Production and

Operations Management
Syed Sajjad Ahmed
Head of Supply Planning & Sourcing @ Shell Pakistan
Visiting Faculty - IBA
Chapter 4
Forecasting
Introduction to Forecasting
 Forecasting
Process of estimating a future event
Underlying basis of all business
decisions
 Production
 Inventory
 Personnel
 Facilities
 Applications of Forecasting
Accounting Cost/profit estimates

Finance Cash flow and funding

Human Resources Hiring/recruiting/training

Marketing Pricing, promotion, strategy

MIS IT/IS systems, services

Operations Schedules, MRP, workloads

Product/service New products and services

design
 Forecasting – Time Horizon
 Short-range forecast Long-range
forecasting
 Up to 1 year, generally less than 3 months
 Purchasing, job scheduling, workforce levels, job
Medium-range
assignments, production levels forecasting

 Medium-range forecast
 3 months to 3 years Short-range forecasting

 Sales and production planning, budgeting

 Long-range forecast Production/operation control

 3+ years
 New product planning, facility location, research
and development
 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
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

 Forecasts – Idealism & Reality
Timely
Seldom Perfect

Reliable
Based on Assumptions

Reality
Ideal

Accurate

Meaningful Aggregate are more

accurate than individual

Written
Accuracy decreases as time
horizon increases
Easy to use
 Approaches to Forecast
Qualitative Methods
 Used when situation is vague and little data exist; for example
New products, New technology

 Involves intuition, experience. e.g., forecasting sales on Internet

Quantitative Methods
 Used when situation is ‘stable’ and historical data exist; for
example Existing products, Current technology

 Involves mathematical techniques,

 Overview of Qualitative Approaches
1. Jury of Executive opinion

2. Delphi Method

3. Sales force composite

4. Consumer Market Survey

 Overview of Qualitative Methods
Jury of executive opinion

 Involves small group of high-level experts and managers

 Combines managerial experience with statistical models

 Quick decisions but group think is disadvantage

Delphi method

 Iterative group process, continues until consensus is

reached

 3 types of participants; Decision makers, Staff,

Respondents
 Overview of Qualitative Methods
Sales force composite
 Each salesperson projects his or her sales

 Combined at district and national levels

 Tends to be overly optimistic

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
1. Naive approach

2. Moving averages
time-series
models
3. Exponential smoothing

4. Trend projection
associative
5. Linear regression model
Time Series Forecasting
 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 Forecasting
Trend Component
 Persistent, overall upward or downward pattern

 Changes due to population, technology, age, culture, etc.

 Typically several years duration

Seasonal Component
Number of
 Regular pattern of up and down fluctuations Period Length Seasons
Week Day 7
Month Week 4-4.5
 Due to weather, customs, etc. Month Day 28-31
Year Quarter 4
Year Month 12
 Occurs within a single year Year Week 52
 Time Series Forecasting
Cyclical Component
 Repeating up and down movements

 Affected by business cycle, political, and economic factors

 Multiple years duration

Random Component
 Erratic, unsystematic, ‘residual’ fluctuations

 Due to random variation or unforeseen events

 Short duration and nonrepeating

 1- 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

 Simple to use, Virtually no cost

 Cannot provide high accuracy

 2- 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

∑ demand in previous n periods

Moving average = n
2- Moving Average Method
Actual 3-Month
Month Shed Sales Moving Average
January 10
February 12
March 13
April 16 (10 + 12 + 13)/3 = 11 2/3
May 19 (12 + 13 + 16)/3 = 13 2/3
June 23 (13 + 16 + 19)/3 = 16
July 26 (16 + 19 + 23)/3 = 19 1/3
 2- Weighted Moving Average Method
 Used when some trend might be present

 Older data usually less important

 Weights based on experience and intuition

 2- Weighted Moving Average Method
Actual 3-Month Weighted
Month Shed Sales Moving Average
January 10
February 12
March 13
April 16 [(3 x 13) + (2 x 12) + (10)]/6 = 121/6
May 19 [(3 x 16) + (2 x 13) + (12)]/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

Weights Applied Period

3 Last month
2 Two months ago
1 Three months ago
6 Sum of weights
 Potential Problems With Moving Average
 Increasing n smoothes the forecast
but makes it less sensitive to changes

 Do not forecast trends well

 Require extensive historical data

 The weighted moving average,

however, usually reacts more
quickly to demand changes.
 3 - 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

 3 - Exponential Smoothing
 Predicted demand = 142 Ford Mustangs

 Actual demand = 153

 Smoothing constant a = .20

Ft = Ft–1 +  ·(At–1 - Ft–1)

New forecast = 142 + .2(153 – 142) = 144.2  144 units

 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

 = A t - 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 - Forecasti|/Actuali
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
MAD = Tonnage
Actual Forecast Deviation Forecast Deviation
n with for with for
Quarter Unloaded  = .10  = .10  = .50  = .50
For1 = .10180 175 5.00 175 5.00
2 168 175.5 7.50 177.50 9.50
3
= 82.45/8
159
= 10.31
174.75 15.75 172.75 13.75
For45 = .50175
190
173.18
173.36
1.82
16.64
165.88
170.44
9.12
19.56
6 =205
98.62/8175.02
= 12.3329.98 180.22 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

∑ (forecastRounded
errors)2Absolute Rounded Absolute
MSE = Actual Forecast Deviation Forecast Deviation
Tonnage n with for with for
Quarter Unloaded  = .10  = .10  = .50  = .50
For1 = .10180 175 5.00 175 5.00
2 168 175.5 7.50 177.50 9.50
3
= 1,526.54/8
159
= 190.82
174.75 15.75 172.75 13.75
For45 = .50175
190
173.18
173.36
1.82
16.64
165.88
170.44
9.12
19.56
6 = 1,561.91/8
205 = 195.24
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
n
∑100|deviation
Rounded i|/actual
Absolutei Rounded Absolute
MAPE = i =Tonnage
1
Actual Forecast
with
Deviation Forecast Deviation

Quarter Unloaded
n
 = .10
for
 = .10
with
 = .50
for
 = .50
1  = .10
For 180 175 5.00 175 5.00
2 168 175.5 7.50 177.50 9.50
3
=
159
44.75/8 =
174.75
5.59%
15.75 172.75 13.75
4 175 173.18 1.82 165.88 9.12
For
5
 = .50
190 173.36 16.64 170.44 19.56
6 = 54.05/8
205 = 6.76%
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
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 190.82 195.24
MAPE 5.59% 6.76%
 Comparison of Forecast Error
0.1 0.2 0.3 0.4 0.5
Actial F Dev. F Dev. F Dev. F Dev. F Dev.
1 180 175 5 175 5 175 5 175 5 175 5
2 168 175.5 7.5 176 8 176.5 8.5 177 9 177.5 9.5
3 159 174.75 15.75 174.4 15.4 173.95 14.95 173.4 14.4 172.75 13.75
4 175 173.18 1.82 171.32 3.68 169.465 5.535 167.64 7.36 165.88 9.12
5 190 173.36 16.64 172.056 17.944 171.1255 18.8745 170.584 19.416 170.44 19.56
6 205 175.05 29.95 175.6448 29.3552 176.7879 28.21215 178.3504 26.6496 180.22 24.78
7 180 178.02 1.98 181.5158 1.51584 185.2515 5.251495 189.0102 9.01024 192.61 12.61
8 182 178.22 3.78 181.2127 0.787328 183.676 1.676047 185.4061 3.406144 186.3 4.3
82.42 81.68237 87.99919 94.24198 98.62
MAD 10.3025 10.2103 10.9999 11.78025 12.3275
MAPE 5.591537 5.545828 5.992131 6.436648 6.755313
 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 - ) 2 (1 - ) 3 (1 - )4

 = .1 .1 .09 .081 .073 .066

 = .5 .5 .25 .125 .063 .031

 Effect of Smoothing Constants
 Chose high values of  when underlying average is likely to
change

225 –  Choose low values of  when underlying average is stable

Actual  = .5
200 – demand
Demand

175 –

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

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 24 Step 1: Forecast for Month 2
6 21
7 31 F2 = A1 + (1 - )(F1 + T1)
8 28 F2 = (.2)(12) + (1 - .2)(11 + 2)
9 36
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 24 Step 2: Trend for Month 2
6 21
7 31 T2 = (F2 - F1) + (1 - )T1
8 28 T2 = (.4)(12.8 - 11) + (1 - .4)(2)
9 36
10 = .72 + 1.2 = 1.92 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
3 20
4 19
5 24 Step 3: Calculate FIT for Month 2
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 –

30 – Actual demand (At)

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)
 4 - 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
^ = computed value of the variable to
where y
be predicted (dependent variable)
a = y-axis intercept
b = slope of the regression line
x = the independent variable
 Linear Regression Method
Least squares method minimizes the sum of the squared errors (deviations)
Values of Dependent Variable

Actual observation Deviation7

(y-value)

Deviation5 Deviation6

Deviation3

Deviation4

Deviation1
(error) Deviation2
Trend line, y^ = a + bx

Time period
 Linear Regression Method
Equations to calculate the regression variables

y^ = a + bx

xy - nxy
b=
x2 - nx2

a = y - bx
 Linear Regression Method - 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
∑x2 - nx2 140 - (7)(42)

a = y - bx = 98.86 - 10.54(4) = 56.70

 Linear Regression Method - 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
The trend line
2006 4 is 90 16 360
2007^ 5 105 25 525
2008y = 56.70
6 + 10.54x
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
∑x2 - nx2 140 - (7)(42)

a = y - bx = 98.86 - 10.54(4) = 56.70

 Linear Regression Method - Example

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

130 –
120 –
110 –
100 –
90 –
80 –
70 –
60 –
50 –
| | | | | | | | |
2003 2004 2005 2006 2007 2008 2009 2010 2011
Year
 5 - Seasonal Variations In Data
The multiplicative seasonal model can adjust trend
data for seasonal variations in demand
 5 - 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
 5 - Seasonal Variations In Data
San Diego Hospital
Demand Average Average Seasonal
Month 2015 2016 2017 2015-2017 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
 5 - Seasonal Variations In Data
San Diego Hospital
Demand Average Average Seasonal
Month 2015 2016 2017 2015-2017 Monthly Index
Jan 80 85 105 90 94 0.957
Feb 70 85 85 80 94
Mar 80 93 Average
82 85 monthly 94
2015-2017 demand
Seasonal90index95= 115
Apr 100 94
Average monthly 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
 5 - Seasonal Variations In Data
San Diego Hospital
Demand Average Average Seasonal
Month 2015 2016 2017 2015-2017 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
 5 - Seasonal Variations In Data
San Diego Hospital
Demand Average Average Seasonal
Month 2015 2016 2017 2015-2017 Monthly Index
Jan 80 85 105 90 94 0.957
Feb 70 85 85 80 94 0.851
Forecast for 2018
Mar 80 93 82 85 94 0.904
Apr 90 95 annual
Expected 115 100 = 1,20094
demand 1.064
May 113 125 131 123 94 1.309
Jun 110 115 120 1,200 115 94 1.223
Jul 100 Jan
102 113 x .957
105 = 96 94 1.117
12
Aug 88 102 110 100 94 1.064
Sept 85 90 1,200
95 90 94 0.957
Feb x .851 = 85
Oct 77 78 8512 80 94 0.851
Nov 75 72 83 80 94 0.851
Dec 82 78 80 80 94 0.851
5 - Seasonal Variations In Data
2018 Forecast
140 – San Diego Hospital 2017 Demand
130 – 2016 Demand
2015 Demand
120 –
Demand

110 –
100 –
90 –
80 –
70 –
| | | | | | | | | | | |
J F M A M J J A S O N D
Time
Associative Forecasting
 Associative Forecasting
Forecasting an outcome based on predictor
variables using the least squares technique

where 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 to predict the
value of the dependent variable
 Associative Forecasting - Example
Sales Local Payroll
($ millions), y ($ billions), x
2.0 1
3.0 3
2.5 4
2.0 2 4.0 –
2.0 1
3.5 7 3.0 –

Sales 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
 Associative Forecasting - Example
^
y = 1.75 + .25x Sales = 1.75 + .25(payroll)

If payroll next year

is estimated to be 4.0 –
$6 billion, then:
3.25
3.0 –

Sales
Sales = 1.75 + .25(6)
2.0 –
Sales = $3,250,000
1.0 –

| | | | | | |
0 1 2 3 4 5 6 7
Area payroll
 Monitoring and Controlling Forecasts
Tracking
 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
+

0 MADs Acceptabl
e range

–
Lower control limit

Time
 Tracking Signal - Example
Cumulative
Absolute Absolute
Actual Forecast Forecast Forecast
Qtr Demand Demand Error RSFE Error Error MAD
(AD) (FD) (AD-FD) |RSFE| (CAFÉ) CAFÉ/Qtr

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 Forecast
Signal Forecast Forecast
Qtr Demand Demand Error RSFE Error Error MAD
(RSFE/MAD)
1 90 =100
-10/10 -1 -10 -10 10 10 10.0
2 95 =100
-15/7.5 -2 -5 -15 5 15 7.5
3 1150/10 =100
0 +15 0 15 30 10.0
-10/10 = -1
4 100 110
+5/11 = +0.5 -10 -10 10 40 10.0
5 125 =110
+35/14.2 +2.5 +15 +5 15 55 11.0
6 140 110 +30 +35 30 85 14.2

The variation of the tracking signal between -2.0

and +2.5 is within acceptable limits
Miscellaneous Forecasting
 Adaptive Forecasting
It’s possible to use the computer to continually
monitor forecast error and adjust the values of
the α and β 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 ones
2. There is no single technique 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
 References
 Operations Management, 10th Ed., by J.
Heizer & B. Render
 Operations Management, William J.
Stevenson.
 Operations Management, 7th Ed., N. Slack,
A.B. Jones, R. Johnston.
 Cases in Operations Management, S.
Chambers, C. Harland, A. Harison, N. Slack.