Forecasting

Forecasting at Disney World

 Global portfolio includes parks in Hong
Kong, Paris, Tokyo, Orlando, and
Anaheim
 Revenues are derived from people – how
many visitors and how they spend their
money
 Daily management report contains only
the forecast and actual attendance at
each park
Forecasting at Disney World
 Disney generates daily, weekly, monthly,
annual, and 5-year forecasts
 Forecast used by labor management,
maintenance, operations, finance, and
park scheduling
 Forecast used to adjust opening times,
rides, shows, staffing levels, and guests
admitted
Forecasting at Disney World
 20% of customers come from outside the
USA
 Economic model includes gross
domestic product, cross-exchange rates,
arrivals into the USA
 A staff of 35 analysts and 70 field people
survey 1 million park guests, employees,
and travel professionals each year
Forecasting at Disney World
 Inputs to the forecasting model include
airline specials, Federal Reserve
policies, Wall Street trends,
vacation/holiday schedules for 3,000
school districts around the world
 Average forecast error for the 5-year
forecast is 5%
 Average forecast error for annual
forecasts is between 0% and 3%
 What is Forecasting?
 Process of
predicting a future
event
 Underlying basis of
??
all business
decisions
 Production
 Inventory
 Personnel
 Facilities
 Forecasting Time Horizons
 Short-range forecast
 Up to 1 year, generally less than 3 months
 Purchasing, job scheduling, workforce levels,
job assignments, production levels
 Medium-range forecast
 3 months to 3 years
 Sales and production planning, budgeting
 Long-range forecast
 3+ years
 New product planning, facility location,
research and development
 Distinguishing Differences
 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
 Influence of Product Life
Cycle
Introduction – Growth – Maturity – Decline
 Introduction and growth require longer
forecasts than maturity and decline
 As product passes through life cycle,
forecasts are useful in projecting
 Staffing levels
 Inventory levels
 Factory capacity
 Product Life Cycle
Introduction Growth Maturity Decline
Best period to Practical to change Poor time to Cost control
Company Strategy/Issues

increase market price or quality change image, critical

share image price, or quality

R&D engineering is Strengthen niche Competitive costs

critical become critical
Defend market
position
CD-ROMs
Internet search engines
Analog TVs
Drive-through
LCD & plasma TVs restaurants

Sales iPods

3 1/2”
Xbox 360 Floppy
disks

Figure 2.5
 Types of Forecasts
 Economic forecasts
 Address business cycle – inflation rate,
money supply, housing starts, etc.
 Technological forecasts
 Predict rate of technological progress
 Impacts development of new products
 Demand forecasts
 Predict sales of existing products and
services
 Strategic Importance of
Forecasting

 Human Resources – Hiring, training,

laying off workers
 Capacity – Capacity shortages can
result in undependable delivery, loss
of customers, loss of market share
 Supply Chain Management – Good
supplier relations and price
advantages
Seven Steps in Forecasting
 Determine the use of the forecast
 Select the items to be forecasted
 Determine the time horizon of the
forecast
 Select the forecasting model(s)
 Gather the data
 Make the forecast
 Validate and implement results
 The Realities!

 Forecasts are seldom perfect

 Most techniques assume an
underlying stability in the system
 Product family and aggregated
forecasts are more accurate than
individual product forecasts
Forecasting Approaches
Qualitative Methods
 Used when situation is vague
and little data exist
 New products
 New technology
 Involves intuition, experience
 e.g., forecasting sales on Internet
 Forecasting Approaches
Quantitative Methods
 Used when situation is ‘stable’ and
historical data exist
 Existing products
 Current technology
 Involves mathematical techniques
 e.g., forecasting sales of color
televisions
 Overview of Qualitative
Methods
 Jury of executive opinion
 Pool opinions of high-level experts,
sometimes augment by statistical
models
 Delphi method
 Panel of experts, queried iteratively
 Overview of Qualitative
Methods
 Sales force composite
 Estimates from individual
salespersons are reviewed for
reasonableness, then aggregated
 Consumer Market Survey
 Ask the customer
 Overview of Quantitative
Approaches
1. Naive approach
2. Moving averages
Time-Series
3. Exponential Models
smoothing
4. Trend projection
Associative
5. Linear regression Model
 Time Series Forecasting
 Set of evenly spaced numerical data
 Obtained by observing response
variable at regular time periods
 Forecast based only on past values,
no other variables important
 Assumes that factors influencing
past and present will continue
influence in future
Time Series Components

Trend Cyclical

Seasonal Random
 Trend Component
 Persistent, overall upward or
downward pattern
 Changes due to population,
technology, age, culture, etc.
 Typically several years
duration
 Seasonal Component
 Regular pattern of up and
down fluctuations
 Due to weather, customs, etc.
 Occurs within a single year
Number of
Period Length Seasons
Week Day 7
Month Week 4-4.5
Month Day 28-31
Year Quarter 4
Year Month 12
Year Week 52
 Cyclical Component
 Repeating up and down movements
 Affected by business cycle,
political, and economic factors
 Multiple years duration
 Often causal or
associative
relationships

0 5 10 15 20
 Random Component
 Erratic, unsystematic, ‘residual’
fluctuations
 Due to random variation or
unforeseen events
 Short duration and
nonrepeating

M T W T F
 Naive Approach
 Assumes demand in next
period is the same as
demand in most recent period
 e.g., If January sales were 68, then
February sales will be 68
 Sometimes cost effective and
efficient
 Can be good starting point
 Moving Average Method
 MA is a series of arithmetic means
• While a naive forecast uses data from the previous
period, a moving average forecast uses a number of the
most recent actual data values
 Used if little or no trend
 Used often for smoothing
 Provides overall impression of data over time

∑ demand in previous n periods

Moving average = n
 Moving Average Example
Actual 3-Month
Month Shed Sales Moving Average
January 10
February 12
March 13
April 16 (10 + 12 + 13)/3 =
May 19 (12 + 13 + 16)/3 =
June 23 (13 + 16 + 19)/3 =
July 26 (16 + 19 + 23)/3 =
Weighted Moving Average
 Used when trend is present
 Older data usually less important
 Weights based on experience and
intuition
∑ (weight for period n)
Weighted x (demand in period n)
=
moving average ∑ weights
 Weights Applied Period
Weighted Moving
3 Average
Last month
2 Two months ago
1 Three months ago
6 Sum of weights

Actual 3-Month Weighted

Month Shed Sales Moving Average
January 10
February 12
March 13
April 16 [(3 x 13) + (2 x 12) + (10)]/6 =
May 19 [(3 x 16) + (2 x 13) + (12)]/6 =
June 23 [(3 x 19) + (2 x 16) + (13)]/6 =
July 26 [(3 x 23) + (2 x 19) + (16)]/6 =
 Potential Problems With
Moving Average
 Increasing n smooths the forecast
but makes it less sensitive to
changes
 Do not forecast trends well
 Require extensive historical data
 Moving Average And
Weighted Moving Average
30 – Weighted
moving
average
25 –
Sales demand

20 –
Actual
15 – sales

10 – Moving
average
5 –

| | | | | | | | | | | |
J F M A M J J A S O N D
 Exponential Smoothing
 Form of weighted moving average
 Weights decline exponentially
 Most recent data weighted most
 Requires smoothing constant ( )
 Ranges from 0 to 1
 Subjectively chosen
 Involves little record keeping of past
data
 Exponential Smoothing

t = Last period’s forecast

+  (Last period’s actual demand
– Last period’s forecast)

Ft = Ft – 1 +  (At – 1 - Ft – 1)

where Ft = new forecast

Ft – 1 = previous forecast
 = smoothing (or weighting)
constant (0 ≤  ≤ 1)
 Exponential Smoothing
Example
Predicted demand = 142 Ford Mustangs
Actual demand = 153
Smoothing constant  = .20
 Exponential Smoothing
Example
Predicted demand = 142 Ford Mustangs
Actual demand = 153
Smoothing constant  = .20

New forecast = 142 + .2(153 – 142)

 Exponential Smoothing
Example
Predicted demand = 142 Ford Mustangs
Actual demand = 153
Smoothing constant  = .20

New forecast = 142 + .2(153 – 142)

= 142 + 2.2
= 144.2 ≈ 144 cars
 Effect of
Smoothing Constants

Weight Assigned to
Most 2nd Most 3rd Most 4th Most 5th Most
Recent Recent Recent Recent Recent
Smoothing Period Period Period Period Period
Constant ( )  (1 -  )  (1 -  ) 2
 (1 -  ) 3
 (1 -  )4

 = .1 .1 .09 .081 .073 .066

 = .5 .5 .25 .125 .063 .031

 Impact of Different 
225 –

200 –
Actual  = .5
demand
Demand

175 –

150 –  = .1
| | | | | | | | |
1 2 3 4 5 6 7 8 9

Quarter
 Impact of Different 
225 –

Actual  = .5
 Chose
200 – high values of 
demand
Demand

when underlying average

is –likely to change
175
 Choose low values of 
when
150 – underlying average  = .1
is stable
| | | | | | | | |
1 2 3 4 5 6 7 8 9

Quarter
 Choosing 
The objective is to obtain the most
accurate forecast no matter the
technique
We generally do this by selecting the
model that gives us the lowest forecast
error
Forecast error = Actual demand - Forecast value
= At - Ft
Common Measures of Error
Mean Absolute Deviation (MAD)
∑ |Actual - Forecast|
MAD = n

Mean Squared Error (MSE)

∑ (Forecast Errors)2
MSE = n
Common Measures of Error

Mean Absolute Percent Error (MAPE)

n
∑100|Actuali - Forecasti|/Actuali
i=1
MAPE = n
 Comparison of Forecast
Error
Rounded Absolute Rounded Absolute
Actual Forecast Deviation Forecast Deviation
Tonnage for for
Quarter Unloaded  = .10  = .50
1 180 175 5.00 175 5.00
2 168 175.5 7.50 177.50 9.50
3 159 174.75 15.75 172.75 13.75
4 175 173.18 1.82 165.88 9.12
5 190 173.36 16.64 170.44 19.56
6 205 175.02 29.98 180.22 24.78
7 180 178.02 1.98 192.61 12.61
8 182 178.22 3.78 186.30 4.30
82.45 98.62
 Comparison of Forecast
Error
∑ |deviations|
Rounded Absolute Rounded Absolute
MADActual
= n
Forecast Deviation Forecast Deviation
Tonnage with for with for
Quarter Unloaded  = .10  = .10  = .50  = .50
1
For  =
180
.10 175 5.00 175 5.00
2 168 = 82.45/8
175.5 = 10.31
7.50 177.50 9.50
3 159 174.75 15.75 172.75 13.75
4 For 175
= .50 173.18 1.82 165.88 9.12
5 190 173.36 16.64 170.44 19.56
6 205 = 98.62/8
175.02 = 12.33
29.98 180.22 24.78
7 180 178.02 1.98 192.61 12.61
8 182 178.22 3.78 186.30 4.30
82.45 98.62
 Comparison of Forecast
Error
∑ (forecast errors) 2

MSE = Actual Rounded

n
Forecast
Absolute
Deviation
Rounded
Forecast
Absolute
Deviation
Tonnage with for with for
Quarter Unloaded  = .10  = .10  = .50  = .50
1
For  =
180
.10 175 5.00 175 5.00
2 = 1,526.54/8
168 175.5 = 190.82
7.50 177.50 9.50
3 159 174.75 15.75 172.75 13.75
4 For 175
= .50 173.18 1.82 165.88 9.12
5 190 173.36 16.64 170.44 19.56
6 = 1,561.91/8
205 175.02 = 195.24
29.98 180.22 24.78
7 180 178.02 1.98 192.61 12.61
8 182 178.22 3.78 186.30 4.30
82.45 98.62
MAD 10.31 12.33
 Comparison of Forecast
n
Error|/actual
∑100|deviation i i
i=1 Rounded Absolute Rounded Absolute
MAPE = Actual Forecast n Deviation Forecast Deviation
Tonnage with for with for
Quarter Unloaded  = .10  = .10  = .50  = .50
1
 = .10 175
For 180 5.00 175 5.00
2 168 = 44.75/8
175.5 = 7.50
5.59% 177.50 9.50
3 159 174.75 15.75 172.75 13.75
4 For =
175 .50 173.18 1.82 165.88 9.12
5 190 173.36 16.64 170.44 19.56
6 205 = 54.05/8
175.02 =29.98
6.76% 180.22 24.78
7 180 178.02 1.98 192.61 12.61
8 182 178.22 3.78 186.30 4.30
82.45 98.62
MAD 10.31 12.33
MSE 190.82 195.24
 Comparison of Forecast
Error
Rounded Absolute Rounded Absolute
Actual Forecast Deviation Forecast Deviation
Tonnage with for with for
Quarter Unloaded  = .10  = .10  = .50  = .50
1 180 175 5.00 175 5.00
2 168 175.5 7.50 177.50 9.50
3 159 174.75 15.75 172.75 13.75
4 175 173.18 1.82 165.88 9.12
5 190 173.36 16.64 170.44 19.56
6 205 175.02 29.98 180.22 24.78
7 180 178.02 1.98 192.61 12.61
8 182 178.22 3.78 186.30 4.30
82.45 98.62
MAD 10.31 12.33
MSE 190.82 195.24
MAPE 5.59% 6.76%
 Exponential Smoothing with
Trend Adjustment
When a trend is present, exponential
smoothing must be modified

Forecast Exponentially Exponentially

including (FITt) = smoothed (Ft) + (Tt) smoothed
trend forecast trend
Exponential Smoothing with
Trend Adjustment

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

Tt =  (Ft - Ft - 1) + (1 -  )Tt - 1

Step 1: Compute Ft
Step 2: Compute Tt
Step 3: Calculate the forecast FITt = Ft + Tt
 Exponential Smoothing with
Trend Adjustment Example
Forecast
Actual Smoothed Smoothed Including
Month(t) Demand (At) Forecast, Ft Trend, Tt Trend, FITt
1 12 11 2 13.00
2 17
3 20
4 19
5 24
6 21
7 31
8 28
9 36
10
Table 4.1
 Exponential Smoothing with
Trend Adjustment Example
Forecast
Actual Smoothed Smoothed Including
Month(t) Demand (At) Forecast, Ft Trend, Tt Trend, FITt
1 12 11 2 13.00
2 17
3 20
4 19
5 24 Step 1: Forecast for Month 2
6 21 F2 = A1 + (1 - )(F1 + T1)
7 31
8 28 F2 = (.2)(12) + (1 - .2)(11 + 2)
9 36
10 = 2.4 + 10.4 = 12.8 units
Table 4.1
 Exponential Smoothing with
Trend Adjustment Example
Forecast
Actual Smoothed Smoothed Including
Month(t) Demand (At) Forecast, Ft Trend, Tt Trend, FITt
1 12 11 2 13.00
2 17 12.80
3 20
4 19
5 24 Step 2: Trend for Month 2
6 21 T2 = (F2 - F1) + (1 - )T1
7 31
8 28 T2 = (.4)(12.8 - 11) + (1 - .4)(2)
9 36
10 = .72 + 1.2 = 1.92 units
Table 4.1
 Exponential Smoothing with
Trend Adjustment Example
Forecast
Actual Smoothed Smoothed Including
Month(t) Demand (At) Forecast, Ft Trend, Tt Trend, FITt
1 12 11 2 13.00
2 17 12.80 1.92
3 20
4 19
5 24 Step 3: Calculate FIT for Month 2
6 21 FIT2 = F2 + T1
7 31
8 28 FIT2 = 12.8 + 1.92
9 36
10 = 14.72 units
Table 4.1
 Exponential Smoothing with
Trend Adjustment Example
Forecast
Actual Smoothed Smoothed Including
Month(t) Demand (At) Forecast, Ft Trend, Tt Trend, FITt
1 12 11 2 13.00
2 17 12.80 1.92 14.72
3 20 15.18 2.10 17.28
4 19 17.82 2.32 20.14
5 24 19.91 2.23 22.14
6 21 22.51 2.38 24.89
7 31 24.11 2.07 26.18
8 28 27.14 2.45 29.59
9 36 29.28 2.32 31.60
10 32.48 2.68 35.16
Table 4.1
Exponential Smoothing with
Trend Adjustment Example
35 –

30 – Actual demand (At)

Product demand

25 –

20 –

15 –

10 – Forecast including trend (FITt)

5 – with  = .2 and  = .4

0 –
| | | | | | | | |
1 2 3 4 5 6 7 8 9
Figure 4.3
Time (month)
 Trend Projections
Fitting a trend line to historical data points
to project into the medium to long-range
Linear trends can be found using the least
squares technique

y^ = a + bx
^
where y = computed value of
the variable to be predicted
(dependent variable)
a = y-axis intercept
b = slope of the regression line
x = the independent variable
Values of Dependent Variable Least Squares Method

Actual observation Deviation7

(y value)

Deviation5 Deviation6

Deviation3

Deviation4

Deviation1
(error) Deviation2
Trend line, y^ = a + bx

Time period Figure 4.4

Values of Dependent Variable Least Squares Method

Actual observation Deviation7

(y value)

Deviation5 Deviation6

Deviation3 Least squares method

minimizes the sum of the
Deviation
squared errors (deviations)
4

Deviation1
Deviation2
Trend line, y^ = a + bx

Time period Figure 4.4

 Least Squares Method
Equations to calculate the regression variables

y^ = a + bx

 xy - nxy
b=
 x2 - nx2

a = y - bx
 Least Squares Example
Time Electrical Power
Year Period (x) Demand x2 xy
2001 1 74 1 74
2002 2 79 4 158
2003 3 80 9 240
2004 4 90 16 360
2005 5 105 25 525
2005 6 142 36 852
2007 7 122 49 854
∑x = 28 ∑y = 692 ∑x2 = 140 ∑xy = 3,063
x=4 y = 98.86
∑xy - nxy 3,063 - (7)(4)(98.86)
b= = 140 - (7)(42) = 10.54
∑x2 - nx2

a = y - bx = 98.86 - 10.54(4) = 56.70

 Least Squares Example
Time Electrical Power
Year Period (x) Demand x2 xy
1999 1 74 1 74
2000 2 79 4 158
2001The trend3 line is 80 9 240
2002 4 90 16 360
2003 y^ 5= 56.70 + 10.54x
105 25 525
2004 6 142 36 852
2005 7 122 49 854
 x = 28  y = 692  x2 = 140  xy = 3,063
x=4 y = 98.86
 xy - nxy 3,063 - (7)(4)(98.86)
b =  x2 - nx2 = 140 - (7)(42) = 10.54

a = y - bx = 98.86 - 10.54(4) = 56.70

 Least Squares Example
160 –
Trend line,
150 – y^ = 56.70 + 10.54x
140 –
Power demand

130 –
120 –
110 –
100 –
90 –
80 –
70 –
60 –
50 –
| | | | | | | | |
2001 2002 2003 2004 2005 2006 2007 2008 2009
Year
Seasonal Variations In Data

The multiplicative
seasonal model
can adjust trend
data for seasonal
variations in
demand
 Seasonal Variations In Data
Steps in the process:

1. Find average historical demand for each

season
2. Compute the average demand over all
seasons
3. Compute a seasonal index for each season
4. Estimate next year’s total demand
5. Divide this estimate of total demand by the
number of seasons, then multiply it by the
seasonal index for that season
 Seasonal Index Example
Demand Average Average Seasonal
Month 2005 2006 2007 2005-2007 Monthly Index
Jan 80 85 105 90 94
Feb 70 85 85 80 94
Mar 80 93 82 85 94
Apr 90 95 115 100 94
May 113 125 131 123 94
Jun 110 115 120 115 94
Jul 100 102 113 105 94
Aug 88 102 110 100 94
Sept 85 90 95 90 94
Oct 77 78 85 80 94
Nov 75 72 83 80 94
Dec 82 78 80 80 94
 Seasonal Index Example
Demand Average Average Seasonal
Month 2005 2006 2007 2005-2007 Monthly Index
Jan 80 85 105 90 94 0.957
Feb 70 85 85 80 94
Mar 80 93 average
82 2005-2007
85 monthly demand
94
Seasonal index =
Apr 90 95 115 average monthly
100 demand94
May 113 125= 90/94
131 = .957 123 94
Jun 110 115 120 115 94
Jul 100 102 113 105 94
Aug 88 102 110 100 94
Sept 85 90 95 90 94
Oct 77 78 85 80 94
Nov 75 72 83 80 94
Dec 82 78 80 80 94
 Seasonal Index Example
Demand Average Average Seasonal
Month 2005 2006 2007 2005-2007 Monthly Index
Jan 80 85 105 90 94 0.957
Feb 70 85 85 80 94 0.851
Mar 80 93 82 85 94 0.904
Apr 90 95 115 100 94 1.064
May 113 125 131 123 94 1.309
Jun 110 115 120 115 94 1.223
Jul 100 102 113 105 94 1.117
Aug 88 102 110 100 94 1.064
Sept 85 90 95 90 94 0.957
Oct 77 78 85 80 94 0.851
Nov 75 72 83 80 94 0.851
Dec 82 78 80 80 94 0.851
 Seasonal Index Example
Demand Average Average Seasonal
Month 2005 2006 2007 2005-2007 Monthly Index
Jan 80 85 105 90 94 0.957
Feb 70 85 Forecast
85 for802008 94 0.851
Mar 80 93 82 85 94 0.904
Apr 90Expected
95 115annual demand
100 = 1,200
94 1.064
May 113 125 131 123 94 1.309
Jun 110 115 120 1,200 115 94 1.223
Jan x .957 = 96
Jul 100 102 113 12 105 94 1.117
Aug 88 102 110 1,200 100 94 1.064
Sept 85 Feb 95
90 x90.851 = 85 94 0.957
12
Oct 77 78 85 80 94 0.851
Nov 75 72 83 80 94 0.851
Dec 82 78 80 80 94 0.851
 Seasonal Index Example
2008 Forecast
140 – 2007 Demand
130 – 2006 Demand
120 – 2005 Demand
Demand

110 –
100 –
90 –
80 –
70 –
| | | | | | | | | | | |
J F M A M J J A S O N D
Time
 San Diego Hospital
Trend Data
10,200 –

10,000 –
Inpatient Days

9,800 – 9745
9702
9616 9659
9,600 – 9573 9766
9530 9680 9724
9594 9637
9,400 – 9551
9,200 –

9,000 – | | | | | | | | | | | |
Jan Feb Mar Apr May June July Aug Sept Oct Nov Dec
67 68 69 70 71 72 73 74 75 76 77 78
Month
Figure 4.6
 San Diego Hospital
Seasonal Indices
1.06 –
1.04 – 1.04 1.04
Index for Inpatient Days

1.03
1.02 – 1.02
1.01
1.00 – 1.00
0.99
0.98 – 0.98
0.99
0.96 –
0.97 0.97
0.94 – 0.96

0.92 – | | | | | | | | | | | |
Jan Feb Mar Apr May June July Aug Sept Oct Nov Dec
67 68 69 70 71 72 73 74 75 76 77 78
Month
Figure 4.7
 Associative Forecasting
Used when changes in one or more
independent variables can be used to predict
the changes in the dependent variable

Most common technique is linear

regression analysis

We apply this technique just as we did

in the time series example
 Associative Forecasting
Forecasting an outcome based on predictor
variables using the least squares technique

y^ = a + bx
^
where y = computed value of
the variable to be predicted
(dependent variable)
a = y-axis intercept
b = slope of the regression line
x = the independent variable
though to predict the value of the
dependent variable
 Associative Forecasting
Example
Sales Local Payroll
($ millions), y ($ billions), x
2.0 1
3.0 3
2.5 4 4.0 –
2.0 2
2.0 1 3.0 –
3.5 7 Sales
2.0 –

1.0 –

| | | | | | |
0 1 2 3 4 5 6 7
Area payroll
 Associative Forecasting
Example
Sales, y Payroll, x x2 xy
2.0 1 1 2.0
3.0 3 9 9.0
2.5 4 16 10.0
2.0 2 4 4.0
2.0 1 1 2.0
3.5 7 49 24.5
∑y = 15.0 ∑x = 18 ∑x2 = 80 ∑xy = 51.5

∑xy - nxy 51.5 - (6)(3)(2.5)

x = ∑x/6 = 18/6 = 3 b= ∑x2 - nx2 = 80 - (6)(32) = .25

y = ∑y/6 = 15/6 = 2.5 a = y - bx = 2.5 - (.25)(3) = 1.75

 Associative Forecasting
Example
y^ = 1.75 + .25x Sales = 1.75 + .25(payroll)

If payroll next year 4.0 –

is estimated to be
3.25
$6 billion, then: 3.0 –
Sales
2.0 –
Sales = 1.75 + .25(6) 1.0 –
Sales = $3,250,000
| | | | | | |
0 1 2 3 4 5 6 7
Area payroll
 Correlation
 How strong is the linear
relationship between the
variables?
 Correlation does not necessarily
imply causality!
 Coefficient of correlation, r,
measures degree of association
 Values range from -1 to +1
Correlation Coefficient
n xy -  x y
r=
[n x2 - ( x)2][n y2 - ( y)2]
y
Correlation Coefficient y

n xy -  x y
r=
[n x2 - ( x)2][n y2 - ( y)2]
(a) Perfect positive x (b) Positive x
correlation: correlation:
r = +1 0<r<1

y y

x (d) Perfect negative x

(c) No correlation:
r=0 correlation:
r = -1
 Correlation
 Coefficient of Determination, r2,
measures the percent of change in
y predicted by the change in x
 Values range from 0 to 1
 Easy to interpret

For the Nodel Construction example:

r = .901
r2 = .81
 Multiple Regression
Analysis
If more than one independent variable is to be
used in the model, linear regression can be
extended to multiple regression to
accommodate several independent variables
^
y = a + b1x1 + b2x2 …

Computationally, this is quite

complex and generally done on the
computer
 Monitoring and Controlling
Forecasts
Tracking Signal
 Measures how well the forecast is
predicting actual values
 Ratio of running sum of forecast errors
(RSFE) to mean absolute deviation (MAD)
 Good tracking signal has low values
 If forecasts are continually high or low, the
forecast has a bias error
Monitoring and Controlling
Forecasts

Tracking = RSFE
signal MAD

∑(Actual demand in
period i -
Forecast demand
Tracking = in period i)
signal  ∑|Actual - Forecast|/n)
 Tracking Signal
Signal exceeding limit
Tracking signal
Upper control limit
+

0 MADs Acceptable
range
–

Lower control limit

Time
 Tracking Signal Example
Cumulative
Absolute Absolute
Actual Forecast Forecast Forecast
Qtr Demand Demand Error RSFE Error Error MAD

1 90 100 -10 -10 10 10 10.0

2 95 100 -5 -15 5 15 7.5
3 115 100 +15 0 15 30 10.0
4 100 110 -10 -10 10 40 10.0
5 125 110 +15 +5 15 55 11.0
6 140 110 +30 +35 30 85 14.2
 Tracking Signal Example
Cumulative
Tracking Absolute Absolute
Actual Signal
Forecast Forecast Forecast
Qtr (RSFE/MAD)
Demand Demand Error RSFE Error Error MAD

1 90-10/10
100= -1 -10 -10 10 10 10.0
2 95
-15/7.5
100= -2 -5 -15 5 15 7.5
3 115 0/10
100= 0 +15 0 15 30 10.0
4 100-10/10
110= -1 -10 -10 10 40 10.0
5 125
+5/11110
= +0.5+15 +5 15 55 11.0
6 140
+35/14.2
110= +2.5
+30 +35 30 85 14.2

The variation of the tracking signal

between -2.0 and +2.5 is within acceptable
limits
 Adaptive Forecasting

It’s possible to use the computer to

continually monitor forecast error and
adjust the values of the  and 
coefficients used in exponential
smoothing to continually minimize
forecast error
This technique is called adaptive
smoothing
 Focus Forecasting
Developed at American Hardware Supply,
focus forecasting is based on two principles:
1. Sophisticated forecasting models are not
always better than simple ones
2. There is no single technique that should
be used for all products or services
This approach uses historical data to test
multiple forecasting models for individual items
The forecasting model with the lowest error is
then used to forecast the next demand
Forecasting in the Service
Sector
 Presents unusual challenges
 Special need for short term records
 Needs differ greatly as function of
industry and product
 Holidays and other calendar events
 Unusual events
 Fast Food Restaurant
Forecast
20% –
Percentage of sales

15% –

10% –

5% –

11-12 1-2 3-4 5-6 7-8 9-10

12-1 2-3 4-5 6-7 8-9 10-11
(Lunchtime) (Dinnertime)
Hour of day Figure 4.12
FedEx Call Center Forecast
12% –

10% –

8% –

6% –

4% –

2% –

0% –

2 4 6 8 10 12 2 4 6 8 10 12
A.M. P.M.
Hour of day
Figure 4.12