Chapter 2

Project Management & Forecasting

Dr Selvi @ Kausiliha Vijayan
Learning Objectives (1 of 2)
When you complete this chapter you should be able to:
3.1 Use a Gantt chart for scheduling

3.2 Draw AOA and AON networks

3.3 Complete forward and backward passes for a project

3.4 Determine a critical path

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Learning Objectives (2 of 2)
When you complete this chapter you should be able to:
3.5 Calculate the variance of activity times

3.6 Crash a project

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Importance of Project Management
• Bechtel Project Management
– International workforce, construction professionals,
cooks, medical personnel, security
– Strategic value of time-based competition
– Quality mandate for continual improvement

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Project Characteristics
• Single unit
• Many related activities
• Difficult production planning and inventory control
• General purpose equipment
• High labor skills

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Examples of Projects
• Building Construction

• Research Project

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Management of Projects
1. Planning - goal setting, defining the project, team
organization
2. Scheduling - relate people, money, and supplies to
specific activities and activities to each other
3. Controlling - monitor resources, costs, quality, and
budgets; revise plans and shift resources to meet time
and cost demands

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Project Management Activities

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Project Planning, Scheduling, and
Controlling (1 of 2)
Figure 3.1

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Project Planning, Scheduling, and
Controlling (2 of 2)
Figure 3.1

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Project Planning
• Establishing objectives
• Defining project
• Creating work breakdown
structure
• Determining resources
• Forming organization

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Project Organization
• Often temporary structure
• Uses specialists from entire
company
• Headed by project manager
– Coordinates activities
– Monitors schedule and
costs
• Permanent structure called
‘matrix organization’

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Project Organization Most Helpful
When:
1. Work can be defined with a specific goal and deadline
2. The job is unique or somewhat unfamiliar to the existing
organization
3. The work contains complex interrelated tasks requiring
specialized skills
4. The project is temporary but critical to the organization
5. The project cuts across organizational lines

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A Sample Project Organization
Figure 3.2

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Matrix Organization

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The Role of the Project Manager
(1 of 2)

Highly visible, Responsible for making sure that:

1. All necessary activities are finished in order and on time
2. The project comes in within budget
3. The project meets quality goals
4. The people assigned to the project receive motivation,
direction, and information

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The Role of the Project Manager
(2 of 2)
Highly visible, Responsible for making sure that:
1. All necessary activities are finished in order and on time
2. The project comes in within budget
3. The project meets quality goals
4. The people assigned to the project receive motivation,
direction, and information
Project managers should be:

• Good coaches
• Good communicators
• Able to organize activities from a variety of disciplines
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Ethical Issues
• Project managers face many ethical decisions on a daily
basis
• The Project Management Institute has established an
ethical code to deal with problems such as:
1. Offers of gifts from contractors
2. Pressure to alter status reports to mask delays
3. False reports for charges of time and expenses
4. Pressure to compromise quality to meet schedules

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Work Breakdown Structure (1 of 2)
Level
1. Project
2. Major tasks in the project
3. Subtasks in the major tasks
4. Activities (or “work packages”) to be completed

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Work Breakdown Structure (2 of 2)
Figure 3.3

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Project Scheduling Techniques (1 of 2)
• Ensure that all activities are
planned for
• Their order of performance
is accounted for
• The activity time estimates
are recorded
• The overall project time is
developed

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Purposes of Project Scheduling
1. Shows the relationship of each activity to others and to
the whole project
2. Identifies the precedence relationships among activities
3. Encourages the setting of realistic time and cost
estimates for each activity
4. Helps make better use of people, money, and material
resources by identifying critical bottlenecks in the project

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Project Scheduling Techniques (2 of 2)
1. Gantt chart
2. Critical Path Method (CPM)
3. Program Evaluation and Review Technique (PERT)

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A Simple Gantt Chart

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Service For a Delta Jet
Figure 3.4

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Project Controlling
• Close monitoring of
resources, costs, quality,
budgets
• Feedback enables revising
the project plan and shift
resources
• Computerized tools
produce extensive reports

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Project Management Software
• There are several popular packages for managing projects
– Oracle Primavera
– Mind View
– HP Project
– Fast Track
– Microsoft Project

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Project Control Reports
1. Detailed cost breakdowns for each task
2. Labor requirements
3. Cost and hour summaries
4. Raw material and expenditure forecasts
5. Variance reports
6. Time analysis reports
7. Work status reports

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Project Control (1 of 2)
• Well-defined – Waterfall Projects
– Extensive planning
– Known constraints
– Well-defined specifications

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Project Control (2 of 2)
• Ill-defined – Agile Projects
– Many unknowns
– Evolving technology and specifications
– Project developed iteratively and incrementally

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PERT and CPM
• Network techniques
• Developed in 1950s
– CPM by DuPont for chemical plants (1957)
– PERT by Booz, Allen & Hamilton with the U.S. Navy,
for Polaris missile (1958)
• Consider precedence relationships and interdependencies
• Each uses a different estimate of activity times

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Six Steps PERT and CPM (1 of 2)
1. Define the project and prepare the work breakdown
structure
2. Develop relationships among the activities – decide
which activities must precede and which must follow
others
3. Draw the network connecting all of the activities

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Six Steps PERT and CPM (2 of 2)
4. Assign time and/or cost estimates to each activity
5. Compute the longest time path through the network – this
is called the critical path
6. Use the network to help plan, schedule, monitor, and
control the project

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Questions PERT and CPM Can
Answer (1 of 2)
1. When will the entire project be completed?
2. What are the critical activities or tasks in the project?
3. Which are the noncritical activities?
4. What is the probability the project will be completed by a
specific date?

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Questions PERT and CPM Can
Answer (2 of 2)
5. Is the project on schedule, behind schedule, or ahead of
schedule?
6. Is the money spent equal to, less than, or greater than
the budget?
7. Are there enough resources available to finish the project
on time?
8. If the project must be finished in a shorter time, what is
the way to accomplish this at least cost?

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A Comparison of AON and AOA
Network Conventions (1 of 3)

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A Comparison of AON and AOA
Network Conventions (2 of 3)

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A Comparison of AON and AOA
Network Conventions (3 of 3)

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AON Example
Table 3.1 Milwaukee Paper Manufacturing’s Activities and
Predecessors
IMMEDIATE
ACTIVITY DESCRIPTION PREDECESSORS
A Build internal components Blank
B Modify roof and floor Blank
C Construct collection stack A
D Pour concrete and install frame A, B
E Build high-temperature burner C
F Install pollution control system C
G Install air pollution device D, E
H Inspect and test F, G
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AON Network for Milwaukee Paper
(1 of 3)
Figure 3.5

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AON Network for Milwaukee Paper
(2 of 3)
Figure 3.6

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AON Network for Milwaukee Paper
(3 of 3)
Figure 3.7

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AOA Network for Milwaukee Paper
Figure 3.8

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Determining the Project Schedule
(1 of 4)
Perform a Critical Path Analysis
• The critical path is the longest path through the network
• The critical path is the shortest time in which the project
can be completed
• Any delay in critical path activities delays the project
• Critical path activities have no slack time

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Determining the Project Schedule
(2 of 4)
Table 3.2 Time Estimates for Milwaukee Paper
Manufacturing

ACTIVITY DESCRIPTION TIME (WEEKS)

A Build internal components 2
B Modify roof and floor 3
C Construct collection stack 2
D Pour concrete and install frame 4
E Build high-temperature burner 4
F Install pollution control system 3
G Install air pollution device 5
H Inspect and test 2
Blank Total time (weeks) 25

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Determining the Project Schedule
(3 of 4)
Perform a Critical Path Analysis
Earliest start (ES) = earliest time at which an activity can
start, assuming all predecessors have
been completed
Earliest finish (EF) =earliest time at which an activity can be
finished
Latest start (LS) = latest time at which an activity can start
so as to not delay the completion time
of the entire project
Latest finish (LF) = latest time by which an activity has to
be finished so as to not delay the
completion time of the entire project
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Determining the Project Schedule
(4 of 4)
Figure 3.9

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Forward Pass (1 of 2)
Begin at starting event and work forward
Earliest Start Time Rule:
• If an activity has only a single immediate predecessor, its
ES equals the EF of the predecessor
• If an activity has multiple immediate predecessors, its ES
is the maximum of all the EF values of its predecessors
ES = Max {EF of all immediate predecessors}

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Forward Pass (2 of 2)
Begin at starting event and work forward
Earliest Finish Time Rule:
• The earliest finish time (EF) of an activity is the sum of its
earliest start time (ES) and its activity time
EF = ES + Activity time

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ES/EF Network for Milwaukee Paper
(1 of 7)

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ES/EF Network for Milwaukee Paper
(2 of 7)

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ES/EF Network for Milwaukee Paper
(3 of 7)

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ES/EF Network for Milwaukee Paper
(4 of 7)

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ES/EF Network for Milwaukee Paper
(5 of 7)

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ES/EF Network for Milwaukee Paper
(6 of 7)

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ES/EF Network for Milwaukee Paper
(7 of 7)
Figure 3.10

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Backward Pass (1 of 2)
Begin with the last event and work backwards
Latest Finish Time Rule:
• If an activity is an immediate predecessor for just a single
activity, its LF equals the LS of the activity that immediately
follows it
• If an activity is an immediate predecessor to more than
one activity, its LF is the minimum of all LS values of all
activities that immediately follow it
LF = Min {LS of all immediate following activities}

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Backward Pass (2 of 2)
Begin with the last event and work backwards
Latest Start Time Rule:
• The latest start time (LS) of an activity is the difference of
its latest finish time (LF) and its activity time
LS = LF − Activity time

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LS/LF Times for Milwaukee Paper
(1 of 4)

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LS/LF Times for Milwaukee Paper
(2 of 4)

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LS/LF Times for Milwaukee Paper
(3 of 4)

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LS/LF Times for Milwaukee Paper
(4 of 4)

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Computing Slack Time (1 of 3)
After computing the ES, EF, LS, and LF times for all
activities, compute the slack or free time for each activity
• Slack is the length of time an activity can be delayed
without delaying the entire project

Slack = LS − ES or Slack = LF − EF

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Computing Slack Time (2 of 3)
Table 3.3 Milwaukee Paper’s Schedule and Slack Times
EARLIEST LATEST LATEST ON
START EARLIEST START FINISH SLACK CRITICAL
ACTIVITY ES FINISH EF LS LF LS − ES PATH
A 0 2 0 2 0 Yes
B 0 3 1 4 1 No
C 2 4 2 4 0 Yes
D 3 7 4 8 1 No
E 4 8 4 8 0 Yes
F 4 7 10 13 6 No
G 8 13 8 13 0 Yes
H 13 15 13 15 0 Yes

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Computing Slack Time (3 of 3)
Table 3.3 Milwaukee Paper’s Schedule and Slack Times

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Critical Path for Milwaukee Paper

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ES − EF Gantt Chart for Milwaukee
Paper

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LS − LF Gantt Chart for Milwaukee
Paper

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Variability in Activity Times (1 of 4)
• CPM assumes we know a fixed time estimate for each
activity and there is no variability in activity times
• PERT uses a probability distribution for activity times to
allow for variability

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Variability in Activity Times (2 of 4)
• Three time estimates are required
– Optimistic time (a) – if everything goes according to
plan
– Pessimistic time (b) – assuming very unfavorable
conditions
– Most likely time (m) – most realistic estimate

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Variability in Activity Times (3 of 4)
Estimate follows beta distribution
Expected activity time:
t = ( a + 4m + b ) / 6
Variance of activity completion times:
v = [(b – a ) / 6]2

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Variability in Activity Times (4 of 4)
Figure 3.11
Estimate follows beta distribution

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Computing Variance
Table 3.4 Time Estimates (in weeks) for Milwaukee Paper's
Project

MOST
OPTIMISTIC LIKELY PESSIMISTIC EXPECTED TIME VARIANCE
ACTIVITY a m b t = (a + 4m + b)/6 [(b − a)/6]2
A 1 2 3 2 .11
B 2 3 4 3 .11
C 1 2 3 2 .11
D 2 4 6 4 .44
E 1 4 7 4 1.00
F 1 2 9 3 1.78
G 3 4 11 5 1.78
H 1 2 3 2 .11

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Probability of Project Completion
(1 of 7)

Project variance is computed by summing the variances

of critical activities

 p2 = Project variance
=  ( variances of activities on critical path )

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Probability of Project Completion
(2 of 7)

Project variance is computed by summing the variances

of critical activities

Project variance

2p = .11 + .11 + 1.00 + 1.78 + .11 = 3.11

Project standard deviation

p = Project variance

= 3.11 = 1.76 weeks

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Probability of Project Completion
(3 of 7)

PERT makes two more assumptions:

• Total project completion times follow a normal probability
distribution
• Activity times are statistically independent

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Probability of Project Completion
(4 of 7)
Figure 3.12

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Probability of Project Completion
(5 of 7)

What is the probability this project can be completed on

or before the 16-week deadline?

Z = ( Due date − Expected date of completion ) /  p

= (16 weeks – 15 weeks ) /1.76
= 0.57

Where Z is the number of

standard deviations the due
date or target date lies from the
mean or expected date

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Probability of Project Completion
(6 of 7)

What is the probability this project can be completed on

or before the 16-week deadline?

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Probability of Project Completion
(7 of 7)
Figure 3.13

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Determining Project Completion Time
Figure 3.14

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Variability of Completion Time for
Noncritical Paths
• Variability of times for activities on noncritical paths must
be considered when finding the probability of finishing in a
specified time
• Variation in noncritical activity may cause change in critical
path

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What Project Management Has
Provided So Far
1. The project’s expected completion time is 15 weeks
2. There is a 71.57% chance the equipment will be in place
by the 16-week deadline
3. Five activities (A, C, E, G, and H) are on the critical path
4. Three activities (B, D, F) are not on the critical path and
have slack time
5. A detailed schedule is available

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Cost–Time Trade-Offs and Project
Crashing
It is not uncommon to face the following situations:
• The project is behind schedule
• The completion time has been moved forward

Shortening the duration of the project is called

project crashing

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Factors to Consider When Crashing a
Project
• The amount by which an activity is crashed is, in fact,
permissible
• Taken together, the shortened activity durations will enable
us to finish the project by the due date
• The total cost of crashing is as small as possible

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Steps in Project Crashing (1 of 3)
Step 1: Compute the crash cost per time period. If crash
costs are linear over time:
Crash cost ( Crash cost – Normal cost )
=
per period ( Normal time – Crash time )
Step 2: Using current activity times, find the critical path(s)
and identify the critical activities

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Steps in Project Crashing (2 of 3)
Step 3: If there is only one critical path, then select the
activity on this critical path that (a) can still be
crashed, and (b) has the smallest crash cost per
period. If there is more than one critical path, then
select one activity from each critical path such that
(a) each selected activity can still be crashed, and
(b) the total crash cost of all selected activities is the
smallest. Crash each selected activity by one period.

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Steps in Project Crashing (3 of 3)
Step 4: Update all activity times. If the desired due date has
been reached, stop. If not, return to Step 2.

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Crashing the Project
Table 3.5 Normal and Crash Data for Milwaukee Paper
Manufacturing

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Crash and Normal Times and Costs
for Activity B
Figure 3.15

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Critical Path and Slack Times for
Milwaukee Paper
Figure 3.16

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Crashing Activity A One Week (1 of 2)
Figure 3.16 (revised)

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Crashing Activity A One Week (2 of 2)
Figure 3.16 (revised)

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Crashing Activity G One Week (1 of 2)
Figure 3.16 (revised)

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Crashing Activity G One Week (2 of 2)
Figure 3.16 (revised)

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Advantages of PERT/CPM (1 of 2)
1. Especially useful when scheduling and controlling large
projects
2. Straightforward concept and not mathematically complex
3. Graphical networks help highlight relationships among
project activities
4. Critical path and slack time analyses help pinpoint
activities that need to be closely watched

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Advantages of PERT/CPM (2 of 2)
5. Project documentation and graphics point out who is
responsible for various activities
6. Applicable to a wide variety of projects
7. Useful in monitoring not only schedules but costs as well

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Limitations of PERT/CPM
1. Project activities have to be clearly defined, independent,
and stable in their relationships
2. Precedence relationships must be specified and
networked together
3. Time estimates tend to be subjective and are subject to
fudging by managers
4. There is an inherent danger of too much emphasis being
placed on the longest, or critical, path

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Using Microsoft Project (1 of 3)
Program 3.1

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Using Microsoft Project (2 of 3)
Program 3.2

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Using Microsoft Project (3 of 3)
Program 3.3

Pollution Project Percentage Completed on April 9

ACTIVITY COMPLETED ACTIVITY COMPLETED

A 100 E 20
B 100 F 20
C 100 G 0

D 10 H 0

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Operations Management: Sustainability
and Supply Chain Management
Thirteenth Edition

Chapter 4
Forecasting

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Learning Objectives (1 of 2)
When you complete this chapter 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, exponential
smoothing, and trend methods

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Learning Objectives (2 of 2)
When you complete this chapter you should be able to:
4.4 Compute three measures of forecast accuracy
4.5 Develop seasonal indices
4.6 Conduct a regression and correlation analysis
4.7 Use a tracking signal

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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, capital expenditures,
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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Influence of Product Life Cycle
Introduction – Growth – Maturity – Decline

• Introduction and growth require longer forecasts than

maturity and decline
• As product passes through life cycle, forecasts are useful
in projecting
– Staffing levels
– Inventory levels
– Factory capacity

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Product Life Cycle (1 of 2)
Figure 2.5

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Product Life Cycle (2 of 2)
Figure 2.5

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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 (1 of 2)
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 (2 of 2)
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 of 2)

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
(2 of 2)

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 until
consensus is reached
• Three types of
participants
– Decision makers
– Staff
– Respondents

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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

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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

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Components of Demand
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
“SEASON” 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

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

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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

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Weighted Moving Average (1 of 3)
• Used when some trend might be present
– Older data usually less important
• Weights based on experience and intuition

Weighted moving average =

 ( ( Weight for period n )( Demand in period n ) )
 Weights

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Weighted Moving Average (2 of 3)

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Weighted Moving Average (3 of 3)

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Potential Problems With Moving
Average (1 of 2)
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
Figure 4.2

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Potential Problems With Moving
Average (2 of 2)
• Form of weighted moving average
– Weights decline exponentially
– Most recent data weighted most
• Requires smoothing constant (α)
– 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
+ α (Last period’s actual demand
− Last period’s forecast)

Ft = Ft – 1+ α ( At – 1 – Ft – 1 )

where Ft = new forecast

Ft – 1 = previous period’s forecast
α = smoothing (or weighting) constant (0 ≤ α ≤ 1)
At – 1 = previous period’s actual demand

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Exponential Smoothing Example
(1 of 3)

• Predicted demand = 142 Ford Mustangs

• Actual demand = 153
• Smoothing constant α = .20

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Exponential Smoothing Example
(2 of 3)

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Exponential Smoothing Example
(3 of 3)

Predicted demand = 142 Ford Mustangs

Actual demand = 153
Smoothing constant α = .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 ≤ α ≤ .50
• As α increases, older values become less significant

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Impact of Different α (1 of 2)

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Impact of Different α (2 of 2)

• Choose high values of α when underlying average is

likely to change
• Choose low values of α when underlying average is
stable
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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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Common Measures of Error (1 of 3)
Mean Absolute Deviation (MAD)

MAD =
å Actual - Forecast
n

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Determining the MAD (1 of 2)

ACTUAL FORECAST
TONNAGE WITH
QUARTER UNLOADED FORECAST WITH α = .10 α = .50
1 180 175 175
2 168 175.50 = 175.00 + .10(180 − 175) 177.50
3 159 174.75 = 175.50 + .10(168 − 175.50) 172.75
4 175 173.18 = 174.75 + .10(159 − 174.75) 165.88
5 190 173.36 = 173.18 + .10(175 − 173.18) 170.44
6 205 175.02 = 173.36 + .10(190 − 173.36) 180.22
7 180 178.02 = 175.02 + .10(205 − 175.02) 192.61
8 182 178.22 = 178.02 + .10(180 − 178.02) 186.30
9 ? 178.59 = 178.22 + .10(182 − 178.22) 184.15

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Determining the MAD (2 of 2)

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Common Measures of Error (2 of 3)
Mean Squared Error (MSE)

 (Forecast errors )2

MSE =
n

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Determining the MSE

 (Forecast errors )2

MSE = = 1,526.52/8 = 190.8

n
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Common Measures of Error (3 of 3)
Mean Absolute Percent Error (MAPE)

100 Actual − Forecast /Actual

i i i
MAPE = i =1
n

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Determining the MAPE

MAPE =
 absolute percent error 44.75%
= = 5.59%
n 8
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Comparison of Measures
Table 4.1 Comparison of Measures of Forecast Error
APPLICATION TO CHAPTER
MEASURE MEANING EXAMPLE
Mean absolute How much the forecast For α = .10 in Example 4, the
deviation (MAD) missed the target forecast for grain unloaded was off
by an average of 10.31 tons.
Mean squared error The square of how much For α = .10 in Example 5, the
(MSE) the forecast missed the square of the forecast error was
target 190.8. This number does not have
a physical meaning, but is useful
when compared to the MSE of
another forecast.
Mean absolute The average percent For α = .10 in Example 6, the
percent error (MAPE) error forecast is off by 5.59% on
average. As in Examples 4 and 5,
some forecasts were too high, and
some were low.

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Comparison of Forecast Error (1 of 5)

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Comparison of Forecast Error (2 of 5)

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Comparison of Forecast Error (3 of 5)

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Comparison of Forecast Error (4 of 5)

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Comparison of Forecast Error (5 of 5)

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Exponential Smoothing with Trend
Adjustment (1 of 3)
When a trend is present, exponential smoothing must be
modified

MONTH ACTUAL DEMAND FORECAST (Ft) FOR MONTHS 1 – 5

1 100 F1 = 100 (given)

2 200 F2 = F1 + α(A1 − F1) = 100 + .4(100 − 100)
= 100
3 300 F3 = F2 + α(A2 − F2) = 100 + .4(200 − 100)
= 140
4 400 F4 = F3 + α(A3 − F3) = 140 + .4(300 − 140)
= 204
5 500 F5 = F4 + α(A4 − F4) = 204 + .4(400 − 204)
= 282

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Exponential Smoothing with Trend
Adjustment (2 of 3)
Forecast Exponentially Exponentially
including ( FITt ) = smoothed ( Ft ) = smoothed (Tt )
trend forecast forecast

Ft =  (A t- 1 ) + (1 - a)( Ft- 1 + Tt- 1 )

Tt =  ( Ft - Ft - 1 ) + (1 -  )Tt- 1

where Ft = exponentially smoothed forecast average

Tt = exponentially smoothed trend
At = actual demand
α = smoothing constant for average (0 ≤ α ≤ 1)
β = smoothing constant for trend (0 ≤ β ≤ 1)
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Exponential Smoothing with Trend
Adjustment (3 of 3)

Step 1: Compute Ft
Step 2: Compute Tt
Step 3: Calculate the forecast FITt = Ft + Tt

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Exponential Smoothing with Trend
Adjustment Example
MONTH ACTUAL MONTH (t) ACTUAL DEMAND (At)
(t) DEMAND (At)
1 12 6 21
2 17 7 31
3 20 8 28
4 19 9 36
5 24 10 ?

α = .2 β = .4

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Exponential Smoothing with Trend
Adjustment Example (1 of 5)
Table 4.2 Forecast with α = .2 and β = .4

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Exponential Smoothing with Trend
Adjustment Example (2 of 5)
Table 4.2 Forecast with α = .2 and β = .4

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Exponential Smoothing with Trend
Adjustment Example (3 of 5)
Table 4.2 Forecast with α = .2 and β = .4

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Exponential Smoothing with Trend
Adjustment Example (4 of 5)
Table 4.2 Forecast with α = .2 and β = .4
SMOOTHED
ACTUAL SMOOTHED FORECAST INCLUDING
MONTH FORECAST
DEMAND TREND, Tt TREND, FITt
AVERAGE, Ft
1 12 11 2 13.00
2 17 12.80 1.92 14.72

3 20 15.18 2.10 17.28

4 19 17.82 2.32 20.14

5 24 19.91 2.23 22.14
6 21 22.51 2.38 24.89
7 31 24.11 2.07 26.18
8 28 27.14 2.45 29.59
9 36 29.28 2.32 31.60
10 blank 32.48 2.68 35.16

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Exponential Smoothing with Trend
Adjustment Example (5 of 5)
Figure 4.3

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Trend Projections (1 of 2)
• Fitting a trend line to historical data points to project into
the medium to long-range
• Linear trends can be found using the least-squares
technique

yˆ = a + bx
where yˆ = computed value of the variable to be predicted
( dependent variable)
a = y-axis intercept
b = slope of the regression line
x = the independent variable
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Least Squares Method (1 of 2)
Figure 4.4

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Least Squares Method (2 of 2)
Equations to calculate the regression variables

ŷ = a + bx

b=
å xy - nxy
å x - nx 2 2

a = y - bx

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Least Squares Example (1 of 4)
ELECTRICAL ELECTRICAL
YEAR YEAR
POWER DEMAND POWER DEMAND
1 74 5 105
2 79 6 142
3 80 7 122
4 90 blank blank

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Least Squares Example (2 of 4)

x=
 x 28
= =4 y=
 y 692
= = 98.86
n 7 n 7
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Least Squares Example (3 of 4)

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Least Squares Example (4 of 4)
Figure 4.5

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Least Squares Requirements
1. We always plot the data to insure a linear relationship
2. We do not predict time periods far beyond the database
3. Deviations around the least squares line are assumed to
be random

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Seasonal Variations In Data (1 of 2)
The multiplicative seasonal
model can adjust trend
data for seasonal variations
in demand

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Seasonal Variations In Data (2 of 2)
Steps in the process for monthly seasons:
1. Find average historical demand for each month
2. Compute the average demand over all months
3. Compute a seasonal index for each month
4. Estimate next year’s total demand
5. Divide this estimate of total demand by the number of
months, then multiply it by the seasonal index for that
month

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Seasonal Index Example (1 of 6)

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Seasonal Index Example (2 of 6)

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Seasonal Index Example (3 of 6)

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Seasonal Index Example (4 of 6)

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Seasonal Index Example (5 of 6)
Seasonal forecast for Year 4

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Seasonal Index Example (6 of 6)

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San Diego Hospital (1 of 5)
Figure 4.6

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San Diego Hospital (2 of 5)

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San Diego Hospital (3 of 5)
Figure 4.7

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San Diego Hospital (4 of 5)

Period 67 68 69 70 71 72
Month Jan Feb Mar Apr May June
Forecast with Trend & 9,911 9,265 9,764 9,691 9,520 9,542
Seasonality
Period 73 74 75 76 77 78
Month July Aug Sept Oct Nov Dec
Forecast with Trend & 9,949 10,068 9,411 9,724 9,355 9,572
Seasonality

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San Diego Hospital (5 of 5)
Figure 4.8

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Adjusting Trend Data

yˆseasonal = Index  yˆ trend forecast

Quarter I: ŷ I = (1.30)($100,000) = $130,000

Quarter II: ŷ II = (.90)($120,000) = $108,000
Quarter III: ŷ III = (.70)($140,000) = $98,000
Quarter IV: ŷ IV = (1.10)($160,000) = $176,000

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Cyclical Variations
• Cycles – patterns in the data that occur every several
years
– Forecasting is difficult
– Wide variety of factors

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Associative Forecasting
Used when changes in one or more independent variables
can be used to predict the changes in the dependent
variable
Most common technique is linear-regression analysis
We apply this technique just as we did in the time-series
example

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Trend Projections (2 of 2)
Forecasting an outcome based on predictor variables using
the least squares technique

yˆ = a + bx

where yˆ = value of the dependent variable ( in our example, sales)

a = y-axis intercept
b = slope of the regression line
x = the independent variable

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Associative Forecasting Example
(1 of 6)

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Associative Forecasting Example
(2 of 6)

x=
 x 18
= =3 y=
 y 15
= = 2.5
6 6 6 6

b=
 xy − nxy 51.5 − (6)(3)(2.5)
= = .25 a = y − bx = 2.5 − (.25)(3) = 1.75
 x − nx
2 2
80 − (6)(3 ) 2

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Associative Forecasting Example
(3 of 6)

x=
 x 18
= =3 y=
 y 15
= = 2.5
6 6 6 6

b=
 xy − nxy 51.5 − (6)(3)(2.5)
= = .25 a = y − bx = 2.5 − (.25)(3) = 1.75
 x − nx
2 2
80 − (6)(3 ) 2

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Associative Forecasting Example
(4 of 6)

b=
 xy − nxy = 51.5 − (6)(3)(2.5) = .25 a = y − bx = 2.5 − (.25)(3) = 1.75
 x − nx
2 2
80 − (6)(3 ) 2

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Associative Forecasting Example
(5 of 6)

If payroll next year is estimated to be $6 billion, then:

Sales (in $ millions) = 1.75 + .25(6)
= 1.75 + 1.5 = 3.25
Sales = $3,250,000

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Associative Forecasting Example
(6 of 6)

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Standard Error of the Estimate (1 of 4)
• A forecast is just a point estimate of a future value
• This point is actually the mean or expected value of a probability distribution
Figure 4.9

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Standard Error of the Estimate (2 of 4)

Sy,x =
 (y − y c ) 2

n−2

where y = y-value of each data point

yc = computed value of the dependent variable,
from the regression equation
n = number of data points

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Standard Error of the Estimate (3 of 4)
Computationally, this equation is considerably easier to use

 y 2 − a  y − b  xy
S y,x =
n−2

We use the standard error to set up prediction intervals

around the point estimate

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Standard Error of the Estimate (4 of 4)
 y 2 − a  y − b  xy 39.5 − 1.75(15.0) − .25(51.5)
S y,x = =
n−2 6−2
= .09375
= .306(in $ millions )

The standard error of the

estimate is $306,000 in
sales

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Correlation (1 of 2)
• How strong is the linear relationship between the
variables?
• Correlation does not necessarily imply causality!
• Coefficient of correlation, r, measures degree of
association
– Values range from −1 to +1

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Correlation Coefficient (1 of 4)
Figure 4.10

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Correlation Coefficient (2 of 4)

n xy -  x  y
r=
 n x 2 ( x )2   n y 2 ( y )2 
      

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Correlation Coefficient (3 of 4)

( 6 )( 51.5) − (18)(15.0 )
2

r=
( 6 )( 80 ) − (18 )2  (16 )( 39.5 ) − (15.0 )2 
  
309 − 270 39 39
= = = = .901
(156 ) (12 ) 1,872 43.3
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Correlation (2 of 2)
• Coefficient of Determination, r2, measures the percent of
change in y predicted by the change in x
– Values range from 0 to 1
– Easy to interpret
For the Nodel Construction example:
r = .901
r2 = .81

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Multiple-Regression Analysis (1 of 2)
If more than one independent variable is to be used in the
model, linear regression can be extended to multiple
regression to accommodate several independent variables

ŷ = a + b1x1 + b 2 x 2
Computationally, this is quite complex and generally
done on the computer

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Multiple-Regression Analysis (2 of 2)
In the Nodel example, including interest rates in the model
gives the new equation:

ŷ = 1.80 + .30 x1 − 5.0 x2

An improved correlation coefficient of r = .96 suggests this

model does a better job of predicting the change in
construction sales
Sales = 1.80 + .30 ( 6 ) − 5.0 (.12 ) = 3.00
Sales = $3,000,000

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Monitoring and Controlling Forecasts
(1 of 2)

Tracking Signal
• Measures how well the forecast is predicting actual values
• Ratio of cumulative forecast errors to mean absolute
deviation (MAD)
– Good tracking signal has low values
– If forecasts are continually high or low, the forecast has
a bias error

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Monitoring and Controlling Forecasts
(2 of 2)

Cumulative error
Tracking signal =
MAD

=
 (Actual demand in period i - Forecast demad in period i)
 | Actual − Forecast |
n

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Correlation Coefficient (4 of 4)
Figure 4.11

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Tracking Signal Example

At the end of quarter 6, MAD =

 Forecast errors
=
85
= 14.2
n 6
Cumulative error 35
Tracking signal = = = 2.5 MADs
MAD 14.2
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Adaptive Smoothing
• It’s possible to use the computer to continually monitor
forecast error and adjust the values of the α and β
coefficients used in exponential smoothing to continually
minimize forecast error
• This technique is called adaptive smoothing

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Focus Forecasting
• Developed at American Hardware Supply, based on two
principles:
1. Sophisticated forecasting models are not always
better than simple ones
2. There is no single technique that should be used for
all products or services
• Uses historical data to test multiple forecasting models for
individual items
• Forecasting model with the lowest error used to forecast
the next demand

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Forecasting in the Service Sector
• Presents unusual challenges
– Special need for short-term records
– Needs differ greatly as function of industry and product
– Holidays and other calendar events
– Unusual events

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Fast Food Restaurant Forecast
Figure 4.12a

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FedEx Call Center Forecast
Figure 4.12b

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