PARTTHREE

CHAPTER TWO
FORECASTING
FORCASTING

•Chapter Three
•Forecasting

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Inc., 1999
 CHAPTER THREE
FORCASTING

Chapter 3

Forecasting

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 CHAPTER THREE
FORCASTING
Elements of a Good Forecast

Timely

Reliable Accurate

l se
f u u
ng Written to
n i y
a s
M
e Ea
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 CHAPTER THREE
FORCASTING

• Assumes causal system

past ==> future
• Forecasts rarely perfect because of randomness
• Forecasts more accurate for
I see that you will
groups vs. individuals get an A this semester.
• Forecast accuracy decreases
as time horizon increases

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 CHAPTER THREE
FORCASTING
Steps in the Forecasting Process

“The forecast”

Step 6 Monitor the forecast

Step 5 Prepare the forecast
Step 4 Gather and analyze data
Step 3 Select a forecasting technique
Step 2 Establish a time horizon
Step 1 Determine purpose of forecast

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 CHAPTER THREE
FORCASTING
Types of Forecasts

• Judgmental - uses subjective inputs

• Time series - uses historical data
assuming the future will be like the past
• Associative models - uses explanatory
variables to predict the future

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 CHAPTER THREE
FORCASTING
Judgmental Forecasts
• Executive opinions
• Sales force composite
• Consumer surveys
• Outside opinion
• Opinions of managers and staff
– Delphi technique

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 CHAPTER THREE
FORCASTING
Time Series Forecasts
• Trend - long-term movement in data
• Seasonality - short-term regular variations
in data
• Irregular variations - caused by unusual
circumstances
• Random variations - caused by chance

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 CHAPTER THREE
Figure 3-1 FORCASTING
Forecast Variations
Irregular
variation

Trend

Cycles

90
89
88
Seasonal variations
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 CHAPTER THREE
FORCASTING
Techniques for Averaging

• Naïve forecasts
• Moving Averages
• Exponential Smoothing

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 CHAPTER THREE
FORCASTING
Naive Forecasts
Uh, give me a minute....
We sold 250 wheels last
week.... Now, next
week we should sell....

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 CHAPTER THREE
Figure 3-4 FORCASTING
Simple Moving Average

900

800 Actual
MA3
700 MA5

600
1 2 3 4 5 6 7 8 9 10 11 12 13

 A i
MAn = i=1

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 CHAPTER THREE
FORCASTING
Exponential Smoothing

Ft = Ft-1 + (At-1 - Ft-1)

 Premise--The most recent observations
might have the highest predictive value.
– Therefore, we should give more weight to the
more recent time periods when forecasting.

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 CHAPTER THREE
FORCASTING
Picking a Smoothing Constant
1400
1350
1300
1250
1200
Demand
1150 .2 F (.05)
1100
F(.2)
1050
1000
950
.05
900
April July October January

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 CHAPTER THREE
Figure 3-5 FORCASTING
Common Nonlinear Trends

Parabolic

Exponential

Growth

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 CHAPTER THREE
FORCASTING
Linear Trend Equation
Y

Yt = a + bt
0 1 2 3 4 5 t
• b is similar to the slope. However, since it is calculated
with the variability of the data in mind, its formulation is
not as straight-forward as our usual notion of slope.

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 CHAPTER THREE
FORCASTING
Calculating a and b

n  (ty) -  t  y
b =
2
n t - (  t) 2

 y - b t
a =
n

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 CHAPTER THREE
FORCASTING
Linear Trend Equation Example
t y
2
W eek t S a le s ty
1 1 150 150
2 4 157 314
3 9 162 486
4 16 166 664
5 25 177 885

2
 t = 15  t = 55  y = 812  ty = 2 4 9 9
2
(  t) = 2 2 5
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 CHAPTER THREE
FORCASTING
Linear Trend Calculation
5 (2499) - 15(812) 12495-12180
b = = = 6.3
5(55) - 225 275 -225

812 - 6.3(15)
a = = 143.5
5

y = 143.5 + 6.3t
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 CHAPTER THREE
FORCASTING
Associative Forecasting
• Predictor variables - used to predict
values of variable interest
• Regression - technique for fitting a line
to a set of points
• Least squares line - minimizes sum of
squared deviations around the line

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 CHAPTER THREE
FORCASTING
Linear Model Seems Reasonable
X Y
7 15 50 Computed
2 10
40
relationship
6 13
4 15 30
14 25
15 27 20
16 24
10
12 20
14 27 0
20 44 0 5 10 15 20 25
15 34
7 17
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 CHAPTER THREE
FORCASTING
Forecast Accuracy
• Error - difference between actual
value and predicted value
• Mean absolute deviation (MAD)
– Average absolute error
• Mean squared error (MSE)
– Average of squared error
• Tracking signal
– Ratio of cumulative error and MAD
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 CHAPTER THREE
FORCASTING
MAD & MSE

 Actual forecast
MAD =
n

2
 (Actual forecast)
MSE =
n -1
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 CHAPTER THREE
FORCASTING
Tracking Signal

Tracking signal =
(Actual-forecast)
MAD

Tracking signal = (Actual-forecast)

 Actual-forecast
n

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 CHAPTER THREE
T3-2 Exponential Smoothing FORCASTING

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 CHAPTER THREE
T3-3 Linear Trend Equation FORCASTING

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 CHAPTER THREE
T3-4 Trend Adjusted Exponential Smoothing FORCASTING

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 CHAPTER THREE
T3-5 Simple Linear Regression FORCASTING

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