Operations Management

BU 385

Roadmap

Last Class

Today

Competitiveness, Strategy & Productivity

(Ch 2)

Forecasting Part 1 (Ch 3)

Next class

Forecasting Part 2 (Ch 3)

Forecasting Matters!
"According to a person familiar
with the matter, the company
initially expected to sell four Galaxy
S6 smartphones for each Galaxy
S6 Edge that it sold, and set up its
production facilities accordingly,"
The Journal reported. "Instead,
demand was much likely closer to
even for the two devices, the
person said. The company ended
up having more white S6 phones
than it could sell and not enough
S6 Edge handsets, which hurt
sales, revenue and profit figures.
http://www.eweek.com/mobile/samsung-estimated-q2-profit-revenue-fall-again-as-troubles-persist.html

Today

Forecasting

What is it?
Why forecast?
What makes for a good forecast?
How do we approach forecasting? (i.e. a
process)
Next 2 classes

Types of forecast methods

Qualitative (Judgmental)
Quantitative

Time Series
Linear Trend

Techniques for seasonality

Associative models
Accuracy & control of
forecasting

The Art of Forecasting

Foreseeing the future

blend of art and science
Prediction relies on past performance
but sometimes the unexpected happens
Perfection is not a realistic goal
All forecasts are wrong. The best we can hope
for is to
reduce the amount of error
(unknown)
A Demand Forecast is an estimate of demand expected over a future
time period

Why do we need forecasts?

Many management decisions are planning

decisions for the future
Forecasts anticipate future
Forecasts reduce uncertainty
Planning decisions are made continuously
forecasts are needed continuously
Design
Design the
the System
System

long
long term
term
(annual)
(annual)

(types
(types of
of products
products &
&
services
to
services to offer,
offer,
capacities,
capacities, facilities
facilities
layout, equipment,
equipment,
layout,
location)
location)

Use
Use of
of the
the System
System

Schedule
Schedule the
the System
System

medium
medium term
term (monthly)
(monthly)

(inventory,
(inventory, workforce
workforce
levels,
planning
levels, planning

short
short term
term
(daily,
(daily, weekly)
weekly)

(production,
(production,
purchasing,
purchasing, staff
staff

production)
production)

scheduling)
scheduling)

Operations Planning Hierarchy

Process Planning
Long
Strategic Capacity Planning

Range
Medium
Range

Aggregate Planning
Manufacturing

Services

Master Production Scheduling

Material Requirements Planning

Order Scheduling

Weekly Workforce &

Customer Scheduling

Short
Range

Daily Workforce &

Customer Scheduling

Features of Forecasting

Assumes causal system that existed in

the past and will do so in the future

Forecasts are rarely perfect because of

randomness

Forecasts are more accurate for groups

vs. individual items

Forecast accuracy decreases as time

horizon increases

Elements of A Good Forecast

Time Period
Accuracy
Reliability
Meaningful units
In writing
Simple
Aggregation

Usual Tradeoffs

Cost vs
Accuracy

Steps in the Forecasting Process

1 Determine

2 Establish a time

3 Obtain, clean and

purpose of forecast

horizon

analyze data

5 Prepare the

6 Monitor the

forecast

forecast

4 Select a
forecasting
technique

Approaches to Forecasting
Judgmental

non-quantitative analysis of subjective

inputs
considers soft information such as
human factors, experience, gut instinct

Quantitative

Time series models

extends historical patterns of numerical data

Associative models

create equations with explanatory variables

to predict the future

Judgmental Methods

Executive opinions

Expert opinions

long term strategic or new product

development
Delphi method: iterative questionnaires
circulated until consensus is reached

Sales force (employee) opinions

Based on direct customer contact

Consumer Surveys
Historical analogies

Use demand for similar products

Quantitative Forecasting Methods

Quantitative
Forecasting

Associative

Time Series

(Causal)

Models

Models

Moving

Exponential

Average

Smoothing

Trend
Projection

Linear
Regression

Time Series

Predicts future based on past data

Used when situation is stable &
historical data exist

Existing products
Current technology

Models are chosen based on

Time horizon to forecast

usually short-term

Time Series
Forecasting is the

Data availability
most commonly used
Accuracy required
Size of forecasting budget
because it is
Availability of qualified personnel
inexpensive and easy

Time Series Methods for Today

Naive
Moving Averages
Exponential Smoothing
Trend Projections (Good for longer-term)
Trend Adjusted Exponential Smoothing

What is a Time Series?

A time ordered sequence of
observations taken at regular
intervals of time
Forecast based only on past values

Assumes that factors influencing past

and present will continue influence in
future

Example
Year: 1998 1999 2000 2001 2002
Sales: 78.7 63.5 89.7 93.2 92.1

Patterns in a Time Series

Level: (average) horizontal pattern

Trend: steady upward or downward

movement

Seasonality: regular variations related

to time of year or day

Cycles: wavelike variations lasting

more than one year

Irregular variations: caused by

unusual circumstances, not reflective
of typical behaviour

Basic patterns for historic data

Level

Trend

Seasonal

Cycle

Time

Patterns of a Time Series

Seasonal peaks (winters)

Trend component

Demand for snowboards

Actual demand line

Random
variation

Year
1

Year
2

Year
3

Year
4

Time series models

Naive methods
Averaging methods

Trend models

Moving average
Weighted moving average
Exponential smoothing
Linear (and non-linear trend)
Trend adjusted exponential
smoothing

Techniques for seasonality

Techniques for cycles

Naive Methods

Next period = last period

Simple to use and understand
Very low cost
Low accuracy

Stable time series data : Ft At 1

Seasonal variations : Ft At n

Data with trend : Ft At 1 At 1 At 2

F = forecast

A = actual

Nave Method

A bakery sold 30 loafs of bread yesterday

How many loafs of bread will the bakery

sell today, based on the nave
forecasting method for a stable time
series?

Stable time series data : Ft At 1

F2 = A 1

30 loafs

Simple Average

To forecast next period, take the average

of all previous periods

Advantages:

Simple to use

Disadvantages:

Ends up with a lot of data

Gives equal importance to very old data

Simple Average

Example:

t 1

Ft i t N
N

F3 = (42+40)/2 = 41
F4 = (42 + 40 + 43)/3 = 41.67
.

Period Actual
Simple Avg.
1
42
2
40
42
3
43
41
4
40 41.666667
5
41
41.25
6
39
41.2
7
46 40.833333
8
44 41.571429
9
45
41.875
10
38 42.222222
11
40
41.8
12
39 41.636364

Averaging Methods: Level Data

Moving
: Ft
Average

Demand in previous n periods

Weighted
: Ft
Moving Average

Weight

period n

Demand

Weights

Exponentia l
: Ft Ft 1 At 1 Ft 1
Smoothing
F = forecast

A = actual

= smoothing
constant

period n

Moving Average

average of last few actual data values,

updated each period

easy to calculate and understand

smoothes bumps, lags behind changes

Advantages:

Ignores data that is too old

Requires less data than simple average
More responsive than simple average

Disadvantages:

Still lags behind trend like simple average,

(though not as badly)

Moving Average - Example

Compute a three-period moving

average forecast for period 6, given
the demand below
Period Demand
1
42
2
40

3
43
4
40

5
41

Moving Average - Example

Compute a three-period moving

average forecast for period 6, given
the demand below
Period

Demand

42

40

43

40

41

F3 F4 F5 43 40 41

41.33
F6
3
3

Moving Average
t 1

Ft
a)

i t n

Compute a 3-period moving average

forecast given demand for shopping
carts for the last five periods.

MA3
b)

43 40 41
41.33
3

If the actual demand in period 6 turns out to be 39, what

would be the moving average forecast for period 7?

MA3

40 41 39
40.00
3

Period Deman
d
1
42
2
40
3
43
4
40
5
41
6
?
7
?
41.33

40.00

39

Graph of Moving Average

Moving Average
Forecast

30
28

Actual Sales

26
24

Quantity

22
20
18
16
14
12
10
|

10

11

12

Value of Old Data?

Choosing the number of periods for a

moving average

fewer data points = more sensitive to

changes
more data points = smoother, less
responsive

Weighted Moving Average

Similar to moving average

Gives more importance to more recent

data points

The choice of weights may involve the

use of trial and error to find a suitable
weighting scheme

Weights must add up to 100%

Weighted Moving Average Example

a) Compute a weighted average
forecast using a weight of .40 for the
most recent period, .30 for the next
most recent, .20 for the next, and .10
for the next.
Forecast .40(41) .30(40) .20(43) .10(40) 41.0

b) If the actual demand in period 6 turns out to be 39, what

would be the weighted moving average forecast for period 7?

Period Deman
d
1
42
2
40
3
43
4
40
5
41
6
?
7
?
41.0

Forecast .40(39) .30(41) .20(40) .10(43) 40.2

40.2

39

Moving Average And

Weighted Moving Average
Weighted moving

30

average

25

20

Quantity

Actual sales
15
Moving average

10

|
1

10

11

12

Exponential Smoothing

sophisticated weighted moving average

subjectively choose smoothing constant

weights decline exponentially

most recent data weighted most

ranges from 0 to 1 (commonly .05 to .5)

widely used

easy to use
easy to alter weighting

Exponential Smoothing Formula

Forecast = previous forecast plus a

percentage of the forecast error

(Actual Forecast) is the error term

is the % feedback

F = F + (A - F )
t
t-1
t-1
t-1
F = forecast

A = actual

Exponential Smoothing:
Alternate Formula

Forecast = previous forecast plus a

percentage of the forecast error
is the weight on actual demand
is the weight on previous forecast

F = (1 - F + (A )
t
t-1
t-1

F = forecast

A = actual

Exponential Smoothing: Example

Prepare a forecast using smoothing constant = 0.40.
What is the starting point?
average of several periods of actual data
subjective estimate (for this example, use 60)
first actual value (nave approach)

Period Actual Forecast Calculations

1
65
60
2
55
3
58
4
64

Exponential Smoothing: Example

Prepare a forecast using smoothing constant = 0.40.
What is the starting point?
average of several periods of actual data
subjective estimate (for this example, use 60)
first actual value (nave approach)

Period Actual
Forecast
Calculations
1
65
60
2
55
F2 F1 0.4 A1 F1
60 0.4 65 - 60 62
3
58
F3 F2 0.4 A 2 F2
62 0.4 55 - 62 59.2
4
64
F4 F3 0.4 A 3 F3 59.2 0.4 58 - 59.2 58.72

Exponential Smoothing Example

What are the exponential smoothing

forecasts for periods 2-5 using =0.7?
Use the nave approach for 1st week
W eek

Dem and

820

775

680

655

F = (1 - F + (A )
t
t-1
t-1

Exponential Smoothing Example

F2=(.7)(820)+(1 - .7)(820) =820

F3=(.7)(775)+(1 - 0.7)(820)=788.5

F = (1 - F + (A )
t
t-1
t-1

Selecting a Smoothing
Constant
225

200

Actual

a = .5

Demand

demand
175

150

a = .1
|

5
Period

Choosing

When demand is fairly stable, use a

lower value for

When demand increasing or

decreasing, use a higher value for

smoothes out random fluctuations

more responsive to real changes

Try to find balance

trial and error

can change over time

True or False?
A moving average forecast tends to be
more responsive to changes in the
data series when more data points are
included in the average.
False
As compared to a simple moving
average, the weighted moving
average is more reflective of the
recent changes.
True
A smoothing constant of 0.1 will cause
an exponential smoothing forecast to
react more quickly to a sudden
change than a value of .3 will.

Techniques for Trend

Develop an equation that describes the

trend

Look at historical data

Nonlinear Trends (Exclusion)

Linear Trend Equation

Fit a trend line to a series of historical data

Use regression to find the equation of the line
(called the Least Squares Line) [exclusion]

Equation : yt a bt
Slope : b

n ty t y
n t t
2

y b t

y - intercept : a
n

Linear Trend
Actual observation

Demand

Deviation

Deviation

Deviation

Deviation
Deviation
Deviation

Deviation

Points on the line

yt a bt
Time

Linear Trend: Example

week t

Sales y

t2

ty

1
2
3

150
157
162

1
4
9

150
314
486

4
5

166
177

16
25

664
885

t 15

y 812

2
t
55

ty 2,499

225

5 2,499 15 812 12,495 12,180

6.3
5 55 225
275 225
812 6.3 15
a
143.5
5

yt a bt 143.5 6.3t

Excel - Linear Trend

Insert Chart
Scatter
Highlight data
range
Right Click on a
data point
Add Trendline
Type: Linear
Options: Display
equation on chart
Or Insert Functions:
=SLOPE(Range of y's,Range of x's)
=INTERCEPT(Range of y's,Range of x's)

Forecast based on Linear Trend

Estimate sales for period 6

week t
1

Sales y
150

2
3

157
162

4
5

166
177

y = 143.5 + 6.3(6) = 181.3

t

yt a bt 143.5 6.3t

Trend-Adjusted Exponential
Smoothing
TAF

=S +T
t+1
t
t

S = TAF +(A TAF )

t
t
t
t
S T )
t-1 t-1

T =T
+ ( S
t
t-1
t

where
S = smoothed average at the end of period t
t
T = smoothed trend at the end of period t
t

Trend-Adjusted Exponential
Smoothing

select values (usually through trial

and error) for

= smoothing constant for average

= smoothing constant for trend

estimate starting smoothed average

and smoothed trend

use most recent data

Trend-Adjusted Forecast: Example

Next Class

Forecasting (Part 2) Ch 3 (cont)

More on Linear Trend.

Seasonality
Associative Models