4 Forecasting Demand

PowerPoint presentation to accompany

Heizer, Render, and Al-Zu’bi
Operations Management, Arab
World Edition

Original PowerPoint slides by Jeff Heyl

Adapted by Zu’bi Al-Zu’bi

4-1
 What is Forecasting?

•Process of predicting a future event

•Underlying basis of all business decisions
- Production
- Inventory
- Personnel
- Facilities

4-2
 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

4-3
 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
4-4
 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

4-5
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
4-6
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 returning
Shift toward runs
costs good margin
product focus Product
Limited models Reduce
Enhance improvement and
capacity
Attention to distribution cost cutting
quality

Figure 2.5
4-7
 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
4-8
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
4-9
 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
4 - 10
 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

4 - 11
 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

4 - 12
 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

4 - 13
 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 repeatedly

4 - 14
 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

4 - 15
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
4 - 16
 Delphi Method

 Repetitive group
process, continues Decision Makers
until consensus is (Evaluate
reached responses and
make decisions)
 3 types of
participants Staff
(Administering
 Decision makerssurvey)

 Staff
 Respondents Respondents
(People who can
make valuable
judgments)
4 - 17
 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

4 - 18
 Consumer Market Survey

 Ask customers about purchasing

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

4 - 19
 Overview of Quantitative Approaches

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

4 - 20
 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 to influence
in future

4 - 21
Time-Series Components

Trend Cyclical

Seasonal Random

4 - 22
 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
4 - 23
Trend Component

 Persistent, overall upward or

downward pattern
 Changes due to population,
technology, age, culture, etc.
 Typically several years duration

4 - 24
 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

4 - 25
 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
4 - 26
 Random Component

 Erratic, unsystematic, ‘residual’

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

M T W T F
4 - 27
 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

4 - 28
 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

4 - 29
Moving Average Example

Actual 3-Month
Month Shed Sales Moving Average
January 10
February 12
March 13
April 16 (10 + 12 + 13)/3
13 = 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

4 - 30
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

4 - 31
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

4 - 32
 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)
13 + (2 x 12)
12 + (10)]/6
10 = 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

4 - 33
 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
© 2013 Pearson Education 4 - 34
 Potential Problems With
Moving Average

 Increasing n smooths the forecast

but makes it less sensitive to
changes
 Does not forecast trends well
 Requires extensive historical data

4 - 35
Exponential Smoothing

 Form of weighted moving average

 Weights decline exponentially
 Most recent data give most weight
 Requires smoothing constant ()
 Ranges from 0 to 1
 Subjectively chosen
 Involves little record keeping of past data

4 - 36
 Exponential Smoothing

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

Ft = Ft – 1 + (At – 1 - Ft – 1)

where Ft = new forecast

Ft – 1 = previous forecast
 = smoothing (or weighting)

constant (0 ≤  ≤ 1)
4 - 37
 Exponential Smoothing Example

Predicted demand = 142 Ford Mustangs

Actual demand = 153
Smoothing constant  = .20

4 - 38
 Exponential Smoothing Example

Predicted demand = 142 Ford Mustangs

Actual demand = 153
Smoothing constant  = .20

New forecast = 142 + .2(153 – 142)

4 - 39
 Exponential Smoothing Example

Predicted demand = 142 Ford Mustangs

Actual demand = 153
Smoothing constant  = .20

New forecast = 142 + .2(153 – 142)

= 142 + 2.2
= 144.2 ≈ 144 cars

4 - 40
 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 () (1 - ) (1 - )2
(1 - )3
(1 - )4

 = .1 .1 .09 .081 .073 .066

 = .5 .5 .25 .125 .063 .031

4 - 41
 Impact of Different 

225 –

Actual  = .5
demand
200 –
Demand

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

4 - 42
 Impact of Different 
 Chose high values of  when
underlying average is likely to change
 Choose low values of  when
underlying average is stable
225 –
Actual  = .5
demand
Demand

200 –

 = .1
175 –

| | | | | | | | |
150 –
1 2 3 4 5 6 7 8 9
Quarter 4 - 43
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
4 - 44
Common Measures of Error

Mean Absolute Deviation (MAD)

∑ |Actual - Forecast|
MAD =
n

Mean Squared Error (MSE)

∑ (Forecast Errors)2
MSE =
n
4 - 45
Common Measures of Error

Mean Absolute Percent Error (MAPE)

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

4 - 46
 Comparison of Forecast Error

Rounded Absolute Rounded Absolute

Actual Forecast Deviation Forecast Deviation
Tonnage with for with for
Quarter Unloaded  = .10  = .10  = .50  = .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
4 - 47
 Comparison of Forecast Error

Rounded Absolute Rounded Absolute

Actual Forecast Deviation Forecast Deviation
Tonnage with for with for
Quarter Unloaded  = .10  = .10  = .50  = .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

4 - 48
 Comparison of Forecast Error

Rounded Absolute Rounded Absolute

Actual Forecast Deviation Forecast Deviation
Tonnage with for with for
Quarter Unloaded  = .10  = .10  = .50  = .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
MAD 10.31 12.33

4 - 49
 Comparison of Forecast Error

Rounded Absolute Rounded Absolute

Actual Forecast Deviation Forecast Deviation
Tonnage with for with for
Quarter Unloaded  = .10  = .10  = .50  = .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
MAD 10.31 12.33
MSE 190.82 195.24
4 - 50
 Comparison of Forecast Error

Rounded Absolute Rounded Absolute

Actual Forecast Deviation Forecast Deviation
Tonnage with for with for
Quarter Unloaded  = .10  = .10  = .50  = .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
MAD 10.31 12.33
MSE 190.82 195.24
MAPE 5.59% 6.76% 4 - 51
Exponential Smoothing with Trend Adjustment

When a trend is present, exponential

smoothing must be modified

Forecast Exponentially Exponentially

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

4 - 52
Exponential Smoothing with Trend Adjustment

Ft = (At - 1) + (1 - )(Ft - 1 + Tt - 1)

Tt = (Ft - Ft - 1) + (1 - )Tt - 1

Step 1: Compute Ft
Step 2: Compute Tt
Step 3: Calculate the forecast FITt = Ft + Tt
4 - 53
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 - 54
 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 = A1 + (1 - )(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 - 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 12.80
3 20
4 19
5 24 Step 2: Trend for Month 2
6 21
7 31 T2 = (F2 - F1) + (1 - )T1
8 28
9 36
T2 = (.4)(12.8 - 11) + (1 - .4)(2)
10 = .72 + 1.2 = 1.92 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 1.92
3 20
4 19
5 24 Step 3: Calculate FIT for Month 2
6 21
7 31 FIT2 = F2 + T2
8 28
FIT2 = 12.8 + 1.92
9 36
10 = 14.72 units
Table 4.1
4 - 57
 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
4 - 58
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 - 59
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
4 - 60
Least Squares Method
Values of Dependent Variable

Actual observation Deviation7

(y-value)

Deviation5 Deviation6

Deviation3

Deviation4

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

Time period Figure 4.4

4 - 61
Least Squares Method
Values of Dependent Variable

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

4 - 62
Least Squares Method

Equations to calculate the regression variables

y^ = a + bx

xy - nxy
b=
x2 - nx2

a = y - bx

4 - 63
Least Squares Example

Time Electrical Power

Year Period (x) Demand x2 xy
2005 1 74 1 74
2006 2 79 4 158
2007 3 80 9 240
2008 4 90 16 360
2009 5 105 25 525
2010 6 142 36 852
2011 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

4 - 64
 The trend line is
Least Squares Example y^ = 56.70 + 10.54x

Time Electrical Power

Year Period (x) Demand x2 xy
2005 1 74 1 74
2006 2 79 4 158
2007 3 80 9 240
2008 4 90 16 360
2009 5 105 25 525
2010 6 142 36 852
2011 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

4 - 65
Least Squares Example

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

130 –
120 –
110 –
100 –
90 –
80 –
70 –
60 –
50 –
| | | | | | | | |
2005 2006 2007 2008 2009 2010 2011 2012 2013
Year
4 - 66
 Seasonal Variations In Data

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

4 - 68
 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
4 - 69
Seasonal Index Example

Demand Average Average Seasonal

Month 2009 2010 2011 2009-2011 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
4 - 70
 Average 2009-2011 monthly demand
Seasonal index =
Average monthly demand
= 90/94 = .957

Demand Average Average Seasonal

Month 2009 2010 2011 2009-2011 Monthly Index
Jan 80 85 105 90 94 0.957
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
4 - 71
Seasonal Index Example

Demand Average Average Seasonal

Month 2009 2010 2011 2009-2011 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
4 - 72
Seasonal Index Example

Demand Average Average Seasonal

Month 2009 2010 2011 2007-2009 Monthly Index
Jan 80 85 105 90 94 0.957
Feb 70 85 Forecast
85 for802012 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
100 102 113 12
x .957 = 96 94
105 1.117
Aug 88 102 110 100 94 1.064
1,200
Sept 85 Feb
90 95 x90.851 = 85 94 0.957
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
4 - 73
Seasonal Index Example

2012 Forecast
140 – 2011 Demand
130 – 2010 Demand
2009 Demand
120 –
Demand

110 –
100 –
90 –
80 –
70 –
| | | | | | | | | | | |
J F M A M J J A S O N D
Time
4 - 74
 San Diego Hospital

Trend Data

10,200 –

10,000 –
Inpatient Days

9745
9,800 – 9702
9616 9659
9573 9724 9766
9,600 – 9530 9680
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
4 - 75
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
4 - 76
 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

4 - 78
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 - 79
 Associative Forecasting Example

Sales Area Payroll

($ millions), y ($ billions), x
2.0 1
3.0 3
2.5 4 4.0 –
2.0 2
2.0 1 3.0 –
3.5 7 Sales
2.0 –

1.0 –
| | | | | | |
0 1 2 3 4 5 6 7
Area payroll

4 - 80
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

4 - 81
 Associative Forecasting Example

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

If payroll next year

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

Shaer’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

4 - 82
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 Shaer’s sales
3.0 –
probability
2.0 –
distribution
1.0 –
| | | | | | |
0 1 2 3 4 5 6 7
Area payroll
Figure 4.9

4 - 83
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
4 - 84
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

4 - 85
 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
Shaer’s sales
3.0 –
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

© 2013 Pearson Education 4 - 86

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

4 - 87
Correlation Coefficient

nxy - xy
r=
[nx2 - (x)2][ny2 - (y)2]

4 - 88
Correlation Coefficient
y

nxy - xy
r=
[nx2 - (x)2][ny2 - (y)2]
(b) Positive x
correlation:
0<r<1

y y y

(c) No x (d) Perfect negative x

(a) Perfect positive x correlation:
correlation: correlation: r = -1
r=0 r = +1
4 - 89
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 Shaer Construction example:

r = .901
r2 = .81
4 - 90
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 - 91
Multiple Regression Analysis

In the Shaer example, including interest rates in

the model gives the new equation:

^ = 1.80 + .30x - 5.0x

y 1 2

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 - 92
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 - 93
Monitoring and Controlling Forecasts

Tracking Cumulative error

signal =
MAD

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

4 - 94
Tracking Signal

Signal exceeding limit

Tracking signal
Upper control limit
+

Acceptable
0 MADs range

– Lower control limit

Time

4 - 95
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

4 - 96
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 - 97
Adaptive Forecasting

 It’s possible to use the computer to

continually monitor forecast error
and adjust the values of the  and 
coefficients used in exponential
smoothing to continually minimize
forecast error
 This technique is called adaptive
smoothing

4 - 98
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 need to
be factored in
 Unusual events can affect actual demand

4 - 99
 Fast Food Restaurant Forecast

20% –
Percentage of sales

15% –

10% –

5% –

11-12 1-2 3-4 5-6 7-8 9-10

12-1 2-3 4-5 6-7 8-9 10-11
(Lunchtime) (Dinnertime)
Figure 4.12
Hour of day
4 - 100
Call Center Forecast

12% –

10% –

8% –

6% –

4% –

2% –

0% – 2 4 6 8 10 12 2 4 6 8 10 12
A.M. P.M.
Hour of day
Figure 4.12
4 - 101