Management Science II Dr.T.T.

Narendran

MODULE 3

Forecasting

• Forecast: an educated guess for the future based on objective analysis (to
the extent possible)

• Despite inaccuracy same Forecast is better than no Forecast

• But analytical Forecast is better than intuitive Forecast

• Type of Forecast

• Demand

• (Common)

• Environmental

• (Social, Political, economic)

• Sales characteristics: RCTS

• Users

• Long range – Facilities

• Medium range – Production Planning

• Short range – Product Forecast

Forecast Types Based On Source

• Subjective Opinion

• Index

• Averages

• Statistical

• Combination

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• Market Survey

Subjective Opinion

• Collective opinion of sales department

• Advantage

• People directly concerned

• Disadvantage

• Too much influence of immediate past

• Big Boss opinion

• Can’t blame anyone for goods

Index Of Business Activity

• Trend of gross national income, per capita income

• index of construction etc.,

• Not very accurate

Averages

• Average of past sales

• Moving average

• Weighted average (for nearer past)

Methods of least squares

let Y=f(x) be the function.

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Management Science II Dr.T.T.Narendran

Sum of deviation & M.A.D

i.e. Could mislead by canceling out.

So take

and minimize it set the error

f = Then minimum error function is obtained by minimizing this E function.

Combination

• Use other information to stratify methods

e.g.:

Impact of advertisement,

New competition,

Obsolescence's,

General economy etc.,

Market Survey
• Draw demand Vs time

• Determine which technique to try

• Evaluate expected error

• Look for better techniques if necessary

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Management Science II Dr.T.T.Narendran

Forecaster Could Be
Constant (Random Fluctuation only)

Linear (Trend)

Cyclic (combination)

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Management Science II Dr.T.T.Narendran

Forecasting (constant)
Least Squares Fit
Year X Y XY X2
1967 -5 2 -10 25
1968 -4 3 -12 16
1969 -3 6 -18 9
1970 -2 10 -20 4
1971 -1 8 -8 1
1972 0 7 0 0
1973 1 12 12 1
1974 2 14 28 4
1975 3 14 42 9
1976 4 18 72 16
1977 5 19 95 25
∑ X=0 ∑ Y=113 ∑ XY=181 ∑ X2=110

a =
∑ Y
=
113
= 1 0 .3
n 11

b =
∑ XY
=
181
= 1 .6
∑ X 2
110

• Forecasting equation is Y=10.3 + 1.6X

(Where Year 0 = 1972)

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Management Science II Dr.T.T.Narendran

What is the demand for 1982?

For 1982, X = 1982-1972 =10

y = 10.3 + 1.6(10)=26.3 tons.

Note : We have assumed linearity-check by actually

2π 2π
Y = a + u cos X + v sin X
N N
Plotting the real data Forecasting (Cyclic)
Cyclic Forecaster
Cyclic Trend

2π 2π
a + b + u cos X + v sin X
N N

Moving Average

Year Demand 3 Year Moving

Average

1967 -5 -
1968 -4 3.7
1969 -3 6.3
1970 -2 10
1971 -1 8.0
1972 0 8.3
1973 1 9.0
1974 2 11.0
1975 3 13.314
1976 4 15.3
1977 5 17.0

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Management Science II Dr.T.T.Narendran

• Smoothens curve

• Independent of Y to X relationship

• Loses sight of end values

• Lags in trend

• Forecast only for next immediate period e.g., for 1978

• This can be rectified by Weighted Moving Average

∑ (W t ) X
∑ (W t )

Least Squares Fit

Method Of Least Squares Fit

• Y is the actual sales

Y ' = a+bX

• Error for the ith period

ei =Yi −Y'i

ei =Yi −a−bXi

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Management Science II Dr.T.T.Narendran

Method Of Least Squares Fit

n
E = ∑
i=1
( Y i − Y i ') 2
n
E = ∑
i=1
(Y i − a − b X i )2

In Order To Find A And B, Such That E Is Minimum

∂E
=0
∂a

∂E
= −2 ∑ (Yi − a − b X i ) = 0
∂a

or ∑ Yi − n a − b ∑ X i = 0

or
∑ Y = n a + b ∑ X ...........(1)
i i

∂E
=0
∂b

n
∂E
= − 2 ∑ (Yi − a − b X i ) X i = 0
∂b i =1

∑ X Y =a∑ X
i i i + b ∑ X i2 .......................(2)

∑ Y = n a + b ∑ X ...........(1)
i i

∑ X Y =a∑ X
i i i + b ∑ X i2 .......................(2)

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Management Science II Dr.T.T.Narendran

Solving For A And B

∑ X Y = a ∑ X + b ∑ X .......................(2)
i i i i
2

= a ∑ X + ∑ X (∑Y − n a)
i i i

= a ∑ X + ∑ X ∑Y − n a ∑ X
i i i i

= ∑ X ∑ Y + a ( ∑ X − n∑ X )
i i i i

∴a =
∑ X Y − ∑ X ∑Y i i i i

∑ X −n∑ X i i

b=
∑ XY − n X Y ;
∑ X −n X 2 2

a =Y − b X

Then We Normalize The Scale

∑X i =0

b=
∑ XY
∑X 2

a=
∑Y
n

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Management Science II Dr.T.T.Narendran

Problem No.1

Sales data for a certain item is given below for last 11 years.

Problem No.1

Year Demand
1994 2
1995 3
1996 6
1997 10
1998 8
1999 7
2000 12
2001 14
2002 14
2003 18
2004 19

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Management Science II Dr.T.T.Narendran

Question
Fit regression line and make a forecast for the year 2009?

Forecasting (Constant)

Least Squares Fit

Year X Y XY X2
1994 -5 2 -10 25
1995 -4 3 -12 16
1996 -3 6 -18 9
1997 -2 10 -20 4
1998 -1 8 -8 1
1999 0 7 0 0
2000 1 12 12 1
2001 2 14 28 4
2002 3 14 42 9
2003 4 18 72 16
2004 5 19 95 25
∑X=0 ∑ Y = 113 ∑ XY = 181 ∑ X2 = 110

a=
∑ Y = 113 = 10.3
n 11

b=
∑ XY = 181 = 1.6
∑ X 110
2

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Management Science II Dr.T.T.Narendran

• Forecasting equation is Y= a + b X

• Forecasting equation is Y=10.3 + 1.6 X

(Where Year 0 = 1999)

Correlation Coefficient

n ∑ X iYi − ∑ X i ∑ Yi
r=
n X 2 −   n Y 2 − ( Y )2  
∑ ∑   ∑ i ∑ i  
2

  i ( X i )

Forecasting (Cyclic)

Cyclic Forecaster

2π 2π
Y =a+ucos X+vsin X
N N

Cyclic Trend

2π 2π
a+b+ucos X +vsin X
N N

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Management Science II Dr.T.T.Narendran

Exponential Smoothing

Yt1+1 = (1 − α ) Yt + (1 − α ) α Yt −1 + (1 − α ) α 2 Yt − 2
+ .......................... + (1 − α ) α n Yt − n

WhereYt +1 = Forecast for the next period .

α = Smoothing factor 0 < α < 1.
Yt − n = Demand ' n ' periods ago

Once the first forecast is obtained , for the

subsequent months

Yt1+1 = (1 − α ) Yt + α Yt1

WhereYt1 = Forecast demand for previous period .

Example
• A hospital has used a nine month moving average forecast method to
predict drug and surgical dressing inventory requirements. The actual
demand for one such item is shown in the below given Table. Using the
previous moving average data, convert to exponential smoothing.

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Management Science II Dr.T.T.Narendran

Month 24 25 26 27 28 29 30 31 32

Demand (X) 78 65 90 71 80 101 84 60 73

Solution

M.A. =
∑X 78 + 65 + .........+ 73
= = 78.
noof periods 9

Assume 78 asthe forecast demand forthemonth 32.

2 2
α= = = 0.2
n +1 9 +1

Yt1+1 = (1 − α ) Yt + α Yt1

= 0.8 (78) + 0.2 (73)

= 0.8 (73) + 0.2 (78)

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Management Science II Dr.T.T.Narendran

Example-2
Month Actual Demand Old forecast
43 105 100
44 106 100.50
45 110 101.05
46 110 101.95
47 114 102.46
48 121 103.61
49 130 105.35

50 128 107.82
51 137 109.84
52

Moving Average
Year Demand 3 Year Moving Average

1997 -5 -
1998 -4 3.7
1999 -3 6.3
2000 -2 10
2001 -1 8.0
2002 0 8.3
2003 1 9.0
2004 2 11.0
2005 3 13.314
2006 4 15.3
2007 5 17.0

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Management Science II Dr.T.T.Narendran

• Smoothens curve

• Independent of Y to X relationship

• Loses sight of end values

• Lags in trend

• Forecast only for next immediate period e.g., for 1998

• This can be rectified by Weighted Moving Average

∑ (W t ) X
∑ (W t )

Forecast Errors
Use
• To set safety stocks or safety capacity and thereby ensure a desired level
of protection against stock out.

• To monitor erratic demand observations or outliers which should be

carefully evaluated and perhaps rejected from the data.

• To determine when the forecasting method is no longer tracking actual

demand and needs to be reset.

• Monitor validity of forecaster

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Management Science II Dr.T.T.Narendran

Notations

• Dt = Demand during period t

• Ft+1 = Forecast demand for period t + 1

• et = Dt - Ft = Forecast error in period t

Cumulative Sum Of Forecast Errors (Cfe)

n
CFE = ∑ et
t =1

Mean Square Error (Mse)

n

∑t =1
et 2
M SE =
n

Mean Absolute Deviation Of Forecast Errors (Mad)

∑e
t =1
t
MAD =
n

MADt = α Dt − Ft + (1 − α ) MADt −1

n
et
∑D
t =1
100
t
MAPE =
n

(expressed as a percentage)

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Management Science II Dr.T.T.Narendran

Mean Absolute Percentage Errors

Tracking Signal (Ts)

TS = Cumulative sum of forecast deviation / MAD (most recent)

TS = CFE / MADt

Selection Of Forecasting Method

User and system sophistication

Time and Resources available

Use or decision characteristics

Data availability ( and accuracy)

Data pattern (plot on graph and check – I Step)

Best ‘fit’ is not necessarily best ‘predictor’ do it in 2 days – first fit various
models, then predict and choose the one with the least error.

REMEMBER – Sometimes, human beings do better than quantitative

forecasts

Using Forecast In An Organization

• Bias - Due to Sales ‘Boosting’
- Due to production reducing

• Can we probability in forecasting?

• Who shared forecast? – Collective inputs

Indian Institute of Technology Madras

Management Science II Dr.T.T.Narendran

Indian Institute of Technology Madras

Management Science II Dr.T.T.Narendran

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