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Forecasting
CHAPTER
Forecasting
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Forecasting
Forecast
We make forecasts about such things as weather, demand, and resource availability Forecasts are an important element in making informed decisions
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Forecasting
Uses of Forecasts
Accounting Finance Human Resources Marketing MIS Operations Product/service design Cost/profit estimates Cash flow and funding Hiring/recruiting/training Pricing, promotion, strategy IT/IS systems, services Schedules, MRP, workloads New products and services
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Forecasting
The level of demand may be a function of some structural variation such as trend or seasonal variation Related to the potential size of forecast error
Accuracy
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Forecasting
Techniques assume some underlying causal system that existed in the past will persist into the future Forecasts are not perfect Forecasts for groups of items are more accurate than those for individual items Forecast accuracy decreases as the forecasting horizon increases I see that you will
get an A this semester.
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Forecasting
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Forecasting
Determine the purpose of the forecast Establish a time horizon Select a forecasting technique Obtain, clean, and analyze appropriate data Make the forecast Monitor the forecast
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Forecasting
Types of Forecasts
Judgmental - uses subjective inputs Time series - uses historical data assuming the future will be like the past Associative models - uses explanatory variables to predict the future
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Forecasting
It is nearly impossible to correctly forecast realworld variable values on a regular basis So, it is important to provide an indication of the extent to which the forecast might deviate from the value of the variable that actually occurs
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Error = Actual Forecast If errors fall beyond acceptable bounds, corrective action may be necessary
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Forecast t n Forecast t )
2
MAD weights all errors evenly MSE weights errors according to their squared values
n 1
MAPE =
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Forecasting Approaches
Qualitative Forecasting
Human factors Personal opinions Hunches These factors are difficult, or impossible, to quantify
Quantitative techniques involve either the projection of historical data or the development of associative methods that attempt to use causal variables to make a forecast These techniques rely on hard data
Quantitative Forecasting
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Judgmental Forecasts
Forecasts that use subjective inputs such as opinions from consumer surveys, sales staff, managers, executives, and experts
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Assume that future values of the time-series can be estimated from past values of the timeseries
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Trend - long-term movement in data Seasonality - short-term regular variations in data Cycle wavelike variations of more than one years duration Irregular variations - caused by unusual circumstances Random variations - caused by chance
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Forecast Variations
Figure 3.1
Irregular variation
Trend
Cycles
90 89 88 Seasonal variations
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Naive Forecasts
Nave Forecast
Uses a single previous value of a time series as the basis for a forecast The forecast for a time period is equal to the previous time periods value Can be used when The time series is stable There is a trend There is seasonality
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These Techniques work best when a series tends to vary about an average
Averaging techniques smooth variations in the data They can handle step changes or gradual changes in the level of a series Techniques
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Moving Averages
Technique that averages a number of the most recent actual values in generating a forecast
Ft = MA t =
A
i =1
t i
where Ft = Forecast for time period t MA t = n period moving average At 1 = Actual value in period t 1 n = Number of periods in the moving average
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Moving Averages
As new data become available, the forecast is updated by adding the newest value and dropping the oldest and then recomputing the average The number of data points included in the average determines the models sensitivity
Fewer data points used-- more responsive More data points used-- less responsive
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The most recent values in a time series are given more weight in computing a forecast
The choice of weights, w, is somewhat arbitrary and involves some trial and error
F =w A +w 1 t(n1+.. +wA 1 . t n tn n A ) 1 t wr he e w =wgtf rpro e h o ei d i t, w 1 egtf rpro i i t1t . , ec t t =w h o e d A =t e culvl ef rpro h at a au o ei d t, A 1 h at avl ef rpro u u i t t =t e c l a o e d t1t . , ec
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MA3
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Exponential Smoothing
Therefore, we should give more weight to the more recent time periods when forecasting.
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Exponential Smoothing
Weighted averaging method based on previous forecast plus a percentage of the forecast error A-F is the error term, is the % feedback
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Focus Forecasting
Apply several forecasting methods to the last several periods of historical data The method with the highest accuracy is used to make the forecast for the following period This process is repeated each month
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Diffusion Models
Historical data on which to base a forecast are not available for new products
Predictions are based on rates of product adoption and usage spread from other established products Take into account facts such as
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Parabolic trend equation Exponential trend equation Growth curve trend equation
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A simple data plot can reveal the existence and nature of a trend Linear trend equation
Ft = a+b t w ere h Ft =F recast fo p d o r erio t a=V of Ft at t =0 alue b=S p o th lin lo e f e e t =S ecifiednu b o tim perio s fro p m er f e d m
t =0
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y b t a=
n
( t)
or y bt
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e e k
t 1 4 9 1 6 2 5
y S 1 1 1 1 1 a 5 5 6 6 7 le s 0 7 2 6 7 t y 1 5 3 1 4 8 6 6 8 8 0 4 6 4 5
=5 5 y
8 1 2 t y 2= 4 9 9 =
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y = 143.5 + 6.3t
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Associative Forecasting
Home values may be related to such factors as home and property size, location, number of bedrooms, and number of bathrooms
Associative techniques are based on the development of an equation that summarizes the effects of predictor variables
Predictor variables - variables that can be used to predict values of the variable of interest
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Simple linear regression - the simplest form of regression that involves a linear relationship between two variables
The object of simple linear regression is to obtain an equation of a straight line that minimizes the sum of squared vertical deviations from the line (i.e., the least squares criterion)
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y b x a=
n where
( x)
or y bx
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Standard Error
Standard error of estimate A measure of the scatter of points around a regression line If the standard error is relatively small, the predictions using the linear equation will tend to be more accurate than if the standard error is larger
Se = where S e = standard error of estimate y = the value of each data point n = number of data points
( y yc ) 2
n2
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Computed relationship
5 0 40 3 0 2 0 1 0 0 0 5 1 0 1 5 2 0 2 5
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Correlation Coefficient
Correlation A measure of the strength and direction of relationship between two variables Ranges between -1.00 and +1.00 r2, square of the correlation coefficient A measure of the percentage of variability in the values of y that is explained by the independent variable Ranges between 0 and 1.00
n y x x y 2 r = 2 2 n 2 x x n 2 y y
( )( ) ) ( ( )( ) ( )( )
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Given the following values of X and Y, (a) obtain a linear regression line for the data, and (2) what percentage of the variation is explained by the regression line? x y xy x2 y2 15.00 74.00 1110.0 225.0 5476.0 25.00 80.00 2000.0 625.0 6400.0 40.00 84.00 3360.0 1600.0 7056.0 32.00 81.00 2592.0 1024.0 6561.0 51.00 96.00 4896.0 2601.0 9216.0 47.00 95.00 4465.0 2209.0 9025.0 30.00 83.00 2490.0 900.0 6889.0 18.00 78.00 1404.0 324.0 6084.0 14.00 70.00 980.0 196.0 4900.0 15.00 72.00 1080.0 225.0 5184.0 22.00 85.00 1870.0 484.0 7225.0 24.00 88.00 2112.0 576.0 7744.0 33.00 90.00 2970.0 1089.0 8100.0
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1. 2.
3.
Variations around the line are random Deviations around the average value (the line) should be normally distributed Predictions are made only within the range of observed values
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Issues to consider
Always plot the line to verify that a linear relationships is appropriate The data may be time-dependent.
If they are
use analysis of time series use time as an independent variable in a multiple regression analysis
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Control chart
A visual tool for monitoring forecast errors Used to detect non-randomness in errors
All errors are within the control limits No patterns, such as trends or cycles, are present
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Cost Accuracy
Historical data Computers Time needed to gather and analyze the data Forecast horizon
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Reactive approach
View forecasts as probable future demand React to meet that demand Seeks to actively influence demand Advertising Pricing Product/service modifications Generally requires either and explanatory model or a subjective assessment of the influence on demand
Proactive approach