FORECASTING

FORECASTING PROBLEM
Based On Previous Demand Data, Forecast The Number Of Units To Be Produced in
Future.

Month Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

Demand 220 90 210 396 616 700 378 220 200 115 95 260

Productio
22 18 21 22 22 20 21 22 20 23 19 20
n Days

50-50 PHONE A FRIEND PUBLIC OPINION

Supply & Demand

A SMALL demand and a BIG supply tend to

lower the price
Supply & Demand

A BIG demand and a SMALL supply results

in lost sales
 FORECASTING OBJECTIVES AND USES

Forecasts are estimates of the occurrence, timing, or magnitude of

uncertain future events. Forecasts are essential for the smooth
operations of business organizations. They provide information that can
assist managers in guiding future activities toward organizational goals.

Operations managers are primarily concerned with forecasts of

demand—which are often made by (or in conjunction with) marketing.
However, managers also use forecasts to estimate raw material prices,
plan for appropriate levels of personnel, help decide how much
inventory to carry, and a host of other activities. This results in better
use of capacity, more responsive service to customers, and improved
profitability.
 FORECASTING DECISION VARIABLES

Forecasting activities are a function of (1) the type of forecast (e.g.,

demand, technological), (2) the time horizon (short, medium, or long
range), (3) the database available, and (4) the methodology employed
(qualitative or quantitative).
Forecasts of demand are based primarily on non-random trends and
relationships, with an allowance for random components. Forecasts for
groups of products tend to be more accurate than those for single
products, and short-term forecasts are more accurate than long-term
forecasts (greater than five years).
 FORECASTING METHODS

There are numerous methods to forecasting depending on the

need of the decision-maker. These can be categorized in two
ways:
1. Opinion and Judgmental Methods or Qualitative Methods.
2. Quantitative Forecasting Methods.
Time Series Methods
 Moving Average
 Hand fitting
 Least Squares
Exponential Smoothing
Regression And Correlation Methods
 Opinion and Judgmental Methods

Some opinion and judgment forecasts are largely intuitive, whereas

others integrate data and perhaps even mathematical or statistical
techniques. Judgmental forecasts often consist of
(1) forecasts by individual sales people, (2) Forecasts by division or
product-line managers, and (3) combined estimates of the two.
Historical analogy relies on comparisons; Delphi relies on the best method from
a group of forecasts. All these methods can incorporate experiences
and personal insights. However, results may differ from one individual
to the next and they are not all amenable to analysis. So there may be
little basis for improvement over time.
 Opinion and judgment (qualitative)
Method Description

Sales force composites Estimates from field sales people are aggregated

Executive opinion Marketing, finance, and production managers jointly

prepare forecast

Field sales and product-line Estimates from regional sales people are reconciled
Management

Historical analogy Forecast from comparison with similar product

previously introduced

Delphi Experts answer a series of questions (anonymously)

receive feedback, and revise estimates

Market surveys Questionnaires/interviews for data to learn about MR-LR H

consumer behavior
 Time Series Methods
Time series is a set of observations of a variable at regular intervals over
time.
Time series Analysis: Plot the demand data on a time scale to reveal
patterns of demand
Characteristics of Demand over time:
Trend is a gradual long-term directional movement in the data
Seasonal effects are similar variations occurring during corresponding
periods
Cyclical factors are the long-term swings about the trend line. They are
often associated with business cycles and may extend out to several years
in length.
Random component are sporadic (unpredictable) effects due to
chance and unusual occurrences. They are the residual after the trend,
cyclical, and seasonal variations are removed.
What is noise in demand data?
 Time Series Methods

The forecast value (Ye) is commonly expressed as a

multiplicative or additive function of its components
Ye= T. S. C. R multiplicative model
Ye= T + S + C + R additive model
Three methods for describing trend are:
(1) Moving average
(2) Hand fitting
(3) Least squares
 MOVING AVERAGE
A centered moving average (MA) is obtained by summing and
averaging the values from a given number of periods repetitively,
each time deleting the oldest value and adding a new value.

A weighted moving average allows some values to be emphasized

by varying the weights assigned to each component of the average.
 HAND FITTING
A hand fit or freehand curve is simply a plot of a representative line that
(subjectively) seems to best fit the data points.

For linear data, the forecasting equation will be of the form:

Yc = a + b (X) (signature)

where Yc is the trend value, a is the intercept (where line crosses the vertical axis), b is
the slope (the rise, Δ y, divided by the run, Δ x), and X is the time value (years,
quarters, etc.).
The ―signature‖ identifies the point in time when X = 0, as well as the X andY
units.
 LEAST SQUARES

a mathematical technique of fitting a trend to data points.

For linear equations the line of best fit is found by the simultaneous
solution for a and b of the following two normal equations:

ΣY = na + bΣX
Σ XY = aΣX+bΣX 2
However, with time series, the data can also be coded so that ΣX = 0 ,and
the solution is simplified
 Seasonal patterns
Many organizations experience seasonal demand for their services or
goods. Seasonal patterns are regularly repeating upwards of
downwards movements in demand measured in periods if less than one
year. (hours, days, weeks, months or quarters)
Multiplicative seasonal method:
Seasonal factors are multiplied by an estimate of average demand to
arrive at a seasonal forecast.

The four step procedure:

1. For each year, calculate the average demand per season by dividing
annual demand by the number of seasons per year.
2. For each year, divide the actual demand for a season by average
demand for season. The result is a seasonal index for each season in the
[Link] indicates level of demand relative to the average demand.
3. Calculate the average seasonal index for each season, using step 2. add
the seasonal indices for a season and divide by the number of years of
data.
4. Calculate each season’s forecast for next year. Use any of the time
series or linear regression method to forecast the demand. Then obtain
the seasonal factor by multiplying the seasonal index by average
demand per season.
 EXPONENTIAL SMOOTHING
Exponential smoothening is a moving-average forecasting technique that
weights past data in an Exponential manner so that most recent data carry
more weight in the moving average. With simple Exponential smoothening,
the forecast Ft is made up of the last period forecast Ft–1 plus a portion, α, of the
difference between the last periods actual demand Dt–1 and last period
forecast Ft–1.
Ft = Ft–1 + (Dt–1– Ft–1).
Selection of α
A firm uses simple exponential smoothing with α = 0.1 to forecast
demand. The forecast for the week of February 1 was 500 units, whereas
actual demand turned out to be 450 units.
(a) Forecast the demand for the week of February 8.
(b) Assume that the actual demand during the week of February 8 turned
out to be 505 units. Forecast the demand for the week of February 15,
Continue forecasting through March 15, assuming that subsequent
demands were actually 516, 488, 467, 554 and 510 units.
Ft = Ft–1 + α (Dt–1– Ft–1)
= 500 + 0.1(450 – 500) = 495 unit

Dt–1 Dt–1 Dt–1 Dt–1

 Adjusted Exponential Smoothing
Adjusted exponential smoothing models have all the features of simple
exponential smoothing models, plus they project into the future (for
example, to time period t + 1) by adding a trend correction increment, Tt, to the
current period smoothed average,

a trend-adjusted forecast that utilizes a second smoothing coefficient β . The

β value determines the extent to which the trend adjustment relies on the
latest difference in forecast amounts versus the previous trend Tt–1 Thus:

Dt–1
 Problem
Develop an adjusted exponential forecast for the week of 5/14 for a firm with the
demand shown in Table 5.14. Let α = 0.1 and β = 0.2. Begin with a previous
average of Fˆt –1 = 650, and let the initial trend adjustment,Tt–1 = 0.
 Regression Analysis
A casual forecasting model in which, from historical data, a functional
relationship is established between variables and then used to forecast
dependent variable values.
The simple linear regression model takes the form Yc = a + bX, where Yc is the
dependent variable and X the independent variable. Values for the slope b and
intercept α are obtained by using the normal equations written in the convenient form
 Problem
The general manager of a building materials production plant feels that the demand for plasterboard
shipments may be related to the number of construction permits issued in the county during the previous
[Link] manager has collected the data shown in Table
(a) Compute values for the slope b and intercept a.
(b) Determine a point estimate for plasterboard shipments when the number of construction
permits is 30.