Module 2

DEMAND
FORECASTING

©2017 Batangas State University

 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
 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
 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
 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%
Tour at Disney World
Tour at Disney World
Tour at Disney World
Tour at Disney World
Tour at Disney Land
 Learning Objectives
► Understand the three time horizons and which models
apply for each use
► Explain when to use each of the four qualitative models
► Apply the naïve, moving average, exponential smoothing,
and trend methods
► Compute three measures of forecast accuracy
► Develop seasonal indexes
► Conduct a regression and correlation analysis
► Use a tracking signal
 Topics
 What is Forecasting
 Forecasting Time Horizon
 Influence of Product Life Cycle
 Types of Forecast
 Strategic Importance of Forecasting
 Forecasting Approaches
 Qualitative Forecasting Models
 Quantitative Forecasting Models
 Topics
 Time-Series Forecasting
 Decomposition of a Time Series
 Naive Approach
 Moving Averages
 Exponential Smoothing
 Exponential Smoothing with Trend Adjustment
 Trend Projections
 Seasonal Variations in Data
 Cyclical Variations in Data
 Topics
 Associative Forecasting Methods: Regression
and Correlation Analysis
 Using Regression Analysis for Forecasting
 Standard Error of Estimate
 Correlation Coefficients for Regression Lines
 Multiple Regression Analysis
 Monitoring and Controlling Forecast
 Adaptive Smoothing
 Focus Forecasting
 Forecasting in the Service Sector
 What is Forecasting?
 Art and science 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
 Product Life Cycle
Introduction Growth Maturity Decline
Product design Forecasting Standardization Little product
and critical differentiation
Fewer product
development
Product and changes, more Cost
critical
process minor changes minimization
Frequent reliability Optimum Overcapacity
product and
Competitive capacity in the
process design
product industry
changes Increasing
OM Strategy/Issues

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 Enhance improvement and Reduce
capacity
Attention to distribution cost cutting
quality
 Product Life Cycle

Introduction Growth Maturity Decline

Best period to Practical to change Poor time to Cost control
increase market price or quality change image, critical
Company Strategy/Issues

share image price, or quality

R&D engineering is Strengthen niche Competitive costs

critical become critical
Defend market
position
CD-ROMs
Internet search engines
Analog TVs
Drive-through
LCD & plasma TVs restaurants

Sales iPods
3 1/2”
Xbox 360 Floppy
disks
 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
 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
 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
 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 Methods
 Used when situation is vague
and little data exist
 New products
 New technology
 Involves intuition, experience
 e.g., forecasting sales on
Internet
 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
Overview of Qualitative Methods

• Jury of executive opinion

 Pool opinions of high-level experts,
sometimes augment by statistical
models
• Delphi method
 Panel of experts, queried iteratively
Overview of Qualitative Methods

• Sales force composite

 Estimates from individual
salespersons are reviewed for
reasonableness, then aggregated
• Consumer Market Survey
 Ask the customer
 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
 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
 Iterative group process, Decision Makers
continues until (Evaluate
consensus is reached responses and
make decisions)
 3 types of participants
 Decision makers Staff
(Administering
 Staff survey)
 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
• Naive approach
• Moving averages
time-series
• Exponential models
smoothing
• Trend projection
• Linear regression associative
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, no

other variables important
 Assumes that factors influencing past and
present will continue influence in future
Time Series Components

Trend Seasonal

Cyclical Random
 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)
 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

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
 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
 Random Component
 Erratic, unsystematic, ‘residual’ fluctuations

 Due to random variation or unforeseen

events
 Short duration
and nonrepeating

M T W T F
 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
 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
𝑴𝒐𝒗𝒊𝒏𝒈 𝑨𝒗𝒆𝒓𝒂𝒈𝒆=
∑ 𝒅𝒆𝒎𝒂𝒏𝒅 𝒊𝒏 𝒑𝒓𝒆𝒗𝒊𝒐𝒖𝒔 𝒏𝒑𝒆𝒓𝒊𝒐𝒅𝒔
𝒏
 Moving Average Example
Actual 3-Month
Month Shed Sales Moving Average
January 10 10
February 12 12
March 13
13
April 16
May 19 (1
June 23 (12 + 13 + 16)/3 =
July
13 2/ 26
3
(13 + 16 + 19)/3 =
16
(16 + 19 + 23)/3 =
19 1/3
 Graph of Moving Average
Moving Average
Forecast

30 –
28 – Actual Sales
26 –
24 –
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 some trend might be present
 Older data usually less important

 Weights based on experience and

intuition

Weighted
moving average
 Weighted Moving Average
Weights Applied Period
3
Last month
Actual 2
3-Month Weighted
Month Shed Sales Moving Averageago
Two months
1
Three months ago
January 10 6 10
Sum of weights
February 12 12
March 13 13
April 16 [(3 x
May 19 [(3
13) x+16)
(2 x+12)
(2 x+(10)]/6
13) + (12)]/6
= 121/6= 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 Average
Weighted
moving
30 – average
25 –
Sales demand

20 – Actual
sales
15 –
Moving
10 – average

5 –
| | | | | | | | | | | |
J F M A M J J A S O N D
 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
st = Last 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)
 Exponential Smoothing Example

In January, a car dealer predicted February demand for

142 Ford Mustangs. Actual February demand
was 153 autos. Using a smoothing constant chosen by
management of a = .20, the dealer wants to forecast
March demand using the exponential smoothing model.

Predicted demand = 142 Ford Mustangs

Actual demand = 153
Smoothing constant  = .20
Exponential Smoothing Example

Predicted demand = 142 Ford Mustangs

Actual demand = 153
Smoothing constant  = .20
Ft = Ft – 1 + (At – 1 - Ft – 1)

New forecast = 142 + .2(153 – 142)

= 142 + 2.2
= 144.2 ≈ 144 cars
 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 - )  (1 - )  (1 - )4
2 3

 = .1 .1 .09 .081 .073 .066

 = .5 .5 .25 .125 .063 .031

 Impact of Different 

225 –

Actual  = .5
200 – demand
Demand

175 –

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

225 –

Actual  = .5
200
Chose
– high values of 
demand
Demand

when underlying average

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

MAPE ¿ 𝒊=𝟏
𝒏
 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
 Comparison of Forecast Error
∑ |deviations|
Rounded Absolute Rounded Absolute
MADActual
= Forecast Deviation Forecast Deviation
Tonnage n
with for with for
Quarter Unloaded  = .10  = .10  = .50  = .50
1
For  =
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 175
= .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
 Comparison of Forecast Error
∑ (forecast
Rounded
errors) 2
Absolute Rounded Absolute
MSE = Actual Forecast Deviation Forecast Deviation
Tonnage n
with for with for
Quarter Unloaded  = .10  = .10  = .50  = .50
1
For  =
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
4For 175
= .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
 Comparison of Forecast Error
n
∑ 100|deviation
Rounded i|/actual
Absolute Rounded
i Absolute
MAPE Actual
= i=1
Forecast Deviation Forecast Deviation
Tonnage with for with for
Quarter Unloaded  = .10 n  = .10  = .50  = .50
1
 = .10175
For 180 5.00 175 5.00
2 168 = 44.75/8
175.5 = 7.50
5.59% 177.50 9.50
3 159 174.75 15.75 172.75 13.75
4 =
For 175 .50173.18 1.82 165.88 9.12
5 190 173.36 16.64 170.44 19.56
6 205 = 54.05/8
175.02 =29.98
6.76% 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
 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
 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
 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
 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
 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 Step 1: Forecast for Month 2
24
6 21
7 31 F2 =  A1 + (1 - )(F1 + T1)
8 28
9
F = (.2)(12) + (1 - .2)(11 + 2)
36 2
10 = 2.4 + 10.4 = 12.8 units
 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 Step 2: Trend for Month 2
24
6 21
7 31 T2 = (F2 - F1) + (1 - )T1
8 28
9
T = (.4)(12.8 - 11) + (1 - .4)(2)
36 2
10 = .72 + 1.2 = 1.92 units
Table 4.1
 Exponential Smoothing with
Trend Adjustment Example
Forecast
Actual Smoothed Smoothed Including
Month(t) Demand (At) Forecast, Ft Trend, TtTrend, FITt
1 12 11 2 13.00
2 17 12.80 1.92
3 20
4 19
5 Step 3: Calculate FIT for Month 2
24
6 21
7 31 FIT2 = F2 + T2
8 28
FIT2 = 12.8 + 1.92
9 36
10 = 14.72 units
 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
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
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
x = the independent variable
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
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

 Least Squares Method
Equations to calculate the regression variables

^𝒚 =𝒂+𝒃𝒙
 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

 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

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

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

The multiplicative
seasonal model can
adjust trend data
for seasonal
variations in
demand
 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
 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
 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
Seasonal
Apr 90index95= 115 Average monthly
100 94
demand
May 113 125 131 123 94
= 90/94 = .957
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
 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
 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 for 2010
80 94 0.851
Mar 80 93 82 85 94 0.904
Apr 90 Expected
95 115 100 = 1,200
annual demand 94 1.064
May 113 125 131 123 94 1.309
Jun 110 115 120 1,200 115 94 1.223
Jan x .957 = 96
Jul 100 102 113 12 105 94 1.117
Aug 88 102 110 100 94 1.064
Sept 85 90 95 1,200
Feb x 90
.851 = 85 94 0.957
12
Oct 77 78 85 80 94 0.851
Nov 75 72 83 80 94 0.851
Dec 82 78 80 80 94 0.851
 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
 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
 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
 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 Sales
7 2.0 –

1.0 –

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

𝒙 𝟏𝟖
𝒙=∑ = =𝟑
𝟔 𝟔
𝒚 𝟏𝟓
𝒚 =∑ = =𝟐. 𝟓 𝒂= 𝒚 − 𝒃 𝒙=𝟐 . 𝟓 − ( 𝟎 . 𝟐𝟓 ) ( 𝟑 )=𝟏 . 𝟕𝟓
𝟔 𝟔
 Associative Forecasting Example
y^ = 1.75 + .25x Sales = 1.75 + .25(payroll)

If payroll next year is

estimated to be $6 4.0 –
billion, then: 3.25
3.0 –
Nodel’s sales
2.0 –
Sales = 1.75 + .25(6) 1.0 –
Sales = $3,250,000
| | | | | | |
0 1 2 3 4 5 6 7
Area payroll
 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
nxy - xy
r=
[nx2 - (x)2][ny2 - (y)2]
y y
Correlation Coefficient
nxy - xy
r=
(a) Perfect positive [n
x  x 2
- (  x) 2
][n y 
(b) Positive]
2
- ( y) 2
x
correlation: correlation:
r = +1 0<r<1

y y

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

r=0 correlation:
r = -1
 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
 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
 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
Monitoring and Controlling Forecasts

Tracking RSFE
signal =
MAD

∑(actual demand in
period i -
forecast demand
Tracking in period i)
signal = (∑|actual - forecast|/n)
 Tracking Signal

Signal exceeding limit

Tracking signal
Upper control limit
+

Acceptable
0 MADs range

– Lower control limit

Time
 Tracking Signal Example

Cumulative
Absolute Absolute
Actual Forecast Forecast Forecast
Qtr Demand Demand Error RSFE 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
 Tracking Signal Example

Cumulative
Tracking Absolute Absolute
Actual Signal
Forecast Forecast Forecast
Qtr (RSFE/MAD)
Demand Demand Error RSFE 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
 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:

1. Sophisticated forecasting models are not

always better than simple models
2. There is no single techniques that 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
 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)
Hour of day
 End of Chapter Exercises
Problem 1:
Weekly sales of ten-grain bread at the local organic food market are in the table
below. Based on this data, forecast week 9 using a five-week moving average.

Week Sales
1 415
2 389
3 420
4 382
5 410
6 432
7 405
8 421
 End of Chapter Exercises
Problem 2:
Given the following data, calculate the three-year moving averages for years 4
through 10:

Week Sales
1 74
2 90
3 59
4 91
5 140
6 98
7 110
8 123
9 99
 End of Chapter Exercises
Problem 3:
What is the forecast for May based on a weighted moving average applied to the
following past demand data and using the weights: 4, 3, 2 (largest weight is for
most recent data)?

Nov Dec Jan Feb Mar Apr

37 36 40 42 47 43
 End of Chapter Exercises
Problem 4:
Weekly sales of copy paper at Cubicle Suppliers are in the table below. Compute a
three-period moving average and a four-period moving average for weeks 5, 6, and
7. Compute MAD for each forecast. Which model is more accurate? Forecast week
8 with the more accurate method.

Week Sales (cases)

1 17
2 21
3 27
4 31
5 19
6 17
7 21
 End of Chapter Exercises
Problem 5:
The last four weekly values of sales were 80, 100, 105, and 90 units. The last four
forecasts (for the same four weeks) were 60, 80, 95, and 75 units. Calculate MAD,
MSE, and MAPE for these four weeks.

Sales Forecast Error Error Percent Error

Squared
80 60 20 400 0.25
100 80 20 400 0.20
105 95 10 100 0.095
90 75 15 225 0.167
 End of Chapter Exercises
Problem 6:
Use exponential smoothing with α = 0.2 to calculate smoothed averages and a
forecast for period 7 from the data below. Assume the forecast for the initial period
is 7.

Period Demand
1 10
2 8
3 7
4 10
5 12
6 9
 End of Chapter Exercises
Problem 7:
Jim's department at a local department store has tracked the sales of a product over
the last ten weeks. Forecast demand using exponential smoothing with an alpha of
0.4, and an initial forecast of 28.0. Calculate MAD and the tracking signal. What
do you recommend?
Period Demand
1 24
2 23
3 26
4 36
5 26
6 30
7 32
8 26
9 25
10 28
 End of Chapter Exercises
Problem 8:
Favors Distribution Company purchases small imported trinkets in bulk, packages
them, and sells them to retail stores. They are conducting an inventory control
study of all their items. The following data are for one such item, which is not
seasonal.
a. Use trend projection to estimate the relationship between time and sales (state
the equation).
b. Calculate forecasts for the first four months of the next year.

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

Month Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

Sales 51 55 54 57 50 68 66 59 67 69 75 73
 End of Chapter Exercises
Problem 8:
A restaurant has tracked the number of meals served at lunch over the last four
weeks. The data shows little in terms of trends, but does display substantial
variation by day of the week. Use the following information to determine the
seasonal (daily) index for this restaurant.

Week
Day 1 2 3 4
Sunday 40 35 39 43
Monday 54 55 51 59
Tuesday 61 60 65 64
Wednesday 72 77 78 69
Thursday 89 80 81 79
Friday 91 90 99 95
Saturday 80 82 81 83
 End of Chapter Exercises
Problem 9:
A restaurant has tracked the number of meals served at lunch over the last four
weeks. The data shows little in terms of trends, but does display substantial
variation by day of the week. Use the following information to determine the
seasonal (daily) index for this restaurant.

Week
Day 1 2 3 4
Sunday 40 35 39 43
Monday 54 55 51 59
Tuesday 61 60 65 64
Wednesday 72 77 78 69
Thursday 89 80 81 79
Friday 91 90 99 95
Saturday 80 82 81 83
 End of Chapter Exercises
Problem 10:
firm has modeled its experience with industrial accidents and found that the
number of accidents per year (Y) is related to the number of employees (X) by the
regression equation Y = 3.3 + 0.049*X. R-Square is 0.68. The regression is based
on 20 annual observations. The firm intends to employ 480 workers next year.
How many accidents do you project? How much confidence do you have in that
forecast?