Factors influencing forecast

• Past demand (historical data)

• Delivery lead times
• Planned advertising or marketing efforts
• Planned price discounts
• State of the economy (financial status of the firm)
• Competitors’ actions in the market place

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 Characteristics of forecasts

• Forecasts are always inaccurate, as it is very unlikely that

the error will be zero

• It’s better to have a range forecast than a point forecast

• Long-term forecasts are less accurate than short-term

forecasts

• Aggregated forecasts are more accurate than disaggregated

forecasts

02/02/2021 3
 Quantitative forecasting methods

Moving average

Exponential smoothing

Holt’s method

Winters’ method

Regressions

ARIMA/ARIMAX etc.
02/02/2021 4
 Components of an observation

Observed demand (O) = Systematic component (S) +

Random component (R)

• Systematic component:
– Level (current deseasonalized value of a variable)

– Trend (growth or decline in the variable)

– Seasonality (predictable seasonal fluctuation)

continued…..
02/02/2021 5
 Continued…..

• Calculation of systematic components:

– Multiplicative: (level)(trend)(seasonal factor)

– Additive: level + trend + seasonal factor

– Mixed: (level + trend)(seasonal factor)

• Random component = the part of the forecast that deviates

from the systematic component

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 Comparison of forecasting methods

Forecasting method Applicability

Moving average No trend or seasonality

Simple exponential smoothing No trend or seasonality

Holt’s model Trend but no seasonality

Winters’ model Trend and seasonality

ARIMA/ARIMAX Trend and seasonality

02/02/2021 7
 Moving averages
−1 −1+ −2 −2+ ⋯………………….+ − −
=
−1 + −2 + ⋯ … … … … … … … … . + −

Where:

Ft = forecast for the period t

n = no of periods

Di = actual time series value during i

Wi = weight for the period I

Note: for simple moving average, Wt-1 = Wt-2 = ….= Wt-n = 1 and for
weighted moving average ∑Wi = 1 (weights can be optimized)

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 Exponential smoothing

+1 = + (1 − )
Where:

F1 = average (Di)

α is called as smoothing constant varying

between 0 and 1 (can be optimized)

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 Holt’s and Winters’ models
Systematic component = (level + trend)*seasonal factor

For trend and level – regression should be carried out:

Where:

Intercept = level

Coefficient = trend

Holt’s method: only trend is addressed (two smoothing constants needed, α and
β, both varying between 0 and 1 (all can be optimized)

Winters’ method: both trend and seasonality are addressed (three smoothing
constants needed, α, β and γ, all varying between 0 and 1 (all can be optimized)

02/02/2021 10
 Estimating seasonality

−1+( 2 )
−(2 )
+ +( 2 )
+∑ 2
+1−( 2 )
= ,
2

−1
+( )
2

= ( / ),
−1
−( 2 )

02/02/2021 11
 ACF and white noise model

• Auto-correlation function(ACF):

• Partial auto-correlation function (PACF): PACF of order k (lag) is denoted by

αk and can be calculated by regressing yt against yt-1, yt-2, ……, yt-k:

yt = b0 + b1 y t-1 + b2 yt-2 +………………….+bp yt-p

• White noise model: yt = c + et (c = overall value and et = random error

and are un-correlated from time period to time period, yt and y t-1 are
uncorrelated)

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 Tests for ACF and PACF

• Box – Pierce test (Q statistics):

• Ljung − Box test:

⎡ k r j2 ⎤
⎢Q ( k ) = N ( N + 2 ) ∑ ⎥
⎢⎣ j =1 N − j ⎥⎦

• Both tests the auto-correlations for the errors are different from
zero:

– H0: The model does not show lack of fit

– H1: The model exhibits lack of fit

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 ARIMA models
Consider a regression equation:
y = b0 + b1x1 + b2x2 +………………………….+bpxp + et
If we define:
x1 = yt-1, x2 = yt-2,………………………….., xp = yt-p
then:
yt = b0 + b1 y t-1 + b2 yt-2 +………………….+bp yt-p + et (AR)
and
yt = b0 + b1 e t-1 + b2 et-2 +………………….+bp et-p + et (MA)

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 Box-Jenkins methodology

02/02/2021 15
Source: Box and Jenkins (1970) as said in Makridakis (1998)
 ARIMA (p, d, q)
• AR: p = order of autoregressive part

• I: d = degree of first differencing involved (change in the

observations of original time series)

• MA: q = order of moving average

• For example: p = 1, d = 0, q = 1: ARIMA (1,0,1) or ARMA

(1,1) and so on

(Note: White-noise model is classified as (ARIMA (0, 0, 0))

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 ARIMA models in general

ARMA model:

ARIMA model:

continued…..
02/02/2021 17
 Continued…..
Seasonal ARIMA(1,1,1)(1,1,1)4:

02/02/2021 18
 Identification of p, d and q
• Plot the data and observe to find out if there is trend and variance. If it

is there then the transformation of data is needed.

• Plot and the ACF (decides the MA part) and PACF (decides the AR

part).

• If the time plot is not horizontal or the ACF and PACF do not drop to

zero, non-stationarity is indicated (Dickey-Fuller test, 1979 is used)

• Use differencing method to make the data stationary. In most cases, a

maximum of two differences will transform the data into a stationary

series.
02/02/2021 19
 Non-stationary series

Source: Dow-Jones data as said in Makridakis (1998)

02/02/2021 20
 ACF and PACF plots

Source: Brockwell and Davis (1996) as said in Makridakis (1998)

02/02/2021 21
 Data transformation

Source: Dow-Jones data as said in Makridakis (1998)

02/02/2021 22
 ACF and PACF plots

Source: Dow-Jones data as said in Makridakis (1998)

02/02/2021 23
 Estimating the parameters

• The method of least squares can be used for ARIMA

models, just as with regression for AR part

• The models involving an MA component, a

preliminary estimate is chosen and a computer
program estimate the errors iteratively until the sum
of squared errors is minimized

02/02/2021 24
 Measures of forecasting error
1. MSE (mean squared error) = (1/n)∑Et2

2. RMSE (root mean squared error) = Sqrt((1/n)∑Et2)

3. MAD (mean absolute deviation) = (1/n)∑Abs(Et )

4. MAPE (mean absolute percentage error) = ∑Abs((Et/Dt)*100/n)

5. Normalized BIC= ln(MSE) + k * ln(n)/n , k= number of parameters

in the model, n = number of non-missing residuals

6. TS (tracking signal) = (∑Et)/ MAD varies between “-6.0 and +6.0”

continued.....
02/02/2021 25
 Continued.....
• Akaike’s information criterion:

AIC = -2(log-likelihood) + 2K, where =

• For small sample sizes (n/K <= 40):

AICc = -2(log-likelihood) + 2K + (2K(K+1)/(n-K-1))

Where:

• n = sample size

• K= number of model parameters

02/02/2021 26
 Implications of forecasting error

• Errors in forecasting can cause significant misallocation of

resources
• Long lead times, seasonality, short product life cycles, few
customers and lumpy demand
• Improper orders placed by intermediaries in a supply chain
• Mitigation strategies:
– Increasing the responsiveness of the supply chain
– Utilizing opportunities for pooling of demand

02/02/2021 27
 Forecasting in practice

• Collaborate in building forecasts (joint

decision making)
• The value of data depends on where you are in
the supply chain
• Be sure to distinguish between demand and
sales

02/02/2021 28
 References/suggested readings
1. Box, G. E. P., Jenkins, G. M. (1970). Time series analysis: forecasting and control. San
Francisco: Holden-Day.

2. Chopra, S., & Meindl, P. (2012). Supply chain management: strategy, planning and
operation. New Delhi: Prentice Hall.

3. Dickey, D. A., & Fuller, W. A. (1979). Distribution of estimation of auto-regressive time

series with a unit root. Journal of the American Statistical Association, 74, 427-431.

4. Makridakis, S., Wheelwright, S. C. & Hyndman, R. J. (1998). Forecasting methods and

applications (3rd ed.). USA: John Wiley & Sons.

5. Simchi-Levi, D., Kaminsky, P., Simchi-Levi, E., & Shankar R. (2009). Designing and
managing the supply chain – concepts, strategies and case studies. New Delhi: Tata McGraw-
Hill Education.

02/02/2021 29
 Disclaimer!
The content of this presentation is solely intended to be used by MBA-IV semester
“Supply Chain Analytics” students of School of Management Studies, University
of Hyderabad. Distribution of the same without the permission of the instructor is
strictly prohibited. The instructor, Dr. Pramod K. Mishra, declares that the sources
of various concepts/theories cited in the presentation are duly acknowledged.
Nobody should edit/post/upload any supply chain analytics (SCA) class materials
(cases, texts, ppts, video recordings or any other related contents) in/on to any
social networking sites, print media, YouTube etc. without the prior permission of
the concerned teacher “Dr. Pramod K. Mishra.” Disciplinary action, as per rule,
will be taken against the concerned student/s for such misconducts.

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