American Marketing Association

Modeling and Forecasting Sales Data by Time Series Analysis

Author(s): S. G. Kapoor, P. Madhok and S. M. Wu
Source: Journal of Marketing Research, Vol. 18, No. 1 (Feb., 1981), pp. 94-100
Published by: American Marketing Association
Stable URL: http://www.jstor.org/stable/3151318
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 - y |~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~

S. G. KAPOOR, P. MADHOK, and S. M. WU*

Time series modeling technique is used to model a series of sales data

in which seasonality causes distinct spike peaks. The analysis of actual sales
data shows that the seasonality in the data can be approximated by a
deterministic function and the stochastic component is a sixth-order autoregres-
sive moving average model. Use of the combined deterministic and stochastic
models to derive the minimum mean squared forecast yields reliable results.

Modeling and Forecasting Sales Data by

Time Series Analysis

Obtaining accurate sales forecasts for the selection
of proper marketing strategy is a problem of growing
concern. Most of the prevailing forecasting methods
make use of static techniques like regression and
correlation analysis (Pindyck and Rubenfeld 1976).
These techniques ignore the dynamics or memory of
the process involved and treat the data, which are
mostly in the form of time series, as being independent.
Serial or autocorrelation, generally present in such
data, then distorts the analysis, masking the true nature
of the interrelationships and inflating the forecast
errors. A popular technique which does not require
the assumption of independent data is exponential
smoothing (Brown 1962). However, it is an ad hoc
technique and involves the problem of selecting, often
arbitrarily, an appropriate weight factor.
Time series analysis provides an ideal solution to
the problem of serially correlated data. Some work
in marketing research using time series analysis has
been reported recently (Helmer and Johansson 1977;
Mabert and Radcliffe 1974; Moriarty and Adams 1979;
Tiao and Pack 1975). The advantage of time series
modeling over other econometric methods of obtaining
forecasts has been demonstrated by Geurts and Ibra-
him (1975). Most recent work in time series modeling
has followed the Box-Jenkins (1970) method whereby
seasonality in data is accounted for by using a stochas-
*S. G. Kapoor is Assistant Professor, Department of Mechanical
and Industrial Engineering, University of Illinois at Urbana-
Champaign. P. Madhok is Research Engineer, Honeywell, Inc. S.
M. Wu is Professor, Department of Mechanical Engineering, Uni-
versity of Wisconsin-Madison.
94
tic difference operator of the form (1 - Bs). However,
the use of this operator may be ineffective or even
inappropriate in certain situations (Wu 1977), especial-
ly those cases in which the seasonality in the data
is not homogeneous.
The purpose of our article is to illustrate the use
of an alternative modeling approach to time series
analysis in an actual business situation wherein the
nonstochastic structure in the data is captured by the
use of deterministic functions. The alternative ap-
proach is different from the Box-Jenkins method both
in model philosophy and in modeling strategy (Wu
1977).
The time series data on the sale of a particular
line of consumer products are analyzed. A brief
overview of the alternative modeling procedure for
the nonstationary time series is given first; the applica-
tion of the technique in forecasting product demand
is then described and discussed.
MODELING PROCEDURE FOR THE
NONSTA TIONAR Y TIME SERIES
Consider a scalar time series, Y, t E Z (Z is the
set of integers). It can be shown that any covariance
stationary time series can be decomposed linearly into
two parts, one deterministic and the other stochastic,
i.e.:
(1) Y,= (t, ) + Xt, t E Z
where ,u(t, *) is a deterministic function for the mean
with parameter vector 1. For a stationary process,
,u(t, i) is a constant whereas for a nonstationary
process it is a function of time. Xt is a stochastic
series with zero mean and can be further represented

Journal of Marketing Research

Vol. XVIII (February 1981), 94-100

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MODELINGAND FORECASTINGSALESDATA 95

as an autoregressive moving average model (ARMA) Figure 1

as follows. FLOWCHART
OF MODELINGPROCEDURE

(2) X, = X,_,X- Oeka_, + a,, t E Z

X,I k-I

where n and m are the autoregressive and moving

average orders, respectively, and (, and ok are the
autoregressive and moving average parameters. The
a, is a discrete white noise process of strength c2
(i.e., E(a,a,+k) =
kaa2 t, k E Z where 8k is the
Kronecker delta function).
Modeling Steps
Let us reconsider equation 1. Assume that the
function p,(t, *) is known but the parameters, 4, are
not. One of the objectives of the modeling process
is to obtain the estimates of these parameter values.
For a nonstationary time series the modeling proceeds
in three stages. In the first stage, the initial values
of the parameters of the deterministic function, ,I(t, 4),
are obtained by the method of least squares. The
second stage determines the order (n, m) and the initial
values of 4)'s and O's for the ARMA model of the
stochastic component, X,. Finally, in the third stage,
a simulataneous estimation of the model is carried
out by using the initial values obtained from the first
two stages. The three stages are detailed hereafter.
Stage 1. Assume that the output data Y,are available
for N time periods. The initial values of 4, denoted
by 4i, are obtained by fitting the tentative model
Y, = I(t, ,) + ,, t= 1, 2..., N
where X, are the residuals. We obtain the parameters,
4i, by minimizing the sum of squares of the X,.
Stage 2. In this stage, we fit an ARMA model to
the residuals X, obtained from Stage 1. The adequate Stage 3. The last stage of the modeling precedure
consists of fitting the simultaneous models
ARMA model is obtained by systematically fitting
higher order models (Wu 1977). For example, in the Y = (t,(I)+ X,
case of scalar models, we successively fit ARMA (2n, n m
2n - 1) models. At each stage, the conditional least
X, = ,X,_,- Oka,_ + a,
squares estimates of 4), 42, ...f (), , 01, 029... 9 0n-, -i lk-I
are obtained by minimizing the sum of squares of
residuals. The adequacy of the model is checked by where the a, are residuals. The initial values, 4,
statistical tests such as an F-test (Wu 1977) or by obtained from Stage 1 and i,, 0k from Stage 2 are
the plots of the residuals, Q-statistic (Box and Jenkins used to start the nonlinear regression routine for the
estimation of the parameters which are obtained by
1970), etc.
Let us write the model obtained for the residuals minimizing the sum of squares, S = N a2 A final
X, as check for the adequacy of the model is then undertak-
en. Figure 1 is a flowchart depicting the three stages
ni~ m
of modeling.
Xt E Xt-, E kda,-k + a,.
i-\1 k-I DATA DESCRIPTION
The tildes on the 4('s and O's indicate that the parame- Figures 2a and 3a are the plots of the two series
ters obtained are only initial values and will be used of data used in the analysis. Series 1 is the total market
to obtain the final estimates in Stage 3. The tildes demand for all products of both the firm and the
on the X, and a,, likewise, represent the fact that rest of the competitors. Series 2 is the total demand
the X, and d, themselves are only residuals from Stage for the firm's products. The firm has a market share
I and Stage 2, respectively. of about 60%. For each series, there is a total of

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 96 JOURNALOF MARKETINGRESEARCH,FEBRUARY1981

Figure 2 a dummy variable which takes a value 1 for the periods

SALESSERIES1 corresponding to August peak and 0 for other periods.
Likewise, C2d2 approximates the December peak,
where d2 is another dummy variable accounting for
'1 rI
I
I
)(DATA
I
FOR
I
PERIODS
w
I
periods corresponding to December peaks. Therefore,
72,73,74
the deterministic function ,i(t, u) is of the following
form.
(/)
I- x(t, ,) = a + C1di + C2d2 where i = [a, Cl, C2]; a
is the average value of the sales data for all periods
excludingAugust and December.
After the deterministic function, pL(t,4),was decided
upon, the model was fitted in the following sequence.
0 20 40 60 80 100 In Stage 1, the initial values, v = [&, C,, C2 ], were
(0) ACTUAL DATA ALONG WITH FORCASTS obtained for the parameters of the deterministic func-
AND THEIR
i- 95% CONFIDENCE LIMITS
tion, u(t,4*), by minimizing the sum of squares of
the residuals X,. The results for series 1 and 2 are
150 1 | , | Il given in Table 1. The total sum of squares of residuals
DECEMBER PEAK
from Stage 1 is 3455 for series 1 and 1073 for series
2. The deterministic function estimated in Stage 1
( AUGUST PEAK
100I
/
for series I and 2 is shown in Figures 2b and 3b,
respectively. The residuals, X,, from Stage 1, i.e.,
*3
MEAN LEVEL [Y, - px(t, *)], for series 1 and series 2 are shown
/
in Figures 2c and 3c.
o50 . .

Figure 3
0 20 40 60 80 100
SALESSERIES2
(b) DETERMINISTIC FUNCTION (STAGE I)

An -Irv ~~I . -_ -
I
-
I
- v

2
2.
Z o
-2' o . 80 100 ,
00,1 20 40 60
->
(c) RESIDUALS FROM STAGE I

71 observations (periods) taken at intervals of every

four weeks covering a period from February 1971
(0) ACTUAL DATA ALONG WITH FORECASTS
to August 1976. AND THEIR 95% CONFIDENCE LIMITS
As is apparent from the plots, both series have
nonstationary components characterized by sharp
peaks which occur with regularity during the months
of August and December. In the trade, the minor
peak in August is referred to as the "back to school ,)
peak." The major peak in December which is due (0
z
to the surge in demand during the Christmas shopping
season is known as the "Christmas peak."
MODELING THE DA TA
Before modeling the data, one must ascertain the
actual form of the deterministic function, ,i(t, *). The
(b) DETEMINISTIC FUNCTION (STAGE I)
function must account for both peaks and also for on.
Av I II aI r I
)
the mean level of sales for the periods other than
the peak periods of August and December. The August
peak in the data is approximated by C, d, where C,
is the average value of the August sales for five years
z
_ rtI
L
"0 20 40 60
I.
80 100

from 1971 to 1976 represented in the data and d, is (C) RESIDUALS FROM STAGE I

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MODELINGAND FORECASTINGSALESDATA 97

Table 1
MODELSFOR DATA

Series 1 Series 2
Stage 2 Stage 3 Stage 2 Stage 3
Parameters Stage I A RMA(6,5) simultaneous Stage I A RMA (6,5) simultaneous
a 31.4 31.9 20.8 21.2
cl 13.9 13.5 6.5 5.87
C2 76.0 70.6 44.4 42.8
I0, 1.5109 1.6412 0.4969 0.5697
4)2 -0.7329 -0.9525 -0.1166 -0.1784
c43 -0.8245 -0.6638 -0.1384 -0.1092
4h4 1.0971 1.1778 0.5455 0.5510
5^ -0.4049 -0.6014 -0.6673 -0.7248
4)6 -0.2080 -0.0985 -0.2638 -0.2085
01 1.4124 1.4204 0.5002 0.5179
02 -0.9050 -0.8716 -0.3243 -0.3191
03 -0.7445 -0.7345 -0.1354 -0.1320
04 1.2616 1.2655 0.6549 0.6539
05 -0.7770 -0.7551 -0.8189 -0.8287
Residual sum
of squares 3455 2197 2120 1073 796 788
Q-value' 14.2 13.6 21.5 19.2
'95% x2 value (table) = 28.9.

Next, ARMA models were fitted to the residuals,
X,, sequentially by using a (2n, 2n - 1) strategy to
determine the order of the models and the initial values
of the parameters to be used in Stage 3. The details
of the (2n, 2n - 1) modeling strategy are given by
Wu (1977). For both series, ARMA(6,5) models were
tentatively taken as adequate models as indicated by
the statistical tests including the F-test and the Q-sta-
tistic; the parameters are listed in Table 1. (The order
of the adequate ARMA model was confirmed in the
final estimation.)
Finally, in Stage 3, the combined deterministic-
stochastic models were estimated (Table 1). As a finmal
check for adequacy, the residual autocorrelations for
30 lags were tested to determine the presence of
recognizable patterns or correlation. The adequate
models were then used to derive the forecasts.
MODEL INTERPRETATION A ND
JUSTIFICA TION
Figures 2a and 3a suggest an annual cycle in the
data because the peaks in the data occur exactly after
every 13 periods. (Each period is four weeks.) One
might therefore be led to conclude that the difference
operator (1 - B13) could be used to represent this
cycle. However, one of the reasons for avoiding its
use is that the seasonality, in this case, is not homoge-
neous. In other words, sales during the Christmas
season may appear to be related to sales during the
last Christmas season but sales are more dependent
on their immediate past than on sales a year ago.
The operator (1 - B ) does not reflect this inhomo-
geneity and imputes a dependence only on last year's
sales for all 13 periods.
Another reason for not using the difference operator
is that it is a stochastic operator; that is, it assumes
a relationship to the previous year's sales. However,
the seasonality could be more deterministic than sto-
chastic. The occurrence of peaks every December
is simply explained by the fact that Christmas is in
December and does not necessarily imply a relation-
ship to the sales of the previous years. In other words,
the occurrence of peaks is only a function of time
and may not be related causally to previous peaks.
The function Ix(t,*) used to account for the August
and December peaks recognizes the deterministic
nature and the inhomogeneity of the seasonality in
the data. However, one may question whether the
ARMA(6,5) models for the stochastic component for
both series capture the 13-period cycle adequately.
To answer this question, the autoregressive polyno-
mials of both models were decomposed into their
monomial factors (Table 2).
The nth-order autoregressive polynomial can be
factored as follows.
(1- ,B)k X, = (1 - XkB)
k-l k=1
where B is the backshift operator defined as BkX,
= X,_k, k = 0, + 1, +2, ..., and kare termed the roots
or eigenvalues of the autoregressive operator. Each
pair of complex roots gives rise to different frequen-
cies. The absolute values of the roots indicate the
extent to which the frequencies are damped. An
absolute value of one is the upper limit for stationary
processes and represents a completely undamped
frequency.

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98 JOURNALOF MARKETINGRESEARCH,FEBRUARY1981

Table 2
ROOTSOF AUTOREGRESSIVE FOR SERIES1 AND 2
POLYNOMIALS

Series I Series 2
(6,5)a (6,5)a
Absolute Frequency Time Absolute Frequency Time
Roots value cycles/period period value cycles/period period
Xi,, 2 0.86 ? i 0.46 0.98 0.078 12.73 0.87 ? i 0.46 0.99 0.078 12.81
X3, X4 0.46 ? i 0.85 0.96 0.171 5.85 -0.02 ? i 0.99 0.99 0.252 3.96
X5 -0.86 0.86 - -0.91 0.91 - -
h6 -0.13 0.13 -0.22 0.22
aARMA order.

From Table 2, we see that the roots for series 1
include a pair of complex roots i, K2= 0.86 ? i 0.46
with an absolute value of 0.98 corresponding to a
time period of 12.73. Similarly, series 2 has a pair
of roots Xi, k2 with an absolute value of 0.99 corre-
sponding to a time period of 12.81. We see, therefore,
that the annual cycle is strongly represented in both
models even though we have models of order lower
than 13. In fact, by not explicitly considering a term
for dependence on last year's data, we put more weight
on recent observations in deriving the forecasts. This
consideration was dictated by the nature of the market.
Whether the peak in this December will be higher
depends more on the current strength of the economy
as revealed in the trends from the recent periods of
September, October, and November than on last
December's sales.
FORECA STS
After identifying the models for series 1 and 2,
we obtained the forecasts by using the usual rules
of conditional expectation (Box and Jenkins 1970).
The results of the forecasts made at period t = 71
for the next 12 periods and their 95% confidence limits
using the normally independently distributed forecast
errors are shown in Figures 2 and 3. For clarity, the
last few observations and the forecasts for series 2
are reproduced on a large scale in Figure 4. The hatched
area covers the region between the upper and lower
95% confidence limits. Actual observations for the
next three periods, i.e., for t = 72, 73, and 74, become
available subsequently and are indicated in Figure 4
by crosses (X). These were also compared with their
forecasted values (Table 3).
For period t = 72, the sales predicted at period t = 71
differed from the actual demand by 21% for series
1 and 14% for series 2. This discrepancy could be
attributed to the fact that the firm conducted a major
promotion campaign during period 72 with discounts
and sales incentives, the effect of which could not
be reflected in the past data. For the next periods,
the forecasts proved very accurate. For series 1, the
two steps ahead forecast made at period t = 71, i.e.,
for period t = 73, with its 95% confidence limit is
33.0 ? 11.0 units. As actual demand was 31 units,
the error is 6%. Similarly, for series 2, the two steps
ahead forecast is 21.4 ? 6.5 and the actual demand
was 21 units, a difference of only 2%. Note that the
confidence limits of the forecast for both series are
very wide. This is to be expected because of the
nonstationary nature of the data and the relatively
short length of the time series record (71 periods)
available to model the data.
It is important to mention that the effect of promo-
tions and sales can be factored in the estimation of
the model parameters. However, in the present case,
promotions and sales incentives were not identified
before modeling and thus contributed to past error.
The forecasts made by the proposed method were
compared with those obtained by the Box-Jenkins and
generalized least squares methods. For illustration,
the models were fitted to series 2. Using the Box-Jen-

Table 3
ACTUAL DEMAND COMPARED WITH FORECASTED VALUES

Series 2
Series I Proposed method Box-Jenkins
Actual Forecasted Percentage Actual Forecasted Percentage Forecasted Percentage
Period demand values error demand values error values error
72 42 33.2 + 10.7a -21 27 23.1 ? 6.5a -14 20 ? 6.9 -26
73 31 33.0 + 11.0 +6 21 21.4 + 6.5 +2 24 + 7.1 +14
74 40 37.3 + 11.4 -7 29 24.9 +?6.6 -14 26 +?7.2 -11
a95% confidence limits.

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 SALESDATA
AND FORECASTING
MODELING 99

Figure 4
FORECASTSAND THEIR95% CONFIDENCELIMITSFOR SERIES2

X DATA FOR PERIODS 72, 73, AND 74

0 FORECASTS

Q)
I-
Z

67 72 77 82
PERIODS

kins identification, estimation, and diagonistic check-
ing procedure, we found the adequate model for series
2 to be
(1 - .31B)( - B3)x,= a,.
The model was used to obtain the forecasts and their
95% confidence limits for the periods t = 72, 73, and
74; the results are given in Table 3. The percentage
errors for the periods t = 72 and 73 are significantly
larger (26% and 14%) than the percentage errors by
the proposed method (14% and 2%). For period t =
74, the percentage errors by the two methods are
close to each other. Furthermore, the forecasts ob-
tained by the Box-Jenkins method have wider confi-
dence limits (6.9-7.2) than the forecasts obtained by
the proposed method (6.5-6.6).
The generalized least squares method was also used
to predict the sales forecasts for periods t = 72, 73,
and 74. The predicted values for three periods were
found to be 21.3. The difference between the actual
and predicted values for periods t = 72 and t = 74
was 21% and 28%, respectively, in contrast to a
difference of 14% from the proposed method. For
t = 73, the two methods gave approximately the same
percentage error in the predicted values.
CONCLUSION
A deterministic function of time trend in conjunction
with a stochastic model is used to fit the series in
which the seasonality is inhomogeneous and of a
deterministic nature. Two series of real market demand
data are analyzed to demonstrate the applicability of
the modeling procedure. For those series in which
a few sharp peaks appearing at regular intervals depict
the nonstationary components, the deterministic
component is approximated by a function involving
the dummy variables accounting for peaks and the
stochastic component is represented by the ARMA
models. Comparison of the minimum mean squared
error forecasts obtained from these models with
subsequently available observations for the next three
periods shows that the actual values are well within

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100
the 95% probability limits of the forecasts.
Clearly time series analysis is widely applicable in
marketing research. An important advantage is the
ability to predict and explain both short- and long-term
effects. However, the care must be taken in modeling
economic time series as the simple strategies of dif-
ferencing data by prevailing techniques may not yield
reliable forecasts. Our time series modeling procedure
is different from the Box-Jenkins method in two main
aspects. First, it avoids the tedious stage of identifying
orders n and m of the ARMA(n, m) model from the
examination of plots of the estimated autocorrelation
and partial autocorrelation functions as recommended
in Box-Jenkins procedure and provides a step-by-step
modeling strategy which can be easily executed on
a digital computer to obtain the statistically adequate
model irrespective of its order.
The second difference is in the modeling of nonsta-
tionary time series. Box and Jenkins use the word
"nonstationary" for discrete ARMA models with one
or more roots with absolute value one, e.g. random
walk, EWMA, etc. However, the probabilistic proper-
ties are still independent of the origin, although theo-
retically their variance is infinite. As a matter of fact
in nonstationary cases, where trends and seasonality
are dominant in the data, the sample autocorrelation
functions fail to damp out quickly. Thus, tentative
identification of the model from their plots is almost
impossible. That is the reason for applying differencing
or seasonality operators (which in turn must be guessed
from the data or sample autocorrelation functions,
etc.). The danger of such an indiscriminate operating
or smoothing of the data merely to simplify analysis
has been pointed by Slutsky [1927]. Such an operation
itself may introduce spurious trends and periods in
the resultant series which are not present in the data.
The final fitted model, though statistically adequate
and apparently parsimonious, may give a completely
distorted picture of the structure of the original series.
ERRATUM
The article "Measuring Personal Values: An Evaluation of Alternative Methods" by Thomas J. Reynolds
and James P. Jolly in the November 1980 JMR contains an error in the formula for transforming Taus. The
correct formula is:
TaU,=/2arcsin
= total - 1/2:tl(t, - 1) Vtotal -
2 arcsin
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JOURNALOF MARKETINGRESEARCH,FEBRUARY1981
Our use of the term "nonstationary" when the
nature of a series of data appears to be dependent
on time origin follows the terminology in stochastic
processes, systems analysis, and control theory. The
models for such a series of data therefore need to
include functions which depend on time origin.
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1/2t2(t2 - 1)