Forecasting

Forecasting
 Demand Management

 Qualitative Forecasting Methods

 Simple & Weighted Moving Average Forecasts

 Exponential Smoothing

 Simple Linear Regression

2
Demand Management
Independent Demand

A Dependent Demand

B(4) C(2)

D(2) E(1) D(3) F(2)

3
Independent Demand

 Take an active role to influence demand

 Takea passive role and simply respond to

demand

4
Types of Forecasts

 Qualitative (Judgmental)

 Quantitative
– Time Series Analysis
– Causal Relationships
– Simulation

5
Components of Demand

What’s going on here?

x
x x
x x
x x
x x
Sales

x x x
x
x
xx
x xx x x
x
x
x x x x x x
x x x x x x
x x x
x xxxxx
x
x x

1 2 3 4
Year 6
A Trend is Worth Noting

 Start by identifying the trend

 Whatis the trend in the sales of personal

computers?

 Are there any seasonal effects, cyclical factors or

other predicted events that might affect the sales
of personal computers?
7
Qualitative Methods

 Grass Roots

 Market Research

 Panel Consensus

8
Qualitative Methods

 Executive Judgment

 Historical Analogy

 Delphi Method

9
Delphi Method
l. Choose the experts to participate. There should be a
variety of knowledgeable people in different areas.

2. Through a questionnaire (or E-mail), obtain forecasts

(and any premises or qualifications for the forecasts)
from all participants.

3. Summarize the results and redistribute them to the

participants along with appropriate new questions.
10
Delphi Method

4. Summarize again, refining forecasts and conditions, and

again develop new questions.

5. Repeat Step 4 if necessary. Distribute the final results to

all participants.

11
Judgmental Forecasting Applications
Small and Large Firms

Low High
Sales Sales
Technique < $100M > $500M
Manager’s opinion 40.7% 39.6%
Jury of executive opinion 40.7% 41.6%
Sales force composite 29.6% 35.4%
Number of Firms 27 48

Source: Nada Sanders and Karl Mandrodt (1994) “Practitioners Continue to Rely on Judgmental Forecasting
Methods Instead of Quantitative Methods,” Interfaces, vol. 24, no. 2, pp. 92-100.

12
Quantitative Forecasting Applications
Small and Large Firms
Low High
Sales Sales
Technique < $100M > $500M
Moving average 29.6% 29.2%
Straight line projection 14.8% 14.6%
Naive 18.5% 14.6%
Exponential smoothing 14.8% 20.8%
Regression 22.2% 27.1%
Simulation 3.7% 10.4%
Classical decomposition 3.7% 8.3%
Box-Jenkins 3.7% 6.3%
Number of Firms 27 48
Source: Nada Sanders and Karl Mandrodt (1994) “Practitioners Continue to Rely on Judgmental Forecasting
Methods Instead of Quantitative Methods,” Interfaces, vol. 24, no. 2, pp. 92-100.

13
Time Series Analysis

Pick a model based on:

1. Time horizon to forecast

2. Data availability
3. Accuracy required
4. Size of forecasting budget
5. Availability of qualified personnel

14
Simple Moving Average
A t-1 + A t-2 + A t-3 +...+A t- n
Week Demand Ft =
1 650
n
2 678
3 720  Let’sdevelop 3-week and 6-
4 785
5 859 week moving average
6 920 forecasts for demand.
7 850
8 758  Assume you only have 3
9 892
10 920
weeks and 6 weeks of
11 789 actual demand data for the
12 844
respective forecasts
15
Week Demand 3-Week 6-Week
1 650
2 678
3 720
4 785 682.67
5 859 727.67
6 920 788.00
7 850 854.67 768.67
8 758 876.33 802.00
9 892 842.67 815.33
10 920 833.33 844.00
11 789 856.67 866.50
12 844 867.00 854.83
16
 1000

900
Demand

800 Demand
3-Week
700
6-Week
600

500
1 2 3 4 5 6 7 8 9 10 11 12
Week

17
In-Class Exercise

 Develop 3-week and

Week Demand
1 820 5-week moving
2 775 average forecasts for
3 680 demand.
4 655
5 620  Assume you only
6 600 have 3 weeks and 5
7 575
weeks of actual
demand data for the
respective forecasts
18
In-Class Exercise (Solution)

Week Demand 3-Week 5-Week

1 820
2 775
3 680
4 655 758.33
5 620 703.33
6 600 651.67 710.00
7 575 625.00 666.00

19
Weighted Moving Average
Ft = w 1 A t -1 + w 2 A t - 2 + w 3 A t -3 + ...+ w n A t - n
n

w
i=1
i =1

Determine the 3-period

Week Demand
1 650
weighted moving average
2 678 forecast for period 4.
3 720
4 Weights:
t-1 .5
t-2 .3
t-3 .2
20
Solution

Week Demand Forecast

1 650
2 678
3 720
4 693.4

F4 = .5(720)+.3(678)+.2(650)
21
In-Class Exercise

Determine the 3-period

weighted moving average
Week Demand
forecast for period 5.
1 820
2 775 Weights:
3 680 t-1 .7
4 655 t-2 .2
t-3 .1

22
Solution

Week Demand Forecast

1 820
2 775
3 680
4 655
5 672

23
Exponential Smoothing

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

 Premise--The most recent observations might

have the highest predictive value.
 Therefore, we should give more weight to the
more recent time periods when forecasting

24
Exponential Smoothing Example
 Determine
Week Demand exponential
1 820
2 775
smoothing forecasts
3 680 for periods 2-10
4 655 using a=.10 and
5 750 a=.60.
6 802
7 798
8 689
9 775  Let F1=D1
10
25
Week Demand 0.1 0.6
1 820 820.00 820.00
2 775 820.00 820.00
3 680 815.50 820.00
4 655 801.95 817.30
5 750 787.26 808.09
6 802 783.53 795.59
7 798 785.38 788.35
8 689 786.64 786.57
9 775 776.88 786.61
10 776.69 780.77

26
Effect of a on Forecast

900
800
Demand

Demand
700 0.1
600 0.6

500
1 2 3 4 5 6 7 8 9 10
Week

27
In-Class Exercise

Week Demand
Determine exponential
1 820 smoothing forecasts for
2 775 periods 2-5 using a =.50
3 680
4 655
5 Let F1=D1

28
In-Class Exercise (Solution)

Week Demand 0.5

1 820 820.00
2 775 820.00
3 680 797.50
4 655 738.75
5 696.88

29
Forecast Errors
n
1 MAD  0.8 standard deviation
A
t=1
t - Ft
1 standard deviation  1.25 MAD
MAD =
n

 Study the formula for a moment

 Now, what does MAD tell you?

30
Example--MAD

Month Sales Forecast

1 220 n/a
2 250 255
3 210 205
4 300 320
5 325 315

Determine the MAD for the four forecast periods

31
Solution

Month Sales Forecast Abs Error

1 220 n/a
2 250 255 5
3 210 205 5
4 300 320 20
5 325 315 10

40

A
t=1
t - Ft
40
MAD = = = 10
n 4
32
Tracking Signal

RSFE Running sum of forecast errors

TS = =
MAD Mean absolute deviation

 Isthe forecast average keeping pace with any

genuine upward or downward changes?

33
What do you notice?

40

35
Sales

30

25

20
0 1 2 3 4 5 6 7 8 9 10
Period

34
Simple Linear Regression Model

Yt = a + bx Y

0 1 2 3 4 5 x (weeks)

b is similar to the slope. However, since it is

calculated with the variability of the data in
mind, its formulation is not as straight-
forward as our usual notion of slope
35
Calculating a and b

a = y - bx

 xy - n(y)(x)
b= 2 2
 x - n(x )

36
Regression Equation Example

Week Sales
1 150
2 157
3 162
4 166
5 177

Develop a regression equation to predict sales

based on these five points.
37
 Week Week*Week Sales Week*Sales
1 1 150 150
2 4 157 314
3 9 162 486
4 16 166 664
5 25 177 885
3 55 162.4 2499
Average Sum Average Sum

b=
 xy - n( y)(x) 2499 - 5(162.4)(3) 63
=  = 6.3
 x - n(x )
2 2
55  5(9 ) 10

a = y - bx = 162.4 - (6.3)(3) = 143.5

38
 y = 143.5 + 6.3t
180
175
170
165
160 Sales
Sales

155 Forecast
150
145
140
135
1 2 3 4 5

Period
39