QUANTITATIVE ANALYSIS (ISD 551)

Lecturer: Dr. Emmanuel Quansah

Department: Supply Chain and Information Systems - KSB
Office: SF 25, KSB Undergraduate Block
 Module 3:
BUSINESS
FORECASTING
Learning Objectives (1 of 2)
After completing this chapter, students will be able to:
5.1 Understand and know when to use various families of
forecasting models.
5.2 Compare moving averages, exponential smoothing,
and other time-series models.
5.3 Calculate measures of forecast accuracy.
5.4 Apply forecast models for random variations.
5.5 Manipulate data to account for seasonal variations.
Introduction…1
• Main purpose of forecasting
• Reduce uncertainty and make better estimates of what will happen
in the future
• Forecasting is essential for a number of planning
decisions and often provides a valuable input on which
future operations of the business enterprise depend.

• Subjective methods
• Seat-of-the pants methods, intuition, experience
• More formal quantitative and qualitative techniques
 Introduction…2
Some of the areas where forecasts of future product
demand would be useful are indicated below

(1) Specification of production targets as functions

of time.

(2) Planning equipment and manpower usage, as well

as additional procurement .

(3) Budget allocation depending on the level of

production and sales. 5
 Introduction…3
4) Determination of the best inventory policy.

5) Decisions on expansion and major changes in

production processes and methods

6) Future trends of product development,

diversification, scrapping, etc.

7) Design of suitable pricing policy.

8) Planning the methods of distribution and sales

promotion. 6
 FORECASTING Vs PREDICTION
FORECASTING

Forecasting generally refers to the scientific methodology that

often uses past data along with some well-defined
assumptions or ‗model‘ to come up with a ―forecast‖ of future
demand.

In that sense, forecasting is OBJECTIVE.

7
 FORECASTING Vs PREDICTION
PREDICTION
A Prediction is a SUBJECTIVE estimate made
by an individual by using his intuitive ‗hunch‘
which may in fact come out true.

The fact that it is subjective (A’s prediction may be

different from B‘s and C‘s) and non-realizable as a
well-documented computer programme (which
would be used by anyone) deprives it of much
value.
8
Forecasting Models
FIGURE 5.1 Forecasting Models
Qualitative Models (1 of 3)
• Incorporate judgmental or subjective
factors
– Useful when subjective factors are important or
accurate quantitative data is difficult to obtain
• Common qualitative techniques
1. Delphi method
2. Jury of executive opinion
3. Sales force composite
4. Consumer market surveys
Qualitative Models (2 of 3)
• Delphi Method
• Iterative group process
• Respondents provide input to decision makers
• Repeated until consensus is reached
• Jury of Executive Opinion
• Collects opinions of a small group of high-level
managers
• May use statistical models for analysis
Qualitative Models (3 of 3)
• Sales Force Composite
• Allows individual salespersons estimates
• Reviewed for reasonableness
• Data is compiled at a district or national level
• Consumer Market Survey
• Information on purchasing plans solicited from
customers or potential customers
• Used in forecasting, product design, new
product planning
 13

QUANTITATIVE METHODS
Quantitative forecasting methods can be used when
(1) past information about the variable being forecast
is available,
(2) the information can be quantified, and

(3) a reasonable assumption is that the pattern of the

past will continue into the future.
In such cases, a forecast can be developed using a
TIME SERIES METHOD or a CAUSAL METHOD.
Time-Series Models
• A time series is a set of observations of a variable
measured at successive points in time or over successive
periods of time.
• Based on a sequence of evenly spaced data points
(weekly, monthly, quarterly etc)
• Predict the future based on the past
• Uses only historical data on one variable
• Extrapolations of past values of a series
• Ignores factors such as
• Economy
• Competition
• Selling price
Components of a Time Series (1 of 4)
• Sequence of values recorded at successive
intervals of time
• Four possible components;
• Trends – upwards or downwards (T)
• Seasonal effects (S)
• Cyclical effects (C)
• Random behaviour (R)
 16

TREND
• This refers to the UPWARD or DOWNWARD movement that

characterizes a time series over time.

• Thus trend reflects the long run growth or decline in the time

series.

• Trend movements can represent a variety of factors. For

example, long run movements in the sales of a particular

industry might be determined by changes in consumer tastes,
increase in total population, and increases in per capita
income.
17
 18

CYCLE
• Refers to recurring UP-AND-DOWN movements around trend

levels.

• These fluctuations can last from 2 to 10 years or even longer

measured from peak to peak or trough to trough. One of the most

common cyclical series data is the Business Cycle which is
represented by fluctuation in the time series caused by recurrent
periods of PROSPERITY and RECESSION.
19
Cyclical Effects
• Cyclical effects describe ups and downs over a much
longer time frame, such as several years.
 21

SEASONAL VARIATIONS
• These are periodic patterns in a time series that complete

themselves within a calendar year or less and are repeated

on a regular basis.

• Often seasonal variations occur yearly. For example, soft

drink sales and hotel room occupancies are annually higher in

the summer months, while department store sales are higher
in during Christmas holidays.
 22

SEASONAL VARIATIONS
• Seasonal variations can also last less than one year. For

example daily restaurant patronage might exhibit within

week seasonal variations, with daily patronage higher on
Fridays and Saturdays.
Seasonal Effects
• A seasonal effect is one that repeats at fixed intervals of
time, typically a year, month, week, or day.
 24

RANDOM/IRREGULAR
FLUCTUATIONS
• These are erratic time series movements that

follow no recognizable or regular pattern.

• Such movements represent what is ―left over‖ in a

time series after trend, cycle, and seasonal

variations have been accounted for.
Components of a Time Series (2 of 4)
FIGURE 5.2 Scatter Diagram for Four Time Series of
Quarterly Data
 Components of a Time Series (4 of 4)
• Product Demand Charted over 4 Years, with Trend and Seasonality
Indicated
Forecasting Time Horizons…1
• The primary purpose of forecasting is to provide

valuable information for planning the design and

operation of the enterprise.

• Planning decisions may be classified as long term,

medium term and short term.

• Long term decisions include decisions like plant

expansion or new product introduction which may

require new technologies or a complete
transformation in social or moral fabric of society
 28

Forecasting Time Horizons…2

.
• Medium term decisions involve such decisions as
planning the production levels in a manufacturing
plant over the next year, determination of manpower
requirements or inventory policy for the firm.

• Short term decisions include daily production planning

and scheduling decisions.

• For both medium and short term forecasting, many

methods and techniques exist.

Time-Series Models
• Two basic forms
– Multiplicative

Demand = T × S × C × R
– Additive

Demand = T + S + C + R
– Combinations are possible
Measures of Forecast Accuracy (1 of 5)
• Compare forecasted values with actual values
– See how well one model works
– To compare models

Forecast error = Actual value − Forecast value

• Measure of accuracy
– Mean absolute deviation (MAD):

MAD 
 forecast error
n
Measures of Forecast Accuracy (2 of 5)
TABLE 5.1 Computing the Mean Absolute Deviation (MAD)
ACTUAL ABSOLUTE VALUE OF
SALES OF WIRELESS ERRORS (DEVIATION),
MONTH SPEAKERS FORECAST SALES (ACTUAL − FORECAST)
1 110 — —
2 100 110 |100 − 110| = 10
3 120 100 |120 − 100| = 20
4 140 120 |140 − 120| = 20
5 170 140 |170 − 140| = 30
6 150 170 |150 − 170| = 20
7 160 150 |160 − 150| = 10
8 190 160 |190 − 160| = 30
9 200 190 |200 − 190| = 10
10 190 200 |190 − 200| = 10
11 — 190 —
Blank Blank Blank Sum of |errors| = 160
Blank Blank Blank MAD = 160÷9 = 17.8
Measures of Forecast Accuracy (3 of 5)
TABLE 5.1 Computing the Mean Absolute Deviation (MAD)
ACTUAL ABSOLUTE VALUE OF
SALES OF WIRELESS ERRORS (DEVIATION),
MONTH SPEAKERS FORECAST SALES (ACTUAL − FORECAST)
1 110 —
2 100 110
3 120 100 • Forecast based on
4 140 120
naïve model
5 170 140
6 150 170 • No attempt to adjust
7 160 150 for time series
8 190 160 components
9 200 190
10 190 200
11 — 190
Blank Blank Blank
Blank Blank Blank
Measures 
offorecast
Forecasterror Accuracy
160 (4 of 5)
MAD    17.8
n 9
TABLE 5.1 Computing the Mean Absolute Deviation (MAD)
ACTUAL ABSOLUTE VALUE OF
SALES OF WIRELESS ERRORS (DEVIATION),
MONTH SPEAKERS FORECAST SALES (ACTUAL − FORECAST)
1 110 — —
2 100 110 |100 − 110| = 10
3 120 100 |120 − 100| = 20
4 140 120 |140 − 120| = 20
5 170 140 |170 − 140| = 30
6 150 170 |150 − 170| = 20
7 160 150 |160 − 150| = 10
8 190 160 |190 − 160| = 30
9 200 190 |200 − 190| = 10
10 190 200 |190 − 200| = 10
11 — 190 —
Blank Blank Blank Sum of |errors| = 160
Blank Blank Blank MAD = 160÷9 = 17.8
Measures of Forecast Accuracy (5 of 5)
• Other common measures
– Mean squared error (MSE)

MSE 
 (error)2

n
– Mean absolute percent error (MAPE)
error
 actual
MAPE  100%
n

– Bias is the average error

Error Metrics and Forecast Accuarcy
n
• Mean absolute deviation  At  Ft
(MAD) MAD  t 1  9.2 
n
 At  Ft 
n 2

• Mean square error (MSE)
MSE  t 1  9.3
n

 At  Ft 2
n
• Root mean square error 
(RMSE) RMSE  t 1
 9.4 
n
n At  Ft
• Mean absolute percentage 
t 1 At
error (MAPE) MAPE  100  9.5 
n
Forecasting Random Variations
• No other components are present
• Averaging techniques smooth out forecasts
• Moving averages
• Weighted moving averages
• Exponential smoothing
Moving Averages (1 of 2)
• Used when demand is relatively steady over time
• The next forecast is the average of the most
recent n data values from the time series
• Smooths out short-term irregularities in the data
series

Sum of demands in previous n periods

Moving average forecast =
n
Moving Averages (2 of 2)
• Mathematically

Yt  Yt 1  ...  Yt n 1
Ft 1 
n

where
Ft+1 = forecast for time period t + 1
Yt = actual value in time period t
n = number of periods to average
Wallace Garden Supply (1 of 4)
• Wallace Garden Supply wants to forecast demand for its
Storage Shed
• Collected data for the past year
• Use a three-month moving average (n = 3)
Wallace Garden Supply (2 of 4)
TABLE 5.2 Wallace Garden Supply Shed Sales
MONTH ACTUAL SHED SALES 3-MONTH MOVING AVERAGE

January 10

February 12

March 13

April 16 (10 + 12 + 13)÷3 = 11.67

May 19 (12 + 13 + 16)÷3 = 13.67

June 23 (13 + 16 + 19)÷3 = 16.00

July 26 (16 + 19 + 23)÷3 = 19.33

August 30 (19 + 23 + 26)÷3 = 22.67

September 28 (23 + 26 + 30)÷3 = 26.33

October 18 (26 + 30 + 28)÷3 = 28.00

November 16 (30 + 28 + 18)÷3 = 25.33

December 14 (28 + 18 + 16)÷3 = 20.67

January — (18 + 16 + 14)÷3 = 16.00

Weighted Moving Averages
• Weighted moving averages use weights to put more
emphasis on previous periods
• Often used when a trend or other pattern is emerging

Ft 1 
 (Weight in period i )(Actual value in period i )
 (Weights)
• Mathematically

w1Yt  w 2Yt 1  ...  w nYt n 1

Ft 1 
w1  w 2  ...  w n
where
wi = weight for the ith observation
Wallace Garden Supply (3 of 4)
• Use a 3-month weighted moving average model to
forecast demand
• Weighting scheme

WEIGHT APPLIED Blank PERIOD

Blank 3 Last month

Blank 2 2 months ago
Blank 1 3 months ago
3 × Sales last month + 2 × Sales 2 months ago + 1 × Sales 3 months ago
Blank 6 Blank
Blank Blank Sum of the weights
Wallace Garden Supply (4 of 4)
TABLE 5.3 Weighted Moving Average Forecast for Wallace Garden Supply
MONTH ACTUAL SHED SALES 3-MONTH WEIGHTED MOVING AVERAGE

January 10

February 12

March 13

April 16 [(3 × 13) + (2 × 12) + (10)]÷6 = 12.17

May 19 [(3 × 16) + (2 × 13) + (12)]÷6 = 14.33

June 23 [(3 × 19) + (2 × 16) + (13)]÷6 = 17.00

July 26 [(3 × 23) + (2 × 19) + (16)]÷6 = 20.5

August 30 [(3 × 26) + (2 × 23) + (19)]÷6 = 23.83

September 28 [(3 × 30) + (2 × 26) + (23)]÷6 = 27.5

October 18 [(3 × 28) + (2 × 30) + (26)]÷6 = 28.33

November 16 [(3 × 18) + (2 × 28) + (30)]÷6 = 23.33

December 14 [(3 × 16) + (2 × 18) + (28)]÷6 = 18.67

January — [(3 × 14) + (2 × 16) + (18)]÷6 = 15.33

Exponential Smoothing (1 of 2)
• Exponential smoothing
• A type of moving average
• Easy to use
• Requires little record keeping of data

New forecast = Last period‘s forecast

+ α(Last period‘s actual demand
−Last period‘s forecast)

α is a weight (or smoothing constant) with a value 0 ≤ α ≤

1
Exponential Smoothing (2 of 2)
• Mathematically
Ft 1  Ft   (Yt  Ft )

where
Ft+1 = new forecast (for time period t + 1)
Ft = pervious forecast (for time period t)
α = smoothing constant (0 ≤ α ≤ 1)
Yt = pervious period‘s actual demand

The idea is simple – the new estimate is the old estimate

plus some fraction of the error in the last period
Exponential Smoothing Example (1 of 2)
• In January, February‘s demand for a certain car model
was predicted to be 142
• Actual February demand was 153 autos
• Using a smoothing constant of α = 0.20, what is the
forecast for March?
New forecast (for March demand) = 142 + 0.2(153 −
142)
= 144.2 or 144 autos
• If actual March demand = 136
New forecast (for April demand) = 144.2 + 0.2(136
− 144.2)
= 142.6 or 143 autos
Exponential Smoothing Example (2 of 2)
• Selecting the appropriate value for α is key to
obtaining a good forecast
• The objective is always to generate an accurate
forecast
• The general approach is to develop trial forecasts
with different values of α and select the α that
results in the lowest MAD
Port of Baltimore Example (1 of 2)
TABLE 5.4 Port of Baltimore Exponential Smoothing
Forecasts for α = 0.10 and α = 0.50
ACTUAL FORECAST
TONNAGE FORECAST USING
QUARTER UNLOADED USING α = 0.10 α = 0.50
1 180 175 175
2 168 175.5 = 175.00 + 0.10(180 − 175) 177.5
3 159 174.75 = 175.50 + 0.10(168 − 175.50) 172.75
4 175 173.18 = 174.75 + 0.10(159 − 174.75) 165.88
5 190 173.36 = 173.18 + 0.10(175 − 173.18) 170.44
6 205 175.02 = 173.36 + 0.10(190 − 173.36) 180.22
7 180 178.02 = 175.02 + 0.10(205 − 175.02) 192.61
8 182 178.22 = 178.02 + 0.10(180 − 178.02) 186.30
9 ? 178.60 = 178.22 + 0.10(182 − 178.22) 184.15
Port of Baltimore Example (2 of 2)
TABLE 5.5 Absolute Deviations and MADs for the Port of Baltimore Example
ACTUAL ABSOLUTE ABSOLUTE
TONNAGE FORECAST DEVIATIONS FOR FORECAST DEVIATIONS
QUARTER UNLOADED WITH α = 0.10 α = 0.10 WITH α = 0.50 FOR α = 0.50
1 180 175 5 175 5
2 168 175.5 7.5 177.5 9.5
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 4.3
Sum of
absolute Blank Blank 82.45 Blank 98.63
deviations
Σ deviations MAD = 12.33
MAD = = 10.31
Blank Blank n Blank

Best choice
Using Software (1 of 7)
PROGRAM 5.1A Selecting the Forecasting Model in
Wallace Garden Supply Problem
Using Software (2 of 7)
PROGRAM 5.1B Initializing Excel QM Spreadsheet for
Wallace Garden Supply Problem
Using Software (3 of 7)
PROGRAM 5.1C Excel QM Output for Wallace Garden
Supply Problem
Using Software (4 of 7)
PROGRAM 5.2A Selecting Time-Series Analysis in QM for
Windows in the Forecasting Module
Using Software (5 of 7)
PROGRAM 5.2B Entering Data for Port of Baltimore
Example in QM for Windows
Using Software (6 of 7)
PROGRAM 5.2C Selecting the Model and Entering Data
for Port of Baltimore Example in QM for Windows
Using Software (7 of 7)
PROGRAM 5.2D Output for Port of Baltimore Example in
QM for Windows
The Practice of Forecasting
• Judgmental and qualitative methods are used for
forecasting sales of product lines and broad company
and industry forecasts.
• Simple time-series models are used for short- and
medium-range forecasts.
• Regression methods are typically used for long-term
forecasts.
Questions???