FORECASTING DEMAND

CHAN SOLIDOR

FORECASTING
The art and science of
predicting events.

FORECASTING TIME HORIZONS

Short-range forecast
- less than 3 months
-planning purchase, job scheduling, job assignments

Medium-range forecast
- 3 months 3 years
- sales planning, production planning, budgeting
Long-range forecast
- 3 years or more
- planning for new products, capital expenditure, facility
location or expansion

TYPES OF FORECASTS
Economic
- planning indicators that are valuable in helping
organizations prepare medium to long-range forecasts
Technological
- long-term forecasts concerned with the rates of
technological progress
Demand
- projection of a companys sales for each time period in
the planning horizon

STRATEGIC IMPORTANCE OF FORECASTING

Supply-chain Management
Human Resources
Capacity

7 STEPS IN THE FORECASTING SYSTEM

1.

Determine the use of the forecast

2. Select the items to be forecasted

3. Determine the time horizon of the forecast
4. Select the forecasting model
5. Gather the data needed to make the
forecast
6. Make the forecast
7. Validate and implement the results

FORECASTING APPROACHES
1.Qualitative Forecasts
- decision makers intuition, emotions, personal
experiences
a. Jury of executive opinion
- uses the opinion of a small group of high-level
managers
b. Delphi Method
- uses a group process that allows experts to make forecasts

c. Sales force composite

- based on salespersons estimates of expected sales
d. Market Survey
- solicits input from customers regarding future purchasing plans

FORECASTING APPROACHES
2. Quantitative Forecasts
- employ mathematical modeling to forecast
demand
a. Nave approach
Time-series Models

b. Moving averages
c. Exponential smoothing

Trend
Seasonality
Cycles
Random Variations

d. Trend projection
e. Linear regression

Associative Models

FORECASTING APPROACH - QUANTITATIVE FORECASTS (CONT)

Nave Approach
- assumes that demand in the next period is equal to demand in
the most recent period
Moving Averages
- uses a number of historical actual data values to generate a forecast
Moving average

demand in previous n periods

n

Ex1.
Sales of hair dryers at the Walgreens store in Youngstown,
Ohio, over the past 4 months have been 100, 110, 120, and 130
units (with 130 being the most recent sales)
a. 4-month moving average

Ans.

115
b. weighted 4-month moving average with the most recent
month
weighted 4, the preceding month 3, then 2, and the oldest
month weighted 1.
Ans.
120

FORECASTING APPROACH - QUANTITATIVE FORECASTS (CONT)

Exponential Smoothing
- a weighted-moving average forecasting technique in which data points are
weighted by an exponential function.
New forecast = Last periods forecast + (Last periods actual demand Last periods
forecast)
= smoothing constant (0 1)
Ex2.
YEAR

SALES

FORECAST (
= .10)

180

175.0

168

175.50

159

174.75

175

173.18

190

173.36

175.02

FORECASTING APPROACH - QUANTITATIVE FORECASTS (CONT)

Trend Projections
- a time-series forecasting method that fits a trend line to a series of historical data
points and then projects the line into the future for forecasts.
Least Square Method

Eq.1 y = a + bx
Eq.2 y = na + bx
Eq.3 xy = xa +
bx2

FORECASTING APPROACH - QUANTITATIVE FORECASTS (CONT)

Ex3. The demand for electric power at N.Y. Edison over the past 7 years is shown in
the following table, in megawatts. The firm wants to forecast next years
demand.
YEAR (x) DEMAND (y)
X2
XY
1

74

79

158

80

240

90

16

360

105

25

525

142

36

852

122

49

854

x = 28

y = 692

x2 =
140

xy = 3063

FORECASTING APPROACH - QUANTITATIVE FORECASTS (CONT)

Eq.2

y = na + bx
692 = 7a + 28b

Eq.3
bx2

xy = xa +
3063 = 28a + 140b

Eq.1

y = a + bx
y = 56.714 + 10.536
(8)
y = 141.02 or 141
megawatts

Solve by elimination method

a = 56.70
b = 10.54

MEASURING FORECAST ERROR

Mean absolute deviation (MAD)
MAD
=

|actual forecast|
n

Mean squared error (MSE)

MSE =

(Forecast errors)2
n

Mean absolute percent error (MAPE)

MAPE =

absolute percentage error

n

Ex.4

(10%
)

MAD =

YEAR

ACTUA
L

FORECAST ( = .
10)

FORECAST ( = .
50)

180

175.0

175

168

175.50

177.5

159

174.75

172.75

175

173.18

165.88

190

173.36

170.44

175.02

180.22

MAD

9.34

11.39

MSE

121.90

154.02

|180-175| + |168-175.5| + |159-174.75| + |175-173.18| + |190173.36|

5

= 9.34

(180-175)2 + (168-175.5)2 + (159-174.75)2 + (175-173.18)2 + (190= 121.90

MSE = 173.36)2
5

MAPE

100(5/180) + 100(7.5/168) + 100(15.75/159) + 100(1.82/175) + 100(16.64/190)

= 5.39%
=
5

(50%)

MAD =

|180-175| + |168-177.5| + |159-172.75| + |175-165.88| + |190-170.44|

5

= 11.39

(180-175)2 + (168-177.5)2 + (159-172.75)2 + (175-165.88)2 + (190-170.44)2

= 154.02
MSE =
5
= 6.52%
100(5/180) + 100(9.5/168) + 100(13.75/159) + 100(9.12/175) + 100(19.56/190)

MAPE =

FORECASTING APPROACH - QUANTITATIVE FORECASTS (CONT)

Linear Regression (Associative Model)

Formulas:

Eq.1

y = a + bx

Eq.2

x = x
n

Eq.3

y = y
n

Eq.4
nxy

b = xy -

Eq.5

a = y - bx

x2 nx2

Ex.
5
Sales, y
(in million)

Payroll, x
(in million)

x2

xy

y2

2.0

2.0

4.0

3.0

9.0

9.0

2.5

16

10.0

6.25

2.0

4.0

4.0

2.0

2.0

4.0

3.5

49

24.5

12.25

y = 15.0

x = 18

x2 = 80

xy = 51.5

y2 = 39.5

x = 18= 3
6

y=
15 6

=
2.5
b = 51.5 (6)(3)
=
(2.5)
80 (6)
0.25
(3)2
a = 2.5 (0.25)(3) = 1.75
y = 1.75 + 0.25(6) =
3.25
Sales =
$3,250,00

Standard Error of the Estimate

It measures the error from the dependent variable, y, to the regression line,
rather than to the mean.
Formula:

y 2 a y b xy

Sy , x
n2

Ex. 6:

Sy,x

39.5 1.75(15.0) 0.25(51.5)

62

0.09375 .306 (in $ millions)

The standard error of the estimate is then $306,000 in sales.