4 Forecasting Demand

4-1
 Chapter Outline
 What Is Forecasting?
 Forecasting definition
 The differences between forecasting & prediction
 Forecasting Time Horizons
 The Influence of Product Life Cycle
 Types Of Forecasts
 The Strategic Importance of Forecasting
 Seven Steps in the Forecasting System
 Forecasting Approaches
 Qualitative approach
 Quantitative approach
4-2
 Outline – Continued
 Time-Series Forecasting
 Decomposition of a Time Series
 Naive Approach
 Moving Averages
 Exponential Smoothing
 Exponential Smoothing with Trend
Adjustment
 Trend Projections
 Seasonal Variations in Data
 Cyclical Variations in Data
4-3
 Associative Forecasting Methods: Regression
and Correlation Analysis
 Monitoring and Controlling Forecasts
 Adaptive Smoothing
 Focus Forecasting
 Forecasting in the Service Sector

4-4
 What is Forecasting?
 Process of predicting
a future event
 Underlying basis
of all business
??
decisions
 Production
 Inventory
 Personnel
 Facilities

4-5
 Forecasting definition
• Forecasting is defined as a planning tool that
helps management in its attempts to cope with
the uncertainty of the future, relying mainly on
data from the past and present and analysis of
trends
• There is a dereferences between forecasting and
prediction

4-6
 The Differences Between
Forecasting & Prediction

Forecasting Prediction
Forecasting involves the Prediction involves judgment in
projection of the past into the management after taking all
future available information into account.
Forecast involves estimating the Prediction involves the anticipated
level of demand of a product on change into the future. It may
the basis of factors that include even new factors that may
generated the demand in the past affect future demand
Forecasting is more scientific Prediction is more intuitive

4-7
It is relatively free from personal It is more governed by personal
bias. bias and preferences.
It is more objective It is more subjective
Error analysis is possible Prediction does not contain error
analysis

4-8
 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
 1 year to 3 years
 Sales and production planning, budgeting
 Long-range forecast
 3+ years
 New product planning, facility location,
research and development
4-9
 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

4 - 10
 Product Life Cycle
Introduction Growth Maturity Decline
Long run Long run Medium Short run
Forecasting Time Horizon

forecasting forecasting forecasting forecasting

+ 3 years + 3 years 1 year – 3 years Up to 1 year

Drive-through
Internet search engines restaurants
CD-ROMs
iPods LCD &
Xbox 360 plasma TVs
Sales
Avatars

Boeing 787 Analog

TVs
Twitter
Figure 2.5
4 - 11
 Types of Forecasts
 Economic forecasts
 Address business cycle – inflation rate,
money supply, dollar price, etc.
 Technological forecasts
 Predict rate of technological progress
 Impacts development of new products
 Demand forecasts
 Predict sales of existing products and
services

4 - 12
 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

4 - 13
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
6. Make the forecast
7. Validate and implement results

4 - 14
 The Realities!

 Forecasts are seldom perfect

 Most techniques assume an
underlying stability in the system
 The aggregated forecasts are
more accurate than individual
forecasts

4 - 15
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
4 - 16
 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
4 - 17
 Overview of Qualitative
Methods
 Sales force composite
 Delphi method
 Consumer Market Survey

4 - 18
 Sales Force Composite

 Each salesperson projects his or

her sales
 Combined at district and national
levels
 Salesperson know customers’
wants
 Tends to be overly optimistic

4 - 19
 Delphi Method
 Iterative group
Decision Makers
process, (Evaluate
continues until responses and
agreement is make decisions)
reached
Staff
 3 types of (Administering
survey)
participants
 Decision makers
 Staff Respondents
(People who can
 Respondents make valuable
judgments)
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 Consumer Market Survey

 Ask customers about purchasing

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

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 Overview of Quantitative
Approaches
1. Naive approach
2. Simple average
3. Moving averages time-series
models
4. Exponential
smoothing
5. Trend projection
associative
6. Linear regression model
4 - 22
 Time Series Forecasting

 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

4 - 24
 COMPONENTS OF TIME
SERIES DEMAND

• .1 average: the mean of the observations over

time
• 2. trend: a gradual increase or decrease in the
average over time
• 3. seasonal influence: predictable short-term
cycling behavior due to time of day, week, month,
season, year, etc.
• 4. cyclical movement: unpredictable long-term
cycling behavior due to business cycle or
product/service life cycle
• 5. random error: remaining variation that cannot
be explained by the other four components 4 - 25
 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
4 - 26
 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
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

4 - 28
 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
4 - 29
 Random Component
 Erratic, unsystematic, ‘residual’
fluctuations
 Due to random variation or unforeseen
events
 Short duration
and non- repeating

M T W T F
4 - 30
 Naive Approach
 It is assume that demand in next
period is the same as demand in
most recent period
 e.g., If January sales were 68 units ,
then February sales will be 68
 This simple way is the most cost-
effective and efficient forecasting
model
 It can be a good starting point
4 - 31
 Naive approach

• Suppose the demand for York factory

last year was 1000 cars

• According to the naive approach the

demand of the next year is 1000 car

4 - 32
Simple Average Method

• It is assume that
demand in the next
period is the mean of the
actual demand in last
periods

4 - 33
 Simple average example

• A XYZ television supplier found a

demand of 200 sets in July, 225 sets
in August & 245 sets in September.
Find the demand forecast for the
month of October using simple
average method.
• F = D1+D2+D3/3=
• 200+225+245/3=223.3
• 224 units
4 - 34
 Moving Average Method
MA
 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

4 - 35
 Moving Average Method
example
• Donna’s garden supply wants a 3 –
month moving average forecast
including a forecast for next January,
for shed sales

4 - 36
 Moving Average Example
Actual 3-Month
Month Shed Sales 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

4 - 37
 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

4 - 38
Weighted Moving Average
 Used when some trend might be
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

4 - 39
 Weighted Moving Average
example
• Donna’s garden supply wants to
forecast shed sales by weighted the
past 3 months ,with more weight
given to recent data to make them
more significant

4 - 40
 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

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

4 - 41
 Moving Average And
Weighted Moving Average
Weighted
30 – moving
average
25 –
Sales demand

20 – Actual
sales
15 –
Moving
10 – average

5 –
| | | | | | | | | | | |
J F M A M J J A S O N D
Figure 4.2
4 - 42
 Potential Problems With
Moving Average
 Increasing n smooths the forecast
but makes it less sensitive to
changes
 Do not forecast trends well
 Require extensive historical data

4 - 43
 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
4 - 44
 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 forecast
 = smoothing (or weighting)
constant (0 ≤  ≤ 1)

4 - 45
 Exponential Smoothing
Example

In January , a car dealer predicted

February demand for 142 ford
mustangs , Actual Febrruary demand =
153 autos, using a Smoothing constant
 = .20 , the dealer wants to forecast
march demand using the exponential
smoothing model

4 - 46
 Exponential Smoothing
Example
Predicted demand = 142 Ford Mustangs
Actual demand = 153
Smoothing constant  = .20

New forecast = 142 + .2(153 – 142)

4 - 47
 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

4 - 48
 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 () (1 - ) (1 - ) 2 (1 - ) 3 (1 - )4

 = .1 .1 .09 .081 .073 .066

 = .5 .5 .25 .125 .063 .031

4 - 49
 Impact of Different 
225 –

Actual  = .5
200 – demand
Demand

175 –

 = .1
150 – | | | | | | | | |
1 2 3 4 5 6 7 8 9
Quarter

4 - 50
 Impact of Different 
225 –

Actual  = .5
200
Chose
– high values
demandof 
Demand

when underlying average

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

4 - 51
 Choosing 

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

4 - 52
Common Measures of Error

Mean Absolute Deviation (MAD)

∑ |Actual - Forecast|
MAD =
n

Mean Squared Error (MSE)

∑ (Forecast Errors)2
MSE =
n

4 - 53
 Comparison of Forecast
Error
Rounded Absolute Rounded Absolute
Actual Forecast Deviation Forecast Deviation
Tonnage with for with for
Quarter Unloaded  = .10  = .10  = .50  = .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

4 - 54
 Comparison of Forecast
Error
∑ |deviations|
Rounded Absolute Rounded Absolute
MADActual
= Forecast Deviation Forecast Deviation
Tonnage n
with for with for
Quarter Unloaded  = .10  = .10  = .50  = .50
1
For 180
= .10 175 5.00 175 5.00
2 168 = 82.45/8
175.5 = 10.31
7.50 177.50 9.50
3 159 174.75 15.75 172.75 13.75
4 For 175
= .50 173.18 1.82 165.88 9.12
5 190 173.36 16.64 170.44 19.56
6 205 = 98.62/8
175.02 = 12.33
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

4 - 55
 Comparison of Forecast
Error2
∑ (forecast errors)
Rounded Absolute Rounded Absolute
MSE = Actual Forecast Deviation Forecast Deviation
Tonnage
n
with for with for
Quarter Unloaded  = .10  = .10  = .50  = .50
1
For 180
= .10 175 5.00 175 5.00
2 = 1,526.54/8
168 175.5 = 190.82
7.50 177.50 9.50
3 159 174.75 15.75 172.75 13.75
4 For 175
= .50 173.18 1.82 165.88 9.12
5 190 173.36 16.64 170.44 19.56
6 = 1,561.91/8
205 175.02 = 195.24
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

4 - 56
 Comparison of Forecast
Error
Rounded Absolute Rounded Absolute
Actual Forecast Deviation Forecast Deviation
Tonnage with for with for
Quarter Unloaded  = .10  = .10  = .50  = .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
4 - 57
 Exponential Smoothing with
Trend Adjustment
When a trend is present, exponential
smoothing must be modified

Forecast Exponentially Exponentially

including (FITt) = smoothed (Ft) + smoothed (Tt)
trend forecast trend

4 - 58
Exponential Smoothing with
Trend Adjustment

Ft = (At - 1) + (1 - )(Ft - 1 + Tt - 1)

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

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

4 - 59
 Exponential Smoothing with
Trend Adjustment Example
Forecast
Actual Smoothed Smoothed Including
Month(t) Demand (At) Forecast, Ft Trend, Tt Trend, FITt
1 12 11 2 13.00
2 17
3 20
4 19
5 24
6 21
7 31
8 28
9 36
10

Table 4.1
4 - 60
 Exponential Smoothing with
Trend Adjustment Example
Forecast
Actual Smoothed Smoothed Including
Month(t) Demand (At) Forecast, Ft Trend, Tt Trend, FITt
1 12 11 2 13.00
2 17
3 20
4 19
5 24 Step 1: Forecast for Month 2
6 21
7 31 F2 = A1 + (1 - )(F1 + T1)
8 28 F2 = (.2)(12) + (1 - .2)(11 + 2)
9 36
10 = 2.4 + 10.4 = 12.8 units
Table 4.1
4 - 61
 Exponential Smoothing with
Trend Adjustment Example
Forecast
Actual Smoothed Smoothed Including
Month(t) Demand (At) Forecast, Ft Trend, Tt Trend, FITt
1 12 11 2 13.00
2 17 12.80
3 20
4 19
5 24 Step 2: Trend for Month 2
6 21
7 31 T2 = b(F2 - F1) + (1 - b)T1
8 28 T2 = (.4)(12.8 - 11) + (1 - .4)(2)
9 36
10 = .72 + 1.2 = 1.92 units
Table 4.1
4 - 62
 Exponential Smoothing with
Trend Adjustment Example
Forecast
Actual Smoothed Smoothed Including
Month(t) Demand (At) Forecast, Ft Trend, Tt Trend, FITt
1 12 11 2 13.00
2 17 12.80 1.92
3 20
4 19
5 24 Step 3: Calculate FIT for Month 2
6 21
7 31 FIT2 = F2 + T2
8 28 FIT2 = 12.8 + 1.92
9 36
10 = 14.72 units
Table 4.1
4 - 63
 Exponential Smoothing with
Trend Adjustment Example
Forecast
Actual Smoothed Smoothed Including
Month(t) Demand (At) Forecast, Ft Trend, Tt Trend, FITt
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 32.48 2.68 35.16

Table 4.1
4 - 64
Exponential Smoothing with
Trend Adjustment Example
35 –

30 – Actual demand (At)

Product demand

25 –

20 –

15 –

10 – Forecast including trend (FITt)

with  = .2 and b = .4
5 –

0 – | | | | | | | | |
1 2 3 4 5 6 7 8 9
Figure 4.3
Time (month)
4 - 65
 Trend Projections
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

y^ = a + bx
^ = computed value of the variable to
where y
be predicted (dependent variable)
a = y-axis intercept
b = slope of the regression line
x = the independent variable

4 - 66
 Least Squares Method
Equations to calculate the regression variables

y^ = a + bx

Sxy - nxy
b=
Sx2 - nx2

a = y - bx

4 - 67
 Least Squares Example
Time Electrical Power
Year Period (x) Demand (y) x2 xy
2003 1 74 1 74
2004 2 79 4 158
2005 3 80 9 240
2006 4 90 16 360
2007 5 105 25 525
2008 6 142 36 852
2009 7 122 49 854
∑x = 28 ∑y = 692 ∑x2 = 140 ∑xy = 3,063
x=4 y = 98.86

∑xy - nxy 3,063 - (7)(4)(98.86)

b= = = 10.54
∑x2 - nx2 140 - (7)(42)

a = y - bx = 98.86 - 10.54(4) = 56.70

4 - 68
 Least Squares Example
Time Electrical Power
Year Period (x) Demand x2 xy
2003 1 74 1 74
2004 2 79 4 158
2005The trend
3 line is 80 9 240
2006 4 90 16 360
2007 y^ 5= 56.70 + 10.54x
105 25 525
2008 6 142 36 852
2009 7 122 49 854
∑x = 28 ∑y = 692 ∑x2 = 140 ∑xy = 3,063
x=4 y = 98.86

∑xy - nxy 3,063 - (7)(4)(98.86)

b= = = 10.54
∑x2 - nx2 140 - (7)(42)

a = y - bx = 98.86 - 10.54(4) = 56.70

4 - 69
Seasonal Variations In Data

The multiplicative
seasonal model
can adjust trend
data for seasonal
variations in
demand

4 - 71
Seasonal Variations In Data
Steps in the process:
1. Find average historical demand for each season
2. Compute the average demand over all seasons
3. Compute a seasonal index for each season
4. Estimate next year’s total demand
5. Divide this estimate of total demand by the
number of seasons, then multiply it by the
seasonal index for that season

4 - 72
 Seasonal Index Example
Demand Average Average Seasonal
Month 2007 2008 2009 2007-2009 Monthly Index
Jan 80 85 105 90 94
Feb 70 85 85 80 94
Mar 80 93 82 85 94
Apr 90 95 115 100 94
May 113 125 131 123 94
Jun 110 115 120 115 94
Jul 100 102 113 105 94
Aug 88 102 110 100 94
Sept 85 90 95 90 94
Oct 77 78 85 80 94
Nov 75 72 83 80 94
Dec 82 78 80 80 94
4 - 73
 Seasonal Index Example
Demand Average Average Seasonal
Month 2007 2008 2009 2007-2009 Monthly Index
Jan 80 85 105 90 94 0.957
Feb 70 85 85 80 94
Mar 80 93 Average
82 85 monthly 94
2007-2009 demand
Seasonal90index95= 115 Average monthly
Apr 100 demand94
May 113 125 131 123 94
= 90/94 = .957
Jun 110 115 120 115 94
Jul 100 102 113 105 94
Aug 88 102 110 100 94
Sept 85 90 95 90 94
Oct 77 78 85 80 94
Nov 75 72 83 80 94
Dec 82 78 80 80 94
4 - 74
 Seasonal Index Example
Demand Average Average Seasonal
Month 2007 2008 2009 2007-2009 Monthly Index
Jan 80 85 105 90 94 0.957
Feb 70 85 85 80 94 0.851
Mar 80 93 82 85 94 0.904
Apr 90 95 115 100 94 1.064
May 113 125 131 123 94 1.309
Jun 110 115 120 115 94 1.223
Jul 100 102 113 105 94 1.117
Aug 88 102 110 100 94 1.064
Sept 85 90 95 90 94 0.957
Oct 77 78 85 80 94 0.851
Nov 75 72 83 80 94 0.851
Dec 82 78 80 80 94 0.851
4 - 75
 Seasonal Index Example
Demand Average Average Seasonal
Month 2007 2008 2009 2007-2009 Monthly Index
Jan 80 85 105 90 94 0.957
Feb 70 85 Forecast
85 for802010 94 0.851
Mar 80 93 82 85 94 0.904
Apr 90Expected
95 115annual demand
100 = 1,200
94 1.064
May 113 125 131 123 94 1.309
Jun 110 115 120 1,200 115 94 1.223
Jul Jan 113
100 102 x .957 = 96 94
105 1.117
12
Aug 88 102 110 100 94 1.064
1,200
Sept 85 90
Feb 95 x90.851 = 85 94 0.957
Oct 77 78 85 12 80 94 0.851
Nov 75 72 83 80 94 0.851
Dec 82 78 80 80 94 0.851
4 - 76
 Seasonal Index Example
2010 Forecast
140 – 2009 Demand
130 – 2008 Demand
2007 Demand
120 –
Demand

110 –
100 –
90 –
80 –
70 –
| | | | | | | | | | | |
J F M A M J J A S O N D
Time
4 - 77
 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

4 - 78
 Associative Forecasting
Forecasting an outcome based on
predictor variables using the least squares
technique
y^ = a + bx
^
where y = computed value of the variable to
be predicted (dependent variable)
a = y-axis intercept
b = slope of the regression line
x = the independent variable though to
predict the value of the dependent
variable
4 - 79
 Correlation
 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

4 - 80
Correlation Coefficient
nSxy - SxSy
r=
[nSx2 - (Sx)2][nSy2 - (Sy)2]

4 - 81
y y
Correlation Coefficient
nSxy - SxSy
r=
[nSx 2 - (Sx)2][nSy2 - (Sy)2]
(a) Perfect positive x (b) Positive x
correlation: correlation:
r = +1 0<r<1

y y

(c) No correlation: x (d) Perfect negative x

r=0 correlation:
r = -1 4 - 82
 Correlation
 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 example if:

r = .901
r2 = .81
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• R ---------- to what extent there is a
correlation relationship between two
variables (-1 to 1)
• (positive +)or( negative (-)
• (strong more than .5) or( weak less than
.5 )
• R2 ----------- to what extent the change in one
variable can be explained by the other
variables %

4 - 84
 Multiple Regression
Analysis
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

y^ = a + b1x1 + b2x2 …

Computationally, this is quite

complex and generally done on the
computer
4 - 85
 Multiple Regression
Analysis
In the Nodel example, including interest rates in
the model gives the new equation:

y^ = 1.80 + .30x1 - 5.0x2

An improved correlation coefficient of r = .96

means 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
4 - 86
 Monitoring and Controlling
Forecasts
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

Tracking Cumulative error

signal =
MAD

∑(Actual demand in
period i -
Forecast demand
Tracking in period i)
signal = (∑|Actual - Forecast|/n)

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 Tracking Signal

Signal exceeding limit

Tracking signal
Upper control limit
+

0 MADs Acceptable
range

–
Lower control limit

Time

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 Tracking Signal Example
Cumulative
Absolute Absolute
Actual Forecast Cumm Forecast Forecast
Qtr Demand Demand Error Error Error Error MAD

1 90 100 -10 -10 10 10 10.0

2 95 100 -5 -15 5 15 7.5
3 115 100 +15 0 15 30 10.0
4 100 110 -10 -10 10 40 10.0
5 125 110 +15 +5 15 55 11.0
6 140 110 +30 +35 30 85 14.2

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 Tracking Signal Example
Tracking Cumulative
Absolute Absolute
Actual Signal
Forecast Cumm Forecast Forecast
(CummDemand
Qtr Demand Error/MAD)
Error Error Error Error MAD

1 90-10/10
100= -1 -10 -10 10 10 10.0
2 95
-15/7.5
100= -2 -5 -15 5 15 7.5
3 115 0/10
100= 0 +15 0 15 30 10.0
4 100-10/10
110= -1 -10 -10 10 40 10.0
5 125
+5/11110
= +0.5+15 +5 15 55 11.0
6 140
+35/14.2
110= +2.5
+30 +35 30 85 14.2

The variation of the tracking signal

between -2.0 and +2.5 is within acceptable
limits
4 - 91
 Adaptive Forecasting
 It’s possible to use the computer to
continually monitor forecast error
and adjust the values of the  and b
coefficients used in exponential
smoothing to continually minimize
forecast error
 This technique is called adaptive
smoothing

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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
20% –
Percentage of sales

15% –

10% –

5% –

11-12 1-2 3-4 5-6 7-8 9-10

12-1 2-3 4-5 6-7 8-9 10-11
(Lunchtime) (Dinnertime)
Hour of day Figure 4.12
4 - 94
FedEx Call Center Forecast
12% –

10% –

8% –

6% –

4% –

2% –

0% –
2 4 6 8 10 12 2 4 6 8 10 12
A.M. P.M.
Hour of day
Figure 4.12
4 - 95