Forecasting

Good afternoon all!

1 4-1
 Why use forecasting?

Let us look at Disney?

Look at the impact in the

supply chain of Disney.

4-2
 Forecasting at Disney World
 Global portfolio includes parks in Hong
Kong, Paris, Tokyo, Orlando, and
Anaheim
 Revenues are derived from people – how
many visitors and how they spend their
money
 Daily management report contains only
the forecast and actual attendance at
each park

© 2011 Pearson Education, Inc. publishing as Prentice Hall 4-3

 Forecasting at Disney World
 Disney generates daily, weekly, monthly,
annual, and 5-year forecasts
 Forecast used by labor management,
maintenance, operations, finance, and
park scheduling
 Forecast used to adjust opening times,
rides, shows, staffing levels, and guests
admitted

© 2011 Pearson Education, Inc. publishing as Prentice Hall 4-4

 Forecasting at Disney World
 20% of customers come from outside the
USA
 Economic model includes gross
domestic product, cross-exchange rates,
arrivals into the USA
 A staff of 35 analysts and 70 field people
survey 1 million park guests, employees,
and travel professionals each year

© 2011 Pearson Education, Inc. publishing as Prentice Hall 4-5

 Forecasting at Disney World
 Inputs to the forecasting model include
airline specials, Federal Reserve
policies, Wall Street trends,
vacation/holiday schedules for 3,000
school districts around the world
 Average forecast error for the 5-year
forecast is 5%
 Average forecast error for annual
forecasts is between 0% and 3%

© 2011 Pearson Education, Inc. publishing as Prentice Hall 4-6

 What is Forecasting?
 Process of predicting
a future event
 Underlying basis
of all business
??
decisions
 Production
 Inventory
 Personnel
 Facilities

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 Forecasting Time Horizons
 Short-range forecast
 Up to 1 year, generally less than 3 months
 Purchasing, job scheduling, workforce
levels, job assignments, production levels
 Medium-range forecast
 3 months to 3 years
 Sales and production planning, budgeting
 Long-range forecast
 3+ years
 New product planning, facility location,
research and development

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 Distinguishing Differences
 Medium/long range forecasts deal with
more comprehensive issues and support
management decisions regarding
planning and products, plants and
processes
 Short-term forecasting usually employs
different methodologies than longer-term
forecasting
 Short-term forecasts tend to be more
accurate than longer-term forecasts

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 Influence of Product Life
Cycle
Introduction – Growth – Maturity – Decline

 Introduction and growth require longer

forecasts than maturity and decline
 As product passes through life cycle,
forecasts are useful in projecting
 Staffing levels
 Inventory levels
 Factory capacity

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 Product Life Cycle
Introduction Growth Maturity Decline
Best period to Practical to change Poor time to Cost control
Company Strategy/Issues

increase market price or quality change image, critical

share image price, or quality

R&D engineering is Strengthen niche Competitive costs

critical become critical
Defend market
position Drive-through
Internet search engines restaurants
CD-ROMs
iPods LCD &
Xbox 360 plasma TVs
Sales
Avatars

Boeing 787 Analog

TVs
Twitter
Figure 2.5
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 Product Life Cycle
Introduction Growth Maturity Decline
Product design Forecasting Standardization Little product
and critical Fewer product differentiation
development Product and changes, more Cost
OM Strategy/Issues

critical process minor changes minimization

Frequent reliability Optimum Overcapacity
product and Competitive capacity in the
process design product industry
changes Increasing
improvements stability of Prune line to
Short production and options process eliminate
runs Increase capacity items not
Long production
High production Shift toward runs returning
costs product focus good margin
Product
Limited models Enhance improvement and Reduce
Attention to distribution cost cutting capacity
quality

Figure 2.5
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 Types of Forecasts
 Economic forecasts
 Address business cycle – inflation rate,
money supply, housing starts, etc.
 Technological forecasts
 Predict rate of technological progress
 Impacts development of new products
 Demand forecasts
 Predict sales of existing products and
services

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 Strategic Importance of
Forecasting
 Human Resources – Hiring, training,
laying off workers
 Capacity – Capacity shortages can
result in undependable delivery, loss
of customers, loss of market share
 Supply Chain Management – Good
supplier relations and price
advantages

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Seven Steps in Forecasting
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(s)
5. Gather the data
6. Make the forecast
7. Validate and implement results

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 The Realities!

 Forecasts are seldom perfect

 Most techniques assume an
underlying stability in the system
 Product family and aggregated
forecasts are more accurate than
individual product forecasts

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Forecasting Approaches
Qualitative Methods
 Used when situation is vague
and little data exist
 New products
 New technology
 Involves intuition, experience
 e.g., forecasting sales on
Internet

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 Forecasting Approaches
Quantitative Methods
 Used when situation is ‘stable’ and
historical data exist
 Existing products
 Current technology
 Involves mathematical techniques
 e.g., forecasting sales of color
televisions

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 Overview of Qualitative
Methods
1. Jury of executive opinion
 Pool opinions of high-level experts,
sometimes augment by statistical
models
2. Delphi method
 Panel of experts, queried iteratively

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 Overview of Qualitative
Methods
3. Sales force composite
 Estimates from individual
salespersons are reviewed for
reasonableness, then aggregated
4. Consumer Market Survey
 Ask the customer

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 Jury of Executive Opinion
 Involves small group of high-level
experts and managers
 Group estimates demand by working
together
 Combines managerial experience with
statistical models
 Relatively quick
 ‘Group-think’
disadvantage

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 Sales Force Composite

 Each salesperson projects his or

her sales
 Combined at district and national
levels
 Sales reps know customers’ wants
 Tends to be overly optimistic

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 Delphi Method
 Iterative group
Decision Makers
process, (Evaluate
continues until responses and
consensus is make decisions)
reached
Staff
 3 types of (Administering
survey)
participants
 Decision makers
 Staff Respondents
 Respondents (People who can
make valuable
judgments)
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 Consumer Market Survey
 Ask customers about purchasing
plans
 What consumers say, and what
they actually do are often different
 Sometimes difficult to answer

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 Overview of Quantitative
Approaches
1. Naive approach
2. Moving averages
3. Exponential time-series
models
smoothing
4. Trend projection
5. Linear regression associative
model

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 Time Series Forecasting

 Set of evenly spaced numerical

data
 Obtained by observing response
variable at regular time periods
 Forecast based only on past values,
no other variables important
 Assumes that factors influencing
past and present will continue
influence in future
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Time Series Components

Trend Cyclical

Seasonal Random

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 Components of Demand
Trend
component
Demand for product or service

Seasonal peaks

Actual demand
line

Average demand
over 4 years

Random variation
| | | |
1 2 3 4
Time (years)
Figure 4.1
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 Trend Component
 Persistent, overall upward or
downward pattern
 Changes due to population,
technology, age, culture, etc.
 Typically several years
duration

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 Seasonal Component
 Regular pattern of up and
down fluctuations
 Due to weather, customs, etc.
 Occurs within a single year
Number of
Period Length Seasons
Week Day 7
Month Week 4-4.5
Month Day 28-31
Year Quarter 4
Year Month 12
Year Week 52

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 Cyclical Component
 Repeating up and down movements
 Affected by business cycle,
political, and economic factors
 Multiple years duration
 Often causal or
associative
relationships

0 5 10 15 20
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 Random Component
 Erratic, unsystematic, ‘residual’
fluctuations
 Due to random variation or unforeseen
events
 Short duration
and nonrepeating

M T W T F
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 Naive Approach
 Assumes demand in next
period is the same as
demand in most recent period
 e.g., If January sales were 68, then
February sales will be 68
 Sometimes cost effective and
efficient
 Can be good starting point

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 Moving Average Method

 MA is a series of arithmetic means

 Used if little or no trend

 Used often for smoothing

 Provides overall impression of data
over time
∑ demand in previous n periods
Moving average = n

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 Moving Average Example
Actual 3-Month
Month Shed Sales Moving Average
January 10
February 12
March 13
April 16 (10 + 12 + 13)/3 = 11 2/3
May 19 (12 + 13 + 16)/3 = 13 2/3
June 23 (13 + 16 + 19)/3 = 16
July 26 (16 + 19 + 23)/3 = 19 1/3

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 Graph of Moving Average
Moving
Average
30 –
28 –
Forecast
26 – Actual
24 – Sales
Shed Sales

22 –
20 –
18 –
16 –
14 –
12 –
10 –
| | | | | | | | | | | |
J F M A M J J A S O N D

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Weighted Moving Average
 Used when some trend might be
present
 Older data usually less important
 Weights based on experience and
intuition
∑ (weight for period n)
Weighted x (demand in period n)
moving average = ∑ weights

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 Weights Applied Period
Weighted Moving Average
3 Last month
2 Two months ago
1 Three months ago
6 Sum of weights

Actual 3-Month Weighted

Month Shed Sales Moving Average
January 10
February 12
March 13
April 16 [(3 x 13) + (2 x 12) + (10)]/6 = 121/6
May 19 [(3 x 16) + (2 x 13) + (12)]/6 = 141/3
June 23 [(3 x 19) + (2 x 16) + (13)]/6 = 17
July 26 [(3 x 23) + (2 x 19) + (16)]/6 = 201/2

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 Potential Problems With
Moving Average
 Increasing n smooths the forecast
but makes it less sensitive to
changes
 Do not forecast trends well
 Require extensive historical data

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 Moving Average And
Weighted Moving Average
Weighted
moving
30 – average
25 –
Sales demand

20 – Actual
sales
15 –
Moving
10 – average

5 –
| | | | | | | | | | | |
Figure 4.2
J F M A M J J A S O N D
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 Exponential Smoothing
 Form of weighted moving average
 Weights decline exponentially
 Most recent data weighted most
 Requires smoothing constant ()
 Ranges from 0 to 1
 Subjectively chosen
 Involves little record keeping of past
data
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 Exponential Smoothing
t = Last period’s forecast
+ a (Last period’s actual demand
– Last period’s forecast)

Ft = Ft – 1 + a(At – 1 - Ft – 1)

where Ft = new forecast

Ft – 1 = previous forecast
a = smoothing (or weighting)
constant (0 ≤ a ≤ 1)

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 Exponential Smoothing
Example
Predicted demand = 142 Ford Mustangs
Actual demand = 153
Smoothing constant a = .20

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 Exponential Smoothing
Example
Predicted demand = 142 Ford Mustangs
Actual demand = 153
Smoothing constant a = .20

New forecast = 142 + .2(153 – 142)

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 Exponential Smoothing
Example
Predicted demand = 142 Ford Mustangs
Actual demand = 153
Smoothing constant a = .20

New forecast = 142 + .2(153 – 142)

= 142 + 2.2
= 144.2 ≈ 144 cars

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 *Effect of
Smoothing Constants

Weight Assigned to
Most 2nd Most 3rd Most 4th Most 5th Most
Recent Recent Recent Recent Recent
Smoothing Period Period Period Period Period
Constant (a) a(1 - a) a(1 - a)2
a(1 - a)3
a(1 - a)4

a = .1 .1 .09 .081 .073 .066

a = .5 .5 .25 .125 .063 .031

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 *Impact of Different 

225 –

Actual a = .5
demand
200 –
Demand

175 –
a = .1
| | | | | | | | |
150 –
1 2 3 4 5 6 7 8 9
Quarter

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 Impact of Different 

225 –
Actual a = .5
 Chose high values
demandof 
when
underlying average
Demand

200 –
is likely to change
175
Choose
– low values of 
when underlying average
a = .1
is stable
| | | | | | | | |
150 –
1 2 3 4 5 6 7 8 9
Quarter

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 Choosing 

The objective is to obtain the most

accurate forecast no matter the
technique
We generally do this by selecting the
model that gives us the lowest forecast
error

Forecast error = Actual demand - Forecast value

= At - Ft
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Common Measures of Error

Mean Absolute Deviation (MAD)

∑ |Actual - Forecast|
MAD =
n

Mean Squared Error (MSE)

∑ (Forecast Errors)2
MSE =
n
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Common Measures of Error

Mean Absolute Percent Error (MAPE)

n
∑100|Actuali - Forecasti|/Actuali
MAPE = i=1
n

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 *Comparison of Forecast
Error
Rounded Absolute Rounded Absolute
Actual Forecast Deviation Forecast Deviation
Tonnage with for with for
Quarter Unloaded a = .10 a = .10 a = .50 a = .50
1 180 175 5.00 175 5.00
2 168 175.5 7.50 177.50 9.50
3 159 174.75 15.75 172.75 13.75
4 175 173.18 1.82 165.88 9.12
5 190 173.36 16.64 170.44 19.56
6 205 175.02 29.98 180.22 24.78
7 180 178.02 1.98 192.61 12.61
8 182 178.22 3.78 186.30 4.30
82.45 98.62

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 Comparison of Forecast
Error
∑ |deviations|
Rounded Absolute Rounded Absolute
MADActual
= Forecast Deviation Forecast Deviation
Tonnage n
with for with for
Quarter Unloaded a = .10 a = .10 a = .50 a = .50
1
For a =
180
.10 175 5.00 175 5.00
2 168 = 82.45/8
175.5 = 10.31
7.50 177.50 9.50
3 159 174.75 15.75 172.75 13.75
4 For a175
= .50 173.18 1.82 165.88 9.12
5 190 173.36 16.64 170.44 19.56
6 205 = 98.62/8
175.02 = 12.33
29.98 180.22 24.78
7 180 178.02 1.98 192.61 12.61
8 182 178.22 3.78 186.30 4.30
82.45 98.62

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 Comparison of Forecast
Error
∑ (forecast errors)
Rounded
2
Absolute Rounded Absolute
MSE = Actual Forecast Deviation Forecast Deviation
Tonnage n
with for with for
Quarter Unloaded a = .10 a = .10 a = .50 a = .50
1
For a =
180
.10 175 5.00 175 5.00
2 = 1,526.54/8
168 175.5 = 190.82
7.50 177.50 9.50
3 159 174.75 15.75 172.75 13.75
4 For a175
= .50 173.18 1.82 165.88 9.12
5 190 173.36 16.64 170.44 19.56
6 = 1,561.91/8
205 175.02 = 195.24
29.98 180.22 24.78
7 180 178.02 1.98 192.61 12.61
8 182 178.22 3.78 186.30 4.30
82.45 98.62
MAD 10.31 12.33

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 Exponential Smoothing with
Trend Adjustment Example
Forecast
Actual Smoothed Smoothed Including
Month(t) Demand (At) Forecast, Ft Trend, Tt Trend, FITt
1 12 11 2 13.00
2 17
3 20
4 19
5 24
6 21
7 31
8 28
9 36
10
Table 4.1
4 - 55
 Exponential Smoothing with
Trend Adjustment Example
Forecast
Actual Smoothed Smoothed Including
Month(t) Demand (At) Forecast, Ft Trend, Tt Trend, FITt
1 12 11 2 13.00
2 17
3 20
4 19
5 24 Step 1: Forecast for Month 2
6 21
7 31 F2 = aA1 + (1 - a)(F1 + T1)
8 28
9 36 F2 = (.2)(12) + (1 - .2)(11 + 2)
10 = 2.4 + 10.4 = 12.8 units
Table 4.1
4 - 56
 Exponential Smoothing with
Trend Adjustment Example
Forecast
Actual Smoothed Smoothed Including
Month(t) Demand (At) Forecast, Ft Trend, Tt Trend, FITt
1 12 11 2 13.00
2 17 12.80
3 20
4 19
5 24 Step 2: Trend for Month 2
6 21
7 31 T2 = b(F2 - F1) + (1 - b)T1
8 28
9 36 T2 = (.4)(12.8 - 11) + (1 - .4)(2)
10 = .72 + 1.2 = 1.92 units
Table 4.1
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 Exponential Smoothing with
Trend Adjustment Example
Forecast
Actual Smoothed Smoothed Including
Month(t) Demand (At) Forecast, Ft Trend, Tt Trend, FITt
1 12 11 2 13.00
2 17 12.80 1.92
3 20
4 19
5 24 Step 3: Calculate FIT for Month 2
6 21
7 31 FIT2 = F2 + T2
8 28
9 36
FIT2 = 12.8 + 1.92
10 = 14.72 units
Table 4.1
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 Exponential Smoothing with
Trend Adjustment Example
Forecast
Actual Smoothed Smoothed Including
Month(t) Demand (At) Forecast, Ft Trend, Tt Trend, FITt
1 12 11 2 13.00
2 17 12.80 1.92 14.72
3 20 15.18 2.10 17.28
4 19 17.82 2.32 20.14
5 24 19.91 2.23 22.14
6 21 22.51 2.38 24.89
7 31 24.11 2.07 26.18
8 28 27.14 2.45 29.59
9 36 29.28 2.32 31.60
10 32.48 2.68 35.16
Table 4.1
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Exponential Smoothing with
Trend Adjustment Example
35 –
Actual demand (At)
30 –
Product demand

25 –

20 –

15 –

10 –
Forecast including trend (FITt)
with  = .2 and  = .4
5 –

0 – | | | | | | | | |
1 2 3 4 5 6 7 8 9
Figure 4.3
Time (month)
4 - 60
 Trend Projections
Fitting a trend line to historical data points
to project into the medium to long-range
Linear trends can be found using the least
squares technique

y^ = a + bx
^ where y = computed value of the
variable to be predicted (dependent
variable)
a = y-axis intercept
b = slope of the regression line
x = the independent variable
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Values of Dependent Variable Least Squares Method

Actual observation Deviation7

(y-value)

Deviation5 Deviation6

Deviation3

Deviation4

Deviation1
(error) Deviation2
Trend line, y^ = a + bx

Time period Figure 4.4

4 - 62
Values of Dependent Variable Least Squares Method

Actual observation Deviation7

(y-value)

Deviation5 Deviation6

Deviation3 Least squares method

minimizes the sum of the
squared errors (deviations)
Deviation 4

Deviation1
(error) Deviation2
Trend line, y^ = a + bx

Time period Figure 4.4

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 Least Squares Method
Equations to calculate the regression variables

y^ = a + bx

Sxy - nxy
b=
Sx2 - nx2

a = y - bx

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 Least Squares Example
Time Electrical Power
Year Period (x) Demand x2 xy
2003 1 74 1 74
2004 2 79 4 158
2005 3 80 9 240
2006 4 90 16 360
2007 5 105 25 525
2008 6 142 36 852
2009 7 122 49 854
∑x = 28 ∑y = 692 ∑x2 = 140 ∑xy = 3,063
x=4 y = 98.86

∑xy - nxy 3,063 - (7)(4)(98.86)

b= = = 10.54
∑x - nx
2 2 140 - (7)(4 )
2

a = y - bx = 98.86 - 10.54(4) = 56.70

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 Least Squares Example
Time Electrical Power
Year Period (x) Demand x2 xy
2003 1 74 1 74
2004 2 79 4 158
2005The trend
3 line is 80 9 240
2006 4 90 16 360
2007 y^ 5= 56.70 + 10.54x
105 25 525
2008 6 142 36 852
2009 7 122 49 854
∑x = 28 ∑y = 692 ∑x2 = 140 ∑xy = 3,063
x=4 y = 98.86

∑xy - nxy 3,063 - (7)(4)(98.86)

b= = = 10.54
∑x - nx
2 2 140 - (7)(4 )
2

a = y - bx = 98.86 - 10.54(4) = 56.70

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 Least Squares Example
Trend line,
160 –
150 –
y^ = 56.70 + 10.54x
140 –
Power demand

130 –
120 –
110 –
100 –
90 –
80 –
70 –
60 –
50 –
| | | | | | | | |
2003 2004 2005 2006 2007 2008 2009 2010 2011
Year
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Seasonal Variations In Data

The multiplicative
seasonal model
can adjust trend
data for seasonal
variations in
demand

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 Seasonal Variations In Data
Steps in the process:
1. Find average historical demand for each season
2. Compute the average demand over all seasons
3. Compute a seasonal index for each season
4. Estimate next year’s total demand
5. Divide this estimate of total demand by the
number of seasons, then multiply it by the
seasonal index for that season

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 Seasonal Index Example
Demand Average Average Seasonal
Month 2007 2008 2009 2007-2009 Monthly Index
Jan 80 85 105 90 94
Feb 70 85 85 80 94
Mar 80 93 82 85 94
Apr 90 95 115 100 94
May 113 125 131 123 94
Jun 110 115 120 115 94
Jul 100 102 113 105 94
Aug 88 102 110 100 94
Sept 85 90 95 90 94
Oct 77 78 85 80 94
Nov 75 72 83 80 94
Dec 82 78 80 80 94

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 Seasonal Index Example
Demand Average Average Seasonal
Month 2007 2008 2009 2007-2009 Monthly Index
Jan 80 85 105 90 94 0.957
Feb 70 85 85 80 94
Mar 80 93 Average
82 85 monthly 94
2007-2009 demand
Seasonal90index95= 115
Apr 100 94
Average monthly demand
May 113 125 131 123 94
Jun 110 115= 90/94
120 = .957 115 94
Jul 100 102 113 105 94
Aug 88 102 110 100 94
Sept 85 90 95 90 94
Oct 77 78 85 80 94
Nov 75 72 83 80 94
Dec 82 78 80 80 94

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 Seasonal Index Example
Demand Average Average Seasonal
Month 2007 2008 2009 2007-2009 Monthly Index
Jan 80 85 105 90 94 0.957
Feb 70 85 85 80 94 0.851
Mar 80 93 82 85 94 0.904
Apr 90 95 115 100 94 1.064
May 113 125 131 123 94 1.309
Jun 110 115 120 115 94 1.223
Jul 100 102 113 105 94 1.117
Aug 88 102 110 100 94 1.064
Sept 85 90 95 90 94 0.957
Oct 77 78 85 80 94 0.851
Nov 75 72 83 80 94 0.851
Dec 82 78 80 80 94 0.851

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 Seasonal Index Example
Demand Average Average Seasonal
Month 2007 2008 2009 2007-2009 Monthly Index
Jan 80 85 105 90 94 0.957
Feb 70 85 Forecast
85 for802010 94 0.851
Mar 80 93 82 85 94 0.904
Apr 90Expected
95 115annual demand
100 = 1,200
94 1.064
May 113 125 131 123 94 1.309
Jun 110 115 120 1,200 115 94 1.223
Jul Jan 113
100 102 x .957 = 96 94
105 1.117
12
Aug 88 102 110 100 94 1.064
Sept 85 90 95 1,200 90 94 0.957
Feb x .851 = 85
Oct 77 78 85 12 80 94 0.851
Nov 75 72 83 80 94 0.851
Dec 82 78 80 80 94 0.851

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 Seasonal Index Example
2010 Forecast
140 – 2009 Demand
130 – 2008 Demand
2007 Demand
120 –
Demand

110 –
100 –
90 –
80 –
70 –
| | | | | | | | | | | |
J F M A M J J A S O N D
Time
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 San Diego Hospital
Trend Data

10,200 –

10,000 –
Inpatient Days

9745
9,800 – 9659 9702
9573 9616 9766
9,600 – 9530 9680 9724
9594 9637
9551
9,400 –

9,200 –
| | | | | | | | | | | |
9,000 –
Jan Feb Mar Apr May June July Aug Sept Oct Nov Dec
67 68 69 70 71 72 73 74 75 76 77 78
Month
Figure 4.6
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 San Diego Hospital
Seasonal Indices

1.06 –
1.04 1.04
Index for Inpatient Days

1.04 – 1.03
1.02
1.02 – 1.01
1.00
1.00 – 0.99
0.98
0.98 – 0.99
0.96 – 0.97 0.97
0.96
0.94 –
| | | | | | | | | | | |
0.92 –
Jan Feb Mar Apr May June July Aug Sept Oct Nov Dec
67 68 69 70 71 72 73 74 75 76 77 78
Month
Figure 4.7
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 San Diego Hospital
Combined Trend and Seasonal Forecast

10,200 – 10068
9949
10,000 – 9911
Inpatient Days

9764 9724
9,800 – 9691
9572
9,600 –
9520 9542
9,400 –
9411
9265 9355
9,200 –
| | | | | | | | | | | |
9,000 –
Jan Feb Mar Apr May June July Aug Sept Oct Nov Dec
67 68 69 70 71 72 73 74 75 76 77 78
Month
Figure 4.8
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 Associative Forecasting
Used when changes in one or more
independent variables can be used to predict
the changes in the dependent variable

Most common technique is linear

regression analysis

We apply this technique just as we did

in the time series example

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 Associative Forecasting
Forecasting an outcome based on predictor
variables using the least squares technique

y^ = a + bx
^ where y = computed value of the
variable to be predicted (dependent
variable)
a = y-axis intercept
b = slope of the regression line
x = the independent variable
though to predict the value of the
dependent variable 4 - 80
 Associative Forecasting
Example
Sales Area Payroll
($ millions), y ($ billions), x
2.0 1
3.0 3
2.5 4
2.0 2 4.0 –
2.0 1
3.0 –
3.5 7 Sales
2.0 –

1.0 –
| | | | | | |
0 1 2 3 4 5 6 7
Area payroll
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 Associative Forecasting
Example
Sales, y Payroll, x x2 xy
2.0 1 1 2.0
3.0 3 9 9.0
2.5 4 16 10.0
2.0 2 4 4.0
2.0 1 1 2.0
3.5 7 49 24.5
∑y = 15.0 ∑x = 18 ∑x2 = 80 ∑xy = 51.5

∑xy - nxy 51.5 - (6)(3)(2.5)

x = ∑x/6 = 18/6 = 3 b= = = .25
∑x - nx
2 2 80 - (6)(3 2
)

y = ∑y/6 = 15/6 = 2.5 a = y - bx = 2.5 - (.25)(3) = 1.75

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 Associative Forecasting
Example
y^ = 1.75 + .25x Sales = 1.75 + .25(payroll)

If payroll next year

is estimated to be 4.0 –
$6 million, then: 3.25

Nodel’s sales
3.0 –

Sales = 1.75 + .25(6) 2.0 –

Sales = $3,250,000
1.0 –
| | | | | | |
0 1 2 3 4 5 6 7
Area payroll

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 Standard Error of the
Estimate
 A forecast is just a point estimate of a
future value
 This point is
4.0 –
actually the 3.25
mean of a
Nodel’s sales
3.0 –
probability
2.0 –
distribution
1.0 –
| | | | | | |
0 1 2 3 4 5 6 7
Area payroll
Figure 4.9

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 Standard Error of the
Estimate

∑(y - yc)2
Sy,x =
n-2

where y = y-value of each data point

yc = computed value of the
dependent variable, from the
regression equation
n = number of data points

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 Standard Error of the
Estimate
Computationally, this equation is
considerably easier to use

∑y2 - a∑y - b∑xy

Sy,x =
n-2

We use the standard error to set up

prediction intervals around the
point estimate

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 *Standard Error of the
Estimate
∑y2 - a∑y - b∑xy = 39.5 - 1.75(15) - .25(51.5)
Sy,x =
n-2 6-2

Sy,x = .306 4.0 –

3.25
Nodel’s sales3.0 –
The standard error
of the estimate is 2.0 –
$306,000 in sales
1.0 –
| | | | | | |
0 1 2 3 4 5 6 7
Area payroll

4 - 87
 Correlation
 How strong is the linear
relationship between the variables?
 Correlation does not necessarily
imply causality!
 Coefficient of correlation, r,
measures degree of association
 Values range from -1 to +1

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Correlation Coefficient
nSxy - SxSy
r=
[nSx2 - (Sx)2][nSy2 - (Sy)2]

4 - 89
 y
Correlation Coefficient y

nSxy - SxSy
r=
[nSx
(a) Perfect positive x
2
- (Sx) 2
][nSy
(b) Positive ]
2
- (Sy) 2
x
correlation: correlation:
r = +1 0<r<1

y y

(c) No correlation: x (d) Perfect negative x

r=0 correlation:
© 2011 Pearson Education, Inc. publishing as Prentice Hall
r = -1 4 - 90
 Correlation
 Coefficient of Determination, r2,
measures the percent of change in
y predicted by the change in x
 Values range from 0 to 1
 Easy to interpret

For the Nodel Construction example:

r = .901
r2 = .81
4 - 91
 Multiple Regression
Analysis
If more than one independent variable is to be
used in the model, linear regression can be
extended to multiple regression to
accommodate several independent variables
^
y = a + b1x1 + b2x2 …

Computationally, this is quite

complex and generally done on the
computer
4 - 92
 Multiple Regression
Analysis
In the Nodel example, including interest rates in
the model gives the new equation:

^
y = 1.80 + .30x1 - 5.0x2

An improved correlation coefficient of r = .96

means this model does a better job of predicting
the change in construction sales

Sales = 1.80 + .30(6) - 5.0(.12) = 3.00

Sales = $3,000,000
4 - 93
 Monitoring and Controlling
Forecasts
Tracking Signal
 Measures how well the forecast is
predicting actual values
 Ratio of cumulative forecast errors to
mean absolute deviation (MAD)
 Good tracking signal has low values
 If forecasts are continually high or low, the
forecast has a bias error

4 - 94
Monitoring and Controlling
Forecasts

Tracking Cumulative error

signal =
MAD

∑(Actual demand in
period i -
Forecast demand
Tracking in period i)
signal = (∑|Actual - Forecast|/n)

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 Tracking Signal

Signal exceeding limit

Tracking signal
Upper control limit
+

Acceptable
0 MADs range

– Lower control limit

Time

4 - 96
 Tracking Signal Example
Cumulative
Absolute Absolute
Actual Forecast Cumm Forecast Forecast
Qtr Demand Demand Error Error Error Error MAD

1 90 100 -10 -10 10 10 10.0

2 95 100 -5 -15 5 15 7.5
3 115 100 +15 0 15 30 10.0
4 100 110 -10 -10 10 40 10.0
5 125 110 +15 +5 15 55 11.0
6 140 110 +30 +35 30 85 14.2

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 Tracking Signal Example
Cumulative
Tracking Absolute Absolute
Actual Signal
Forecast Cumm Forecast Forecast
Qtr (CummDemand
Demand Error/MAD)
Error Error Error Error MAD

1 90-10/10
100= -1 -10 -10 10 10 10.0
2 95
-15/7.5
100= -2 -5 -15 5 15 7.5
3 115 0/10
100= 0 +15 0 15 30 10.0
4 100-10/10
110= -1 -10 -10 10 40 10.0
5 125
+5/11110
= +0.5+15 +5 15 55 11.0
6 140
+35/14.2
110= +2.5
+30 +35 30 85 14.2

The variation of the tracking signal

between -2.0 and +2.5 is within acceptable
limits
4 - 98