MD 021 - Operations Management Forecasting Outline Components of demand Judgment methods Linear regression Time series methods Forecast

ecast errors

Components of Demand

Quantity

Time (a) Average: Data cluster about a horizontal line

Quantity Time (b) Linear trend: Data consistently increase or decrease Year 1 Year 2 Quantity 1

Quantity

J F M A M J J A S O N D Months (c) Seasonal influence: Data consistently show peaks and valleys

4 Years

(d) Cyclical movements: Data reveal gradual increases and decreases over extended periods of time

Judgment Methods

Sales force estimates Executive opinion Market research Delphi method

Linear Regression
Yi = a + bX i

where: Y = dependent variable X = independent variable a = Y-intercept of the line b = slope of the line

Measures of Forecast Accuracy in Linear Regression

Coefficient of correlation Coefficient of determination Standard error of the estimate

Regression Analysis Example The manager of Als Diner is interested in forecasting the number of potato skin appetizers sold each week. He believes that the number sold has a linear relationship to the price and uses linear regression to determine if this is the case.

X Y Week (Price) (Appetizers) 1. $2.70 760 2. 3.50 510 3. 2.00 980 4. 4.20 250 5. 3.10 320 6. 4.05 480

The Excel output is below:

Regression Statistics Multiple R 0.843 R Square 0.711 Adjusted R Square 0.639 Standard Error 165.257 Observations 6 ANOVA df Regression Residual Total 1 4 5 SS 269160 109239 378400 Significance F 269160 9.856 0.035 27309 MS F

Intercept Price ($)

Coefficients Standard Error 1454.604 295.939 -277.628 88.434

t Stat

Pvalue 4.915 0.008 -3.139 0.035

Linear Regression Example A professor is interested in determining whether average study hours per week are a good predictor of test scores. The results of her study are: Hours (X) 3.0 2.1 5.8 3.8 4.2 3.2 5.3 4.6 Score (Y) 90 95 65 80 95 60 85 70

A student says: "Professor, what can I do to get a B on the next test? The professor asks, "On average, how many hours do you spend studying for this course per week?" The student responds, "About 2 hours." Use linear regression to forecast the student's test score.

The Excel output is below:

Regression Statistics Multiple R 0.391 R Square 0.153 Adjusted R Square 0.0121 Standard Error 13.544 Observations 8 ANOVA df Regression Residual Total 1 6 7 SS 199.246 1100.753 1300 Significance F 199.246 1.0861 0.3375 183.458 MS F

Intercept Study hours

Coefficients Standard Error 97.325 17.301 -4.331 4.156

t Stat 5.625 -1.042

P-value 0.0013 0.3375

Time Series Methods Naive forecasts Moving averages Weighted moving averages Exponential smoothing Trend-adjusted exponential smoothing Regression method Multiplicative seasonal method

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Moving Average Method

Ft = MAn = i =1

At i n

Month 1 2 3 4

Customer arrivals 800 740 810 790

Use a 3-month moving average to forecast customer arrivals for month 5.

F5 =

If the actual demand for month 5 is 805 customers, what is the forecast for month 6?
F6 =

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Comparison of 3-month and 6-month Moving Average Forecasts

Customer arrivals

3-month MA forecast

6-month MA forecast

10

15

20

25

Month

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Weighted Moving Average Method

Ft = wn At n + wn 1 At ( n 1) + ... + w1 At 1

Month 1 2 3 4

Customer arrivals 800 740 810 790

Let W1 = 0.50, W2 = 0.30, and W3 = 0.20. Calculate the forecast for month 5.
F5 =

If the actual demand for month 5 is 805 customers, what is the forecast for month 6?
F6 =

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Exponential Smoothing

Ft = (1 ) Ft 1 + At 1

Month 1 2 3 4

Customer arrivals 800 740 810 790

Suppose F3 = 783 customers and = 0.20. What is the forecast for month 5?
F4 =
F5 =

If D5 = 805, what is the forecast for month 6?

F6 =

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Trend-Adjusted Exponential Smoothing

St = TAFt + ( At TAFt ) Tt = Tt 1 + (TAFt TAFt 1 Tt 1 ) TAFt +1 = St + Tt

Month 1 2 3 4 5

Customer Arrivals 48 52 50 54 55

Using months 1-4, an initial estimate of the trend is 2 [(4-2+4)/3 = 2]. The starting forecast for month 5 is 54+2 = 56. Using = 0.3 and = 0.4 , forecast the number of patients in month 6.
S5 = T5 =
TAF6 =

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 If the actual number of patients in month 6 is 58, what is the forecast for month 7?
S6 = T6 =
TAF7 =

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Regression Method
Example: Garcia Garage Month (t) Number of time periods from t = 0 1 2 3 4 5 6 7 8 Number of Oil Changes (Y) 41 46 57 52 59 51 60 62

Jan. Feb. Mar. Apr. May Jun. Jul. Aug.

1. Forecast the numbers of oil changes in September, October, and November. 2. What is the average value of the trend?

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The Excel output is below:

Regression Statistics Multiple R 0.817 R Square 0.668 Adjusted R Square 0.613 Standard Error 4.572 Observations 8.000 ANOVA df 1.000 6.000 7.000 SS 252.595 125.405 378.000 Standard Error 3.562 0.705 MS 252.595 20.901 F 12.085 Significance F 0.013

Regression Residual Total

Intercept X Variable 1

Coefficients 42.464 2.452

t Stat 11.921 3.476

P-value 0.000 0.013

Lower 95% 33.748 0.726

Upper 95% 51.181 4.179

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Multiplicative Seasonal Method

Step 1: Step 2: Calculate the trend line based on the available data using regression. Calculate the centered moving average, with the number of periods equal to the number of seasons. Calculate the seasonal relative for a period by dividing the actual demand for the period by the corresponding centered moving average. Calculate the overall estimated seasonal relative by averaging the seasonal relatives from the same periods over the cycle. Calculate the trend values for each of the periods to be forecast based on the trend line determined in Step 1. To get a forecast for a given period in a future cycle, multiply the seasonal factor by the trend values.

Step 3:

Step 4:

Step 5:

Step 6:

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Multiplicative Seasonal Method Application

Quarter Demand CMA (4 seasons) 100 1 2 3 4 5 6 7 8 9 10 11 12 400 250 300 273 200 275 192 296 408 300 384 216 331 344 356 369 (trend value*) (trend value*) (trend value*) (trend value*) 227 480 417 275 (forecast) (forecast) (forecast) (forecast) Total 3.918786436 4 298 1.369127517 1.397501537 285.5 0.672504378 0.686441468 274 0.729927007 0.745054133 261.5 1.147227533 1.171002862 MA (2 periods) Seasonal Relatives Normalized S.R.

* Using regression, the trend line is 218.86 + 12.48t.

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et = At Ft

Forecast Errors

Systematic errors --- Bias Random errors --- Variability Example: Actual Demand Forecast 1 105 Forecast 2 50 Day 1 Day 2 100 100 105 150 Day 3 100 105 50 Day 4 100 105 150

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Forecast Error Measures

Bias:
n

Average error
Variability:

= t =1 n

et

Mean squared error Standard deviation

MSE
s

= t =1 n 1 = MSE et n
[
n

et

Mean absolute error

MAD

t =1

Mean percent absolute error

MAPE

t =1

et (100)] At n

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Control Chart for Forecast Errors Upper Control Limit: UCL = 0 + z MSE Lower Control Limit: LCL = 0 z MSE

z = the number of standard deviations from the mean

Where to find z given the percentage of the control chart, P 0 ? Where to find z given the probability for type I error, ? Normal Distribution Table (page 882-883, Table B)

e.g. A 95% control chart has = 1-95% = 5%, which means its probability for type I error is 5%. Thus probability in the table should be 0.975 (Pr = 1-0.025 or Pr = 0.5+ 0.475), which corresponds to z = 1.96.

Look for z corresponds to the probability: P Pr{Z<= z} = 1 = 0.5 + 0 , P0 = 1

2

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Summarizing Forecast Accuracy

Period 1 2 3 4 5 6 7 8 9 Actual (A) 113 85 96 86 121 100 142 92 72 Forecast (F) 95 80 103 119 117 125 67 96 116 Total MAD = MSE = s= MAPE = 23.9 1213.1 34.8 23.8% Error (e=A-F) 18 5 -7 -33 4 -25 75 -4 -44 -11 Abs Error 18 5 7 33 4 25 75 4 44 215 Error Sq 324 25 49 1089 16 625 5625 16 1936 9705 [(Abs E)/A] x 100 15.93 5.88 7.29 38.37 3.31 25.00 52.82 4.35 61.11 214.06

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Tracking and Analyzing Forecast Errors

Period 10 11 12 13 14 15 16 17 18 Actual (A) 102 107 112 118 89 142 100 94 111 Forecast (F) 130 102 89 97 115 82 130 137 89 Total
80 60 40 20 0 -20 -40 -60 -80 10 11 12 13 14 15 16 17 18

Error (e=A-F) -28 5 23 21 -26 60 -30 -43 22 4

Average error (periods 1-18)= Standard deviation (periods 1-9) = 2s control limits: 0 +/- 2(34.8) = 0 +/- 69.6

-0.39 34.8

UCL = 69.6

LCL = -69.6

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Examples of Nonrandomness
(a) Point outside control limits UCL (b) Trend UCL

LCL

LCL

(c) Cycling UCL

(d) Bias UCL

LCL Source: Figure 3.12, Page 100, from Stevenson

LCL

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Forecasting Summary Notes

Choosing a Forecasting Method General considerations: Pros Cons Method Subjective estimates are subject to the biases and Judgment Can be used in the absence of historical data (e.g. new product) motives of the estimators Helpful in identifying turning points and preparing medium- and long-term forecasts Causal Most sophisticated method Must have historical data on independent and Very good for predicting turning points and dependent variables preparing medium- and long-term forecasts Relationships can be difficult to specify Time Easy to implement Rely exclusively on past demand data Work well when demand is relatively stable Only useful for short-term estimates series Specific considerations for time series methods: Pros Method Easiest method, low cost Naive forecast Works well when random errors are small Simple moving Easiest moving average average method To some extent, controls for random error

Cons Results in highly variable forecasts if the random errors are large
Data

must be retained for n periods Forecast lags changes in the underlying average of demand

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Weighted moving average

can be varied to be responsive to demand pattern To some extent, controls for random error Exponential smoothing Requires little data can be varied to be responsive to demand pattern To some extent, controls for random error

Weights

Data

must be retained for n periods Forecast lags changes in the underlying average of demand
Forecast

lags changes in the underlying average of

demand

In general, emphasize recent demand (i.e. small n, large weights for recent observations, large ) for dynamic (i.e. uncertain) demand patterns. Emphasize historical experience for stable demand patterns. If a trend is present, simple moving average, weighted moving average, and exponential smoothing estimates will always lag actual demand.

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Forecasting Notes
Choosing a Time Series Forecasting Method Evaluating forecast performance: Forecast errors can be classified as either bias errors or random errors. Bias errors are the results of systematic over- or underestimation. Random errors are unpredictable. Ideally, a forecast should minimize both bias and random errors. Method Mean forecast errors Mean squared error (MSE) Mean absolute deviation (MAD) Mean absolute percent error (MAPE) Forecast error control chart Purpose Measures bias Measures the dispersion of forecast errors; large errors get more weight than when using MAD Measures the dispersion of forecast errors; method is intuitive

Measures the dispersion of forecast errors relative to the level of demand Determines whether the method of forecasting is accurately predicting actual changes in demand

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