Department of Business Administration

SPRING 19

Demand Forecasting
Source (1. Managerial economics in global economy by Dominick Salvatore , 9 th edition .
2. Operations Management by Heizer/Render , 9th edition)

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 Learning Objectives
When you complete this chapter you should be able to
:

1. Understand the three time horizons and which

models apply for each use
2. Apply the naive, moving average, exponential
smoothing, and trend methods
4. Compute three measures of forecast accuracy
5. Develop seasonal indices

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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,
research and development
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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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 Forecasting Techniques

 Judgmental - uses subjective inputs

such as opinion from consumer
surveys, sales staff etc..
 Time series - uses historical data
assuming the future will be like the
past
 Associative models - uses
explanatory variables to predict the
future

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 Forecast Variations
Irregular
variation

Trend

Cycles

90
89
88
Seasonal variations

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Reasons for Fluctuations in Time Series
Data
 Secular Trend are noted by an upward or downward
sloping line- long-term movement in data (e.g.
Population shift, changing income and cultural changes).
 Cycle fluctuations is a data pattern that may cover

several years before it repeats itself- wavelike variations

of more than one year’s duration (e.g. Economic,
political and agricultural conditions).
 Seasonality is a data pattern that repeats itself over

the period of one year or less- short-term regular

variations in data (e.g. Weekly or daily restaurant and
supermarket experiences).
 Irregular variations caused by unusual circumstances

(e.g. Severe weather conditions, strikes or major

changes in a product or service).
 Random influences (noise) or variations results from

random variation or unexplained causes. (e.g. residuals)

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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 “SEASONS” 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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 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

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 Moving Average Example

MONTH ACTUAL SHED SALES 3-MONTH 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
August 30 (19 + 23 + 26)/3 = 22 2/3
September 28 (23 + 26 + 30)/3 = 26 1/3
October 18 (29 + 30 + 28)/3 = 28
November 16 (30 + 28 + 18)/3 = 25 1/3
December 14
(28 + 18 + 16)/3 = 20 2/3

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 Weighted Moving Average

► Used when some trend might be present

► Older data usually less important
► Weights based on experience and intuition

Weighted
moving
average

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 Weighted Moving Average

MONTH ACTUAL SHED SALES 3-MONTH WEIGHTED MOVING AVERAGE

January 10
February 12
March 13
April 16 [(3 x 13) + (2 x 12) + (10)]/6 = 12 1/6
May 19
WEIGHTS APPLIED PERIOD
June 23
3 Last month
July 26
2 Two months ago
August 30
1 Three months ago
September 28
6 Sum of the weights
October 18
Forecast for this month =
November 16
3 x Sales last mo. + 2 x Sales 2 mos. ago + 1 x Sales 3 mos. ago
December 14
Sum of the weights

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 Weighted Moving Average

MONTH ACTUAL SHED SALES 3-MONTH WEIGHTED MOVING AVERAGE

January 10
February 12
March 13
April 16 [(3 x 13) + (2 x 12) + (10)]/6 = 12 1/6
May 19 [(3 x 16) + (2 x 13) + (12)]/6 = 14 1/3
June 23 [(3 x 19) + (2 x 16) + (13)]/6 = 17
July 26 [(3 x 23) + (2 x 19) + (16)]/6 = 20 1/2
August 30 [(3 x 26) + (2 x 23) + (19)]/6 = 23 5/6
September 28 [(3 x 30) + (2 x 26) + (23)]/6 = 27 1/2
October 18
[(3 x 28) + (2 x 30) + (26)]/6 = 28 1/3
November 16
[(3 x 18) + (2 x 28) + (30)]/6 = 23 1/3
December 14
[(3 x 16) + (2 x 18) + (28)]/6 = 18 2/3

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 Potential Problems With
Moving Average

► Increasing n smooths the forecast but makes it less sensitive to

changes
► Does not forecast trends well
► Requires extensive historical data

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 Graph of Moving Averages
Weighted moving average

30 –

25 –
Sales demand

20 –
Actual sales
15 –

Moving average
10 –

5–
| | | | | | | | | | | |

J F M A M J J A S O N D
Figure 4.2 Month

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 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

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

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 Exponential Smoothing Example

Predicted demand = 142 Ford Mustangs

Actual demand = 153
Smoothing constant  = .20

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 Exponential Smoothing Example

Predicted demand = 142 Ford Mustangs

Actual demand = 153
Smoothing constant  = .20

New forecast = 142 + .2(153 – 142)

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 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

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 Effect of
Smoothing Constants
▶ Smoothing constant generally .05 ≤  ≤ .50
▶ As  increases, older values become less
significant

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

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 Impact of Different 

225 –
Actual  = .5
demand
200 –
Demand

175 –
 = .1
| | | | | | | | |
150 –
1 2 3 4 5 6 7 8 9
Quarter
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 Impact of Different 
► Chose high values of 
when underlying average
is likely to change
225 –
► Choose low values of 
Actual
when underlying
demandaverage
 = .5

200is– stable
Demand

175 –
 = .1
| | | | | | | | |
150 –
1 2 3 4 5 6 7 8 9
Quarter
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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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 MAD, MSE and MAPE
 MAD
 Easy to compute
 Weights errors linearly
 MSE
 Squares error
 More weight to large errors
 MAPE
 Puts errors in perspective

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 Common Measures of Error

Mean Absolute Deviation (MAD)

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 Determining the MAD
ACTUAL
TONNAGE FORECAST WITH
QUARTER UNLOADED FORECAST WITH  = .10  = .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
ACTUAL FORECAST ABSOLUTE FORECAST ABSOLUTE
TONNAGE WITH DEVIATION WITH DEVIATION
QUARTER UNLOADED  = .10 FOR a = .10  = .50 FOR a = .50
1 180 175 5.00 175 5.00

2 168 175.50 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

Sum of absolute deviations: 82.45 98.62

Σ|Deviations|
MAD = 10.31 12.33
n

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 Common Measures of Error

Mean Squared Error (MSE)

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 Determining the MSE
ACTUAL
TONNAGE FORECAST FOR
QUARTER UNLOADED  = .10 (ERROR)2
1 180 175 52 = 25
2 168 175.50 (–7.5)2 = 56.25
3 159 174.75 (–15.75)2 = 248.06
4 175 173.18 (1.82)2 = 3.31
5 190 173.36 (16.64)2 = 276.89
6 205 175.02 (29.98)2 = 898.80
7 180 178.02 (1.98)2 = 3.92
8 182 178.22 (3.78)2 = 14.29
Sum of errors squared = 1,526.52

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 Common Measures of Error

Mean Absolute Percent Error (MAPE)

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 Determining the MAPE
ACTUAL
TONNAGE FORECAST FOR ABSOLUTE PERCENT ERROR
QUARTER UNLOADED  = .10 100(ERROR/ACTUAL)
1 180 175.00 100(5/180) = 2.78%
2 168 175.50 100(7.5/168) = 4.46%
3 159 174.75 100(15.75/159) = 9.90%
4 175 173.18 100(1.82/175) = 1.05%
5 190 173.36 100(16.64/190) = 8.76%
6 205 175.02 100(29.98/205) = 14.62%
7 180 178.02 100(1.98/180) = 1.10%
8 182 178.22 100(3.78/182) = 2.08%
Sum of % errors = 44.75%

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