Chapter 9

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 (collaborative
forecasts)

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
(from e.g. MRP systems).

Chapter 9, Slide 3
 Role of Forecasting
in a Supply Chain
• The basis for all strategic and planning decisions in
a supply chain
• Collaborative forecasts
• Examples:
– Production: scheduling, inventory, aggregate planning
– Marketing: sales force allocation, promotions, new
production introduction
– Finance: plant/equipment investment, budgetary planning
– Personnel: workforce planning, hiring, layoffs
• All of these decisions are interrelated

Chapter 9, Slide 4
 Forecasting Approaches
Qualitative
Methods
• Used when situation
is vague and little
data exist
– New products
– New technology
• Involves intuition,
experience
*****************************
• E.g., forecasting sales
to a new market
Quantitative Methods
• Used when situation is
‘stable’ and historical
data exist
– Existing products
– Current technology
• Heavy use of
mathematical
techniques
*******************************
• E.g., forecasting sales
of a mature product
Chapter 9, Slide 5
Forecasting methods

Next slide

Chapter 9, Slide 6
 Qualitative Forecasting,
2018
• Executive opinions
• Life cycle analogy
• Consumer surveys
• Outside opinions
• Delphi method

Chapter 9, Slide 7
Life-Cycle Planning Framework
Quantitativ forecasting:
Headlines
• 9.5 Basic time series models
 Moving Average, Weighted MA
 Exponential Smoothing,
 Linear Regression
 Seasonal Adjustment

• 9.6 Causal forecasting models

 Linear Regression

 Multiple Regression

• 9.7 Forecast accuracy

Chapter 9, Slide 9
 Time series models

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

. . . randomness

Time
Chapter 9, Slide 11
 Time Series with . . .
Demand

. . . Randomness and trend

Time
Chapter 9, Slide 12
 Time series with . . .
Demand

. . . randomness, trend and seasonality

May May May May

Chapter 9, Slide 13
Idea Behind Time Series
Models

Distinguish between random

fluctuations and true changes in
underlying demand patterns

Chapter 10, Slide 14

 Moving Average Modeller,
here MA(3)

Period Demand
1 12
2 15
3 11
4 9
5
6
7
8
10
8
14
12
 3-period moving average
forecast for Periode 8:
= (14 + 8 + 10) / 3
= 10.67

Chapter 9, Slide 15
 Moving Average Modeller,
MA(3), forecast of D8

Period Demand
1 12
2 15
3 11
4 9
5
6
7
8
10
8
14
12
 3-periode moving
average forecast for
period 8:
= (14 + 8 + 10) / 3
= 10.67

Chapter 9, Slide 16
 Weighted Moving Averages,
(slightly different formula)

Forecast for period 8

= [(0.5  14) + (0.3  8) + (0.2  10)] / (0.5 + 0.3 + 0.2)
= 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.
 Table of Forecasts and
Demand Values . . .
Two-period
Moving Tre-period Weighted Moving
Actual Average Average Forecast ,Weights =
Period Demand Forecast 0.5, 0.3, 0.2
1 12    
2 15    
3 11 13.5  
4 9 13 12.4
5 10 10 10.8
6 8 9.5 9.9
7 14 9 8.8
8 12 11 11.4
9   13 11.8

Chapter 9, Slide 18
 . . . and Resulting Graph

Note how the forecasts smooth out variations Chapter 9, Slide 19

Figure 9.6 MA(2) og MA(4) for
Emergency Care Facility
 Exponential Smoothing I
• Sophisticated weight averaging model
• Needs only three numbers to create Ft+1 :
Ft = Forecast for the
current period t

Dt = Actual demand for the current period t

a = Weight between 0 and 1

Chapter 9, Slide 21
 Exponential Smoothing II
Formula Weighted average of
i) last periodes actual demand, and
ii) last periodes demand forecast

Ft+1 =
a × Dt + (1 – a) × Ft =
Ft + a (Dt – 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 22
 Exponential Smoothing
Forecast with a = 0.3
Exponential
Aktual Smoothing
Period demand Forecast
F2 = 0.3×12 + 0.7×11
1 12 11.00
2 15 11.30
= 3.6 + 7.7
3 11 12.41
= 11.3
4 9 11.99
5 10 11.09
6 8 10.76 F3 = 0.3×15 + 0.7×11.3
7 14 9.93
= 12.41
8 12 11.15
9   11.41

Chapter 9, Slide 23
 Resulting Graph -
Exponential Smoothing

Chapter 9, Slide 24
 Resulting Graph -
Exponential Smoothing

Actual
Demand

Chapter 9, Slide 25
 Graph - Exponential
Smoothing

Demand

The general rule for determining the alpha value is this:

The greater the randomness in the time series data is, the lower the alpha value should be.
Conversely, the less randomness there is in the time series data, the higher
the alpha value should be. Chapter 9, Slide 26
 Figure 9.7 and 9.8
alpha = 0.2

Choice of alpha = 0.2 good/bad? Choice of alpha = 0.2 good/bad?

Chapter 9, Slide 27
 Trends

Notice, all forecasting methods so far, i.e. MA(m), Weighted MA(m) and
Exponential Smothing ”require an assumption”, that there is no trend in
data, i.e. data can be described generated as (in a statistical sense):

When we allow for a trend in data then this corresponds to an assumption

that data can be described generated as (in a statistical sense):

Chapter 10, Slide 28

 Same Exponential Smoothing Model
F3 = 0.3×12 + 0.7×11 as Before with a = 0.3
= 3.6 + 7.7
= 11.3

Exponential
Actual Smoothing
Period Demand Forecast
1 11 11.00
2 12 11.00
3 13 11.30
4 14 11.81 Exponential Smothing

5 15 12.47
Since the model
6 16 13.23 is based on
7 17 14.06 historical demand,
8 18 14.94 it always lags
9   15.86
the obvious
upward trend
Chapter 9, Slide 29
Adjusting Exponential Smoothing for
Trend
Double exponential Smoothing

• 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 AFt+1 = Ft+1 + Tt+1

Chapter 9, Slide 30
 Adjusted exponential
smoothing with trend.
Double exponential smoothing

• Ft+1 = a × Dt + (1 – a) × Ft
• Tt+1 =  × (Ft+1 – Ft) + (1 – ) × Tt
• AFt+1 = Ft+1 + Tt+1
• Ft+1We are
adjusted
weighting
for trend is AF t+1
i) last period’s actual demand/trend, and
ii) last period’s demand/trend forecast.
Not quite true, since (Ft+1 – Ft) is the trend derived from forecasts
Chapter 9, Slide 31
 Simple Linear Regression
• Time series OR causal model
• Assumes a linear relationship:
y
y = a + b(x)

x
Chapter 9, Slide 32
 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
Demand for grill sausages in Denmark:
Depends on the weather in summer time – however weather is difficult to
predict. Chapter 9, Slide 33
The Trick is how to “estimate” a and
b:

Chapter 9, Slide 34
 Example 9.3 – Clem’s
Competition Clutches
• Mike Clem, owner of Clem’s
Competition Clutches, designs
and manufacturers heavy-duty car
clutches for use in drag racing.
In his first 10 months of business,
Mike has experienced the demand
shown in Table 9.7 and Figure 9.11.
Use Linear Regression to forecast
demand for months 11, 12, and 13.

Table
9.7
Example 9.3 – Clem’s
Competition Clutches
Ten-Month Time Series of Demand

Figure
9.11
Example 9.3 – Clem’s
Competition Clutches
 Ex9_3.xls
Example 9.3 – Clem’s Competition Clutches
Month Demand Regression
1 8 11,8
2 12 19,13333
3 25 26,46667
4 40 33,8
5 50 41,13333
6 65 48,46667
7 36 55,8
8 61 63,13333
9 88 70,46667
10 63 77,8

SUMMARY OUTPUT

Regression Statistics
Multiple R 0,873286
R Square 0,762628
Adjusted R
Square 0,732957

Standard Error 13,13837

Observations 10

ANOVA

  df SS MS F Significance F

Regression 1 4436,667 4436,667 25,70242 0,000965

Residual 8 1380,933 172,6167
Total 9 5817,6     

  Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95,0% Upper 95,0%
Intercept 4,466667 8,975213 0,497667 0,632108 -16,2302 25,16354 -16,2302 25,16354

X Variable 1 7,333333 1,446487 5,069756 0,000965 3,997729 10,66894 3,997729 10,66894

Chapter 9, Slide 38
Example 9.3 – Clem’s
Competition Clutches

Figure
9.12
Dealing with Seasonality

Quarter Period Demand

Winter 02 1 80
Spring 2 240
Summer 3 300
Fall 4 440
Winter 03 5 400
Spring 6 720
Summer 7 700
Fall 8 880
Chapter 9, Slide 40
 What Do You Notice?
Forecasted Demand = –18.57 + 108.57 x period

Actual Regression
Period Demand forecast Forecast Error
Winter 02 1 80 90 -10
Spring 2 240 198.6 41.4
Summer 3 300 307.1 -7.1
Fall 4 440 415.7 24.3
Winter 03 5 400 524.3 -124.3
Spring 6 720 632.9 87.2
Summer 7 700 741.4 -41.4
Fall 8 880 850 30
Chapter 9, Slide 41
Regression picks up trend, but
not seasonality effect

spring

spring

Chapter 9, Slide 42
 A simple 4 step procedure to do seasonal
adjustment
To make sense it requires a time series covering more than
one year
1. For each of the demands in the time series, calculate the
corresponding forecast using one of the forecast method (i.e.
regression) (not doing any adjustment).
2. For each demand value, calculate the ratio Demand/Forecast.
i. If the ratio < 1, then the forecast model has “over-
forecasted”
ii. If the ratio > 1, then the forecast model has “under-
forecasted”;
3. Since the time series covers more than one year we can
calculate the average value of these ratios Demand/Forecast
for each of the months or each quarter. Use these 12 (4)
averages as SEASON INDEX
4. Multiply the non-adjusted forecasts from step 1 with these
season index to get the adjusted values. Chapter 9, Slide 43
 Calculating Seasonal
Index: Winter Quarter
(Actual / Forecast) for Winter Quarters:

Winter ‘02: (80 / 90) = 0.89

Winter ‘03: (400 / 524.3) = 0.76
Average of these two = 0.83
Interpret!

Chapter 9, Slide 44
 Seasonally adjusted forecast
model
For Winter Quarter

[ –18.57 + 108.57×Period ] × 0.83

Or more generally:

[ –18.57 + 108.57 × Period ] × Seasonal Index

Chapter 9, Slide 45
 Seasonally adjusted
forecasts
Demand Forecast = –18.57 + 108.57 x period

Seasonal
Actual Regression Demand/ Seasonal adjusted Forecast
Period Demand forecast Forecast Index Forecast Error
Winter 02 1 80 90 0.89 0.83 74.33 5.67
Spring 2 240 198.6 1.21 1.17 232.97 7.03
Summer 3 300 307.1 0.98 0.96 294.98 5.02
Fall 4 440 415.7 1.06 1.05 435.19 4.81
winter 03 5 400 524.3 0.76 0.83 433.02 -33.02
Spring 6 720 632.9 1.14 1.17 742.42 -22.42
Summer 7 700 741.4 0.94 0.96 712.13 -12.13
Fall 8 880 850 1.04 1.05 889.84 -9.84

Chapter 9, Slide 46
Seasonally adjusted forecasts
SimpleSeasonalityCorrection2018.xlsx

Chapter 9, Slide 47
 Example 9.4 – Seasonal
Adjustments
Based on the results of the regression model, develop a seasonal
index for each month and reforecast months 1 through 24 (January
2016 – December 2017) using the seasonal indices.

Figure 9.15
Example 9.4 – Seasonal
Adjustments 98.71 + 8.22*t
Example 9.4 – Seasonal
Adjustments
 Example 9.4 – Seasonal
Adjustments
Calculate the (Demand/Forecast) for each of the time periods:
January 2016: (Demand/Forecast) = 51/106.9 = 0.477
January 2017: (Demand/Forecast) = 112/205.6 = 0.545

Calculate the monthly seasonal indices:

Monthly seasonal index, January = (.477 + .545)/2 = .511

Calculate the seasonally adjusted forecasts

Seasonally adjusted forecast = unadjusted forecast x seasonal index

January 2016: 106.9 x .511 = 54.63

January 2017: 205.6 x .511 = 105.06
Example 9.4 – Seasonal
Adjustments Figure 9.16
 Example 9.4 – Seasonal
Adjustments
Plot of Seasonally Adjusted Regression Forecast against a
Time Series Showing Seasonality

Figure 9.16