Operations Management

Forecasting

Why Forecasting?

Decision making is often complicated due to uncertainty Since Each decision involves considerable cash flow, time & other resource, good estimate is a crucial requirement Forecast are estimate of timing & magnitude of the occurrence of future events. Primary Function is to Predict the Future using (time series related or other) data we have in hand Forecasting involves a study of the present & past data with a view to estimate the future.

Why are we interested?

The better the Management is able to forecast the future the better will it be prepared to face the future.

Where is forecasting used in POM

Forecast dynamic & complex environment Forecast short term fluctuations in production forecast availability/need for manpower Better materials management Basis for planning & scheduling Strategic decision.

Forecasting based on Time Horizon

Short-range forecast Up to 1 year; usually less than 3 months Employed to fine tune an existing plan Act as an input to tactical decisions Degree of uncertainty is low Job scheduling, worker assignments Medium-range forecast Planning horizon is usually 12 to 18 months Aggregation of data is done considering cyclical & seasonal patterns

Nature of decision will be tactical as well as strategic E.g. annual production planning, capacity augmentation, Long-range forecast Involves purely strategic decision for time period of about 5 to 10 years It involves subjective knowledge from the experts Level of uncertainty is high E.g. New product planning, facility location

Sources of data
Good forecasting depends on quantity & quality of data that is available. Some of the imp sources of data are

Sales force estimate Point of sales (pos)data systems Forecasts from supply chain partners Trade / industry association journals B2B portals / market places Economic surveys & indicators Subjective knowledge

Qualitative Methods

Quantitative Methods

Subjective approach Used when situation is vague & little data exist New products New technology Involves intuition, experience

Objective in nature Used when situation is stable & historical data exist Existing products Current technology Involves mathematical techniques

Qualitative Forecasting Methods

Sales Force Composites Customer Surveys Jury of Executive Opinion The Delphi Method

Jury of Executive Opinion

Involves small group of high-level managers Combines managerial experience with statistical models Relatively quick Group-think disadvantage

1995 Corel Corp.

Sales Force Composite

Each salesperson projects his or her sales Combined at district & national levels Sales reps know customers wants Tends to be overly optimistic

Sales

Delphi Method
The Delphi Method seeks to achieve a consensus among group members through a series of questionnaires. The questionnaires are answered anonymously and individually by each member of the group. The answers are summarized and sent back to the group members along with the next questionnaire. This process is repeated until a group consensus is reached. This usually only takes two iterations, but can sometimes take as many as six rounds before a consensus is reached.

Consumer Market Survey

Respondents are asked a variety of questions regarding their behavior, intentions, attitude, awareness, demographic & lifestyle characteristics What consumers say, and what they actually do are often different, 1995 sometimes difficult to Corel answer Corp.

How many hours will you use the Internet next week?

Quantitative Methods
Extrapolative methods Make use of past data & prepare future estimates by extrapolating. Considers only one factor at a time E.g. moving avg method, weighted moving average, exponential method Causal models Analyze data from the point view of cause & effect relationship. Considers more than one factor & their relationship. E.g. Linear regression, econometric models.

Moving Average
Naive forecast demand in the current period is used as next periods forecast Simple moving average The forecast is computed by taking average of the actual sales in the preceding months Can be used when demand is stable and with no pronounced behavioral patterns Weighted moving average weights are assigned to most recent data Adjusts moving average method to more closely reflect data fluctuations

Simple Moving Average

n

1 Di i=
MAn =
where n = number of periods in the moving average Di = demand in period i

Weighted Moving Average

Wi Di

WMAn =
where

i=1

Wi = the weight for period i, &

always it is Wi = 1.00

Exponential Smoothing

Averaging method Weights most recent data more strongly Reacts more to recent changes Widely used, accurate method

Exponential Smoothing (cont.)

Ft +1 = Ft + (Dt - Ft )
where: Ft +1 = forecast for next period Dt = actual demand for present period Ft = previously determined forecast for present period = weighting factor, smoothing constant

Effect of Smoothing Constant

0.0 1.0 If = 0.20, then Ft +1 = 0.20 Dt + 0.80 Ft If = 0, then Ft +1 = 0 Dt + 1 Ft 0 = Ft
Forecast does not reflect recent data i.e. forecast is not

responsive to demand

If = 1, then Ft +1 = 1 Dt + 0 Ft = Dt
Forecast based only on most recent data

Exponential Smoothing (cont.)

70 60 50 Orders 40 = 0.30 Actual = 0.50

30
20 10 0 | 1 | 2 | 3 | 4 | 5 | 6 | 7 | 8 | 9 | 10 | 11 | 12 | 13

Month

Basic patterns of demand

Trend (T) There is a systematic increase or decrease in the mean of the series over a period of time. Seasonality (S) There are fixed cycles in which data often move from one period to period. Cyclical(C) Cycles that repeat over a much longer period of say 5 -10 years Random(R) Uncontrollable events happening in the short term that could influence demand.

Components of time series

Demand Demand Random movement Time (a) Trend Time( yrs) (b) Cycle Time (mths) (c) Seasonal pattern Demand Time (d) Trend with seasonal pattern

Demand

Exponential Smoothing with Trend Adjustment

It a method to make forecast with the trend adjustment added in. AFt+1 = Ft+1 + Tt+1
Where

Ft 1 ( Dt ) (1 )(Ft Tt )

Tt +1 = = Tt = =

(Ft+1 Ft ) + (1 - ) Tt trend factor for the next period trend factor for the current period smoothing constant for the trend adjustment factor

Linear Trend Line

y = a + bx
where a = intercept b = slope of the line x = usually time period (independent variable) y = forecast for demand for period x (dependent variable) xy - nxy b = x2 - nx2 a = y-bx

where n = number of periods x x = = mean of the x values n y y = n = mean of the y values

Linear trend line y = 35.2 + 1.72x Forecast for period 13 y = 35.2 + 1.72(13) = 57.56 units
70 60 50 Demand 40 Linear trend line 30 20

Actual

10
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Seasonal Adjustments
It adjust the forecast by scaling up the estimate during periods of high demand & scaling down during periods of low demand Seasonality index is estimated by taking a ratio of actual period demand with the average demand for the period Di Seasonal factor = Si = D

Measurement of Forecast Accuracy

Forecast error

Difference between demand & forecast for the period. Positive value indicates underestimation of demand & vice versa. Forecast error t = Dt Ft SFE (Sum of forecast error) MAD (mean absolute deviation) Tracking Signal

Some Popular measures are

Sum of forecast error(SFE)

Sum of errors during the period of consideration.

SFE ei
i 1

Mean Absolute Deviation (MAD)

To overcome limitation of SFE one could take absolute values of Error & avg it. n MAD 1 ei n i 1

Monitoring & controlling forecasting error.

Tracking Signal
Helps to know how far the forecast is drifting away from actual. Tracking Signal = SFE/MAD Positive TS indicate that demand is greater than forecast & vice versa