4-Demand Forecasting Techniques (Short Term & Long Term) - 11!08!2021 (11-Aug-2021) Material - I - 11-Aug-2021 - 3 - MEE1014 - Forecasting

MEE1014
INDUSTRIAL ENGINEERING AND MANAGEMENT
Dr T SAMPATH KUMAR
Associate Professor
School of Mechanical Engineering
VIT University
Sampath.thepperumal@vit.ac.in
9443964297
Module I
Introduction to macro and micro economics:

Macro economic measures – micro economics – Demand and supply –
Determinants of demand and supply – Elasticity of demand – Demand
forecasting techniques (short term & long term) – Problems.
7/30/2019 DrT Sampath Kumar, Associate Professor, SMEC-VIT 2

Forecasting
“Prediction is very difficult,

especially if it's about the future.”
Nils Bohr
Forecasting is a tool used for predicting
future demand based on
past demand information.

Forecasting
Forecasting is the use of historic data to determine the direction of future trends.
Businesses utilize forecasting to determine how to allocate their budgets or plan for
anticipated expenses for an upcoming period of time.
This is typically based on the projected demand for the goods and services they offer.

Introduction to Forecasting
• What is forecasting?
– Primary Function is to Predict the Future
• Why are we interested?
– Affects the decisions we make today
• Examples: who uses forecasting in their jobs?
– forecast demand for products and services
– forecast availability of manpower
– forecast inventory and materiel needs daily

Why do we need forecast?
In general, forecasts are almost always wrong. So,
Throughout the day we forecast very different things such as
weather, traffic, stock market, state of our company from
different perspectives.
Virtually every business attempt is based on forecasting. Not all

of them are derived from sophisticated methods. However,
“Best" educated guesses about future are more valuable for
purpose of planning than no forecasts and hence no planning.

Importance of Forecasting in OM
Departments throughout the organization depend on forecasts to
formulate and execute their plans.
Finance needs forecasts to project cash flows and capital

requirements.
Human resources need forecasts to anticipate hiring needs.
Production needs forecasts to plan production levels, workforce,

material requirements, inventories, etc.
Importance of Forecasting in OM
• Demand is not the only variable of interest to

forecasters.
• Manufacturers also forecast worker absenteeism,
machine availability, material costs,
transportation and production lead times, etc.
• Besides demand, service providers are also
interested in forecasts of population, of other
demographic variables, of weather, etc.
What Makes a Good Forecast
• It should be timely
• It should be as accurate as possible
• It should be reliable
• It should be in meaningful units
• It should be presented in writing
• The method should be easy to use and understand in most
cases.
– Ease of updating as new data becomes available.

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?
Forecast Horizons in Operation Planning

Demand Forecasting

Why is demand 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
How should we pick our forecasting model?
1. Data availability
2. Time horizon for the forecast
3. Required accuracy
4. Required Resources

Characteristics of Forecasts
1. Forecasts are normally wrong since it is an approximation of demand

estimates in the future.
2. A good forecast has more than a single number, as it includes
 A mean value and standard deviation
 An accuracy range (high and low)
3. Aggregated forecasts are usually more accurate because it can adjust the
variation in actual demand of individual products.
4. Accuracy erodes as we go further into the future because the increase in time
horizon increases the uncertainty in demand pattern.
5. Forecasts should not be used to the exclusion of known information.
Forecasting Horizons
 Short-range forecast Quantitative
Usually < 3 months methods
Detailed use of
Job scheduling, worker assignments system
 Medium-range forecast
3 months to 2 years
Sales/production planning
 Long-range forecast
Design of
> 2 years Qualitative
system
New product planning Methods

Steps of Forecasting
1. Determination of objectives of forecasting

2. Selection of the items to be forecast
3. Determination of the time horizon of the forecast
4. Selection of the suitable forecasting model
5. Collection of the data
6. Validation of the forecasting model
7. Forecasting the demand
8. Implementation of the results.
Types of Forecasting Models
• Types of Forecasts
– Qualitative --- based on experience, judgment, knowledge;
– Quantitative --- based on data, statistics;
• Methods of Forecasting
– Formal Methods --- systematically reduce forecasting errors;
• time series models (e.g. exponential smoothing);
• causal models (e.g. regression).
– Focus here on Time Series Models
• Assumptions of Time Series Models
– There is information about the past;
– This information can be quantified in the form of data;
– The pattern of the past will continue into the future.
Forecasting methods
Forecasting methods are divided into two categories:

 Qualitative forecasting
 Quantitative forecasting

Types of forecasting methods
Quantitative methods
Qualitative methods
Rely on subjective opinions Rely on data and analytical

from one or more experts. techniques.

Qualitative Forecasting
• Qualitative forecasting is an estimation methodology that uses expert judgment,

rather than numerical analysis.
• This type of forecasting relies upon the knowledge of highly experienced

employees and consultants to provide insights into future outcomes.
• This approach is substantially different from quantitative forecasting, where

historical data is compiled and analysed to discern future trends.

• Qualitative forecasting is most useful in situations where it is suspected that

future results will depart markedly from results in prior periods, and which
therefore cannot be predicted by quantitative means.
• For example, the historical trend in sales may indicate that sales will increase
again in the next year, which would normally be measured using trend line
analysis; however, an industry expert points out that there will be a materials
shortage at a key supplier that will force sales downward.

• Another situation in which qualitative forecasting can be useful is in the

assimilation of large amounts of narrowly-focused local data to discern trends
that a more quantitative analysis might not find.
• For example, a construction company needs to know what style of home to build
in a certain area, and relies on a local population expert to find out that the area in
question is being abandoned by younger families and replaced by an older,
retirement-age group. Consequently, the builder constructs smaller one-level
homes with fewer bedrooms.

• This approach also works well when a course of action must be derived from
inadequate data. In this case, a qualitative analysis will seek to link disparate data
to construct a more broad-based view, sometimes incorporating intuition to
construct this view.

Executive committee
consensus
Delphi method
Survey of sales force
Expert evaluation
technique

Executive Judgment: Opinion of a group of high level experts or managers is pooled
Sales Force Composite: Each regional salesperson provides his/her sales estimates.
Those forecasts are then reviewed to make sure they are realistic. All regional forecasts
are then pooled at the district and national levels to obtain an overall forecast.
Market Research/Survey: Solicits input from customers pertaining to their future

purchasing plans. It involves the use of questionnaires, consumer panels and tests of new
products and services.
Delphi Method: As opposed to regular panels where the individuals involved are in
direct communication, this method eliminates the effects of group potential dominance
of the most vocal members. The group involves individuals from inside as well as
outside the organization.
Typically, the procedure consists of the following steps:

• Each expert in the group makes his/her own forecasts in form of
statements
• The coordinator collects all group statements and summarizes them
• The coordinator provides this summary and gives another set of questions
to each group member including feedback as to the input of other experts.
• The above steps are repeated until a consensus is reached.
Advantages of qualitative forecasting
• Ability to predict changes in sales patterns

• Allow decision makers to incorporate rich data sources consisting of their intuition,
experience and expert judgement.

Disadvantages of qualitative forecasting
• Ability to forecast accurately suffers due to;

• Considers only readily available and/or recently perceived information
• Unable to process large amounts of complex information
• Overconfident about their ability to forecast
• Political factors
• Infer relationships or patterns in data
• Influenced by other previous forecasts

Quantitative Forecasting
A statistical technique for making projections about the future which uses numerical
facts and prior experience to predict upcoming events.
The two main types of quantitative forecasting used by business analysts are;
• Time series method that uses past trends to make forecasts.
• Explanatory method that attempts to correlate two or more variables

Quantitative Forecasting
Quantitative
Forecasting
Time Series Causal

Models Models
Moving Exponential Trend Regression

Average Smoothing Models

What is a Time Series ?
Time series data is a sequence of observations.

Time series is dynamic, it does change over time
Set of evenly spaced numerical data obtained by observing response variable at
regular time periods
Forecast based only on past values, assumes that factors influencing past, present
and future will continue
Example
Year: 2013 2014 2015 2016 2017
Sales: 78.7 63.5 89.7 93.2 92.1
Time Series Components
Trend Cyclical
Seasonal Irregular
Trend Component
Persistent, overall upward or downward pattern

Due to population, technology etc.
Data taken over a period of years

Cyclical Component
Repeating up and down movements/swings

Due to interactions of factors influencing economy
Usually 2-10 years duration
May Vary in Length

Seasonal Component
Regular pattern of up and down fluctuations/swings

Due to weather, customs etc.
Occurs within one year

Irregular Component
Erratic, unsystematic, ‘residual’ fluctuations

Due to random variation or unforeseen events
• Union strike
• War
Short duration and nonrepeating

Time series forecasting
Time Series
NO YES
Trend
Smoothing methods Trend models
?
Moving average Exponential Smoothing
Linear Quadratic Exponential Autoregressive

Plotting time series data

Time Series
NO YES
Trend
?

Measures of Forecast Accuracy
Dt = Demand for the period t
Ft = Forecast demand for the period t and
Then, Forecast error for the period t , (et) = ?
et = Dt - Ft

Mean Squared Error (MSE)
• The average of the squared forecast errors for the historical data is calculated.
• The forecasting method or parameter(s) which minimize this mean squared error
is then selected.
n
 (D t  Ft ) 2
MSE  i 1
n = Number of time period used

Mean Absolute Deviation (MAD)
• The mean of the absolute values of all forecast errors is calculated, and the
forecasting method or parameter(s) which minimize this measure is selected.
• The mean absolute deviation measure is less sensitive to individual large forecast
errors than the mean squared error measure.
𝑛
𝑖=1 𝐷𝑡 − 𝐹𝑡
𝑀𝐴𝐷 =
𝑛

Mean Absolute Percentage Error (MAPE)
• It is the mean of the percentage deviations of the forecast demands from the actual
demands
1 n Dt  Ft
MAPE   x100
n i 1 Dt

Mean Forecast Error (MFE)
• It is the mean of the deviations of the forecast demands from the actual demands
𝑛
𝑡=1 𝐷𝑡 − 𝐹𝑡
𝑀𝐹𝐸 =
𝑛
n = Number of years (time period used)

Naïve Method
Number of periods used for smoothing is 1.
The forecast for a period t, is simply the observed value of the previous period, t-1.
It can only be used to forecast up to one period in the future
Used only for its simplicity

Simple Moving Average Method (SMAM)
1
𝐹𝑡+1 = 𝐷𝑡 + 𝐷𝑡−1 + ⋯ + 𝐷𝑡+1−𝑛
𝑛
𝑡
1
𝐹𝑡+1 = 𝐷𝑖 𝐷
𝑛
𝑖=𝑡+1−𝑛
t = Current period
t+1 = Forecast period
F = Forecast
Dt = Actual demand in period t
n= Number of the averaging period

The monthly demands for an office furniture (in units) are given in Table below.
Forecast the demand using 3-period .
Month
1 2 3 4 5 6 7 8 9 10 11 12
(t)
Demand
600 628 670 735 809 870 800 708 842 870 739 -
(Dt)

1
𝐹𝑡+1 = 𝐷𝑡 + 𝐷𝑡−1 + ⋯ + 𝐷𝑡+1−𝑛
𝑛
𝑡
1
𝐹𝑡+1 = 𝐷𝑖 𝐷
𝑛
𝑖=𝑡+1−𝑛
t = Current period
F = Forecast
Dt = Actual demand in period t
n= Number of the averaging period

Time Demand for month Moving Average
(month (t)) (Dt) M(t)
1 600
2 628
3 670
4 735 633 Three period moving average t = 3
5 809 678 1
𝐹𝑡+1 = 𝐷 + 𝐷𝑡−1 + ⋯
6 870 738 𝑛 𝑡
+ 𝐷𝑡+1−𝑛
7 800 805
8 708 826 1
9 842 793 𝐹3+1 = 600 + 628 + 670
3
10 870 783
11 739 807 𝐹4 = 632.66 ≈ 633
12 - 817
Double Moving Average Method (DMAM)
Just repeat simple moving average method again….

Forecast the demand for 3-periods using double moving average method.
Month
1 2 3 4 5 6 7 8 9 10 11 12
(t)
Demand
600 628 670 735 809 870 800 708 842 870 739 -
(Dt)

Double Moving
Time Demand for Moving Average
Average M(t)
(month (t)) month (Dt) M(t)
Three period moving average t = 3
1 600 1
2 628 𝐹𝑡+1 = 𝐷 + 𝐷𝑡−1 + ⋯
𝑛 𝑡
3 670 + 𝐷𝑡+1−𝑛
4 735 633
5 809 678 1
𝐹6+1 = 633 + 678 + 738
6 870 738 3
7 800 805 683 𝐹7 = 683
8 708 826 741
9 842 793 790
10 870 783 808
11 739 807 801
12 - 817 795
Weighted Moving Average Method (WMAM)
𝐹𝑡+1 = 𝑊1 𝐷𝑡 + 𝑊2 𝐷𝑡−1 … … . . +𝑊𝑛 𝐷𝑡+1−𝑛
𝑊1 > 𝑊2 >. . . . > 𝑊𝑛

t = Current period
F = Forecast
Wt = Weight applied to period t
n= Total number of periods
Largest weight = More recent period…………..Lowest weight = Last period

Forecast the demand using 3-period WMAM.
The most recent data should be given 50 percent weightage, second year past data,
30 percent, and third year past data, 20 percent.
Month
1 2 3 4 5 6 7 8 9 10 11 12
(t)
Demand
600 628 670 735 809 870 800 708 842 870 739 -
(Dt)

𝐹𝑡+1 = 𝑊1 𝐷𝑡 + 𝑊2 𝐷𝑡−1 … … . . +𝑊𝑛 𝐷𝑡+1−𝑛
𝑊1 > 𝑊2 >. . . . > 𝑊𝑛
𝑊1 = 0.5 > 𝑊2 = 0.3 > 𝑊3 = 0.2

t = Current period
F = Forecast
Wt = Weight applied to period t
n= Total number of periods = 3
Largest weight = More recent period…………..Lowest weight = Last period
Time in Weighted Moving Three period moving average t = 3
Deamnd (Dt)
months (t) Average M(t) 𝐹𝑡+1
1 600 = 𝑊1 𝐷𝑡
2 628 + 𝑊2 𝐷𝑡−1 … … . . +𝑊𝑛 𝐷𝑡+1−𝑛
3 670
𝑊1 > 𝑊2 >. . . . > 𝑊𝑛
4 735 643
5 809 694 𝑊1 = 0.5 > 𝑊2 = 0.3 > 𝑊3 = 0.2
6 870 759
7 800 825 𝐹3+1 = 0.5 × 670 + 0.3 × 628 +
8 708 823 0.2 × 600
9 842 768
𝐹4 = 643.4 ≈ 644
10 870 793
11 739 829
12 799
Summary of Moving Averages
• Advantages of Moving Average Method
– Easily understood
– Easily computed
– Provides stable forecasts
• Disadvantages of Moving Average Method
– Requires saving all past N data points
– Lags behind a trend
– Ignores complex relationships in data

Time Series
NO YES
Trend
?

Why use exponential smoothing?
1. Uses less storage space for data

2. Extremely accurate
3. Easy to understand
4. Little calculation complexity

Exponential Smoothing Method (ESM)
𝐹𝑡 = 𝐹𝑡−1 + 𝛼(𝐷𝑡−1 − 𝐹𝑡−1 )
Where
Ft = Smoothed average forecast for period t
Ft-1= Previous period forecast
α = Smoothing constant, weight given to previous data (0≤α≤1)
(Preferred range 0.1 to 0.3)
Dt-1=previous period demand

Forecast the demand for the periods using the exponential smoothing method ,
considering the Smoothing constant as, α = 0.3
Month
1 2 3 4 5 6 7 8 9 10 11 12
(t)
Demand
600 628 670 735 809 870 800 708 842 870 739 -
(Dt)

Time in
Demand (Dt) Forecast, Ft
months (t)
𝐹𝑡 = 𝐹𝑡−1 + 𝛼(𝐷𝑡−1 − 𝐹𝑡−1 )
1 600
2 628 600 ∝ = 0.3
3 670 608
𝐹2 = 600 + 0.3 600 − 600 = 600
4 735 627
5 809 659 𝐹3 = 600 + 0.3 628 − 600 = 608.4
6 870 704
7 800 754 𝐹4 = 608.4 + 0.3 670 − 608.4 = 626.8
8 708 768
9 842 750
10 870 777
11 739 805
12 785
Simple Linear Regression Method (SLRM)
Linear regression is based on
• Fitting a straight line to data

• Explaining the change in one variable through changes in other variables.
• In simple regression, only one independent variable is used, where as in multiple
regression two or more independent variables are involve
• By using linear regression, we are trying to explore which independent variables
affect the dependent variable
dependent variable d= a + b  (independent variable)

a=intercept, b=slope
• Identify dependent (y) and independent (x) variables
• Solve for the slope of the line
𝑥𝑦 − 𝑛 𝑦 𝑥
𝑏=
𝑥 2 − 𝑛 (𝑥 )2
• Solve for the y intercept

𝑎 = 𝑦 − 𝑏𝑥
• Develop your equation for the trend line
𝑦 = 𝑎 + 𝑏. 𝑥
Where,
a – a constant
b – a coefficient of variable x
𝑥 – mean value of x
𝑦 – mean value of y
x – is the time
y – demand
n – time period

The weekly demands of a motorcycle by a retailer are shown in Table. Find an

equation of the regression line and estimate the demand for the 14 th week.
Week (x) 1 2 3 4 5 6 7 8 9 10 11 12
Demand
420 450 460 420 500 550 480 520 610 570 600 590
(y)

Week (x) Demand (y) xy x2 𝑥𝑦 − 𝑛 𝑦 𝑥

𝑏=
𝑥 2 − 𝑛 (𝑥 )2
1 420 420 1
2 450 900 4 6170 78
42570 − 12 × ( )×( )
3 460 1380 9 𝑏= 12 12
650 − 12 × (78/12)2
4 420 1680 16
5 500 2500 25 𝑏 = 17.23
6 550 3300 36
7 480 3360 49 𝑎 = 𝑦 − 𝑏𝑥
8 520 4160 64
𝑎 = 514.1667 − 17.23 × 6.5 = 402.17
9 610 5490 81
10 570 5700 100 Therefore, the regression equation is
11 600 6600 121
12 590 7080 144 𝑦 = 402.17 + 17.23𝑥
∑x = 78 ∑y = 6170 ∑xy = 42570 ∑x = 650
2
𝑦14 = 402.17 + 17.23 × 14 = 643.39

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MEE1014

INDUSTRIAL ENGINEERING AND MANAGEMENT

Introduction to macro and micro economics:

7/30/2019 DrT Sampath Kumar, Associate Professor, SMEC-VIT 2

“Prediction is very difficult,

7/30/2019 DrT Sampath Kumar, Associate Professor, SMEC-VIT 4

7/30/2019 DrT Sampath Kumar, Associate Professor, SMEC-VIT 5

7/30/2019 DrT Sampath Kumar, Associate Professor, SMEC-VIT 6

Virtually every business attempt is based on forecasting. Not all

7/30/2019 DrT Sampath Kumar, Associate Professor, SMEC-VIT 7

Finance needs forecasts to project cash flows and capital

Human resources need forecasts to anticipate hiring needs.

Production needs forecasts to plan production levels, workforce,

• Demand is not the only variable of interest to

7/30/2019 DrT Sampath Kumar, Associate Professor, SMEC-VIT 10

7/30/2019 DrT Sampath Kumar, Associate Professor, SMEC-VIT 12

7/30/2019 DrT Sampath Kumar, Associate Professor, SMEC-VIT 13

Demand for products and services is usually uncertain.

7/30/2019 DrT Sampath Kumar, Associate Professor, SMEC-VIT 15

1. Forecasts are normally wrong since it is an approximation of demand

7/30/2019 DrT Sampath Kumar, Associate Professor, SMEC-VIT 17

1. Determination of objectives of forecasting

Forecasting methods are divided into two categories:

7/30/2019 DrT Sampath Kumar, Associate Professor, SMEC-VIT 20

Rely on subjective opinions Rely on data and analytical

7/30/2019 DrT Sampath Kumar, Associate Professor, SMEC-VIT 21

• Qualitative forecasting is an estimation methodology that uses expert judgment,

• This type of forecasting relies upon the knowledge of highly experienced

• This approach is substantially different from quantitative forecasting, where

7/30/2019 DrT Sampath Kumar, Associate Professor, SMEC-VIT 22

• Qualitative forecasting is most useful in situations where it is suspected that

7/30/2019 DrT Sampath Kumar, Associate Professor, SMEC-VIT 23

• Another situation in which qualitative forecasting can be useful is in the

7/30/2019 DrT Sampath Kumar, Associate Professor, SMEC-VIT 24

7/30/2019 DrT Sampath Kumar, Associate Professor, SMEC-VIT 25

Survey of sales force

7/30/2019 DrT Sampath Kumar, Associate Professor, SMEC-VIT 26

Executive Judgment: Opinion of a group of high level experts or managers is pooled

Market Research/Survey: Solicits input from customers pertaining to their future

Typically, the procedure consists of the following steps:

• Ability to predict changes in sales patterns

7/30/2019 DrT Sampath Kumar, Associate Professor, SMEC-VIT 29

• Ability to forecast accurately suffers due to;

7/30/2019 DrT Sampath Kumar, Associate Professor, SMEC-VIT 30

7/30/2019 DrT Sampath Kumar, Associate Professor, SMEC-VIT 31

Time Series Causal

Moving Exponential Trend Regression

7/30/2019 DrT Sampath Kumar, Associate Professor, SMEC-VIT 32

Time series data is a sequence of observations.

Persistent, overall upward or downward pattern

7/30/2019 DrT Sampath Kumar, Associate Professor, SMEC-VIT 35

Repeating up and down movements/swings

7/30/2019 DrT Sampath Kumar, Associate Professor, SMEC-VIT 36

Regular pattern of up and down fluctuations/swings

7/30/2019 DrT Sampath Kumar, Associate Professor, SMEC-VIT 37

Erratic, unsystematic, ‘residual’ fluctuations

7/30/2019 DrT Sampath Kumar, Associate Professor, SMEC-VIT 38

Moving average Exponential Smoothing

Linear Quadratic Exponential Autoregressive

7/30/2019 DrT Sampath Kumar, Associate Professor, SMEC-VIT 40

Moving average Exponential Smoothing

Linear Quadratic Exponential Autoregressive