Operations Management

Week-5

Forecasting
Collaborative Planning, Forecasting and Replenishment (CPRF) Demand Patterns and Forecasting Techniques Design of Forecasting Systems

Forecasting What is it all about ?

Process of developing the most probable view of what future demand will be, given a set of assumptions about :

Technology Competitors Pricing Marketing Expenditures Sales efforts

Elements of a Good Forecast

Timely

Reliable

Accurate

Written

Types of Forecasts
Qualitative Methods Judgmental - uses subjective inputs Quantitative Methods Time series - uses historical data assuming the future will be like the past Associative models / Causal Methods- uses explanatory variables to predict the future (when historical data are available and the relationship between

Demand Patterns
The repeated observations of demand in their order of occurrence form a pattern known as time series. Five basic patterns: Horizontal Trend Seasonal Cyclical Random

Steps in Forecasting

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

Designing Forecast Methods

Deciding what to forecast Level of Aggregation Units of measurement Choosing the type of technique

1. Judgment Methods
In some cases, these are the only way to make a forecast. In others, these can be used to modify forecasts generated quantitatively. Four types are common:

1) 2) 3) 4)

Salesforce Estimates Executive Opinion Market Research Delphi Method

Are Judgmental Methods always reliable?

We've all heard predictions about the future. Sure, sometimes "experts" are right on target, but check out what they got wrong
"Man will never reach the moon regardless of all future scientific advances." -- Dr. Lee DeForest, Inventor of TV "The bomb will never go off. I speak as an expert in explosive." -- Admiral William Leahy, U.S. Atomic Bomb Project "I think there is a world market for maybe five computers." -- Thomas Watson, chairman of IBM, 1943 "640K ought to be enough for anybody." -- Bill Gates, 1981

"This 'telephone' has too many shortcomings to be seriously considered as a means of communication. The device is inherently of no value to us." -- Western Union internal memo, 1876

2. Causal Methods
Linear Regression Analysis
- Establishes relationship between a DEPENDANT variable and one or more INDEPENDENT variables -We use our knowledge of the relationship between the two and about the future values of the independent variables to forecast the future values of the dependant variable. - If there is only one independent variable, it is called as Simple Regression Analysis (Generally time period)

Y = a + bX

a
0 1 2 3 4 5 X (Time)

2. Causal Methods
Linear Regression Analysis
Problem: The Renovators construction company repairs/reconstructs old roads in Sacramento, U.S. Over time they have found that companys dollar volume of reconstruction work (Sales) is dependant on the total amount of road construction contracts offered by City Council every quarter . Management wants to establish a mathematical relationship to help predict sales.!!!!!!!!!!!!!!!!!!!!!!!! Year 1 Quarter Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Sales (Thousand $) 8 10 15 9 12 13 12 16 Contracts (Thousand $) 150 170 190 170 180 190 200 220

 Linear Regression Analysis

x= independent variable y= dependent variable n= number of observations a= vertical axis intercept b= slope of regression line y = mean value of dep. Variable Y = values of y that lie on the trend line X = values of x that lie on the trend line r= coefficient of correlation r2 = coefficient of determination

a= (x2 y - x xy) / (n x2 (x)2) b= ( n xy - x y) / (n x2 (x)2 ) r= (nxy - x y) / [n x2 (x)2 ][ny2 (y)2 ]

Time Series Methods

Unlike causal methods, these methods use historical information regarding ONLY the dependent variable

Naive Forecast : Forecast for the next period equals the

demand (Dt) for current period o Simple and low-cost o If random variation is large, highly useless for planning Estimating the Average: Simple Moving Average Weighted Moving Average Exponential Smoothing

Exponential Smoothing
A sophisticated weighted-moving average forecasting method that involves very little record keeping of past data. New Forecast = Last periods forecast + ( Last periods actual demand Last periods forecast) Or Ft + 1 =Ft + (Dt Ft)

Mean Actual Deviation (MAD)

First measure of the overall forecast error

MAD =

I Actual demand - Forecast I --------------------------------------------n

Trend Adjusted Exponential Smoothing

Simple exponential smoothing, like moving averages methods fail to respond to .?????? At = (Demand this period) + (1-) (Average + Trend estimate last period) = ( Dt ) + (1-)(At-1 + Tt-1 ) Tt = (Avg. this period Avg. last period) + (1 ) (Trend estimate last period) = (At - At-1 ) + (1 ) Tt-1 Ft+1 = At + Tt