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Production and Operations Management - Session 10-11

This document discusses forecasting in manufacturing, services, and public policy contexts. It defines forecasting as estimating the magnitude and timing of uncertain future events. Forecasting is an important tool for operations planning and decision making that requires understanding demand levels and accuracy. The key steps in forecasting include determining the purpose, time horizon, data collection, technique selection, forecast development, and error monitoring. Sources of data, elements of a good forecast, metrics like MAPE and MSE, and qualitative forecasting techniques are also covered.

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0% found this document useful (0 votes)
77 views47 pages

Production and Operations Management - Session 10-11

This document discusses forecasting in manufacturing, services, and public policy contexts. It defines forecasting as estimating the magnitude and timing of uncertain future events. Forecasting is an important tool for operations planning and decision making that requires understanding demand levels and accuracy. The key steps in forecasting include determining the purpose, time horizon, data collection, technique selection, forecast development, and error monitoring. Sources of data, elements of a good forecast, metrics like MAPE and MSE, and qualitative forecasting techniques are also covered.

Uploaded by

Manik Kapoor
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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PRODUCTION

&
OPERATIONS MANAGEMENT
SESSION 10-11
FORECASTING
Manufacturing
• A manufacturer of household appliances wants to add another product line for
manufacturing microwave ovens. The decision requires a good understanding
of the nature of demand for the range of microwave ovens proposed to be
manufactured
Services
• A hospital chooses to add one more specialty health care wing, it needs to
make some assumptions about the demand for the facility
Public Policy
• Government of India needs to have a reasonable estimate of the population
growth over the next 10 – 20 years while it formulates long term plans for
creating infrastructure for transport
FORECASTING
• Forecasts are estimates of
• magnitude and
• timing
of uncertain events that happen in every business setting
• Forecast – a statement about the future value of a variable of interest
• We make forecasts about such things as weather, demand, and resource availability
• An estimation tool
• A way of addressing complex and uncertain environment surrounding
business decision-making
• A tool for predicting events related to operations planning & control
• A vital pre-requisite for the planning process in organizations
• Forecasts are important to making informed decisions
FORECASTING
• Two Important Aspects
• Expected level of demand
• The level of demand may be a function of some structural variation such as trend or
seasonal variation
• Accuracy
• Related to the potential size of forecast error
NEED FOR FORECASTING
• The key applications of forecasting are:
• Understanding Dynamic & Complex environment
• Managing Short-term fluctuations in production
• Better Materials Management
• Rationalized man-power decisions
• Providing a basis for
• Strategic decisions
• Planning & scheduling
FORECAST USES
• Plan the system
• Generally involves long-range plans related to:
• Types of products and services to offer
• Facility and equipment levels
• Facility location
• Plan the use of the system
• Generally involves short- and medium-range plans related to:
• Inventory management
• Workforce levels
• Purchasing
• Production
• Budgeting
• Scheduling
FORECASTING: TIME HORIZON
Criterion Short-term Medium-term Long-term
Typical Duration 1 – 3 months 12 – 18 months 5 – 10 Years

Nature of decisions Purely Tactical Tactical as well as Strategic Purely Strategic

Key considerations Random (short-term) Seasonal and Cyclical Long-term trends


effects effects Business Cycles

Nature of data Mostly quantitative Subjective & Quantitative Largely subjective

Degree of uncertainty Low Significant High

Some examples ▪ Revising quarterly ▪Annual Production ▪ New Product Introduction


production plans Planning ▪ Facilities Location
▪ Rescheduling supply of ▪Capacity Augmentation decisions
raw material ▪ New business
development
STEPS IN THE FORECASTING PROCESS
1. Determine the purpose of the forecast
2. Establish a time horizon
3. Obtain, clean, and analyze appropriate data
4. Select a forecasting technique
5. Make the forecast
6. Monitor the forecast errors
Error = Actual – Forecast
DESIGN OF A FORECASTING SYSTEM

Develop a forecasting logic by identifying the


Stage 1 purpose, data and models to be used

Establish control mechanisms to obtain reliable


Stage 2 forecasts

Incorporate managerial considerations in using


Stage 3 the forecasting system
DEVELOPING A FORECASTING LOGIC
Identify purpose
Identify a suitable technique
• Purpose of forecast
Start • Collect/analyze past data
• Time horizon
• Select an appropriate model
• Type of data needed

Develop a forecasting logic


• Establish model parameters
• Build the model

No

Test model adequacy


Stop Satisfactory
• Test using historical data
Yes
SOURCES OF DATA
• Field Data
• Sales force estimates
• Point of Sale (POS) Data systems
• Forecasts from supply chain partners
• Secondary data
• Trade/Industry Association Journals
• B2B Portals/Market Places
• Economic Surveys and Indicators
• Subjective Knowledge
FEATURES COMMON TO ALL FORECASTS
• Techniques assume some underlying causal system that existed in the past will
persist into the future
• Forecasts are not perfect
• Because random variation is always present, there will always be some residual error,
even if all other factors have been accounted for.
• Forecasts for groups of items are more accurate than those for individual items
• Forecast accuracy decreases as the forecasting horizon increases
ELEMENTS OF A GOOD FORECAST
The forecast
• should be timely
• should be accurate
• should be reliable
• should be expressed in meaningful units
• should be in writing
• technique should be simple to understand and use
• should be cost-effective
FORECASTS: METRICS
• Forecast Error (FE):  t = Dt − Ft
n

• Sum of Forecast Errors (SFE): 


i =1
i

1 n
• Mean Absolute Deviation (MAD): MAD = *   i
n i =1
• Mean Absolute Percentage Error (MAPE): 1 n i
MAPE = *  * 100
n i =1 Di
𝑛
1
• Mean Squared Error (MSE): 𝑀𝑆𝐸 = ∗ ෍ 𝜀𝑖2
𝑛−1
𝑖=1

• Tracking Signal (TS): SFE


TS =
MAD
Dt = Demand during period ‘t’, Ft = Forecast during period ‘t’, n = No. of periods
FORECASTS: METRICS
MAD =
 Actual t − Forecast t Mean Absolute Deviation weights all
errors evenly
n

 (Actual t − Forecast t )
2 Mean Square Error weights errors according to
MSE = their squared values
n −1

Actual t − Forecast t
 Actual t
100 Mean Absolute Percent Error weights errors
MAPE = according to relative error
n
FORECASTS: METRICS
•Tracking signal
–Ratio of cumulative error to MAD

Tracking signal =
(Actual-forecast)
MAD
Bias – Persistent tendency for forecasts to be
Greater or less than actual values.
Value of zero would be ideal for Tracking signal.
Limits of +/-4 or +/- 5are often used for a range of
acceptable values of the tracking signal.
FORECASTS: METRICS
Actual Forecast
Period (A-F) Error
(A) (F) |Error| Error2 [|Error|/Actual]x100

1 107 110 -3 3 9 2.80%

2 125 121 4 4 16 3.20%

3 115 112 3 3 9 2.61%

4 118 120 -2 2 4 1.69%

5 108 109 -1 1 1 0.93%

Sum 13 39 11.23%

n=5 n-1 = 4 n=5

MAD MSE MAPE

= 2.6 = 9.75 = 2.25%


QUALITATIVE FORECASTS
• Forecasts that use subjective inputs such as opinions from consumer surveys,
sales staff, managers, executives, and experts
• Executive opinions
• a small group of upper-level managers may meet and collectively develop a forecast
• Sales force opinions
• members of the sales or customer service staff can be good sources of information due to their direct
contact with customers and may be aware of plans customers may be considering for the future
• Consumer surveys
• since consumers ultimately determine demand, it makes sense to solicit input from them
• consumer surveys typically represent a sample of consumer opinions
• Other approaches
• managers may solicit 0pinions from other managers or staff people or outside experts to help with
developing a forecast.
• the Delphi method is an iterative process intended to achieve a consensus
QUANTITATIVE FORECASTS: TIME-SERIES
• Forecasts that project patterns identified in recent time-series observations
• Time-series - a time-ordered sequence of observations taken at regular time intervals
• Assume that future values of the time-series can be estimated from past values
of the time-series
• Time-Series Behaviors
DEMAND PATTERNS
• There are five basic time series patterns
1. Horizontal
2. Trend
3. Seasonal
4. Cyclical
5. Random
DEMAND PATTERNS
1. Horizontal: Data cluster about a 2. Trend: Data consistently increase or
horizontal line decrease
DEMAND PATTERNS
3. Seasonal: Data consistently show 4. Cyclical: Data reveal gradual increases
peaks and valleys and decreases over extended periods
TRENDS AND SEASONALITY
• Trend
• A long-term upward or downward movement in data
• Population shifts
• Changing income
• Seasonality
• Short-term, fairly regular variations related to the calendar or time of day
• Restaurants, service call centers, and theaters all experience seasonal demand
CYCLES AND VARIATIONS
• Cycle
• Wavelike variations lasting more than one year
• These are often related to a variety of economic, political, or even agricultural conditions
• Irregular variation
• Due to unusual circumstances that do not reflect typical behavior
• Labor strike
• Weather event
• Random Variation
• Residual variation that remains after all other behaviors have been accounted for
DEMAND PATTERNS
Seasonality Cyclical Random
1
3
5
7
9
11
13
15
17
19
21
23
25
27
29
31
33
35
37
39
41
43
45
47
M o nth
QUANTITATIVE FORECASTS: TIME-SERIES
• Naïve
• Simple Moving Average
• Weighted Moving Average
• Exponential Smoothing
• ES with Trend and Seasonality
TIME-SERIES FORECASTING - NAÏVE FORECAST
• Naïve Forecast
• Uses a single previous value of a time series as the basis for a forecast
• The forecast for a time period is equal to the previous time period’s value

Uh, give me a minute....


We sold 250 wheels last
week.... Now, next week we
should sell....
TIME-SERIES FORECASTING - NAÏVE FORECAST
Period 1 2 3 4 5 6 7 8 Average
Demand 74 86 88
Forecast 98 90
change 12 2
TIME-SERIES FORECASTING - NAÏVE FORECAST
Advantages
• Simple to use
• Virtually no cost
• Data analysis is nonexistent
• Easily understandable
Disadvantage
• Cannot provide high accuracy
MOVING AVERAGE
• As new data become available, the forecast is updated by adding the newest
value and dropping the oldest and then re-computing the average
• The number of data points included in the average determines the model’s
sensitivity
• Fewer data points used-- more responsive
• More data points used-- less responsive
MOVING AVERAGE
Model parameter
Number of periods for moving average 3 months

Month Actual Sales Forecast*


January 24,500
February 27,000
March 25,500
April 26,000 25,667
May 21,200 26,167
June 18,900 24,233
July 17,500 22,033
August 19,000 19,200
September 18,467
WEIGHTED MOVING AVERAGE
• The most recent values in a time series are given more weight in computing a
forecast
• The choice of weights, w, is somewhat arbitrary and involves some trial and error

Ft = wt ( At ) + wt −1 ( At −1 ) + ... + wt − n ( At − n )
where
wt = weight for period t , wt −1 = weight for period t − 1, etc.
At = the actual value for period t , At −1 = the actual value for period t − 1, etc.
WEIGHTED MOVING AVERAGE
Model parameter
Number of periods for moving average 3 months
Weights for three periods
Immediate past 0.45
Two periods before 0.30
Three periods before 0.25

Month Actual Sales Forecast*


January 24,500
February 27,000
March 25,500
April 26,000 25,700
May 21,200 26,100
June 18,900 23,715
July 17,500 21,365
August 19,000 18,845
September 18,525
EXPONENTIAL SMOOTHING
• A weighted averaging method that is based on the previous forecast plus a
percentage of the forecast error
𝐹𝑡 = 𝐹𝑡−1 + 𝛼(𝐴𝑡−1 − 𝐹𝑡−1 )
where
𝐹𝑡 = Forecast for period 𝑡
𝐹𝑡−1 = Forecast for the previous period
𝛼 = Smoothing constant
𝐴𝑡−1 = Actual demand or sales from the previous period
EXPONENTIAL SMOOTHING
 = 0.20  = 0.80

Model Parameter Model Parameter


Smoothening Constant () 0.20 Smoothening Constant () 0.80

Period Forecast Actual Demand Period Forecast Actual Demand


January 100 90 January 100 90
February 98 95 February 92 95
March 97 105 March 94 105
April 99 110 April 103 110
May 101 100 May 109 100
June 101 130 June 102 130
July 107 90 July 124 90
August 103 110 August 97 110
September 105 100 September 107 100
October 104 140 October 101 140
November 111 November 132

A lower value of  indicates that forecast is not responsive to the demand


EXPONENTIAL SMOOTHING
alpha = 0.2 alpha = 0.9 Actual Demand alpha = 0.5

150

140
Demand/Forecast (units)

130

120

110

100

90

80

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Forecast period
EXPONENTIAL SMOOTHING WITH TREND & SEASONALITY
• The trend adjusted forecast consists of
• Smoothed error
• Trend factor
• Alpha and beta are smoothing constants
• Trend-adjusted exponential smoothing has the ability to respond to changes in
trend
TAFt +1 = St + Tt
St = TAFt +  (At − TAFt )
Tt = Tt−1 +  (TAFt − TAFt−1 − Tt−1 )
TECHNIQUES FOR SEASONALITY
• Seasonality – regularly repeating movements in series values that can be tied
to recurring events
• Expressed in terms of the amount that actual values deviate from the average value of a
series
• Models of seasonality
• Additive
• Seasonality is expressed as a quantity that gets added to or subtracted from the time-series
average in order to incorporate seasonality
• Multiplicative
• Seasonality is expressed as a percentage of the average (or trend) amount which is then used to
multiply the value of a series in order to incorporate seasonality
TECHNIQUES FOR SEASONALITY
MONITORING THE FORECAST
• Tracking forecast errors and analyzing them can provide useful insight into
whether forecasts are performing satisfactorily
• Sources of forecast errors:
• The model may be inadequate due to
a. omission of an important variable
b. a change or shift in the variable the model cannot handle
c. the appearance of a new variable
• Irregular variations may have occurred
• Random variation
• Control charts are useful for identifying the presence of non-random error in
forecasts
CONTROL CHART
• Control chart
• A visual tool for monitoring forecast errors
• Used to detect non-randomness in errors
• Control limits:
UCL = 0 + z √MSE
LCL = 0 – z √MSE
z typically=2 or 3
• Forecasting errors are in control if
• All errors are within the control limits
• No patterns, such as trends are present
CONTROL CHART
1. Compute the MSE.
2. Estimate of standard deviation of the distribution of errors
s= MSE
3. UCL : 0 + z MSE
4. LCL : 0 − z MSE
where z = Number of standard deviations from the mean
USING THE FORECASTING SYSTEM
Data Time
Cost
Availability Frame
Key inferences
from
research/practice
How to get started?
• Choice of model
• Estimation of parameters

New
Competitor
Issues in using the system
• How to incorporate external information
• Stability Vs Responsiveness Sales
Promotions

When to change the system?


• Parameter re-estimation Vs model change Forecast
Reliability
1. Forecasts based on averages. Given the following data:
• Prepare a forecast for period 6 using each of these approaches:
• a. The appropriate naive approach.
• b. A three-period moving average.
• c. A weighted average using weights of .50 (most recent), .30, and .20.
• d. Exponential smoothing with a smoothing constant of .40.
Period Number of Complaints
1 60
2 65
3 55
4 58
5 64
2. Using seasonal relatives. Apple’s Citrus Fruit Farm ships boxed fruit anywhere
in the world. Using the following information, a manager wants to forecast
shipments for the first four months of next year.
• The monthly forecast equation being used is:
• Ft = 402 + 3t
• Where: t0 = January of last year
• Ft = Forecast of shipments for month t
3. Accuracy of forecasts. The manager of a large manufacturer of industrial
pumps must choose between two alternative forecasting techniques. Both
techniques have been used to prepare forecasts for a six-month period. Using
MAD as a criterion, which technique has the better performance record?
4. Control chart. Given the demand data that follow, prepare a naive forecast for
periods 2 through 10. Then determine each forecast error, and use those values
to obtain 2s control limits. If demand in the next two periods turns out to be 125
and 130, can you conclude that the forecasts are in control?

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