COMM341: Operations

Management
Forecasting Techniques
G. Pond

Outline

Background
Time-Series Models
Associative Models
Forecast Accuracy
Forecast Control

Background
Within a business context, forecasting methods can
be used to forecast:
Consumer demand
Utility prices
Network expansion (social media)
Labour requirements
Machine-time demands
Capacity growth
Market share growth.

Demand
Dependent Demand
Internal (e.g., four screws for every chair
leg)
- How can firms influence internal demand?

Independent Demand
External (e.g. , consumer demand for toys
at Christmas)
How can firms influence external demand?

Time-Series Models

Nave Method
Moving Averages
Weighted Moving Averages
Exponential Smoothing
Linear Trend Projection
Trend-Adjusted Exponential Smoothing
Cyclical/Seasonal Demands

The Nave Method

Three Possibilities:
1) Stable Series
Actual Value at Previous Timestep = Forecast Value at Next Timestep
600
400
200
0
Jan

June Forecast
Value

May Observed
Value
Feb

Mar

Apr

May

June

July

The Nave Method

2) Seasonal or Cyclic Variation
Actual Value at Same Season in Previous Year
= Forecast Value at Same Season in Current Year
1500
1000
500

Dec 2015 Observed

Value

0
Nov Dec Jan

Dec 2016 Forecast

Value

Feb Mar Apr May June July Aug Sept Oct Nov Dec Jan

Feb

The Nave Method

3) Trend
Difference Between Two Previous Timesteps + Value of Previous Timestep
= Forecast Value at Next Timestep

675 + 75 =
750
675

800

600
675 600 =
75

600
400
200
0
Jan

Feb

Mar

Apr

May

June

July

Moving Average

Forecast

value is the average of the

previous n observed values

Moving Average
Consider the following temperatures for the first
week in March, 1996, in Kingston:
Date
Temperature

1
-2

2
2

3
-4

Use a 3-period moving average to forecast the

temperature on Day 4

Moving Average

What value should you use for ?

In this class, the value for will be
given in the problem.
In practice it depends. The following
slides illustrate the effect of
increasing the value of .

Moving Average
The scattergram below depicts the number of
students registered in
business/commerce/management programs in the
province of Ontario: 12,000
10,000
8,000
Student Registration

6,000
4,000
2,000
0
2004

2006

2008
Year

2010

2012

Moving Average
12,000
10,000
8,000
Student Registration

Raw Data

6,000

n=2

4,000

n=3
n=4

2,000
0
2000 2005 2010 2015
Year

How are the three moving averages different?

Which of the three do you think provides the
better forecast?

Weighted Moving Averages

Consider this table of temperatures:
Date
Temperature

1
-2

2
2

3
-4

Suppose an equipment malfunction is suspected

on the 2nd. A weighted moving average can be
used to put less emphasis on the corresponding
weigh
observed value.

ts

Exponential Smoothing

where:

is the forecast value at time

is the smoothing constant, in the interval
(0,1)
is the observed value at time (previous time
step)
An alternative form of the same equation:
is the forecast value at the previous time step

Exponential Smoothing

Small problem though

How do we start an exponentially smoothed

forecast to find when it depends on having a

forecast value at the
previous time step ()?
So we use the Nave method to forecast the first
value.

Exponential Smoothing
Year
Actual
2005
9,228
2006
9,297
2007
10,573
2008
11,047
2009
10,326
2010
10,354
2011
10,940

Reconsider the number of registrants:

Develop

an exponentially smoothing forecast with

= 0.6
To start, use the nave method to obtain a
forecast value for Year 2006

Exponential Smoothing
Foreca
Actual st

Year
2005
2006

1
2

9,228
9,297

2007

3 10,573

2008

4 11,047

2011

7 10,940

9,228

Now we can use the

exponentially
smoothed
2009
5 10,326
forecasting formula
2010
6 10,354

Exponential Smoothing
Year

Foreca
Actual st

2005
2006
2007

1 9,228
2 9,297
3 10,573

2008

4 11,047

2009

5 10,326

2010

6 10,354

2011

7 10,940

9,228
9,269

and we would continue the forecast through the

remaining timesteps available

Exponential Smoothing
11,000
10,500
10,000

Student Registration

Raw Data

9,500

alpha = 0.6
alpha = 0.5

9,000

alpha = 0.4
alpha = 0.1

8,500
8,000
200420062008201020122014
Year

Exponential Smoothing
Note:

Be sure to start the forecast using one of the
nave methods
Smaller values of the smoothing constant () put
more emphasis on forecast values and trend
(consequently, the forecast is more smooth).
Typical values for are in the range (0.05,0.5)
Use as much of the data as possible to help
train your model.

Linear Trend Projection

This method is based on the equation of a straight
line (that you may know as )
where:

is the projected (or estimated) value at time

is the vertical axis intercept
is the slope of the line
Seems easy. but.

Linear Trend Projection

Finding the values for and can be a bit tedious:

Linear Trend Projection

Examp
Consider the following table of students registering
le
in undergraduate business degree programs in
Year
Actual
Ontario:
2005
9,228
2006
2007
2008
2009
2010
2011

9,297
10,573
11,047
10,326
10,354
10,940

Linear Trend Projection

Example
To develop a linear trend forecast, add additional
(cont)
columns, as follows:
Year
2005

Actual
9,228

2006 Actual
9,297
Year
2007
2005

10,573
9,228

2008
2006

11,047
9,297

2009 10,573
10,326
2007
2010 11,047
10,354
2008

Linear Trend Projection

Example
and fill in the rest of the table:
(cont)
Year
Actual
2005
9,228
2006
9,297
2007
10,573
Year
Actual
2008
11,047
2009
10,326
2005
9,228
2010
10,354
2006
9,297
2011
10,940

2007
2008
2009
2010
2011

10,573
11,047
10,326
10,354
10,940

1
2
3
4
15
6
27

3
4
5
6
7

1
4
9
16
25
1
36
4
49

9
16
25
36
49

9,228
18,594
31,719
44,188
51,630
9,228
62,124
18,594
76,580

31,719
44,188
51,630
62,124
76,580

Linear Trend Projection

Example
Lastly, find the column totals as follows:
(cont)
Year
Actual
2005
9,228
2006
9,297
2007
10,573
Year
Actual
2008
11,047
2009
10,326
2005
9,228
2010
10,354
2006
9,297
2011
10,940

2007
2008
2009
2010
2011

10,573
71,765
11,047
10,326
10,354
10,940

1
2
3
4
15
26
7

3
28
4
5
6
7

1
4
9
16
25
1
36
4
49

9
140
16
25
36
49

9,228
18,594
31,719
44,188
51,630
9,228
62,124
18,594
76,580

31,719
294,063
44,188
51,630
62,124
76,580

Now we have
everything we
need:

Linear Trend Projection

Example
Substitute into the formula for :
(cont)

Linear Trend Projection

Example
Substitute into the formula for :
(cont)

Linear Trend Projection

Example
Lastly, substitute into the equation of a straight
(cont)
line:

Linear Trend Projection

Of course youre probably thinking that was
ridiculously long and that there has got to be an
easier way youd be right.
Plot the data in Excel

12,000
10,000
8,000

Student Registration

6,000
4,000
2,000
0
2005 2006 2007 2008 2009 2010 2011
Year

Linear Trend Projection

Right-click on one of the points (in an Excel line
chart)

Select Add
Trendline

Linear Trend Projection

In the window that opens, make the following
selections:

Linear Trend Projection

The result is:

12,000
10,000

f(x) = 250.11x + 9251.71

8,000
Student Registration

6,000
4,000
2,000
0
2005 2006 2007 2008 2009 2010 2011
Year

The equation we obtained mathematically was:

(same thing Excel
found)

Trend-Adjusted
Exponential Smoothing

where:

is the smoothed forecast at time , defined below

is the smoothed trend at time , defined below

Trend-Adjusted
Exponential Smoothing

As in the case of exponential smoothing, we need to

start the forecast using the nave method but in this
case, well use the nave method for trends
Example
Year
2005
2006
2007
2008
Year
2009
2010
200
2011
5

200
6

Actual
1
9,228
2
9,297
3
10,573
4
11,047
Actual
5
10,326
6
10,354
10,940
17 9,228

9,297

We
can obtain by averaging the
first three observed values to get

Trend-Adjusted
Exponential Smoothing

Example
Year
2005
2006
Year
2007
2008
200
2009
5
2010
200
2011

6
200
7
200
8
200
9

Actual
1
9,228
2
9,297
Actual
3
10,573
4
11,047
5
10,326
16 9,228
10,354
7
10,940

9,297

3 10,573
4 11,047
5 10,326

The average increment provides

an initial estimate of

Trend-Adjusted
Exponential Smoothing

Example
Year

Actual

2005

9,228

2006
2007

2
3

9,297
10,573

2008

11,047

9,699

673

10,372

2009
5with 10,326
NOW, we can proceed
using our TA Exp. Sm. formula:
2010
6
10,354
1. Find
2. Find
2011
7
10,940
3. Find

Trend-Adjusted
Exponential Smoothing

Example

Year

Actual

2005

9,228

2006
2007

2
3

9,297
10,573

2008

11,047

10,326

2010

10,354

2011

10,940

2009

9,699

673

10,372

Trend-Adjusted
Exponential Smoothing

Example

Year

Actual

2005

9,228

2006
2007

2
3

9,297
10,573

9,699

2008

11,047

10,432

2009

10,326

2010

10,354

2011

10,940

673

10,372

Trend-Adjusted
Exponential Smoothing

Example
Year

Actual

2005

9,228

2006
2007

2
3

9,297
10,573

9,669

673

2008

11,047

10,432

697

2009

2010

2011

10,326
10,354
10,940

10,372

Trend-Adjusted
Exponential Smoothing

Example
Continuing to use the TA Exp Sm.
Forecasting method throughout the
remainder of the table permits obtaining a
future value for 2012:
Year

Actual

2005

9,228

2006
2007
2008
2009
2010
2011

2
3
4
5
6
7

9,297
10,573
11,047
10,326
10,354
10,940

2012

9,699
10,432
11,105
11,352
11,411

673
697.1
687.2
511.3
330.2

10,372
11,129
11,792
11,863
11,741

11,501

234.1

11,735

Seasonal/Cyclic Demand
Pearson Airport (Enplaned + Deplaned)
Passenger Volume
1,800,000
1,600,000
1,400,000

Number of
Domestic
Passenger
s

1,200,000
1,000,000
800,000
600,000
400,000
200,000
0

Month

Seasonal/Cyclic Demand
First, we need to de-seasonalize the data. We can consider each
month as a season that repeats yearly and then find a 12-period
moving average.
- we use 12 periods because, in total, there are 12 seasons that
Date
Actual
repeat annually
Jan
926,061
Feb
Mar
Apr
May
Jun
Jul
Aug
Sep
Oct
Nov
Dec
Jan

870,271
980,311
979,293
1,123,837
1,174,270
1,342,358
1,394,984
1,153,668
1,129,786
967,043
1,036,631
980,596

1,089,876

Seasonal/Cyclic Demand
First, we need to de-seasonalize the data. We can consider each
month as a season that repeats yearly and then find a 12-period
moving average.
- we use 12 periods because, in total, there are 12 seasons that
Date
Actual
repeat annually
Jan
926,061
Feb
Mar
Apr
May
Jun
Jul
Aug
Sep
Oct
Nov
Dec
Jan

870,271
980,311
979,293
1,123,837
1,174,270
1,342,358
1,394,984
1,153,668
1,129,786
967,043
1,036,631
980,596

1,089,876
1,094,421

Seasonal/Cyclic Demand
First, we need to de-seasonalize the data. We can consider each
month as a season that repeats yearly and then find a 12-period
moving average.
- we use 12 periods because, in total, there are 12 seasons that
Date
Actual
repeat annually
Jan
926,061
Feb
Mar
Apr
May
Jun
Jul
Aug
Sep
Oct
Nov
Dec
Jan

870,271
980,311
979,293
1,123,837
1,174,270
1,342,358
1,394,984
1,153,668
1,129,786
967,043
1,036,631
980,596

1,089,876
1,094,421

1,092,148

Seasonal/Cyclic Demand

Date
Jan
Feb
Mar
Apr
May
Jun
Jul
Aug
Sep
Oct
Nov
Dec
Jan

Actual
926,061
870,271
980,311
979,293
1,123,837
1,174,270
1,342,358
1,394,984
1,153,668
1,129,786
967,043
1,036,631
980,596

Centred
Moving
Average
1,089,876
1,094,421

Seasonal
Relative for
July

1,092,148

Seasonal/Cyclic Demand
Date
Jan-11
Feb
Mar
Apr
May
Jun
Jul
Aug
Sep
Oct
Nov
Dec
Jan-12
Feb
Mar
Apr
May
Jun
Jul

Actual
926,061
870,271
980,311
979,293
1,123,837
1,174,270
1,342,358
1,394,984
1,153,668
1,129,786
967,043
1,036,631
980,596
941,046
1,003,134
1,029,917
1,149,068
1,197,496
1,373,150

12-Period Moving
Average

1,089,876
1,094,421
1,100,319
1,102,221
1,106,439
1,108,542
1,110,477

Centred Moving
Average

1,092,148
1,097,370
1,101,270
1,104,330
1,107,490
1,109,510

Seasonal
Relative

1.22909856
1.27120705
1.04758005
1.02305124
0.87318405
0.93431467

Seasonal/Cyclic Demand
Date

Actual

2011 Jan

926,061

Feb

870,271

Mar

980,311

Apr

979,293

Seasonal
Relative

Using all of the data available, obtain a

seasonal relative for each season by
averaging all those calculated earlier for the
same season. For July,

May

1,123,837

Jun

1,174,270

Jul

1,342,358

1.229

Aug

1,394,984

1.271

Sep

1,153,668

1.048

Oct

1,129,786

1.023

Seasonal/Cyclic Demand

Season
Jan
Feb
Mar
Apr
May
Jun
Jul
Aug
Sep
Oct
Nov
Dec

Average
Seasonal
Relative
0.859
0.815
0.905
0.935
1.049
1.100
1.233
1.294
1.046
1.042
0.877
0.934

Seasonal/Cyclic Demand
Now divide each of the observed (actual) values by its seasonal
Seasonal Deseasonalized
Year
Date
Actual
Relative Passenger Load
relative
2011 Jan
926,061 0.858985
1,078,087
Feb

870,271

0.814857

1,068,005

Mar

980,311

0.90535

1,082,798

Apr

979,293

0.935123

1,047,234

May

1,123,837

1.04872

1,071,628

Jun

1,174,270

1.099889

1,067,626

Jul

1,342,358

1.233022

1,088,673

Aug

1,394,984

1.294222

1,077,855

Sep

1,153,668

1.046004

1,102,929

Oct

1,129,786

1.042401

1,083,830

Seasonal/Cyclic Demand
1,800,000
1,600,000
1,400,000
1,200,000
1,000,000
800,000
600,000
400,000
200,000
0

f(x) = 5063.9x + 1075972.74

Actual Load
Deseasonalized Load
Linear (Deseasonalized Load)

Seasonal/Cyclic Demand
Suppose we want to forecast passenger load for December, 2015
(Period #62 in my data set),

*BUT* this figure represents the trend (or de-seasonalized passenger

load for December, 2015). To find the actual expected load, we must
RE-SEASONALIZE this number for December by multiplying it by the
seasonal relative for December:

Associative Models

Associate
models are those where the independent variable is
something other than time. For example, it may be forecasting your
term grade (the dependent variable, ) as a function of the number of
practice problems you complete (the independent variable, )
Linear regression can be done to obtain a trend, just as it was done
before. The only difference is that where appeared in the previous
equations, it is replaced with

where:

Measuring Forecast Accuracy

With
so many different forecasting
methods, how does one know which is
best?
Mean Absolute Deviation (MAD)
Mean Absolute Percentage Error
(MAPE)
Mean Squared Error (MSE)
Correlation coefficient ()

Measuring Forecast Accuracy

Correlation Coefficient

Used for linear trends ONLY!!! (not exponential, logarithmic,

or power formulas)

The closer is to 1, the better the forecasting model

represents the observed data

Correlation Coefficient
12,000
10,000

R
f(x)==1250.11x + 9251.71

8,000
Student Registration

6,000
4,000
2,000
0
2005 2006 2007 2008 2009 2010 2011
Year

Warning:
Higher values arent always better. A perfect fit to your
data can be made using a polynomial function but it might be
garbage when used in forecasting

Measuring Forecast Accuracy

Mean Squared Error (MSE)

Recall our moving average example:
Date
Temperature ()
Forecast Value ()

-2

-4

-4
-1.3

-2
-2

-7

-10

Error ()
Date

2.7
4

0
5

Squared Error ()

-2

-4

-4
7.1

-2
0

-7

-10

1.3
2.7

-2

7.1

Measuring Forecast Accuracy

Mean Absolute Deviation (MAD)

Recall our moving average example:
Date
Temperature ()
Forecast Value ()

-2

-4

-4
-1.3

-2
-2

-7

-10

Error ()
Date

2.7
4

0
5

Squared Error ()

-2

-4

-4
7.1

-2
0

-7

-10

1.3
2.7

-2

7.1

Measuring Forecast Accuracy

Mean Absolute Percentage Error

Recall our moving average example:
(MAPE)
Date
1
2
3
4
5
6
7
Temperature ()
Forecast Value ()

-2

-4

-4
-1.3

-2
-2

-7

-10

Error ()
Date

2.7
4

0
5

Squared Error ()

-2

-4

-4
7.1

-2
0

-7

-10

-1.3
67.5%

-2
0%

2.7

7.1

67.5
%

0%

% Error

% Error

Measuring Forecast Accuracy

Tracking

Signal

Rule of thumb: If the tracking signal is

larger than 4, its time to develop a new
forecasting model.

Choosing a Forecast Technique

Forecasting
Method

Amount of Historical
Data

Data Pattern

Forecast
Horizon

Preparation time

Complexity

Simple
exponential
smoothing

5 to 10 observations

Data should be
stationary

Short

Short

Little sophistication

Trend-adjusted
exponential
smoothing

10 to 15
observations

Trend

Short to
medium

Short

Moderate
sophistication

Regression
Trend models

10 to 20

Trend

Short,
medium, long

Short

Moderate
sophistication

Seasonal

Enough to see 3
peaks and troughs

seasonal patterns

Short to
medium

Short to moderate

Moderate
sophistication

Causal
regression
models

10 obs per
independent
variable

Can handle complex

patterns

Medium or
long

Long development
time, short time
implementation

Considerable
sophistication

Source: J. Holton Wilson and D. Allison-Koerber, Combining Subjective and Objective Forecasts Improves Results,
Journal of Business Forecasting Methods & Systems, 11(3) Fall 1992, p. 4.
62

Choosing a Forecast Technique

Factor
1. Frequency

Short Term
daily,
weekly

Medium Term
monthly,
quarterly

Long Term
annual

2. Level of
aggregation

Item

Product family

Total output

3. Type of model

Smoothing
Trend

4. Degree of
management
involvement
5. Cost per forecast

Low

Trend
Seasonal
Regression
Moderate

Managerial
Judgment
Trend Regression
High

Low

Moderate

High

Source: C. L. Jain, Benchmarking Forecasting Models, Journal of Business Forecasting Methods & Systems, Fall
2002, pp. 1820, 30.
63

Before Next Week

Review Chapter 3
Try Problems 4, 10 17
Read Chapter 8