Production Systems: Forecasting

Production
Systems
Forecasting
Batangas State University
Lipa City
Industrial Engineering
Department
2006 Prentice Hall, Inc. 41
Outline
Global Company Profile:
Tupperware Corporation
What Is Forecasting?
Forecasting Time Horizons
The Influence of Product Life Cycle
Types Of Forecasts

Outline Continued
The Strategic Importance Of
Forecasting
Human Resources
Capacity
Supply-Chain Management
Seven Steps In The Forecasting
System

Outline Continued
Forecasting Approaches
Overview of Qualitative Methods
Overview of Quantitative Methods

Outline Continued
Time-series Forecasting
Decomposition of a Time Series
Nave Approach
Moving Averages
Exponential Smoothing
Exponential Smoothing with Trend
Adjustment
Trend Projections
Seasonal Variations in Data
Cyclical Variations in Data
Outline Continued
Associative Forecasting Methods:
Regression And Correlation
Analysis
Using Regression Analysis to
Forecast
Standard Error of the Estimate
Correlation Coefficients for
Regression Lines
Multiple-Regression Analysis

Outline Continued
Monitoring And Controlling
Forecasts
Adaptive Smoothing
Focus Forecasting
Forecasting In The Service Sector

Learning Objectives
When you complete this chapter, you
should be able to :
Identify or Define:
Forecasting
Types of forecasts
Time horizons
Approaches to forecasts

Learning Objectives
When you complete this chapter, you
should be able to :
Describe or Explain:
Moving averages
Exponential smoothing
Trend projections
Regression and correlation analysis
Measures of forecast accuracy
Forecasting at Tupperware
Each of 50 profit centers around the
world is responsible for
computerized monthly, quarterly,
and 12-month sales projections
These projections are aggregated by
region, then globally, at
Tupperwares World Headquarters
Tupperware uses all techniques
discussed in text
2006 Prentice Hall, Inc. 4 10
Tupperwares Process

Three Key Factors for
Tupperware
The number of registered
consultants or sales
representatives
The percentage of currently active
dealers (this number changes each
week and month)
Sales per active dealer, on a weekly
basis
Forecast by Consensus
Although inputs come from sales,
marketing, finance, and production,
final forecasts are the consensus of
all participating managers
The final step is Tupperwares
version of the jury of executive
opinion

What is Forecasting?
Process of
predicting a future
event
Underlying basis of
??
all business
decisions
Production
Inventory
Personnel
Facilities
Forecasting Time Horizons
Short-range forecast
Up to 1 year, generally less than 3 months
Purchasing, job scheduling, workforce levels,
job assignments, production levels
Medium-range forecast
3 months to 3 years
Sales and production planning, budgeting
Long-range forecast
3+ years
New product planning, facility location,
research and development
Distinguishing Differences
Medium/long range forecasts deal with
more comprehensive issues and support
management decisions regarding
planning and products, plants and
processes
Short-term forecasting usually employs
different methodologies than longer-term
forecasting
Short-term forecasts tend to be more
accurate than longer-term forecasts

Influence of Product Life
Cycle
Introduction Growth Maturity Decline
Introduction and growth require longer
forecasts than maturity and decline
As product passes through life cycle,
forecasts are useful in projecting
Staffing levels
Inventory levels
Factory capacity

Product Life Cycle
Best period to Practical to change Poor time to Cost control
Company Strategy/Issues
increase market price or quality change image, critical

share image price, or quality
R&D engineering is Strengthen niche Competitive costs

critical become critical
Defend market
position
CD-ROM Fax machines
Internet Drive-through
restaurants
Color printers
Sales
3 1/2
Floppy
Flat-screen disks
monitors DVD
Figure 2.5
Product Life Cycle
Product design Forecasting Standardization Little product
and critical differentiation
Less rapid
development Product and product changes Cost
OM Strategy/Issues
critical process more minor minimization

Frequent reliability changes Overcapacity
product and Competitive Optimum in the
process design product capacity industry
changes improvements Increasing Prune line to
Short production and options stability of eliminate
runs Increase capacity process items not
High production returning
Shift toward Long production
costs good margin
product focus runs
Limited models Reduce
Enhance Product
capacity
Attention to distribution improvement and
quality cost cutting
Figure 2.5
Types of Forecasts
Economic forecasts
Address business cycle inflation rate,
money supply, housing starts, etc.
Technological forecasts
Predict rate of technological progress
Impacts development of new products
Demand forecasts
Predict sales of existing product

Strategic Importance of
Forecasting
Human Resources Hiring, training,
laying off workers
Capacity Capacity shortages can
result in undependable delivery, loss
of customers, loss of market share
Supply-Chain Management Good
supplier relations and price advance

Seven Steps in Forecasting
Determine the use of the forecast
Select the items to be forecasted
Determine the time horizon of the
forecast
Select the forecasting model(s)
Gather the data
Make the forecast
Validate and implement results
The Realities!
Forecasts are seldom perfect

Most techniques assume an
underlying stability in the system
Product family and aggregated
forecasts are more accurate than
individual product forecasts

Qualitative Methods
Used when situation is vague
and little data exist
New products
New technology
Involves intuition, experience
e.g., forecasting sales on Internet

Quantitative Methods
Used when situation is stable and
historical data exist
Existing products
Current technology
Involves mathematical techniques
e.g., forecasting sales of color
televisions

Overview of Qualitative
Methods
Jury of executive opinion
Pool opinions of high-level
executives, sometimes augment by
statistical models
Delphi method
Panel of experts, queried iteratively

Overview of Qualitative
Methods
Sales force composite
Estimates from individual
salespersons are reviewed for
reasonableness, then aggregated
Consumer Market Survey
Ask the customer

Jury of Executive Opinion
Involves small group of high-level
managers
Group estimates demand by working
together
Combines managerial experience with
statistical models
Relatively quick
Group-think
disadvantage

Sales Force Composite
Each salesperson projects his or
her sales
Combined at district and national
levels
Sales reps know customers wants
Tends to be overly optimistic

Delphi Method
Iterative group Decision Makers
(Evaluate
process, responses and
continues until make decisions)
consensus is
reached Staff
(Administering
3 types of survey)
participants
Decision makers
Staff Respondents
(People who can
Respondents make valuable
judgments)
Consumer Market Survey
Ask customers about purchasing
plans
What consumers say, and what
they actually do are often different
Sometimes difficult to answer

Overview of Quantitative
Approaches
1. Naive approach
2. Moving averages
Time-Series
3. Exponential Models
smoothing
4. Trend projection
Associative
5. Linear regression Model

Time Series Forecasting
Set of evenly spaced numerical
data
Obtained by observing response
variable at regular time periods
Forecast based only on past
values
Assumes that factors influencing
past and present will continue
influence in future
Time Series Components
Trend Cyclical
Seasonal Random

Components of Demand
Trend
component
Demand for product or service
Seasonal peaks
Actual
demand
Average
demand over
Random four years
variation
| | | |
1 2 3 4
Year Figure 4.1
Trend Component
Persistent, overall upward or
downward pattern
Changes due to population,
technology, age, culture, etc.
Typically several years
duration

Seasonal Component
Regular pattern of up and
down fluctuations
Due to weather, customs, etc.
Occurs within a single year
Number of
Period Length Seasons
Week Day 7
Month Week 4-4.5
Month Day 28-31
Year Quarter 4
Year Month 12
Year Week 52
Cyclical Component
Repeating up and down movements
Affected by business cycle,
political, and economic factors
Multiple years duration
Often causal or
associative
relationships
0 5 10 15 20
Random Component
Erratic, unsystematic, residual
fluctuations
Due to random variation or
unforeseen events
Short duration and
nonrepeating
M T W T F
Naive Approach
Assumes demand in next period is
the same as demand in most
recent period
e.g., If May sales were 48, then June
sales will be 48
Sometimes cost effective and
efficient

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
demand in previous n periods

Moving average = n

Moving Average Example
Actual 3-Month
Month Shed Sales 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

Graph of Moving Average
Moving
30 Average
28 Forecast
26 Actual
24 Sales
Shed Sales
22
20
18
16
14
12
10
| | | | | | | | | | | |
J F M A M J J A S O N D

Weighted Moving Average
Used when trend is present
Older data usually less important
Weights based on experience and
intuition
(weight for period n)
Weighted x (demand in period n)
=
moving average weights

Weights Applied Period
Weighted Moving
3 Average
Last month
2 Two months ago
1 Three months ago
6 Sum of weights
Actual 3-Month Weighted

Month Shed Sales Moving Average
January 10
February 12
March 13
April 16 [(3 x 13) + (2 x 12) + (10)]/6 = 121/6
May 19 [(3 x 16) + (2 x 13) + (12)]/6 = 141/3
June 23 [(3 x 19) + (2 x 16) + (13)]/6 = 17
July 26 [(3 x 23) + (2 x 19) + (16)]/6 = 201/2

Potential Problems With
Moving Average
Increasing n smooths the forecast
but makes it less sensitive to
changes
Do not forecast trends well
Require extensive historical data

Moving Average And
Weighted Moving Average
30 Weighted
moving
average
25
Sales demand
20
Actual
15 sales
10 Moving
average
5
| | | | | | | | | | | |
Figure 4.2
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
New forecast = last periods forecast

+ (last periods actual demand
last periods forecast)
Ft = Ft 1 + (At 1 - Ft 1)
where Ft = new forecast

Ft 1 = previous forecast
= smoothing (or weighting)
constant (0 1)
Example
Predicted demand = 142 Ford Mustangs
Actual demand = 153
Smoothing constant = .20

Example
Actual demand = 153
New forecast = 142 + .2(153 142)

Example
Actual demand = 153
New forecast = 142 + .2(153 142)

= 142 + 2.2
= 144.2 144 cars

Effect of
Smoothing Constants
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

Impact of Different
225
200
Actual = .5
demand
Demand
175
150 = .1
| | | | | | | | |
1 2 3 4 5 6 7 8 9
Quarter

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

Common Measures of Error
Mean Absolute Deviation (MAD)
|actual - forecast|
MAD = n
Mean Squared Error (MSE)

(forecast errors)2
MSE = n
Common Measures of Error
Mean Absolute Percent Error (MAPE)
n
100 |actuali - forecasti|/actuali
i=1
MAPE = n

Comparison of Forecast
Error
Rounded Absolute Rounded Absolute
Actual Forecast Deviation Forecast Deviation
Tonnage with for with for
Quarter Unloaded = .10 = .10 = .50 = .50
1 180 175 5 175 5
2 168 176 8 178 10
3 159 175 16 173 14
4 175 173 2 166 9
5 190 173 17 170 20
6 205 175 30 180 25
7 180 178 2 193 13
8 182 178 4 186 4
84 100

Error
|deviations|
MADActual
= n
Forecast Deviation Forecast Deviation
Tonage with for with for
1
For =
180
.10 175 5 175 5
2 168 = 84/8 = 10.50
176 8 178 10
3 159 175 16 173 14
4 For 175
= .50 173 2 166 9
5 190 173 17 170 20
6 205 = 100/8
175 = 12.5030 180 25
7 180 178 2 193 13
8 182 178 4 186 4
84 100

Error
(forecast errors) 2
MSE = Actual Rounded

n
Forecast
Absolute
Deviation
Rounded
Forecast
Absolute
Deviation
1
For =
180
.10 175 5 175 5
2 = 1,558/8
168 = 194.758
176 178 10
3 159 175 16 173 14
4 For 175
= .50 173 2 166 9
5 190 173 17 170 20
6 = 1,612/8
205 =
175 201.5030 180 25
7 180 178 2 193 13
8 182 178 4 186 4
84 100
MAD 10.50 12.50

n
Error|/actual
100 |deviation i i
i =Rounded
1 Absolute Rounded Absolute
MAPE =Actual Forecast n Deviation Forecast Deviation
1
= .10 175
For 180 5 175 5
2 168 = 45.62/8
176 = 5.70%
8 178 10
3 159 175 16 173 14
4 =
For 175 .50 173 2 166 9
5 190 173 17 170 20
6 205 = 54.8/8
175 = 6.85%
30 180 25
7 180 178 2 193 13
8 182 178 4 186 4
84 100
MAD 10.50 12.50
MSE 194.75 201.50

Error
Actual Forecast Deviation Forecast Deviation
Tonnage with for with for
1 180 175 5 175 5
2 168 176 8 178 10
3 159 175 16 173 14
4 175 173 2 166 9
5 190 173 17 170 20
6 205 175 30 180 25
7 180 178 2 193 13
8 182 178 4 186 4
84 100
MAD 10.50 12.50
MSE 194.75 201.50
MAPE 5.70% 6.85%
Exponential Smoothing with
Trend Adjustment
When a trend is present, exponential
smoothing must be modified
Forecast exponentially exponentially

including (FITt) = smoothed (Ft) + (Tt) smoothed
trend forecast trend

Trend Adjustment
Ft = (At - 1) + (1 - )(Ft - 1 + Tt - 1)
Tt = (Ft - Ft - 1) + (1 - )Tt - 1
Step 1: Compute Ft
Step 2: Compute Tt
Step 3: Calculate the forecast FITt = Ft + Tt

Trend Adjustment Example
Forecast
Actual Smoothed Smoothed Including
Month(t) Demand (At) Forecast, Ft Trend, Tt Trend, FITt
1 12 11 2 13.00
2 17
3 20
4 19
5 24
6 21
7 31
8 28
9 36
10
Table 4.1
Forecast
1 12 11 2 13.00
2 17
3 20
4 19
5 24 Step 1: Forecast for Month 2
6 21 F2 = A1 + (1 - )(F1 + T1)
7 31
8 28 F2 = (.2)(12) + (1 - .2)(11 + 2)
9 36
10 = 2.4 + 10.4 = 12.8 units
Table 4.1
Forecast
1 12 11 2 13.00
2 17 12.80
3 20
4 19
5 24 Step 2: Trend for Month 2
6 21 T2 = (F2 - F1) + (1 - )T1
7 31
8 28 T2 = (.4)(12.8 - 11) + (1 - .4)(2)
9 36
10 = .72 + 1.2 = 1.92 units
Table 4.1
Forecast
1 12 11 2 13.00
2 17 12.80 1.92
3 20
4 19
5 24 Step 3: Calculate FIT for Month 2
6 21 FIT2 = F2 + T1
7 31
8 28 FIT2 = 12.8 + 1.92
9 36
10 = 14.72 units
Table 4.1
Forecast
1 12 11 2 13.00
2 17 12.80 1.92 14.72
3 20 15.18 2.10 17.28
4 19 17.82 2.32 20.14
5 24 19.91 2.23 22.14
6 21 22.51 2.38 24.89
7 31 24.11 2.07 26.18
8 28 27.14 2.45 29.59
9 36 29.28 2.32 31.60
10 32.48 2.68 35.16
Table 4.1
35
30 Actual demand (At)

Product demand
25
20
15
10 Forecast including trend (FITt)

5
0
| | | | | | | | |
1 2 3 4 5 6 7 8 9
Figure 4.3
Time (month)
Trend Projections
Fitting a trend line to historical data points
to project into the medium-to-long-range
Linear trends can be found using the least
squares technique
y^ = a + bx
^
where y = computed value of
the variable to be predicted
(dependent variable)
a = y-axis intercept
b = slope of the regression line
2006 Prentice Hall, Inc.
x = the independent variable 4 71
Values of Dependent Variable Least Squares Method
Actual observation Deviation7

(y value)
Deviation5 Deviation6
Deviation3
Deviation4
Deviation1
Deviation2
Trend line, y^ = a + bx
Time period Figure 4.4

Values of Dependent Variable Least Squares Method
Actual observation Deviation7

(y value)
Deviation5 Deviation6
Deviation3 Least squares method

minimizes the sum of the
Deviation
squared errors (deviations)
4
Deviation1
Deviation2
Trend line, y^ = a + bx
Time period Figure 4.4

Least Squares Method
Equations to calculate the regression variables
y^ = a + bx
xy - nxy
b=
x2 - nx2
a = y - bx

Least Squares Example
Time Electrical Power
Year Period (x) Demand x2 xy
1999 1 74 1 74
2000 2 79 4 158
2001 3 80 9 240
2002 4 90 16 360
2003 5 105 25 525
2004 6 142 36 852
2005 7 122 49 854
x = 28 y = 692 x2 = 140 xy = 3,063
x=4 y = 98.86
xy - nxy 3,063 - (7)(4)(98.86)
b= = 140 - (7)(42) = 10.54
x2 - nx2
a = y - bx = 98.86 - 10.54(4) = 56.70

Time Electrical Power
Year Period (x) Demand x2 xy
1999 1 74 1 74
2000 2 79 4 158
2001The trend3 line is 80 9 240
2002 4 90 16 360
2003 y^ 5= 56.70 + 10.54x
105 25 525
2004 6 142 36 852
2005 7 122 49 854
x = 28 y = 692 x2 = 140 xy = 3,063
x=4 y = 98.86
xy - nxy 3,063 - (7)(4)(98.86)
b = x2 - nx2 = 140 - (7)(42) = 10.54
a = y - bx = 98.86 - 10.54(4) = 56.70

160
Trend line,
150 y^ = 56.70 + 10.54x
140
Power demand
130
120
110
100
90
80
70
60
50
| | | | | | | | |
1999 2000 2001 2002 2003 2004 2005 2006 2007
Year
Seasonal Variations In Data
The multiplicative seasonal model can
modify trend data to accommodate
seasonal variations in demand
1. Find average historical demand for each season

2. Compute the average demand over all seasons
3. Compute a seasonal index for each season
4. Estimate next years total demand
5. Divide this estimate of total demand by the
number of seasons, then multiply it by the
seasonal index for that season
Seasonal Index Example
Demand Average Average Seasonal
Month 2003 2004 2005 2003-2005 Monthly Index
Jan 80 85 105 90 94
Feb 70 85 85 80 94
Mar 80 93 82 85 94
Apr 90 95 115 100 94
May 113 125 131 123 94
Jun 110 115 120 115 94
Jul 100 102 113 105 94
Aug 88 102 110 100 94
Sept 85 90 95 90 94
Oct 77 78 85 80 94
Nov 75 72 83 80 94
Dec 82 78 80 80 94
Jan 80 85 105 90 94 0.957
Feb 70 85 85 80 94
Mar 80 93 average
82 2003-2005
85 monthly demand
94
Seasonal index =
Apr 90 95 115 average monthly
100 demand94
May 113 125= 90/94
131 = .957 123 94
Jun 110 115 120 115 94
Jul 100 102 113 105 94
Aug 88 102 110 100 94
Sept 85 90 95 90 94
Oct 77 78 85 80 94
Nov 75 72 83 80 94
Dec 82 78 80 80 94
Jan 80 85 105 90 94 0.957
Feb 70 85 85 80 94 0.851
Mar 80 93 82 85 94 0.904
Apr 90 95 115 100 94 1.064
May 113 125 131 123 94 1.309
Jun 110 115 120 115 94 1.223
Jul 100 102 113 105 94 1.117
Aug 88 102 110 100 94 1.064
Sept 85 90 95 90 94 0.957
Oct 77 78 85 80 94 0.851
Nov 75 72 83 80 94 0.851
Dec 82 78 80 80 94 0.851
Jan 80 85 105 90 94 0.957
Feb 70 85 Forecast
85 for802006 94 0.851
Mar 80 93 82 85 94 0.904
Apr 90Expected
95 115annual demand
100 = 1,200
94 1.064
May 113 125 131 123 94 1.309
Jun 110 115 120 1,200 115 94 1.223
Jan x .957 = 96
Jul 100 102 113 12 105 94 1.117
Aug 88 102 110 1,200 100 94 1.064
Sept 85 Feb 95
90 x90.851 = 85 94 0.957
12
Oct 77 78 85 80 94 0.851
Nov 75 72 83 80 94 0.851
Dec 82 78 80 80 94 0.851
2006 Forecast
140 2005 Demand
130 2004 Demand
120 2003 Demand
Demand
110
100
90
80
70
| | | | | | | | | | | |
Time
San Diego Hospital
Trend Data
10,200
10,000
Inpatient Days
9,800 9745
9702
9616 9659
9,600 9573 9766
9530 9680 9723
9594 9637
9,400 9551
9,200
9,000 | | | | | | | | | | | |
Jan Feb Mar Apr May June July Aug Sept Oct Nov Dec
67 68 69 70 71 72 73 74 75 76 77 78
Month
Figure 4.6
San Diego Hospital
Seasonal Indices
1.06
1.04 1.04 1.04
Index for Inpatient Days
1.03
1.02 1.02
1.01
1.00 1.00
0.99
0.98 0.98
0.99
0.96
0.97 0.97
0.94 0.96
0.92 | | | | | | | | | | | |
67 68 69 70 71 72 73 74 75 76 77 78
Month
Figure 4.7
San Diego Hospital
Combined Trend and Seasonal Forecast
10,200
10068
10,000 9949
9911
Inpatient Days
9,800 9764 9724

9691
9,600 9572
9,400 9520 9542
9411
9,200 9265 9355
9,000 | | | | | | | | | | | |
67 68 69 70 71 72 73 74 75 76 77 78
Month
Figure 4.8
Associative Forecasting
Used when changes in one or more
independent variables can be used to predict
the changes in the dependent variable
Most common technique is linear

regression analysis
We apply this technique just as we did

in the time series example

Forecasting an outcome based on predictor
variables using the least squares technique
y^ = a + bx
^
where y = computed value of
the variable to be predicted
(dependent variable)
a = y-axis intercept
b = slope of the regression line
x = the independent variable
though to predict the value of the
dependent variable 4 89
Example
Sales Local Payroll
($000,000), y ($000,000,000), x
2.0 1
3.0 3
2.5 4 4.0
2.0 2
2.0 1 3.0
3.5 7 Sales
2.0
1.0
| | | | | | |
0 1 2 3 4 5 6 7
Area payroll

Example
Sales, y Payroll, x x2 xy
2.0 1 1 2.0
3.0 3 9 9.0
2.5 4 16 10.0
2.0 2 4 4.0
2.0 1 1 2.0
3.5 7 49 24.5
y = 15.0 x = 18 x2 = 80 xy = 51.5
xy - nxy 51.5 - (6)(3)(2.5)

x = x/6 = 18/6 = 3 b= x2 - nx2 = 80 - (6)(32) = .25
y = y/6 = 15/6 = 2.5 a = y - bx = 2.5 - (.25)(3) = 1.75

Example
y^ = 1.75 + .25x Sales = 1.75 + .25(payroll)
If payroll next year 4.0

is estimated to be
3.25
$600 million, then: 3.0
Sales
2.0
Sales = 1.75 + .25(6) 1.0
Sales = $325,000
| | | | | | |
0 1 2 3 4 5 6 7
Area payroll
Standard Error of the
Estimate
A forecast is just a point estimate of a
future value
This point is 4.0
actually the 3.25
3.0
mean of a Sales
2.0
probability
distribution 1.0
| | | | | | |
0 1 2 3 4 5 6 7
Area payroll
Figure 4.9
Estimate
(y - yc)2
Sy,x =
n-2
where y = y-value of each data

point
yc = computed value of
the dependent variable, from the
regression equation
n = number of data
2006 Prentice Hall, Inc. points 4 94
Estimate
Computationally, this equation is
considerably easier to use
y2 - ay - bxy
Sy,x =
n-2
We use the standard error to set up

prediction intervals around the
point estimate
Estimate
y2 - ay - bxy 39.5 - 1.75(15) - .25(51.5)
Sy,x = =
n-2 6-2
Sy,x = .306 4.0

3.25
3.0
Sales
The standard error 2.0
of the estimate is 1.0
$30,600 in sales
| | | | | | |
0 1 2 3 4 5 6 7
Area payroll
Correlation
How strong is the linear
relationship between the
variables?
Correlation does not necessarily
imply causality!
Coefficient of correlation, r,
measures degree of association
Values range from -1 to +1

Correlation Coefficient
n xy - x y
r=
[n x2 - ( x)2][n y2 - ( y)2]

y y
(a) Perfect positive x (b) Positive x

correlation: correlation:
r = +1 0<r<1
y y
x (d) Perfect negative x

(c) No correlation:
r=0 correlation:
r = -1
Correlation
Coefficient of Determination, r2,
measures the percent of change in
y predicted by the change in x
Values range from 0 to 1
Easy to interpret
For the Nodel Construction example:

r = .901
r2 = .81
Multiple Regression
Analysis
If more than one independent variable is to be
used in the model, linear regression can be
extended to multiple regression to
accommodate several independent variables
y^ = a + b1x1 + b2x2
Computationally, this is quite

complex and generally done on the
computer 4 101
Multiple Regression
Analysis
In the Nodel example, including interest rates in
the model gives the new equation:
y^ = 1.80 + .30x1 - 5.0x2
An improved correlation coefficient of r = .96

means this model does a better job of predicting
the change in construction sales
Sales = 1.80 + .30(6) - 5.0(.12) = 3.00

Sales = $300,000
Monitoring and Controlling
Forecasts
Tracking Signal
Measures how well the forecast is
predicting actual values
Ratio of running sum of forecast errors
(RSFE) to mean absolute deviation (MAD)
Good tracking signal has low values
If forecasts are continually high or low, the
forecast has a bias error

Monitoring and Controlling
Forecasts
Tracking = RSFE
signal MAD
(actual demand in
period i -
forecast demand
Tracking = in period i)
signal |actual - forecast|/n)

Tracking Signal
Signal exceeding limit
Tracking signal
Upper control limit
+
0 MADs Acceptable
range

Lower control limit
Time

Tracking Signal Example
Cumulative
Absolute Absolute
Actual Forecast Forecast Forecast
Qtr Demand Demand Error RSFE Error Error MAD
1 90 100 -10 -10 10 10 10.0

2 95 100 -5 -15 5 15 7.5
3 115 100 +15 0 15 30 10.0
4 100 110 -10 -10 10 40 10.0
5 125 110 +15 +5 15 55 11.0
6 140 110 +30 +35 30 85 14.2

Tracking Signal Example
Cumulative
Tracking Absolute Absolute
Actual Signal
Forecast Forecast Forecast
Qtr (RSFE/MAD)
Demand Demand Error RSFE Error Error MAD
1 90-10/10
100= -1 -10 -10 10 10 10.0
2 95
-15/7.5
100= -2 -5 -15 5 15 7.5
3 115 0/10
100= 0 +15 0 15 30 10.0
4 100-10/10
110= -1 -10 -10 10 40 10.0
5 125
+5/11110
= +0.5+15 +5 15 55 11.0
6 140
+35/14.2
110= +2.5
+30 +35 30 85 14.2
The variation of the tracking signal

between -2.0 and +2.5 is within acceptable
limits
Adaptive Forecasting
Its possible to use the computer to

continually monitor forecast error and
adjust the values of the and
coefficients used in exponential
smoothing to continually minimize
forecast error
This technique is called adaptive
smoothing

Focus Forecasting
Developed at American Hardware Supply,
focus forecasting is based on two principles:
1. Sophisticated forecasting models are not
always better than simple models
2. There is no single techniques that should
be used for all products or services
This approach uses historical data to test

multiple forecasting models for individual items
The forecasting model with the lowest error is
then used to forecast the next demand
Forecasting in the Service
Sector
Presents unusual challenges
Special need for short term records
Needs differ greatly as function of
industry and product
Holidays and other calendar events
Unusual events

Fast Food Restaurant
Forecast
20%
Percentage of sales
15%
10%
5%
11-12 1-2 3-4 5-6 7-8 9-10

12-1 2-3 4-5 6-7 8-9 10-11
(Lunchtime) (Dinnertime)
Hour of day Figure 4.12

Production Systems: Forecasting

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Production

2006 Prentice Hall, Inc. 42

2006 Prentice Hall, Inc. 43

2006 Prentice Hall, Inc. 44

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2006 Prentice Hall, Inc. 4 11

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increase market price or quality change image, critical

R&D engineering is Strengthen niche Competitive costs

critical process more minor minimization

2006 Prentice Hall, Inc. 4 20

2006 Prentice Hall, Inc. 4 21

Forecasts are seldom perfect

2006 Prentice Hall, Inc. 4 23

2006 Prentice Hall, Inc. 4 24

2006 Prentice Hall, Inc. 4 25

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2006 Prentice Hall, Inc. 4 31

2006 Prentice Hall, Inc. 4 32

2006 Prentice Hall, Inc. 4 34

2006 Prentice Hall, Inc. 4 36

2006 Prentice Hall, Inc. 4 40

demand in previous n periods

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2006 Prentice Hall, Inc. 4 42

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2006 Prentice Hall, Inc. 4 44

Actual 3-Month Weighted

2006 Prentice Hall, Inc. 4 45

2006 Prentice Hall, Inc. 4 46

New forecast = last periods forecast

where Ft = new forecast

2006 Prentice Hall, Inc. 4 50

New forecast = 142 + .2(153 142)

2006 Prentice Hall, Inc. 4 51

New forecast = 142 + .2(153 142)

2006 Prentice Hall, Inc. 4 52

= .1 .1 .09 .081 .073 .066

= .5 .5 .25 .125 .063 .031

2006 Prentice Hall, Inc. 4 53

2006 Prentice Hall, Inc. 4 54

2006 Prentice Hall, Inc. 4 55

Mean Squared Error (MSE)

Mean Absolute Percent Error (MAPE)

2006 Prentice Hall, Inc. 4 57

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MSE = Actual Rounded

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Forecast exponentially exponentially

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2006 Prentice Hall, Inc. 4 64

30 Actual demand (At)

10 Forecast including trend (FITt)

Actual observation Deviation7