ME 403

Production Planning & Control

Lecture on –
“Forecasting”

© 2008 Prentice Hall, Inc. 4 –1

 Forecasting

“The most reliable way to

forecast the future is to try to
understand the present.”

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 Introduction

▪ Forecasting is an estimate of what is likely to happen in

the future.
▪ Forecasts are concerned with determining what the future
will look like.
▪ Forecasting provides a basis for coordinating activities in
various parts of the company.
▪ Forecasts are important input to both long-term, strategic
decision-making, as well as for short-term planning for
day-to-day operations.

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 Importance

• Finance uses long-term forecasts for capital planning and short-

term forecasts for budgeting.

• Marketing produces sales forecasts for market planning and

market strategy.

• Operations develops and uses forecasts for scheduling,

inventory management, and long-term capacity planning.

• Human Resource Management uses forecasts to estimate the

need for employees.

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 Some general characteristics of forecasts
• Forecasts are always wrong
• Forecasts are more accurate for groups or families of items
• Forecasts are more accurate for shorter time periods
• Every forecast should include an error estimate
• Forecasts are no substitute for calculated demand.

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 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

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 ForecastingApproaches

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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 ForecastingApproaches

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

© 2008 Prentice Hall,Inc. 4 – 10

 Forecasting Approaches

Qualitative Methods Quantitative Methods

• Jury of Executive Opinion • Naive approach
• Sales Force Composite • Moving average
• Delphi Method • Weighted moving average
• Consumer Market Survey • Exponential Smoothing
• Trend Projection
• Linear Regression

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 Overview of Quantitative Approaches

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

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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 Average
• A technique that uses a number of historical data values to
generate a forecast.
• Involves finding a series of successive averages by dropping the
first data value in the series and adding the last data value.
• Useful for data without trend, seasonality, or cycles.

∑ demand in previous n periods

Moving average = n

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 Moving Average Example

Actual 3-Month
Month Shed Sales Moving Average
January 1100
February 1122
March 1133
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

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 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

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 Potential Problems With
Moving Average

 Increasing n , smoothes the forecast but makes it less

sensitive to changes
 Do not forecast trends well
 Require extensive historical data

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 Weighted Moving Average

Assumes data from some periods are more important than

◼
data from other periods (e.g. earlier periods).
◼ Use weights to place more emphasis on some periods and less
on others
 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

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 WeightsApplied Period
Weighted MovingAverage
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

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 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

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 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

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 Why use exponential smoothing?

1. Uses less storage space for data

2. Extremely accurate
3. Easy to understand
4. Little calculation complexity
5. There are simple accuracy tests

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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 forecast
a = smoothing (or weighting)
constant (0 ≤ a ≤ 1)
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 Exponential Smoothing Example

Predicted demand = 142 Ford Mustangs

Actual demand = 153
Smoothing constant a = .20

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 Exponential Smoothing Example

Predicted demand = 142 Ford Mustangs

Actual demand = 153
Smoothing constant a = .20

New forecast = 142 + .2(153 – 142)

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 Exponential Smoothing Example

Predicted demand = 142 Ford Mustangs

Actual demand = 153
Smoothing constant a = .20

New forecast = 142 + .2(153 – 142)

= 142 + 2.2
= 144.2 ≈ 144 cars

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 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

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 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

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 Common Measures of Error

Mean Absolute Deviation (MAD)

∑ |Actual - Forecast|
MAD = n

Mean Squared Error (MSE)

∑ (Forecast Errors)2
MSE = n

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 Common Measures of Error

Mean Absolute Percent Error (MAPE)

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

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 Sources of Forecast errors

• Model may be inadequate

• Irregular variations
• Incorrect use of forecasting technique

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 Comparison of Forecast Error
Absolute 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

© 2008 Prentice Hall,Inc. 4 – 39

 Comparison of Forecast Error
Absolute 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

© 2008 Prentice Hall,Inc. 4 – 39

 Comparison of ForecastError
∑ |deviations|
Rounded Absolute Absolute
MAD =
Actual n
Forecast Deviation Forecast Deviation
Tonnage with for with for
Quarter Unloaded  = .10  = .10  = .50  = .50
For  = .10
1 180 175 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

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 Comparison of ForecastError
∑ (forecast errors)2
Rounded Absolute Absolute
MSE =Actual Forecast Deviation Forecast Deviation
Tonnage
n
with for with for
Quarter Unloaded  = .10  = .10  = .50  = .50
For  = .10
1 180 175 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

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 Comparison of ForecastError
n
∑100|deviationi|/actuali
i = 1 Rounded Absolute Round Actualed Absolute
MAPE Forecast
= Deviation Foreca Tonnage with st Deviation
for n with for
Quarter Unloaded  = .10  = .10  = .5 0  = .50
For  = .10
1 180 175 5.00 175 5.00
2 168 = 44.75/8
175.5 = 7.50
5.59% 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 = 54.05/8
175.02 =29.98
6.76% 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

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 Comparison of Forecast Error
Absolute 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
MAPE 5.59% 6.76%
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 Choosing a Forecasting Technique

• No single technique works in every situation

• Two most important factors
➢ Cost
➢ Accuracy
• Other factors include the availability of:
➢ Historical data
➢ Computers
➢ Time needed to gather and analyze the data
➢ Forecast horizon

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 Thank You!

© 2008 Prentice Hall,Inc. Reference: Operations Management (11th edition) By William Stevenson (Chapter 3)
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