4 Forecasting

PowerPoint presentation to accompany

Heizer and Render
Operations Management, 10e
Principles of Operations Management, 8e

PowerPoint slides by Jeff Heyl

1
 Outline
 What Is Forecasting?
 Forecasting Time Horizons
 Forecasting Approaches
 Overview of Qualitative Methods and Quantitative Methods
 Time-Series Forecasting
 Decomposition of a Time Series
 Naive Approach
 Time-Series Forecasting (cont.)
 Moving Averages
 Exponential Smoothing(with trend)
 Associative Forecasting Methods: Regression and
Correlation
 Using Regression Analysis for Forecasting
 Correlation Coefficients for Regression Lines
 Multiple-Regression Analysis

2
 Learning Objectives
When you complete this chapter you
should be able to :
1. Understand the three time horizons and
which models apply for each use
2. Explain when to use each of the four
qualitative models
3. Apply the naive, moving average, and
exponential smoothing
4. Compute measures of forecast accuracy

3
Forecasting at Disney World
 Revenues are derived from people
 Forecast used to adjust opening times, rides,
shows, staffing levels, and guests admitted
 Model includes gross domestic product, cross-
exchange rates, arrivals into the USA
 Survey 1 million park guests, employees, and
travel professionals each year
 Inputs are airline specials, Federal Reserve
policies, Wall Street trends, vacation/holiday
schedules for 3,000 school districts around the
world

4
 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
5
Forecasting Approaches
 Qualitative Methods
 Used when situation is vague and little data exist
 Involves intuition, experience

 Quantitative Methods
 Used when situation is ‘stable’ - historical data exist
 Involves mathematical techniques

6
 Overview of Qualitative
Methods
1. Jury of executive opinion
 Pool opinions of high-level experts
2. Delphi method
3. Sales force composite
 Aggregated estimates from salespersons
4. Consumer Market Survey

7
 Delphi Method
 Iterative group
Decision Makers
process, (Evaluate
continues until responses and
consensus is make decisions)
reached
Staff
 3 types of (Administering
survey)
participants
 Decision makers
 Staff Respondents
(People who can
 Respondents make valuable
judgments)
8
 Overview of Quantitative
Approaches
1. Naive approach
2. Moving averages
time-series
3. Exponential models
smoothing
4. Trend projection
5. Linear regression associative
model

9
 Time Series Forecasting

 Set of evenly spaced numerical data

 Forecast based only on past values, no
other variables important
 Components of a Time Series:
 Trend
 Seasonal
 Cyclical
 Random

10
 Components of Demand
Trend
component
Demand for product or service

Seasonal peaks

Actual demand
line

Average demand
over 4 years

Random variation
| | | |
1 2 3 4
Time (years)
Figure 4.1
11
 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

12
 Moving Average Method

 MA is a series of arithmetic means

 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

13
 Moving Average Example
Actual 3-Month
Month Shed Sales Moving Average
January 10
February 12
March 13
April 16 (10 + 12 + 13)/3 = 11 2/3
May 19 (12 + 13 + 16)/3 = 13 2/3
June 23 (13 + 16 + 19)/3 = 16
July 26 (16 + 19 + 23)/3 = 19 1/3

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 Graph of Moving Average
Moving
30 –
Average
28 –
Forecast
26 – Actual
24 – Sales
Shed Sales

22 –
20 –
18 –
16 –
14 –
12 –
10 –
| | | | | | | | | | | |
J F M A M J J A S O N D

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Weighted Moving Average
 Used when some trend might be
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

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 Weights Applied Period
Weighted Moving Average
3 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 = 121/6
May 19 [(3 x 16) + (2 x 13) + (12)]/6 = 141/3
June 23 [(3 x 19) + (2 x 16) + (13)]/6 = 17
July 26 [(3 x 23) + (2 x 19) + (16)]/6 = 201/2

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 Moving Average And
Weighted Moving Average
Weighted
30 – moving
average
25 –
Sales demand

20 – Actual
sales
15 –
Moving
10 – average

5 –
| | | | | | | | | | | |
J F M A M J J A S O N D
Figure 4.2
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 Exponential Smoothing
 Form of weighted moving average
 Weights decline exponentially
 Most recent data weighted most
 Requires smoothing constant ()
 Ranges from 0 to 1
 Less need for keeping past data

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 Exponential Smoothing
New forecast = 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)

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

21
 Exponential Smoothing
Example
Predicted demand = 142 Ford Mustangs
Actual demand = 153
Smoothing constant  = .20

New forecast = 142 + .2(153 – 142)

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 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

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 Impact of Different 
225 –

Actual  = .5
200 – demand
Demand

175 –

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

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 Impact of Different 
225 –

Actual  = .5
200
Chose
– high values
demandof 
Demand

when underlying average

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

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 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

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 Common Measures of Error
• Mean Absolute Deviation (MAD)
σ |Actual−Forecast|
MAD=
n

• Mean Squared Error (MSE)

σ (Forecast Errors)𝟐
MSE=
n

• Mean Absolute Percent Error (MAPE)

σ𝒏𝒊=𝟏 100|Actuali−Forecasti|/Actuali
MAPE=
n

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 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

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 Comparison of Forecast
Error
∑ |deviations|
Rounded Absolute Rounded Absolute
MADActual
= Forecast Deviation Forecast Deviation
Tonnage n
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

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 Comparison of Forecast
Error2
∑ (forecast errors)
Rounded Absolute Rounded Absolute
MSE = Actual Forecast Deviation Forecast Deviation
Tonnage
n
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

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 Comparison of Forecast
n Error
∑100|deviation |/actual i i
Rounded Absolute Rounded Absolute
MAPE = i=1
Actual Forecast Deviation Forecast Deviation
Tonnage with n 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

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 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%
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 Exponential Smoothing with
Trend Adjustment
When a trend is present, exponential
smoothing must be modified

Forecast Exponentially Exponentially

including (FITt) = smoothed (Ft) + smoothed (Tt)
trend forecast trend

© 2011 Pearson Education, Inc. publishing as Prentice Hall

33
 Exponential Smoothing with
Trend Adjustment

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

Tt = b(Ft - Ft - 1) + (1 - b)Tt - 1

Step 1: Compute Ft
Step 2: Compute Tt
Step 3: Calculate the forecast FITt = Ft + Tt

© 2011 Pearson Education, Inc. publishing as Prentice Hall

34
 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
© 2011 Pearson Education, Inc. publishing as Prentice Hall
35
 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
7 31 F2 = A1 + (1 - )(F1 + T1)
8 28 F2 = (.2)(12) + (1 - .2)(11 + 2)
9 36
10 = 2.4 + 10.4 = 12.8 units
Table 4.1
© 2011 Pearson Education, Inc. publishing as Prentice Hall
36
 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
7 31 T2 = b(F2 - F1) + (1 - b)T1
8 28 T2 = (.4)(12.8 - 11) + (1 - .4)(2)
9 36
10 = .72 + 1.2 = 1.92 units
Table 4.1
© 2011 Pearson Education, Inc. publishing as Prentice Hall
37
 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
7 31 FIT2 = F2 + T2
8 28 FIT2 = 12.8 + 1.92
9 36
10 = 14.72 units
Table 4.1
© 2011 Pearson Education, Inc. publishing as Prentice Hall
38
 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
© 2011 Pearson Education, Inc. publishing as Prentice Hall
39
 Exponential Smoothing with
Trend Adjustment Example
35 –

30 – Actual demand (At)

Product demand

25 –

20 –

15 –

10 – Forecast including trend (FITt)

with  = .2 and b = .4
5 –

0 – | | | | | | | | |
1 2 3 4 5 6 7 8 9
Figure 4.3
Time (month)
© 2011 Pearson Education, Inc. publishing as Prentice Hall
40
 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

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 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
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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

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 Associative Forecasting
Example
Sales Area 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

44
 Associative Forecasting
Example
y^ = 1.75 + .25x Sales = 1.75 + .25(payroll)

If payroll next year

4.0 –
is estimated to be
$6 billion, then: 3.25
3.0 –
Nodel’s sales
2.0 –
Sales = 1.75 + .25(6)
Sales = $3,250,000 1.0 –

| | | | | | |
0 1 2 3 4 5 6 7
Area payroll

45
 Correlation
 How strong is the linear relationship
between the variables?
 Coefficient of correlation r
 measures degree of association
 Values range from -1 to +1

 Coefficient of Determination r2
 the % change in y predicted by the change in x
 Values range from 0 to 1

For example, when r = .901 r2 = .81

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 Correlation Coefficient
y y

x x
(a) Perfect positive (b) Positive correlation:
correlation: r = +1 0<r<1

y y

x x
(c) No correlation: (d) Perfect negative
r=0 correlation: r = -1
47
 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
48
 Multiple Regression
Analysis
In the Nodel example, including interest rates in
the model gives the new equation:

y^ = 1.80 + .30x1 - 5.0x2

An improved correlation coefficient of r = .96

means this model does a better job of predicting
the change in construction sales

Sales = 1.80 + .30(6) - 5.0(.12) = 3.00

Sales = $3,000,000

49
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

50
 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
51
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
52
 In-Class Problems from the
Lecture Guide Practice Problems
Problem 1:
Auto sales at Carmen’s Chevrolet are shown below. Develop a 3-
week moving average.

Week Auto
Sales
1 8
2 10
3 9
4 11
5 10
6 13
7 -

53
 In-Class Problems from the
Lecture Guide Practice Problems
Problem 2:
Carmen’s decides to forecast auto sales by weighting the three
weeks as follows:

Weights Period
Applied
3 Last week
2 Two weeks ago
1 Three weeks ago
6 Total

54
 In-Class Problems from the
Lecture Guide Practice Problems

Problem 3:
A firm uses simple exponential smoothing with α=0.1 to forecast
demand. The forecast for the week of January 1 was 500 units
whereas the actual demand turned out to be 450 units. Calculate
the demand forecast for the week of January 8.

55
 In-Class Problems from the
Lecture Guide Practice Problems

Problem 4:
Exponential smoothing is used to forecast automobile battery sales.
Two value of α are examined α = 0.8 and α=0.5. Evaluate the
accuracy of each smoothing constant. Which is preferable?
(Assume the forecast for January was 22 batteries.) Actual sales
are given below:
Month Actual Forecast
Battery
Sales
January 20 22
February 21
March 15
April 14
May 13
June 16

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