CHAPTER 5
FORECASTING
To accompany
Quantitative Analysis for Management, Tenth Edition,
by Render, Stair, and Hanna © 2008 Prentice-Hall, Inc.
Power Point slides created by Jeff Heyl © 2009 Prentice-Hall, Inc.
Learning Objectives
After completing this chapter, students will be able to:
1. Understand and know when to use various
families of forecasting models
2. Compare moving averages, exponential
smoothing, and trend time-series models
3. Seasonally adjust data
4. Understand Delphi and other qualitative
decision making approaches
5. Compute a variety of error measures
© 2009 Prentice-Hall, Inc. 5–2
Chapter Outline
5.1 Introduction
5.2 Types of Forecasts
5.3 Scatter Diagrams and Time Series
5.4 Measures of Forecast Accuracy
5.5 Time-Series Forecasting Models
5.6 Monitoring and Controlling Forecasts
5.7 Using the Computer to Forecast
© 2009 Prentice-Hall, Inc. 5–3
Introduction
Managers are always trying to reduce uncertainty
and make better estimates of what will happen in
the future
This is the main purpose of forecasting
Some firms use subjective methods
Seat-of-the pants methods, intuition, experience
There are also several quantitative techniques
Moving averages, exponential smoothing, trend
projections, least squares regression analysis
© 2009 Prentice-Hall, Inc. 5–4
Introduction
Eight steps to forecasting:
1. Determine the use of the forecast—what
objective are we trying to obtain?
2. Select the items or quantities that are to be
forecasted
3. Determine the time horizon of the forecast
4. Select the forecasting model or models
5. Gather the data needed to make the
forecast
6. Validate the forecasting model
7. Make the forecast
8. Implement the results
© 2009 Prentice-Hall, Inc. 5–5
Introduction
These steps are a systematic way of initiating,
designing, and implementing a forecasting
system
When used regularly over time, data is
collected routinely and calculations performed
automatically
There is seldom one superior forecasting
system
Different organizations may use different
techniques
Whatever tool works best for a firm is the one
they should use
© 2009 Prentice-Hall, Inc. 5–6
Forecasting Models
Forecasting
Techniques
Qualitative Time-Series Causal
Models Methods Methods
Delphi Moving Regression
Methods Average Analysis
Jury of Executive Exponential Multiple
Opinion Smoothing Regression
Sales Force Trend
Composite Projections
Figure 5.1
Consumer
Market Survey Decomposition
© 2009 Prentice-Hall, Inc. 5–7
Time-Series Models
Time-series models attempt to predict
the future based on the past
Common time-series models are
Moving average
Exponential smoothing
Trend projections
Decomposition
Regression analysis is used in trend
projections and one type of
decomposition model
© 2009 Prentice-Hall, Inc. 5–8
Causal Models
Causal models use variables or factors
that might influence the quantity being
forecasted
The objective is to build a model with
the best statistical relationship between
the variable being forecast and the
independent variables
Regression analysis is the most
common technique used in causal
modeling
© 2009 Prentice-Hall, Inc. 5–9
Qualitative Models
Qualitative models incorporate judgmental
or subjective factors
Useful when subjective factors are
thought to be important or when accurate
quantitative data is difficult to obtain
Common qualitative techniques are
Delphi method
Jury of executive opinion
Sales force composite
Consumer market surveys
© 2009 Prentice-Hall, Inc. 5 – 10
Qualitative Models
Delphi Method – an iterative group process where
(possibly geographically dispersed) respondents
provide input to decision makers
Jury of Executive Opinion – collects opinions of a
small group of high-level managers, possibly
using statistical models for analysis
Sales Force Composite – individual salespersons
estimate the sales in their region and the data is
compiled at a district or national level
Consumer Market Survey – input is solicited from
customers or potential customers regarding their
purchasing plans
© 2009 Prentice-Hall, Inc. 5 – 11
Scatter Diagrams
Wacker Distributors wants to forecast sales for
three different products
YEAR TELEVISION SETS RADIOS COMPACT DISC PLAYERS
1 250 300 110
2 250 310 100
3 250 320 120
4 250 330 140
5 250 340 170
6 250 350 150
7 250 360 160
8 250 370 190
9 250 380 200
10 250 390 190
Table 5.1
© 2009 Prentice-Hall, Inc. 5 – 12
Scatter Diagrams
(a)
Sales appear to be
Annual Sales of Televisions
330 –
constant over time
250 –
Sales = 250
200 – A good estimate of
150 – sales in year 11 is
100 –
250 televisions
50 –
| | | | | | | | | |
0 1 2 3 4 5 6 7 8 9 10
Time (Years)
Figure 5.2
© 2009 Prentice-Hall, Inc. 5 – 13
Scatter Diagrams
(b)
420 – Sales appear to be
400 – increasing at a
Annual Sales of Radios
380 – constant rate of 10
360 – radios per year
340 –
Sales = 290 + 10(Year)
320 –
A reasonable
300 –
estimate of sales in
280 –
year 11 is 400
| | | | |
0 1 2 3 4 5 6 7 8 9 10
| | | | |
televisions
Time (Years)
Figure 5.2
© 2009 Prentice-Hall, Inc. 5 – 14
Scatter Diagrams
This trend line may
(c) not be perfectly
Annual Sales of CD Players
200 –
accurate because
180 – of variation from
160 – year to year
Sales appear to be
140 –
increasing
120 – A forecast would
100 – probably be a
| | | | | | | | | |
larger figure each
0 1 2 3 4 5 6 7 8 9 10 year
Time (Years)
Figure 5.2
© 2009 Prentice-Hall, Inc. 5 – 15
Measures of Forecast Accuracy
We compare forecasted values with actual values
to see how well one model works or to compare
models
Forecast error = Actual value – Forecast value
One measure of accuracy is the mean absolute
deviation (MAD)
MAD
MAD
forecast error
n
© 2009 Prentice-Hall, Inc. 5 – 16
Measures of Forecast Accuracy
Using a naïve forecasting model
ACTUAL ABSOLUTE VALUE OF
SALES OF CD ERRORS (DEVIATION),
YEAR PLAYERS FORECAST SALES (ACTUAL – FORECAST)
1 110 — —
2 100 110 |100 – 110| = 10
3 120 100 |120 – 110| = 20
4 140 120 |140 – 120| = 20
5 170 140 |170 – 140| = 30
6 150 170 |150 – 170| = 20
7 160 150 |160 – 150| = 10
8 190 160 |190 – 160| = 30
9 200 190 |200 – 190| = 10
10 190 200 |190 – 200| = 10
11 — 190 —
Sum of |errors| = 160
MAD = 160/9 = 17.8
Table 5.2 © 2009 Prentice-Hall, Inc. 5 – 17
Measures of Forecast Accuracy
Using a naïve forecasting model
ACTUAL ABSOLUTE VALUE OF
SALES OF CD ERRORS (DEVIATION),
YEAR PLAYERS FORECAST SALES (ACTUAL – FORECAST)
1 110 — —
2 100 110 |100 – 110| = 10
3 120 100 |120 – 110| = 20
4
MAD
5
forecast error 160
140
170
120
17.8
140
|140 – 120| = 20
|170 – 140| = 30
6 150 n 170 9 |150 – 170| = 20
7 160 150 |160 – 150| = 10
8 190 160 |190 – 160| = 30
9 200 190 |200 – 190| = 10
10 190 200 |190 – 200| = 10
11 — 190 —
Sum of |errors| = 160
MAD = 160/9 = 17.8
Table 5.2 © 2009 Prentice-Hall, Inc. 5 – 18
Measures of Forecast Accuracy
There are other popular measures of forecast
accuracy
The mean squared error
MSE
( error) 2
n
The mean absolute percent error
error
actual
MAPE 100%
n
And bias is the average error
© 2009 Prentice-Hall, Inc. 5 – 19
Time-Series Forecasting Models
A time series is a sequence of evenly
spaced events
Time-series forecasts predict the future
based solely of the past values of the
variable
Other variables are ignored
© 2009 Prentice-Hall, Inc. 5 – 20
Decomposition of a Time-Series
A time series typically has four components
1. Trend (T) is the gradual upward or
downward movement of the data over time
2. Seasonality (S) is a pattern of demand
fluctuations above or below trend line that
repeats at regular intervals
3. Cycles (C) are patterns in annual data that
occur every several years
4. Random variations (R) are “blips” in the
data caused by chance and unusual
situations
© 2009 Prentice-Hall, Inc. 5 – 21
Decomposition of a Time-Series
Demand for Product or Service
Trend
Component
Seasonal Peaks
Actual
Demand
Line
Average Demand
over 4 Years
| | | |
Year Year Year Year
1 2 3 4
Time
Figure 5.3
© 2009 Prentice-Hall, Inc. 5 – 22
Decomposition of a Time-Series
There are two general forms of time-series
models
The multiplicative model
Demand = T x S x C x R
The additive model
Demand = T + S + C + R
Models may be combinations of these two
forms
Forecasters often assume errors are
normally distributed with a mean of zero
© 2009 Prentice-Hall, Inc. 5 – 23
Moving Averages
Moving averages can be used when
demand is relatively steady over time
The next forecast is the average of the
most recent n data values from the time
series
This methods tends to smooth out short-
term irregularities in the data series
Sum of demands in previous n periods
Moving average forecast
n
© 2009 Prentice-Hall, Inc. 5 – 24
Moving Averages
Mathematically
Y Yt 1 ... Yt n1
Ft 1 t
n
where
Ft 1for time period t + 1
= forecast
Yt
= actual value in time period t
n= number of periods to average
© 2009 Prentice-Hall, Inc. 5 – 25
Wallace Garden Supply Example
Wallace Garden Supply wants to
forecast demand for its Storage Shed
They have collected data for the past
year
They are using a three-month moving
average to forecast demand (n = 3)
© 2009 Prentice-Hall, Inc. 5 – 26
Wallace Garden Supply Example
MONTH ACTUAL SHED SALES THREE-MONTH MOVING AVERAGE
January 10
February 12
March 13
April 16 (10 + 12 + 13)/3 = 11.67
May 19 (12 + 13 + 16)/3 = 13.67
June 23 (13 + 16 + 19)/3 = 16.00
(16 + 19 + 23)/3 = 19.33
July 26
(19 + 23 + 26)/3 = 22.67
August 30
(23 + 26 + 30)/3 = 26.33
September 28
(26 + 30 + 28)/3 = 28.00
October 18
(30 + 28 + 18)/3 = 25.33
November 16 (28 + 18 + 16)/3 = 20.67
December 14 (18 + 16 + 14)/3 = 16.00
January —
Table 5.3
© 2009 Prentice-Hall, Inc. 5 – 27
Weighted Moving Averages
Weighted moving averages use weights to put
more emphasis on recent periods
Often used when a trend or other pattern is
emerging
Ft 1
( Weight in period i )( Actual value in period)
( Weights )
Mathematically
w1Yt w2Yt 1 ... w nYt n1
Ft 1
w1 w2 ... w n
ere
wi= weight for the ith observation
© 2009 Prentice-Hall, Inc. 5 – 28
Wallace Garden Supply Example
Wallace Garden Supply decides to try a
weighted moving average model to forecast
demand for its Storage Shed
They decide on the following weighting
scheme
WEIGHTS APPLIED PERIOD
3 Last month
2 Two months ago
1 Three months ago
3 x Sales last month + 2 x Sales two months ago + 1 X Sales three months ago
6
Sum of the weights
© 2009 Prentice-Hall, Inc. 5 – 29
Wallace Garden Supply Example
THREE-MONTH WEIGHTED
MONTH ACTUAL SHED SALES MOVING AVERAGE
January 10
February 12
March 13
April 16 [(3 X 13) + (2 X 12) + (10)]/6 = 12.17
May 19 [(3 X 16) + (2 X 13) + (12)]/6 = 14.33
June 23 [(3 X 19) + (2 X 16) + (13)]/6 = 17.00
[(3 X 23) + (2 X 19) + (16)]/6 = 20.50
July 26
[(3 X 26) + (2 X 23) + (19)]/6 = 23.83
August 30
[(3 X 30) + (2 X 26) + (23)]/6 = 27.50
September 28
[(3 X 28) + (2 X 30) + (26)]/6 = 28.33
October 18
[(3 X 18) + (2 X 28) + (30)]/6 = 23.33
November 16 [(3 X 16) + (2 X 18) + (28)]/6 = 18.67
December 14 [(3 X 14) + (2 X 16) + (18)]/6 = 15.33
January
Table 5.4 —
© 2009 Prentice-Hall, Inc. 5 – 30
Exponential Smoothing
Exponential smoothing is easy to use and
requires little record keeping of data
It is a type of moving average
ecast = Last period’s forecast
+ (Last period’s actual demand
– Last period’s forecast)
Where is a weight (or smoothing constant)
constant
with a value between 0 and 1 inclusive
© 2009 Prentice-Hall, Inc. 5 – 31
Exponential Smoothing
Mathematically
Ft 1 Ft (Yt Ft )
where
Ft+1= new forecast (for time period t + 1)
Ft= previous forecast (for time period t)
= smoothing constant (0 ≤ ≤ 1)
Yt= previous period’s actual demand
The idea is simple – the new estimate is the
old estimate plus some fraction of the error in
the last period
© 2009 Prentice-Hall, Inc. 5 – 32
Exponential Smoothing Example
In January, February’s demand for a certain
car model was predicted to be 142
Actual February demand was 153 autos
Using a smoothing constant of = 0.20, what
is the forecast for March?
New forecast (for March demand) = 142 + 0.2(153 – 142)
= 144.2 or 144 autos
If actual demand in March was 136 autos, the
April forecast would be
New forecast (for April demand) = 144.2 + 0.2(136 – 144.2)
= 142.6 or 143 autos
© 2009 Prentice-Hall, Inc. 5 – 33
Selecting the Smoothing Constant
Selecting the appropriate value for is
key to obtaining a good forecast
The objective is always to generate an
accurate forecast
The general approach is to develop trial
forecasts with different values of and
select the that results in the lowest MAD
© 2009 Prentice-Hall, Inc. 5 – 34
Port of Baltimore Example
Exponential smoothing forecast for two values of
ACTUAL
TONNAGE FORECAST FORECAST
QUARTER UNLOADED USING =0.10 USING =0.50
1 180 175 175
2 168 175.5 = 175.00 + 0.10(180 – 175) 177.5
3 159 174.75 = 175.50 + 0.10(168 – 175.50) 172.75
4 175 173.18 = 174.75 + 0.10(159 – 174.75) 165.88
5 190 173.36 = 173.18 + 0.10(175 – 173.18) 170.44
6 205 175.02 = 173.36 + 0.10(190 – 173.36) 180.22
7 180 178.02 = 175.02 + 0.10(205 – 175.02) 192.61
8 182 178.22 = 178.02 + 0.10(180 – 178.02) 186.30
9 ? 178.60 = 178.22 + 0.10(182 – 178.22) 184.15
Table 5.5
© 2009 Prentice-Hall, Inc. 5 – 35
Port of Baltimore Example
Exponential smoothing forecast for two values of
ACTUAL
TONNAGE FORECAST FORECAST
QUARTER UNLOADED USING =0.10 USING =0.50
1 180 175 175
2 168 175.5 = 175.00 + 0.10(180 – 175) 177.5
3 159 174.75 = 175.50 + 0.10(168 – 175.50) 172.75
4 175 173.18 = 174.75 + 0.10(159 – 174.75) 165.88
5 190 173.36 = 173.18 + 0.10(175 – 173.18) 170.44
6 205 175.02 = 173.36 + 0.10(190 – 173.36) 180.22
7 180 178.02 = 175.02 + 0.10(205 – 175.02) 192.61
8 182 178.22 = 178.02 + 0.10(180 – 178.02) 186.30
9 ? 178.60 = 178.22 + 0.10(182 – 178.22) 184.15
Table 5.5
© 2009 Prentice-Hall, Inc. 5 – 36
Trend Projection
Trend projection fits a trend line to a
series of historical data points
The line is projected into the future for
medium- to long-range forecasts
Several trend equations can be
developed based on exponential or
quadratic models
The simplest is a linear model developed
using regression analysis
© 2009 Prentice-Hall, Inc. 5 – 37
Trend Projection
The mathematical form is
Yˆ b0 b1 X
where
= predicted
Ŷ value
b0= intercept
b1= slope of the line
X= time period (i.e., X = 1, 2, 3, …, n)
© 2009 Prentice-Hall, Inc. 5 – 38
Trend Projection
Value of Dependent Variable
Dist7 *
Dist5 * Dist6
* Dist3 *
Dist4
Dist1 * Dist2
*
*
Time Figure 5.4
© 2009 Prentice-Hall, Inc. 5 – 39
Midwestern Manufacturing
Company Example
Midwestern Manufacturing Company has
experienced the following demand for it’s electrical
generators over the period of 2001 – 2007
YEAR ELECTRICAL GENERATORS SOLD
2001 74
2002 79
2003 80
2004 90
2005 105
2006 142
2007 122
Table 5.7
© 2009 Prentice-Hall, Inc. 5 – 40
Formulae for intercept and slope
For the simple linear regression model, the
values of the intercept and slope can be
calculated using the formulas below
Yˆ b0 b1 X
X
X
average (mean) of X values
n
Y
Y
average (mean) of Y values
n
b1
( X X )(Y Y )
(X X ) 2
b0 Y b1 X
© 2009 Prentice-Hall, Inc. 5 – 41
Midwestern Manufacturing
Company Example
The forecast equation is
Yˆ 56.71 10.54 X
To project demand for 2008, we use the coding
system to define X = 8
(sales in 2008) = 56.71 + 10.54(8)
= 141.03, or 141 generators
Likewise for X = 9
(sales in 2009) = 56.71 + 10.54(9)
= 151.57, or 152 generators
© 2009 Prentice-Hall, Inc. 5 – 42
Midwestern Manufacturing
Company Example
160 –
150 –
140 –
Trend Line
130 –
Generator Demand
Yˆ 56.71 10.54 X
120 –
110 –
100 –
90 –
80 –
70 – Actual Demand Line
60 –
50 –
| | | | | | | | |
2001 2002 2003 2004 2005 2006 2007 2008 2009
Figure 5.5 Year
© 2009 Prentice-Hall, Inc. 5 – 43
Seasonal Variations
Recurring variations over time may
indicate the need for seasonal
adjustments in the trend line
A seasonal index indicates how a
particular season compares with an
average season
When no trend is present, the seasonal
index can be found by dividing the
average value for a particular season by
the average of all the data
© 2009 Prentice-Hall, Inc. 5 – 44
Seasonal Variations
Eichler Supplies sells telephone
answering machines
Data has been collected for the past two
years sales of one particular model
They want to create a forecast this
includes seasonality
© 2009 Prentice-Hall, Inc. 5 – 45
Seasonal Variations
SALES DEMAND
AVERAGE
AVERAGE TWO- MONTHLY SEASONAL
MONTH YEAR 1 YEAR 2 YEAR DEMAND DEMAND INDEX
January 80 100 94 0.957
90
February 85 75 94 0.851
80
March 80 90 94 0.904
85
April 110 90 94 1.064
100
May 115 131 94 1.309
123
June 120 110 94 1.223
115
July 100 110 94 1.117
105
August 110 90 94 1.064
1,128 100 Average two-year demand
Average monthly demand = = 94 Seasonal index =
12 months Average monthly demand
September 85 95 94 0.957
Table 5.8 90 © 2009 Prentice-Hall, Inc. 5 – 46
Seasonal Variations
The calculations for the seasonal indices are
1,200 1,200
Jan. 0.957 96 July 1.117 112
12 12
1,200 1,200
Feb. 0.851 85 Aug. 1.064 106
12 12
Monthly Calculation =
1,200 1,200
Mar. 0.904 90 Sept. 0.957 96
12 12
Average Monthly Demand
1,200 1,200
Apr. 1.064 106 x Oct. 0.851 85
12
Seasonal Index 12
1,200 1,200
May 1.309 131 Nov. 0.851 85
12 12
1,200 1,200
June 1.223 122 Dec. 0.851 85
12 12
© 2009 Prentice-Hall, Inc. 5 – 47
END
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