= new forecast
F
t 1
= previous forecast
A
t 1
= previous actual demand
o = smoothing (or weighting)
constant (0 o 1)
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Predicted demand = 142 Ford Mustangs
Actual demand = 153
Smoothing constant o = .20
New forecast = 142 + .2(153 142)
= 142 + 2.2
= 144.2 144 cars

F
t
= F
t 1
+ o(A
t 1
- F
t 1
)
Impact of Di f f er ent o
225
200
175
150
| | | | | | | | |
1 2 3 4 5 6 7 8 9
Quarter
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o = .1
Actual
demand
o = .5
Chose high values of o when underlying average is likely to change
Choose low values of o when underlying average is stable
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Choosi ng o
The objective is to obtain the most
accurate forecast no matter the
technique
We generally do this by selecting the model
that gives us the lowest forecast error
Forecast error = Actual demand - Forecast value
= A
t
- F
t

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Common Measures of Er r or
Mean Absolute Deviation (MAD)
MAD =
|Actual - Forecast|
n
Mean Squared Error (MSE)
MSE =
(Forecast Errors)
2

n
Mean Absolute Percent Error (MAPE)
MAPE =
100|Actual
i
- Forecast
i
|/Actual
i

n
n
i = 1
Compar i son of Forecast Error
Rounded Absolute Rounded Absolute
Actual Forecast Deviation Forecast Deviation
Tonnage with for with for
Quarter Unloaded o = .10 o = .10 o = .50 o = .50
1 180 175 5.00 175 5.00
2 168 175.5 7.50 177.50 9.50
3 159 174.75 15.75 172.75 13.75
4 175 173.18 1.82 165.88 9.12
5 190 173.36 16.64 170.44 19.56
6 205 175.02 29.98 180.22 24.78
7 180 178.02 1.98 192.61 12.61
8 182 178.22 3.78 186.30 4.30
82.45 98.62

Fi l l t hese
col umns
Fi l l t hese
col umns
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Compar i son of For ecast Er r or
1 180 175 5.00 175 5.00
2 168 175.5 7.50 177.50 9.50
3 159 174.75 15.75 172.75 13.75
4 175 173.18 1.82 165.88 9.12
5 190 173.36 16.64 170.44 19.56
6 205 175.02 29.98 180.22 24.78
7 180 178.02 1.98 192.61 12.61
8 182 178.22 3.78 186.30 4.30
82.45 98.62

MAD =
|deviations|
n
= 82.45/8 = 10.31
For o = .10
= 98.62/8 = 12.33
For o = .50
1 180 175 5.00 175 5.00
2 168 175.5 7.50 177.50 9.50
3 159 174.75 15.75 172.75 13.75
4 175 173.18 1.82 165.88 9.12
5 190 173.36 16.64 170.44 19.56
6 205 175.02 29.98 180.22 24.78
7 180 178.02 1.98 192.61 12.61
8 182 178.22 3.78 186.30 4.30
82.45 98.62
MAD 10.31 12.33

= 1,526.54/8 = 190.82
For o = .10
= 1,561.91/8 = 195.24
For o = .50
MSE =
(forecast errors)
2

n
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1 180 175 5.00 175 5.00
2 168 175.5 7.50 177.50 9.50
3 159 174.75 15.75 172.75 13.75
4 175 173.18 1.82 165.88 9.12
5 190 173.36 16.64 170.44 19.56
6 205 175.02 29.98 180.22 24.78
7 180 178.02 1.98 192.61 12.61
8 182 178.22 3.78 186.30 4.30
82.45 98.62
MAD 10.31 12.33
MSE 190.82 195.24

= 44.75/8 = 5.59%
For o = .10
= 54.05/8 = 6.76%
For o = .50
MAPE =
100|deviation
i
|/actual
i

n
n
i = 1
1 180 175 5.00 175 5.00
2 168 175.5 7.50 177.50 9.50
3 159 174.75 15.75 172.75 13.75
4 175 173.18 1.82 165.88 9.12
5 190 173.36 16.64 170.44 19.56
6 205 175.02 29.98 180.22 24.78
7 180 178.02 1.98 192.61 12.61
8 182 178.22 3.78 186.30 4.30
82.45 98.62
MAD 10.31 12.33
MSE 190.82 195.24
MAPE 5.59% 6.76%
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Exponent ial Smoot hing
wi t h Tr end Adj ust ment
When a trend is present, exponential
smoothing must be modified
2
nd
Order Smoothing
Forecast
including (FIT
t
) =
trend
Exponentially Exponentially
smoothed (F
t
) + smoothed (T
t
)
Forecast Trend
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Exponent i al Smoot hi ng w i t h Tr end
Adj ust ment
F
t
= o(A
t - 1
) + (1 - o)(F
t - 1
+ T
t - 1
)
T
t
= |(F
t
- F
t - 1
) + (1 - |)T
t - 1

Step 1: Compute F
t

Step 2: Compute T
t

Step 3: Calculate the forecast FIT
t
= F
t
+ T
t

o = 0.2, | = 0.4 Forecast
Actual Smoothed Smoothed Including
Month(t) Demand (A
t
) Forecast, F
t
Trend, T
t
Trend, FIT
t

1 12 11 2 13.00
2 17
3 20
4 19
5 24
6 21
7 31
8 28
9 36
10
F
2
= oA
1
+ (1 - o)(F
1
+ T
1
)
F
2
= (.2)(12) + (1 - .2)(11 + 2)
= 2.4 + 10.4 = 12.8 units
Step 1: Forecast for Month 2
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o = 0.2, | = 0.4 Forecast
Month(t) Demand (A
t
) Forecast, F
t
Trend, T
t
Trend, FIT
t

1 12 11 2 13.00
2 17 12.80
3 20
4 19
5 24
6 21
7 31
8 28
9 36
10
T
2
= |(F
2
- F
1
) + (1 - |)T
1

T
2
= (.4)(12.8 - 11) + (1 - .4)(2)
= .72 + 1.2 = 1.92 units
Step 2: Trend for Month 2
o = 0.2, | = 0.4 Forecast
Month(t) Demand (A
t
) Forecast, F
t
Trend, T
t
Trend, FIT
t

1 12 11 2 13.00
2 17 12.80 1.92
3 20
4 19
5 24
6 21
7 31
8 28
9 36
10
FIT
2
= F
2
+ T
1

FIT
2
= 12.8 + 1.92
= 14.72 units
Step 3: Calculate FIT for Month 2
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o = 0.2, | = 0.4 Forecast
Month(t) Demand (A
t
) Forecast, F
t
Trend, T
t
Trend, FIT
t

1 12 11 2 13.00
2 17 12.80 1.92 14.72
3 20
4 19
5 24
6 21
7 31
8 28
9 36
10

15.18 2.10 17.28
17.82 2.32 20.14
19.91 2.23 22.14
22.51 2.38 24.89
24.11 2.07 26.18
27.14 2.45 29.59
29.28 2.32 31.60
32.48 2.68 35.16
Fi l l t hese col umns
Exponent i al Smoot hing
| | | | | | | | |
1 2 3 4 5 6 7 8 9
Time (month)
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35
30
25
20
15
10
5
0
Actual demand (A
t
)
Forecast including trend (FIT
t
)
with o = .2 and | = .4
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Trend Proj ect i ons
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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Least Squares M et hod
Time period
V
a
l
u
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s

o
f

D
e
p
e
n
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e
n
t

V
a
r
i
a
b
l
e

Deviation
1

(error)
Deviation
5

Deviation
7

Deviation
2

Deviation
6

Deviation
4

Deviation
3

Actual observation
(y value)
Trend line, y = a + bx
^
Least squares method minimizes the sum of the squared errors (deviations)
Least Squares Met hod
Equations to calculate the regression variables
b =
Exy - nxy
Ex
2
- nx
2

y = a + bx
^
a = y - bx
n = Number of data points
or Observations
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Least Squares
b = = = 10.54
xy - nxy
x
2
- nx
2

3,063 - (7)(4)(98.86)
140 - (7)(4
2
)
a = y - bx = 98.86 - 10.54(4) = 56.70
Time Electrical Power
Year Period (x) Demand x
2
xy
2001 1 74 1 74
2002 2 79 4 158
2003 3 80 9 240
2004 4 90 16 360
2005 5 105 25 525
2005 6 142 36 852
2007 7 122 49 854
x = 28 y = 692 x
2
= 140 xy = 3,063
x = 4 y = 98.86
Least Squares
b = = = 10.54
Exy - nxy
Ex
2
- nx
2

3,063 - (7)(4)(98.86)
140 - (7)(4
2
)
a = y - bx = 98.86 - 10.54(4) = 56.70
Time Electrical Power
Year Period (x) Demand x
2
xy
1999 1 74 1 74
2000 2 79 4 158
2001 3 80 9 240
2002 4 90 16 360
2003 5 105 25 525
2004 6 142 36 852
2005 7 122 49 854
Ex = 28 Ey = 692 Ex
2
= 140 Exy = 3,063
x = 4 y = 98.86
The trend line is
y = 56.70 + 10.54x
^
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Least Squares
| | | | | | | | |
2001 2002 2003 2004 2005 2006 2007 2008 2009
160
150
140
130
120
110
100
90
80
70
60
50
Year
P
o
w
e
r

d
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m
a
n
d

Trend line,
y = 56.70 + 10.54x
^
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Seasonal Vari at i ons In Dat a
The multiplicative
seasonal model can
adjust trend data for
seasonal variations
in demand
Seasonal Var i at i ons In Dat a
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 years total demand
5. Divide this estimate of total demand by the
number of seasons, then multiply it by the
seasonal index for that season
Steps in the process:
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Seasonal 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
= 1,128
Demand Average Average Seasonal
Month 2005 2006 2007 2005-2007 Monthly Index
Seasonal 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
0.957
Seasonal index =
average 2005-2007 monthly demand
average monthly demand
= 90/94 = .957
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Seasonal 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
Seasonal 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
Expected annual demand = 1,200
Jan x .957 = 96
1,200
12
Feb x .851 = 85
1,200
12
Forecast for 2008
D
o

N
o
t

C
o
p
y

o
r

P
o
s
t
30
San Di ego Hospi t al
10,200
10,000
9,800
9,600
9,400
9,200
9,000
| | | | | | | | | | | |
Jan Feb Mar Apr May June July Aug Sept Oct Nov Dec
67 68 69 70 71 72 73 74 75 76 77 78
Month
I
n
p
a
t
i
e
n
t

D
a
y
s

9530
9551
9573
9594
9616
9637
9659
9680
9702
9724
9745
9766
Trend Data
y = 8090 + 21.5x
^
1.06
1.04
1.02
1.00
0.98
0.96
0.94
0.92
| | | | | | | | | | | |
67 68 69 70 71 72 73 74 75 76 77 78
Month
I
n
d
e
x

f
o
r

I
n
p
a
t
i
e
n
t

D
a
y
s
1.04
1.02
1.01
0.99
1.03
1.04
1.00
0.98
0.97
0.99
0.97
0.96
Seasonal Indices
D
o

N
o
t

C
o
p
y

o
r

P
o
s
t
31
10,200
10,000
9,800
9,600
9,400
9,200
9,000
| | | | | | | | | | | |
67 68 69 70 71 72 73 74 75 76 77 78
Month
I
n
p
a
t
i
e
n
t

D
a
y
s

9911
9265
9764
9520
9691
9411
9949
9724
9542
9355
10068
9572
Combined Trend and Seasonal Forecast
D
o

N
o
t

C
o
p
y

o
r

P
o
s
t
32
REFERENCES

Operations Management
William J. Stevenson

Operations Management
Barry Render & Jay Heizer

Unit08 - Demand Forecasting

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