OPC

FORECASTING TECHNIQUES

February 2022
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Introduction:
Forecasting is always very difficult, but some estimates
have to be made for future planning. We will try and
develop for applying the principles learnt earlier, to
real manufacturing problems.
Our approach is based on two premises:
1. Problems at different levels of the organization
require different levels of understanding, detailing,
modeling, assumptions, and planning frequency.
2. Planning and analysis tools must be consistent across
levels.
Unfortunately, above two approaches are somewhat
conflicting with each other.
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To develop suitable planning methods, following steps
are suggested :
1. Divide the overall system appropriately. Different
methods for different parts of the process, different
product categories, different time horizons, can be
used. The purpose is to divide them in manageable,
sections that permit integration.
2. Identify links between the divisions. For example, if
production plans for two products with a shared work
center are made separately, they should be integrated
via the capacity of the shared process.
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3. If we use different methods to plan production
requirements over various time horizons, we should
integrate them with regard to major assumptions about
capacity, product mix, manpower, etc.
4. All analysis, planning, and control and system runs,
we should continually update various parameters
pertaining to; plant/line capacity, machine speeds,
yields; demand, and many others, and properly
coordinate and aggregate this information, rather than
allow the inputs to be estimated in an ad hoc and
uncoordinated manner. Use multiple iterations as may
be required.
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Disaggregation :
The first step in developing a planning structure is to
break down the various decision problems into
manageable subproblems. This can be done explicitly,
through the development of a formal planning hierarchy,
or it can be done implicitly by addressing the various
decisions and assumptions for different models.
In any situation, some form of disaggregation has to be
done, since all real-world production systems are too
complex and can not be explained with a single model.
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Time Schedules:
Perhaps the most important dimensions for
disaggregation is that of time frame. The manufacturing
decisions differ greatly with regard to the length of time
over which their consequences persist.
For example, the construction of a new plant will affect a
firm's position for years or even decades, while the
effects of selecting a particular part to work on at a
particular workstation may have very short term
implications. Therefore, it is important to make use of
different planning horizons in the decision-making
process.
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These issues bring in the concept of futuristic

technological changes expected, their implications for
the company and issues of flexibility desired in the
system and what are the options available.
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The planning horizon varies across different type of
industries. Some industries, for example oil and
satellite communications, routinely make use of long
horizons, because the consequences of their business
decisions persist rather long.
Within most companies, long time horizons are
generally used at the corporate office, which is
responsible for long-range planning.
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However, at the plant level, only day-to-day execution
decisions are made. Our focus will be on decisions
relevant to running a plant.
Therefore, we divide the planning horizon into long,
intermediate, and short terms. At the plant level, long
term planning horizon is usually one to two years. An
intermediate planning period can be one or two
months or even up to a year. A short time horizon can
be from an hour to a day or a week or a month.
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Other Aspects of Disaggregation
In addition to time, there are other dimensions along
which the production planning and control problem is
typically broken down. Because modern factories are
large and complex, it is quite often difficult to consider
the plant as a whole whilst making specific decisions.
The following are three dimensions that can be used to
break the plant into more manageable pieces for
analysis and management:
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Products :
Although plants dedicated to a single product exist (a
forging plant, casting plant, plastic product plant),
many plants today make multiple products.
For example, in automobile industry, it is quite
common to find a plant with 10,000 to 20,000 distinct
part numbers, counting all finished products and
components. Because of difficulty, to consider part
numbers individually, many manufacturing plants
aggregate part numbers into major sub assemblies
categories for planning and management purposes.
Some units are specialising only in Design and
Assembly.
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Processes :
Traditionally, most plants were organized according to
manufacturing process requirements, like casting,
turning, milling, grinding, boring, drilling, and heat
treatment etc., often called job shop approach.
Now such process organisation have become less popular
due to JIT revolution, with flow-oriented cellular layouts.
However, process divisions are necessary and still exist.
For example, forging, casting or press operations are very
different, and sometimes physically distant, from rolling
in a steel mill.
With different processes, we need to use different
planning, scheduling, and control procedures.
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People:
There are a host of ways that a factory's workforce
can be broken down:
labor versus management, union versus nonunion,
factory floor versus staff support, permanent versus
temporary, department wise; for example,
manufacturing, production control, engineering,
personnel, shift work, and so on. In a large plant, the
personnel organisation scheme can be almost as
complex as the machinery.
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COORDINATION:
In previous slides, we have suggested about
separating decision problems along the dimensions of
time, process, product, or people. For instance,
virtually every manufacturing operation in the world
does some sort of long, intermediate and short-range
decision making.
Basically, what distinguishes a good system from
others is not whether it makes such a breakdown, but
how well the resulting small problems are solved and,
how systematically they are coordinated with one
another, to achieve desired goals.
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The first real issue for coordination always is what parts

to make and what to buy and at what times ?
This is addressed at the long term, intermediate term
and at short-term levels.
For the long term, we need to plan for rough cut
capacity and product mix in order to plan for capacity
and manpower.
For the intermediate term, we need to develop a more
detailed production plan, in order to set up supply chain
for materials, select specific vendors, and negotiate
supply contracts.
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For the short term, we need to prepare and execute a
detailed work schedule that controls what happens
today, tomorrow and this month at each work station.
The core essence of all three problems is the same; but
the time frame is different. Therefore, it is essential that
the decisions made at the three different levels should
be consistent, at least in expectation, with one another.
As one might expect, this is easier said than done.
Among the western world, ERP of course provides a very
good solution to above issues. And for the Japanese,
practice of JIT concepts along with suitable ERP system
provides a right solution.
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We are all planning and thinking for tomorrow, and
future. Therefore, the starting point of almost all
planning systems, including production planning
systems is forecasting.
But since no one can predict the future, the only way is
to make best use of whatever information is available
in the present to predict for the future.
Obviously, dependence on the future is not unique to
manufacturing. It influences all decisions or plans
made for future. Even the long term plans of all
Governments world over are dependent on future
forecasts.
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Since there are many different approaches one can
make use of to predict for the future, forecasting is a
large and varied field. One basic distinction is between
methods of
1. Qualitative forecasting
2. Quantitative forecasting
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Qualitative forecasting methods try to develop likely
future scenarios by using the expert knowledge of
people, rather than any mathematical models. One
structured method for obtaining forecasts from experts
is Delphi.
In Delphi method, experts are queried about some
future subject, for instance, the likely introduction date
of a new technology, say hydrogen cell vehicles. This is
usually done in written form, but can be done orally.
The responses are tabulated and returned to the panel
of experts, who reconsider and respond again, to the
original and possibly some new questions as well.
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The process can be repeated several times, until
consensus is reached or the respondents have
stabilized in their answers. Delphi and techniques
like it are useful for long-term forecasting where the
future depends on the past in very complex ways.
Technological forecasts, where predicting highly
uncertain breakthroughs is at the core of the
exercise, frequently use this type of approach.
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Quantitative forecasting methods are based on the

belief that the future can be predicted by applying
analytical methods on the past data in some kind of
mathematical model. There are two types of
quantitative forecasting models:
1. Causal models that predict a future parameter as a
function of other parameters, for example, demand for
a product like vehicles or housing to; as a function of
interest rates, or growth in GNP linked to new
infra/housing projects.
2. Time series models that predict a future parameter
for example demand for a product, as a function of past
values of that parameter, the historical demand, trends,
seasonality etc.
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For discussion purposes, we will restrict our focus only
to those techniques that have the greatest relevance to
operations management. This is so, because operational
decisions are mainly concerned with problems having
short planning horizons of less than two years.
For long-term, there are techniques available of
qualitative forecasting, but these are not widely used in
operations management.
It is further observed that time series models are simple
to use and have direct association with the commonly
used production control modules. Therefore, we will
mainly focus our attention to these.
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Before proceeding further, we must note the following
well-known rules of forecasting:
First Rule : Forecasts are usually wrong!
Second Rule : Detailed forecasts are worse than
aggregate forecasts!
Third Rule : The further into the future, the less reliable
the forecast will be!
No matter how qualified the experts are or how good
is the model, perfect prediction of the future is simply
not possible.
As per the concept of variability pooling, an aggregate
forecast , say of a product family, will show less
variability than a detailed forecast, for an individual
product.
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The more we look in the future, more is uncertainty

and possibility for qualitative changes, technology
advancements, new discovery or the competition
introduces and starts marketing an important new
product, which can completely change whatever
forecasting approach we may have used.
This does not or should not mean that we should give
up the idea of forecasting. On the other hand, the
entire concept of a planning process is based on good
forecasting techniques.
There is simply no other way to make decisions about
how much capacity to plan for, how big a workforce to
plan for, or how much inventory to keep without some
estimate of figures for future demand.
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But since our forecasts are best estimates only, we

should strive to make these decisions as favourable as
possible with respect to variability in the forecast.
For example, we plan using flexible equipment and
plant layouts that can accommodate new products, use
multi skilled manpower and this approach is
sometimes referred to as ‘agile manufacturing’, can
reduce the consequences of forecasting errors.
Japanese have already adapted many of these practices
as part of their lean manufacturing initiatives.
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In a causal forecast, we attempt to explain the behavior

of an uncertain future parameter in terms of other,
observable or at least more predictable, parameters.
The most commonly used model is the simple linear
model, of the form

where Y represents the parameter to be predicted say

demand and the Xi variables are the predictive
parameters say, population, economic situation etc. The
bi values are constants that can be statistically
estimated from data.
This technique for fitting a function to data is called
regression analysis.
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Let us consider example of a fast food chain.
A fast food chain management wanted to set up a new
location for an outlet. The top Management was of the
view that success of location depends on the number
of orders received; and this depends on the population
within 5 km radius of the location. Analysts collected
the data of 12 locations where the Company already
had outlets. This is given on next slide. The data gives
population in thousand numbers vs Sales in lakhs of Rs.
To develop a model for predicting sales based on the
population within 5 km radius of the location, a tool for
best fit selection of given data was developed based on
“Regression Analysis”.
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A straight line for best fit was drawn based on least

square method under Regression Analysis ;
For each observation Y can be described by model
Y = a0 + a1 x + e
or
Y = b0 + b 1 x + e
or
Y =mx+c+e
Standard equation for a straight line, with slope m and
intercept c, and error function e.
SIMPLE LINEAR REGRESSION contd…
For each observation Y can be described by
model
Y = b0 + b1 x + e
Where, e is random error with mean = 0, and
variance s2.
Both these quantities are not known.

Now, b0 and b1 should result in a best fit line.

This is a simple linear regression model, since
there is only one independent variable or
regressor.
SIMPLE LINEAR REGRESSION contd…

Karl Gauss 1777-1855, proposed estimating

b0 and b1 , based on least square method.

That is minimise the

sum of squares in the
vertical deviation,
in the attached figure.
 LEAST SQUARE REGRESSION METHOD
Therefore,
Yi = b0 + b1 xi + ei , where i = 1,2,3,......n

Sum of least squares

LEAST SQUARE REGRESSION METHOD contd…
To minimise L in above equations, and to find
values of b0 and b1,
we find partial derivatives with respect to b0
and b1.
LEAST SQUARE REGRESSION METHOD contd…
Simplifying above equations, we get;

These equations are called least squares

normal equations.
Solution to above equations results in least
square estimates for b0 and b1 Suffix ‘s’
represents least square values.
LEAST SQUARE REGRESSION METHOD contd…
Simplifying above equations further, we get;
LEAST SQUARE REGRESSION METHOD contd…
For the purpose of simplifying calculations, the
numerator Sxx and denominator Sxy are defined
as below;
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Now we apply this method to our forecast method
model analysis for the fast food chain.
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Now to use this method for forecasting, we can
interpolate Sales forecast ( Y ) for any given population
in the Area ( X ).
For example, for X = 40, (40,000 population), the
estimated corresponding Sales is Rs 217 Lakhs, and for
X = 100,000, the estimated corresponding Sales is Rs
467 Lakhs.
This model appears to give a reasonable estimate,
provided the required estimate of population is with in
15,000 and 110,000 numbers.
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Since we used only one parameter for estimation, above

is called a simple regression model. If we use more
parameters, then in a similar approach, we go for
multiple regression model. General equation can be
given by;

where Y represents the parameter to be predicted say

demand and the Xi variables are the predictive
parameters say, population, economic situation etc.
The bi values are constants that can be statistically
estimated from data.
 R
SIMPLE LINEAR REGRESSION contd… E
P
E
Karl Gauss 1777-1855, proposed estimating A
b0 and b1 , based on least square method. T

S
That is minimise the L
I
sum of squares in the D
vertical deviation, E
in the attached figure.

Y = b0 + b1 x + e
Simple Linear Regression Contd….
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Time Series Forecasting :
In many situations, past results can be used as an
indicator of future behaviour, but where a cause and
effect relationship is not available. In such situations, a
time series model can be used.
Future Demand for most products can be predicted
based on this methodology, and therefore demand
forecasting is one of the most common applications of
this technique.
In most cases, demand can be expressed as a function
of some factors as brand image, advertisement strategy,
customer appeal, marketing effectiveness, and
competing products.
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Although most of these factors are difficult to model
explicitly, but they do have a history over time, and so
past data of demand is often a good predictor of
future demand. What time series models do is to try to
capture past trends and extrapolate them into the
future.
There are many different time series models, but the
basic procedure is the same for all. We treat time in
periods, could be months, or years on X-axis, as i = 1,2,
... , t, where period t is the most recent data. We
denote the actual observations by A(i) on Y-axis and
let the forecasts for periods t + t, t = 1,2, ... , be
represented by (t +t).
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As shown in above Figure, a time series model takes as

input the actual past observations A(i), i = 1, ... , t, A(i)
which could represent demand in month i, where t
represents the most recent month for which data are
available and generates predictions for the future
values (t +t), t = 1,2, ..., (t +t) can represents the
forecasted demand for month t + t, which is t months
into the future.
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Some models, compute a smoothed estimate F (t),

which represents an estimate of the current
position of the process under consideration, and a
smoothed trend T (t), which represents an estimate
of the current trend of the process.
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Moving Average Forecast :

One of the simplest way to convert actual observations
to forecasts is to simply average them. In doing this, we
are assuming that there is no trend, so that T(t) = 0, for
all t.
We then compute the smoothed estimate as the simple
average and use this average for all future forecasts,

The problem with this approach is that it gives all past

data equal weight regardless of their age.
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To give more weight to recent data, which is more
representative of future outcomes, all time series
models contain a method for discounting old data.
The simplest method for doing this is to discard the
data beyond some point in the past.
This approach is called the moving-average method.
The approach is same as the simple average except
that only the most recent m data points, where m is
selected by the user, are considered for taking the
average.
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Again, the trend is assumed to be zero, so T(t) = 0, and

all future forecasts beyond the present are assumed
to be equal to the current smoothed estimate.

It should be noted that selection of m will make a

difference in how moving average performs.

This is elaborated with an example.

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CONCLUSIONS :
We can compare from the chart above, the difference
in values when m=3, and when m=5. Actual results are
better when m=3, because more weight is given to
recent values and therefore, trend is considered.
Based on above example, following conclusions can be
drawn;
1. Higher value of m will make model more stable,
but less responsive to change in forecast values.
2. The parameters with increasing trend are
underestimated and the parameters with
decreasing trend are overestimated
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EXPONENTIAL SMOOTHENING:
The problem with moving average forecast is that it
gives all past m data equal weight, and zero weight to
previous data.
A simple way is to discount old data points is to
average the current smoothed estimate with the most
recent data point. As per mathematical algorithm, the
older data points, will get lesser weight in determining
forecast. This is called exponential smoothening.
We assume the trend as zero, so T(t) =0. Then we
calculate smoothed estimate and forecast at time ‘t’ as:

where a is a smoothening constant between 0 and 1.

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EXPONENTIAL SMOOTHENING:
To initialise, we start with historical data F(1) = A(1) =10.
At time t=1, our forecast for period 2 and beyond is
f(2)=F(1) = 10. When we reach period 2, we observe
A(2)=12. Our updated smoothed estimate becomes,
for a =0.2;

Calculations are made again for a =0.6; and comparison

of results is given below:
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As can be observed from above, that when we select
a=0.6, instead of a=0.2, the forecast is more sensitive to
new data point, simply because a has highest influence
on the most recent data point.
The increased sensitivity is desirable, if it is tracking a
trend. But otherwise, it can give over responsive results
for one off unusual observation.
Based on above example, following conclusions can be
drawn;
1. Lower value of a will make model more stable, but
less responsive to changes in process being forecast.
2. The parameters with increasing trend are
underestimated and the parameters with decreasing
trend are overestimated
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As can be observed from above, the selection of a has

to be made judiciously, based on actual data and trend.
It is like selection of m in moving average forecast.
Often trial and error method can be adopted with
different values of a, to get the best fit.
One can observe that a=0.6 gives forecast estimates
that are closer to actual data than with a=0.2.
As can be observed selection of a high value of a=0.6,
makes the forecast more sensitive to an increasing
trend, but a single exponential value, can not assume
or track the trend, since in both cases, forecasts are
lagging the actual values.
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Rewriting in abridged format,

By substitution, we get,
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Adjusting Forecasting Parameters:
We have discussed two time series models, namely;
•Moving Average, and
•Exponential Smoothening.
Both models consider selection of some constants, like m
in Moving Average, and a in Exponential Smoothening,
These constants must be tuned and adjusted to in any
forecasting situation.
The question arises, how do we select these coefficients?
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The first step is to study the data to understand if it is
showing a trend, and whether it can be forecasted at
all?
Once we select a model, we review the forecasted data
with different coefficient combinations to finalise
optimum value for selection.
In order to be more objective in our selection, we
define three parameters to measure accuracy of the
selected model.
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The most common quantitative measures for
comparing the forecasting models are;
Mean Absolute Deviation, defined as :

Mean Square Deviation, defined as :

Bias, defined as :
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Since MAD and MSD are always positive, idea is to
select coefficients in a manner that makes them as
small as possible.
The BIAS can be positive, depending upon whether the
forecast data tends to over estimate the actual data or
negative, depending upon whether the forecast data
tends to under estimate the actual data. Here, the idea
is to select coefficients in a manner that makes them as
close to zero as possible. It should be noted that zero
only means that sum of values above and below are
equal, but does not give any idea about variability of
data.
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Let us take example of Exponential Smoothening a
varying from 0.1 to 0.95 .
From the table, it seems that for the given set of values,
with a= 0.75 to 0.8 gives minimum value of MAD and
MSD, but value of BIAS is continuously decreasing.
It should be noted that it is not always possible to get
coefficients that give best results for all three
parameters.
It should also be noted that data analysis in table is for
the given specific case only.
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Exponential Smoothening a varying from 0.1 to 0.95 .

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From the table, it seems that with a= 0.75 and 0.8 gives
minimum value of MAD and MSD.
However, with help of computers, we can calculate the
value of a, which gives better results.
So far we have discussed forecast for next time period.
That is t=1. In many cases we have to go beyond this
period for forward planning purposes. We can follow a
similar approach to plan for t=3 or 4 periods or even
beyond.
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We have discussed some important tools for forecasting,
like regression analysis and time series model based
forecasting. There are many other tools for forecasting,
based on similar concepts.
In conclusion, forecasting is an art of selecting appropriate
tool and then using trial and error methods to get the best
results in a given situation.
There are many other unexpected situations that arise,
due to which the planner has to first use the quantitative
tools and then override them. It could be due to sudden
unexpected situation of competition or another example
is the recent Pandemic situation we all passed through in
Mar./April 2020, in April 2021 and now again in Jan 2022 .
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