I.

FORECASTING AS A PREREQUISITE
STEP FOR MOST PLANNING ACTIVITIES
Information on most recent demand and production

Demand forecast for operations

Planning the System Scheduling the system Controlling the system

(designing)
Product design Aggregate Production Production control
Process design Planning Inventory control
Equipment investment Operations scheduling Labor control
and replacement Cost control
Capacity Planning

Output of goods and services

 Forecasting Vs. Prediction
Com parisons Forecasting Prediction
G oal Estimating a future Estim ating a future event
event (U sually in
figures)
M ethod A predetermined w aySubjective considerations
(a defined model)
Information Base
Past data K now ledge, intuition,
preference, emotion...
✦ Most social and nature phenomena carry with them an
inertia. Forecasting intends to cast the historical pattern into
the future.
 II. THE UNDERLYING
PATTERN OF THE DATA
Production Demand (units)

Season(Cyclical)

Linear trend

Constant

Time
 II. THE UNDERLYING
PATTERN OF THE DATA
Noise in demand
Production demand (units)

Demand Pattern
with trend and
seasonal
components

Low Noise
High Noise

Time
II. THE UNDERLYING PATTERN OF
THE DATA
✦ (1)Constant:
★ a horizontal pattern statistically, this is referred
to as a stationary pattern. For example, stable
sales.
✦ (2)Trend:
★ a general increase/decrease in the data over
time. For example, sales of a new product, or
sales of a product which is fading out.
II. THE UNDERLYING PATTERN OF
THE DATA
✦ (3)Seasonal:
★ a series fluctuates according to some seasonal factors.
★ The "season" may represent a month or the four seasons of
the year, or the days of the month, or the days of the week.
★ For example:
◆ Sales of items conditional on the weather.
◆ The receipt of revenues at an utility company depends on the

pattern in sending out the bills and the pay period in the
community.
 II. THE UNDERLYING
PATTERN OF THE DATA
✦ (4)Cyclical:
★ similar to a seasonal pattern, but the length of a
cycle is generally longer than a year.
★ For example:
◆ Number of housing starts
◆ price of metals

◆ GNP
III. THE CRITERIA IN EVALUATING
FORECASTING PERFORMANCE
(FORECAST ERROR)
For a single period, the forecast error is the
difference between actual data and forecasted
data.
Et = Ft - Dt
✦ where
★ Et: error
★ Ft: forecast for period t (made prior to period t)
★ Dt: actual demand of period t
 IV. FORECAST ERROR
MEASURES

✦ When multiple periods are involved,

usually we derive some single measures to
reflect forecasting performance.
 (A) Mean Absolute Deviation
(MAD) n
∑ Ft − Dt
t =1
MAD =
n

✦ If Et~ N ( U , σ
2
)
✦ i.e.,forecast errors follow a normal distribution
with zero mean and a variance, e σ 2

✦ then σ e = 1.25MAD
✦ Theoretically 2
E ( MAD) = σe
π
 (B) Bias

n
∑ ( Ft − Dt )
t=1
Bias=
n
(C) Mean Square Error (MSE)

n
∑ ( Ft − Dt )
2

t=1
M ES =
n
 IV-1. Comparisons:
✦ MAD measures the absolute magnitude of
errors.
✦ Bias reflects the direction of errors (positive
or negative).
✦ MSE intends to amplify large errors.
 IV-2. A thought question :
✦ Question: Which one is the best measure?
✦ Answer:
 IV-3. Computation of forecast
error measures
✦ Example:

Period Forecast Demand Et=Ft-Dt

1 100 90 10
2 110 105 5
3 120 117 3
4 130 135 -5
★ MAD = 5.75
★ Bias = 3.25
★ MSE = 39.75
V. FORECASTING TECHNIQUES
COMPARISONS
✦ Qualitative vs. Quantitative
Comparisons Qualitative Quantitative
Structure Problem is not Problem is well
well structured structured
Past Data Past data is not Past data is
available available
Implementation Through Through models
individual or
group judgment
 Time Series vs. Causal

Comparisons Time Series Causal

Planning Short-run Long-term planning
Horizon planning
Purpose Operations Strategic consideration
processes
Assumption Inertia exists Cause-effect relationship
Implementation Empirical studies Theoretical
 Regression Analysis vs.
Econometric Modeling

Y = a0 + a1X1 (Simple Regression)

Y = b0 + b1x1 + b2x2 (Multiple Regression)
Y1 = C1X1 + C2X2
Y2 = D0 + D1X1 + D2X2 (An econometric model)
Y3 = E0 + E1X2 + E2X1 (A system of equations)
 Forecasting Techniques
✦ Qualitative
★ Delphi Method
★ Market Research
★ Historical Analogy
✦ Time Series
★ Moving Average
★ Exponential Smoothing
★ Box-Jenkins
✦ Causal
★ Regression
★ Econometric Models
 Forecasting Techniques
✦ Question: What is the naive model?
✦ Answer:
★ In Forecasting, "using the most recent demand
as the forecast for next period" is referred to as
the naive model.
VI. USEFUL FORECASTING
MODELS FOR OPERATIONS
 VI-1. Simple Average (Mean)

✦ Use the mean of historical demand to identify

the constant level of demand pattern.
 VI-2. Linear Regression

✦ Use regression analysis to identify the increase

rate or decrease rate of trend in the demand
pattern.
VI-3. Simple Moving Average
n
∑ Dt
MA = t = n− m
n
✦ for n period moving average
✦ t = 1 is the oldest period
✦ t = n is the most recent period
VI -4. Simple Exponential
Smoothing
Ft = αDt −1 + ( 1 − α ) Ft −1

✦ Ft: Forecast for period t

✦ Dt-1 :Demand of period t-1
✦ Ft-1 :Forecast for period t-1
✦ The weight assigned to the most recent
demand, 0 ≤ α ≤ 1
 Why is this model called exponential smoothing?
Ft = α Dt −1 + ( 1 − α ) Ft −1
Ft −1 = αDt − 2 + ( 1 − α ) Ft − 2
F 2 = αDt − 3 + ( 1 − α ) Ft − 3

✦ Substituting Ft-n-1 into Ft-n , continuing the procedure, we

have an expanded form as follows:
Ft = αDt −1 + α ( 1 − α ) Dt − 2 + α ( 1 − α ) Dt − 3 + ....+α ( 1 − α )
n −1
Dt − n + (1 − α )n Ft − n
2

✦ The weights α , α (1-α ), . . ., assigned to the past data

decrease exponentially. "Smoothing" means "averaging
out" errors by using more than one period's data.
VI-5. Weighted Moving Average
(WMA)
n
WMA = ∑ Ct Dt
t =1

✦ Ct is the weight assigned to Dt n

✦ where , 0 ≤ Ct ≤ 1 and ∑ Ct = 1
t =1
 VI -6. Adaptive Model

✦ The parameter value of the model is

allowed to change, and the procedure is
designed in the forecasting model to change
automatically when the model detects the
need to change.
 VII. EXAMPLE:
✦ Time series data for monthly sales :

Jan 460
Feb 440
Mar 460
Apr 510
May 520
June 495
July 470
 VII-1.Use the three-month moving
average model to forecast the demand
for May, June, and July.

MAApril = (460 + 440 + 460)/3 = 453

MAMay= (440 + 460 + 510)/3 = 470
MAJune= (460 + 510 + 520)/3 = 497
MAJuly = (510 + 520 + 495)/3 = 508
 VII-2.Use simple exponential
smoothing model to forecast the
demand for May, June and July.

Question:
What do you need to know to make
the forecast?
 Answer:
✦ (1) the initial forecast for March (assume it is
440)
✦ (2) the parameter value (assume = 0.6)

FApril = (0.6)(460)+(0.4)(440) = 452

FMay = (0.6)(510)+(0.4)(452) = 487
FJune = (0.6)(520)+(0.4)(487) = 507
FJuly= (0.6)(495)+(0.4)(507) = 500
VII-3.Use a weighted moving average
model to forecast the demand for May,
June and July.

✦ Question:What do you need to know to

implement the forecast?
✦ Answer:
★ The relative weights of selected number of periods.
Assuming C1 = .2, C2 = .3, C3 = .5

WMAApril = (.2)(460)+(.3)(440)+(.5)(460) = 454

WMAMay = (.2)(440)+(.3)(460)+(.5)(510) = 481
WMAJune = (.2)(460)+(.3)(510)+(.5)(520) = 505
WMAJuly = (.2)(510)+(.3)(520)+(.5)(495) = 506
 VII-4.Use Bias, MAD & MSE to
evaluate the performance of these
models.
Demand 3-month MA Exp. Smoothing Weighted MA
Forecast Error Forecast Error Forecast Error
Aprial 510 453 -57 452 -58 454 -56
May 520 470 -50 487 -33 481 -39
June 495 497 2 507 12 505 10
July 475 508 33 500 25 506 31
BIAS = -18.0 -13.5* -13.5*
MAD = 35.5 32.0* 34.0
MSE = 1,710.5 1,305.5* 1,429.5
◆ *:the best performance for each measure
◆ In this example, exponential smoothing is the best

model.
VIII. SUGGESTED READING
✦ Chapter 13 Forecasting
pp.497-510 (Background & Time Series
Forecasting)
pp.513-516 (Forecast Error)
pp.529-530 (Choosing A Forecasting
Method)
✦ Study Solved Problem 1, pp.537-538