Forecasting

Forecasting is the art and science of predicting future events Institute of business forecasting

Why Forecast?
Lead

times require that decisions be made in advance of uncertain events. Forecasting is an important for all strategic and planning decisions in a supply chain. Forecasts of product demand, materials, labor, financing are an important inputs to scheduling, acquiring resources, and determining resource requirements.

Demand Management
Demand

management is the interface between manufacturing planning and control and the marketplace. Activities include: Forecasting. Order Processing. Making delivery promises.

Demand Management
Resource Planning Production Planning

Marketplace

Demand Mgt.
Master Production Planning

Forecasting Horizons.
Short

Term (0 to 3 months): for inventory management and scheduling. Medium Term (3 months to 2 years): for production planning, purchasing, and distribution. Long Term (2 years and more): for capacity planning, facility location, and strategic planning.

Principles of Forecasting
Forecasts

are almost always wrong. Every forecast should include an estimate of the forecast error. The greater the degree of aggregation, the more accurate the forecast. Long-term forecasts are usually less accurate than short-term forecasts.

Forecasting Methods
Qualitative

methods are subjective in nature since they rely on human judgment and opinion. Quantitative methods use mathematical or simulation models based on historical demand or relationships between variables.

Some Qualitative Methods

Jury of Executive Opinion (opinions of a small group of high-level managers is pooled).

Sales Force Composite (aggregation of salespersons estimate of sales in their territory). Market Research Method (solicit input from customers or potential customers regarding future purchasing plans).

Delphi Method (a forecasting group uses a staff to prepare, distribute, collect, and summarize a series of questionnaires and survey results from geographically dispersed respondents, whose judgements are valued).

Quantitative Forecast Methods

Time Series Methods use historical data extrapolated into the future. They are best suited for stable environments. Moving averages, exponential smoothing methods, time series decomposition, and Box-Jenkins Methods. Causal Methods assume demand is highly correlated with certain environmental factors (indicators). Correlation methods, regression models, and econometric models. Simulation Methods imitate the consumer choices that give rise to demand to arrive at a forecast.

Time Series Demand Model

Observed Demand = Systematic Component + Random Component.

Systematic Component measures the expected value of demand and consists of: Level: the current deseasonalized demand. Trend: the rate of growth or decline in demand. Seasonality: the regular periodic oscillation in demand. Random Component is that part of demand that follows no discernable or predictable pattern.The random component is estimated by the forecast error (forecast actual demand).

Basic Forecasting Approach

Understand the forecasting objective. What decisions will be made from the forecasts? What parties in the supply chain will be affected by the decision. Integrate demand planning and forecasting. All planning activities within the supply chain that will use the forecast or influence demand should be linked. Identify factors that influence the demand forecast. Is demand growing or declining? Is there are relationship (complementary or substitution) between products?

Forecasting Approach (cont.)

Understand and Identify customer segments. Customer demand can be separately forecast for different segments based on service requirements, volume, order frequency, volatility, etc. Determine the appropriate forecasting technique. Typically, using a combination of the different techniques is of the the most effective approach. Establish performance and error measures. Forecasts need to be monitored for their accuracy and timeliness.

Time Series Forecasting

Static
Assume

estimates of level, trend, and seasonality do not vary as new data is observed. forecast as new data becomes available

Adaptive
Update

Time Series Forecasting

Static
Adaptive
Moving

average Single exponential smoothing Trend-adjusted exponential smoothing (Holts) Trend & Seasonal adjusted exponential smoothing (Winters)

Find the equation of the line static

Use

simple regression

Excel:

(Tools/Data Analysis/Regression) Dependent variable (y) is deseasonalized demand Independent variable (x) is period t y= intercept + slope * x = demand Other Excel Analysis Functions

Adaptive Forecasting
Moving Average
As each new observation becomes available, a new average can be computed by dropping the oldest observation and including the newest one.

The moving average will then be the forecast for the next period.
We use a moving average when demand has no discernable trend or seasonality. In this case, Systematic component of demand = level

Moving Average (N=3)

t Demand Level Forecast 0 1 20 2 60 (20+60+25)/3=35 3 25 35.00 (60+25+70)/3=51.67 4 70 51.67 5 28 41.00 (25+70+28)/3=41 6 72 56.67

1 2

(70+28+72)/3=56.67

Moving Average (N=3)

t Demand Level Forecast 0 1 20 2 60 3 25 35.00 4 70 51.67 5 28 41.00 6 72 56.67 1 56.67 2 56.67

Forecast = last level calculated

Adaptive Forecasting
Simple Exponential Smoothing
Weighted average of observations over time to predict future realizations of the series. The weights are an exponentially decreasing function of a smoothing constant. The greatest weight is given to the most recent observation and the weights add to one.

This method is appropriate when demand has no observable trend or seasonality. In this case, Systematic component of demand = level

Simple Exponential Smoothing, a=0.1

t Demand Level Forecast 0 45.83 1 20 L0=(20+60+25+70+28+72)/6=45.83 2 60 3 25 4 70 5 28 6 72

1 2

Simple Exponential Smoothing, a=0.1

t Demand Level Forecast 0 45.83 L1=a(20)+(1-a)(45.83)=43.25 1 20 43.25 2 60 44.93 L2=a(60)+(1-a)(43.25)=44.93 3 25 4 70 5 28 6 72 1 2

Simple Exponential Smoothing, a=0.1

t Demand Level Forecast 0 45.83 1 20 43.25 2 60 44.93 3 25 42.93 4 70 45.64 5 28 43.88 6 72 46.69 1 46.69 2 46.69

Forecast = last level calculated

4. Exponential Smoothing: An Airline company

estimates the demand for air travel using exponential smoothing.

Last week the forecast was 110,000 traffic and 90,000 passenger flow was actually realized. a. Using a = 0.2, prepare a forecast for next week. b. Calculate the forecast using a = 0.3 & a =0.4 for the problem. c. If actual demand = 98,000 , which value of a give the "Best" forecast ?

Part a and b
Alpha Actual Last week Forecast last week Forecast this week

PART c

.2
.3 .4

90000
90000 90000

110000
110000 110000

106000
104000 102000

Actual This week 98000 98000 98000

Error

-8000
-6000 -4000