RESEARCH #1: FORECASTING

Panaguiton, Maria Jose

Production and Operations Management
Monday and Wednesday: 6:00pm 7:30pm
Dr. Ramon A. Victor
November 23, 2015
 EXECUTIVE SUMMARY

Forecast is a statement about the future. It is the art and science of

predicting future events. It involves taking historical data and projecting them

about the future and is the basic input in the decision processes of operations

management. It is important for businesses because forecasts will be the basis

for budgeting, planning capacity, sales, production and inventory, personnel,

purchasing and more different departments in an entity. It has an important role

in the planning process because they enable managers to anticipate the future

so they can plan accordingly.

To further discuss how forecasting affects decisions throughout the

organization. Here are some examples of its uses:

Accounting. In projecting financial statements. By having a look to the

future of those financial statements, the management will adjust to come up with

a better standing. It can also be use in coming up with a new product/process

estimates, profit projections and cash management.

Finance. Equipment/ equipment replacement needs, timing and amount of

funding/ borrowing needs.

Human Resources. Hiring activities, including recruitment, interviewing,

and training; layoff planning, including outplacement counseling.

Marketing. Pricing and promotion, e-business strategies, global

competition strategies, MIS.

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 Operations. Schedules, capacity planning, work assignments and

workloads, inventory planning, make-or-buy decisions, outsourcing, project

management,

Product/service design. Revision of current features, design of new

products or services.

There are two uses for forecasts. One is to help managers plan the

system, and the other is to help them pan the use of the system. Planning the

system generally involves long-range plans about the types of products and

services to offer, what facilities and equipment to have, where to locate, etc.

planning the use of the system refers to short range and immediate-range

planning, which involve task such as planning inventory and work force levels,

planning purchasing, and production, budgeting, and scheduling.

In forecasting, the elements and features of a forecast must be first

known, for you to be able to make a great forecast. And by that, First in this

research are features common to all forecasts and elements of a good forecasts.

There are four common features which are: Generally assume that the same

forces that made things happen in the past will continue to make things happen

in the future, Forecasts are almost never perfect predictions of the future,

Forecasts for groups of items are generally more accurate than forecasts for

individual items, because errors tend to cancel each other out, Forecast accuracy

decreases as the time horizon increases. The 7 elements of a good forecast are:

timeliness, accuracy, reliability, expressed meaningful units, written, method

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should be simple and easy to understand and measurable.

There are also steps in forecasting that will serve as a guide to how to

make a great forecast. There are 6 steps namely: Determine purpose of the

forecast, Select the items to be forecast, Establish a time horizon, Select

forecasting technique, Gather and analyze the appropriate data, Prepare the

forecast and Monitor the forecast. These steps are detailed explained in this

research.

There are also types of forecast that the entity can choose from which

may be qualitative and quantitative approaches. By using different methods or

techniques, then business must know how accurate their projections are. By that

there are different ways to test the accuracy. There are 4 measures of accuracy,

namely: Mean Forecast Error (MFE), Mean Absolute Deviation (MAD), Mean

Squared Error (MSE) and Mean Absolute Percentage Error (MAPE).

In this research, there different forecasting techniques and models. There

are many ways to forecast and that vary from different entities. The must choose

what way to forecast their business, they must choose the best from this

techniques/ models to be able to come up to the most accurate projections.

Lastly, after the judgements and decisions are made. The entity must monitor the

forecasting technique and finally use the forecasting information.

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 TABLE OF CONTENTS

FEATURES COMMON TO ALL FORECAST ___________________________ 1

ELEMENTS OF A GOOD FORECAST ________________________________ 2

STEPS IN FORECASTING PROCESSES _____________________________ 3

FORECASTING ACCURACY _______________________________________ 5

APPROACHES TO FORECASTING _________________________________ 10

FORECASTS BASED ON JUDGEMENT AND OPINION

AND BASED ON TIME SERIES DATA _______________________________ 17

ASSOCIATIVE FORECASTING TECHNIQUES ________________________ 19

MONITORING FORECASTING TECHNIQUES ________________________ 22

USING FORECASTING INFORMATION _____________________________ 26

BIBLIOGRAPHY ________________________________________________ 27

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 FEATURES COMMON TO ALL FORECAST

1. All forecasting techniques assume that there is some degree of stability in

the system, and what happened in the past will continue to happen in the

future.

- There are occurrences where the managers must know that will

have a certain effect in the future. Those are the occurrences

that happened in the past that will continue to happen in the

future. By that, managers must be alert to such occurrences and

be ready to override forecasts, which assume a stable causal

system.

2. Forecasting is rarely perfect.

- Of course, forecasting have predictions/ deviations, there are

cases that are really impossible to predict perfectly. Actual

results usually differs from predicted ones.

3. Forecasts for groups of items tend to be more accurate than forecasts for

individual ones.

- If we forecast groups and we made an error it has a cancelling

effect. But if we had an error to an individual product, that error

cannot be in any form corrected.

4. Forecast accuracy decreases as the time period covered by the forecast-

the time horizon-increases.

- Short-range forecast must contend with fewer uncertainties than

longer-range forecast, so they tend to be more accurately.

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 ELEMENTS OF A GOOD FORECAST

The following are the 7 elements of a good forecast:

1. TimelinessIt should predict events far enough ahead of time to allow

managers to make decisions based on those predictions. Also,

Forecasting horizon must cover the time necessary to implement possible

changes.

2. AccuracyNo forecast is perfect, so the degree of accuracy expected

should be stated.

3. ReliabilityIf the forecast doesnt work consistently, people will start to

lose faith in it. Forecast should work consistently.

4. Expressed in meaningful unitsDepending on the situation, you may

need to forecast dollars, units, heads, machines, etc. because of those

situations, financial planners should know how many dollars needed,

production should know how many units to be produced, and schedulers

need to know what machines and skills will be required.

5. WrittenNot only allows post-mortem analysis of the accuracy of the

forecast, but also allows users to understand the assumptions that went in

to making it. It is also to guarantee use of the same information and to

make easier comparison to actual results.

6. Method should be simple and easy to understandPeople dont trust

what they dont understand.

7. MeasurableTo be helpful, a forecast must be monitored to determine its

effectiveness and any adjustments that need be made in the future

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 STEPS IN FORECASTING PROCESSES

These are the five steps in forecasting process:

1. Determine the purpose of the forecast.

- What am I forecasting? What is its purpose and when will it be

needed? This will provide the indication of the level of detail

required in the forecast, the amount of resource that can be

justified, and the level of accuracy necessary.

- Example: Disney uses park attendance forecasts to drive

decisions about staffing, opening times, ride availability, and

food supplies.

2. Select the items to be forecast.

- Example: Disney uses six main parks. A forecast of daily

attendance at each is the main number that determines the

labor, maintenance and scheduling.

3. Establish the time horizon.

- It is the length of time. The forecast must indicate a time limit,

keeping in mind that accuracy decreases as the time horizon

increases.

- Is it short, medium, or long term?

4. Select a forecasting technique.

- Example: Disney uses a variety of statistical models that we

shall discuss, including moving averages, econometrics, and

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 regression analysis. It also employs judgemental, or

nonquantitative models.

5. Gather and analyze the appropriate data.

- Before a forecast can be prepared, date must be gathered and

analyze. Indentify any assumptions that are made in conjunction

with preparing and using the forecast.

- Example: Disney uses a firm called Global Insights for travel

industry forecasts and gathers data on exchange rates, arrivals

into the U.S., airline specials, etc.

6. Prepare the forecast.

7. Monitor the forecast.

- A forecast has to be monitored to determine whether it is

performing in a satisfactory manner. If it is not, reexamine the

method, assumptions, validity of data, and so on; modify as

needed; and prepare a revised forecast.

- Disney review their forecast daily at the highest levels to make

sure that the model, assumptions and data are valid.

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 FORECASTING ACCURACY

1. Mean Forecast Error (MFE): Forecast error is a measure of how

accurate our forecast was in a given time period. It is calculated as the actual

demand minus the forecast, or Et = At Ft.

Forecast error in one time period does not convey much information, so

we need to look at the accumulation of errors over time. We can calculate the

average value of these forecast errors over time (i.e., a Mean Forecast Error, or

MFE).Unfortunately, the accumulation of the Et values is not always very

revealing, for some of them will be positive errors and some will be negative.

These positive and negative errors cancel one another, and looking at them

alone (or looking at the MFE over time) might give a false sense of security.

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 2. Mean Absolute Deviation (MAD): To eliminate the problem of positive

errors canceling negative errors, a simple measure is one that looks at the

absolute value of the error (size of the deviation, regardless of sign). When we

disregard the sign and only consider the size of the error, we refer to this

deviation as the absolute deviation. If we accumulate these absolute deviations

over time and find the average value of these absolute deviations, we refer to this

measure as the mean absolute deviation (MAD). For our hypothetical two

forecasting methods, the absolute deviations can be calculated for each year and

an average can be obtained for these yearly absolute deviations, as follows:

The smaller misses of Method 1 has been formalized with the calculation

of the MAD. Method 1 seems to have provided more accurate forecasts over this

six year horizon, as evidenced by its considerably smaller MAD.

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 3. Mean Squared Error (MSE): Another way to eliminate the problem of

positive errors canceling negative errors is to square the forecast error.

Regardless of whether the forecast error has a positive or negative sign, the

squared error will always have a positive sign. If we accumulate these squared

errors over time and find the average value of these squared errors, we refer to

this measure as the mean squared error (MSE). For our hypothetical two

forecasting methods, the squared errors can be calculated for each year and an

average can be obtained for these yearly squared errors, as follows:

Method 1 seems to have provided more accurate forecasts over this six

year horizon, as evidenced by its considerably smaller MSE.

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 4. Mean Absolute Percent Error (MAPE): A problem with both the MAD

and MSE is that their values depend on the magnitude of the item being forecast.

If the forecast item is measured in thousands or millions, the MAD and MSE

values can be very large. To avoid this problem, we can use the MAPE. MAPE is

computed as the average of the absolute difference between the forecasted and

actual values, expressed as a percentage of the actual values. In essence, we

look at how large the miss was relative to the size of the actual value. For our

hypothetical two forecasting methods, the absolute percentage error can be

calculated for each year and an average can be obtained for these yearly values,

yielding the MAPE, as follows:

Method 1seems to have provided more accurate forecasts over this six

year horizon, as evidenced by the fact that the percentages by which the

forecasts miss the actual demand are smaller with Method 1 (i.e., smaller

MAPE).

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 SUMMARY OF THE FOUR FORECAST ACCURACY METHOD

You can observe that for each of these forecasting methods, the same

MFE resulted and the same MAD resulted. With these two measures, we would

have no basis for claiming that one of these forecasting methods was more

accurate than the other. With several measures of accuracy to consider, we can

look at all the data in an attempt to determine the better forecasting method to

use. Interpretation of these results will be impacted by the biases of the decision

maker and the parameters of the decision situation.

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 APPROACHES TO FORECASTING

Two approaches to forecasting:

1. Qualitative methods: These types of forecasting methods are based on

judgments, opinions, intuition, emotions, or personal experiences and are

subjective in nature. They do not rely on any rigorous mathematical

computations.

Qualitative Methods:

a. Executive Opinion - Approach in which a group of managers meet

and collectively develop a forecast.

b. Market Survey- Approach that uses interviews and surveys to judge

preferences of customer and to assess demand.

c. Sales Force Composite- Approach in which each salesperson

estimates sales in his or her region

d. Delphi Method- Approach in which consensus agreement is

reached among a group of experts

2. Quantitative methods: These types of forecasting methods are based on

mathematical (quantitative) models, and are objective in nature. They rely

heavily on mathematical computations.

Quantitative Methods:

a. Time-Series Models- Time series models look at past patterns of

data and attempt to predict the future based upon the underlying

patterns contained within those data.

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 b. Associative Models- Associative models (often called causal

models) assume that the variable being forecasted is related to

other variables in the environment. They try to project based upon

those associations.

TIME SERIES MODELS

1. Nave Uses- last periods actual value as a forecast.

- In this illustration we assume that each year (beginning with

year 2) we made a forecast, then waited to see what demand

unfolded during the year. We then made a forecast for the

subsequent year, and so on right through to the forecast for

year 7.

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2. Simple Mean (Average) - Uses an average of all past data as a

forecast.

- We will also assume that, in the absence of data at startup, we

made a guess for the year 1 forecast (300). At the end of year 1

we could start using this forecasting method. In this illustration

we assume that each year (beginning with year 2) we made a

forecast, then waited to see what demand unfolded during the

year. We then made a forecast for the subsequent year, and so

on right through to the forecast for year 7.

3. Simple Moving Average- Uses an average of a specified number of the

most recent observations, with each observation receiving the same

emphasis (weight).

- In this illustration we assume that a 2-year simple moving

average is being used. We will also assume that, in the absence

of data at startup, we made a guess for the year 1 forecast

(300). Then, after year 1 elapsed, we made a forecast for year 2

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 using a nave method (310). Beyond that point we had sufficient

data to let our 2-year simple moving average forecasts unfold

throughout the years.

4. Weighted Moving Average- Uses an average of a specified number of

the most recent observations, with each observation receiving a

different emphasis (weight).

5. Exponential Smoothing- A weighted average procedure with weights

declining exponentially as data become older.

- Ft= Ft-1 + a (At-1 Ft-1) equation 1

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 - Ft= aAt-1+(1-a)Ft-1

6. Trend Projection- Technique that uses the least squares method to fit a

straight line to the data.

- Y = a + bX

- Where X represents the values on the horizontal axis (time),

and Y represents the values on the vertical axis (demand).

7. Seasonal Indexes- A mechanism for adjusting the forecast to

accommodate any seasonal patterns inherent in the data.

PATTERNS THAT MAY BE PRESENT IN A TIME SERIES

1. Trend: Data exhibit a steady growth or decline over time.

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2. Seasonality: Data exhibit upward and downward swings in a short to

intermediate time frame (most notably during a year).

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3. Cycles: Data exhibit upward and downward swings in over a very long

time frame.

4. Random variations: Erratic and unpredictable variation in the data over

time with no discernable pattern.

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FORECASTS BASED ON JUDGEMENT AND OPINION AND BASED ON TIME

SERIES DATA

1. Forecast Based on Judgement and Opinion

- Judgemental forecast rely on analysis of subjective inputs

obtained from various sources, such as customer surveys, the

sales staff, managers and executives and panels of experts.

Frequently, these sources provide insights that are not

otherwise available.

a. Executive Opinions. A small group of managers of upper-

level managers may meet and collectively develop a

forecast. This approach is often used as a part of a long-

range planning and new product development.

b. Sales Force Composite. The sales staff is often a good

source of information because of its direct contact wth

consumers. Thus, the salespeople are often aware of any

plans the customers may be considering for the future.

c. Consumer surveys. Since it is the consumers who

ultimately determine to demand, it seems natural to solicit

input from them. In some instances, every customer or

potential customer can be contacted.

d. Outside opinion. this is needed to make a forecast. These

may include advise on political or economic conditions in

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 the United States or a foreign currency, or some other

aspect of importance with which an organization lacks

familiarity.

e. Opinions of managers and staff. A manager may use staff

to generate forecast or to provide several forecasting

alternatives from which to choose.

2. Forecasts Based on Time Series (Historical) Data

- Some forecasting techniques depend on uncovering relationship

between two variables that can be used to predict the future

values of one of them; others simply attempt to project past

experience into the future. The second approach exemplifies

forecasts that use historical, or time series, data with

assumption that the future will be like the past. Some models

merely attempt to smooth out random variations in historical

data; others attempt to identify specific patterns in the data. In

effect, approaches based in historical data treat the data as a

mirror that reflects the combination of all the forces influencing

the variable in question without trying to identify or measure

those forces directly. Trends on the time series are already

discuss on the previous topic.

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 ASSOCIATIVE FORECASTING TECHNIQUES

Associative forecasting models (causal models) assume that the variable

being forecasted (the dependent variable) is related to other variables

(independent variables) in the environment. This approach tries to project

demand based upon those associations. In its simplest form, linear regression is

used to fit a line to the data. That line is then used to forecast the dependent

variable for some selected value of the independent variable.

In this illustration a distributor of drywall in a local community has historical

demand data for the past eight years as well as data on the number of permits

that have been issued for new home construction. These data are displayed in

the following table:

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If we attempted to perform a time series analysis on demand, the results would

not make much sense, for a quick plot of demand vs. time suggests that there is

no apparent pattern relationship here, as seen below.

If you plot the relationship between demand and the number of construction

permits, a pattern emerges that makes more sense. It seems to indicate that

demand for this product is lower when fewer construction permits are issued, and

higher when more permits are issued. Therefore, regression will be used to

30000 35000 40000 45000 50000 55000 60000 65000 70000 2003 2004 2005

2006 2007 2008 2009 2010 2011 Demand Year Demand vs. Time establish a

relationship between the dependent variable (demand) and the independent

variable (construction permits).

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 The independent variable (X) is the number of construction permits. The
dependent variable (Y) is the demand for drywall. Application of regression
formulas yields the following forecasting model:

Y = 250 + 150X

If the company plans finds from public records that 350 construction
permits have been issued for the year 2012, then a reasonable estimate of
drywall demand for 2012 would be:

Y = 250 + 150(350) = 250 + 52,500 = 52,750

(which means next years forecasted demand is 52,750 sheets of drywall)

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 MONITORING FORECASTING TECHNIQUES

It is necessary to monitor forecast errors to ensure that the forecast is performing

adequately over time. This is generally accomplished by comparing forecast

errors to predefined values, or action limits, as illustrated below.

There are Possible sources of forecast errors which are the omission of an

important variable, a sudden or unexpected change in the variable (causing by

severe weather or other nature phenomena, temporary shortage or breakdown,

catastrophe, or similar events), appearance of a new variable, being used

incorrectly, data being misinterpreted, an random variation.

Two common methods in forecast control / monitor are tracking

signal and control chart.

Tracking Signal

A tracking signal focuses on the ratio of cumulative forecast error to the

corresponding MAD:

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 .

The tracking signal often ranges from to . For the most part, we shall use

limits of , which are roughly comparable to three standard deviation limits.

Values within the limits suggest --- but do not guarantee --- that the forecast is

performing adequately.

MAD can be updated using the following exponential smoothing equation:

Control Chart

The control chart sets the limits as multiples of the squared root of MSE. Basic

assumptions are

Forecast errors are randomly distributed around a mean of zero, and

The distribution of errors is normal.

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The square root of MSE is used in practice as an estimate of the standard

deviation of the distribution of errors. That is,

For a normal distribution, 95% of the errors fall within , and approximately

99.7% of the errors fall within . Errors fall outside these limits should be

regarded as evidence that corrective action is needed.

Plotting the errors with the help of a control chart can be very informative. A plot

helps you to visualize the process and enables you to check for possible

patterns, nonrandom errors, within the limit that suggests an improved forecast is

possible.

The control chart approach is generally superior to the tracking signal approach.

The major weakness of the tracking signal approach is its use of cumulative

errors: individual errors can be obscured so that large positive and negative

errors cancel each other.

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 USING FORECASTING INFORMATION

A manager can take a reactive and proactive approach to a forecast.

1. Reactive approach views forecasts as probable future demand, and a

manager reacts to meet that demand (e.g., adjusts production rates,

inventories, the workforce). Conversely, a proactive approach seeks to actively

influence demand (e.g., by means of advertising, pricing, or

product/service changes).

2. Proactive approach requires either an explanatory model (e.g.,regression)

or a subjective assessment of the influence on demand. A manager might

make two forecasts: one to predict what will happen under the status quo

and a second one based on a what if approach, if the results of the

status quo forecast are unacceptable.

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BIBLIOGRAPHY

Books:

Production/ Operations Management, fifth edition by William J. Stevenson

Operations Management, tenth edition by Jay Heizer and Barry Render

Websites:

https://www.scribd.com/doc/12395603/Operations-Management-Forecasting-

MBA-lecture-notes

http://mech.at.ua/Forecasting.pdf

http://mcu.edu.tw/~ychen/op_mgm/notes/part2.html

https://www.scribd.com/doc/53246144/2/USING-FORECAST-INFORMATION

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