Demand

Forecasting
What is forecasting?

Forecasting is a tool used for predicting

future demand based on
past demand information.
Decisions that Need Forecasts
 Which markets?
 What products to produce?
 How many people to hire?
 How many units to purchase?
 How many units to produce?
 And so on……
 Why is forecasting important?

Demand for products and services is usually uncertain.

Forecasting can be used for…
• Strategic planning (long range planning)
• Finance and accounting (budgets and cost
controls)
• Marketing (future sales, new products)
• Production and operations
Forecasting Horizons
 Long Term
 5+ years into the future
 R&D, plant location, product planning
 Principally judgment-based
 Medium Term
 1 season to 5 years
 Aggregate planning, capacity planning, sales forecasts
 Mixture of quantitative methods and judgement
 Short Term
 1 day to 1 year, less than 1 season
 Demand forecasting, staffing levels, purchasing, inventory
levels
 Quantitative methods
Short Term Forecasting: Needs and Uses
 Scheduling existing resources
 How many employees do we need and when?
 How much product should we make in anticipation of
demand?
 Acquiring additional resources
 When are we going to run out of capacity?
 How many more people will we need?
 How large will our back-orders be?
 Determining what resources are needed
 What kind of machines will we require?
 Which services are growing in demand? declining?
 What kind of people should we be hiring?
Forecasting Steps
 What needs to be forecast?
 Level of detail units of analysis & time horizon
required
 What data is available to evaluate?
 Identify needed data & whether it’s available
 Select and test the forecasting model
 Cost, ease of use & accuracy
 Generate the forecast
 Monitor forecast accuracy over time
Forecasting Techniques

Qualitative
 Judgmental methods
 Market research methods
 Time series methods
 Casual methods Quantitative
Judgmental methods

 Judgmental methods
 Panels of experts
 Delphi method

 Market research method

 Markey experiment
 Market survey
Qualitative Methods

Type Characteristics Strengths Weaknesses

Executive A group of managers Good for strategic or One person's opinion
opinion meet & come up with new-product can dominate the
a forecast forecasting forecast

Market Uses surveys & Good determinant of It can be difficult to

research interviews to identify customer preferences develop a good
customer preferences questionnaire

Delphi Seeks to develop a Excellent for Time consuming to

method consensus among a forecasting long-term develop
group of experts product demand,
technological
changes, and
Quantitative forecasting methods

Time Series: models that predict future

demand based on past history trends

Causal Relationship: models that use

statistical techniques to establish relationships
between various items and demand

Simulation: models that can incorporate

some randomness and non-linear effects
 Exponential Smoothing I
 Include all past observations
 Weight recent observations much more heavily than
very old observations:

weight
Decreasing weight given
to older observations

today
 Exponential Smoothing I
 Include all past observations
 Weight recent observations much more heavily than
very old observations:

0  1
weight
Decreasing weight given 
to older observations

today
 Exponential Smoothing I
 Include all past observations
 Weight recent observations much more heavily than
very old observations:

0  1
weight
Decreasing weight given 
to older observations
 (1 )

today
 Exponential Smoothing I
 Include all past observations
 Weight recent observations much more heavily than
very old observations:

0  1
weight
Decreasing weight given 
to older observations
 (1   )
 (1   ) 2

today
 Exponential Smoothing: Concept
 Include all past observations
 Weight recent observations much more heavily than
very old observations:

0  1
weight
Decreasing weight given 
to older observations
 (1   )
 (1   ) 2
 (1   ) 3

today 
 Exponential Smoothing: Math

Ft  Dt   (1   ) Dt 1   (1   ) 2 Dt 2  
Ft  Dt  (1   )Dt 1   (1  a ) Dt 2  
Seasonality problem: a university wants to develop
forecasts for the next year’s quarterly enrollments. It has
collected quarterly enrollments for the past two years. It
has also forecast total enrollment for next year to be
90,000 students. What is the forecast for each quarter of
next year?

Quarter Year 1 Seasonal Year 2 Seasonal Avg. Year3

Index Index Index

Fall 24000 26000

Winter 23000 22000
Spring 19000 19000
Summer 14000 17000
Total 90000
Average
Seasonality Problem: Solution

Quarter Year 1 Seasonal Year 2 Seasonal Avg. Year3

Index Index Index
Fall 24000 1.20 26000 1.24 1.22 27450
Winter 23000 1.15 22000 1.05 1.10 24750
Spring 19000 0.95 19000 0.90 0.93 20925
Summer 14000 0.70 17000 0.81 0.76 17100
Total 80000 4.00 84000 4.00 4.01 90000
Average 20000 21000 22500
Linear regression in forecasting

Linear regression is based on

1. Fitting a straight line to data
2. Explaining the change in one variable through changes in
other variables.

dependent variable = a + b  (independent

variable)

By using linear regression, we are trying to explore

which independent variables affect the dependent
variable
Example: do people drink more when it’s
cold?
Alcohol Sales

Which line best

fits the data?

Average
Monthly
Temperature
The best line is the one that minimizes the
error
The predicted line is …

Y  a  bX

So, the error is …

εi  yi - Yi

Where: ε is the error

y is the observed value
Y is the predicted value
Least Squares Method of Linear
Regression

The goal of LSM is to minimize the sum of squared

errors…

Min i
 2
What does that mean?

Alcohol Sales ε ε
ε

So LSM tries to
minimize the
distance between
the line and the
points!
Average
Monthly
Temperature
Least Squares Method of Linear
Regression
Then the line is defined by

Y  a  bX

a  y  bx

b
 xy  nx y
 x  nx2 2
Linear Regression

 Identify dependent (y) and

independent (x) variables
b
 XY  X  Y   Solve for the slope of the
 X 2  X  X  line

b
 XY  n X Y

 X  nX
2 2

 Solve for the y intercept

a  Y  bX
 Develop your equation for
the trend line
Y=a + bX
 Linear Regression Problem: A maker of golf shirts has
been tracking the relationship between sales and
advertising dollars. Use linear regression to find out what
sales might be if the company invested $53,000 in
advertising next year.
b
 XY  n X Y
Sales $ Adv.$ XY X^2 Y^2
 X  nX 2 2
(Y) (X)
1 130 48 4240 2304 16,900 30282  451.25147.25
b  3.58
2 151 52 7852 2704 22,801 10533  451.25
2

3 150 50 7500 2500 22,500 a  Y  b X  147.25  3.5851.25

4 158 55 8690 3025 24964 a  -36.20
Y  a  bX  -36.20  3.58x
Y5  -36.20  3.5853  153.54
Tot 589 205 30282 10533 87165
Avg 147.25 51.25
5 153.54 53