C4 - 1

Forecasting
A. Introduction
B. Qualitative Forecasting Methods
C. Quantitative Forecasting Methods
D. Constant Processes & Cumulative Average
E. Quasi-Constant Processes
F. Comparing Alternative Models
G. Linear Trend Processes
C4 - 2
H. Seasonal Processes
I. Causal Models
J. Advanced Models
K. Implementation & Use Of Forecasting
Systems
C4 - 3
What do we Forecast
List a few variable that we forecast.
Segregate the variables as per the business
functional areas (like Human Resource,
Finance etc.)
C4 - 4
A. Introduction
Forecasting - art & science of predicting future
events
Decreasing time frame for decisions makes it
more important
Increase accuracy & automate process
C4 - 5
Forecasting In Operations
facility planning location & size of plants
personnel number & type of employees
production volume & type of products
marketing product demand
distribution volume & destination
C4 - 6
Forecasting is an Integral Part
of Business Planning

Forecast
Method(s)
Demand
Estimates
Sales
Forecast
Management
Team
Inputs:
Market,
Economic,
Other
Business
Strategy
Production Resource
Forecasts
C4 - 7
Points To Consider
Purpose of forecast & decisions from it
Lead time needed for forecast to be useful
Specific variable to be forecasted
Knowledge about variable
What factors are related to the variable
Current data/info available about variable
C4 - 8
Quantitative vs. Qualitative
Methods
Quantitative (objective)
mathematical models of relationships between
variables
repeatable method
Qualitative (subjective)
experts intuition, experience, opinions
not repeatable by others
C4 - 9
The Role Of Time
Short-term - less than 3 months
tactical decisions: production & material planning
simple statistical methods
Intermediate-term - 3-12 months
aggregate (higher level) planning
complex statistical models
Long-term - 2-5 years
new products, capital expenditures
complex mathematical models or qualitative methods
C4 - 10
Quantitative Methods
Try to predict random variable Y
t

Y
t
generated by an unknown process
Observe Y
t
over time - time series data
Develop function of the process
Y
t
= f() + e
t
, e
t
is normally distributed error
Forecast F
t
uses function; for example,
F
t
= f(t, Y
t-1
, P
t
) + e
t
C4 - 11
Steps In Modeling
1. Graph relevant data
trends, linearity, patterns
2. Select general form of function
Y
t
= a + e
t
, where a is a constant
3. Estimate parameters of function
4. Evaluate quality of model
5. Select & implement best model
cost, timeliness, accuracy
C4 - 12
Graphs Of Demand Data










Upward trend











Seasonal pattern
P
r
o
d
u
c
t

d
e
m
a
n
d

P
r
o
d
u
c
t

d
e
m
a
n
d

C4 - 13
Constant Processes
Y
t
Permanent
component
Time
Random
component











}
{
a
C4 - 14
Cumulative Average
No trend, seasonality, cycle
Approximated by Y
t
= a + e
t
so, F
t
= a
Estimate a using cumulative average (CA)
CA =
t
y
t =1
T

|
\
|
.
/ T
C4 - 15
Bakery Example - CA
Week Actual, Y
t
Forecast, F
t
1 110
2 102 110.00=110/1
3 108 106.00=(110+102)/2
4 121 106.67=(110+102+108)/3
5 112 110.25=(110+102+108+121)/4
6 105 110.60= (110+102+108+121+112)/5
7 114 109.67= (110+102+108+121+112+105)/6
8 106 110.29= (110+102+... +105+114)/7
9 115 109.75= (110+102+... +114+106)/8
Forecast week 10 & 11
10 110.33= (110+102+... +106+115)/9
11 110.33= (110+102+... +106+115)/9
C4 - 16
Quasi-constant Processes
Y
t
Time
Not completely constant





a
1
a
2
a
3










Period 1
constant
Period 2
constant
Period 3
constant




C4 - 17
Simple Moving Average
SMA(N) = [y
T
+ y
T-1
+ ... + y
T-N+1
]/N

F
T
= SMA(N)

Small N, more responsive to changes in data
Large N, more stable forecasts over time
N is typically between 3 & 10
C4 - 18
Bakery Example - SMA(3)
Week Actual, Y
t
Forecast, F
t
1 110
2 102
3 108
4 121 106.67=(110+102+108)/3
5 112 110.33=(102+108+121)/3
6 105 113.67=(108+121+112)/3
7 114 112.67=(121+112+105)/3
8 106 110.33=(112 +105+114)/3
9 115 108.33=(105+114+106)/3
Forecast week 10 & 11
10 111.67=(114+106+115)/3
11 111.67=(114+106+115)/3
C4 - 19
Weighted Moving Average
WMA(N) = w
1
y
T
+ w
2
y
T-1
+ ... + w
N
y
T-N+1

F
T
= WMA(N)

w
1
> w
2
> ... > w
N
> 0, weights sum to 1
Sum-of-digits weights
S= 1+2+...+N
w
1
= N/S, w
2
= (N-1)/S, w
N
= 1/S
C4 - 20
Bakery Example - WMA(4)
Week Actual, Y
t
Forecast, F
t
1 110
2 102
3 108
4 121
5 112 112.2=0.4(121)+0.3(108)+0.2(102)+0.1(110)
6 105 112.9=0.4(112)+0.3(121)+0.2(108)+0.1(102)
7 114 110.6=0.4(105)+0.3(112)+0.2(121)+0.1(108)
8 106 111.6=0.4(114)+0.3(105)+0.2(112)+0.1(121)
9 115 108.8=0.4(106)+0.3(114)+0.2(105)+0.1(112)
Forecast week 10 & 11
10 111.1=0.4(115)+0.3(106)+0.2(114)+0.1(105)
11 111.1=0.4(115)+0.3(106)+0.2(114)+0.1(105)
C4 - 21
Simple Exponential Smoothing
F
T+1
= a = F
T
+o( y
T
- F
T
)


smoothing constant 0 s o s 1
y
T
- F
T
= forecasting error in period T
Larger o values make forecast more responsive
If o=1, naive model
In practice, 0.05 s o s 0.30
C4 - 22
Weights & Initial Forecasts
w
1
=o, w
2
=o(1- o ), w
3
=o(1- o )
2
...
Initial forecast required
use actual value at initial period
F
1
= y
1

use average of some initial actual values
F
1
= [y
1
+ y
2
+ y
3
]/3
C4 - 23
Bakery Example - (SES)
o= 0.2, initial forecast , F
1
= y
1
= 110
Week Actual, Y
t
Forecast, F
t
1 110
2 102 110.0=110.0+0.2(110-110)
3 108 108.4=110.0+0.2(102-110.0)
4 121 108.3=108.4+0.2(108-108.4)
5 112 110.8=108.3+0.2(121- 108.3)
6 105 111.0=110.8+0.2(112- 110.8)
7 114 109.8=111.0+0.2(105-111.0)
8 106 110.6=109.8+0.2(114-109.8)
9 115 109.7=110.6+0.2(106-110.6)
Forecast week 10 & 11
10 110.8= 109.7+0.2(115-109.7)
11 110.8= 109.7+0.2(115-109.7)
C4 - 24
Mean Error (ME)
ME =
i
y

i
F ( )/ K
i=1
K

Also called bias

Forecast error for period i = y
i
- F
i

K = number of periods of evaluation
C4 - 25
Errors When SMA Model Used
To Forecast Trend Process









Errors
y
t
> y
t
^
y
t
< y
t
^
+
-
Time
C4 - 26
Mean Squared Error
Most commonly used
Penalizes large errors more than small ones
Used to estimate variance of error
MSE =
i
y

i
F ( )
2
i=1
K

(

(
K
C4 - 27
Absolute Deviations
Use with decision makers
Intuitive feeling for size of errors
MAD =
i
y

i
F
i=1
K

(

(
K
MAPE =100x
i
y

i
F
i=1
K
/
i
y



(

(
K
C4 - 28
Bakery Errors - SMA(3)
Week Actual, Y
t
Fcst Error Error
2

1 110
2 102
3 108
4 121 106.7 +14.3 204.5
5 112 110.3 +1.7 2.9
6 105 113.7 -8.7 75.7 Evaluation
7 114 112.7 +1.3 1.7 Period
8 106 110.3 -4.3 18.5
9 115 108.3 +6.7 44.9
C4 - 29
Bakery Errors - WMA(4)
Week Actual, Y
t
Fcst Error Error
2

1 110
2 102
3 108
4 121
5 112 112.2 -0.2 0.0
6 105 112.9 -7.9 62.4 Evaluation
7 114 110.6 +3.4 11.6 Period
8 106 111.6 -5.6 31.4
9 115 108.8 +6.2 38.4
C4 - 30
Bakery Errors - SES(o=0.2)
Week Actual, Y
t
Fcst Error Error
2

1 110 110.0
2 102 110.0 -8.0 64.0
3 108 108.4 -0.4 0.2
4 121 108.3 +12.7 161.3
5 112 110.8 +1.2 1.4
6 105 111.0 -6.0 36.0 Evaluation
7 114 109.8 +4.2 17.6 Period
8 106 110.6 -4.6 21.2
9 115 109.7 +5.3 28.1
C4 - 31
Accuracy Comparison
SMA(3) WMA(4) SES(o=0.2)
MSE 35.20 35.95 25.73
MAD 5.25 5.78 5.03
MAPE 4.83% 5.30% 4.59%
good worst best
C4 - 32
G. Linear Trend Processes
Cum. Aver. SMA(4)
t Month Patients Fcst. Err. Fcst. Err.
1 January 328
2 February 310 328.0 -18.0
3 March 355 319.0 +36.0
4 April 362 331.0 +31.0
5 May 375 338.8 +36.2 338.8 +36.2
6 June 380 346.0 +34.0 350.5 +29.5
7 July 408 351.7 +56.3 68.0 +40.0
8 August 415 359.7 +55.3 381.3 +33.7
9 September 417 366.6 +50.4 394.5 +22.5
10 October 412 372.2 +39.8 405.0 +7.0
11 November 429 376.2 +52.8 413.0 +16.0
12 December 434 381.0 +53.0 418.3 +15.7
MAD=42.1 MAD=25.1
C4 - 33
Emergency Room Patients
300
320
340
360
380
400
420
440
1 3 5 7 9
1
1
Month
P
a
t
i
e
n
t
s
C4 - 34
Linear Trend Model
Y
t
= a + bt + e
t
a = basis
b = trend over time
F
t
= a + bt

b =
n
i
x
i
y
( )

i
x ( )
i
y
( )
n
i
2
x
( )

i
x ( )
2
a =
i
y
( )
n
| |
b
i
x ( ) n
| |
C4 - 35
Coefficient of Correlation (r)
r is computed by:
2 2 2 2
( ) ( )
n xy x y
r
n x x n y y

=
( (



C4 - 36
Coefficient of Determination (r
2
)
The coefficient of
determination, r
2
, is the
square of the coefficient of
correlation.
The modification of r to r
2

allows us to shift from
subjective measures of
relationship to a more
specific measure.
r
2
is determined by the ratio
of explained variation to
total variation:




2
2
2
( )
( )
Y y
r
y y

C4 - 37
Hospital Computations


t (x
i
) Patients (y
i
) x
i
2

x
i
y
i

1 328 1 328
2 310 4 620
3 355 9 1,065
4 362 16 1,448
5 375 25 1,875
6 380 36 2,280
7 408 49 2,856
8 415 64 3,320
9 417 81 3,753
10 412 100 4,120
11 429 121 4,719
12 434 144 5,208

78 4625 650 31,592 Sums
C4 - 38
b =
12(31, 592) (78)(4625)
12(650) (78)
2
=
18, 354
1716
= 10.7
F
t
= 315.9 + 10.7t
F
6
= 315.9 + 10.7(6) = 380.1
a = (4625/12)-10.7(78/12) = 315.9
C4 - 39
Hospital Forecasts
t Month Patients Fcst. Err.
1 January 328 326.6 +1.4
2 February 310 337.3 -27.3
3 March 355 348.0 +7.0
4 April 362 358.7 +3.3
5 May 375 369.4 +5.6
6 June 380 380.1 -0.1
7 July 408 390.8 +17.2
8 August 415 401.5 +13.5
9 September 417 412.2 +4.8
10 October 412 422.9 -10.9
11 November 429 433.6 -4.6
12 December 434 444.3 -10.3
MAD=8.8
C4 - 40
Moving Linear Regression
Linear processes can vary over time
Reestimate parameters a & b
Use most recent N periods
Removes bias of older data
C4 - 41
Double Exponential Smoothing
(DES)
Alternative to moving linear regression
Use o to smooth intercept and | to smooth
slope
o & | < 0.2, | s o
Time origin moves with t, not at 0
I
t
= estimate of mean value (intercept) at time t
S
t
= estimator of b (slope) at time t
C4 - 42
Time t Forecast
F
t+1
= I
t
+ S
t
where
I
t
= (I
t-1
+ S
t-1
) + o [y
t
- (I
t-1
+ S
t-1
)]
= F
t
+ o [y
t
- F
t
]
= forecast for period t + o [actual - forecast]

S
t
= S
t-1
+ | [(I
t
- I
t-1
) - S
t-1
]
= slope estimate for t + | [actual slope - slope estimate]

C4 - 43
Hospital Forecasts (DES)
F
1
= I
0
+ S
0
= 316.0 + 10.5 = 326.5
I
1
= (I
0
+ S
0
) + o [y
1
- (I
0
+ S
0
)]
= 326.5 + 0.2 (328 - 326.5) = 326.8
S
1
= S
0
+ | [(I
1
- I
0
) - S
0
]
= 10.5 + 0.1[(326.8 - 316) - 10.5] = 10.5

F
2
= I
1
+ S
1
= 326.8 + 10.5 = 337.3
I
2
= (I
1
+ S
1
) + o [y
2
- (I
1
+ S
1
)]
= 337.3 + 0.2 (310 - 337.3) = 331.9
S
2
= S
1
+ | [(I
2
- I
1
) - S
1
]
= 10.5 + 0.1[(331.9 - 326.8) - 10.5] = 10.0
C4 - 44
t Patients I
t-1
S
t-1
F
t
= I
t-1
+ S
t-1
Error
1 328 316.0 10.5 326.5 +1.5
2 310 326.8 10.5 337.3 -27.3
3 355 331.9 10.0 341.9 +13.1
4 362 344.5 10.3 354.8 +7.2
5 375 356.2 10.4 366.6 +8.4
6 380 368.3 10.6 378.9 +1.1
7 408 379.1 10.6 389.7 +18.3
8 415 393.4 11.0 404.4 +10.6
9 417 406.5 11.2 417.7 -0.7
10 412 417.6 11.2 428.8 -16.8
11 429 425.4 10.9 436.3 -7.3
12 434 434.8 10.7 445.5 -11.5
MAD = 10.3

C4 - 45
Forecasting Future Periods
I
12
= 445.5 + 0.2 [434 - 445.5] = 443.2
S
12
= 10.7 + 0.1[(443.2 - 434.8) - 10.7] = 10.5
F
13
= 443.2 + 10.5 = 453.7

Forecast for period 15
F
12+3
= 443.2 + 3(10.5) = 474.7
C4 - 46
H. Seasonal Processes
Daily, Weekly, Monthly,Quarterly
Lawn mowers, snow skis
Seasonality incorporated into existing models
Additive seasonal model
add/subtract from basic process
Multiplicative seasonal model
basic process multiplied by proportions
C4 - 47
I. Causal Models
Use independent variable (X) to predict
dependent variable (Y)
Causal or associative forecasting
Not explaining relationship, just forecasting it
Simple linear causal model
Y = a + bX + e
e = normally distributed error
C4 - 48
Steps In Process
Identify independent variable
Pair observations x
i
and y
i
Consider time lags
Plot data
Compute a & b
C4 - 49
Time Lags In Oil Filters
8
9
10
11
12
13
2
.
2
2
.
7
2
.
9
Cars
F
i
l
t
e
r
s
8
10
12
14
2
.
2
2
.
7
2
.
9
3
.
2
Cars
F
i
l
t
e
r
s
No Lag 2 Quarter Lag
C4 - 50
Linear Causal Model Calculations
NC
t-2
OF
t

i x
i
y
i
x
i
2
x
i
y
i

1 2.45 10.10 6.00 24.75
2 2.70 10.90 7.29 29.43
3 2.20 8.70 4.84 19.14
4 2.85 11.70 8.12 33.35
5 3.10 12.50 9.61 38.75
6 2.90 11.50 8.41 33.35
7 3.20 13.00 10.24 41.60
19.40 78.40 54.51 220.37

b = 4.15 a = -0.30
OF
t
= -0.30 + 4.15 NC
t-2

C4 - 51
Forecasts Using Model
Q Act Fcst Error Error
2

3 10.10 9.87 +0.23 0.05
4 10.90 10.91 -0.01 0.00
5 8.70 8.83 -0.13 0.02
6 11.70 11.53 +0.17 0.03
7 12.50 12.57 -0.07 0.00
8 11.50 11.74 -0.24 0.05
9 13.00 12.98 +0.02 0.00
MAD = 0.12 MSE = 0.02
C4 - 52
Time Series Models
Permanent component, P
Trend, T
Seasonal, S
Cyclic, C
Random, e
t

Examples
Y
t
= (P + T) + S + e
t
, additive

Y
t
= (P + T) x S + e
t
, multiplicative
C4 - 53
Process With Trend & Large
Random Component
Y
t
Permanent
component
Random variations
Time
Trend
component
{
C4 - 54
Process With Seasonal
Component
Day of week
M T W Th F
Permanent
component
Seasonal
components
Y
t
M T W Th F M T W Th F
C4 - 55
Process With Cyclic Components
Y
t
Permanent
component
Time
Cyclic
component
C4 - 56
Bank Example
Apply cumulative average model
Large, non-random errors
Seasonality present
Multiplicative model
Y
t
= a c
s
+ e
t
a = permanent component
c
s
= daily seasonal component
C4 - 57
Cumulative average applied to bank data
Wk Day Act. CA Errors Error
2

1 Mon 624
Tue 325 624 -299.0 89,401
Wed 401 474.5 -73.5 5,402
Thu 423 450 -27.0 729
Fri 679 443.3 +235.7 55,554
2 Mon 598 490.4 +107.6 11,577
Tue 342 508.3 -166.3 27,657
Wed 417 484.6 -67.6 4,570
Thu 358 476.1 -118.1 13,948
Fri 642 463 +179.0 32,041
3 Mon 671 480.9 +190.1 36,138
Tue 380 498.2 -118.2 13,971
Wed 426 488.3 -62.3 3,881
Thu 372 483.5 -111.5 12,432
Fri 620 475.6 +144.4 20,851
MAD = 135.7 MSE = 23,440
C4 - 58
Errors From CA Model
-300
-200
-100
0
100
200
300
M T W Th F Day
Errors

1
2
3
2
3
1
2
3
1, 2, 3 indicate week number
1
2
3
1
2
3
C4 - 59
Constructing Model
Compute N-period moving averages (CMA)
N = # of seasons
Compute seasonal ratios
= Actual/CMA = Col(1)/Col(2)
Estimate c
s
= average of ratios for season s
Deseasonalize data = Actual/ c
s

Estimate a for deseasonalized data
Forecast deseasonalized process
Forecast = deseasonalized forecast x c
s
for season
C4 - 60
(1) (2) (3) (4)
t Wk Day Act. CMA Seas. Ratio Deseas. Data
1 1 M 624 488
2 1 T 325 443
3 1 W 401 490.4 0.818 472
4 1 T 423 485.2 0.872 529
5 1 F 679 488.6 1.390 508
6 2 M 598 491.8 1.216 468
7 2 T 342 478.8 0.714 466
8 2 W 417 471.4 0.885 491
9 2 T 358 486.0 0.737 448
10 2 F 642 493.6 1.301 480
11 3 M 671 495.4 1.354 525
12 3 T 380 498.2 0.763 518
13 3 W 426 493.8 0.863 501
14 3 T 372 465
15 3 F 620 463

C4 - 61
Computing Seasonal Factors
c
1
= (1.216 + 1.354)/2 = 1.2850 x [5/5.0288] = 1.278
c
2
= (0.714 + 0.763)/2 = 0.7385 x [5/5.0288] = 0.734
c
3
= (0.818 + 0.885 + 0.863)/3 = 0.8553 x [5/5.0288] = 0.850
c
4
= (0.872 + 0.737)/2 = 0.8045 x [5/5.0288] = 0.800
c
5
= (1.390 + 1.301)/2 = 1.3455 x [5/5.0288] = 1.338
Totals 5.0288 5.000

C4 - 62
y
t
Dy
t
c
s

t Wk Day Act. Des. CA x Factor = Fcst Error Err
2

1 1 M 624 488
2 1 T 325 443 488 0.734 358 -33 1089
3 1 W 401 472 466 0.850 396 +5 25
4 1 T 423 529 468 0.800 374 +49 2401
5 1 F 679 508 483 1.338 646 +33 1089
6 2 M 598 468 488 1.278 623 -25 625
7 2 T 342 466 485 0.734 356 -14 196
8 2 W 417 491 482 0.850 410 +7 49
9 2 T 358 448 483 0.800 386 -28 784
10 2 F 642 480 479 1.338 641 +1 1
11 3 M 671 525 479 1.278 612 +59 3481
12 3 T 380 518 483 0.734 355 +25 625
13 3 W 426 501 486 0.850 413 +13 169
14 3 T 372 465 487 0.800 390 -18 324
15 3 F 620 463 486 1.338 650 -30 900

C4 - 63
Comments
Average one observation from each season to
get average of process
Seasonal effects balanced out
Actual - centered moving average = seasonal
effects
C4 - 64
Linear Trend With Seasonality
Carpet example
Apply linear trend model
1st & 2nd quarter errors positive
3rd & 4th quarter errors negative
Seasonality present
Multiplicative model
Y
t
= [a + bt] c
s
+ e
t
a + bt = 135.7 + 12.2 t = linear trend component
c
s
= quarterly seasonal factor
C4 - 65
Linear trend applied to carpet data
Y
t
F
t

t Yr Qtr Act. Fcst. Errors Error
2

1 1 1 160 147.9 +12.1 146.4
2 1 2 170 160.1 +9.9 98.0
3 1 3 140 172.3 -32.3 1043.3
4 1 4 150 184.5 -34.5 1190.3
5 2 1 230 196.7 +33.3 1108.9
6 2 2 240 108.9 +31.1 967.2
7 2 3 180 221.1 -41.1 1689.2
8 2 4 200 233.3 -33.3 1108.9
9 3 1 310 245.5 +64.5 4160.3
10 3 2 310 257.5 +52.3 2735.3
11 3 3 230 269.9 -39.9 1592.0
12 3 4 260 282.1 -22.1 488.4

MAD = 33.9 MSE = 1360.7

C4 - 66
Carpet Data & Trend Line
120
170
220
270
320
1 3 5 7 9
1
1
Time
S
a
l
e
s
C4 - 67
Constructing Model
Compute 4-period moving averages,
e.g., average quarters 1-4, then quarters 2-5
Compute centered moving averages,
[avg for 1-4 + avg for 2-5]/2
Compute seasonal ratios
= Actual/CMA = Col(1)/Col(3)
Estimate c
s
= average of seasonal ratios for season s
Deseasonalize data = Actual/ c
s

Estimate a & b for deseasonalized data
Forecast = deseasonalized forecase x c
s
for quarter
C4 - 68
(1) (2) (3) (4) (5)
t Yr Qtr Act. MA CMA c
s
Deseas.
1 1 1 160 134
2 1 2 170 155.0 147
3 1 3 140 172.5 163.75 0.855 169
4 1 4 150 190.0 181.25 0.828 182
5 2 1 230 200.0 195.00 1.179 193
6 2 2 240 212.5 506.25 1.164 208
7 2 3 180 232.5 222.50 0.809 217
8 2 4 200 250.0 241.25 0.829 242
9 3 1 310 262.5 256.25 1.210 260
10 3 2 310 277.5 270.00 1.148 269
11 3 3 230 277
12 3 4 260 315

C4 - 69
Computing Terms
c
1
= (1.179 + 1.210)/2 = 1.195 x [4/4.011] = 1.191
c
2
= (1.164 + 1.148)/2 = 1.156 x [4/4.011] = 1.153
c
3
= (0.855 + 0.809)/2 = 0.832 x [4/4.011] = 0.830
c
4
= (0.828 + 0.829)/2 = 0.828 x [4/4.011] = 0.826
Totals 4.011 4.000
Use deseasonalized data to compute a & b
b = 15.4, a = 117.6
F
t
= [117.6 + 15.4 t] c
s
F
t
= [117.6 + 15.4 (6)] 1.153 = 242


C4 - 70
y
t
F
t

t Yr Qtr Act. Fcst Error Error
2

1 1 1 160 158 +2 4
2 1 2 170 171 -1 1
3 1 3 140 136 +4 16
4 1 4 150 148 +2 4
5 2 1 230 232 -2 4
6 2 2 240 242 -2 4
7 2 3 180 187 -7 49
8 2 4 200 199 +1 1
9 3 1 310 305 +5 25
10 3 2 310 313 -3 9
11 3 3 230 238 -8 64
12 3 4 260 250 +10 100

MAD = 3.9 MSE = 23.4
C4 - 71
Comments On Seasonal Models
More data required
At least 4 (5-10 is better) observations in each
season
MAD & MSE should be much smaller than
simpler models
Consider additive seasonality if not improved
C4 - 72
Using Qualitative Methods
Little or no historical data available
Unstable environment during forecast horizon
Forecast has long time horizon
C4 - 73
Qualitative Forecasting Techniques
Grass Roots
Market Research
Executive Opinion / Judgement
Panel Consensus / Group Consensus
Delhpi Method
Historical Analogy
C4 - 74
Improving Qualitative Methods
Standardize the process
Monitor forecasts
Create incentives for accuracy
Use group methodologies
group averaging
group consensus
Delphi method
C4 - 75
K. Implementation & Use Of
Forecasting Systems
Model evaluation & testing
use holdout data to test model
Combine forecasts
average forecasts from several models
Use tracking signal to monitor performance
C4 - 76
Tracking Signal
Automate tracking of forecast accuracy
Tracking signal

If errors are small & unbiased TS is small
If |TS| > limit investigate problem
Limits range from 3 - 8
TS =
i
y

i
F ( ) MAD
C4 - 77
Linear Causal Model Calculations
y
i
F
i
(y
i
- F
i
) Sum of Errors MAD
Per Act. Fcst. Err Per 6 Per 1 TS
1 129 136 -7
2 141 136 +5
3 136 139 -3
4 132 136 -4
5 135 134 +1 4.00

6 140 138 +2 +2 3.67 +0.54
7 134 137 -3 -1 3.57 -0.28
8 133 136 -3 -4 3.50 -1.14
9 130 136 -6 -10 3.78 -2.65
10 128 133 -5 -15 4.30 -3.49
11 127 131 -4 -19 3.91 -4.86
C4 - 78
Tracking Signal Problems
Positive & negative errors tend to cancel
Not picked up by TS
Cycling errors are not detected well
An alternative: tracking control charts
limit = 3 * sqrt (MSE)
C4 - 79
Ranging Forecasts
Forecasts for future periods are only estimates
and are subject to error.
One way to deal with uncertainty is to develop
best-estimate forecasts and the ranges within
which the actual data are likely to fall.
The ranges of a forecast are defined by the
upper and lower limits of a confidence interval.

C4 - 80
Ranging Forecasts
The ranges or limits of a forecast are estimated by:

Upper limit = Y + t(s
yx
)
Lower limit = Y - t(s
yx
)
where:
Y = best-estimate forecast
t = number of standard deviations from the mean
of the distribution to provide a given proba-
bility of exceeding the limits through chance
s
yx
= standard error of the forecast
C4 - 81
Ranging Forecasts
The standard error
(deviation) of the forecast
is computed as:




2
yx
y - a y - b xy
s =
n - 2

C4 - 82
Practical Hints
Objective is accurate & timely forecasts
Time lags usually preferred
Forecasts of independent variables are useful
Some independent variables are controllable
advertising, prices, etc.
C4 - 83
J. Advanced Models
Data can contain nonlinear trends
Multiple independent variables are common
Errors can be correlated
ARIMA models are useful
autoregressive/integrated/moving average
also called Box-Jenkins models
C4 - 84
Adaptive Models
Build system which adapts to changing data
Focus forecasting uses several models
Best model used in each period
C4 - 85
Buildup & Breakdown Models
Breakdown or decomposition method
forecast an aggregate variable
decompose it into components of interest
Buildup or composition method
forecast components
combine components into variable of interest