13 – 1 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. Forecasting 13 For Operations Management, 9e by Krajewski/Ritzman/Malhotra

13 – 1Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall.

ForecastingForecasting13

For For Operations Management, 9eOperations Management, 9e by by Krajewski/Ritzman/Malhotra Krajewski/Ritzman/Malhotra © 2010 Pearson Education© 2010 Pearson Education

PowerPoint Slides PowerPoint Slides by Jeff Heylby Jeff Heyl


ForecastingForecasting

Forecasts are critical inputs to business plans, annual plans, and budgets

Finance, human resources, marketing, operations, and supply chain managers need forecasts to plan: output levels, purchases of services and materials, workforce and output schedules, inventories, and long-term capacities

Forecasts are made on many different variables

Forecasts are important to managing both processes and managing supply chains


Demand PatternsDemand Patterns

A time series is the repeated observations of demand for a service or product in their order of occurrence

There are five basic time series patterns Horizontal Trend Seasonal Cyclical Random



Qu

anti

ty

Time

(a) Horizontal: Data cluster about a horizontal line

Figure 13.1 – Patterns of Demand



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Time

(b) Trend: Data consistently increase or decrease



Demand PatternsDemand PatternsQ

uan

tity

| | | | | | | | | | | |J F M A M J J A S O N D

Months

(c) Seasonal: Data consistently show peaks and valleys

Year 1

Year 2




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| | | | | |1 2 3 4 5 6

Years

(d) Cyclical: Data reveal gradual increases and decreases over extended periods



Key DecisionsKey Decisions

Deciding what to forecast Level of aggregation Units of measure

Choosing a forecasting systemChoosing the type of forecasting technique

Judgment and qualitative methods Causal methods Time-series analysis

Key factor in choosing the proper forecasting approach is the time horizon for the decision requiring forecasts


Judgment MethodsJudgment Methods

Other methods (casual and time-series) require an adequate history file, which might not be available

Judgmental forecasts use contextual knowledge gained through experience

Salesforce estimates

Executive opinion is a method in which opinions, experience, and technical knowledge of one or more managers are summarized to arrive at a single forecast

Delphi method


Judgment MethodsJudgment Methods

Market research is a systematic approach to determine external customer interest through data-gathering surveys

Delphi method is a process of gaining consensus from a group of experts while maintaining their anonymity

Useful when no historical data are available

Can be used to develop long-range forecasts and technological forecasting


Time Series MethodsTime Series Methods

In a naive forecast the forecast for the next period equals the demand for the current period (Forecast = Dt)

Estimating the average: simple moving averages Used to estimate the average of a demand time

series and thereby remove the effects of random fluctuation

Most useful when demand has no pronounced trend or seasonal influences

The stability of the demand series generally determines how many periods to include


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0 5 10 15 20 25 30

Week

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410 –

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370 –

350 –

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Time Series MethodsTime Series Methods

Figure 13.4 – Weekly Patient Arrivals at a Medical Clinic


Simple Moving AveragesSimple Moving Averages

Specifically, the forecast for period t + 1 can be calculated at the end of period t (after the actual demand for period t is known) as

Ft+1 = =Sum of last n demands

n

Dt + Dt-1 + Dt-2 + … + Dt-n+1

n

whereDt = actual demand in period tn = total number of periods in the average

Ft+1 = forecast for period t + 1


Simple Moving AveragesSimple Moving Averages

For any forecasting method, it is important to measure the accuracy of its forecasts. Forecast error is simply the difference found by subtracting the forecast from actual demand for a given period, or

whereEt = forecast error for period tDt = actual demand in period tFt = forecast for period t

Et = Dt – Ft


Using the Moving Average MethodUsing the Moving Average Method

EXAMPLE 13.2

a. Compute a three-week moving average forecast for the arrival of medical clinic patients in week 4. The numbers of arrivals for the past three weeks were as follows:

Week Patient Arrivals

1 400

2 380

3 411

b. If the actual number of patient arrivals in week 4 is 415, what is the forecast error for week 4?

c. What is the forecast for week 5?


Using the Moving Average MethodUsing the Moving Average Method

SOLUTION

a. The moving average forecast at the end of week 3 is


1 400

2 380

3 411

b. The forecast error for week 4 is

F4 = = 397.0411 + 380 + 4003

E4 = D4 – F4 = 415 – 397 = 18

c. The forecast for week 5 requires the actual arrivals from weeks 2 through 4, the three most recent weeks of data

F5 = = 402.0415 + 411 + 3803


Application 13.1aApplication 13.1a

Estimating with Simple Moving Average using the following customer-arrival data

Month Customer arrival

1 800

2 740

3 810

4 790

Use a three-month moving average to forecast customer arrivals for month 5

F5 = = 780D4 + D3 + D2

3

790 + 810 + 740

3=

Forecast for month 5 is 780 customer arrivals



If the actual number of arrivals in month 5 is 805, what is the forecast for month 6?

F6 = = 801.667D5 + D4 + D3

3

805 + 790 + 810

3=


Month Customer arrival

1 800

2 740

3 810

4 790



Forecast error is simply the difference found by subtracting the forecast from actual demand for a given period, or

Given the three-month moving average forecast for month 5, and the number of patients that actually arrived (805), what is the forecast error?

Forecast error for month 5 is 25

Et = Dt – Ft

E5 = 805 – 780 = 25


In the weighted moving average method, each historical demand in the average can have its own weight, provided that the sum of the weights equals 1.0. The average is obtained by multiplying the weight of each period by the actual demand for that period, and then adding the products together:

Weighted Moving AveragesWeighted Moving Averages

Ft+1 = W1D1 + W2D2 + … + WnDt-n+1

A three-period weighted moving average model with the most recent period weight of 0.50, the second most recent weight of 0.30, and the third most recent might be weight of 0.20

Ft+1 = 0.50Dt + 0.30Dt–1 + 0.20Dt–2


Application 13.1bApplication 13.1b

Revisiting the customer arrival data in Application 13.1a. Let W1 = 0.50, W2 = 0.30, and W3 = 0.20. Use the weighted moving average method to forecast arrivals for month 5.

= 0.50(790) + 0.30(810) + 0.20(740)

F5 = W1D4 + W2D3 + W3D2

= 786


Given the number of patients that actually arrived (805), what is the forecast error?


E5 = 805 – 786 = 19


Application 13.1bApplication 13.1b

If the actual number of arrivals in month 5 is 805, compute the forecast for month 6

= 0.50(805) + 0.30(790) + 0.20(810)

F6 = W1D5 + W2D4 + W3D3

= 801.5



Exponential SmoothingExponential Smoothing

A sophisticated weighted moving average that calculates the average of a time series by giving recent demands more weight than earlier demands

Requires only three items of data The last period’s forecast The demand for this period A smoothing parameter, alpha (α), where 0 ≤ α ≤ 1.0

The equation for the forecast is

Ft+1 = α(Demand this period) + (1 – α)(Forecast calculated last period)

= αDt + (1 – α)Ft

Ft+1 = Ft + α(Dt – Ft)

or the equivalent


Exponential SmoothingExponential Smoothing

The emphasis given to the most recent demand levels can be adjusted by changing the smoothing parameter

Larger α values emphasize recent levels of demand and result in forecasts more responsive to changes in the underlying average

Smaller α values treat past demand more uniformly and result in more stable forecasts

Exponential smoothing is simple and requires minimal data

When the underlying average is changing, results will lag actual changes


450 –

430 –

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390 –

370 –

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Week

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0 5 10 15 20 25 30

3-week MAforecast

6-week MAforecast

Exponential smoothing = 0.10

Exponential Smoothing and Exponential Smoothing and Moving AverageMoving Average


Using Exponential SmoothingUsing Exponential Smoothing

EXAMPLE 13.3

a. Reconsider the patient arrival data in Example 13.2. It is now the end of week 3. Using α = 0.10, calculate the exponential smoothing forecast for week 4.


1 400

2 380

3 411

4 415

b. What was the forecast error for week 4 if the actual demand turned out to be 415?

c. What is the forecast for week 5?



SOLUTION

a. The exponential smoothing method requires an initial forecast. Suppose that we take the demand data for the first two weeks and average them, obtaining (400 + 380)/2 = 390 as an initial forecast. (POM for Windows and OM Explorer simply use the actual demand for the first week as a default setting for the initial forecast for period 1, and do not begin tracking forecast errors until the second period). To obtain the forecast for week 4, using exponential smoothing with and the initial forecast of 390, we calculate the average at the end of week 3 as

F4 =

Thus, the forecast for week 4 would be 392 patients.

0.10(411) + 0.90(390) = 392.1



b. The forecast error for week 4 is

c. The new forecast for week 5 would be

E4 =

F5 =

or 394 patients. Note that we used F4, not the integer-value forecast for week 4, in the computation for F5. In general, we round off (when it is appropriate) only the final result to maintain as much accuracy as possible in the calculations.

415 – 392 = 23

0.10(415) + 0.90(392.1) = 394.4


Application 13.1cApplication 13.1c

Suppose the value of the customer arrival series average in month 3 was 783 customers (let it be F4). Use exponential smoothing with α = 0.20 to compute the forecast for month 5.

Ft+1 = Ft + α(Dt – Ft) = 783 + 0.20(790 – 783) = 784.4


Given the number of patients that actually arrived (805), what is the forecast error?

E5 =


805 – 784 = 21


Application 13.1cApplication 13.1c

Given the actual number of arrivals in month 5, what is the forecast for month 6?

Ft+1 = Ft + α(Dt – Ft) = 784.4 + 0.20(805 – 784.4) = 788.52



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0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

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70 –

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50 –

40 –

30 –

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Week

Actual blood test requests

Trend-adjusted forecast

Using Trend-Adjusted Exponential Using Trend-Adjusted Exponential SmoothingSmoothing

Figure 13.5 – Trend-Adjusted Forecast for Medanalysis


Seasonal PatternsSeasonal Patterns

Seasonal patterns are regularly repeated upward or downward movements in demand measured in periods of less than one year

Account for seasonal effects by using one of the techniques already described but to limit the data in the time series to those periods in the same season

This approach accounts for seasonal effects but discards considerable information on past demand


1. For each year, calculate the average demand for each season by dividing annual demand by the number of seasons per year

2. For each year, divide the actual demand for each season by the average demand per season, resulting in a seasonal index for each season

3. Calculate the average seasonal index for each season using the results from Step 2

4. Calculate each season’s forecast for next year

Multiplicative Seasonal MethodMultiplicative Seasonal Method

Multiplicative seasonal method, whereby seasonal factors are multiplied by an estimate of the average demand to arrive at a seasonal forecast


The manager wants to forecast customer demand for each quarter of year 5, based on an estimate of total year 5 demand of 2,600 customers

Using the Multiplicative Seasonal Using the Multiplicative Seasonal Method Method

EXAMPLE 13.5

The manager of the Stanley Steemer carpet cleaning company needs a quarterly forecast of the number of customers expected next year. The carpet cleaning business is seasonal, with a peak in the third quarter and a trough in the first quarter. Following are the quarterly demand data from the past 4 years:

Quarter Year 1 Year 2 Year 3 Year 4

1 45 70 100 100

2 335 370 585 725

3 520 590 830 1160

4 100 170 285 215

Total 1000 1200 1800 2200



SOLUTION

Figure 13.6 shows the solution using the Seasonal Forecasting Solver in OM Explorer. For the Inputs the forecast for the total demand in year 5 is needed. The annual demand has been increasing by an average of 400 customers each year (from 1,000 in year 1 to 2,200 in year 4, or 1,200/3 = 400). The computed forecast demand is found by extending that trend, and projecting an annual demand in year 5 of 2,200 + 400 = 2,600 customers.

The Results sheet shows quarterly forecasts by multiplying the seasonal factors by the average demand per quarter. For example, the average demand forecast in year 5 is 650 customers (or 2,600/4 = 650). Multiplying that by the seasonal index computed for the first quarter gives a forecast of 133 customers (or 650 × 0.2043 = 132.795).



Figure 13.6 – Demand Forecasts Using the Seasonal Forecast Solver of OM Explorer


(a) Multiplicative pattern


Period

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0 2 4 5 8 10 12 14 16

Dem

and



(b) Additive pattern

Period

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0 2 4 5 8 10 12 14 16

Dem

and


Choosing a Time-Series MethodChoosing a Time-Series Method

Forecast performance is determined by forecast errors

Forecast errors detect when something is going wrong with the forecasting system

Forecast errors can be classified as either bias errors or random errors

Bias errors are the result of consistent mistakes

Random error results from unpredictable factors that cause the forecast to deviate from the actual demand


CFE = Et

Measures of Forecast ErrorMeasures of Forecast Error

(Et – E )2

n – 1 =

Et2

nMSE =

|Et |nMAD =

(|Et |/ Dt)(100)nMAPE =

E =CFE

n


Calculating Forecast ErrorsCalculating Forecast Errors

EXAMPLE 13.6

The following table shows the actual sales of upholstered chairs for a furniture manufacturer and the forecasts made for each of the last eight months. Calculate CFE, MSE, σ, MAD, and MAPE for this product.

Montht

DemandDt

ForecastFt

ErrorEt

Error2

Et2

Absolute Error |Et|

Absolute % Error (|Et|/Dt)(100)

1 200 225 –25

2 240 220 20

3 300 285 15

4 270 290 –20

5 230 250 –20 400 20 8.7

6 260 240 20 400 20 7.7

7 210 250 40 1,600 40 19.0

8 275 240 35 1,225 35 12.7

Total –15 5,275 19581.3%



EXAMPLE 13.6

The following table shows the actual sales of upholstered chairs for a furniture manufacturer and the forecasts made for each of the last eight months. Calculate CFE, MSE, σ, MAD, and MAPE for this product.

Montht

DemandDt

ForecastFt

ErrorEt

Error2

Et2

Absolute Error |Et|

Absolute % Error (|Et|/Dt)(100)

1 200 225 –25 625 2512.5%

2 240 220 20 400 20 8.3

3 300 285 15 225 15 5.0

4 270 290 –20 400 20 7.4

5 230 250 –20 400 20 8.7

6 260 240 20 400 20 7.7

7 210 250 40 1,600 40 19.0

8 275 240 35 1,225 35 12.7

Total –15 5,275 19581.3%


SOLUTION

Using the formulas for the measures, we get

Cumulative forecast error (bias):


CFE = –15

Average forecast error (mean bias):

Mean squared error:

MSE =Et

2

n

CFEnE = –1.875=

5,2758

=


Standard deviation:


Mean absolute deviation:

Mean absolute percent error:

[Et – (–1.875)]2

n – 1 =

|Et |nMAD =

(|Et |/ Dt)(100)nMAPE =

= 27.4

= = 24.4195

8

= = 10.2%81.3%

8



A CFE of –15 indicates that the forecast has a slight bias to overestimate demand. The MSE, σ, and MAD statistics provide measures of forecast error variability. A MAD of 24.4 means that the average forecast error was 24.4 units in absolute value. The value of σ, 27.4, indicates that the sample distribution of forecast errors has a standard deviation of 27.4 units. A MAPE of 10.2 percent implies that, on average, the forecast error was about 10 percent of actual demand. These measures become more reliable as the number of periods of data increases.


Tracking SignalsTracking Signals

A measure that indicates whether a method of forecasting is accurately predicting actual changes in demand

Useful when forecast systems are computerized because it alerts analysts when forecast are getting far from desirable limits

Tracking signal =CFEMAD

Each period, the CFE and MAD are updated to reflect current error, and the tracking signal is compared to some predetermined limits



The MAD can be calculated as a weighted average determined by the exponential smoothing method

MADt = α|Et| + (1 – α)MADt-1

If forecast errors are normally distributed with a mean of 0, the relationship between σ and MAD is simple

σ = ( /2)(MAD) 1.25(MAD)

MAD = 0.7978σ 0.8σ


+2.0 –

+1.5 –

+1.0 –

+0.5 –

0 –

–0.5 –

–1.0 –

–1.5 –| | | | |

0 5 10 15 20 25 Observation number

Tra

ckin

g s

ign

alOut of control


Control limit

Control limit

Figure 13.7 – Tracking Signal


Criteria for Selecting MethodsCriteria for Selecting Methods

Criteria to use in making forecast method and parameter choices include

1. Minimizing bias

2. Minimizing MAPE, MAD, or MSE

3. Meeting managerial expectations of changes in the components of demand

4. Minimizing the forecast error last period

Statistical performance measures can be used1. For projections of more stable demand patterns, use

lower α and β values or larger n values

2. For projections of more dynamic demand patterns try higher α and β values or smaller n values


Using Multiple TechniquesUsing Multiple Techniques

Combination forecasts are forecasts that are produced by averaging independent forecasts based on different methods or different data or both

Focus forecasting selects the best forecast from a group of forecasts generated by individual techniques


Forecasting as a ProcessForecasting as a Process

A typical forecasting processStep 1: Adjust history file

Step 2: Prepare initial forecasts

Step 3: Consensus meetings and collaboration

Step 4: Revise forecasts

Step 5: Review by operating committee

Step 6: Finalize and communicate

Forecasting is not a stand-alone activity, but part of a larger process


Forecasting as a ProcessForecasting as a Process

Finalize and

communicate6

Review by Operating Committee

5

Revise forecasts

4

Consensus meetings and collaboration

3

Prepare initial

forecasts2

Adjust history

file1


Forecasting PrinciplesForecasting Principles

TABLE 13.2 | SOME PRINCIPLES FOR THE FORECASTING PROCESS

Better processes yield better forecasts

Demand forecasting is being done in virtually every company, either formally or informally. The challenge is to do it well—better than the competition

Better forecasts result in better customer service and lower costs, as well as better relationships with suppliers and customers

The forecast can and must make sense based on the big picture, economic outlook, market share, and so on

The best way to improve forecast accuracy is to focus on reducing forecast error

Bias is the worst kind of forecast error; strive for zero bias

Whenever possible, forecast at more aggregate levels. Forecast in detail only where necessary

Far more can be gained by people collaborating and communicating well than by using the most advanced forecasting technique or model

Documents

13 – 1 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. Forecasting 13 For Operations Management, 9e by Krajewski/Ritzman/Malhotra