Supply Chain Management

Forecasting

McGraw-Hill/Irwin

Copyright 2011 by The McGraw-Hill Companies, Inc. All rights reserved.

Agenda
Forecast information
Uses for forecast information
Forecasting techniques
Forecast evaluation
Linkage of planning and forecasting
3-2

What is Forecasting?
o Process of predicting a
future event
o Underlying basis of
all business decisions
o
o
o
o
o

Sales will be
$200
Million!

Marketing
Production
Inventory
Personnel
Facilities

3-3

Demand for product or service

Forecast objective: Identify the underlying

demand pattern (level, trend, seasonal,
cyclical) and randomness.
Seasonal peaks

Trend component

Actual
demand line
Average
demand

Random
variation
Year
1

Year
2

Year
3

Year
4
3-4

Seven Steps in Forecasting

1.
2.
3.

4.
5.
6.
7.

Determine the use of the forecast

Select the items to be forecast
Determine the time horizon of the
forecast
Select the forecasting model(s)
Gather the data
Make the forecast
Validate and implement results
3-5

Determine Use of the Forecast

Strategic

Decisions--- long-term (1-5 year) forecast in sales

dollars for resource planning, e.g., capacity.
Sales & Operations Planning--- medium-term
(monthly/quarterly) forecast aggregated by product families
for use in product family production planning.
Master Production Scheduling and Control -- short-term
(weekly) forecast across all sales locations served by the
facility for use in item production planning.
Inventory planning at Distributor/Retailer --short-term
(daily/weekly) forecast by item and selling point location.

3-6

Pick Forecasting Model

Based On
1.
2.
3.
4.
5.

Time horizon to forecast

Data availability
Accuracy required
Size of forecasting budget
Availability of qualified personnel

3-7

A Guide to Selecting an
Appropriate Forecasting Method

3-8

Selecting a Forecasting Method

Balance the total costs of the
forecasting method.
Forecast Preparation Cost
Data Gathering
Software
Personnel
Cost of Forecast Error
Extra Inventory
Extra Capacity
Missed Sales
3-9

Short-term Forecasting

Forecasting Methods
Moving

Average
Weighted Moving Average
Simple Exponential Smoothing
Exponential Smoothing with Trend

Forecast Accuracy Measures

3-10

Short-term Forecasting for SKU

Sales and Production Planning

Forecast by individual stock keeping units.

Forecast is highly automated using simple models with
managerial override.
Assumption: past is a valid predictor of the future
Sales events (e.g., promotions) must be included and
make forecasting difficult
Forecast is typically prepared weekly with a several
week planning horizon

3-11

Short-Term Forecasting
Techniques

Popular Short-term Forecasting Models

Moving Average
Simple Exponential Smoothing
Exponential Smoothing with Trend
Models assume there is an underlying pattern of
demand that may change over time
Issue: Forecast responsiveness versus stability.
Forecast is prepared at end of period t for use in
period t + 1

3-12

Moving Average Forecasting

t

Moving Avg Forecast ( MAFt )

ActualDemand

i t n 1

Ft 1

i period number
t current period for which demand is known
n - number of periods in moving average (smaller n makes forecast more
responsive to recent values

Forecast for period 33 is:

F33 = 1,300

F33 = 1,433

3-13

Moving Average Methods

Easy to calculate and understand
Responsiveness versus Stability
Increasing n makes forecast more stable
but less responsive to demand changes
Does not forecast trend well
May require much historical data

3-14

Moving Average Forecasts with

Constant Demand Pattern

6-Week MAF
is more
stable.

3-15

Moving Average Forecasts with

Seasonal Demand Pattern

3-Week MAF
is more
responsive.

3-16

Weighted Moving Average (WMAF)

Method

Used when demand pattern is not stable

Older data usually less important
Weights (Wi) based on intuition
Usually values between 0 & 1 that sum to 1.0
Highest weights are placed on most recent demand.
Weights impact stability and responsiveness.

WMAF =

Wi At
Wi
3-17

Moving Average Example

What is the forecast for February using WMA with weights of .5, .3
and .2 on the most recent demands?
Demand
September
October
November
December
January

Weight

2
4
3 x
5 x
7 x

.2 = 0.6
.3 = 1.5
.5 = 3.5

WMA Feb. Forecast = 5.6

3-18

Weighted Moving Average Example

An electric motor manufacturer has experienced quarterly
demand for its biggest motor as follows:
Quarter
Demand

1 2 3 4 5 6 7 8
50 52 48 50 49 46 48 44

Calculate a 5-period WMAF at the end of period 8 for use

in period 9 using weights of (0.4, 0.3, 0.2, 0.05, 0.05).
.4x44 + .3x48 + .2x46 + .05x49 + .05x50 = 46.15
3-19

Exponential Smoothing Graph

Ft = Ft-1 + (At-1 - Ft-1)
Ft = previous forecast + (forecast error)

At-1= 110

Error = At-1 - Ft-1= 10

Ft-1=100
If = .1, Ft = 100 + .1(10) = 101
If = .3, Ft = 100 + .3(10) = 103
If = 1.0, Ft = 100 + 1.(10) = 110

t-1

t+1

time

3-20

Declining Effect of Smoothing

Constant on Past Demand
= Ft-1 + (At-1 - Ft-1)

Ft

Ft = At-1 + (1- Ft-1

Ft

= At-1 + (1- At-2 + (1- Ft-2)]

At-1 + (1- At-2 + (1- Ft-2

Expands to: Ft = At - 1 + (1-)At - 2 +

(1- )2At - 3 + ... (1- )t-1A0

3-21

Declining Effect of Smoothing

Constant on Past Demand
Ft = At - 1 + (1- ) At - 2 + (1- )2At - 3 + ...
Weights
=

Prior Period

2 periods ago 3 periods ago

(1 - )

(1 - )2

= 0.10

.10

.09

.081

= 0.90

.90

.09

.009
3-22

Exponential Smoothing Example

Beginning in 2007 what would have been the
forecast demand for 2008- 2012 using exponential
smoothing ( = .10) if the 2007 forecast was 175.
Year Demand Forecast
2007
180
175
2008 168
2009 159
2010 175
2011 190
3-23

Exponential Smoothing Example

Ft+1 = Ft + (At - Ft)

Time Actual

Forecast, Ft
( = .10)

2007

180

2008

168

175.00 (Given)
175.00 + .10(180 - 175.00) = 175.50

2009

159

175.50 + .10(168 - 175.50) = 174.75

2010

175

174.75 + .10(159 - 174.75) = 173.18

2011

190

2012

NA

173.18 + .10(175 - 173.18) = 173.36

173.36 + .10(190 - 173.36) = 175.02
3-24

Exponential Smoothing when the

Demand Pattern has a Trend

=.1

=.5

3-25

Exponential Smoothing with Trend

A trend in data causes the exponential forecast

to always lag behind the actual data
Forecast be improved by adding in a trend
adjustment
To correct the trend, we need two smoothing
constants
Smoothing constant alpha ()
Trend smoothing constant beta ()

3-26

Exponential Smoothing with Trend

FITt = Ft + Tt
Ft = FITt-1 + (At-1 - FITt-1)
= previous forecast + (forecast error)

Tt = Tt-1 + (Ft - FITt-1)

= previous trend + (trend error)
= smoothing constant for the smoothed forecast
= smoothing constant for the trend

3-27

Exponential Smoothing with Trend

for One Period Look Ahead
=.3, =.2, At-1 = 130, FITt-1 = 100, Tt-1= 10
Ft = FITt-1 + (At-1 - FITt-1) = 109

At-1= 130

Tt = Tt-1 + (Ft - FITt-1) = 11.8

FITt = Ft + Tt = 120.8
Forecast Error = At-1 - FITt-1= 30

Ft = 109
Trend Error = Ft - FITt-1= 9
FITt-1= 100

t-1

time
3-28

Exponential Smoothing with Trend

What is the forecast for February?
Given: =.3, =.2, TJan= 15, FITJan= 60, AJan= 70
FFeb = FITJan + (AJan - FITJan) = 63
TFeb = TJan + (FFeb - FITJan) = 15.6
FITFeb = FFeb + TFeb = 78.6

3-29

Exponential Smoothing with Trend

for One Period Look Ahead
Given Month 1 data and =0.2 and =0.4, what is FIT4
and FIT5 ?
Month

At

Ft

Tt

FITt

12

11

17

11.2

2.08

13.28

Tt = Tt-1 + (Ft - FITt-1)

20

14.024

2.3776

16.4

19

FITt = Ft + Tt

24

Ft = FITt-1 + (At-1 - FITt-1)

F2 = 11 +.2(12 - 11) = 11.2

F3 = 13.28 +.2(1713.28) = 14.024

T2 = 2 +.4(11.2- 11) = 2.08

T3 = 2.08 +.4(14.024 13.28) = 2.3776

FIT2= 11.2 + 2.08 = 13.28

FIT3 = F 14.024 + 2.3776 = 16.4

3-30

Exponential Smoothing with Trend

for a One Period Look Ahead

=.3
=.4

3-31

Exponential Smoothing with Trend:

Multiple Period Look Ahead

: forecast prepared at end of period t for use n

periods in future (e.g., for use in time t + n)
Example: At end of t = 3, prepare a forecast for period
7 given F4 = 30, T4 = 6 and n = 4
= 54

3-32

Exponential Smoothing with Damped

Trend: Multiple Period Look Ahead
In practice, the trend often decays extending into the future.
Hence, it may be damped to reflect this phenomena.

t: end of period when forecast is prepared.

n: number of time periods in the future for forecast use
t + n: time period being forecast
0 damping factor for the trend
if = 1, the trend is linear
if < 1, the trend declines exponentially
3-33

Exponential Smoothing with

Damped Trend: Example

What is FIT1+3 when F2 = 400, T2 = 20, and n = 3, when,

= 1:

FIT1+3 = 400 + 3(20) = 460

= .8:

FIT1+3 = 400 + .8(20)+.64(20) +.512(20)

= 400 +16+12.8+10.24 = 439.04

3-34

Forecast Evaluation: Measures of

Accuracy

Is the forecast too high or too low?

What is the magnitude of the forecast error?
Measuring forecast accuracy is critical to
understanding the quality of the forecast

3-35

Forecast Error

Bias: indicates a tendency to over/under

forecast
Random errors: errors that cannot be explained
by the forecast model being used
Measures of error
Forecast error: Actual Forecast
Running Sum of Forecast Errors (RSFE)
Mean absolute deviation (MAD)
Mean absolute percent error (MAPE)
Mean squared error (MSE)
Tracking signal
3-36

Running Sum of Forecast Errors

Timet

At

1
2
3
4
5
6

120
130
110
140
110
130

Ft

At Ft
125
125
125
125
125
125

-5
5
-15
15
-15
5

RSFE
-5
0
-15
0
-15
-10

Average forecast error = -10/6 = -1.67

Bias: Tendency to slightly over forecast.

3-37

Measures of Forecast Accuracy

Timet At Ft
At Ft |At Ft|
1
120
125
-5
5
2
130
125
5
5
3
110
125
-15
15
4
140 125
15
15
5
110
125
-15
15
6
130
125
5
5
Total 740
750
-10
60

(At Ft)2
25
25
225
225
225
25
750

MAD = 60/6 = 10
MAPE = 60/740 = .081 = 8.1%
MSE = 750/6 = 125
3-38

Tracking Signal

The tracking signal (TS) indicates whether the

forecast is keeping pace with upward or
downward trends in demand
Depending on the number of MADs selected,
the TS can be used like a quality control chart
indicating when the model is generating too
much error in its forecasts

RSFE Running sum of forecast errors

TS =
=
MAD
Mean absolute deviation
3-39

Computing the Tracking Signal

3-40

Measures of Forecast Accuracy

Using the past forecasts and actual demands for 10-foot
fishing boats, compute the tracking signal and MAD at the end
of period 6.
Year
1
2
3
4
5
6

Forecast Actual
Demand Demand |Error|
78
71
75
80
83
101
84
84
88
60
85
73
RSFE
Tracking Signal =
MAD

RSFE

Tracking
MAD Signal

=
3-41

Updating the Forecast Method

or Parameters

Error metrics may indicate that the forecast is

producing poor results. Hence, changes to the
forecasting process may be needed.
Change

forecast method to better match the actual

demand pattern.
Change parameter values to make the model more
responsive or stable.
Scan environment to see if unanticipated factors are
impacting demand (e.g., promotions, competitor
actions, trends, etc.).
3-42

A Suggested Forecasting Format

Historical
Data
Model Selection
& Initialization

Model Fit & Evaluation

Forecast
Model
Human
Input

Managerial
Judgment

Statistical
Forecast

Demand
Forecast

Performance Feedback

Actual
Demand

Calculation of
Forecast Error
and Error
Updating

3-43

Some Final Thoughts

The forecast is always wrong.
Manage demand
Monitor and manage forecast errors

3-44

Homework

Problems 10, 13, 14 and 15 at the end

of Chapter 3.

3-45