Chapter 5

Forecasting

To accompany
Quantitative Analysis for Management, Tenth Edition,
by Render, Stair, and Hanna © 2008 Prentice-Hall, Inc.
Power Point slides created by Jeff Heyl © 2009 Prentice-Hall, Inc.
 Introduction
 Managers are always trying to reduce
uncertainty and make better estimates of what
will happen in the future
 This is the main purpose of forecasting
 Some firms use subjective methods
 Seat-of-the pants methods, intuition,
experience
 There are also several quantitative
techniques
 Moving averages, exponential smoothing,
trend projections, least squares regression
analysis

© 2009 Prentice-Hall, Inc. 5–2

 Introduction
 Eight steps to forecasting :
1. Determine the use of the forecast—what
objective are we trying to obtain?
2. Select the items or quantities that are to be
forecasted
3. Determine the time horizon of the forecast
4. Select the forecasting model or models
5. Gather the data needed to make the
forecast
6. Validate the forecasting model
7. Make the forecast
8. Implement the results
© 2009 Prentice-Hall, Inc. 5–3
 Introduction
 These steps are a systematic way of initiating,
designing, and implementing a forecasting
system
 When used regularly over time, data is
collected routinely and calculations performed
automatically
 There is seldom one superior forecasting
system
 Different organizations may use different
techniques
 Whatever tool works best for a firm is the one
they should use

© 2009 Prentice-Hall, Inc. 5–4

 Forecasting Models
Forecasting

Techniques
Qualitative Time-Series Causal
Models Methods Methods

Delphi Moving Regression

Methods Averag Analysis
e
Jury of Executive Exponential Multiple
Opinion Smoothing Regression

Sales Force Trend

Composite Projections

Figure 5.1
Consumer
Decomposition
Market Survey

© 2009 Prentice-Hall, Inc. 5–5

 Time-Series
Models
 Time-series models attempt to predict
the future based on the past
 Common time-series models are
 Moving average
 Exponential smoothing
 Trend projections
 Decomposition
 Regression analysis is used in trend
projections and one type of
decomposition model

© 2009 Prentice-Hall, Inc. 5–6

 Causal Models

 Causal models use variables or factors

that might influence the quantity
being forecasted
 The objective is to build a model with
the best statistical relationship between
the variable being forecast and the
independent variables
 Regression analysis is the most
common technique used in causal
modeling

© 2009 Prentice-Hall, Inc. 5–7

 Qualitative
Models
 Qualitative models incorporate judgmental
or subjective factors
 Useful when subjective factors are
thought to be important or when accurate
quantitative data is difficult to obtain
 Common qualitative techniques are
 Delphi method
 Jury of executive opinion
 Sales force composite
 Consumer market surveys

© 2009 Prentice-Hall, Inc. 5–8

 Qualitative
Models
 Delphi Method – an iterative group process where
(possibly geographically dispersed) respondents
provide input to decision makers
 Jury of Executive Opinion – collects opinions of a
small group of high-level managers, possibly
using statistical models for analysis
 Sales Force Composite – individual salespersons
estimate the sales in their region and the data is
compiled at a district or national level
 Consumer Market Survey – input is solicited from
customers or potential customers regarding
their purchasing plans

© 2009 Prentice-Hall, Inc. 5–9

 Scatter Diagrams
Scatter diagrams are helpful when forecasting time-series
data because they depict the relationship between variables.

450
400
Radios
350
Annual Sales

300
250
Televisions
200
pac t Discs
150
100
Com
50
0
0 2 4 6 8 10 12
Time (Years)

© 2009 Prentice-Hall, Inc. 5 – 10

 Scatter Diagrams
 Wacker Distributors wants to forecast sales for
three different products
YEAR TELEVISION SETS RADIOS 1 COMPACT DISC PLAYERS
250 300 110
2 250 100
310 120
3 250 140
320
170
4 250
150
330
160
5 250
340 190
6 250 200
350 190
7 250
360 © 2009 Prentice-Hall, Inc. 5 – 11
 Scatter Diagrams

(a)
 Sales appear to be
Annual Sales of Televisions

330 –
constant over
250 –          time

Sales = 250
200 –  A good estimate of
150 – sales in year 11 is
100 –
250 televisions
50 –
| | | |
| | | |
| |

0 1 2 3 4 5 6
7 8 9 10
Time (Years)
© 2009 Prentice-Hall, Inc. 5 – 12
 Scatter Diagrams

(b)
420 –  Sales appear to be
400 – increasing at a
Annual Sales of Radios

 
380 – constant rate of 10
 
360 – radios per year
 
340 –
  Sales = 290 +
320 –
10(Year)

300 –   A reasonable
280 – estimate of sales in
| |
|
|
|
|
|
|
|
year 11 is 400
|
televisions
0 1 2 3 4 5 6
7 8 9 10
Time (Years)

Figure 5.2 © 2009 Prentice-Hall, Inc. 5 – 13

 Scatter Diagrams
 This trend line may
(c) not be perfectly
Annual Sales of CD Players

200 –
 accurate because
 
180 – of variation from
160 –  year to year

  Sales appear to be
140 – 
increasing
120 – 

 A forecast would
100 –  probably be a
| | | | |
larger figure each
|
|
| | |
year
0 1 2 3 4 5 6
7 8 9 10
Time (Years)

Figure 5.2 © 2009 Prentice-Hall, Inc. 5 – 14

 Measures of Forecast Accuracy

 We compare forecasted values with actual values

to see how well one model works or to compare
models
Forecast error = Actual value – Forecast value

 One measure of accuracy is the mean absolute

deviation (MAD)

MAD 
 forecast error
n

© 2009 Prentice-Hall, Inc. 5 – 15

 Measures of Forecast Accuracy
 Using a naïve forecasting model
ACTUAL ABSOLUTE VALUE OF
SALES OF CD ERRORS (DEVIATION),
YEAR PLAYERS FORECAST SALES (ACTUAL – FORECAST)
1 110 — —
2 100 110 |100 – 110| = 10
3 120 100 |120 – 110| = 20
4 140 120 |140 – 120| = 20
5 170 140 |170 – 140| = 30
6 150 170 |150 – 170| = 20
7 160 150 |160 – 150| = 10
8 190 160 |190 – 160| = 30
9 200 190 |200 – 190| = 10
10 190 200 |190 – 200| = 10
11 — 190 —
Sum of |errors| = 160
MAD = 160/9 = 17.8

Table 5.2 © 2009 Prentice-Hall, Inc. 5 – 16

 Measures of Forecast Accuracy
 Using a naïve forecasting model
ACTUAL ABSOLUTE VALUE OF
SALES OF CD ERRORS (DEVIATION),
YEAR PLAYERS FORECAST SALES (ACTUAL – FORECAST)
1 110 — —
2 100 110 |100 – 110| = 10
3 120 100 |120 – 110| = 20
4 140 120 |140 – 120| = 20

MAD
5
  forecast
170 error 140

160
 17.8
|170 – 140| = 30
6 150 170 |150 – 170| = 20
7 160 n 150 |160 – 150| = 10
8 190 160 |190 – 160| = 30
9 200 190 |200 – 190| = 10
10 190
9 200 |190 – 200| = 10
11 — 190 —
Sum of |errors| = 160
MAD = 160/9 = 17.8

Table 5.2 © 2009 Prentice-Hall, Inc. 5 – 17

 Measures of Forecast Accuracy
 There are other popular measures of forecast
accuracy
 The mean squared error

MSE   (error)2
n
 The mean absolute percent error
error

MAPE  actual 100%
n
 And bias is the average error and tells whether the
forecast tends to be too high or too low and by
how much. Thus, it can be negative or positive .
© 2009 Prentice-Hall, Inc. 5 – 18
Measures of Forecast Accuracy

Year Actual CD Sales Forecast Sales |Actual -Forecast|

1 110
2 100 110 10
3 120 100 20
4 140 120 20
5 170 140 30
6 150 170 20
7 160 150 10
8 190 160 30
9 200 190 10
10 190 200 10
11 190
Sum of |errors| 160
MAD 17.8

© 2009 Prentice-Hall, Inc. 5 – 19

 Hospital Days Forecast Error
Example
Month Forecast Actual
Ms. Smith forecasted
JAN 250 243
total hospital inpatient
FEB 320 315
days last year. Now
that the actual data are MAR 275 286
known, she is APR 260 256
reevaluating her MAY 250 241
forecasting model. JUN 275 298
JUL 300 292
Compute the MAD,
AUG 325 333
MSE, and MAPE for her
SEP 320 326
forecast.
OCT 350 378
NOV 365 382
DEC 380 396

© 2009 Prentice-Hall, Inc. 5 – 20

 Hospital Days Forecast Error
Example
Forecast Actual |error| error2 |error/actual|
JAN 250 243 7 49 0.03
FEB 320 315 5 25 0.02
MAR 275 286 11 121 0.04
260 256 4 16 0.02
APR 250 241 9 81 0.04
275 298 23 529 0.08
MAY 300 292 8 64 0.03
JUN 325 333 8 64 0.02
JUL 320 326 6 36 0.02
350 378 28 784 0.07
AUG 365 382 17 289 0.04
SEP 380 396 16 256 0.04
MAD= MSE= MAPE=
OCT AVERAGE 192.83 .0381*100 =
11.83 3.81

NOV © 2009 Prentice-Hall, Inc. 5 – 21

 Time-Series Forecasting Models

 A time series is a sequence of evenly

spaced events (weekly, monthly, quarterly,
etc.)
 Time-series forecasts predict the future
based solely of the past values of the
variable
 Other variables, no matter how potentially
valuable, are ignored

© 2009 Prentice-Hall, Inc. 5 – 22

Decomposition of a Time-Series

 A time series typically has four components

1. Trend (T) is the gradual upward or
downward movement of the data over time
2. Seasonality (S) is a pattern of demand
fluctuations above or below trend line that
repeats at regular intervals
3. Cycles (C) are patterns in annual data that
occur every several years
4. Random variations (R) are “blips” in the
data caused by chance and unusual
situations

© 2009 Prentice-Hall, Inc. 5 – 23

 Decomposition of a Time-Series
Demand for Product or Service

Trend
Component

Seasonal Peaks

Actual
Demand
Line
Average Demand
over 4 Years

| | | |
Year Year Year Year
1 2 3 4
Time
Figure 5.3

© 2009 Prentice-Hall, Inc. 5 – 24

Decomposition of a Time-Series

 There are two general forms of time-series

models
 The multiplicative model
Demand = T x S x C x R
 The additive model

Demand = T + S + C + R

 Models may be combinations of these two

forms
 Forecasters often assume errors are
normally distributed with a mean of zero

© 2009 Prentice-Hall, Inc. 5 – 25

 Moving Averages
 Moving averages can be used when demand is
relatively steady over time
 The next forecast is the average of the most
recent n data values from the time series
 The most recent period of data is added and
the oldest is dropped
 Thismethods tends to smooth out short-term
irregularities in the data series

Sum of demands in previous n periods

Moving average forecast 
n © 2009 Prentice-Hall, Inc. 5 – 26
 Moving Averages

 Mathematically

Ft Yt  Yt 1  ...  Yt  n1
 n
1

here
= forecFats1t for time period t + 1
= actualYvtalue in time period t
n = number of periods
to average

© 2009 Prentice-Hall, Inc. 5 – 27

Wallace Garden Supply Example

 Wallace Garden Supply wants to

forecast demand for its Storage Shed
 They have collected data for the past
year
 They are using a three-month moving
average to forecast demand (n = 3)

© 2009 Prentice-Hall, Inc. 5 – 28

 Wallace Garden Supply Example

MONTH ACTUAL SHED SALES THREE-MONTH MOVING AVERAGE

January 10
February 12
March 13
April 16 (10 + 12 + 13)/3 = 11.67
May 19 (12 + 13 + 16)/3 = 13.67
June 23 (13 + 16 + 19)/3 = 16.00
July 26 (16 + 19 + 23)/3 = 19.33
August 30 (19 + 23 + 26)/3 = 22.67
September 28 (23 + 26 + 30)/3 = 26.33
October 18 (26 + 30 + 28)/3 = 28.00
November 16 (30 + 28 + 18)/3 = 25.33
December 14 (28 + 18 + 16)/3 = 20.67
January — (18 + 16 + 14)/3 = 16.00

Table 5.3
© 2009 Prentice-Hall, Inc. 5 – 29
 Weighted Moving Averages
 Weighted moving averages use weights to put
more emphasis on recent periods
 Often used when a trend or other pattern is
emerging

Ft
  (Weight in period i)(Actual value in
1
period) (Weights)
 Mathematically
Ft w1Yt  w2Yt 1  ...  wnYt  n1
 w1  w2  ...  w n
1
re
wi = weight for the ith observation
© 2009 Prentice-Hall, Inc. 5 – 30
 Weighted Moving Averages
 Both simple and weighted averages are
effective in smoothing out fluctuations in
the demand pattern in order to provide
stable estimates
 Problems
 Increasing the size of n smoothes out
fluctuations better, but makes the method
less sensitive to real changes in the data
 Moving averages can not pick up trends
very well – they will always stay within past
levels and not predict a change to a higher or
lower level
© 2009 Prentice-Hall, Inc. 5 – 31
Wallace Garden Supply Example

 Wallace Garden Supply decides to try a

weighted moving average model to forecast
demand for its Storage Shed
 They decide on the following weighting
scheme
WEIGHTS APPLIED PERIOD
3 Last month
2 Two months ago
1

Three months ago

3 x Sales last month + 2 x Sales two
months ago + 1 X Sales three months
ago
© 2009 Prentice-Hall, Inc. 5 – 32
6
 Wallace Garden Supply Example
THREE-MONTH WEIGHTED
MONTH ACTUAL SHED SALES MOVING AVERAGE
January 10
February 12
March 13
April 16 [(3 X 13) + (2 X 12) + (10)]/6 = 12.17
May 19 [(3 X 16) + (2 X 13) + (12)]/6 = 14.33
June 23 [(3 X 19) + (2 X 16) + (13)]/6 = 17.00
July 26 [(3 X 23) + (2 X 19) + (16)]/6 = 20.50
August 30 [(3 X 26) + (2 X 23) + (19)]/6 = 23.83
September 28 [(3 X 30) + (2 X 26) + (23)]/6 = 27.50
October 18 [(3 X 28) + (2 X 30) + (26)]/6 = 28.33
November 16 [(3 X 18) + (2 X 28) + (30)]/6 = 23.33
December 14 [(3 X 16) + (2 X 18) + (28)]/6 = 18.67
January — [(3 X 14) + (2 X 16) + (18)]/6 = 15.33
Table 5.4
© 2009 Prentice-Hall, Inc. 5 – 33
 Wallace Garden Supply Example

Program 5.1A
© 2009 Prentice-Hall, Inc. 5 – 34
 Wallace Garden Supply Example

Program 5.1B
© 2009 Prentice-Hall, Inc. 5 – 35
 Exponential Smoothing
 Exponential smoothing is easy to use and
requires little record keeping of data
 It is a type of moving average

ecast = Last period’s forecast

+ (Last period’s actual demand
– Last period’s forecast)

Where  is a weight (or smoothing constant)

with a value between 0 and 1 inclusive

A larger  gives more importance to recent

data while a smaller value gives more
importance to past data © 2009 Prentice-Hall, Inc. 5 – 36
 Exponential Smoothing

 Mathematically
  (Yt  Ft )
Ft 1  Ft
re
= new forecast (for time period t + 1)
Ft+1
Ft = pervious forecast (for time period t)
 = smoothing constant (0 ≤  ≤ 1)
Yt = pervious period’s actual demand

 The idea is simple – the new estimate is the

old estimate plus some fraction of the error in
the last period

© 2009 Prentice-Hall, Inc. 5 – 37

Exponential Smoothing Example
 In January, February’s demand for a certain
car model was predicted to be 142
 Actual February demand was 153 autos
 Using a smoothing constant of  = 0.20, what
is the forecast for March?

New forecast (for March demand) = 142 + 0.2(153 – 142)

= 144.2 or 144 autos

 If actual demand in March was 136 autos, the

April forecast would be
New forecast (for April demand) = 144.2 + 0.2(136 –
144.2)
= 142.6 or 143 autos
© 2009 Prentice-Hall, Inc. 5 – 38
Selecting the Smoothing Constant

 Selecting the appropriate value for  is

key to obtaining a good forecast
 The objective is always to generate an
accurate forecast
 The general approach is to develop trial
forecasts with different values of  and
select the  that results in the lowest MAD

© 2009 Prentice-Hall, Inc. 5 – 39

 Port of Baltimore Example
 Exponential smoothing forecast for two values of 
ACTUAL
TONNAGE FORECAST FORECAST
QUARTER UNLOADED USING  =0.10 USING  =0.50
1 180 175 175
2 168 175.5 = 175.00 + 0.10(180 – 175) 177.5
3 159 174.75 = 175.50 + 0.10(168 – 175.50) 172.75
4 175 173.18 = 174.75 + 0.10(159 – 174.75) 165.88
5 190 173.36 = 173.18 + 0.10(175 – 173.18) 170.44
6 205 175.02 = 173.36 + 0.10(190 – 173.36) 180.22
7 180 178.02 = 175.02 + 0.10(205 – 175.02) 192.61
8 182 178.22 = 178.02 + 0.10(180 – 178.02) 186.30
9 ? 178.60 = 178.22 + 0.10(182 – 178.22) 184.15

Table 5.5
© 2009 Prentice-Hall, Inc. 5 – 40
 Selecting the Best Value of 
ACTUAL FORECAST ABSOLUTE ABSOLUTE
TONNAGE WITH  = DEVIATIONS DEVIATIONS
QUARTE 0.10 FORECAST FOR  = 0.10 FOR  =
R WITH  = 0.50 0.50
175 175
UNLOADE 5 . 5
D
175.5 177.5
7.5 . 9.5
1
180 174.75 172.75
15.75 13.75

2 173.18 165.88
1.82 9.12
168
173.36 170.44
16.64 19.56
3
159 175.02 180.22
29.98 24.78

4 178.02 192.61
1.98 12.61
175
Table 5.6
8 186.30
3.78 4.3
5
182
Sum 190
Best cc h h oi
of absolute deviations
17 8. 2 2
82.45 98.63
ce Σ|deviations|
6 MAD = = ©M20A09DPr=entic1e-
5 – 41
 Port of Baltimore Example

Program 5.2A
© 2009 Prentice-Hall, Inc. 5 – 42
Port of Baltimore Example

Program 5.2B

© 2009 Prentice-Hall, Inc. 5 – 43

 PM Computer: Moving Average
Example
 PM Computer assembles customized personal
computers from generic parts

 The owners purchase generic computer

parts in volume at a discount from a variety
of sources whenever they see a good deal.

 It is important that they develop a good

forecast of demand for their computers so
they can purchase component parts
efficiently.
© 2009 Prentice-Hall, Inc. 5 – 44
 PM Computers: Data
Period Month Actual Demand
1 Jan 37
2 Feb 40
3 Mar 41
4 Apr 37
5 May 45
6 June 50
7 July 43
8 Aug 47
9 Sept

 56
Compute a 3-month weighted average using weights of
Compute a 2-month
4,2,1 for the moving
past three average
months of data
 Compute an exponential smoothing forecast using  =
0.7, previous forecast of 40
 Using MAD, what forecast is most accurate? 5 – 45
© 2009 Prentice-Hall, Inc.
 PM Computers: Moving Average
Solution
2 m o n t h
M A Abs. D e v 3 m o n t h W M A Abs. D e v E x p .S m . Abs. D e v

3 7 .0 0

3 7 .0 0 3 .0 0

3 8 .5 0 2 .5 0 3 9 .1 0 1 .9 0

4 0 .5 0 3 .5 0 4 0 .1 4 3 .1 4 4 0 .4 3 3 .4 3

3 9 .0 0 6 .0 0 3 8 .5 7 6 .4 3 3 8 .0 3 6 .9 7

4 1 .0 0 9 .0 0 4 2 .1 4 7 .8 6 4 2 .9 1 7 .0 9

4 7 .5 0 4 .5 0 4 6 .7 1 3 .7 1 4 7 .8 7 4 .8 7

4 6 .5 0 0 .5 0 4 5 .2 9 1 .7 1 4 4 .4 6 2 .5 4

4 5 .0 0 1 1 .0 0 4 6 .2 9 9 .7 1 4 6 .2 4 9 .7 6
5 1 .5 0 5 1 .5 7 5 3 .0 7
MAD 5 .2 9 5 .4 3 4 .9 5

Exponential smoothing resulted in the lowest MAD.

© 2009 Prentice-Hall, Inc. 5 – 46
 Exponential Smoothing with
Trend Adjustment
 Like all averaging techniques, exponential
smoothing does not respond to trends
 A more complex model can be used that
adjusts for trends
 The basic approach is to develop an
exponential smoothing forecast then adjust it
for the trend

) = New forecast (Ft)

+ Trend correction (Tt)

© 2009 Prentice-Hall, Inc. 5 – 47

 Exponential Smoothing with
Trend Adjustment
 The equation for the trend correction uses a
new smoothing constant 
 Tt is computed by

Tt 1  (1  )Tt   (Ft 1  Ft )

where
Tt+1 = smoothed trend for period t + 1
Tt = smoothed trend for
preceding period
= trend smooth constant
that we select Ft+1 = simple exponential
smoothed forecast for period t + 1
Ft = forecast for pervious
© 2009 Prentice-Hall, Inc. 5 – 48
 Selecting a Smoothing Constant

 As with exponential smoothing, a high value of 

makes the forecast more responsive to changes
in trend
 A low value of  gives less weight to the recent
trend and tends to smooth out the trend
 Values are generally selected using a trial-and-
error approach based on the value of the MAD for
different values of 
 Simple exponential smoothing is often referred to
as first-order smoothing
 Trend-adjusted smoothing is called second-
order, double smoothing, or Holt’s method

© 2009 Prentice-Hall, Inc. 5 – 49

 Trend Projection
 Trend projection fits a trend line to a
series of historical data points
 The line is projected into the future for
medium- to long-range forecasts
 Several trend equations can be
developed based on exponential or
quadratic models
 The simplest is a linear model developed
using regression analysis

© 2009 Prentice-Hall, Inc. 5 – 50

 Trend Projection
 Trend projections are used to forecast time-
series data that exhibit a linear trend.
 A trend line is simply a linear regression
equation in which the independent variable (X)
is the time period
 Least squares may be used to determine a
trend projection for future forecasts.
 Least squares determines the trend line forecast by
minimizing the mean squared error between the
trend line forecasts and the actual observed values.
 The independent variable is the time period
and the dependent variable is the actual
observed value in the time series.
© 2009 Prentice-Hall, Inc. 5 – 51
 Trend Projection
 The mathematical form is

Yˆ b0  b1 X
where
= pYrˆedicted value
b0 = intercept
b1 = slope of the line
X = time period (i.e., X = 1, 2,
3, …, n)
© 2009 Prentice-Hall, Inc. 5 – 52
 Trend Projection
Value of Dependent Variable
Dist7 *
Dist5 * Dist6

* Dist3 *
Dist4

Dist1 * Dist2
*
*

Time Figure 5.4

© 2009 Prentice-Hall, Inc. 5 – 53

 Midwestern Manufacturing
Company Example
 Midwestern Manufacturing Company has
experienced the following demand for it’s electrical
generators over the period of 2001 – 2007

YEAR ELECTRICAL GENERATORS SOLD

2001 74
2002 79
2003 80
2004 90
2005 105
2006 142
2007 122

Table 5.7

© 2009 Prentice-Hall, Inc. 5 – 54

 Midwestern Manufacturing
Company Example

Notice code
instead of
actual years

Program 5.3A
© 2009 Prentice-Hall, Inc. 5 – 55
 Midwestern Manufacturing
Company Example

r2 says model predicts

about 80% of the
variability in demand

Significance level for

F-test indicates a
definite relationship

Program 5.3B
© 2009 Prentice-Hall, Inc. 5 – 56
 Midwestern Manufacturing
Company Example
 The forecast equation is

Yˆ 56.71 10.54 X

 To project demand for 2008, we use the coding

system to define X = 8
(sales in 2008) = 56.71 + 10.54(8)
= 141.03, or 141 generators

 Likewise for X = 9

(sales in 2009) = 56.71 + 10.54(9)

= 151.57, or 152 generators
© 2009 Prentice-Hall, Inc. 5 – 57
 Midwestern Manufacturing
Company Example

160 –
150 –

140 – 
Trend Line
130 –
Generator Demand

Yˆ  56.71 10.54
120 – 
X
110 –

100 –
90 – 
80 –  
70 –  Actual Demand Line

60 –
50 –
| | | | | | | | |

2001 2002 2003 2004 2005 2006 2007 2008 2009

Figure 5.5 Year
© 2009 Prentice-Hall, Inc. 5 – 58
 Midwestern Manufacturing
Company Example

Program 5.4A

© 2009 Prentice-Hall, Inc. 5 – 59

 Midwestern Manufacturing
Company Example

Program 5.4B
© 2009 Prentice-Hall, Inc. 5 – 60
 Seasonal Variations
■ Recurring variations over time may
indicate the need for seasonal
adjustments in the trend line
■ A seasonal index indicates how a
particular season compares with an
average season
■ When no trend is present, the seasonal
index can be found by dividing the
average value for a particular season by
the average of all the data

© 2009 Prentice-Hall, Inc. 5 – 61

 Seasonal Variations

■ Eichler Supplies sells telephone

answering machines
■ Data has been collected for the past two
years sales of one particular model
■ They want to create a forecast that
includes seasonality

© 2009 Prentice-Hall, Inc. 5 – 62

 Seasonal Variations
SALES DEMAND
AVERAGE
AVERAGE TWO- MONTHLY SEASONAL
MONTH YEAR 1 YEAR 2 YEAR DEMAND DEMAND INDEX
January 80 100 94 0.957
90
February 85 75 94 0.851
80
March 80 90 94 0.904
85
April 110 90 94 1.064
100
May 115 131 94 1.309
123
June 120 110 94 1.223
115
July 100 110 94 1.117
105
August 110
1,12890 100
Seasonal
9 4
index = Av e rage two-
Average monthly demand = = 94 Average monthly demand
September 12 months 1 .0 60.957
85
95 r d e4mand
yea94
90 © 2009 Prentice-Hall, Inc. 5 – 63
Table 5.8
 Seasonal Variations
■ The calculations for the seasonal indices are

Jan. 1,200 July 1,200

12  0.957  96 12  1.117  112

Feb. 1,200 Aug. 1,200

12  0.851  12  1.064  106
85
Mar. 1,200 Sept. 1,200
12  0.904  90 12  0.957  96

Apr. 1,200 Oct. 1,200

12  1.064  106 12  0.851 
85
May 1,200 Nov. 1,200
12  1.309  131 12  0.851 
85
June 1,200 Dec. 1,200
12  1.223  122 12  0.851 
85 © 2009 Prentice-Hall, Inc. 5 – 64
 Regression with Trend and
Seasonal Components
■ Multiple regression can be used to forecast both
trend and seasonal components in a time series
■ One independent variable is time
■ Dummy independent variables are used to represent the
seasons
■ The model is an additive decomposition model

Yˆ  a  b1 X 1  b2 X 2  b3 X 3  b4 X 4

where
X1 = time period
X2 = 1 if quarter 2, 0 otherwise
X3 = 1 if quarter 3, 0 otherwise
X4 = 1 if quarter 4, 0 otherwise
© 2009 Prentice-Hall, Inc. 5 – 65
 Regression with Trend and
Seasonal Components

Program 5.6A

© 2009 Prentice-Hall, Inc. 5 – 66

 Regression with Trend and
Seasonal Components

Program 5.6B (partial)

© 2009 Prentice-Hall, Inc. 5 – 67
 Regression with Trend and
Seasonal Components
■ The resulting regression equation is

Yˆ  104.1 2.3 X1  15.7 X 2  38.7 X 3  30.1X 4

■ Using the model to forecast sales for the first two

quarters of next year

Yˆ  104.1 2.3(13)  15.7(0)  38.7(0)  30.1(0)  134

Yˆ  104.1 2.3(14)  15.7(1)  38.7(0)  30.1(0)  152

■ These are different from the results obtained

using the multiplicative decomposition method
■ Use MAD and MSE to determine the best © 2009 Prentice-Hall, Inc. 5 – 68
 Regression with Trend and
Seasonal Components
■ American Airlines original spare parts inventory
system used only time-series methods to
forecast the demand for spare parts
■ This method was slow to responds to even moderate
changes in aircraft utilization let alone major fleet
expansions
■ They developed a PC-based system named RAPS
which uses linear regression to establish a
relationship between monthly part removals and
various functions of monthly flying hours
■ The computation now takes only one hour instead of
the days the old system needed
■ Using RAPS provided a one time savings of $7 million
and a recurring annual savings of nearly $1 million

© 2009 Prentice-Hall, Inc. 5 – 69

 Monitoring and Controlling Forecasts

■ Tracking signals can be used to monitor

the performance of a forecast
■ Tacking signals are computed using the
following equation

RSFE
Tracking signal  MAD

where
MAD 
 forecast error
n

© 2009 Prentice-Hall, Inc. 5 – 70

 Monitoring and Controlling Forecasts

Signal Tripped
Upper Control Limit Tracking Signal
+

Acceptable
0 MADs Range

–
Lower Control Limit

Time

Figure 5.7

© 2009 Prentice-Hall, Inc. 5 – 71

 Monitoring and Controlling Forecasts

■ Positive tracking signals indicate demand is

greater than forecast
■ Negative tracking signals indicate demand is less
than forecast
■ Some variation is expected, but a good forecast
will have about as much positive error as
negative error
■ Problems are indicated when the signal trips
either the upper or lower predetermined limits
■ This indicates there has been an unacceptable
amount of variation
■ Limits should be reasonable and may vary from
item to item
© 2009 Prentice-Hall, Inc. 5 – 72
 Regression with Trend and
Seasonal Components
■ How do you decide on the upper and lower
limits?
■ Too small a value will trip the signal too often and
too large will cause a bad forecast
■ Plossl & Wight – use maximums of ±4 MADs for
high volume stock items and ±8 MADs for lower
volume items
■ One MAD is equivalent to approximately 0.8
standard deviation so that ±4 MADs =3.2 s.d.
■ For a forecast to be “in control”, 89% of the errors
are expected to fall within ±2 MADs, 98% with ±3
MADs or 99.9% within ±4 MADs whenever the
errors are approximately normally distributed
© 2009 Prentice-Hall, Inc. 5 – 73
 Kimball’s Bakery Example
■ Tracking signal for quarterly sales of croissants

TIME FORECAST ACTUAL |FORECAST | CUMULATIVE TRACKING

PERIOD DEMAND DEMAND ERROR RSFE | ERROR | SIGNAL
ERROR MAD
–1
1 100 90 –10 –10 10 10
10.0 –2

2 100 95 –5 –15 5 15 0
7.5 –1
3 100 115 +15 0 15 30 +0.5
10.0
+2.5
4 110 100 –10 –10 10 40
10.0
5 110 125 +15 +5 15 55
11.0
6 110 140 +30 +35 30 85
14.2 RSFE 35
Tracking signal   
2.5MADs
 forecastMAD
error 85
© 2009 Prentice-Hall, Inc. 5 – 74
 Forecasting at Disney
■ The Disney chairman receives a daily
report from his main theme parks that
contains only two numbers – the forecast
of yesterday’s attendance at the parks and
the actual attendance
■ An error close to zero (using MAPE as the
measure) is expected
■ The annual forecast of total volume
conducted in 1999 for the year 2000
resulted in a MAPE of 0

© 2009 Prentice-Hall, Inc. 5 – 75

 Using The Computer to Forecast

■ Spreadsheets can be used by small and

medium-sized forecasting problems
■ More advanced programs (SAS, SPSS,
Minitab) handle time-series and causal
models
■ May automatically select best model
parameters
■ Dedicated forecasting packages may be
fully automatic
■ May be integrated with inventory planning
and control

© 2009 Prentice-Hall, Inc. 5 – 76