PRODUCTION OPERATION

MANAGEMENT
1-) What is sales forecasting?

2-) Why is forecasting important?

3-) Principles of forecasting

4-) Reasons for undertaking sales
forecasts

5-) General characteristics of
forecasts

6-) Key issues in forecasting





7-) Types of forecasting methods

8-) Moving average

9-) Exponential Smoothing Methods

10-) Linear regression

11-) Conclusion





SALES FORECASTING
Sales forecasting is a difficult area of management.
Most managers believe they are good at forecasting.
However, forecasts made usually turn out to be wrong!
Marketers argue about whether sales forecasting is a
science or an art.

WHY IS FORECASTING
IMPORTANT
Forecasting can be used for
Strategic planning (long range planning)
Finance and accounting (budgets and cost
controls)
Marketing (future sales, new products)
Production and operations

PRINCIPLES OF
FORECASTING
Many types of forecasting models that
differ in complexity and amount of data & way
they generate forecasts:

1-) Forecasts are rarely perfect
2-)Forecasts are more accurate for grouped
data than for individual items
3-) Forecast are more accurate for shorter than
longer time periods

REASONS FOR SALES
FORECAST
Businesses are forced to look well ahead in
order to plan their investments, launch new
products, decide when to close or withdraw
products and so on. The sales forecasting
process is a critical one for most businesses. Key
decisions that are derived from a sales forecast
include:

- Employment levels required
- Promotional mix
- Investment in production capacity

GENERAL CHARACTERISTICS OF
FORECAST
Forecasts are always wrong

Forecasts are more accurate for groups or
families of items

Forecasts are more accurate for shorter time
periods

Every forecast should include an error estimate

Forecasts are no substitute for calculated
demand.


KEY ISSUES IN FORECASTING
1. A forecast is only as good as the information
included in the forecast (past data)
2. History is not a perfect predictor of the future
(i.e.: there is no such thing as a perfect forecast)

TYPES OF FORECASTING
METHODS
Rely on data and
analytical
techniques.
Rely on subjective
opinions from one
or more experts.
Qualitative methods Quantitative methods
QUALITATIVE METHODS
Grass Roots: deriving future demand by asking the
person closest to the customer.
Market Research: trying to identify customer habits;
new product ideas.
Panel Consensus: deriving future estimations from
the synergy of a panel of experts in the area.
Historical Analogy: identifying another similar
market.
Delphi Method: similar to the panel consensus but
with concealed identities.

QUANTITATIVE METHODS
Time Series: models that predict future
demand based on past history trends
Causal Relationship: models that use
statistical techniques to establish relationships
between various items and demand
Simulation: models that can incorporate
some randomness and non-linear effects

TYPES OF TIME SERIES
METHOD
1-) Moving Average

2-) Linear Regression

3-) Exponential Smoothing
Methods

MOVING AVERAGE
The average value over a set time period
(e.g.: the last four weeks)

Each new forecast drops the oldest data
point & adds a new observation

More responsive to a trend but still lags
behind actual data

n / A F
t 1 t

Example: Weekly Department Store Sales

The weekly sales figures (in
millions of dollars)
presented in the following
table are used by a major
department store to
determine the need for
temporary sales personnel.


Period (t) Sales (y)
1 5.3
2 4.4
3 5.4
4 5.8
5 5.6
6 4.8
7 5.6
8 5.6
9 5.4
10 6.5
11 5.1
12 5.8
13 5
14 6.2
15 5.6
16 6.7
17 5.2
18 5.5
19 5.8
20 5.1
21 5.8
22 6.7
23 5.2
24 6
25 5.8
Example: Weekly Department Store Sales
Use a three-week moving average (k=3) for the
department store sales to forecast for the week 24 and
26.



The forecast error is


9 . 5
3
8 . 5 7 . 6 2 . 5
3
) (

21 22 23
24

y y y
y
1 . 9 . 5 6
24 24 24
y y e
Example: Weekly Department Store Sales
The forecast for the week 26 is ;


7 . 5
3
2 . 5 6 8 . 5
3

23 24 25
26

y y y
y
EXPONENTIAL SMOOTHING
METHODS
Assume that we are currently in period t. We calculated the
forecast for the last period (F
t-1
) and we know the actual
demand last period (A
t-1
)
) (
1 1 1

t t t t
F A F F
The smoothing constant expresses how much our
forecast will react to observed differences
If is low: there is little reaction to differences.
If is high: there is a lot of reaction to differences.
WHY USE EXPONENTIAL SMOOTHING
1. Uses less storage space for data
2. Extremely accurate
3. Easy to understand
4. Little calculation complexity
5. There are simple accuracy tests
EXPONENTIAL SMOOTHING
METHODS
SINGLE EXP. SMOOTHING
Series without trend and without seasonal
components.
DOUBLE EXP. SMOOTHING
Series with trend but without seasonal
component.
TRIPLE EXP. SMOOTHING (WINTERS
METHOD)
Series with trend and seasonal components.
Example - Exponential Smoothing
Period Actual 0,1 Error 0,4 Error
1 83
2 80 83 -3,00 83 -3
3 85 82,70 2,30 81,80 3,20
4 89 82,93 6,07 83,08 5,92
5 92 83,54 8,46 85,45 6,55
6 95 84,38 10,62 88,07 6,93
7 91 85,44 5,56 90,84 0,16
8 90 86,00 4,00 90,90 -0,90
9 88 86,40 1,60 90,54 -2,54
10 93 86,56 6,44 89,53 3,47
11 92 87,20 4,80 90,92 1,08
12 87,68 91,35
F
t
= F
t-1
+ (A
t-1
- F
t-
1
)
Example: bottled water at Kroger
Month Actual Forecasted
Jan 1,325 1,370
Feb 1,353 1,361
Mar 1,305 1,359
Apr 1,275 1,349
May 1,210 1,334
Jun ? 1,309
= 0.2
F
t
= F
t-1
+ (A
t-1
- F
t-1
)
Example: bottled water at Kroger
= 0.8
Month Actual Forecasted
Jan 1,325 1,370
Feb 1,353 1,334
Mar 1,305 1,349
Apr 1,275 1,314
May 1,210 1,283
Jun ? 1,225
F
t
= F
t-1
+ (A
t-1
- F
t-1
)
Impact of the smoothing constant
1200
1220
1240
1260
1280
1300
1320
1340
1360
1380
0 1 2 3 4 5 6 7
Actual
a = 0.2
a = 0.8
LINEAR REGRESION
Linear regression is based on
1. Fitting a straight line to data
2. Explaining the change in one variable through changes in
other variables.
By using linear regression, we are trying to explore which
independent variables affect the dependent variable
dependent variable = a + b (independent variable)
Example: do people drink more when its cold?
Alcohol Sales
Average Monthly
Temperature
Which line best
fits the data?
The best line is the one that minimizes the error ;
bX a Y
The predicted line is
So, the error is
i i
Y - y
i

Where: is the error

y is the observed value
Y is the predicted value