Industrial Engineering

FORECASTING

OUTLINE
1.0 2.0 3.0 4.0 5.0 6.0 Introduction Types of Forecasts by Time Horizon Steps in the Forecasting Process Qualitative Forecasting Methods Quantitative Forecasting Methods Forecasting Errors and Tracking Signals

1.0 INTRODUCTION

DEFINITION OF FORECASTING
A statement

about the future value of a variable of interest such as demand (Stevenson, 2005). Process (art and science) of predicting a future event (Heizer & Render, 2004) Forecasts affect decisions and activities throughout an organization
Accounting,

finance Human resources Marketing MIS Operations Product / service design

Forecasts Forecasts Forecast

rarely perfect because of randomness more accurate for groups vs. individuals accuracy decreases as time horizon increases
I see that you will get an A this semester.

Usage of Forecasting
Accounting Finance Human Resources Marketing MIS Operations Product/service design Cost/profit estimates Cash flow and funding Hiring/recruiting/training Pricing, promotion, strategy IT/IS systems, services Schedules, MRP, workloads New products and services

Elements of a Good Forecast

Timely

Reliable
l fu

Accurate
e s u

ng i n a e

Written

y s Ea

to

Realities of Forecasting
Forecasts

are seldom perfect Most forecasting methods assume that there is some underlying stability in the system Both product family and aggregated product forecasts are more accurate than individual product forecasts

2.0 TYPES OF FORECASTS BY TIME HORIZON

Types of Forecasts by Time Horizon

Short-range

forecast Up to 1 year; usually less than 3 months Job scheduling, worker assignments Medium-range forecast 3 months to 3 years Sales & production planning, budgeting Long-range forecast 3+ years New product planning, facility location

Short-term vs. Longer-term Forecasting

Medium/long

range forecasts deal with more comprehensive issues and support management decisions regarding planning and products, plants and processes. Short-term forecasting usually employs different methodologies than longer-term forecasting Short-term forecasts tend to be more accurate than longer-term forecasts.

3.0 STEPS IN FORECASTING PROCESS

Steps in the Forecasting Process

The forecast

Step 6 Monitor the forecast Step 5 Prepare the forecast Step 4 Gather and analyze data Step 3 Select a forecasting technique Step 2 Establish a time horizon Step 1 Determine purpose of forecast

FORECASTING APPROACHES

Forecasting Approaches
Qualitative Methods
Used

Quantitative Methods
Used

when situation is vague/uncertain & little data exist

New

when situation is stable & historical data exist

Existing

products New technology

Involves

products Current technology

Involves

intuition, experience

mathematical techniques

4.0 QUALITATIVE FORECASTING METHODS

Overview of Qualitative/Judgmental Forecasting Methods

Executive opinions Pool opinions of high-level executives, sometimes augment by statistical models Sales force opinions Estimates from individual salespersons are reviewed for reasonableness, then aggregated Consumer Surveys Ask the customer Delphi method Panel of experts, queried iteratively

5.0 QUANTITATIVE FORECASTING METHODS

Overview of Quantitative Approaches

Nave

approach Simple Moving Averages Weighted Moving Average Exponential smoothing Trend Projections
Linear

Time-series Models

regression

Associative models (Causal)

5.0 QUANTITATIVE FORECASTING METHODS (TIME SERIES MODEL)

What is a Time Series?

Set of evenly spaced numerical data (weekly, monthly etc)

Obtained

by observing response variable at regular time periods that factors influencing past and present will continue influence in future Year: Sales: 19981999200020012002 78.763.589.7 93.292.1

Forecast based only on past values

Assumes

Example

Overview of Time-Series Forecasting Model

Nave

approach Simple Moving Average Weighted Moving Average Exponential smoothing Trend Projections

Techniques for averaging

Naive Approach
Assumes

demand in next period is the same as demand in most recent period

e.g.,

If May sales were 48, then June sales will be 48

Sometimes

cost effective
1995 Corel Corp.

& efficient

Naive Forecasts
Uh, give me a minute.... We sold 250 wheels last week.... Now, next week we should sell....
The forecast for any period equals the previous periods actual value.

Nave Forecasts
Simple

to use Virtually no cost Quick and easy to prepare Data analysis is nonexistent Easily understandable Cannot provide high accuracy

Simple Moving Average

Used if little or no trend Equation: Demand in Previous n Periods MA = n

MAn =

A i i=1 n

Simple Moving Average Example

Youre manager of a museum store that sells historical replicas. You want to forecast sales (000) for 2003 using a 3period moving average. 1998 4 1999 6 2000 5 2001 3 2002 7

1995 Corel Corp.

Moving Average Solution

Time 1998 1999 2000 2001 2002 2003 Response Yi 4 6 5 3 7 NA Moving Total (n=3) NA NA NA 4+6+5=15 Moving Average (n=3) NA NA NA 15/3 = 5

Moving Average Solution

Time 1998 1999 2000 2001 2002 2003 Response Yi 4 6 5 3 7 NA Moving Total (n=3) NA NA NA 4+6+5=15 6+5+3=14 Moving Average (n=3) NA NA NA 15/3 = 5 14/3=4 2/3

Moving Average Solution

Time 1998 1999 2000 2001 2002 2003 Response Yi 4 6 5 3 7 NA Moving Total (n=3) NA NA NA 4+6+5=15 6+5+3=14 5+3+7=15 Moving Average (n=3) NA NA NA 15/3=5.0 14/3=4.7 15/3=5.0

Weighted Moving Average Method

Used

when trend is present

data usually less important

Older

Weights
Often

based on intuition

lay between 0 & 1, & sum to 1.0

Equation

WMA =

(Weight for period n) (Demand in period n) Weights

Weighted Moving Average: Example

Given the following demand data, a. Compute a weighted average forecast using a weight of .40 for the most recent period, .30 for the next most recent, .20 for the next, and .10 for the next. b. If the actual demand for period 6 is 39, forecast demand for period 7 using the same weights as in part a. Period 1 2 3 4 5 Demand42 40 43 40 41 a. F6 = 0.4(41) + 0.3(40) + 0.2(43) + 0.1(40) = 41.0 b. F7 = 0.4(39) + 0.3(41) + 0.2(40) + 0.1(43) = 40.2

Actual Demand, Moving Average, Weighted Moving Average

35 30 Sales Demand 25 20 15 10 5 0 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Month

Weighted moving average Actual sales

Moving average

Disadvantages of Techniques for Averaging Methods

Increasing

n makes forecast less sensitive to real changes in the data Cannot pickup trends very well. Because they are averages, they will always stay within past levels and will not predict changes to either higher or lower levels. Require much historical data

Exponential Smoothing

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

Premise--The most recent observations might have the highest predictive value.
Therefore,

we should give more weight to the more recent time periods when forecasting.

Exponential Smoothing Equations

Ft
Ft Ft-1

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

= Forecast value for period t

Where,
= Forecast value for the previous period At = Actual value for period t At-1= Actual value for the previous period = Smoothing constant

Exponential Smoothing

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

Weighted

averaging method based on previous forecast plus a percentage of the forecast error A-F is the error term, is the % feedback If closer to 0 = less responsiveness, greater smoothing If closer to 1 = greater responsiveness, less smoothing

Exponential Smoothing Example

During the past 8 quarters, the Port of Baltimore has unloaded large quantities of grain. ( = .10). The first quarter forecast was 175. Quarter Actual 1 2 3 4 5 6 7 8 9 180 168 159 175 190 205 180 182 ?

Find the forecast for the 9th quarter.

Exponential Smoothing Solution

Ft = Ft-1 + 0.1(At-1 - Ft-1)
Quarter 1 2 3 4 5 6 Actual 180 168 159 175 190 205 175.00 + Forecast, F t ( = .10) 175.00 (Given)

Exponential Smoothing Solution

Ft = Ft-1 + 0.1(At-1 - Ft-1)
Quarter Actual 1 2 3 4 5 6 180 168 159 175 190 205 175.00 + .10( Forecast, F t ( = .10) 175.00 (Given)

Exponential Smoothing Solution

Ft = Ft-1 + 0.1(At-1 - Ft-1)
Quarter 1 2 3 4 5 6 Actual 180 168 159 175 190 205 175.00 + .10(180 Forecast, Ft ( = .10) 175.00 (Given)

Exponential Smoothing Solution

Ft = Ft-1 + 0.1(At-1 - Ft-1)
Quarter Actual 1 2 3 4 5 6 180 168 159 175 190 205 Forecast, Ft ( = .10) 175.00 (Given) 175.00 + .10(180 - 175.00)

Exponential Smoothing Solution

Ft = Ft-1 + 0.1(At-1 - Ft-1)
Quarter Actual 1 2 3 4 5 6 180 168 159 175 190 205 Forecast, Ft ( = .10) 175.00 (Given) 175.00 + .10(180 - 175.00) = 175.50

Exponential Smoothing Solution

Ft = Ft-1 + 0.1(At-1 - Ft-1)
Quarter 1 2 3 4 5 6 Actual 180 168 159 175 190 205 Forecast, F t ( = .10) 175.00 (Given) 175.00 + .10(180 - 175.00) = 175.50 175.50 + .10(168 - 175.50) = 174.75

Exponential Smoothing Solution

Ft = Ft-1 + 0.1(At-1 - Ft-1)
Quarter Actual 1 2 3 4 5 6 180 168 159 175 190 205 Forecast, F t ( = .10) 175.00 (Given) 175.00 + .10(180 - 175.00) = 175.50 175.50 + .10(168 - 175.50) = 174.75 174.75 + .10(159 - 174.75)= 173.18

Exponential Smoothing Solution

Ft = Ft-1 + 0.1(At-1 - Ft-1)
Quarter Actual 1 2 3 4 5 6 180 168 159 175 190 205 Forecast, F t ( = .10) 175.00 (Given) 175.00 + .10(180 - 175.00) = 175.50 175.50 + .10(168 - 175.50) = 174.75 174.75 + .10(159 - 174.75) = 173.18 173.18 + .10(175 - 173.18) = 173.36

Exponential Smoothing Solution

Ft = Ft-1 + 0.1(At-1 - Ft-1)
Quarter Actual 1 2 3 4 5 6 180 168 159 175 190 205 Forecast, F t ( = .10) 175.00 (Given) 175.00 + .10(180 - 175.00) = 175.50 175.50 + .10(168 - 175.50) = 174.75 174.75 + .10(159 - 174.75) = 173.18 173.18 + .10(175 - 173.18) = 173.36 173.36 + .10(190 - 173.36) = 175.02

Exponential Smoothing Solution

Ft = Ft-1 + 0.1(At-1 - Ft-1)
Time 4 5 6 7 8 9 Actual 175 190 205 180 Forecast, F t ( = .10) 174.75 + .10(159 - 174.75) = 173.18 173.18 + .10(175 - 173.18) = 173.36 173.36 + .10(190 - 173.36) = 175.02 175.02 + .10(205 - 175.02) = 178.02

Exponential Smoothing Solution

Ft = Ft-1 + 0.1(At-1 - Ft-1)
Time 4 5 6 7 8 9 Actual 175 190 205 180 Forecast, F t ( = .10) 174.75 + .10(159 - 174.75) = 173.18 173.18 + .10(175 - 173.18) = 173.36 173.36 + .10(190 - 173.36) = 175.02 175.02 + .10(205 - 175.02) = 178.02 178.02 + .10(180 - 178.02) = 178.22 178.22 + .10(182 - 178.22) = 178.58

182 ?

Impact of
250 200 150 Actual Tonage 100 50 0 1 2 3 4 5 Quarter 6 7 8 9 Actual Forecast (0.5) Forecast (0.1)

TREND PROJECTIONS
A time-series

forecasting method that fits a trend line to a series of historical data points and then projects the line into the future for forecasts. Several mathematical trend equations can be developed (e.g. linear, exponential, quadratic) We will focus on linear trend only

Linear Trend Projection

Used

for forecasting linear trend line Assumes relationship between response variable, Y, and time, X, is a linear function Yi = a + bX i Estimated by least squares method
Minimizes

sum of squared errors

Least Squares Method for finding the bestfitting straight line

Actual observation Values of Dependent Variable
Deviation

Deviation Deviation

Deviation

Deviation Deviation

Deviation

Point on regression line

= a + bx Y
Time

Equations
Equation:
i = a + bx i Y
n

Slope:

b = i =1 n 2 xi nx 2
i =1

x i y i nx y

Y-Intercept:

a = y bx

Computation Table
Xi X1 X2 : Xn Xi Yi Y1 Y2 : Yn Yi
2 Xi 2 X1 2 X2 2 Yi 2 Y1 2 Y2

X iY i X 1Y 1 X 2Y 2 : X nY n X iY i

: Xn
2 2 Xi

: Yn
2 2 Yi

Using a Trend Line

Year 1997 1998 1999 2000 2001 2002 2003 Demand 74 79 80 90 105 142 122
The demand for electrical power at N.Y.Edison over the years 1997 2003 is given at the left. Find the overall trend.

Finding a Trend Line

Year Time Period (x) 1 2 3 4 5 6 7 x=28 Power Demand (y) 74 79 80 90 105 142 122 y=692 x2 xy

1997 1998 1999 2000 2001 2002 2003

1 4 9 16 25 36 49

74 158 240 360 525 852 854

x2=140 xy=3,063

The Trend Line Equation

x= x 28 = =4 n 7 y= y 692 = = 98.86 n 7

b=

xy - nxy 3,063 (7)(4)(98.86) 295 = = = 10.54 2 2 2 x nx 140 (7)(4) 28

a = y - bx = 98.86 - 10.54(4) = 56.70 Demand in 2004 = 56.70 + 10.54(8) = 141.02 megawatts Demand in 2005 = 56.70 + 10.54(9) = 151.56 megawatts

Actual and Trend Forecast

Electric Power Demand
1 60 1 50 1 40 1 30 1 20 1 1 0 1 00 90 80 70 60 1 997 1 998 1 999 2000 2001 Year 2002 2003 2004 2005
Trend line Y = 56.70 + 10.54x

Linear Trend Equation (2nd Technique)

y

y = a + bx
0 1 2 3 4 5
y

= Forecast for period x x = Specified number of time periods a = Value of Ft at t = 0 b = Slope of the line

Calculating a and b
n (xy) - x y b = 2 2 n x - ( x)

y - b x a = n

Linear Trend Equation Example

t W eek 1 2 3 4 5 t = 15 2 ( t) = 2 2 5 t
2

t 1 4 9 16 25 = 55

y S a le s 150 157 162 166 177 y = 812

ty 150 314 486 664 885 ty = 2 4 9 9

Linear Trend Calculation

5 (2499) - 15(812) 12495-12180 b = = = 6.3 5(55) - 225 275 -225

812 - 6.3(15) a = = 143.5 5

y = 143.5 + 6.3x

Assignment
Sales for last 10 weeks are shown in the table below. Plot the data and visually check to see whether a linear trend line is appropriate. Then determine the equation of trend line, and predict sales for weeks 11 and 12.
Week Unit sales 1 70 0 2 72 4 3 72 0 4 5 6 7 8 9 10

728 740 742 758 750 770 775

Solution: a)
Sales vs Week 800 780 760 Sales 740 720 700 680 660 1 2 3 4 5 6 7 8 9 10 Week Sales vs Week

The plot above suggests that a linear trend line is appropriate

b)
Week (t) 1 2 3 4 5 6 7 8 9 10 55 Unit sales (y) ty 700 700 724 1448 720 2160 728 2912 740 3700 742 4452 758 5306 750 6000 770 6930 775 7750 7407 41358 t 1 4 9 16 25 36 49 64 81 100 385
2

TOTAL

b)

b = 10 (41358) 55 (7407) 10 (385) 55 (55) = 6195 / 825 = 7.51 a = 7407 7.51 (55) = 699.40 10 Thus gives us an equation: y = 699.40 + 7.51x

c)

Therefore, the predict sales for weeks 11 and 12 are:

y11 = 699.40 + 7.51(11) = 782.01 y12 = 699.40 + 7.51(12) = 789.51

5.0 QUANTITATIVE FORECASTING METHODS (ASSOCIATIVE / CAUSAL MODEL)

ASSOCIATIVE MODEL
Unlike

time-series method, associative model usually consider several variables that are related to the quantity being predicted E.g.: the sale of IBM PCs might be related to IBMs advertising budget, the companys prices, competitors prices etc. PC sales = dependent variable; other variables = independent variables Main technique: Linear Regression

Linear Regression Model

Shows

linear relationship between dependent & explanatory variables

Example:

Sales & advertising (not time)

Slope

Y-intercept

^ Yi = a + bX i
Dependent (response) variable Independent (explanatory) variable

Example: Expenditure on advertising is expected to cause an increase in sales volume, or Sales Volume = A + B x advertising expenditure Where : A = Sales volume without advertising B = The amount by which one unit of advertising expenditure can increase sales volume.

Equations
Equation:
i = a + bx i Y
n

Slope:

b = i =1 n 2 xi nx 2
i =1

x i y i nx y

Y-Intercept:

a = y bx

or
n (xy) - x y b = 2 2 n x - ( x)

y - b x a = n

Scatter Diagram
Sales versus Payroll
4 3

Sales (in $ hundreds of thousands)

2 1 0

2 3 4 5 6 Area Payroll (in $ hundreds of millions)

EXAMPLE Data shows sales of 20 TV and unemployment. Derive predictive equation for sales based on unemployment levels.
Period 1 2 3 4 5 6 7 8 9 10 11 Unit Sold 20 41 17 35 25 31 38 50 15 19 14 Unemployment (%) 7.2 4.0 7.3 5.5 6.8 6.0 5.4 3.6 8.4 7.0 9.0

Solution: a ) Plot a graph data

Unit Sold vs Level of Unemployment (%) 60 50 Unit Sold 40 30 20 10 0 0.0 2.0 4.0 6.0 8.0 10.0 Level of Unemployment (%) Unit Sold vs Level of Unemployment

b) Calculate x, y, xy, x2, y2

Unemployment (x) 7.2 4.0 7.3 5.5 6.8 6.0 5.4 3.6 8.4 7.0 9.0 Total 70.2 Unit Sold (y) 20 41 17 35 25 31 38 50 15 19 14 305.0 xy 144 164 124.1 192.5 170 186 205.2 180 126 133 126 1750.8 x2 51.84 16 53.29 30.25 46.24 36 29.16 12.96 70.56 49 81 476.3 y2 400 1681 289 1225 625 961 1444 2500 225 361 196 9907.0

b) Calculate value of a and b: b = 11 (1750.8) 70.2(305) 11 (476.4) 70.2 (70.2) = -2152.2 / 312.36 = -6.89 a = 305 (- 6.91)(70.2) 11 c) Make the general equation: = 71.85

y = 71.85 - 6.89x

ASSIGNMENT
National Mixer, Inc., sells can openers. Monthly sales for a seven-month period were as follows:
Month Feb Mar Apr May Jun July Aug. Sales (000 units) 19 18 15 20 18 22 20

a. Plot the monthly data b. Forecast September sales using:

i. A linear trend equation ii. A five-month moving average iii. Exponential smoothing, = 0.2, assume March forecast of 19 (000). iv. The nave approach. v. A weighted moving average using 0.6 for Aug., 0.3 for July, and 0.1 for June.

Solution: a. Plot the monthly data

25 Sales (000 units) 20 15 10 5 0 Feb Mar Apr May Month Jun July Aug

Plot data (-2) Tajuk dan unit paksi x (-2) Tajuk dan unit paksi y (-2)

b. Forecast September sales using:

i. A linear trend equation
Month Feb Mar Apr May Jun July Aug Total Sales (000 units) 19 18 15 20 18 22 20 132 x 1 2 3 4 5 6 7 28 xy 19 36 45 80 90 132 140 542 x2 1 4 9 16 25 36 49 140

Calculate value of a and b: b = 7 (542) 28 (132) 7 (140) 28 (28) = 98 / 196 = 0.5 a = 132 0.5 (28) = 16.86 7 (-1) (-1)

Thus gives us an equation: y = 16.86 + 0.5x The forecast for September are:

(-1)

y8 = 16.86 + 0.5(8) = 20,860 units

(-2)

b. Forecast September sales using:

ii. A five-month moving average

MA5 = 20+22+18+20+15 5 = 19,000 units

(-3)

b. Forecast September sales using:

forecast of 19 (000).
Month Feb Mar Apr May Jun July Aug Sept Sales (000 units) 19 18 15 20 18 22 20

F3 = F2 + (A2F2) iii. Exponential smoothing, = 0.2, assume March

Forecast 19 18.8 18.04 18.432 18.3456 19.07648 19.261184

Example : F3 = 19 + 0.2 (18-19) = 18,800 units

(-3)

b. Forecast September sales using:

iv. The nave approach = 20,000

units

(-1)

v. A weighted moving average using 0.6 for Aug., 0.3 for July, and 0.1 for June.

F8 = 0.6(20) + 0.3(22) + 0.1(18)

= 20,400 units

(-4)

REFERENCES

Heizer, J. and Render, B. (2004). Principles of Operations Management . 5th Edition. New Jersey: Prentice Hall. Stevenson, W.J. (2005). Operations Management. 8th Edition. New York: McGraw-Hill.