Forecasting for Operations Decisions

W S William

Forecasting is the art and science of

predicting future events.
Institute of Business Forecasting

Elements of a Good Forecast

Timely

Reliable

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Accurate

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Key Issues in Forecasting

Choice of forecasting horizon (a week, a month

etc.)
A forecasting method with desired accuracy.
The unit of forecasting ( gross sales, individual
product demand etc.)

Forecast Horizon
Forecast horizon is the period for which forecast is
prepared
Long-Range (years)
( e.g. Process selection, Capacity addition)
Medium-Range (months)
(e.g. Manpower planning, procurement of long lead
time items)
Short-Range (weeks)
(e.g. Production schedules, overtimes etc.)

Examples of Production Resource Forecasts

Forecast
Horizon

Time Span

Item Being Forecast

Units of
Measure

Product lines
Factory capacities
Planning for new products
Capital expenditures
Facility location or expansion
R&D

Dollars, tons, etc.

Product groups
Department capacities
Sales planning
Production planning and
budgeting

Dollars, tons, etc.

Specific product quantities

Machine capacities
Planning
Purchasing
Scheduling
Workforce levels
Production levels
Job assignments

Physical units of
products

Long-Range

Years

MediumRange

Months

Short-Range

Weeks

Principles of Forecasting

Forecasting is almost always wrong

Every forecast should include an estimate of the
forecast error
The greater the degree of aggregation, the more
accurate the forecast
Long-term forecasts are usually less accurate
than short-term forecasts

Forecasting Methods
Broadly, forecasting methods fall under two categories:
Qualitative Methods : These are subjective in nature
(Executive Opinion, Market Research , Delphi Method)
Quantitative Methods: They use mathematical or
simulation methods base d on historical demand or
relationships between variables.
Extrapolated or Time Series (Use past data to forecast
future)
Explanatory or Causal Method (Establishes a relationship
between dependent and independent variables); y= f(x)

Components of Demand

Horizontal Component
Trend Component
Seasonal Component

Simple Moving Average

An averaging period (AP) is given or
selected
The forecast for the next period is the
arithmetic average of the AP most recent
actual demands
It is called a simple average because
each period used to compute the
average is equally weighted
. . . more

Simple Moving Average

It is called moving because as new

demand data becomes available, the
oldest data is not used
By increasing the AP, the forecast is
less responsive to fluctuations in
demand (low impulse response)
By decreasing the AP, the forecast is
more responsive to fluctuations in
demand (high impulse response)

Simple Moving Average

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

A t-1 + A t-2 + A t-3 +...+A t- n

Ft =
n
Lets develop 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

Simple Moving Average

Week
1
2
3
4
5
6
7
8
9
10
11
12

Demand 3-Week 6-Week

650
678
720
785
682.67
859
727.67
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
Slide 13 of

Simple Moving Average

Slide 14 of

Weighted Moving Average

This is a variation on the simple

moving average where instead of the
weights used to compute the average
being equal, they are not equal
This allows more recent demand data
to have a greater effect on the moving
average, therefore the forecast
. . . more

Weighted Moving Average

The weights must add to 1.0 and

generally decrease in value with the
age of the data
The distribution of the weights
determine impulse response of the
forecast

Weighted Moving Average

Ft = w1A t-1 + w 2 A t-2 + w 3A t-3 +...+w n A t-n
Week
1
2
3
4

Demand
650
678
720

Determine
the 3-period
n
weighted
wmoving

i =1
i=1 forecast for
average
period 4
Weights (adding up to 1.0):
t-1: .5
t-2: .3
t-3: .2

Moving Average Method

Step1: Select the number of periods for which

moving average will be computed, thus number N
is called an order of moving average
Step 2: Take the average demand for the most
recent N periods. This average demand then
becomes the forecast for the next period.

Exponential Smoothing

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

Premise--The most recent

observations might have the highest
predictive value.

3-19

Therefore, we should give more weight

to the more recent time periods when
forecasting.

Associative Forecasting

Predictor variables - used to predict values of

variable interest
Regression - technique for fitting a line to a set of
points
Least squares line - minimizes sum of squared
deviations around the line

3-20

Simple Linear Regression

Relationship between one independent variable,
X, and a dependent variable, Y.
Assumed to be linear (a straight line)
Form: Y = a + bX

Y = dependent variable
X = independent variable
a = y-axis intercept
b = slope of regression line

Simple Linear Regression Model

Yt = a + bx

0 1 2 3 4 5
(weeks)

b is similar to the slope. However,

since it is calculated with the
variability of the data in mind, its
formulation is not as straightforward as our usual notion of

Calculating a and b
a = y - bx

b=

xy - n(y)(x)
2

x - n(x )

Regression Equation Example

Week
1
2
3
4
5

Sales
150
157
162
166
177

Develop a regression equation to predict sales

based on these five points.

Regression Equation Example

Week Week*Week
Sales Week*Sales
1
1
150
150
2
4
157
314
3
9
162
486
4
16
166
664
5
25
177
885
3
55
162.4
2499
Average
Sum Average
Sum
xy - n( y)(x) 2499 - 5(162.4)(3) 63

b=
=

= 6.3
55 5(9 )
10
x - n(x )
2

a = y - bx = 162.4 - (6.3)(3) = 143.5

Slide 25 of

Regression Equation Example

Sales

y = 143.5 + 6.3t
180
175
170
165
160
155
150
145
140
135

Sales
Forecast

Period
Slide 26 of

Forecast Accuracy
Accuracy is the typical criterion for
judging the performance of a
forecasting approach
Accuracy is how well the forecasted
values match the actual values

Monitoring Accuracy
Accuracy of a forecasting approach needs
to be monitored to assess the confidence
you can have in its forecasts and changes
in the market may require reevaluation of
the approach
Accuracy can be measured in several ways
Mean absolute deviation (MAD)
Mean squared error (MSE)

Mean Squared Error (MSE)

MSE = (Syx)2
Small value for Syx means data points
tightly grouped around the line and error
range is small. The smaller the standard
error the more accurate the forecast.
MSE = 1.25(MAD)
When the forecast errors are normally
distributed

Example--MAD
Month
1
2
3
4
5

Sales Forecast
220
n/a
250
255
210
205
300
320
325
315

Determine the MAD for the four forecast

periods

Solution
Month
1
2
3
4
5

Sales ForecastAbs Error

220
n/a
250
255
5
210
205
5
300
320
20
325
315
10
40
n

MAD =

t=1

- Ft

40
=
= 10
4

Tracking Signal
Tracking signal
Ratio of cumulative error to MAD

(Actual-forecast)

Tracking signal =
MAD

Bias Persistent tendency for forecasts to be

Greater or less than actual values.

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Criteria for Selecting a Forecasting Method

Cost
Accuracy
Data available
Time span
Nature of products and services
Impulse response and noise dampening

Reasons for Ineffective Forecasting

Not involving a broad cross section of people
Not recognizing that forecasting is integral to
business planning
Not recognizing that forecasts will always be wrong
(think in terms of interval rather than point
forecasts)
Not forecasting the right things
(forecast independent demand only)
Not selecting an appropriate forecasting method
(use MAD to evaluate goodness of fit)
Not tracking the accuracy of the forecasting models

Thank you