Operations

Management
Chapter 3 –
Forecasting

PowerPoint presentation to accompany

Heizer/Render
Principles of Operations Management, 7e
Operations Management, 9e
© 2008 Prentice Hall, Inc. 4–1
 What is Forecasting?
Process of
predicting a future
event
Underlying basis of
??
all business
decisions
Production
Inventory
Personnel
Facilities

© 2008 Prentice Hall, Inc. 4–2

 Forecasting Time Horizons
Short-range forecast
Up to 1 year, generally less than 3 months
Purchasing, job scheduling, workforce
levels, job assignments, production levels
Medium-range forecast
3 months to 3 years
Sales and production planning, budgeting
Long-range forecast
3+ years
New product planning, facility location,
research and development

© 2008 Prentice Hall, Inc. 4–3

 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

© 2008 Prentice Hall, Inc. 4–4

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

© 2008 Prentice Hall, Inc. 4–5

 Strategic Importance of
Forecasting

Human Resources – Hiring, training,

laying off workers
Capacity – Capacity shortages can
result in undependable delivery, loss
of customers, loss of market share
Supply Chain Management – Good
supplier relations and price
advantages

© 2008 Prentice Hall, Inc. 4–6

 Seven Steps in Forecasting
Determine the use of the forecast
Select the items to be forecasted
Determine the time horizon of the
forecast
Select the forecasting model(s)
Gather the data
Make the forecast
Validate and implement results
© 2008 Prentice Hall, Inc. 4–7
 Overview of Qualitative
Methods
Jury of executive opinion
Pool opinions of high-level experts,
sometimes augment by statistical
models
Delphi method
Panel of experts, queried iteratively

© 2008 Prentice Hall, Inc. 4–8

 Overview of Qualitative
Methods
Sales force composite
Estimates from individual
salespersons are reviewed for
reasonableness, then aggregated
Consumer Market Survey
Ask the customer

© 2008 Prentice Hall, Inc. 4–9

 Delphi Method
Iterative group Decision Makers
(Evaluate
process, responses and
continues until make decisions)
consensus is
reached Staff
3 types of (Administering
survey)
participants
Decision makers
Staff Respondents
Respondents (People who can
make valuable
judgments)
© 2008 Prentice Hall, Inc. 4 – 10
 Consumer Market Survey

Ask customers about purchasing

plans
What consumers say, and what
they actually do are often different
Sometimes difficult to answer

© 2008 Prentice Hall, Inc. 4 – 11

 Overview of Quantitative
Approaches
1. Naive approach
2. Moving averages
Time-Series
3. Exponential Models
smoothing
4. Trend projection
5. Linear regression Associative
Model

© 2008 Prentice Hall, Inc. 4 – 12

 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
© 2008 Prentice Hall, Inc. 4 – 13
 Seasonal Component
Regular pattern of up and
down fluctuations
Due to weather, customs, etc.
Occurs within a single year
Number of
Period Length Seasons
Week Day 7
Month Week 4-4.5
Month Day 28-31
Year Quarter 4
Year Month 12
Year Week 52
© 2008 Prentice Hall, Inc. 4 – 14
 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
© 2008 Prentice Hall, Inc. 4 – 15
 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

© 2008 Prentice Hall, Inc. 4 – 16

 Moving Average Method
MA is a series of arithmetic
means
Used if little or no trend
Used often for smoothing
Provides overall impression of data
over time
∑ demand in previous n periods
Moving average = n

© 2008 Prentice Hall, Inc. 4 – 17

 Moving Average Example
Actual 3-Month
MonthShed Sales Moving Average
10
January 10
12
February 12
13
March13
16 + 12 + 13)/3 = 11 2/3
April (10
19 + 13 + 16)/3 = 13 2/3
May (12
June (13
23 + 16 + 19)/3 = 16
26 + 19 + 23)/3 = 19 1/3
July (16

© 2008 Prentice Hall, Inc. 4 – 18

 Graph of Moving Average
Moving
30 –
Average
28 – Forecast
26 – Actual
24 – Sales
Shed Sales

22 –
20 –
18 –
16 –
14 –
12 –
10 –
| | | | | | | | | | | |
J F M A M J J A S O N D

© 2008 Prentice Hall, Inc. 4 – 19

 Weighted Moving Average
Used when trend is present
Older data usually less important
Weights based on experience and
intuition

∑ (weight for period n)

Weighted x (demand in period n)
moving average = ∑ weights

© 2008 Prentice Hall, Inc. 4 – 20

 Weights Applied Period
Weighted Moving Average
3 Last month
2 Two months ago
1 Three months ago
6 Sum of weights

Actual 3-Month Weighted

MonthShed Sales Moving Average
10
January 10
12
February 12
13 13
March
16 x 13) + (2 x 12) + (10)]/6 = 121/6
April [(3
19 x 16) + (2 x 13) + (12)]/6 = 141/3
May [(3
June [(3
23 x 19) + (2 x 16) + (13)]/6 = 17
26 x 23) + (2 x 19) + (16)]/6 = 201/2
July [(3

© 2008 Prentice Hall, Inc. 4 – 21

 Moving Average And
Weighted Moving Average
Weighted
30 – moving
average
25 –
Sales demand

20 –
Actual
sales
15 –

10 – Moving
average
5 –

| | | | | | | | | | |
|
Figure 4.2
J F M A M J J A S O N
© 2008 Prentice Hall, Inc. 4 – 22
 Exponential Smoothing
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
© 2008 Prentice Hall, Inc. 4 – 23
 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 forecast
α = smoothing (or weighting)
constant (0 ≤ α ≤ 1)
© 2008 Prentice Hall, Inc. 4 – 24
 Exponential Smoothing
Example
Predicted demand = 142 Ford Mustangs
Actual demand = 153
Smoothing constant α = .20

© 2008 Prentice Hall, Inc. 4 – 25

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

New forecast = 142 + .2(153 – 142)

© 2008 Prentice Hall, Inc. 4 – 26

 Exponential Smoothing
Example
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

© 2008 Prentice Hall, Inc. 4 – 27

 Effect of
Smoothing Constants

Weight Assigned to
Most 2nd Most 3rd Most 4th Most 5th Most
Recent Recent Recent Recent Recent
Smoothing Period Period Period Period Period
Constant (α) α(1 - α) α(1 - α)2 α(1 - α)3 α(1 - α)4

α = .1 .1 .09 .081.073.066

α = .5 .5 .25 .125.063.031

© 2008 Prentice Hall, Inc. 4 – 28

 Choosing α
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
Forecast error = Actual demand - Forecast
value
= At - Ft
© 2008 Prentice Hall, Inc. 4 – 29
 Common Measures of Error

Mean Absolute Deviation (MAD)

∑ |Actual - Forecast|
MAD = n

Mean Squared Error (MSE)

∑ (Forecast Errors)2
MSE = n
© 2008 Prentice Hall, Inc. 4 – 30
 Common Measures of Error

Mean Absolute Percent Error (MAPE)

n

∑ 100|Actuali - Forecasti|/Actuali
i=1
MAPE = n

© 2008 Prentice Hall, Inc. 4 – 31

 Comparison of Forecast
Error
Rounded Absolute Rounded Absolute
Actual Forecast Deviation Forecast Deviation
Tonnage withfor withfor
Quarter Unloaded α = .10 α = .10 α = .50 α = .50
1 180 175 5.00 175 5.00
2 168 175.5 7.50 177.50 9.50
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 4.30
82.45 98.62

© 2008 Prentice Hall, Inc. 4 – 32

 Comparison of Forecast
Error
∑ |deviations|
Rounded Absolute Rounded Absolute
MAD
Actual= Forecast n Deviation Forecast Deviation
Tonnage withfor withfor
Quarter Unloaded α = .10 α = .10 α = .50 α = .50
For α = .10
1 180 175 5.00 175 5.00
2 168 175.5 =7.50
82.45/8 = 10.31
177.50 9.50
3 159 174.75 15.75 172.75 13.75
4 For
175α = .501.82 165.88 9.12
173.18
5 190 173.36 16.64 170.44 19.56
6 205 175.02=29.98
98.62/8 = 12.33
180.22 24.78
7 180 178.02 1.98 192.61 12.61
8 182 178.22 3.78 186.30 4.30
82.45 98.62

© 2008 Prentice Hall, Inc. 4 – 33

 Comparison of Forecast
Error
∑ (forecast errors)2
= Rounded
MSEActual Forecast
Absolute Rounded Absolute
nDeviation Forecast Deviation
Tonnage withfor withfor
Quarter Unloaded α = .10 α = .10 α = .50 α = .50
For α = .10
1 180 175 5.00 175 5.00
= 1,526.54/8
2 168 175.5 7.50 = 190.82
177.50 9.50
3 159 174.75 15.75 172.75 13.75
4 For
175α = .501.82 165.88 9.12
173.18
5 190 173.36 16.64 170.44 19.56
= 1,561.91/8
6 205 175.02 29.98 180.22 = 195.24
24.78
7 180 178.02 1.98 192.61 12.61
8 182 178.22 3.78 186.30 4.30
82.45 98.62
MAD 10.31 12.33

© 2008 Prentice Hall, Inc. 4 – 34

 Comparison
n
of Forecast
Errori|/actuali
∑100|deviation
i=1
Rounded Absolute Rounded Absolute
MAPE = Forecast Deviation
Actual n Forecast Deviation
Tonnage withfor withfor
Quarter Unloaded α = .10 α = .10 α = .50 α = .50
1
For α = .10 175 5.00
180 175 5.00
2 = 44.75/8
168 175.5 7.50 177.50 =9.50
5.59%
3 159 174.75 15.75 172.75 13.75
4 For α = .50
175 173.18 1.82 165.88 9.12
5 190 173.36 16.64 170.44 19.56
6 = 54.05/8
205 175.02 29.98 180.22=24.78
6.76%
7 180 178.02 1.98 192.61 12.61
8 182 178.22 3.78 186.30 4.30
82.45 98.62
MAD 10.31 12.33
MSE 190.82 195.24

© 2008 Prentice Hall, Inc. 4 – 35

 Comparison of Forecast
Error
Rounded Absolute Rounded Absolute
Actual Forecast Deviation Forecast Deviation
Tonnage withfor withfor
Quarter Unloaded α = .10 α = .10 α = .50 α = .50
1 180 175 5.00 175 5.00
2 168 175.5 7.50 177.50 9.50
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 4.30
82.45 98.62
MAD 10.31 12.33
MSE 190.82 195.24
MAPE 5.59% 6.76%
© 2008 Prentice Hall, Inc. 4 – 36