MBA Production Management - Forecasting - Caguillo, Christine Joy

FORECASTING
Christine Joy V. Caguillo, RPm

September 05, 2021
© 2006 Prentice Hall, Inc. M B A : P R O D U C T I O N M A N A G E M E4 N

– 1T
EXECUTIVE SUMMARY | OUTLINES
 Time-series Forecasting
 Global Company:  Decomposition of a Time Series
Tupperware Corporation  Naïve Approach
 Moving Averages
 What Is Forecasting?  Exponential Smoothing
 Forecasting Time Horizons  Exponential Smoothing with Trend
 The Influence of Product Life Cycle Adjustment
 Trend Projections
 Types Of Forecasts
 Seasonal Variations in Data
 The Strategic Importance Of  Cyclical Variations in Data
Forecasting
 Associative Forecasting Methods:
 Human Resources
Regression And Correlation Analysis
 Capacity
 Using Regression Analysis to Forecast
 Supply-Chain Management
 Standard Error of the Estimate
 Seven Steps In The Forecasting  Correlation Coefficients for Regression Lines
System  Multiple-Regression Analysis
 Forecasting Approaches  Monitoring And Controlling Forecasts
 Overview of Qualitative Methods  Adaptive Smoothing
 Overview of Quantitative Methods  Focus Forecasting
 Forecasting In The Service Sector
© 2006 Prentice Hall, Inc. 4–2
LEARNING OBJECTIVES
When you complete this chapter, you should be able to :
IDENTIFY OR DEFINE: DESCRIBE OR EXPLAIN:
 Forecasting  Moving averages

 Types of forecasts  Exponential smoothing
 Time horizons  Trend projections
 Approaches to forecasts  Regression and correlation analysis
 Measures of forecast accuracy
FORECASTING AT
TUPPERWARE
 Each of 50 profit centers around the world is

responsible for computerized monthly,
quarterly, and 12-month sales projections
 These projections are aggregated by
region, then globally, at Tupperware’s World
Headquarters
 Tupperware uses all techniques discussed
in text

THREE KEY FACTORS
FOR TUPPERWARE
 The number of registered “consultants” or

sales representatives
 The percentage of currently “active” dealers
(this number changes each week and month)
 Sales per active dealer, on a weekly basis

FORECAST
BY CONSENSUS
 Although inputs come from sales,

marketing, finance, and production, final
forecasts are the consensus of all
participating managers
 The final step is Tupperware’s version of
the “jury of executive opinion”

What is
FORECASTING?
 Process of predicting a future event

 Underlying basis of
all business decisions
 Production
 Inventory
 Personnel
 Facilities

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

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

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
© 2006 Prentice Hall, Inc. 4 – 10
PRODUCT LIFE CYCLE
INTRODUCTION GROWTH MATURITY DECLINE
COMPANY STRATEGY/ISSUES
Best period to Practical to change Poor time to change Cost control
increase market price or quality image, price, or critical
share image quality
R&D engineering is Strengthen niche Competitive costs

critical become critical
Defend market
position
CD-ROM Fax machines
Internet Drive-through
restaurants
Color printers
Sales
3 1/2”
Floppy
Flat-screen disks
monitors DVD
Figure 2.5

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 product

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 advance

1
2
DETERMINE THE USE OF THE
FORECAST
SELECT THE ITEMS TO BE

7 STEPS IN
FORECASTING
FORECASTED 5 GATHER THE DATA
DETERMINE THE TIME

3 HORIZON OF THE 6 MAKE THE FORECAST
FORECAST
SELECT THE FORECASTING
4 MODELS(S) 7
VALIDATE AND IMPLEMENT
RESULTS
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

FORECASTING APPROACHES
QUALITATIVE QUANTITATIVE
 Used when situation is vague and  Used when situation is ‘stable’ and
little data exist historical data exist
 New products  Existing products
 New technology  Current technology
 Involves intuition, experience  Involves mathematical techniques
 e.g., forecasting sales on  e.g., forecasting sales of color
Internet televisions
OVERVIEW OF
QUALITATIVE METHODS
 Jury of executive opinion  Sales force composite
 Pool opinions of high-level  Estimates from
executives, sometimes individual salespersons
augment by statistical models are reviewed for
 Delphi method reasonableness, then
 Panel of experts, queried aggregated
iteratively  Consumer Market Survey
 Ask the customer

JURY OF EXECUTIVE
OPINION
 Involves small group of high-
level managers
 Group estimates demand by
working together
 Combines managerial
experience with statistical models
 Relatively quick
 ‘Group-think’
disadvantage

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

DELPHI METHOD
DECISION
 Iterative group MAKERS
process, continues (Evaluate
until consensus is responses and
reached make decisions)
 3 types of participants STAFF
(Administering
 Decision makers survey)
 Staff
 Respondents
RESPONDENTS
(People who can make
valuable judgments)

CONSUMER MARKET
SURVEY
 Ask customers about purchasing

plans
 What consumers say, and what
they actually do are often different
 Sometimes difficult to answer

OVERVIEW OF QUANTITATIVE APPROACHES
1. Naive approach
2. Moving averages TIME-SERIES
3. Exponential smoothing MODELS
4. Trend projection ASSOCIATIVE
5. Linear regression MODEL

TIME SERIES
FORECASTING
 Set of evenly spaced numerical
data
 Obtained by observing
response variable at regular
time periods
 Forecast based only on past values
 Assumes that factors
influencing past and present
will continue influence in future

TIME SERIES COMPONENTS
Trend Cyclical
Seasonal Random

TREND COMPONENT
 Persistent, overall upward or
downward pattern
 Changes due to population,
technology, age, culture, etc.
 Typically several years duration

SEASONAL COMPONENT
 Regular pattern of up and down

fluctuations
 Due to weather, customs, etc.
 Occurs within a single year

CYCLICAL COMPONENT
 Repeating up and down

movements
 Affected by business cycle,
political, and economic factors
 Multiple years duration
 Often causal or associative
relationships

RANDOM COMPONENT
 Erratic, unsystematic, ‘residual’

fluctuations
 Due to random variation or
unforeseen events
 Short duration and
nonrepeating

COMPONENTS OF DEMAND
Components of Demand
Trend
component
Demand for product or service

Seasonal peaks
Actual
demand
Average
demand over
Random four years
variation
| | | |
1 2 3 4
Year Figure 4.1
NAIVE APPROACH
 Assumes demand in next period is
the same as demand in most recent
period
 e.g., If May sales were 48, then
June sales will be 48
 Sometimes cost effective and
efficient

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

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

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

WEIGHTED MOVING AVERAGE
 Used when trend is 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

Weights Applied Period
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
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

MOVING AVERAGE AND
Weighted
moving
30 – average
25 –
Sales demand
20 – Actual
sales
15 –
Moving
10 – average
5 –
| | | | | | | | | | | |
Figure 4.2

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

EXPONENTIAL SMOOTHING
w forecast = 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)

EXPONENTIAL SMOOTING EXAMPLE
Predicted demand = 142 Ford Mustangs

Actual demand = 153
Smoothing constant a = .20


Actual demand = 153
New forecast = 142 + .2(153 – 142)


Actual demand = 153
New forecast = 142 + .2(153 – 142)

= 142 + 2.2
= 144.2 ≈ 144 cars

IMPACT OF DIFFERENT 
225 –
Actual a = .5
demand
200 –
Demand
175 –
a = .1
| | | | | | | | |
150 –
1 2 3 4 5 6 7 8 9
Quarter
Commonly used = 0.05 to 0.50
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

COMMON MEASURES OF ERROR
Mean Absolute Deviation (MAD)

∑ |actual - forecast|
MAD =
n
Mean Squared Error (MSE)

∑ (forecast errors)2
MSE =
n
COMMON MEASURES OF ERROR
Mean Absolute Percent Error (MAPE)
n
100 ∑ |actuali - forecasti|/actuali
MAPE = i=1
n

WITH TREND ADJUSTMENT
When a trend is present, exponential

smoothing must be modified
Forecast exponentially exponentially

including (FITt) = smoothed (Ft) + (Tt) smoothed
trend forecast trend

WITH TREND ADJUSTMENT
Ft = a(At - 1) + (1 - a)(Ft - 1 + Tt - 1)
Tt = b(Ft - Ft - 1) + (1 - b)Tt - 1
Step 1: Compute Ft
Step 2: Compute Tt
Step 3: Calculate the forecast FITt = Ft + Tt
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
Forecast
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
Forecast
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
Forecast
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 + T1
8 28
9 36
FIT2 = 12.8 + 1.92
10 = 14.72 units
Table 4.1
Forecast
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
35 –
Actual demand (At)
Product demand 30 –
25 –
20 –
15 –
10 –
Forecast including trend (FITt)
5 –
0 – | | | | | | | | |
1 2 3 4 5 6 7 8 9
Figure 4.3
Time (month)
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
© 2006 Prentice Hall, Inc.
x = the independent variable 4 – 55
SEASONAL VARIATIONS IN DATA
Find average historical demand for

1 each season
Compute the average demand over all

The multiplicative 2 seasons
seasonal model can
modify trend data to 3
Compute a seasonal index for each
accommodate season
seasonal variations
in demand 4 Estimate next year’s total demand
Divide this estimate of total demand

5 by the number of seasons, then
multiply it by the seasonal index for
that season
SEASONAL INDEX EXAMPLE
Demand Average Average Seasonal

Month 2003 2004 2005 2003-2005 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


Jan 80 85 105 90 94 0.957
Feb 70 85 85 80 94
Mar 80 93 average
82 85 monthly demand
2003-2005 94
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


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


Jan 80 85 105 90 94 0.957
Feb 70 85 Forecast
85 for802006 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

2006 Forecast
140 – 2005 Demand
130 – 2004 Demand
2003 Demand
120 –
Demand
110 –
100 –
90 –
80 –
70 –
| | | | | | | | | | | |
Time
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

EXAMPLE
Sales Local Payroll

($000,000), y ($000,000,000), x
2.0 1
3.0 3
2.5 4
2.0 2 4.0 –
2.0 1
3.0 –
Sales
3.5 7
2.0 –
1.0 –
| | | | | | |
0 1 2 3 4 5 6 7
Area payroll

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

EXAMPLE
y^ = 1.75 + .25x Sales = 1.75 + .25(payroll)
If payroll next year 4.0 –

is estimated to be 3.25
$600 million, then: 3.0 –
Sales
2.0 –
Sales = 1.75 + .25(6)
Sales = $325,000 1.0 –
| | | | | | |
0 1 2 3 4 5 6 7
Area payroll

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
Sales
3.0 –
probability
2.0 –
distribution
1.0 –
| | | | | | |
0 1 2 3 4 5 6 7
Area payroll
Figure 4.9
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
CORRELATION COEFFICIENT
nSxy - SxSy
r=
[nSx2 - (Sx)2][nSy2 - (Sy)2]
CORRELATION COEFFICIENT

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 = $300,000
MONITORING AND
CONTROLLING FORECASTS
Tracking Signal
 Measures how well the forecast is predicting actual
values
 Ratio of running sum of forecast errors (RSFE) to
mean absolute deviation (MAD)
 Good tracking signal has low values
 If forecasts are continually high or low, the
forecast has a bias error

ADAPTIVE FORECASTING
It’s possible to use the computer to
continually monitor forecast error
and adjust the values of the a and b
coefficients used in exponential
smoothing to continually minimize
forecast error
This technique is called adaptive
smoothing

FOCUS FORECASTING
Developed at American Hardware Supply, focus forecasting is based on
two principles:
Sophisticated forecasting models are

1 not always better than simple models
There is no single techniques that

2 should be used for all products or
services
This approach uses historical data to test multiple forecasting models
for individual items
The forecasting model with the lowest error is then used to forecast
the next demand
FORECASTING IN THE
SERVICE SECTOR
 Presents unusual challenges
 Special need for short term
records
 Needs differ greatly as
function of industry and
product
 Holidays and other calendar
events
 Unusual events

Bottomline
 Accuracy and control of forecasts is a vital aspect of forecasting,
so forecasters want to minimize fore cast errors.
 over-order/ understock
 Multiple forecasting models for individual items can be used.

 Availabilty of Data
 Cost efficient
 Monitoring the forecast is very important

 Validate and Implement results
© 2006 Prentice Hall, Inc. M B A : P R O D U C T I O N M A N A G E M E4 N T

– 74
“The goal of forecasting is not to
predict the future but to tell you what
you need to know to take meaningful
action in the present.”
- Paul Soffo

RAESCOGFNTI

Thank you!
CHRITINE JOY V. CAGUILLO, RPm
christine.caguillo@gmail.com
09176349600
© 2006 Prentice Hall, Inc. M B A : P R O D U C T I O N M A N A G E M E4 N T

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FORECASTING

Christine Joy V. Caguillo, RPm

© 2006 Prentice Hall, Inc. M B A : P R O D U C T I O N M A N A G E M E4 N

When you complete this chapter, you should be able to :

IDENTIFY OR DEFINE: DESCRIBE OR EXPLAIN:

 Forecasting  Moving averages

 Each of 50 profit centers around the world is

© 2006 Prentice Hall, Inc. 4–4

 The number of registered “consultants” or

© 2006 Prentice Hall, Inc. 4–5

 Although inputs come from sales,

© 2006 Prentice Hall, Inc. 4–6

 Process of predicting a future event

© 2006 Prentice Hall, Inc. 4–7

© 2006 Prentice Hall, Inc. 4–8

© 2006 Prentice Hall, Inc. 4–9

INTRODUCTION – GROWTH – MATURITY – DECLINE

 Introduction and growth require longer forecasts than maturity

INTRODUCTION GROWTH MATURITY DECLINE

R&D engineering is Strengthen niche Competitive costs

© 2006 Prentice Hall, Inc. 4 – 11

© 2006 Prentice Hall, Inc. 4 – 12

 Human Resources – Hiring, training,

© 2006 Prentice Hall, Inc. 4 – 13

SELECT THE ITEMS TO BE

FORECASTED 5 GATHER THE DATA

DETERMINE THE TIME

 Forecasts are seldom perfect

© 2006 Prentice Hall, Inc. 4 – 15

© 2006 Prentice Hall, Inc. 4 – 17

© 2006 Prentice Hall, Inc. 4 – 18

© 2006 Prentice Hall, Inc. 4 – 19

© 2006 Prentice Hall, Inc. 4 – 20

 Ask customers about purchasing

© 2006 Prentice Hall, Inc. 4 – 21

© 2006 Prentice Hall, Inc. 4 – 22

© 2006 Prentice Hall, Inc. 4 – 23

© 2006 Prentice Hall, Inc. 4 – 24

© 2006 Prentice Hall, Inc. 4 – 25

 Regular pattern of up and down

© 2006 Prentice Hall, Inc. 4 – 26

 Repeating up and down

© 2006 Prentice Hall, Inc. 4 – 27

 Erratic, unsystematic, ‘residual’

© 2006 Prentice Hall, Inc. 4 – 28

Demand for product or service

© 2006 Prentice Hall, Inc. 4 – 30

 MA is a series of arithmetic means

∑ demand in previous n periods

© 2006 Prentice Hall, Inc. 4 – 31

© 2006 Prentice Hall, Inc. 4 – 32

© 2006 Prentice Hall, Inc. 4 – 33

 Used when trend is present

∑ (weight for period n)

© 2006 Prentice Hall, Inc. 4 – 34

Actual 3-Month Weighted

 Increasing n smooths the forecast

© 2006 Prentice Hall, Inc. 4 – 36

© 2006 Prentice Hall, Inc. 4 – 37

© 2006 Prentice Hall, Inc. 4 – 38

w forecast = last period’s forecast

where Ft = new forecast

© 2006 Prentice Hall, Inc. 4 – 39