Forecasting

Demand Characteristics
Independent demand Dependent demand

100 x 1 =
100 tabletops

100 tables 100 x 4 = 400 table legs

Continuous demand
400 – Discrete demand
400 –
300 –
No. of tables

300 –
No. of tables
200 –
200 –
100 –
100 –

1 2 3 4 5
Week M T W Th F M T W Th F
14-2
Demand Management

 Independent demand items are

the only items demand for which
needs to be forecasted
 These items include:
 Finished goods and
 Spare parts
Demand Management

Independent Demand
(finished goods and spare parts)

A Dependent Demand
(components)

B(4) C(2)

D(2) E(1) D(3) F(2)

Introduction

 Demand estimates for independent

demand products and services are the
starting point for all the other forecasts
in POM.
 Management teams develop sales
forecasts based in part on demand
estimates.
 Sales forecasts become inputs to both
business strategy and production
resource forecasts.
What is Forecasting?

 Process of predicting a future event based

on historical data
Sales will be
 Educated Guessing $200 Million!

 Underlying basis of
all business decisions
 Production
 Inventory
 Personnel
 Facilities
Importance of Forecasting in POM
 Departments throughout the organization depend
on forecasts to formulate and execute their plans.

 Finance needs forecasts to project cash flows

and capital requirements.

 Human resources need forecasts to anticipate

hiring needs.

 Production needs forecasts to plan production

levels, workforce, material requirements,
inventories, etc.
The Effect of Inaccurate Forecasting
Product Demand over Time
Demand for product or service

Year Year Year Year

1 2 3 4
Product Demand over Time
Trend component
Seasonal peaks
Demand for product or service

Actual
Random demand line
variation
Year Year Year Year
1 2 3 4
Now let’s look at some time series approaches to forecasting…
Forms of Forecast Movement
Types of Forecasts by Time Horizon
Quantitative
 Short-range forecast methods

 Usually < 3 months

 Job scheduling, worker assignments Detailed
use of
 Medium-range forecast system

 3 months to 2 years
 Sales/production planning

 Long-range forecast
 > 2 years Design
of system
 New product planning Qualitative
Methods
Forecasting Methods

 Time series
 statistical techniques that use historical demand
data to predict future demand
 Regression methods
 attempt to develop a mathematical relationship
between demand and factors that cause its behavior
 Qualitative
 use management judgment, expertise, and
opinion to predict future demand
 Forecasting Approaches

Qualitative Methods Quantitative Methods

(opinion based) (statistics based)
 Used when situation is vague  Used when situation is stable &
& little data exist historical data exist
 New products  Existing products
 New technology  Current technology
 Involves intuition, experience  Involves mathematical
 e.g forecasting sales on techniques
internet  e.g., forecasting sales of
color televisions
Qualitative Forecasting Methods

Qualitative
Forecasting

Models
Executive Sales force Market
judgement survey research/ Delphi Method
survey
Qualitative Methods

 Executive committee consensus

 Delphi method
 Survey of sales force
 Survey of customers
 Historical analogy
 Market research
 Qualitative Methods
Briefly, the qualitative methods are:
Executive Judgment: Opinion of a group of high level
experts or managers is pooled

Sales Force Composite: Each regional salesperson

provides his/her sales estimates. Those forecasts are then
reviewed to make sure they are realistic. All regional
forecasts are then pooled at the district and national levels
to obtain an overall forecast.

Market Research/Survey: Solicits input from customers

pertaining to their future purchasing plans. It involves the
use of questionnaires, consumer panels and tests of new
products and services.
 Qualitative Methods
Delphi Method: As opposed to regular panels where the
individuals involved are in direct communication, this method
eliminates the effects of group potential dominance of the most
vocal members. The group involves individuals from inside as
well as outside the organization. Typically, the procedure
consists of the following steps:
 Each expert in the group makes his/her own forecasts in
form of statements
 The coordinator collects all group statements and
summarizes them
 The coordinator provides this summary and gives another
set of questions to each group member including feedback
as to the input of other experts.
 The above steps are repeated until a consensus is reached.
Quantitative Forecasting Approaches

 Based on the assumption that the

“forces” that generated the past demand
will generate the future demand, i.e.,
history will tend to repeat itself
 Analysis of the past demand pattern
provides a good basis for forecasting
future demand
 Majority of quantitative approaches fall
in the category of time series analysis
Quantitative Forecasting Methods

Quantitative
Forecasting

Time Series Regression

Models Models

2. Moving 3. Exponential
1. Naive
Average Smoothing
a) simple a) level
b) weighted b) trend
c) seasonality
Time Series Models

 Try to predict the future based on past

data
 Assume that factors influencing the past will
continue to influence the future
 A time series is a set of numbers where the order
or sequence of the numbers is important, e.g.,
historical demand
 Analysis of the time series identifies patterns
 Once the patterns are identified, they can be used
to develop a forecast
Components of Time Series

What’s going on here?

x
x x
x x
x x
x x
Sales

x x x
x
x
xx
x xx x x
x
x
x x x x x x
x x x x x x
x x x
x xxxxx
x
x x

1 2 3 4
Year
Components of Time Series
 Trends are noted by an upward or
downward sloping line
 Seasonality is a data pattern that repeats
itself over the period of one year or less
 Cycle is a data pattern that repeats itself...
may take years
 Irregular variations are jumps in the level of
the series due to extraordinary events
 Random fluctuation from random variation
or unexplained causes
1. Simple Naive Approach

 Demand in next period is the same as

demand in most recent period
 May sales = 48 → June forecast = 48

 Usually not good

Moving Average: Naïve Approach

ORDERS
MONTH PER MONTH FORECAST
Jan 120
Feb 90
Mar 100
Apr 75
May 110
June 50
July 75
Aug 130
Sept 110
Oct 90
Nov -
Example: Naïve Approach
ORDERS
MONTH PER MONTH FORECAST
Jan 120 -
Feb 90 120
Mar 100 90
Apr 75 100
May 110 75
June 50 110
July 75 50
Aug 130 75
Sept 110 130
Oct 90 110
Nov - 90
Simple Moving Average

 An averaging period (AP) is selected

 Assumes an average is a good estimator of
future behavior
 It is called a “simple” average because
each period used to compute the
average is equally weighted
Simple Moving Average

 The forecast for the next period is the

arithmetic average of the AP most recent
actual demands
 By increasing the AP, the forecast is less
responsive to fluctuations in demand (low
impulse response)
 By decreasing the AP, the forecast is more
responsive to fluctuations in demand (high
impulse response)
2a. Simple Moving Average

A t + A t -1 + A t -2 + ... + A t -n 1
Ft 1 =
n

Ft+1 = Forecast for the upcoming period, t+1

n = Number of periods to be averaged
At = Actual occurrence in period t
 A t + A t -1 + A t -2 + ... + A t -n 1
Ft 1 =
n
2a. Simple Moving Average
You’re manager in Amazon’s electronics
department. You want to forecast ipod sales for
months 4-6 using a 3-period moving average.
Sales
Month (000)
1 4
2 6
3 5
4 ?
5 ?
6 ?
 A t + A t -1 + A t -2 + ... + A t -n 1
Ft 1 =
n
2a. Simple Moving Average

Sales Moving Average

Month (000) (n=3)
1 4 NA
2 6 NA
3 5 NA
4 ? (4+6+5)/3=5
5 ?
6 ?
2a. Simple Moving Average

What if ipod sales were actually 3 in month 4

Sales Moving Average

Month (000) (n=3)
1 4 NA
2 6 NA
3 5 NA
4 3? 5
5 ?
6 ?
2a. Simple Moving Average

Forecast for Month 5?

Sales Moving Average

Month (000) (n=3)
1 4 NA
2 6 NA
3 5 NA
4 3 5
5 ? (6+5+3)/3=4.667
6 ?
2a. Simple Moving Average

Actual Demand for Month 5 = 7

Sales Moving Average

Month (000) (n=3)
1 4 NA
2 6 NA
3 5 NA
4 3 5
5 ?7 4.667
6 ?
2a. Simple Moving Average

Forecast for Month 6?

Sales Moving Average

Month (000) (n=3)
1 4 NA
2 6 NA
3 5 NA
4 3 5
5 7 4.667
6 ? (5+3+7)/3=5
Simple Moving Average

A t-1 + A t-2 + A t-3 +...+A t- n

Ft =
Week Demand n
1 650
2 678  Let’s develop 3-week
3 720
4 785 and 6-week moving
5 859 average forecasts for
6 920
7 850 demand.
8
9
758
892
 Assume you only have 3
10 920 weeks and 6 weeks of
11 789
12 844
actual demand data for
the respective forecasts
Simple Moving Average

Week Demand 3-Week 6-Week

1 650
2 678
3 720
4 785 682.67
5 859 727.67
6 920 788.00
7 850 854.67 768.67
8 758 876.33 802.00
9 892 842.67 815.33
10 920 833.33 844.00
11 789 856.67 866.50
12 844 867.00 854.83
Simple Moving Average

1000
900
Demand
Demand

800
3-Week
700
6-Week
600
500
1 2 3 4 5 6 7 8 9 10 11 12
Week
Weighted Moving Average
 This is a variation on the simple moving
average where instead of the weights
used to compute the average being
equal, they are not equal
 This allows more recent demand data
to have a greater effect on the moving
average, therefore the forecast
 . . . more
Weighted Moving Average

 The weights must add to 1.0 and

generally decrease in value with the
age of the data
 The distribution of the weights
determine impulse response of the
forecast
 Weighted Moving Average
• Adjusts moving average method to more
closely reflect data fluctuations
n
WMAn =  Wi Di
i=1
where
Wi = the weight for period i,
between 0 and 100
percent
 Wi = 1.00
Weighted Moving Average
Ft = w 1 A t -1 + w 2 A t - 2 + w 3 A t -3 + ...+ w n A t - n

Week Demand
1 650
Determine the 3-period
2 678 weighted moving average
3 720 forecast for period 4
4

Weights (adding up to 1.0):

n

w
i=1
i =1 t-1: .5
t-2: .3
t-3: .2
Solution

Week Demand Forecast

1 650
2 678
3 720
4 693.4

F4 = .5(720)+.3(678)+.2(650)
Weighted Moving Average Example

MONTH WEIGHT DATA

August 17% 130
September 33% 110
October 50% 90
3
November Forecast 
i=1
Wi Di
Weighted Moving Average Example

MONTH WEIGHT DATA

August 17% 130
September 33% 110
October 50% 90
3
November Forecast 
i=1
Wi Di

= (0.50)(90) + (0.33)(110) + (0.17)(130)

= 103.4 orders
 Exponential Smoothing

• Averaging method
• Weights most recent data more strongly
• Reacts more to recent changes
• Widely used, accurate method
• Smoothing constant, α
• applied to most recent data
3a. Exponential Smoothing

 Assumes the most recent observations

have the highest predictive value
 gives more weight to recent time periods

Ft+1 = Ft + a(At - Ft) Need initial

forecast Ft
et to start.

Ft+1 = Forecast value for time t+1

At = Actual value at time t
a = Smoothing constant
3a. Exponential Smoothing – Example 1
Ft+1 = Ft + a(At - Ft)
i Ai

Week Demand
1 820 Given the weekly demand
2 775 data what are the exponential
3 680 smoothing forecasts for
4 655 periods 2-10 using a=0.10?
5 750
6 802 Assume F1=D1
7 798
8 689
9 775
10
3a. Exponential Smoothing – Example 1
Ft+1 = Ft + a(At - Ft)
i Ai Fi

Week Demand a = 0.1 0.6

1 820 820.00 820.00
2 775 820.00 820.00
3 = F1+ a(A793.00
680 F2815.50 1–F1) =820+.1(820–820)
4 655 801.95 725.20=820
5 750 787.26 683.08
6 802 783.53 723.23
7 798 785.38 770.49
8 689 786.64 787.00
9 775 776.88 728.20
10 776.69 756.28
3a. Exponential Smoothing – Example 1
Ft+1 = Ft + a(At - Ft)
i Ai Fi

Week Demand a = 0.1 0.6

1 820 820.00 820.00
2 775 820.00 820.00
3 680 815.50 793.00
F3 = F2+ a(A2–F2) =820+.1(775–820)
4 655 801.95 725.20
5 750 787.26 683.08=815.5
6 802 783.53 723.23
7 798 785.38 770.49
8 689 786.64 787.00
9 775 776.88 728.20
10 776.69 756.28
3a. Exponential Smoothing – Example 1
Ft+1 = Ft + a(At - Ft)
i Ai Fi

Week Demand a = 0.1 0.6

1 820 820.00 820.00
2 775 820.00 820.00
3 680 815.50 793.00
4 655 801.95 725.20
5 750 787.26 683.08
This process
6 802 783.53 723.23
continues
7 798 785.38 770.49
through week
8 689 786.64 787.00
10
9 775 776.88 728.20
10 776.69 756.28
3a. Exponential Smoothing – Example 1
Ft+1 = Ft + a(At - Ft)
i Ai Fi

Week Demand a = 0.1 a = 0.6

1 820 820.00 820.00
2 775 820.00 820.00
3 680 815.50 793.00
4 655 801.95 725.20
5 750 787.26 683.08 What if the
6 802 783.53 723.23 a constant
7 798 785.38 770.49 equals 0.6
8 689 786.64 787.00
9 775 776.88 728.20
10 776.69 756.28
3a. Exponential Smoothing – Example 2
Ft+1 = Ft + a(At - Ft)
i Ai Fi

Month Demand a = 0.3 a = 0.6

January 120 100.00 100.00
February 90 106.00 112.00
March 101 101.20 98.80
April 91 101.14 100.12
May 115 98.10 94.65 What if the
June 83 103.17 106.86 a constant
July 97.12 92.54 equals 0.6
August
September
 3a. Exponential Smoothing – Example 3

Company A, a personal computer producer

purchases generic parts and assembles them to
final product. Even though most of the orders
require customization, they have many common
components. Thus, managers of Company A need
a good forecast of demand so that they can
purchase computer parts accordingly to minimize
inventory cost while meeting acceptable service
level. Demand data for its computers for the past 5
months is given in the following table.
3a. Exponential Smoothing – Example 3
Ft+1 = Ft + a(At - Ft)
i Ai Fi

Month Demand a = 0.3 a = 0.5

January 80 84.00 84.00
February 84 82.80 82.00
March 82 83.16 83.00
April 85 82.81 82.50
May 89 83.47 83.75 What if the
June 85.13 86.38 a constant
July ?? ?? equals 0.5
To Use a Forecasting Method

 Collect historical data

 Select a model
 Moving average methods
 Select n (number of periods)
 For weighted moving average: select weights
 Exponential smoothing
 Select a

 Selections should produce a good forecast

…but what is a good forecast?
A Good Forecast

 Has a small error

 Error = Demand - Forecast
Measures of Forecast Error
et
n

a. MAD = Mean Absolute Deviation A

t=1
t - Ft
MAD =
n

b. MSE = Mean Squared Error 

 t t
A - F 2

t =1
MSE =
n

c. RMSE = Root Mean Squared Error RMSE = MSE

 Ideal values =0 (i.e., no forecasting error)

Mean Absolute Deviation (MAD)

 Actual demand - Forecast demand

i =1
i

MAD =
n
n

 (A - F )
i i

MAD  i 1
n
 n

MAD Example A
t=1
t - Ft = 40 =10
MAD = 4
n

What is the MAD value given the

forecast values in the table below?
At Ft
Month Sales Forecast |At – Ft|
1 220 n/a
2 250 255 5
3 210 205 5
4 300 320 20
5 325 315 10
= 40
 MAD Example

PERIOD DEMAND, At Ft (a =0.3) (At - Ft) |At - Ft|

1 37 37.00 – –
2 40 37.00 3.00 3.00
3 41 37.90 3.10 3.10
4 37 38.83 -1.83 1.83
5 45 38.28 6.72 6.72
6 50 40.29 9.69 9.69
7 43 43.20 -0.20 0.20
8 47 43.14 3.86 3.86
9 56 44.30 11.70 11.70
10 52 47.81 4.19 4.19
11 55 49.06 5.94 5.94
12 54 50.84 3.15 3.15
557 49.31 53.39
MAD Calculation

 At - Ft 
MAD = n
53.39
=
11
= 4.85
 n

 t t
A - F 2

t =1 = 550 =137.5
MSE/RMSE Example MSE =
n 4

What is the MSE value? RMSE = √137.5

=11.73
At Ft
Month Sales Forecast |At – Ft| (At – Ft)2
1 220 n/a
2 250 255 5 25
3 210 205 5 25
4 300 320 20 400
5 325 315 10 100
= 550
Quantitative Forecasting Methods

Quantitative
Forecasting

Time Series Regression

Models Models

2. Moving 3. Exponential
1. Naive
Average Smoothing
a) simple a) level
b) weighted b) trend
c) seasonality
Regression Methods
 Linear regression
 mathematical technique that relates a
dependent variable to an independent
variable in the form of a linear equation
 Correlation
 a measure of the strength of the relationship
between independent and dependent
variables
Simple Linear Regression

 Relationship between one

independent variable, X, and a
dependent variable, Y.
 Assumed to be linear (a straight line)
 Form: Y = a + bX
 Y = dependent variable
 X = independent variable
 a = y-axis intercept
 b = slope of regression line
Simple Linear Regression Model

Yt = a + bx Y

0 1 2 3 4 5 x (weeks)

 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
Calculating a and b

a = y - bx

 xy - n(y)(x)
b= 2 2
 x - n(x )
Regression Equation Example

Week Sales
1 150
2 157
3 162
4 166
5 177

Develop a regression equation to predict sales

based on these five points.
 Regression Equation Example
Week Week*Week Sales Week*Sales
1 1 150 150
2 4 157 314
3 9 162 486
4 16 166 664
5 25 177 885
3 55 162.4 2499
Average Sum Average Sum

b=
 xy - n( y)(x) 2499 - 5(162.4)(3) 63
=  = 6.3
 x - n(x )
2 2
55  5(9 ) 10

a = y - bx = 162.4 - (6.3)(3) = 143.5 Slide 70 of 55

 Regression Equation Example

y = 143.5 + 6.3t
180
175
170
165
160 Sales
Sales

155 Forecast
150
145
140
135
1 2 3 4 5 Period
Slide 71 of 55
Linear Regression Example
x y
(WINS) (ATTENDANCE) xy x2
4 36.3
6 40.1
6 41.2
8 53.0
6 44.0
7 45.6
5 39.0
7 47.5
Linear Regression Example

x=

y=

xy - nxy2
b=
x2 - nx2

a = y - bx
Linear Regression Example
x y
(WINS) (ATTENDANCE) xy x2
4 36.3 145.2 16
6 40.1 240.6 36
6 41.2 247.2 36
8 53.0 424.0 64
6 44.0 264.0 36
7 45.6 319.2 49
5 39.0 195.0 25
7 47.5 332.5 49
49 346.7 2167.7 311
Linear Regression Example

49
x= = 6.125
8
346.9
y= = 43.36
8

xy - nxy2
b=
x2 - nx2
(2,167.7) - (8)(6.125)(43.36)
= (311) - (8)(6.125)2
= 4.06

a = y - bx
= 43.36 - (4.06)(6.125)
= 18.46
Linear Regression Example
60,000 –

50,000 –

40,000 –
Attendance, y

30,000 – Linear regression line,

y = 18.46 + 4.06x

20,000 – Attendance forecast for 7 wins

y = 18.46 + 4.06(7)
10,000 – = 46.88, or 46,880

| | | | | | | | | | |
0 1 2 3 4 5 6 7 8 9 10
Wins, x
Regression – Example
y = a+ b X b
 xy  n x y a  y  bx
 x  nx
2 2

MonthAdvertising Sales X 2 XY
January 3 1 9.00 3.00
February 4 2 16.00 8.00
March 2 1 4.00 2.00
April 5 3 25.00 15.00
May 4 2 16.00 8.00
June 2 1 4.00 2.00
July

TOTAL 20 10 74 38
Linear Regression Example
x y
(WINS) (ATTENDANCE) xy x2
4 36.3 145.2 16
6 40.1 240.6 36
6 41.2 247.2 36
8 53.0 424.0 64
6 44.0 264.0 36
7 45.6 319.2 49
5 39.0 195.0 25
7 47.5 332.5 49
49 346.7 2167.7 311
Linear Regression Example

49
x= = 6.125
8
346.9
y= = 43.36
8

xy - nxy2
b=
x2 - nx2
(2,167.7) - (8)(6.125)(43.36)
= (311) - (8)(6.125)2
= 4.06

a = y - bx
= 43.36 - (4.06)(6.125)
= 18.46