Bozarth ch09

Forecasting
Why Forecast?
Assess long-term capacity needs
Develop budgets, hiring plans, etc.

Plan production or order materials Get agreement within firm and across supply chain partners
2006 Pearson Prentice Hall Introduction to Operations and Supply Chain Management Bozarth & Handfield
Chapter 9, Slide 2
Forecast Characteristics
Almost always wrong by some amount More accurate for groups or families More accurate for shorter time periods No substitute for calculated demand.
Chapter 9, Slide 3
Forecasting Approaches
Qualitative Methods
Used when situation is vague and little data exists
New products New technology
Quantitative Methods
Used when situation is stable and historical data exists
Existing products Current technology
Involves intuition, experience

***************************** E.g., forecasting sales to a new market
Heavy use of mathematical techniques ******************************* E.g., forecasting sales of a mature product
Chapter 9, Slide 4
Q2 Forecasting
Quantitative, then qualitative factors to filter the answer
Chapter 10, Slide 5
Qualitative Forecasting
Executive opinions
Sales force composite

Consumer surveys
Outside opinions
Delphi method
Chapter 9, Slide 6
Demand Forecasting
Basic time series models
Linear regression
For time series or causal modeling
Measuring forecast accuracy Mini-case: Northcutt Bikes (A)

Chapter 9, Slide 7
Time Series Models

Period 1 2 3 4 5 6 7 8 Demand 12 15 11 9 10 8 14 12
What assumptions must we make to use this data to forecast?
Chapter 9, Slide 8
Time Series Components of Demand . . .

Demand
. . . randomness
Time
Chapter 9, Slide 9
Time Series with . . .

Demand
. . . randomness and trend
Time
Chapter 9, Slide 10
Time series with . . .

Demand
. . . randomness, trend and seasonality
May
May
May
May
Chapter 9, Slide 11
Idea Behind Time Series Models

Distinguish between random fluctuations and true changes in underlying demand patterns.
Chapter 10, Slide 12
Moving Average Models

Period 1 2 3 4 5 6 7 8 Demand 12 15 11 9 10 8 14 12
Ft 1
i 1
Dt 1i
n
(14 + 8 + 10) / 3 10.67
Chapter 9, Slide 13
3-period moving average forecast for Period 8:
= =
Weighted Moving Averages

Ft 1 i 1
Wt 1i Dt 1i
i 1 n
Wt 1i
Forecast for Period 8 = [(0.5 14) + (0.3 8) + (0.2 10)] / (0.5 + 0.3 + 0.1) = 11.4
What are the advantages? What do the weights add up to? Could we use different weights? Compare with a simple 3-period moving average.
Chapter 9, Slide 14
Table of Forecasts and Demand Values . . .

Period
1 2 3 4 5 6 Actual Demand 12 15 11 9 10 8 13.5 13 10 9.5 12.4 10.8 9.9 Two-Period Moving Average Forecast Three-Period Weighted Moving Average Forecast Weights = 0.5, 0.3, 0.2
7
8 9
14
12
9
11 13
8.8
11.4 11.8
Chapter 9, Slide 15
. . . and Resulting Graph

20 15 Demand 2-Period Avg 3-Period Wt. Avg.
Volume
10 5 0 1 2 3 4 5 Period 6 7 8 9
Note how the forecasts smooth out variations

Chapter 9, Slide 16
Exponential Smoothing I
Sophisticated weight averaging model Needs only three numbers: Ft Dt
= Forecast for the current period t = Actual demand for the current period t = Weight between 0 and 1
Chapter 9, Slide 17
Exponential Smoothing II
Formula
Ft+1 = Ft + a (Dt Ft) = a Dt + (1 a) Ft

Where did the current forecast come from? What happens as a gets closer to 0 or 1? Where does the very first forecast come from?
Chapter 9, Slide 18
Exponential Smoothing Forecast with a = 0.3

Period 1 Actual Demand 12 Exponential Smoothing Forecast 11.00
2
3 4 5
15
11 9 10
11.30
12.41 11.99 11.09
F2 = 0.312 + 0.711 = 3.6 + 7.7 = 11.3
6
7 8 9
8
14 12
10.76
9.93 11.15 11.41
F3 = 0.315 + 0.711.3 = 12.41
Chapter 9, Slide 19
Resulting Graph
16 14 12 10 8 6 4 2 0 1 2 3 4 5 6 7 8 9 Period
Demand
Demand Forecast
Chapter 9, Slide 20
Trends
What do you think will happen to a moving average or exponential smoothing model when there is a trend in the data?
Chapter 10, Slide 21
Same Exponential Smoothing Model as Before:

Period
1 2 3 4 5 6 7
Actual Demand
11 12 13 14 15 16 17
Exponential Smoothing Forecast

11.00 11.00 11.30 11.81 12.47 13.23 14.06
Since the model is based on historical demand, it always lags the obvious upward trend
Chapter 9, Slide 22
8
9
18
14.94
15.86
Adjusting Exponential Smoothing for Trend

Add trend factor and adjust using exponential smoothing Needs only two more numbers: Tt = Trend factor for the current period t = Weight between 0 and 1 Then: Tt+1 = (Ft+1 Ft) + (1 ) Tt And the Ft+1 adjusted for trend is = Ft+1 + Tt+1
Chapter 9, Slide 23
Simple Linear Regression

Time series OR causal model Assumes a linear relationship:
y
y = a + b(x)
x
Chapter 9, Slide 24
Definitions
Y = a + b(X) Y = predicted variable (i.e., demand)
X = predictor variable
X can be the time period or some other type of variable (examples?)
Chapter 9, Slide 25
The Trick is Determining a and b:

xi y i
n 2 n
( x i )( y i
i 1 i 1
i 1
i 1
xi
n n 2 ( xi )
i 1
a y bx
Chapter 9, Slide 26
Example:
Regression Used for Time Series
Period (X) 1 2 3 4
Demand (Y) 110 190 320 410
X2 1 4 9 16
XY 110 380 960 1640
15 1520 5540 5 b 98 2 15 55 5 1520 15 a 98 10 5 5

Column Sums
Chapter 9, Slide 27
5
15
490
1520
25
55
2450
5540
Resulting Regression Model: Forecast = 10 + 98Period

600 500 400
300 200 100 0 1 2 3 X 4 5
Demand Regression
Chapter 9, Slide 28
Example:
Simplified Regression I
If we redefine the X values so that their sum adds up to zero, regression becomes much simpler
a now equals the average of the y values b simplifies to the sum of the xy products divided by the sum of the x2 values
Chapter 9, Slide 29
Example: Simplified Regression II

Period (X) 1 2 3 4 5 Period (X)' -2 -1 0 1 2 Demand (Y) 110 190 320 410 490 X2 4 1 0 1 4 XY -220 -190 0 410 980
0 1520 980 5 b 98 2 0 10 5 1520 0 a 98 304 5 5
1520
10
980
Chapter 9, Slide 30
Dealing with Seasonality

Quarter
Winter 02 Spring Summer Fall Winter 03 Spring Summer Fall
Period
1 2 3 4 5 6 7 8
Demand
80 240 300 440 400 720 700 880
Chapter 9, Slide 31
What Do You Notice?

Forecasted Demand = 18.57 + 108.57 x Period Actual Demand
80
240 300 440
Period
Winter 02
Spring Summer Fall
Regression Forecast
90
198.6 307.1 415.7
Forecast Error
-10
41.4 -7.1 24.3
1
2 3 4
Winter 03
Spring Summer Fall
5
6 7 8
400
720 700 880
524.3
632.9 741.4 850
-124.3
87.2 -41.4 30
Chapter 9, Slide 32
Regression picks up trend, but not seasonality effect

1000 800 600 400 200 0 1 2 3 4 5 6 7 8 Demand Forecast
Chapter 9, Slide 33
Calculating Seasonal Index: Winter Quarter

(Actual / Forecast) for Winter Quarters: Winter 02: Winter 03: (80 / 90) = 0.89 (400 / 524.3) = 0.76
Average of these two = 0.83 Interpret!
Chapter 9, Slide 34
Seasonally adjusted forecast model

For Winter Quarter [ 18.57 + 108.57Period ] 0.83 Or more generally:
[ 18.57 + 108.57 Period ] Seasonal Index
Chapter 9, Slide 35
Seasonally adjusted forecasts

Forecasted Demand = 18.57 + 108.57 x Period Seasonally Adjusted Forecast
Period
Actual Demand
Regression Forecast
Demand/ Forecast
Seasonal Index
Forecast Error
Winter 02
Spring Summer Fall Winter 03 Spring Summer Fall
1
2 3 4 5 6 7 8
80
240 300 440 400 720 700 880
90
198.6 307.1 415.7 524.3 632.9 741.4 850
0.89
1.21 0.98 1.06 0.76 1.14 0.94 1.04
0.83
1.17 0.96 1.05 0.83 1.17 0.96 1.05
74.33
232.97 294.98 435.19 433.02 742.42 712.13 889.84
5.67
7.03 5.02 4.81 -33.02 -22.42 -12.13 -9.84
Chapter 9, Slide 36
Would You Expect the Forecast Model to Perform This Well With Future Data?
1000 800 600 400 200 0 1 2 3 4 5 6 7 8 Demand forecast
Chapter 9, Slide 37
More Regression Models I

Non-linear models
Example: y = a + b ln(x)
Chapter 9, Slide 38
More Regression Models II

Multiple regression
More than one independent variable
y
y = a + b1 x + b2 z
x z
Chapter 9, Slide 39
Causal Models
Time series assume that demand is a function of time. This is not always true. 1. Pounds of BBQ eaten at party. 2. Dollars spent on drought relief. 3. Lumber sales. Linear regression can be used in these situations as well.
Chapter 9, Slide 40
Measuring Forecast Accuracy

How do we know:
If a forecast model is best? If a forecast model is still working? What types of errors a particular forecasting model is prone to make? Need measures of forecast accuracy
Chapter 9, Slide 41
Measures of Forecast Accuracy

Error = Actual demand Forecast or
Et = Dt Ft
Chapter 9, Slide 42
Mean Forecast Error (MFE)

For n time periods where we have actual demand and forecast values:
MFE
i 1
Ei ) n
Chapter 9, Slide 43
Mean Absolute Deviation (MAD)

For n time periods where we have actual demand and forecast values:
MAD
i 1
Ei n
Chapter 9, Slide 44
What does this tell us that MFE doesnt?

Example
Period Demand Forecast 3 4 5 6 7 8 11 9 10 8 14 12 13.5 13 10 9.5 9 11 Error -2.5 -4.0 0 -1.5 5.0 1.0 Absolute Error 2.5 4.0 0.0 1.5 5.0 1.0
What is the MFE? The MAD? Interpret!

Chapter 9, Slide 45
MFE and MAD: A Dartboard Analogy
Low MFE and MAD: The forecast errors are small and unbiased
Chapter 9, Slide 46
An Analogy (continued)
Low MFE, but high MAD: On average, the arrows hit the bulls eye (so much for averages!)
Chapter 9, Slide 47
An Analogy (concluded)
High MFE and MAD: The forecasts are inaccurate and biased
Chapter 9, Slide 48

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Bozarth ch09

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Forecasting

Develop budgets, hiring plans, etc.

Involves intuition, experience

Chapter 10, Slide 5

Sales force composite

Measuring forecast accuracy Mini-case: Northcutt Bikes (A)

Time Series Models

What assumptions must we make to use this data to forecast?

Time Series Components of Demand . . .

Time Series with . . .

. . . randomness and trend

Time series with . . .

. . . randomness, trend and seasonality

Idea Behind Time Series Models

Chapter 10, Slide 12

Moving Average Models

3-period moving average forecast for Period 8:

Weighted Moving Averages

Table of Forecasts and Demand Values . . .

. . . and Resulting Graph

Note how the forecasts smooth out variations

Ft+1 = Ft + a (Dt Ft) = a Dt + (1 a) Ft

Exponential Smoothing Forecast with a = 0.3

F2 = 0.312 + 0.711 = 3.6 + 7.7 = 11.3

F3 = 0.315 + 0.711.3 = 12.41

Chapter 10, Slide 21

Same Exponential Smoothing Model as Before:

Exponential Smoothing Forecast

Adjusting Exponential Smoothing for Trend

Simple Linear Regression

The Trick is Determining a and b:

Demand (Y) 110 190 320 410

XY 110 380 960 1640

15 1520 5540 5 b 98 2 15 55 5 1520 15 a 98 10 5 5

Resulting Regression Model: Forecast = 10 + 98Period

300 200 100 0 1 2 3 X 4 5

Example: Simplified Regression II

0 1520 980 5 b 98 2 0 10 5 1520 0 a 98 304 5 5

Dealing with Seasonality

What Do You Notice?

Regression picks up trend, but not seasonality effect

Calculating Seasonal Index: Winter Quarter

Average of these two = 0.83 Interpret!

Seasonally adjusted forecast model

Seasonally adjusted forecasts

More Regression Models I

More Regression Models II

Measuring Forecast Accuracy

Measures of Forecast Accuracy

Mean Forecast Error (MFE)

Mean Absolute Deviation (MAD)

What does this tell us that MFE doesnt?

What is the MFE? The MAD? Interpret!

MFE and MAD: A Dartboard Analogy

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