Forecasting

4
PowerPoint slides by Jeff Heyl

Copyright © 2017 Pearson Education, Ltd. 4-1

 Outline
▶ What Is Forecasting?
▶ The Strategic Importance of Forecasting
▶ Seven Steps in the Forecasting System
▶ Forecasting Approaches
▶ Time-Series Forecasting

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 Learning Objectives
When you complete this chapter (part 1)
you should be able to :
4.1 Understand the three time horizons and
which models apply for each
4.2 Explain when to use each of the four
qualitative models
4.3 Apply the naive, moving-average and
exponential smoothing

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 What is Forecasting?
► Process of predicting a
future event
► Underlying basis
of all business
??
decisions
► Production
► Inventory
► Personnel
► Facilities
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 Forecasting Time Horizons
1. Short-range forecast
► Up to 1 year, generally less than 3 months
► Purchasing, job scheduling, workforce levels,
job assignments, production levels
2. Medium-range forecast
► 3 months to 3 years
► Sales and production planning, budgeting
3. Long-range forecast
► 3+ years
► New product planning, facility location,
research and development
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 Distinguishing Differences
1. Medium/long range forecasts deal with more
comprehensive issues and support
management decisions regarding planning
and products, plants and processes
2. Short-term forecasting usually employs
different methodologies than longer-term
forecasting
3. Short-term forecasts tend to be more
accurate than longer-term forecasts

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 Types of Forecasts
1. Economic forecasts
► Address business cycle – inflation rate, money
supply, housing starts, etc.
2. Technological forecasts
► Predict rate of technological progress
► Impacts development of new products
3. Demand forecasts
► Predict sales of existing products and services

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 Strategic Importance of
Forecasting
► Supply-Chain Management – Good
supplier relations, advantages in product
innovation, cost and speed to market
► Human Resources – Hiring, training,
laying off workers
► Capacity – Capacity shortages can result
in undependable delivery, loss of
customers, loss of market share

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 Seven Steps in Forecasting
1. Determine the use of the forecast
2. Select the items to be forecasted
3. Determine the time horizon of the
forecast
4. Select the forecasting model(s)
5. Gather the data needed to make the
forecast
6. Make the forecast
7. Validate and implement the results
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 The Realities!
► Forecasts are seldom perfect,
unpredictable outside factors may
impact the forecast
► Most techniques assume an
underlying stability in the system
► Product family and aggregated
forecasts are more accurate than
individual product forecasts

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 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

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 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
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 Overview of Qualitative Methods

1. Jury of executive opinion

► Pool opinions of high-level experts,
sometimes augmented by statistical
models
2. Delphi method
► Panel of experts, queried iteratively

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 Overview of Qualitative Methods

3. Sales force composite

► Estimates from individual salespersons
are reviewed for reasonableness, then
aggregated
4. Market Survey
► Ask the customer

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 Jury of Executive Opinion
► Involves small group of high-level experts
and managers
► Group estimates demand by working
together
► Combines managerial experience with
statistical models
► Relatively quick
► ‘Group-think’
disadvantage

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 Delphi Method
► Iterative group
process, continues Decision Makers
(Evaluate responses
until consensus is and make decisions)
reached
► Three types of Staff
(Administering
participants survey)

► Decision makers
► Staff
► Respondents Respondents
(People who can make
valuable judgments)
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 Sales Force Composite

► Each salesperson projects his or her

sales
► Combined at district and national
levels
► Sales reps know customers’ wants
► May be overly optimistic

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 Market Survey
► Ask customers about purchasing
plans
► Useful for demand and product
design and planning
► What consumers say and what they
actually do may be different
► May be overly optimistic

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 Overview of Quantitative
Approaches
1. Naive approach
2. Moving averages
3. Exponential Time-series
smoothing models
4. Trend projection
5. Linear regression Associative
model

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 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

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 Time-Series Components

Trend Cyclical

Seasonal Random

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 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

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 Trend Component
► Persistent, overall upward or
downward pattern
► Changes due to population,
technology, age, culture, etc.
► Typically several years duration

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 Seasonal Component
► Regular pattern of up and down
fluctuations
► Due to weather, customs, etc.
► Occurs within a single year
PERIOD LENGTH “SEASON” LENGTH NUMBER OF “SEASONS” IN PATTERN
Week Day 7
Month Week 4 – 4.5
Month Day 28 – 31
Year Quarter 4
Year Month 12
Year Week 52

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 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
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 Random Component
► Erratic, unsystematic, ‘residual’
fluctuations
► Due to random variation or unforeseen
events
► Short duration
and nonrepeating

M T W T
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 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

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 Moving Averages

► MA is a series of arithmetic means

► Used if little or no trend
► Used often for smoothing
► Provides overall impression of data
over time

Moving average =
å demand in previous n periods
n

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 Moving Average Example
MONTH ACTUAL SHED SALES 3-MONTH 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
August 30 (19 + 23 + 26)/3 = 22 2/3
September 28 (23 + 26 + 30)/3 = 26 1/3
October 18 (26 + 30 + 28)/3 = 28
November 16 (30 + 28 + 18)/3 = 25 1/3
December 14 (28 + 18 + 16)/3 = 20 2/3

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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

(( )(
Weighted å Weight for period n Demand in period n
moving =
))
average å Weights

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 Weighted Moving Average
MONTH ACTUAL SHED SALES 3-MONTH WEIGHTED MOVING AVERAGE
January 10
February 12
March 13
April 16 [(3 x 13) + (2 x 12) + (10)]/6 = 12 1/6
May 19
June WEIGHTS
23 APPLIED PERIOD

July 26 3 Last month

August 30 2 Two months ago

September 28 1 Three months ago

October 18 6 Sum of the weights

November Forecast for

16this month =
December 3 x14
Sales last mo. + 2 x Sales 2 mos. ago + 1 x Sales 3 mos. ago
Sum of the weights

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 Weighted Moving Average
MONTH ACTUAL SHED SALES 3-MONTH WEIGHTED MOVING AVERAGE
January 10
February 12
March 13
April 16 [(3 x 13) + (2 x 12) + (10)]/6 = 12 1/6
May 19 [(3 x 16) + (2 x 13) + (12)]/6 = 14 1/3
June 23 [(3 x 19) + (2 x 16) + (13)]/6 = 17
July 26 [(3 x 23) + (2 x 19) + (16)]/6 = 20 1/2
August 30 [(3 x 26) + (2 x 23) + (19)]/6 = 23 5/6
September 28 [(3 x 30) + (2 x 26) + (23)]/6 = 27 1/2
October 18 [(3 x 28) + (2 x 30) + (26)]/6 = 28 1/3
November 16 [(3 x 18) + (2 x 28) + (30)]/6 = 23 1/3
December 14 [(3 x 16) + (2 x 18) + (28)]/6 = 18 2/3

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 Potential Problems With
Moving Average
1. Increasing n smooths the forecast but
makes it less sensitive to changes
2. Does not forecast trends well
3. Requires extensive historical data

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 Graph of Moving Averages
Weighted moving average (from Example 2)

30 –

25 –
Sales demand

20 –

15 – Actual sales

10 – Moving average
(from Example 1)
5–
| | | | | | | | | | | |

J F M A M J J A S O N D
Figure 4.2 Month

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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
► Subjectively chosen
► Involves little record keeping of 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 period’s forecast
 = smoothing (or weighting) constant (0 ≤  ≤ 1)
At – 1 = previous period’s actual demand

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

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 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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 Effect of
Smoothing Constants
▶ Smoothing constant generally .05 ≤  ≤ .50
▶ As  increases, older values become less
significant

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

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 Impact of Different 
225 –

Actual  = .5
demand
200 –
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 –Choose high of  values
demand
when underlying average
Demand

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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 Selecting the Smoothing
Constant
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 according to one of three preferred
measures:
► Mean Absolute Deviation (MAD)
► Mean Squared Error (MSE)
► Mean Absolute Percent Error (MAPE)
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 Practical Problems
▶ Problem 4.1 page 184

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