Forecasting

Nadia Khan

Application Areas
MEDICAL MILITARY TELECOM SCM MANAGEMENT FINANCE WEATHER POLITICS ASTRONOMY DEMOGRAPHY

8 Steps to Forecasting
1.Use or Objective? 2.What items/Quantities to be forecasted? 3.Time Horizon? 1 month (short term) 1 year (mid term) > 1 year (long term) 4.Select the forecasting Model 5.Gather Data 6.Validate the Forecasting Model 7.Make the forecast 8.Implement the results

Forecasting Techniques
Qualitative Models
Delphi Method Jury of Executive Opinion Sales Force Composite Consumer Market Survey

Causal Models
Regression Analysis Multiple Regression

Time Series Models

Moving Averages (Simple & Weighted) Exponential Smoothing Trend Projections Decomposition

Articial Intelligence
Articial Neural Networks Support Vendor Machines

Others
Simulation Prediction Market Probabilistic or Ensemble Forecasting Reference Class Forecasting

Qualitative Models
Decision Making Group

Delphi Method

Staff Personal Respondents

Surveys/Questionnaire

Jury of Executive Opinion

High Level Managers (Small Group)

Statistical Models

Group Estimate of Demand

Qualitative Models
Nationwide Level Forecast Overall Forecast

Sales Force Composite

all regions forecasts

Forecast Regional Salesperson

Customer

Consumer Market Survey

Future Purchases
Forecasts

Also helps in planning and improving product design

Forecast Errors
Measures of forecast accuracy include: Mean Absolute Deviation (MAD)
= |forecast errors| n

Mean Squared Error (MSE)

= (errors) n
2

4th One is Bias i.e. a sum of errors

Mean Absolute Percent Error (MAPE)

=

error actual n

100%

Forecast Accuracy
Example of Mobilink
Forecast Error Mean Absolute Deviation (MAD) Actual Value Forecast Value

Forecast Error n

Year
2005 2006 2007 2008 2009

Forecasted Trafc (Erl) 2045000 4294500 11165700 32380530 35618583

Actual Trafc (Erl) 3027900 5582850 16190265 46951768.5 53994533.8

|Actual-Forecast|
982900 1288350 5024565 14571238.5 18375950.775 40243004.275
On average each forecast missed the actual value by 8.04 Million Erls

Total Sum of Forecast Errors ------>

8048600.8

Forecast Accuracy...Contd
Example of Mobilink
Forecast Error Mean Squared Error (MSE) Actual Value (Error) n
2

Forecast Value

Year
2005 2006 2007 2008 2009

Forecasted Trafc (Erl) 2045000 4294500 11165700 32380530 35618583

Actual Trafc (Erl) 3027900 5582850 16190265 46951768.5 53994533.8

(Error)

Sum of Squared Errors ------>

9.66092E+11 1.65985E+12 2.52463E+13 2.12321E+14 3.37676E+14 5.77869E+14

MSE n
1.15E+14

Forecast Accuracy...Contd
Example of Mobilink
Mean Absolute Percent Error (MAPE) (Error/actual) X 100 n

Year
2005 2006 2007 2008 2009

Forecasted Trafc (Erl) 2045000 4294500 11165700 32380530 35618583

Actual Trafc (Erl) 3027900 5582850 16190265 46951768.5 53994533.8

|(Error/actual)|
0.324614419234453 0.230769230769231 0.310344827586207 0.310344827586207 0.340329835082459 1.51640314025856

MAPE = 30% Error n

Sum of Squared Errors ------>

0.30X100

Forecast Accuracy...Contd
Example of Mobilink
Bias (Error) n
Bias --> not a good measure as negative errors can cancel out the positive errors

Year
2005 2006 2007 2008 2009

Forecasted Trafc (Erl) 2045000 4294500 11165700 32380530 35618583

Actual Trafc (Erl) 3027900 5582850 16190265 46951768.5 53994533.8

Error
982900 1288350 5024565 14571238.5 18375950.775 40243004.275
Bias = too high i.e. +8048600

Sum of Squared Errors ------>

8048600

Activity

Forecast Errors
Ms. Smith forecasted total hospital inpatient days last year. Now that the actual data are known, she is reevaluating her forecasting model. Compute the MAD, MSE, and MAPE for her forecast.
Month JAN FEB MAR APR MAY JUN JUL AUG SEP OCT NOV DEC Forecast 250 320 275 260 250 275 300 325 320 350 365 380 Actual 243 315 286 256 241 298 292 333 326 378 382 396

Forecast Errors
Forecast JAN FEB MAR APR MAY JUN JUL AUG SEP OCT NOV DEC AVERAGE 250 320 275 260 250 275 300 325 320 350 365 380 Actual 243 315 286 256 241 298 292 333 326 378 382 396 |error| 7 5 11 4 9 23 8 8 6 28 17 16 MAD = 11.83 error^2 49 25 121 16 81 529 64 64 36 784 289 256 MSE = 192.83 |error/actual| 0.03 0.02 0.04 0.02 0.04 0.08 0.03 0.02 0.02 0.07 0.04 0.04 MAPE = .0368*100

3.68

Time Series Models

Composition of Time Series

Trend (T): Gradual up or down movement over time Seasonality (S): Pattern of uctuations above or below trend line that occurs every year. In weekly or monthly data, the seasonal component, often referred to as seasonality, is the component of variation in a time series which is dependent on the time of year. It describes any regular uctuations with a period of less than one year. For example, the costs of various types of fruits and vegetables, unemployment gures and average daily rainfall, all show marked seasonal variation.

Composition of Time Series

Cycles(C): Patterns in data that occur every several years. In weekly or monthly data, the cyclical component describes any regular uctuations. It is a non-seasonal component which varies in a recognizable cycle Random variations (R): blipsin the data caused by chance and unusual situations

Time Series & Forecasting

Q: What is Time Series? A: Data collected at regular intervals of time. Q: What is Time Series & Forecasting? A: Using Time Series to detect patterns in data collected over time to cope with uncertainty about the future. Q: Why we use Time Series & Forecasting? A: To cope with uncertainty about the future.
Example: Inventory Requirements for a local shoe store or the local grocery store Predict Annual Sales of the Video Games

Composition of Time Series

Actual Time Series Secular Trend Seasonal Variation Cyclical Fluctuation

Trend Line Irregular Variation

Composition of Time Series

Moving Averages

If all variations in a time series are due to random variations, with no trend, seasonal, or cyclical component, some type of averaging or smoothing model would be appropriate.

Moving Averages
Moving average methods consist of computing an average of the most recent n data values for the time series and using this average for the forecast of the next period.
Month Actual Shed Sales
10 12 13 16 19 23 26 (10+12+13)/3 = 11 2/3 (12+13+16)/3 = 13 2/3 (13+16+19)/3 = 16 (16+19+23)/3 = 19 1/3

Three-Month Moving Average

January February

Simple moving average = demand in previous n periods n

March April May June July

Weighted Moving Averages

rio

Weighted moving averages use weights to put more emphasis on certain recent periods. Month Actual Three-Month Weighted
d n) in
Shed Sales
January February March April May June July 10 12 13 16 19 23 26

pe rio dn w )( ei de gh m ts an d

pe

Moving Average

Weights Applied 3 2 1

Period Last month Two months ago Three months ago

fo r

gh t

[3*13+2*12+1*10]/6 = 12 1/6 [3*16+2*13+1*12]/6 =14 1/3 [3*19+2*16+1*13]/6 = 17 [3*23+2*19+1*16]/6 = 20 1/2

(w

3*Sales last month + 2*Sales two months ago + 1*Sales three months ago
6 Sum of weights

ei

Exponential Smoothing
Exponential smoothing is a type of moving average technique that involves little record keeping of past data.
New forecast = previous forecast + (previous actual previous forecast) Mathematically this is expressed as:
Qtr Actual Tonnage Unloaded 180 168 159 175 190 205 180 182 Rounded Forecast using =0.10

175 176= 175.00+0.10(180-175) 175 =175.50+0.10(168-175.50) 173 =174.75+0.10(159-174.75) 173 =173.18+0.10(175-173.18) 175 =173.36+0.10(190-173.36) 178 =175.02+0.10(205-175.02) 178 =178.02+0.10(180-178.02) 179= 178.22+0.10(182-178.22)

Ft = Ft-1 + (Yt-1 - Ft-1)

Ft = new forecast Ft-1 = previous forecast = smoothing constant Yt-1 = previous period actual

the larger the smoothing parameter , the greater the weight given to the most recent value

2 3 4 5 6 7 8

Exponential Smoothing
Qtr Actual Tonnage Unloaded 180 168 159 175 190 205 180 182 Rounded Forecast using =0.50

Qtr

Actual Tonnage Unloaded 180 168 159 175 190 205 180 182

Rounded Forecast using =0.10

1 2 3 4 5 6 7 8

175 178 =175.00+0.50(180-175) 173 =177.50+0.50(168-177.50) 166 =172.75+0.50(159-172.75) 170 =165.88+0.50(175-165.88) 180 =170.44+0.50(190-170.44) 193 =180.22+0.50(205-180.22) 186 =192.61+0.50(180-192.61) 184 =186.30+0.50(182-186.30)

1 2 3 4 5 6 7 8

175 176= 175.00+0.10(180-175) 175 =175.50+0.10(168-175.50) 173 =174.75+0.10(159-174.75) 173 =173.18+0.10(175-173.18) 175 =173.36+0.10(190-173.36) 178 =175.02+0.10(205-175.02) 178 =178.02+0.10(180-178.02) 179= 178.22+0.10(182-178.22)

Exponential Smoothing
To select the best smoothing constant, evaluate the accuracy of each forecasting model.
Actual 180 168 159 175 190 205 180 182 Forecast with a = 0.10 175 176 175 173 173 175 178 178 Absolute Deviations 5 8 16 2 17 30 2 4 Forecast with a = 0.50 175 178 173 166 170 180 193 186 Absolute Deviations 5 10 14 9 20 25 13 4

The lowest MAD results from = 0.10

MAD 10.0 12

Activity

Class Example
PM Computer assembles customized personal computers from generic parts. The owners purchase generic computer parts in volume at a discount from a variety of sources whenever they see a good deal. It is important that they develop a good forecast of demand for their computers so they can purchase component parts efficiently.
Period 1 2 3 4 5 6 7 8 9 month Jan Feb Mar Apr May June July Aug Sept actual demand 37 40 41 37 45 50 43 47 56

Compute a 2-month moving average Compute a 3-month weighted average using weights of 4,2,1 for the past three months of data Compute an exponential smoothing forecast using = 0.7 Using MAD, what forecast is most accurate?

Class Example Solution

MAD

Exponential smoothing resulted in the lowest MAD.