Demand Forecasting

• Introduction
• Demand Forecasting Techniques
– Qualitative Forecasting Methods
– Quantitative Forecasting Models
• Forecast Error
• Case: Yankee Fork and Hoe Company
• Designing a Demand Forecasting System for PPC
 Forecasting
 Effective planning requires matching
product requirements of customers with the
capacity of operations

 Forecasting: Predicting future events, such

as, customer demand

 Demand forecast is generally

daily/weekly/monthly/quarterly figure for
each product/product group in a geographic
region
 Patterns of Demand /
Components of Demand
Component of demand include:
1) Horizontal/Permanent/Base Demand
2)Trends
3)Cycle
4) Seasonal
5) Promotional
6) Irregular or Random fluctuation (noise)
 Patterns of Demand /
Components of Demand
• Horizontal/Permanent/Base- data cluster about a
horizontal line.
• Trends are noted by a gradual upward or downward
sloping line.
• Cycle is a data pattern (up or down movement) that may
cover several years before it repeats itself.
• Seasonality is a data pattern (periodic oscillation in
demand) that repeats itself over the period of one year or
less.
• Promotional: Demand swing initiated by a firm’s
marketing initiatives such as advertising, deals or
promotions (known to the firm so need not be forecast)
• Random fluctuation (noise) results from random variation
or unexplained causes.
Patterns of Demand: Base
Quantity

Time

(a) Horizontal/Base: It represents long term average

after the remaining components have been removed.
Data cluster about a horizontal line.
Patterns of Demand: Trend
Quantity

Time

(b) Trend: Long term shift in periodic sales. Data

consistently increase or decrease.
Patterns of Demand: Seasonal

Year 1
Quantity

| | | | | | | | | | | |
J F M A M J J A S O N D
Months
(c) Seasonal: Recurring upward/downward trend
repeated within a year.
Patterns of Demand: Seasonal

Year 1
Quantity

Year 2

| | | | | | | | | | | |
J F M A M J J A S O N D
Months
(c) Seasonal: Data consistently show peaks and valleys.
Patterns of Demand: Cyclical
Quantity

| | | | | |
1 2 3 4 5 6
Years
(c) Cyclical: Data reveal gradual increases and
decreases over extended periods.
 Forecasting Techniques
 Forecasting is both an art & a science. The
science part deals with mathematical
models, whereas the art part deals with
judgment, experience and intuition. Thus,
two broad methods

 Qualitative methods (subjective)

 Based on subjective methods

 Quantitative methods (objective)

 Based on mathematical formulas
 Forecasting Techniques
Qualitative Methods (subjective)
• experts’ intuition, experience, opinions
• not repeatable by others.
• Used when
– little or no historical data available
– Unstable environment during forecast horizon
– Forecast has long time horizon
• Methods Available
– Jury of executive opinion
– Sales force composite
– Delphi method
– Consumer market survey
 Qualitative Methods

Jury of Executive Opinion

Given sales data and other reports, a group of high-level

executives give their estimates of future demand.
These estimates are summarized
Main disadvantages-
– Top level executives are not close to the customers
– Power struggles occur among executives
 Qualitative Methods

Sales Force Composite

Each salesperson provides an estimate of sales for his/her

territory, and then the results are aggregated for all
territories. This approach is often called the grass
roots approach because salespeople are close to
customers.
Main disadvantages-
– Overestimate for fear of losing job/territory
– Underestimate to have the quota set at a low level
and reap good bonuses
 Qualitative Methods

Delphi Method

A coordinator asks a group of outside experts to estimate

future demand. A statistical summary of their
responses is prepared and sent back to the experts
who can then revise their estimates if they choose to
do so. The purpose is to reach consensus. Names of
the participants are not revealed.
Main disadvantages
– lengthy process
 Qualitative Methods

Market Research

A systematic approach to determine consumer

interest in a product or service by creating and
testing hypotheses through data-gathering
surveys.
Disadvantage
– Poor response rate
 Forecasting Techniques
Quantitative methods (objective)
• mathematical models of relationships between variables,
repeatable method

• Types of quantitative models

1. Time series methods: analyze the pattern in past demand to

project demand in future period

2. Causal model: Forecast by Regression/Causal methods

estimates sales on the basis of values of other independent
factors.
Quantitative models: Time series models

• A time series is a set of numbers where the

order or sequence of the numbers is
important, e.g., historical demand
• Analysis of the time series identifies patterns
• Once the patterns are identified, they can be
used to develop a forecast
Components of Demand in Time Series
• Permanent (Base) component, B
• Trend, T
• Seasonal, S
• Cyclic, C
• Promotion, P
• Random, et
• Examples
Yt = (B + T) + S + et , additive
Yt = (B + T) x S + et , multiplicative
Seasonal Patterns
(b) Additive pattern
Demand

| | | | | | | | | | | | | | | |
0 2 4 5 8 10 12 14 16
Period
Seasonal Patterns
(a) Multiplicative pattern
Demand

| | | | | | | | | | | | | | | |
0 2 4 5 8 10 12 14 16
Period
Quantitative Method: Time-Series
Methods

• Naive approach
• Moving averages
• Exponential smoothing
• Trend projection (linear regression)
• Seasonal influences
• Combined seasonal and trend
 Time-series method
Naive forecasting
The forecast for the next period equals the demand for the
current period. The naïve forecast can take into account
a demand trend - the forecast is increased with the
number with which it missed the last time. The
advantages of the naive forecasts are its simplicity and
low cost.

Example - If demand for Wednesday was 35 people, then

forecast for Thursday is 35 people. If 42 on Thursday,
then 42 is the forecast for Friday. With trend it will be 49.
 Simple Moving Average, SMA(n)
Ft+1 = [Dt + Dt-1 + ... + Dt-n+1 ]/n

• Small n, more responsive to changes in data

• Large n, more stable forecasts over time
• n is typically between 3 & 10
Time-Series Methods
Simple Moving Averages

450 —

430 —
Patient arrivals

410 —

390 —

370 — Actual patient

arrivals

| | | | | |
0 5 10 15 20 25 30
Week
 Time-Series Methods
Simple Moving Averages

450 — Patient
Week Arrivals
430 — 1 400
2 380
Patient arrivals

410 — 3 411

390 —
411 + 380 + 400
F4 =
370 — 3
Actual patient
arrivals = 397

| | | | | |
0 5 10 15 20 25 30
Week
Time-Series Methods
Simple Moving Averages

450 — 3-week MA 6-week MA

forecast forecast
430 —
Patient arrivals

410 —

390 —

370 — Actual patient

arrivals

| | | | | |
0 5 10 15 20 25 30
Week
 Weighted Moving Average, WMA(n)
Moving averages are unresponsive/sluggish to change,
to partially overcome this we use weighted average
Ft+1 = w1 Dt + w2 Dt-1 + ... + wn Dt-n+1

One method to assign weights (not the only method):

• w1 > w2 > ... > wn > 0, weights sum to 1
• Sum-of-digits weights
S= 1+2+...+n
w1 = n/S, w2 = (n-1)/S, ……, wn = 1/S
Time-Series Methods
Weighted Moving Average

450 — 3-week MA 6-week MA

forecast Weighted
forecastMoving Average
430 — Assigned weights
t 0.70
Patient arrivals

410 — t-1 0.20

t-2 0.10
390 —
F4 = 0.70(411) + 0.20(380) +
0.10(400) =403.7
370 — Actual patient
arrivals

| | | | | |
0 5 10 15 20 25 30
Week
Simple Exponential Smoothing, SES (α)
• To overcome the drawback of large data
requirements of moving averages, SES implicitly
considers previous points. It is a sophisticated
weighted moving average technique.
Ft+1 = Ft +α( Dt - Ft)
Ft+1 = α Dt + α (1− α) Dt-1 + α (1− α)2 Dt-2 +……
+(1− α) t F0
• smoothing constant 0 ≤ α ≤ 1
• Dt - Ft = forecasting error in period t
• Larger α values make forecast more responsive
• If α=1, naive model
• In practice, 0.05 ≤ α ≤ 0.30
 Weights & Initial Forecasts
• w1 =α, w2 =α(1- α ), w3 =α(1- α )2 ...
• Initial forecast required
– use actual value at initial period
F1 = D1
– use average of some initial actual values
F1 = [D1 + D2 + D3 ]/3
Time-Series Methods
Exponential Smoothing

450 —
Exponential Smoothing
430 — α = 0.10
Patient arrivals

410 — Ft +1 = Ft + α (Dt – Ft )

390 —

370 —

| | | | | |
0 5 10 15 20 25 30
Week
Time-Series Methods
Exponential Smoothing

450 —
Exponential Smoothing
430 — α = 0.10
Patient arrivals

410 — Ft +1 = Ft + α (Dt – Ft )

390 — F3 = (400 + 380)/2

D3 = 411
370 —
F4 = 0.10(411) + 0.90(390)

| | | | | |
0 5 10 15 20 25 30
Week
Time-Series Methods
Exponential Smoothing

450 —
Exponential Smoothing
430 — α = 0.10
Patient arrivals

410 — Ft +1 = Ft + α (Dt – Ft )

390 — F3 = (400 + 380)/2

D3 = 411
370 —
F4 = 392.1
| | | | | |
0 5 10 15 20 25 30
Week
Time-Series Methods
Exponential Smoothing

450 —
Exponential Smoothing
430 — α = 0.10
Patient arrivals

410 — Ft +1 = Ft + α (Dt – Ft )

390 — F4 = 392.1
D4 = 415
370 —
F4 = 392.1 F5 = 394.4
| | | | | |
0 5 10 15 20 25 30
Week
Time-Series Methods
Exponential Smoothing

450 —

430 —
Patient arrivals

410 —

390 —

370 — Exponential
smoothing
α = 0.10
| | | | | |
0 5 10 15 20 25 30
Week
Time-Series Methods
Exponential Smoothing

450 — 3-week MA 6-week MA

forecast forecast
430 —
Patient arrivals

410 —

390 —

370 — Exponential
smoothing
α = 0.10
| | | | | |
0 5 10 15 20 25 30
Week
 Time-Series Methods
Trend-Adjusted Exponential Smoothing
A = average; T = Trend
α =smoothing constant for average;
β = smoothing constant for trend

At = α Dt + (1-α) (At-1 + Tt-1)

Tt = β (At – At-1) + (1- β) Tt-1
Ft+1 = At + Tt
Time-Series Methods
Trend-Adjusted Exponential Smoothing
80 —
Medanalysis, Inc.
70 — Demand for blood analysis

At = α Dt + (1 – α)(At-1 + Tt-1)
Patient arrivals

60 —
Tt = β (At – At-1) + (1 – β)Tt-1
50 —
A0 = 28 patients T0 = 3 patients
40 — α = 0.20 β = 0.20

30 —
A1 = 0.2(27) + 0.80(28 + 3)
| | | | | T
| 1 =| 0.2(30.2
| | |- 28)
| + |0.80(3)
| | |
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15
Week
Time-Series Methods
Trend-Adjusted Exponential Smoothing
80 —
Medanalysis, Inc.
70 — Demand for blood analysis

At = α Dt + (1 – α)(At-1 + Tt-1)
Patient arrivals

60 —
Tt = β (At – At-1) + (1 – β)Tt-1
50 —
A0 = 28 patients T0 = 3 patients
40 — α = 0.20 β = 0.20

30 —
A1 = 30.2 Forecast2 =
T 30.2 + 2.8 = 33
| | | | | | 1 =| 2.8
| | | | | | | |
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15
Week
Time-Series Methods
Trend-Adjusted Exponential Smoothing
80 —
Medanalysis, Inc.
70 — Demand for blood analysis

At = α Dt + (1 – α)(At-1 + Tt-1)
Patient arrivals

60 —
Tt = β (At – At-1) + (1 - β)Tt-1
50 —
A2 = 30.2 D2 = 44 T1 = 2.8
40 — α = 0.20 β = 0.20

30 —
A2 = 0.2(44) + 0.80(30.2 + 2.8)
| | | | | |T2 =| 0.2(35.2
| | |- 30.2)
| |+ 0.80(2.8)
| | |
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15
Week
Time-Series Methods
Trend-Adjusted Exponential Smoothing
80 —
Medanalysis, Inc.
70 — Demand for blood analysis

At = α Dt + (1 – α)(At-1 + Tt-1)
Patient arrivals

60 —
Tt = β (At – At-1) + (1 - β)Tt-1
50 —
A2 = 30.2 D2 = 44 T1 = 2.8
40 — α = 0.20 β = 0.20

30 —
A2 = 35.2 Forecast =
35.2 + 3.2 = 38.4
| | | | | |T2 =| | 3.2| | | | | | |
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15
Week
Time-Series Methods
Trend-Adjusted Exponential Smoothing
80 — Trend-adjusted
forecast
70 —
Patient arrivals

60 —

50 —
Actual blood
40 — test requests

30 —

| | | | | | | | | | | | | | |
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15
Week
Time-Series Methods
Seasonal Influences

Quarter Year 1 Year 2 Year 3 Year 4

1 45 70 100 100
2 335 370 585 725
3 520 590 830 1160
4 100 170 285 215
Total 1000 1200 1800 2200
Average 250 300 450 550

Actual Demand
Seasonal Index =
Average Demand
Time-Series Methods
Seasonal Influences

Quarter Year 1 Year 2 Year 3 Year 4

1 45/250 = 0.18 70/300 = 0.23 100/450 = 0.22 100/550 = 0.18
2 335/250 = 1.34 370/300 = 1.23 585/450 = 1.30 725/550 = 1.32
3 520/250 = 2.08 590/300 = 1.97 830/450 = 1.84 1160/550 = 2.11
4 100/250 = 0.40 170/300 = 0.57 285/450 = 0.63 215/550 = 0.39
Time-Series Methods
Seasonal Influences

Quarter Year 1 Year 2 Year 3 Year 4

1 45/250 = 0.18 70/300 = 0.23 100/450 = 0.22 100/550 = 0.18
2 335/250 = 1.34 370/300 = 1.23 585/450 = 1.30 725/550 = 1.32
3 520/250 = 2.08 590/300 = 1.97 830/450 = 1.84 1160/550 = 2.11
4 100/250 = 0.40 170/300 = 0.57 285/450 = 0.63 215/550 = 0.39

Quarter Average Seasonal Index

1 (0.18 + 0.23 + 0.22 + 0.18)/4 = 0.20
2
3
4
Time-Series Methods
Seasonal Influences

Quarter Year 1 Year 2 Year 3 Year 4

1 45/250 = 0.18 70/300 = 0.23 100/450 = 0.22 100/550 = 0.18
2 335/250 = 1.34 370/300 = 1.23 585/450 = 1.30 725/550 = 1.32
3 520/250 = 2.08 590/300 = 1.97 830/450 = 1.84 1160/550 = 2.11
4 100/250 = 0.40 170/300 = 0.57 285/450 = 0.63 215/550 = 0.39

Quarter Average Seasonal Index

1 (0.18 + 0.23 + 0.22 + 0.18)/4 = 0.20
2 (1.34 + 1.23 + 1.30 + 1.32)/4 = 1.30
3 (2.08 + 1.97 + 1.84 + 2.11)/4 = 2.00
4 (0.40 + 0.57 + 0.63 + 0.39)/4 = 0.50
Time-Series Methods
Seasonal Influences

Quarter Year 1 Year 2 Year 3 Year 4

1 45/250 = 0.18 70/300 = 0.23 100/450 = 0.22 100/550 = 0.18
2
Projected Annual Demand = 2600
335/250 = 1.34 370/300 = 1.23 585/450 = 1.30 725/550 = 1.32
3 Average
520/250 = 2.08 Quarterly Demand
590/300 = 1.97 = =2600/4
830/450 = 650 = 2.11
1.84 1160/550
4 100/250 = 0.40 170/300 = 0.57 285/450 = 0.63 215/550 = 0.39

Quarter Average Seasonal Index Forecast

1 (0.18 + 0.23 + 0.22 + 0.18)/4 = 0.20 650(0.20) = 130
2 (1.34 + 1.23 + 1.30 + 1.32)/4 = 1.30
3 (2.08 + 1.97 + 1.84 + 2.11)/4 = 2.00
4 (0.40 + 0.57 + 0.63 + 0.39)/4 = 0.50
Time-Series Methods
Seasonal Influences

Quarter Year 1 Year 2 Year 3 Year 4

1 45/250 = 0.18 70/300 = 0.23 100/450 = 0.22 100/550 = 0.18
2 335/250 = 1.34 370/300 = 1.23 585/450 = 1.30 725/550 = 1.32
3 520/250 = 2.08 590/300 = 1.97 830/450 = 1.84 1160/550 = 2.11
4 100/250 = 0.40 170/300 = 0.57 285/450 = 0.63 215/550 = 0.39

Quarter Average Seasonal Index Forecast

1 (0.18 + 0.23 + 0.22 + 0.18)/4 = 0.20 650(0.20) = 130
2 (1.34 + 1.23 + 1.30 + 1.32)/4 = 1.30 650(1.30) = 845
3 (2.08 + 1.97 + 1.84 + 2.11)/4 = 2.00 650(2.00) = 1300
4 (0.40 + 0.57 + 0.63 + 0.39)/4 = 0.50 650(0.50) = 325
 Linear Trend and Seasonality
• A more refined method will be discussed
Choosing a Method
FORECAST ACCURACY

FORECAST ACCURACY refers to the

difference between forecasts and
corresponding actual sales.
Choosing a Method
Forecast Error

Measures of Forecast Error

Et = Dt – Ft

CFE = ΣEt

MSE =
ΣEt2
n
Σ|Et | Σ[ |Et | (100) ] /Dt
MAD = MAPE = n
n
Choosing a Method
Forecast Error

Absolute
Error Absolute Percent
Month, Demand, Forecast, Error, Squared, Error, Error,
t Dt Ft Et Et2 |Et| (|Et|/Dt)(100)
1 200 225 -25 625 25 12.5%
2 240 220 20 400 20 8.3
3 300 285 15 225 15 5.0
4 270 290 –20 400 20 7.4
5 230 250 –20 400 20 8.7
6 260 240 20 400 20 7.7
7 210 250 –40 1600 40 19.0
8 275 240 35 1225 35 12.7
Total –15 5275 195 81.3%
Choosing a Method
Forecast Error
Measures of Error
Absolute
CFE = – 15 Error Absolute Percent
Month, Demand, Forecast, Error, Squared, Error, Error,
– 15
E =t =D–t 1.875 Ft Et Et2 |Et| (|Et|/Dt)(100)
8
1 200 225 –25 625 25 12.5%
2 240
5275 220 20 400 20 8.3
MSE 3= 300 = 285
659.4 15 225 15 5.0
4 8 270 290 –20 400 20 7.4
5 230 250 –20 400 20 8.7
6 260 240 20 400 20 7.7
7 210 250 –40 1600 40 19.0
8 195
275 240 35 1225 35 12.7
MAD = = 24.4
8 Total –15 5275 195 81.3%

81.3%
MAPE = = 10.2%
8
 Linear Trend With Seasonality
• Carpet example
• Apply linear trend model
• 1st & 2nd quarter errors positive
• 3rd & 4th quarter errors negative
• Seasonality present
• Multiplicative model
Dt = [a + bt] cs + et
a + bt = 135.7 + 12.2 t = linear trend component
cs = quarterly seasonal factor
Linear trend applied to carpet data
Dt Ft
t Yr Qtr Act. Fcst. Errors Error2
1 1 1 160 147.9 +12.1 146.4
2 1 2 170 160.1 +9.9 98.0
3 1 3 140 172.3 -32.3 1043.3
4 1 4 150 184.5 -34.5 1190.3
5 2 1 230 196.7 +33.3 1108.9
6 2 2 240 108.9 +31.1 967.2
7 2 3 180 221.1 -41.1 1689.2
8 2 4 200 233.3 -33.3 1108.9
9 3 1 310 245.5 +64.5 4160.3
10 3 2 310 257.5 +52.3 2735.3
11 3 3 230 269.9 -39.9 1592.0
12 3 4 260 282.1 -22.1 488.4

MAD = 33.9 MSE = 1360.7

 Carpet Data & Trend Line
1 2 170 160.1 9.9 98
1 3 140 172.3 -32.3 1043.3
1 4 150 184.5 -34.5 1190.3
370
2 1 230 196.7 33.3 1108.9
2 2 240 108.9 31.1 967.2
2 3 180 221.1 -41.1 1689.2
320
2
3
4
1
200
320
233.3
245.5
-33.3
64.5
1108.9
4160.3
3 2 310 257.5 52.3 2735.3

270
3 3 230 269.9 -39.9 1592
Sales

Carpe
3 4 260 282.1 -22.1 488.4 t

MAD = 33.9 MSE = 1360.7

Carpet 220
160
Fcst
147.9
170 160.1

170
140
150
172.3
184.5
230 196.7
240 208.9
120
180 221.1
200 233.3
320 245.5
310 257.7
230
260
269.9
282.1
Time
 Constructing Model
1. Compute 4-period moving averages,
e.g., average quarters 1-4, then quarters 2-5
2. Compute centered moving averages (CMA),
[avg for 1-4 + avg for 2-5]/2
3. Compute seasonal ratios
4. = Actual/CMA = Col(1)/Col(3)
5. Estimate cs = average of seasonal ratios for season s
6. Deseasonalize data = Actual/ cs
7. Estimate “a” & “b” for deseasonalized data
8. Forecast = deseasonalized forecast x cs for quarter
 (1) (2) (3) (4) (5) (6)
t Yr Qtr Act. MA CMA SI cs Deseas.
1 1 1 160 1.191 134

2 1 2 170 1.153 147

155.0
3 1 3 140 163.75 0.855* 0.830* 169
172.5
4 1 4 150 181.25 0.828 0.826 182
190.0
5 2 1 230 195.00 1.179 1.191 193
200.0
6 2 2 240 506.25 1.164 1.153 208
212.5
7 2 3 180 222.50 0.809* 0.830 217
232.5
8 2 4 200 241.25 0.829 0.826 242
250.0
9 3 1 310 256.25 1.210 1.191 260
262.5
10 3 2 310 270.00 1.148 1.153 269
277.5
11 3 3 230 0.830 277

12 3 4 260 0.826 315

 Computing Terms
c1 = (1.179 + 1.210)/2 = 1.195 x [4/4.011] = 1.191
c2 = (1.164 + 1.148)/2 = 1.156 x [4/4.011] = 1.153
c3 = (0.855 + 0.809)/2 = 0.832 x [4/4.011] = 0.830
c4 = (0.828 + 0.829)/2 = 0.828 x [4/4.011] = 0.826
Totals 4.011 4.000
Use deseasonalized data to compute a & b
b = 15.4, a = 117.6
Ft = [117.6 + 15.4 t] cs
Ft = [117.6 + 15.4 (6)] 1.153 = 242
 Dt Ft
t Yr Qtr Act. Fcst Error Error2
1 1 1 160 158 +2 4
2 1 2 170 171 -1 1
3 1 3 140 136 +4 16
4 1 4 150 148 +2 4
5 2 1 230 232 -2 4
6 2 2 240 242 -2 4
7 2 3 180 187 -7 49
8 2 4 200 199 +1 1
9 3 1 310 305 +5 25
10 3 2 310 313 -3 9
11 3 3 230 238 -8 64
12 3 4 260 250 +10 100

MAD = 3.9 MSE = 23.4

Case: Yankee Fork and
Hoe Company
Forecasting Techniques: Causal/Regression
Model

Forecast by Regression/Causal methods

estimates sales on the basis of values of
other independent factors. Use historical
data on independent variables, such as
promotional campaigns, economic
conditions and competitors actions to
predict demand
Quantitative Approach: Causal
Method/Regression Model
(Linear Regression)
Deviation,
Y Regression
Estimate of or error
Y from
equation:
Dependent variable

regression Y = a + bX
equation
{ Actual
value
of Y

Value of X used
to estimate Y

X
Independent variable
Causal Methods
Linear Regression

Sales Advertising
Month (000 units) (000 $)
1 264 2.5 a = – 8.137
2 116 1.3 b = 109.23
3 165 1.4 r = 0.98
4 101 1.0
5 209 2.0
r2 = 0.96
Causal Methods
Linear Regression
300 —
Sales (thousands of units)

250 —
Sales Advertising
Month (000 units) (000 $)
200 —
1 264 2.5 a = – 8.137
2—
150 116 1.3 b = 109.23
3 165 1.4 r = 0.98
4—
100 101 1.0 r2 = 0.96
5 209
Y = – 8.137 +2.0109.23X
50 | | | |
Forecast
1.0 1.5for Month
2.0 6
2.5
Advertising (thousands of dollars)
X = $1750, Y = 183.015, or 183,015 units
Causal Methods
Linear Regression (formula)
Sales, Y Advertising, X
Month (000 units) (000 $) XY X2 Y2
1 264 2.5 660.0 6.25 69,696
2 116 1.3 150.8 1.69 13,456
3 165 1.4 231.0 1.96 27,225
4 101 1.0 101.0 1.00 10,201
5 209 2.0 418.0 4.00 43,681
Total 855 8.2 1560.8 14.90 164,259
Y = 171 X = 1.64
ΣXY – nXY
a = Y – bX b=
ΣX 2 – n(X )2
Causal Methods
Linear Regression
Sales, Y Advertising, X
Month (000 units) (000 $) XY X2 Y2
1 264 2.5 660.0 6.25 69,696
2 116 1.3 150.8 1.69 13,456
3 165 1.4 231.0 1.96 27,225
4 101 1.0 101.0 1.00 10,201
5 209 2.0 418.0 4.00 43,681
Total 855 8.2 1560.8 14.90 164,259
Y = 171 X = 1.64
1560.8 – 5(1.64)(171)
a = Y – bX b=
14.90 – 5(1.64)2
Causal Methods
Linear Regression
Sales, Y Advertising, X
Month (000 units) (000 $) XY X2 Y2
1 264 2.5 660.0 6.25 69,696
2 116 1.3 150.8 1.69 13,456
3 165 1.4 231.0 1.96 27,225
4 101 1.0 101.0 1.00 10,201
5 209 2.0 418.0 4.00 43,681
Total 855 8.2 1560.8 14.90 164,259
Y = 171 X = 1.64

nΣXY – ΣX ΣY
r=
[nΣX 2 – (ΣX) 2][nΣY 2 – (ΣY) 2]
 Coefficient of Correlation (r)
• The coefficient of correlation, r, explains the relative
importance of the relationship between x and y.
• The sign of r shows the direction of the relationship.
• The absolute value of r shows the strength of the
relationship.
• The sign of r is always the same as the sign of b.
• r can take on any value between –1 and +1.
 Coefficient of Correlation (r)
• Meanings of several values of r:
-1 a perfect negative relationship (as x goes up, y
goes down by one unit, and vice versa)
+1 a perfect positive relationship (as x goes up, y
goes up by one unit, and vice versa)
0 no relationship exists between x and y
+0.3 a weak positive relationship
-0.8 a strong negative relationship
 Designing a Demand Forecasting System:
some considerations

 Time Frame (How far to forecast?)

 Short-range, medium-range, long-range
 Appropriate Variable to Forecast,
Units of measure (What to forecast?)
 Forecasting Technique (How to
forecast?)
 Purpose of forecast and decisions from it
 Time and effort required
 Data availability
Examples of Production Resource Forecasts

Forecast Time Item Being Unit of

Horizon Span Forecasted Measure
Long Product Lines, Dollars,
Years
Range Factory Capacities Tons
Medium Product Groups, Units,
Months
Range Depart. Capacities Pounds
Short Days, Specific Products, Units,
Range Weeks Machine Capacities Hours
Demand Forecast Applications
Time Horizon
Medium Term Long Term
Short Term (3 months– (more than
Application (0–3 months) 2 years) 2 years)
Forecast quantity Individual Total sales Total sales
products or Groups or families
services of products or
services
Decision area Inventory Staff planning Facility location
management Production Capacity
Final assembly planning planning
scheduling Master production Process
Workforce scheduling management
scheduling Purchasing
Master production Distribution
scheduling
Forecasting Time series Causal Causal
technique Causal Judgment Judgment
Judgment